COVID-19: Additional Loan Forgiveness Guidance

On May 22, the Small Business Association (SBA) delivered on its promise of providing additional guidance with respect to loan forgiveness under the Paycheck Protection Program (PPP). This guidance followed shortly after the PPP loan forgiveness application was released, allowing borrowers to take advantage of the defining feature of the PPP: loan forgiveness for eligible payroll and non-payroll costs.

Payroll Costs Eligible for Forgiveness

The loan forgiveness application and subsequent guidance states that payroll costs paid or incurred during an eight-week period beginning on either the date of disbursement of the PPP loan proceeds or the first day of the first payroll cycle in the covered period (the alternative payroll covered period) may be eligible for forgiveness. Borrowers should note the alternative payroll covered period only applies to payroll costs and doesn’t apply to non-payroll costs.

The guidance clarifies that payroll costs are considered paid on the day paychecks are distributed, and payroll costs are generally incurred on the day the employee’s pay is earned. Payroll costs incurred during the borrower’s last pay period or the alternative payroll covered period are eligible for forgiveness if they’re paid on or before the next regular payroll date. Otherwise, payroll costs must be paid during the covered period in order to be eligible for forgiveness.

The SBA clarified that a borrower with a bi-weekly (or more frequent) payroll cycle may elect to use the alternative payroll covered period that begins on the first day of the first payroll cycle in the covered period and continues for eight weeks. If payroll costs are incurred during the eight-week alternative payroll covered period but paid after the end of the alternative payroll covered period, the payroll costs will be eligible for forgiveness if they’re paid no later than the first regular payroll date after the eight-week period. However, if the alternative payroll period is elected, payroll costs paid before the beginning of the alternative payroll covered period won’t be eligible for forgiveness.

Payroll costs are defined as compensation in the form of wages, salary, commission payments, bonuses, and hazard pay, including those payments made to furloughed employees. However, payments eligible for forgiveness for each employee can’t exceed an annual salary of $100,000, as prorated for the covered period, totaling $15,385 per employee (i.e., $100,000 times 8/52nds).

For example, ABC, Inc. has a bi-weekly payroll schedule. ABC, Inc.’s covered period begins on June 1 and ends on July 26. The first day of ABC Inc.’s first payroll cycle that starts in the covered period is June 7. ABC, Inc. may elect to use the alternative payroll covered period for purposes of determining forgivable payroll costs. This alternative payroll covered period starts on June 7 and ends on August 1. Payroll costs paid during the alternative payroll covered period are eligible for forgiveness. Additionally, payroll costs incurred during the alternative payroll covered period are eligible for forgiveness as long as they’re paid on or before the first regular payroll date occurring after August 1. However, any payroll costs paid between June 1 and June 7 won’t be eligible for forgiveness.

The guidance provides special rules for “owner-employees” (e.g., shareholder employees of an S corporation). The guidance states that the compensation paid to owner-employees that will count toward forgiveness can’t exceed the lesser of $15,385 of cash compensation or 8/52nds of their 2019 cash compensation (approximately 15.38 percent of 2019 compensation) plus what’s spent for their health insurance and retirement benefits. This rule seems to punish new businesses that weren’t in existence for all of 2019 or had limited earnings for 2019. Similarly, Schedule C fliers are capped by the amount of their owner compensation replacement, calculated based on 2019 net profits.

The rule for general partners is slightly different: they’re capped by their 2019 net earnings from self-employment (reduced by claimed 179 expense deduction and unreimbursed partnership expenses) multiplied by 92.35 percent. The 92.35 percent is from Form 1040 Schedule SE, which assesses self-employment taxes on partnership income. It’s intended to make the partner’s self-employment income more closely resemble gross wages received by employees, which aren’t increased by the employer’s share of payroll taxes.

However, for self-employed individuals and general partners, compensation doesn’t include health insurance or retirement plan contributions.        

Non-Payroll Costs Eligible for Forgiveness

Non-payroll costs eligible for forgiveness include interest payments on any business mortgage obligation on real or personal property that was incurred before February 15, 2020 payments on business rent obligations on 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.

Non-payroll costs are eligible for forgiveness if they were either paid during the covered period or incurred during the covered period and paid on or before the next regular billing date, even if the billing date was after the covered period.

For example, as above, ABC, Inc.’s covered period begins on June 1 and ends on July 26. ABC, Inc. pays its May and June electricity bill during the covered period and pays its July electricity bill on August 10, which is the next regular billing date. ABC, Inc. may seek forgiveness for its May and June electricity bills because they were paid during the covered period and also for the portion of its July electricity bill (through July 26, the end of the covered period) because it was incurred during the covered period and paid on the next regular billing date.

When calculating non-payroll costs, borrowers should be mindful that principal payments on mortgage obligations aren’t eligible for forgiveness under any circumstances, and, similarly, advance payments of interest on a covered mortgage obligation aren’t eligible for forgiveness. However, there doesn’t appear to be any prohibition against increasing the interest rate on a covered borrowing or increasing the rent on a covered rent obligation.

Reductions to Loan Forgiveness Amount Due to a Reduction in Number of Employees

Borrowers may be subject to certain reductions in loan forgiveness based on reductions in full-time equivalent (FTE) employees or in employee salary and wages during the covered period. However, borrowers will fall into a statutory exemption if they’ve rehired employee and restored salary and wages by June 30, 2020. If a borrower laid off or reduced an employee’s hours then either offered to rehire the same employee for the same salary and number of hours or restore the reduction in hours and the employee declined the offer, the borrower’s loan forgiveness amount won’t be reduced.

A borrower may exclude any reduction in FTE employee headcount attributable to an individual employee if:

1. The borrower made a good-faith, written offer to rehire the employee during either the covered period or the alternative payroll covered period
2. The offer was for the same salary or wages and same number of hours as earned by the employee in the past pay period prior to the separation or reduction in hours
3. The offer was rejected by the employee
4. The borrower maintained records documenting the offer and its rejection
5. The borrower informed the applicable state unemployment insurance office of the employee’s rejected offer of reemployment within 30 days of the employee’s rejection of the offer

For borrowers that don’t fall within the exclusion, a reduction in FTE employees during either the covered period or the alternative payroll covered period will result in a reduction of loan forgiveness by the same percentage as the percentage reduction in FTE employees. To determine the reduction percentage, borrowers must choose one of three reference periods:

1. February 15, 2019 through June 30, 2019
2. January 1, 2020 through February 29, 2020
3.  In the case of a seasonal employer, either of the two preceding methods or a consecutive 12-week period between May 1, 2019 and September 15, 2019

For example, if ABC, Inc. had 10 FTE employees during their chosen reference period and decreased to 8 FTE employees during the covered period, the percentage of FTE employees declined by 20 percent. Therefore, only 80 percent of otherwise eligible expenses are available for forgiveness.

Calculating and Documenting FTE Employees

Borrowers must document their average number of FTE employees during the covered period or alternative payroll covered period and their chosen reference period. A “full-time equivalent employee” is defined as an employee who works, on average, 40 hours or more each week. The hours of employees who work less than 40 hours are calculated as proportions of a single FTE employee and then aggregated.

When calculating the number of FTE employees, borrowers must divide the average number of hours paid for each employee per week by 40, capping the answer by 1.0. Borrowers who paid employees for less than 40 hours per week of work may choose to calculate the full-time equivalency in one of two ways:

1. Dividing the average number of hours a part-time employee was paid per week by 40. For example, if a part-time employee was paid for 30 hours, they’d be considered an FTE employee of 0.75.
2. A borrower may elect to use a full-time equivalency of 0.5 for each part-time employee (which is more straightforward from an administrative standpoint). Borrowers must apply their chosen method consistently to all part-time employees.

The reduction percentage is then determined by dividing the average FTE employees during the covered period or the alternative payroll covered period by the average FTE employees during the chosen reference period.

Reductions to Loan Forgiveness Amount Due to a Reduction in Salary or Wages

Similar to a reduction in number of FTE employees, a reduction in an employee’s salary or wages in excess of 25 percent will generally result in a reduction in the borrower’s loan forgiveness amount. For each new employee in 2020 and each existing employee who wasn’t paid more than $100,000 annualized in any pay period in 2019, the borrower must reduce their total forgiveness amount by the total dollar amount of the reduction that are in excess of 25 percent of base salary or wages between January 1, 2020 and March 31, 2020 (the reference period). This calculation is performed on a per employee basis, not in the aggregate.

For example, ABC, Inc. reduced a full-time employee’s weekly salary from $1,000 per week during the reference period to $700 per week during the covered period. The employee continued to work on a full-time basis during the covered period and was a FTE employee of 1.0. In this case, the first $250 (25 percent of $1,000) is exempted from the reduction. ABC, Inc. would list $400 as the salary/hourly wage reduction for that employee (the extra $50 weekly reduction multiplied by eight weeks).

Avoiding Excess Reductions

To ensure borrowers aren’t doubly penalized with a more-than-necessary reduction in forgiveness, the salary/wage reduction only applies to the portion of the decline in employee salary and wages that isn’t attributable to the FTE employee reduction.

For example, ABC, Inc. has an hourly wage employee that had been working 40 hours per week during the borrower selected reference period (FTE employee of 1.0), and ABC, Inc. 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 didn’t change, the reduction in the employee’s total wages is entirely attributable to the FTE employee reduction, and ABC, Inc. isn’t required to conduct a salary/wage reduction calculation for that employee.

Borrowers should keep in mind that as long as they restore reductions made to either the number of FTE employees or employee salaries and wages no later than June 30, 2020, the borrower can avoid a reduction in its loan forgiveness amount. Additionally, the documents required to be maintained and submitted by borrowers seeking forgiveness are stated in detail in the loan forgiveness application, which is summarized here.

If you have any questions regarding the content of this alert, please contact Roger Cominsky, Financial Institutions & Lending Practice Area chair, at rcominsky@barclaydamon.com; Danielle Katz, associate, at dkatz@barclaydamon.com; or Samantha Podlas, associate, at spodlas@barclaydamon.com.

We also have a specific team of Barclay Damon attorneys who are actively working on assessing regulatory, legislative, and other governmental updates related to COVID-19 and who are prepared to assist clients. Please contact Yvonne Hennessey, COVID-19 Response Team leader, at yhennessey@barclaydamon.com or any member of the COVID-19 Response Team at COVID-19ResponseTeam@barclaydamon.com.