By Scott Kislin
Now that the money has started to flow to those lucky small businesses who were able to apply for and receive loans under the Federal government’s “Paycheck Protection Program” (PPP) and there are also fresh funds for the PPP, we thought it would be helpful to address some questions that we have received regarding the mechanics of how to use the loan proceeds and how to apply for loan forgiveness. This information is believed accurate at the time of this writing, but new information becomes available on an almost basis. Contact us if you have specific questions.
1. What new information is there about the required certification that borrowers must make about the business necessity of the PPP loan?
While the focus of this note is on businesses who have already started or completed the PPP application process, it is worth noting that as a result of media and Congressional scrutiny the Small Business Administration (SBA) last week significantly tightened the PPP requirements for businesses, especially large businesses, that have other sources of liquidity. Under the CARES Act, which created the PPP, applicants must certify that “[c]urrent economic uncertainty makes this loan request necessary to support the ongoing applications of the Applicant” (although the CARES Act specifically dispenses with the SBA’s ordinary requirement that applicants not be able to obtain credit elsewhere). The SBA’s new guidance says that “Borrowers must make this certification in good faith, taking into account their current business activity and their ability to access other sources of liquidity sufficient to support their ongoing operations in a manner that is not significantly detrimental to the business.” The guidance further goes on to strongly suggest that public companies would be unlikely to make this certification. While venture and private equity funded enterprises are not quite treated the same as public companies, these businesses should carefully weigh the pros and cons of applying for the PPP. Although we do not think this guidance can be fairly be interpreted to require owners of small and mid-size privately held businesses to contribute additional equity to their businesses should they have it, this is becoming a complicated and nuanced topic that is worth considering based on the specific facts of a particular business. Returning PPP loan proceeds may make sense for some companies. Please contact us if you would like to discuss your specific situation.
2. How long does a business have to spend the PPP loan proceeds?
Businesses have 8 weeks from the date the loan is funded to spend the proceeds. Businesses cannot delay the receipt of the funds so that the clock starts at a later time. If the full amount of the loan is not used during this period, the difference does not need to be immediately paid back. However, the difference is not eligible for forgiveness and must be paid back over time in accordance with the loan terms if it is not immediately paid back. In addition, loan proceeds no matter when they are spent can only be used for the permitted purposes specified below. Fines and penalties may apply if the loan proceeds are used for other purposes.
3. What can the PPP loan proceeds be used for?
The loan proceeds can only be used for payroll costs, rent, utilities and interest on mortgages and other business debt. New regulations specify that at least 75% of the loan proceeds must affirmatively be used for payroll costs. While not immediately clear, it appears that rent includes lease payments on business equipment and vehicles as well as rent payments on real property. For everything but payroll costs, the underlying expense must have existed or related to a contract or lease that was in place prior to February 15, 2020. Payroll costs only count for employees whose principal place of residence is in the United States, and payroll costs in excess of $100,000 per employee annually are disregarded. Loan proceeds can also be used to refinance an SBA Economic Injury Disaster Loan (EIDL) made between January 31, 2020 and April 3, 2020. The SBA has taken the position that hedge fund and private equity fund managers are ineligible for the PPP.
4. Can PPP loan proceeds be used to pay debt on loans other than business mortgages?
PPP loan proceeds can only be used to pay mortgage interest and interest on business debt incurred prior to February 15, 2020 or to refinance certain EIDL loans received between January 31, 2020 and April 3, 2020. Notably, while mortgage interest is eligible for loan forgiveness if all of the other requirements are met (see below), loan amounts used to pay other allowable business interest are not eligible for forgiveness. PPP proceeds cannot be used to pay principal payments on mortgage or other indebtedness, including it appears regular amortizing principal payments. However, employees and self-employed individuals are not restricted in how they can use their salaries and owner draws that are funded by PPP loan proceeds, including to make their own personal rent, mortgage and other indebtedness payments.
5. Can PPP funds be used for tax and other withholdings that are taken from an employee’s pay? What about the employer share of such amounts?
Gross employee wages are covered “payroll costs”. This means that any amounts ordinarily withheld from an employee’s wages (e.g., federal, state and local taxes, health care benefits, and the employee share of social security and medicare payroll taxes) are permitted payroll costs eligible to be paid from PPP loan proceeds. However, the employer’s portion of social security and medicare payroll taxes are not covered included in “payroll costs”.
6. Can the funds be used to pay new hires (e.g., individuals who were never previously employed by the business)?
This is unclear, but the answer seems to be yes. All of the loan and forgiveness calculations are based on total payroll and employment levels and do not appear to be tied to specific individuals.
7. How are independent contractors treated by businesses that use them?
Payments made by businesses to independent contractors (i.e., individuals whose payments are reported to the IRS on a Form 1099) are not treated as “payroll costs” and cannot be taken into account when determining the size of a PPP loan that a business is eligible for or in the amount of loan forgiveness. However, these independent contractors can apply for their own PPP loan. While not entirely clear, it also does not appear that payments to an independent contractor are permitted uses of a PPP loan, even if the payments are not considered for forgiveness.
8. Should businesses place PPP loan proceeds into a separate bank account?
Businesses do not need to deposit the loan proceeds into a separate newly established bank account and then fund covered expenses (and only covered expenses) from this account. As a best practice, some advisors are recommending that their clients do establish a separate account to help establish a paper trail that the funds are being used for permitted purposes. But this is not required, and adequate recordkeeping should be sufficient particularly for smaller businesses with less complicated expense structures. Businesses may want to contact their lenders to see if they have a preference.
9. Are covered costs during the 8-week period calculated on a cash or accrual basis? For example, does a business have to incur and pay the expense during this period or can it pay during this period an expense incurred earlier or pay after the period an expense incurred during the period?
This is currently unclear. It is hoped that the SBA will provide guidance on this point in the near future. Certainly, a cash basis approach should be easier to support a request for loan forgiveness. To be clear, this is only relevant for determining the use of loan proceeds and the amount of potential loan forgiveness. Businesses are still obligated to pay expenses in the ordinary course whenever incurred unless alternative arrangements are made or there is otherwise a valid reason for non-payment.
10. Does interest accrue immediately on PPP? Will that be forgiven also?
Interest at the rate of 1% accrues immediately on PPP loans, although all payments of principal and interest are deferred for the first 6 months. Interest will be forgiven to the extent the loan principal amount is forgiven.
11. What is the process for requesting loan forgiveness?
We are awaiting further details from the SBA and lenders on the process for loan forgiveness. What is known is that you will apply through your lender and the lender will have 60 days to review and approve or deny the application.
12. How is the amount of loan forgiveness calculated?
In order for 100% of a PPP loan to be forgiven, a business must:
a) use 100% of the loan to fund eligible costs within 8 weeks of receiving the funds;
b) use at least 75% of the loan proceeds for payroll costs and the rest for other eligible expenses (see above);
c) maintain employment at 100% or more of a base level during this 8-week period (the base level is determined using either the period February 15 – June 30, 2019 or January 1 – February 29, 2020, whichever is most favorable to the business); and
d) not cut the compensation of any employee (who makes less than $100,000) by more than 25% during this period.
Employment levels are determined based on aggregate full-time equivalent employees (or FTEs) during the relevant time periods and not linked to specific employees. If a business has previously cut salaries or terminated employees, they can still receive full loan forgiveness by restoring salaries and/or re-hiring (or hiring) FTEs by June 30. In addition, if a business cannot satisfy the above requirements in full, they will still be eligible for partial forgiveness based on complicated formulas intended to result in proportional reductions in the forgiveness amount.
We are still awaiting guidance from the SBA on how exactly this would all work.
13. Are there any differences in loan forgiveness applicable to self-employed individuals?
In proposed regulations that have not been finalized, the SBA clarified that self-employed individuals can only receive forgiveness of “owner compensation replacement” that is equal to 8/52 of the owner’s 2019 net profit as determined on the owner’s IRS Form 1040, Schedule C (capped at $100,000 per annum). If the 2019 tax return has not yet been filed, self-employed individuals are still required to fill it out and provide it to the SBA as part of the forgiveness process. Self-employed individuals remain entitled to receive forgiveness for other eligible expenses such as payroll for employees, rent, utilities and interest on mortgage debt. Although not clear from the proposed regulations, recent guidance from the SBA suggests that owner compensation replacement is counted as a payroll cost for purposes of the requirement that 75% of loan proceeds be used for payroll costs.
The above applies to Schedule C filers. Partners in a partnership (who receive a K-1) are not entitled to directly apply for a loan through the PPP although the partnership can, and self-employment income of active general partners up to $100,000 is explicitly counted as payroll expense. While guidance does not explicitly address limited liability companies (LLCs), logic also suggests that they be treated the same way as partnerships at least for LLCs that are not 100% owned by one individual.
14. How does the loan forgiveness work for businesses that have also received $10,000 grants under the EIDL program?
Businesses who have received both the $10,000 grant and funds under the PPP may retain the $10,000 grant, but the full amount of the grant will reduce the portion of the PPP loan that is forgiven.
15. Does the amount of loan forgiveness constitute taxable income?
No. Ordinarily, when a lender forgives all or part of loan, the borrower may have to pay tax on the amount of the loan forgiven. In this case, the law specifically provides that loan forgiveness under the PPP is not taxable to the borrower.
Scott Kislin Of Counsel
(646) 680-9664 direct(917)
Nicole D. Galli Managing Partner
(215) 525-9583 direct (PHL)
(646) 680-9661 direct (NYC)