COVID-19 PPP Loan Forgiveness: What We Know

Thoughtware Alert May 26, 2020
Pointing at a notebook with a pen and a hand

At around 9 p.m. MDT on Friday, May 22, the U.S. Small Business Administration (SBA) issued two interim final rules (IFR):

  1. Requirements – Loan Forgiveness
  2. Review Procedures and Related Borrower and Lender Responsibilities

Item 1 above generally follows what was released on Friday, May 15, in connection with the application for Paycheck Protection Program (PPP) loan forgiveness, Form 3508 and instructions. There are a few notable clarifications to what we covered in our webinar on May 18, and we wanted to give you an update on those items, as they were generally favorable.

  • Payroll Costs Eligible for Forgiveness
    • Maintained the paid or incurred language that was in the Form 3508 instructions. This seems to affirm the ability to have more than eight weeks of payroll through the use of the covered period (CP) versus the alternative payroll covered period (APCP).
    • Affirmed that payroll paid to employees who are not performing services is eligible for forgiveness and is deemed to be earned on the day the employee would typically be performing the services.
    • Affirmed that hazard pay (what we have been referring to as Hero Bonuses) and bonuses are payroll costs eligible for forgiveness, subject to the $15,385 cap.
      • It is important to note that if the bonus you are trying to get included was earned outside of the CP or APCP, be sure it is paid within the CP or APCP and not outside of that time under the last pay period earned exception.
    • During the webinar, we discussed the limitation on eligible compensation for an owner-employee and self-employed individual. The IFR confirmed that during the CP or APCP, their respective amount cannot be more than 8/52nds of their 2019 compensation, subject to the $15,385 limit. The IFR provided some good news to the owner-employee in that they can include employer retirement and healthcare contributions in the 2019 payroll amount that is the basis for the limitation. Our reading of the IFR is it is unclear for owner-employees whether the $15,385 limit is a total limit on payroll costs or if the employer retirement and healthcare contributions are layered on top of owner-employee compensation after applying the $15,385 limitation. We believe further clarification is needed on this point.
    • Confirmed that for partners in a partnership, the cap related to their 2019 compensation is the 2019 net earnings from self-employment on your K-1 (Box 14A) reduced by any Section 179 depreciation, unreimbursed partnership expenses and depletion from oil and gas properties. The net of these items is then multiplied by 92.35 percent to reflect the 50 percent deduction available for self-employment taxes. A practical problem arises in that the partnership will not know the amount of unreimbursed partnership expenses without each partner supplying their income tax returns to the partnership.
    • Reinforced again that for partners and self-employed individuals, retirement and healthcare contributions on their behalf are not eligible for forgiveness.
  • Nonpayroll Costs Eligible for Forgiveness
    • Under the next billing cycle exception, we knew that costs incurred during the CP that were paid after the end of the CP were eligible for forgiveness as long as they were paid by the next regular billing date for that bill. Under the IFR, the SBA is requiring proration of that bill so only the days within the CP are allowable. This is a logical result, but this result was not clear prior to this IFR.  
      • Example from the IFR: A borrower’s CP ends on July 26. The borrower pays its May and June electricity bill during the CP and pays its July electricity bill on August 10, which is the next regular billing date. The borrower may seek loan forgiveness for its May and June electricity bills because they were paid during the CP. In addition, the borrower may seek loan forgiveness for the portion of its July electricity bill through July 26 (the end of the CP) because it was incurred during the CP and paid on the next regular billing date. (emphasis added)
  • Reductions to Loan Forgiveness Amount (FTE Reduction & Salary/Wage Reduction)
    • Form 3508 instructions made it clear that a borrower’s forgiveness amount would not be reduced for an employee who had been laid off or had a reduction in hours if that employee was given a written offer to rehire at the old terms but the employee declined the offer.
    • The IFR added one significant additional requirement to meet this exception. The borrower must now notify the state unemployment office of the employee’s rejected offer within 30 days of the rejection.
      • The SBA will post to its website additional information on how this is reported to the unemployment office.
      • This requirement may open itself up to plaintiff attorney group for class action cases regarding what a truly bona fide offer was.
      • The other three exceptions (terminated for cause, voluntarily left employment or requested and received a reduction in hours) are still available.
      • Added a clarification to the “simplified method” of calculating full-time equivalents (FTE). Under the guidance in the IFR for the simplified method, it does not appear that a calculation of average weekly hours for part-time employees is needed; it is as simple as determining that he or she does not exceed 40 hours on average, and if not, they would count as .50 FTE.
    • In calculating the dollar amount of forgiveness reduction due to a 25 percent or more salary/wage rate reduction, the Form 3508 instructions assumed the employee worked the same number of average weekly hours in the CP or APCP as they did in the first quarter of 2020.
      • The IFR provided a new provision that attempted to clarify, but does not appear to address, the calculation problem identified in (d) above. The provision in the IFR simply states that the salary/wage reduction applies only to the portion of the decline in salary and wage that is not attributable to an FTE reduction for that employee.
        • The inconsistency in that statement is the FTE reduction is in comparison of the employee’s FTE for the CP or APCP with the selected reference period (February 15, 2019, to June 15, 2019, or January 1, 2020, to February 29, 2020), not to the first quarter of 2020. The salary/wage rate reduction is to the first quarter of 2020.
        • The example in the IFR does not settle the issue; it simply says an employee went from an FTE of 1 during the reference period to a .50 FTE during the CP or APCP and had no reduction in their hourly rate. The example concludes that since there was no reduction in hourly rate, all of the reduction in total wages is entirely attributable to FTE reduction.
        • We believe the correct calculation just needs one modification. Since the total reduction is calculated based on the average weekly hours for the first quarter, any reduction in FTE is accounted for in that step, but only to the first quarter.
        • The calculation then assumes (by multiplying the first-quarter average weekly reduction by 8) that the employee worked the same FTE level in the CP or APCP as was worked in the first quarter.
        • The fix and correct answer, we believe, should be a further adjustment to the extent that an employee had average weekly hours in the CP or APCP that were more or less than worked in the first quarter.
      • See the comparison below of the Form 3508 instructions with what we believe the intent of the clarification is. The assumptions used are as follows:
        • Hourly employee who is paid $10,400 and $2,880 for the first quarter and CP, respectively.
        • 520 and 240 hours were worked during the first quarter and CP, respectively.
        • During the FTE reference period, the employee worked an average of 40 hours per week and was an FTE of 1.
      • The result in the example below is the reduction in the loan forgiveness is only 75 percent of what otherwise would be the amount. This reflects that the FTE decreased from 1 in the reference period to .75 in the CP. This is the result the IFR is attempting to achieve, we believe.

        Covid-19 PPP Loan Forgiveness: What We Know
      • The IFR maintained both the FTE and salary/wage reduction safe harbors (restoration of FTE and/or salary/wage reductions on or before June 30, 2020) but did not provide any details on the time period either restoration amount is to be maintained subsequent to June 30. The IFR simply refers to “the methodology found in Section 1106(d)(5) of the CARES Act.” The IFR seems to seek to clarify §1106(d)(5) by referring to §1106(d)(5).
      • To avoid a reduction in FTE under the voluntary termination, terminated for cause or voluntary schedule reduction exceptions, the employee is deemed to maintain the same full-time equivalency after the term event as before.
        • We still believe the Table 1 instructions are incorrect, but we now know the calculation of the amount to report on Table 1 to avoid FTE reduction.
        • Table 2 also needs to be corrected, as it appears to assume this exception does not apply to employees listed on Table 2.

By issuing the IFR, the SBA and U.S. Department of the Treasury were likely trying to resolve some of the questions raised when they released the Form 3508 and instructions on May 15. While the IFR issued on May 22 dealing with loan forgiveness and described above was helpful on certain issues, it created additional questions and failed to address others. More guidance is needed and will likely be issued soon.

As a final note, legislation has been introduced in both the House and Senate to make certain structural changes to the PPP. Both proposed bills contain provisions to extend the eight-week covered period and the June 30, 2020, date of end of the program. Borrowers should very carefully consider whether the strategy to ramp up payroll costs simply to get more payroll in the CP or APCP is advantageous. If the eight-week period is extended, borrowers employing this strategy could very well be spending money that would normally not be incurred. 

As with most topics related to COVID-19, changes are being made rapidly. Please note that this information is current as of the date of publication. If you have questions, please reach out to your BKD Trusted Advisor™ or use the Contact Us form below.

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