The Paycheck Protection Program (“PPP”) has provided more than half a trillion dollars in potentially forgivable loans to small businesses trying to weather the medical and economic storm caused by the COVID-19 pandemic and the efforts to control and contain it. As a part of the CARES Act, the PPP was drafted and passed very quickly and, as a consequence, there has been confusion over some aspects of the program, particularly with regard to precisely how a business can maximize forgiveness.
On May 15, 2020, the U.S. Small Business Administration (“SBA”) provided the PPP Loan Forgiveness Application (the “Application”), which gives much-needed additional guidance on loan forgiveness, particularly with regard to how to calculate the average weekly full-time equivalency (“FTE”) of employees and how various payroll periods will or will not be included in the eight-week period beginning with the borrower’s receipt of the PPP funds (“Covered Period”) during which the loan proceeds must be spent. PPP recipients should carefully review the application and the instructions as they spend their PPP loan proceeds during the Covered Period. The completed Application and the additional required documentation must be submitted by the borrower to its PPP lender.
Guidance on Payroll
The apparent intent of the PPP was that a borrower would be able to fund payroll for an eight-week period and that PPP funds used for that purpose would be fully forgiven, with the federal government picking up the tab. The law itself, however, stated that PPP funds would be forgiven for certain “costs incurred and payments made during the covered period.” Because there is a delay between the dates on which an employee performs services – arguably the date that a payroll cost is “incurred” – and the payroll date – arguably when the payment is “made” – there has been some confusion as to which payroll costs were eligible for forgiveness. The SBA’s application and accompanying instructions have, to an extent, cleared that up in a reasonable manner.
The CARES Act states that the amounts spent on “payroll costs” during the Covered Period, starting on the day after the loan was disbursed, are eligible for forgiveness. Payroll costs consist of the following payments made to employees: (1) salary, wages, commissions, or similar compensation (up to an annualized $100,000); (2) cash tips or equivalent; (3) vacation, parental, family medical, or sick leave (excluding payments for emergency paid sick leave or expanded family and medical leaves); (4) separation or dismissal pay; (5) for group health insurance; (6) retirement benefits; and (7) state or local payroll tax (but not federal payroll tax). Cash compensation costs are capped at $15,385 maximum per individual (8/52 weeks of $100,000), plus health insurance and retirement contributions paid by the business as set forth in the Interim Final Rule. Payments to independent contractors are excluded from payroll forgiveness, and payroll forgiveness for self-employed individuals is based on Line 31 of the individual’s 2019 IRS Form 1040 Schedule C, rather than on any amounts paid or incurred in 2020.
The Application confirms that payroll costs must be incurred and paid during the Covered Period. The Application instructions state payroll costs are considered incurred on the day that the employee’s pay is earned. However, payroll costs incurred, but not paid, during the last pay period during the Covered Period or Alternative Payroll Covered Period (see below) are eligible for forgiveness if paid on or before the next regular payroll date.
The Application instructions also provide borrowers an Alternative Payroll Covered Period. Borrowers with a biweekly (every other week) or more frequent payroll schedule may elect to calculate eligible payroll costs using the Alternative Payroll Covered Period, which is the eight-week period that begins on the first day of their first pay period following the PPP loan disbursement. It should be noted that the Alternative Payroll Covered Period applies only to payroll costs, calculation of full-time equivalent employees, and salary/hourly wage reductions. The Alternative Payroll Covered Period does not apply to non-payroll costs.
Eligible non-payroll costs include (1) mortgage interest payments, (2) rent or lease payments, and (3) utility payments. Mortgage obligations, rent or lease agreements, and utility service agreements must have also been executed before February 15, 2020. The Application states that rent includes business rent or lease payments pursuant to lease agreements for real or personal property, and utility payments include payments for distribution of electricity, gas, water, transportation, telephone, or Internet access for which service agreements were in force before February 15, 2020. Non-payroll costs have to be paid during the Covered Period or incurred during the Covered Period and paid on or before the next regular billing date, even if that date is after the Covered Period.
Eligible non-payroll costs cannot exceed 25% of the total loan forgiveness amount. Accordingly, subject to the 25% limitation, it would appear that non-payroll costs paid during the Covered Period will qualify for forgiveness even if such non-payroll costs were incurred before or after the Covered Period. However, line 2 of the instructions to the Application states that “prepayments” of mortgage interest payments should not be included. Curiously, no such instruction is provided for any other non-payroll costs. It therefore seems to suggest that, particularly since mortgage payments are usually due in advance of the period covered, mortgage interest payments that are paid during the Covered Period should qualify for forgiveness.
Two Methods for Calculating Average FTEs
The CARES Act also tied PPP loan forgiveness to the extent to which a loan recipient maintained or restored its workforce to pre-pandemic levels. The Act provides that the business needs to calculate the average number of “full-time equivalent” employees in the covered period and one of two possible reference periods and compare the two. Until now, however, there has been no specific guidance on the definition of FTE.
The SBA has provided two calculation methods for determining the average FTE for all employees. In the first method (“Traditional Method”), the borrower takes the average number of hours paid each week for each employee, divides that by 40, and rounds the total to the nearest 10th. In the second method (“Simple Method”), the borrower assigns 1.0 FTE for each employee who works 40 hours or more per week and 0.5 FTE for each employee who works fewer than 40 hours. Both methods require that the maximum number of hours per employee is 40 or 1.0 FTE, so that a borrower does not get any benefit from any employee who works more than 40 hours in a week.
Although the Simple Method is easier to calculate, it offers the possibility for FTE gamesmanship for employees working under 20 hours per week, while also reducing the total FTE for employees working over 20 hours per week relative to the Traditional Method. For example, using the Simple Method, an employee who works 15 hours a week will be assigned a 0.5 FTE, whereas according to the Traditional Method, the same employee would receive a 0.4 FTE (15/40 = 3.75). The Simple Method also reduces total employee FTE relative to the Traditional Method for employees working over 20 hours per week. For example, using the Simple Method, an employee who works 35 hours will be counted at 0.5 FTE, whereas using the Traditional Method that same employee would have a 0.9 FTE (35/40 = 0.875).
Example of FTE Calculation Under Both Methods:
During the Covered Period, the company had the following employees:
- A, who averaged 48 hours per week during the period;
- B, who averaged 40 hours per week during the period;
- C, who averaged 30 hours per week; and
- D and E, who each averaged 20 hours per week.
|Traditional Method Yields 3.8 FTEs||Simple Method Yields 3.5 FTEs|
|A: 48/40 capped at 1.0||A: 48/40 capped at 1.0|
|B: 40/40 = 1.0||B: 40/40 = 1.0|
|C: 30/40 = 0.8 |
(rounded to the nearest 10th)
|C: 30/40 = 0.5|
|D: 20/40 = 0.5||D: 20/40 = 0.5|
|E: 20/40 = 0.5||E: 20/40 = 0.5|
Reductions in Forgiveness
PPP loan forgiveness will be reduced in proportion to the decrease in the average weekly FTE during the Covered Period or the Alternative Payroll Covered Period, if applicable, that is less than the average weekly FTEs for any of the following periods, as selected by the borrower (the “Reference Period”):
- The period beginning on February 15, 2019, and ending on June 30, 2019; or
- The period beginning on January 1, 2020, and ending on February 29, 2020; or
- For a seasonal employer, as determined by the SBA, either of the two previous periods or any 12-week period between May 1, 2019, and September 15, 2019.
PPP loan forgiveness will be reduced dollar for dollar for the amount of reduction in excess of 25% of the total salary and wages of any employee during the Covered Period or the Alternative Payroll Covered Period, if applicable, as compared with the Reference Period.
This definition of FTE encourages businesses to keep or bring back as many employees as possible, so an employer that has five employees each working 40 hours each week has an advantage over an employer that has four employees each working 50 hours per week. In addition, PPP loan forgiveness will be reduced dollar for dollar to the extent that payroll costs paid during the Covered Period or the Alternative Payroll Covered Period, if applicable, are less than 75% of the total amount of the loan proceeds used during the Covered Period.
Necessity Certification Safe Harbor
On May 13, in Frequently Asked Question (“FAQ”) 46, the SBA announced that any borrower, together with its affiliates, that received PPP loans with an original principal amount of less than $2 million will be deemed to have made the required certification concerning the necessity of the loan in good faith. The Application requires a borrower to check a box if, together with its affiliates, it received a PPP loan of greater than $2 million. Borrowers with loans less than $2 million should not check this box, as the SBA will track this information for purposes of the necessity certification safe harbor provided by FAQ 46.
FTE Reduction Safe Harbor
The SBA requires a reduction in forgiveness request if it does not bring back the same number of employees that it had pre-pandemic. The Application provides a waiver of this FTE reduction if the business failed to bring back its same employee head count during its eight-week period but later brought back the same number of employees by June 30, 2020. FTE reductions will not reduce loan forgiveness in any of the following circumstances:
- The borrower made a good-faith written offer to rehire during the Covered Period or Alternative Payroll Covered Period, if applicable, and the employee rejected that offer. (Note: On May 18, 2020, Secretary Mnuchin stated furloughed individuals who reject an offer from their company to return to work after being laid off due to coronavirus are no longer considered eligible to receive federal unemployment benefits.)
- During the Covered Period or Alternative Payroll Covered Period, if applicable, the employee (1) was fired for just cause; (2) voluntarily resigned; or (3) voluntarily requested a reduction in hours.
- The borrower (1) reduced its FTE employee levels in the period from February 15, 2020, to April 26, 2020, and (2) restored its FTE employee levels by no later than June 30, 2020, to its FTE employee levels in the borrower’s pay period that included February 15, 2020.
Loan forgiveness will not be reduced in respect of an employee salary reduction in excess of 25% during the Covered Period or Alternative Payroll Covered Period, if applicable, from that which existed during the period from January 1, 2020, to March 31, 2020, and if the salary/hourly wage of the employee as of June 30, 2020, is equal to or greater than the salary/hourly wage in effect as of February 15, 2020.
All borrowers requesting loan forgiveness will have to certify the following:
- Non-payroll costs do not exceed 25% of the amount requested.
- The payroll and non-payroll costs for which borrower seeks loan forgiveness are verified.
- They understand the government may pursue civil and criminal remedies for knowing misuse of borrowed funds and for false statements and bank fraud. Penalties for false statements on the Application include “[i]mprisonment of not more than five years and/or a fine of up to $250,000, two years and/or a fine of not more than $5,000; and, if submitted to a Federally insured institution, by imprisonment of not more than thirty years and/or a fine of not more than $1,000,000.”
- They have submitted the required documents for loan forgiveness (see below).
- They have submitted or will submit tax documents to the IRS consistent with those submitted to the SBA.
- They acknowledge that the SBA can request additional information to evaluate loan forgiveness.
Required Document Submission
The Application contains a Loan Forgiveness Calculation Form, a PPP Schedule A, a PPP worksheet to Schedule A, and a Demographic Information Form. All borrowers requesting loan forgiveness will have to submit the following:
- Loan Forgiveness Calculation Form.
- Loan Forgiveness PPP Schedule A.
- Documents showing cash compensation and non-cash compensation benefit payments for each employee during the Covered Period or the Alternative Payroll Covered Period.
- Documents verifying the FTE for the Covered Period or the Alternative Payroll Covered Period. The Alternative Payroll Covered Period applies only to payroll costs, calculation of FTE, and salary/hourly wage reductions.
- Documents detailing non-payroll cost arrangements in place prior to February 15, 2020, and all amounts eligible for forgiveness that were paid or incurred during the Covered Period.
Borrowers applying for loan forgiveness should maintain and collect payroll records for the Covered Period or the Alternative Payroll Covered Period. Borrowers will need to verify payroll costs by providing the following:
- Bank accounts or third-party payroll service reports detailing all cash compensation paid to employees.
- Tax forms (usually 941 Tax forms) or third-party payroll service provider reports and state quarterly wage and unemployment filing for periods coinciding with the Covered Period or the Alternative Payroll Covered Period.
- Payment receipts, cancelled checks, or account statements documenting the amount of employer contributions to employee health insurance and retirement plans.
McCarter & English, LLP, can assist you with maximizing loan forgiveness, completing the loan forgiveness application, and gathering the documentation necessary to be provided to the lender.