**Post Updated May 20, 2020**
The SBA and Treasury released the first version of the PPP Loan Forgiveness application on Friday, May 15th, 2020 giving borrowers much needed guidance and some much-needed clarity on how PPP forgiveness will work. The application itself is two pages long and has an estimated time of 180 minutes to complete; however, the application also includes two pages of instructions, a separate Schedule A and instructions (2 pages) and the schedule A worksheet and instructions, which are 3 pages and finally some additional information on documentation. Overall, the full file (located here) clocks in at 11 pages.
Key Updates For Borrowers to Know
Like nearly all other PPP guidance that has come out, the application has many borrower friendly provisions. While many borrowers are still lamenting the 8-week window (while there has been discussion in media and in a proposed law of extending it, the forgiveness period still remains the same) this application does provide the following key updates:
- Allows for a modified 8-week covered period (“Alternative Payroll Covered Period”) that allows borrowers to align the 8-week covered period with their normal payroll cycle.
- Expands the 8-week window to cover payroll that was incurred but unpaid at the end of the 8-weeks to be an eligible cost if paid by next payroll cycle.
- Clarifies that payroll compensation for all employees during the 8-week period is capped at $15,385 per employee.
- Expands the 8-week window for eligible nonpayroll costs for amounts that were incurred during the covered period but unpaid, so long as paid by the next billing cycle. Also explicitly allows for any payments made during the covered period but not incurred during the period.
- Full-time equivalency (FTE) are based on a 40-hour week and rounded to the nearest tenth. FTEs are calculated based on the average number of hours worked per week.
- There are exemptions for FTE reductions for FTEs that were offered a position but declined, voluntarily left, or voluntary reduced their hours.
- The requirement for 75% of payroll cost is not a “cliff” but rather a reduction of the forgivable amount pro-rata; that is, if you do not meet the 75% payroll cost use, your forgiveness is now reduced to an amount (but not $0) to meet this ratio.
- Owner’s compensation (including owner-employees, partners) is capped at 2019 level or $15,385, whichever is lower.
- Any reduced forgiveness for reductions in salaries is calculated prior to any FTE reductions.
Covered Period vs Payroll Alternative Covered Period, Payroll Costs Paid and Incurred
The first major change provided in the application was the creation an “alternative payroll covered period” which allows borrowers with a payroll frequency of bi-weekly or more to delay, for payroll costs only the covered period start date to the first payroll period after the loan is disbursed. For example, if a borrower has a bi-weekly payroll schedule, and the loan was disbursed (which is the key date) on April 20, 2020 and their next payroll period starts on April 26, 2020, the borrower can make the election to change their covered period to start on April 26, 2020 rather than April 20, 2020. This change was allowed for administrative convenience.
The application does not give much color into payroll with a longer lag and that presents an unsettled issue. Payroll costs are considered paid when the check is issued or ACH Credit transaction is initiated. Payroll costs are considered incurred when the employee provides the service for that day. In a welcome change, payroll costs incurred but not yet paid are eligible for forgiveness if paid on the next regular payroll date, but otherwise must be paid during the covered period.
Under the above, the payroll would need to be paid by 6/26/2020, the next regular payroll date after the covered period (or alternative covered period) under a strict interpretation, leading to potentially the 7/10/2020 pay date not being included.
The application says for “payroll costs paid and payroll costs incurred,” when discussing eligible payroll costs, which can lead to some confusion in the interpretation. The use of payroll costs before both paid and incurred could mean they are independent clauses (i.e. payroll costs incurred or payroll costs paid) or that both are required to be an eligible use. Further, the emphasis on 8 weeks and allowing for the alternative payroll covered period to align with payroll cycles made it seem like there would be an emphasis on incurred, and the different language in nonpayroll costs, explicitly using or, added to this uncertainty. However, the instructions for Line 1 clearly state “payroll costs incurred or paid,” which presumably allows for a borrower to count both. Looking at the first case where there is a limited lag in payroll, this could allow under the standard covered period a potential additional payroll costs, as the payroll paid on May 1, 2020 that covers the period of April 12th – April 25th is paid in the covered period (and in this case, the alternative covered period) it would be allowed as an eligible payroll cost for the full amount. Further, if the loan were disbursed on or before April 17th, the regular pay date of the payroll, then that payroll would be an eligible payroll cost. The application is still clear that the compensation is limited to 8-weeks at a $100,000 cap, but this interpretation allows for potentially more than 8-weeks of compensation to be an eligible cost in the covered period, which may not be the intent.
Flexibility for eligible nonpayroll costs
While the application did not provide much in terms of needed updates on nonpayroll costs, including more clarification on eligible mortgage interest on personal property and leases for cloud computing, it did provide a borrower friendly interpretation similar to the payroll costs. Under the application, it explicitly allows for use and forgiveness for any rents, interest or utilities paid during the 8-week covered period (note: the alternative period is ONLY for payroll costs) and for any that were incurred and then paid during the next regular billing cycle. For instance, if a borrower received a PPP loan on April 20, 2020 and paid a bill for the March Rent on April 24, 2020, this would be considered paid in the 8-week period and a permitted and forgivable use. Alternatively, if the borrower paid the bill for June rent (incurred during the covered period) by July 1, 2020, when the rent is due, this is also acceptable.
Calculating Payroll Cost & Salary Reductions
The forgiveness application does not provide any updates to the definition of payroll costs but does provide more insight into how the salary reduction calculation is handled. As anticipated, the worksheet does calculate these on an employee-by-employee basis in 1 of 2 possible tables. Table 1 is used for any employee that did not earn, for any pay period in 2019, an annualized compensation amount of more than $100,000 per year. Table 2 is used for employees that did earn above this amount, as any reductions do not impact borrower forgiveness per the CARES Act. There is still an open question; if bonuses or supplemental compensation paid in conjunction with normal payroll in 2019 would cause an employee to fall into this category (for example, an employee making $60,000 per year that was paid a $5,000 bonus during a payroll run in 2019, which would put that individual check above $100,000 annualized). However, it is important to note 2 key updates in this calculation
- It is confirmed that the most that should be entered is $15,385 for an employee.
- Owner-employees or partners are not listed in this schedule.
The calculation for salary reductions is done on the individual employee level and can be rather detailed. The calculation on a high level is as follows:
- Determining if pay was reduced by more than 25%. If yes, go to step 2. If no, stop.
- Determining if the wage reduction “safe harbor” was met. If no, go to step 3
- Calculate the wage reduction.
The CARES Act provided a “safe harbor” providing that any salary reduction that occurred between February 15, 2020 and April 26, 2020 and was restored by June 30, 2020 will not reduce forgiveness. The application provides this calculation (it is complex, but requires a calculation of average annual salary in the February 15 – April 26 period and compared to the February 15th period and then the June 30th period), but does not indicate how long someone would have to be employed to take advantage of this safe harbor.
The provided SBA worksheet in Schedule A does not include a person by person breakout, but also has a spot for employer contributions to health insurance, employer contributions to employee retirement plans, and taxes assessed on the borrower for employee compensation. No more guidance has yet been given on if the retirement plan piece only means for 401k or other defined contribution match payments due in the ordinary course of business or if borrowers can make payments toward cash balance plans or discretionary matches during this period.
Calculating FTEs and FTE Safe Harbor
The SBA calculation is based on a 40-hour FTE week and allows for 2 calculations: a simplified method or an average weekly method.
For all employees that worked more than an average of 40 hours per week they are worth 1.0 FTEs. For employees that work less than 40 hours per week they are worth 0.5 FTEs.
Average Weekly Method
Under this method, a borrower will calculate the average number of hours per week during the covered period and divide by 40, rounded to the nearest tenth. Employees are capped at 1.0. The instructions state to enter the average hours paid per week of the covered period (or alternative covered period) which likely means that any payrolls paid but not incurred during the covered period (i.e. a covered period from April 20th – June 14th with a payroll paid on April 20th for the period of April 13th – April 17th) would not impact the FTE calculation.
For many borrowers, the average weekly method will probably yield a higher FTE result, but is also more complex.
The application provides that FTE reduction will be reduced by increasing the number of FTEs under the following circumstances
- Borrower made a good-faith, written offer to an employee which was rejected by the employee.
- Any employee that was fired for cause.
- Any employee that voluntarily resigned.
- Any employee with a voluntary reduction of hours.
Like with the salary reduction, the application also provides a little more clarity into the FTE “safe harbor” but also does not give an indication how long employees would need to continuously be employed. The safe harbor calculation is as follows:
- Total Average FTE between February 15, 2020 and April 26, 2020.
- Total FTE as of February 15, 2020. If the FTE here is greater than above (a reduction) then proceed to step 3. Otherwise, stop.
- Calculate FTE as of June 30, 2020. If the amount on June 30, 2020 is greater or equal to February 15, 2020, the safe harbor is met and there is no reduction.
The final key update in the forgiveness application relates to documentation requirements. The SBA has indicated that documents related to this loan must be kept for six years.
Documentation required for submission for forgiveness
- 3rd party payroll reports for periods that overlap with covered period or alternative covered period.
- Tax Forms for the periods that overlap with the covered period or alternative covered period, including Form 941 and State Payroll tax returns.
- Receipts cancelled checks or account statements for employer contributions to health or retirement plans.
- Lender amortization schedules or account statements for covered mortgage obligations for February 2020, covered period and one month after covered period.
- Lease agreements, lease account statements from February 2020, covered period and one month after covered period.
- Utility invoices from February 2020, covered period and one month after covered period.
Additional Documentation to be kept but not required to be submitted
- PPP Schedule A Worksheet and documentation supporting wage reduction calculation and documentation related to payments of over $100,000 per employee on an annualized basis.
- Documentation regarding job offers and refusals, firings for cause or resignations.
- Documentation supporting an FTE Safe Harbor claim.
The loan forgiveness application has been long anticipated by borrowers to help provide guidance with the PPP Loans. This release helps to provide answers to some questions, but still leaves many questions open, or creates new questions that we still do not have answers on. Further, borrowers may recall that during the initial application, the SBA and Treasury updated the application prior to use which may be a distinct possibility again. Even so, the guidance here can help borrowers make decisions on some of the looming questions.
Edward McWilliams, CPA
Ed is a Partner in the firm’s tax and business advisory practice focusing on providing services to middle market private companies across different industries as well as to early stage startups. Ed has over a decade of experience providing tax and business consulting services to these companies of different sizes and across different industries, bringing a broad and diverse knowledge base and strategic solutions to the many complex issues that businesses face.