On March 27, 2020, the President signed the Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”). On April 24, 2020, the President signed the Paycheck Protection Program and Health Care Enhancement Act which provided additional funding. On June 5, 2020, the President signed the Paycheck Protection Program Flexibility Act of 2020 (the “Flexibility Act”).
On May 22, 2020, the SBA and Department of Treasury jointly posted an interim final rule on loan forgiveness (the “First Loan Forgiveness Rule”). The SBA also posted an interim final rule on May 22, 2020, regarding SBA loan review procedures and related borrower and lender responsibilities (the “First Loan Review Rule”). On June 11, 2020, the SBA posted an interim final rule revising the first PPP interim final rule to incorporate Flexibility Act amendments, including those relating to loan forgiveness.
The SBA and Department of the Treasury published the Business Loan Program Temporary Changes; Paycheck Protection Program-Revisions to Loan Forgiveness and Loan Review Procedures Interim Final Rule on June 26, 2020, which supplemented and modified the First Loan Forgiveness Rule and the First Loan Review Rule (the “June 26 Interim Rule”).
The SBA also published the PPP Loan Forgiveness Application Form 3508, and the PPP Loan Forgiveness Application Form 3508EZ, along with instructions for both forms. The forms and instructions provide good guidance for borrowers.
The purpose of this article is to provide a summary of the most notable provisions of the Flexibility Act and the guidance offered in the First Loan Forgiveness Rule as modified by the June 26 Interim Rule primarily with respect to the topic of loan forgiveness.
For your convenience, attached are links to earlier blog articles written about the CARES Act. CARES Act Offers Much Needed Hope to Small-Businesses, 2020 Update to CARES Act and Paycheck Protection Program – April 6 and 2020 Update to CARES Act and Paycheck Protection Program – April 7. This article does not attempt to explain the entire program. It assumes that the reader is familiar with the provisions of the original CARES Act.
- Borrowers must use a 24-week covered period for loan forgiveness purposes, unless they received loan proceeds before June 5, in which case they may elect to use the 8-week covered period.
- Of the amount of the loan to be forgiven, at least 60% must be for the payment of payroll costs.
- Borrowers with a weekly or bi-weekly payroll cycle may choose an alternative payroll covered period for payroll cost purposes. The alternative payroll covered period commences on the first day of the first payroll cycle that commences during the covered period.
- In all likelihood, a borrower (particularly one with a bi-weekly cycle) will have greater payroll costs, for loan forgiveness purposes, if it uses the covered period rather than the alternative payroll covered period.
- For loan forgiveness purposes, the cap on payroll costs for owner-employees is different than the cap for other employees.
- Borrowers may include the amount of eligible expenses that were paid during the covered period (even amounts that were incurred prior to the covered period).
- Borrowers may also include the amount of eligible expenses that were incurred during the covered period but were paid after the covered period but prior to the next billing cycle.
- With respect to the potential for the loan forgiveness amount to be reduced as a result of reductions in headcount or reductions in salary that occurred between February 15, 2020, and April 26, 2020 (but not reductions that occurred after April 26, 2020), the CARES Act provided for relief from reduction if such reductions were restored prior to June 30, 2020. The period for restoration has been extended until December 31, 2020.
- The Flexibility Act added additional relief provisions to avoid reductions in the loan forgiveness amount as a result of reductions in headcount or reductions in salaries. These additional relief provisions relate to former employees rejecting offers of employment, the inability to fill positions with new employees, and the inability to restore business operations to February 15 levels as a result of governmental actions (such as shut down orders).
- The Flexibility Act provides a minimum maturity of five years for all PPP loans made on or after June 5, 2020. For loans made before June 5, 2020, the maturity is two years; however, borrowers and lenders may mutually agree to extend the maturity of such loans to five years.
Loan Forgiveness Process
Borrower must complete and submit the Loan Forgiveness Application SBA form 3508, SBA Form 3508EZ (if eligible) or lender equivalent within 10 months after the last day of the covered period. The lender must make a decision about loan forgiveness within 60 days from receipt of a complete application to issue a decision to the SBA. This article is not focused on the process.
The CARES Act defined the covered period in two different sections. In Section 1102 it was defined as the period from February 15, 2020 until June 30, 2020. The Flexibility Act replaced June 30, 2020 with December 31, 2020, such that the covered period for the purposes of Section 1102 is defined as the period from February 15, 2020 until December 31, 2020.
Subject to certain limitations, borrowers are eligible for forgiveness in an amount equal to the sum of the following costs incurred or paid (as described below) during the 8-week or 24-week covered period (as defined in Section 1106):
- Payroll costs including salary, wages and tips, up to $100,000 of annualized pay per employee (for 24 weeks, a maximum of $46,154 per individual, or for 8 weeks, a maximum of $15,385 per individual), as well as covered benefits for employees (but not owners), including health care expenses, retirement contributions, and state taxes imposed on employee payroll paid by the employer (such as unemployment insurance premiums). Payroll costs may include compensation to owner-employees and self-employed individuals. However, the cap for such owners is the lesser of 8/52 of 2019 compensation or $15,385 per individual. If a 24-week covered period is used, the cap for such owners is only increased to $20,883.
- C-corporation owner-employees are capped by the amount of their 2019 employee cash compensation and employer retirement and health insurance contributions made on their behalf;
- S-Corporation owner-employees are capped by the amount of their 2019 employee cash compensation and employer retirement contributions made on their behalf, but employer health insurance contributions made on their behalf cannot be separately added because those payments are already included in their employee cash compensation;
- Schedule C or F filers are capped by the amount of their owner compensation replacement, calculated based on 2019 net profit;
- General partners are capped by the amount of their 2019 net earnings from self-employment (reduced by claimed section 179 expense deduction, unreimbursed partnership expenses, and depletion from oil and gas properties) multiplied by 0.9235;
- For self-employed individuals, including Schedule C or F filers and general partners, retirement and health insurance contributions are included in their net self-employment income and therefore cannot be separately added to their payroll calculation.
- interest payments on any business mortgage obligation on real or personal property that was incurred before February 15, 2020 (but not any prepayment or payment of principal);
- payments on business rent obligations on the real or personal property under a lease agreement in force before February 15, 2020; and
- business utility payments for the distribution of electricity, gas, water, transportation, telephone, or internet access for which service began before February 15, 2020.
Payroll Costs (75% reduced to 60%)
Earlier guidance indicated that of the amount to be forgiven, at least 75% had to be based on the expenditure of payroll costs during the covered period. The Flexibility Act reduced that percentage to 60%. This does not mean that 60% of the loan amount must be spent on payroll costs. It just means that of the amount to be forgiven, at least 60% must have been spent on payroll costs. You can determine the maximum potential amount of the loan subject to forgiveness by dividing the payroll costs paid or incurred (discussed below) during the covered period by 60%.
For example, if a borrower receives a $100,000 PPP loan, and during the covered period the borrower spends $54,000 (or 54 percent) of its loan on payroll costs, then because the borrower used less than 60 percent of its loan on payroll costs, the maximum amount of loan forgiveness the borrower may receive is $90,000 (with $54,000 in payroll costs constituting 60 percent of the forgiveness amount and $36,000 in nonpayroll costs constituting 40 percent of the forgiveness amount).
Loan Forgiveness Covered Period (24-weeks, 8-weeks or in between)
For loan forgiveness purposes, the covered period was defined as the 8-week period commencing on the date on which the loan was funded. For example, if the loan was funded on Monday, May 4, 2020, then the 8-week covered period would end on Sunday, June 28, 2020 (56 days). The Flexibility Act amended the definition of “covered period” for these purposes to be the 24-week period beginning on the date the PPP loan is disbursed; provided, however, if the PPP loan was made before June 5, 2020, the borrower may elect to keep the 8-week covered period.
The 24-week covered period would give the borrower a much greater period of time within which to spend the loan proceeds. However, if the borrower were to significantly reduce its workforce or reduce salaries (for those earning less than $100,000 per year) after the conclusion of the 8-week covered period but during the 24-week covered period, it might be better for the borrower to use the 8-week covered period.
The June 26 Interim Rule provides that the borrower may apply for forgiveness before the end of the 8-week or 24-week covered period (e.g., after 12 weeks). If the borrower could not appropriately spend all the PPP loan proceeds within 8 weeks but could within 12 weeks, seeking loan forgiveness at this point rather than waiting until the end of the 24-weeks might be a better option. The SBA has not clearly described this process. The June 26 Interim Rule provides that if the borrower applies for forgiveness before the end of the covered period and has reduced any employee’s salaries or wages in excess of 25%, the borrower must account for the excess salary reduction for the full 8-week or 24-week covered period. The example given assumes that an employee was earning a salary of $1000 per week pre-disaster (January 1 – March 31) but is reduced to $700 per week during the covered period. This reduction, $300, exceeds 25% of $1000. The amount by which it exceeds 25% is $50 per week. If the 8-week covered period is used, then the reduction would be $400 even if loan forgiveness is sought after 6 weeks. If the 24-week covered period is used, then the reduction would be $1,200 even if loan forgiveness is sought after 12 weeks. What is not clear is what happens if the borrower reduces salary even greater after it seeks loan forgiveness. There is also no clear guidance on how the reduction in headcount is measured under these circumstances. This area needs further guidance.
Alternative Payroll Covered Period; Incurred or Paid
Recognizing the inconvenience of measuring payroll costs if the covered period started on a day other than the first day of a payroll cycle, a borrower with a bi-weekly (or more frequent) payroll cycle may elect to use an alternative payroll covered period (for payroll cost purposes only) that begins on the first day of the first payroll cycle that begins in the covered period and continues for either 8-weeks or 24-weeks, as applicable.
If a borrower using an 8-week covered period has a bi-weekly payroll cycle, and received PPP loan proceeds on June 1, then the covered period would commence on June 1 and end on July 26. If the first day of the borrower’s first payroll cycle that starts in the covered period is June 7, then the borrower could elect the alternative payroll covered period for payroll cost purposes that starts on June 7 and ends 55 days later (for a total of 56 days), on August 1. Payroll costs paid during this alternative payroll covered period are eligible for forgiveness. In addition, payroll costs incurred during this alternative payroll covered period are eligible for forgiveness if they are paid on or before the first regular payroll date occurring after August 1. For the measurement of non-payroll costs, the covered period, not the alternative payroll covered period, still applies.
In general, payroll costs paid or incurred during the covered period are eligible for forgiveness. Payroll costs are considered paid on the day that paychecks are distributed or the borrower originates an ACH credit transaction. Payroll costs incurred during the borrower’s last pay period of the covered period or the alternative payroll covered period are eligible for forgiveness if paid on or before the next regular payroll date; otherwise, payroll costs must be paid during the covered period (or alternative payroll covered period) to be eligible for forgiveness. Payroll costs are generally incurred on the day the employee’s pay is earned (i.e., on the day the employee worked). For employees who are not performing work but are still on the borrower’s payroll, payroll costs are incurred based on the schedule established by the borrower (typically, each day that the employee would have performed work).
It would appear that a borrower using a weekly or bi-weekly payroll would only cover eight (weekly) or four (bi-weekly) payroll cycles if that borrower used the alternative payroll covered period. It would appear that if that same borrower used the regular covered period, it might receive at least a portion of an additional payroll cycle. If the borrower uses an 8-week covered period, the borrower receives its PPP loan proceeds on May 4 (8 weeks ends June 28), and the first payroll cycle to begin during the covered period is on May 7, then using the covered period (rather than the alternative payroll covered period) the borrower would be able to include the payments made on May 7, May 21, June 4, and June 18, because it made those payments during the covered period. It would also be able to use a portion of the payment made on July 2 (approximately 10/14 of that payment).
Non-Payroll Costs – Incurred and/or Paid
There had been much discussion about a provision in the CARES Act that indicated that for eligible expenses to be included for loan forgiveness purposes they had to be both paid and incurred during the covered period. A non-payroll cost is eligible for forgiveness if it was (i) paid during the covered period; or (ii) incurred during the covered period and paid on or before the next regular billing date, even if the billing date is after the covered period. This would seem to allow the borrower to pay bills that were incurred prior to the commencement of the covered period. It would also allow the borrower to include a portion of the last billing cycle that extended beyond the end of the covered period. For example, if an 8-week covered period began on May 4 and ended on June 28, then electricity bills paid between May 4 and June 28 could be included (e.g., the April bill). In addition, the electricity bill for the month of June that is paid in July could be partially included as long as it is paid before the next regular billing date. The portion that would be included is 28/30 assuming the electricity bill is on a calendar monthly basis.
This provides greater flexibility and simplicity for borrowers. The protection to the overall system is that only 40% of the amount of loan forgiveness can be based on non-payroll costs.
Advance payments of interest on mortgage obligations are not eligible for loan forgiveness. Likewise, principal on mortgage obligations are not eligible for forgiveness under any circumstances.
Reductions to Loan Forgiveness Amount
Section 1106 of the CARES Act requires certain reductions to a borrower’s loan forgiveness amount based on reductions in full-time equivalent employees or employee salaries and wages during the covered period. Our earlier blog articles explain in much greater detail the methods by which the loan forgiveness amount is reduced as a result of these types of reductions. In general terms, the loan forgiveness amount is multiplied by a fraction, the numerator of which is the average FTE employees per month during the covered period, the numerator of which is the average FTE employees per month during one of two reference periods, either February 15, 2019 through June 30, 2019, or January 1, 2020 through February 29, 2020. For example, if the pre-disaster headcount was 100 and the covered period headcount was 50, the loan forgiveness amount would be reduced by 50%.
The CARES Act and the Flexibility Act and subsequent SBA rules have provided some potential relief from such reductions. I refer to the relief granted under the CARES Act as the “Restoration Relief.”
The Flexibility Act and subsequent SBA rules have provided additional relief based on various factors such as former employees rejecting offers of employment, the inability to hire replacements, and, perhaps most importantly, the fact that business did not return to pre-February 15 levels as result of governmental action. I refer to these as “Flexibility Act Relief.”
The CARES Act provided that if certain employee salaries and wages were reduced between February 15, 2020 and April 26, 2020 (the safe harbor period) but the borrower eliminates those reductions by June 30, 2020 (now December 31, 2020) or earlier, the borrower is exempt from any reduction in loan forgiveness amount that would otherwise be required due to reductions in salaries and wages. Similarly, if a borrower eliminates any reductions in FTE employees occurring during the safe harbor period by June 30, 2020 (now December 31, 2020) or earlier, the borrower is exempt from any reduction in loan forgiveness amount that would otherwise be required due to reductions in FTE employees. A borrower that restores reductions made to employee salaries and wages or FTE employees but not later than December 31, 2020 will avoid a reduction in forgiveness amount.
It is important to note that this ability to restore reductions only applies to reductions that occurred between February 15, 2020 and April 26, 2020. The CARES Act was very specific on this point. The subsequent SBA rules do not appear to change this. If the salary remained the same from February 15 through April 26 and then was reduced, or if the headcount remained the same through April 26 and then was reduced, the Restoration Relief provision will not be available.
Finally, a borrower’s loan forgiveness amount will not be reduced if an employee is fired for cause, voluntarily resigned, or voluntarily requested a schedule reduction.
Flexibility Act Relief
- Former Employees Rejecting Offers of Employment
If the borrower offered to rehire the same employee for the same salary and same number of hours, or restore the reduction in hours (for employees who were not laid off but whose hours were reduced), but the employee declined the offer, then the borrower’s loan forgiveness amount will not be reduced. In this circumstance, the borrower may exclude any reduction in full-time equivalent employee headcount that is attributable to an individual employee if (i) the borrower made a good faith, written offer to rehire such employee (or, if applicable, restore the reduced hours of such employee) during the covered period or the alternative payroll covered period; (ii) the offer was for the same salary or wages and same number of hours as earned by such employee; (iii) the offer was rejected by such employee; (iv) the borrower has maintained records documenting the offer and its rejection; and (v) the borrower informed the applicable state unemployment insurance office of such employee’s rejected offer of reemployment within 30 days of the employee’s rejection of the offer.
- Lack of Employee Availability
Borrowers are exempted from the loan forgiveness reduction arising from a proportional reduction in FTE employees during the covered period if the borrower is able to document in good faith the following: (1) an inability to rehire individuals who were employees of the borrower on February 15, 2020; and (2) an inability to hire similarly qualified individuals for unfilled positions on or before December 31, 2020.
- Reduction in Business Activity
Borrowers are also exempted from the loan forgiveness reduction arising from a reduction in the number of FTE employees during the covered period if the borrower is able to document in good faith an inability to return to the same level of business activity as the borrower was operating at before February 15, 2020, due to compliance with requirements established or guidance issued between March 1, 2020 and December 31, 2020 by the Secretary of Health and Human Services, the director of the Centers for Disease Control and Prevention, or the Occupational Safety and Health Administration related to the maintenance of standards for sanitation, social distancing, or any other worker or customer safety requirements related to COVID-19. This would include a reduction in business activity stemming from state and local government shut down orders that are based in part on guidance from the three federal agencies.
The June 26 Interim Rule provides an example. A borrower in the business of selling beauty products both online and at its physical store had its physical store shut down by the local government based in part on COVID-19 guidance from the three federal agencies. In that case, the borrower would satisfy the Flexibility Act’s exemption and will not have its forgiveness amount reduced because of a reduction in FTEs during the covered period if the borrower in good faith maintains records regarding the reduction in business activity and the local government shut down orders that reference a COVID requirement or guidance as described above. This should be very helpful for bars, restaurants, gyms, and other businesses that were shut down for periods of time during the covered period.
- Loan Forgiveness Application Instructions
The Form 3508 Loan Forgiveness Application Instructions describes the Flexibility Act Relief and the Restoration Relief with respect to a reduction in headcount as follows:
- (Flexibility Act Relief) The Borrower is exempt from the reduction in loan forgiveness based on a reduction in FTE employees described above if the Borrower, in good faith, is able to document that it was unable to operate between February 15, 2020, and the end of the Covered Period at the same level of business activity as before February 15, 2020, due to compliance with requirements established or guidance issued between March 1, 2020 and December 31, 2020, by the Secretary of Health and Human Services, the director of the Centers for Disease Control and Prevention, or the Occupational Safety and Health Administration, related to the maintenance of standards for sanitation, social distancing, or any other worker or customer safety requirement related to COVID-19.
- (Restoration Relief) The Borrower is exempt from the reduction in loan forgiveness based on a reduction in FTE employees described above if both of the following conditions are met: (a) the Borrower reduced its FTE employee levels in the period beginning February 15, 2020, and ending April 26, 2020; and (b) the Borrower then restored its FTE employee levels but not later than December 31, 2020, its FTE employee levels in the Borrower’s pay period that included February 15, 2020.
- Reductions in Salary Resulting from Reductions in Hours
The CARES Act provided that if an employee’s salary or wages were reduced by more than 25%, the loan forgiveness amount would be reduced, dollar for dollar, by the amount of such reduction in excess of 25%. This test only applied to employees who were not paid more than the annualized equivalent of $100,000 in any pay period in 2019. Therefore, if salaries of more highly compensated employees are reduced by more than 25%, it would not result in a reduction in the loan forgiveness amount.
The salary/wage reduction applies only to the portion of the decline in employee salary and wages that is not attributable to the FTE reduction. The First Loan Forgiveness Rule provided an example. An hourly wage employee had been working 40 hours per week during the borrower selected reference period (FTE employee of 1.0) and the borrower reduced the employee’s hours to 20 hours per week during the covered period (FTE employee of 0.5). There was no change to the employee’s hourly wage during the covered period. Because the hourly wage did not change, the reduction in the employee’s total wages is entirely attributable to the FTE employee reduction so the borrower is not required to conduct a salary/wage reduction calculation for that employee.
Full-Time Equivalent Employee Definition and Calculation
The CARES Act did not define how to determine the number of full-time equivalent employees. The First Loan Forgiveness Rule defines this term as an employee who works 40 hours or more, on average, each week. Those employees are a 1.0 FTE employee. The employees who work, on average, less than 40 hours per week are calculated on proportions of a single FTE employee and aggregated. While the CARES Act referenced an average per month, the First Loan Forgiveness Rule and the Form 3508 Loan Forgiveness Application Instructions provide that the borrower must determine the average number of FTE employees during the covered period (or the alternative payroll covered period) and the applicable reference period (2/15/19 – 6/30/19 or 1/1/20 – 2/29/20) by dividing the average number of hours paid for each employee per week by 40, capping this quotient at 1.0. In other words, if an employee is paid for 50 hours per week, that employee is still a 1.0. For employees who are paid for less than 40 hours per week, on average, borrowers may choose to calculate the full-time equivalency in one of two ways. First, the borrower can use the same method used above for full-time employees. An employee that is paid for 30 hours per week would be a 0.75 FTE. The second method is that borrowers may elect to use a 0.5 FTE for each part-time employee regardless of the number of hours paid each week for those employees.
Flexibility Act provides a minimum maturity of five years for all PPP loans made on or after June 5, 2020. For loans made before June 5, 2020, maturity is two years; however, borrowers and lenders may mutually agree to extend the maturity of such loans to five years. For these purposes, the loan is deemed to have been made when the SBA assigns a loan number for the PPP loan.
Pursuant to Section 1110(e)(6) of the CARES Act, if a borrower receives an advance under the EIDL program, and receives a PPP loan, the amount of the advance (they were awarded up to $10,000) is reduced from the loan forgiveness amount.