Thinking about the Payroll Protection Program loan forgiveness?
You are not alone. For those of you who received funding in the first round of payments, that 8-week deadline for using the funds is fast approaching. Many of you have looked at the loan forgiveness application, asked questions and made plans.
We want to tell you, things are going to get a little bit easier.
On June 5, Congress signed new legislation that modified the rules regarding the loan forgiveness and eased the restrictions including:
- The 8-week coverage period is now 24-weeks
- The requirement that 75% of the funds be used for payroll costs has been reduced to 60%
- Companies now have until Dec 31, 2020 to rehire full time employees
- A new exemption is allowed for employers who can document an inability to rehire or hire similarly qualified employees
- The loan repayment period for any funds not forgiven has been extended from 2 years to 5 years
- Borrowers of PPP loan funds can now defer the employer’s share of Social Security and Medicare taxes with 50% of the payment due Dec 31, 2021 and the balance due Dec 31, 2022
There are three ways your PPP loan forgiveness may be reduced. Each of these will need to be considered in your 2020 business plans.
60% Payroll Test
When calculating your estimated loan forgiveness, you must use 60% of the funds to cover payroll costs including wages, salaries, commissions, tips, paid leave, group healthcare and retirement. This also includes state taxes paid on the wages.
It does not include compensation for individual employees receiving annual salaries in excess of $100,000, wages to foreign employees, or sick / family medical leave payments where a credit was allowed.
For sole proprietors, this limit is calculated on your 2019 Schedule C net earnings prorated for the 24-week period. No retirement or health care benefits are included.
For partners in partnerships who applied for PPP funds based on their individual earnings, this limit is calculated on your 2019 net self-employment earnings reduced by Section 179, unreimbursed partner expenses and multiplied by 0.9235.
As a reminder, the other 40% of the loan funds can be used for mortgage interest, rent, utilities and interest on debt obligations incurred before the covered period.
Full Time Equivalent (FTE) Employee Ratio
This test has caused confusion. In a nutshell, the ratio takes your eligible forgiveness costs multiplied by the ratio of the average FTE employees per month during the covered period / the average FTE per month from Feb 15, 2019 to June 30, 2019 (or the alternate period if elected by the business of Jan 1, 2020 to Feb 29, 2020). The result is your loan forgiveness.
For example: If you had 10 full time employees in 2019, but had to reduce staff to 5 full time employees during the covered period, and you received $100,000 in loan funds that was used for qualified expenses your forgiveness amount would be $50,000. (5 FTE / 10 FTE = 50% x $100,000 = $50,000)
Yes, this affects all businesses who were shut down, had operations limited by government authority or had difficulty in getting employees to give up the increased unemployment benefits. Please look further into this summary for the available exemptions.
Loan forgiveness will be limited for the amount of the reduction of salaries and wages of any employee that is in excess of 25% during the covered period, compared to the most recent full quarter. The loan forgiveness application provides a worksheet to calculate this reduction.
Yes, it’s confusing. Let’s look at the available exemptions.
Exemptions and Safe Harbor
- An employer can cure the employee reduction tests if payroll is restored by Dec 31, 2020. This safe harbor is included in the calculations on the forgiveness application.
- There is an exemption if the employer can document the inability to rehire their original employees or hire similarly qualified employees by year-end.
Any employees who are given a rehire offer but decline the offer are generally exempt from the FTE employee ratio and reduction tests.Detailed records should be maintained to support both the offer and employee’s decline of the offer.Additionally, the employee could lose the increased unemployment benefits if they decline an opportunity to return to work.
- A second exemption is available if the employer is unable to return to the same level of business activity due to sanitation, social distancing or other safety requirements and government restrictions. Currently the rules state Federal government restrictions, but this may change to include state restrictions since not all areas are able to reopen.
Many of you are now probably asking a few questions:
- Do you use the 8 or 24-week period?
- Is this income and can expenses paid by the PPP loan funds be deducted?
- How long does this process take?
- What if I don’t agree with the results?
Using the 8 or 24-Week Period
You may feel you have met the requirements for loan forgiveness based on the 8-week timeline. That doesn’t mean you should complete the loan forgiveness application using that 8-week period. The new 24-week coverage period will allow time for the issuance of additional guidance and new bills in Congress to be passed.
Reporting Income and Deducting Expenses
At this time, the Cares Act has excluded forgiveness of the PPP loan funds from being included in taxable income. Yes, your financials will show income. This income will be reported as non-taxable income on the tax return in the year of forgiveness.
Please note, the current rules keep the expenses paid with these funds from being deducted. This means your 2020 net income could be higher than you expect.
Congress was trying to address this in the Heroes Act which passed in the House but did not pass in the Senate. We expect more discussions will happen in Congress concerning the deductibility of the expenses.
Once the 24-week coverage period has elapsed, and the application has been filed, the lenders have 60 days to review the application. If approved by the lender, the SBA will have another 90 days to do a further review.
Most borrowers will be in 2021 before knowing what portion of their loan is forgiven. If Congress doesn’t fix the deductibility of expenses, it may cause some tax planning issues in determining how to handle the 2020 tax returns.
Not Happy with the Results
There will be a right of appeal, but at this time no guidance has been issued on that process. It’s one more thing to be resolved in the coming months.
We cannot stress enough the importance of maintaining good records, backup documentation for all expenses, employee hours and wages, and specific situations that qualify for the exemptions. The SBA has six years after the loan has been paid off to audit the loan. This falls outside of the normal document retention policies.
You are not alone in this process. Our team is available to answer questions and assist in completing the loan forgiveness application.