The first PPP loans now near the end of their eligible 8 week period: significant questions persist and pressure is mounting on the SBA and Treasury to implement program revisions. 

On April 3, 2020, the Small Business Administration (“SBA”) opened its portals and started accepting applications for the $349 billion Paycheck Protection Program (“PPP”).  The first tranche was fully depleted in 13 days, so Congress replenished the program with an additional $310 billion. The program’s appeal was buoyed by 8 weeks of payroll and qualified expenses that are eligible for loan forgiveness. However, significant questions persist as the first loans now near the end of their eligible 8 week period, and pressure is mounting on the SBA and Treasury to implement program revisions. 

8 Week Period of Forgiveness

Some of the pressure on SBA is self-inflicted. A report by the SBA Inspector General issued on May 8, 2020, found that while SBA’s implementing guidance “mostly aligned with the Act,” Loan Proceeds Eligible For Forgiveness was among several program areas that “did not fully align with the Act’s provisions.” One critical issue is the SBA’s requirement that borrowers use at least 75 percent of the loan proceeds on payroll costs during the 8 weeks to receive full forgiveness. The report confirmed that the CARES Act does not include such a requirement.

Though the 75 percent requirement was perhaps well intentioned by compelling loan proceeds to pass to employees, the reality is not all employees can be called back to work — and some of them are not ready to come back to work. This has become a significant problem for many borrowers because the SBA also established that the 8 week period for calculating forgiveness starts on the day that the loan proceeds are first received.  Consequently, many businesses which received loans remain wholly or partially shuttered by extended “Stay at Home” orders and are finding that much of their loan will not be eligible for forgiveness. 

The Inspector General’s report suggested that the agency "evaluate the potential negative impact to borrowers regarding the specified percentage of loan proceeds eligible for forgiveness and update the requirements, as deemed necessary." Industry lobbying efforts have also sought similar revisions, urging that the 8-week covered period under PPP should be aligned with the beginning of a pay period and should commence when restrictions are lifted and the borrower is allowed to operate, not when loan proceeds are received. Leading trade associations have written to Treasury Secretary Steven Mnuchin seeking such changes.

“Good Faith” Certification of “Necessary to Support Ongoing Operations”

Changing SBA guidance with respect to loan eligibility, long after the first tranche was expended, has also been contentious. Under the provisions of the CARES Act, companies are required to certify in good faith on their PPP application that “[c]urrent economic uncertainty makes this loan request necessary to support the ongoing operations of the Applicant.” While the CARES Act expressly waived the SBA’s general loan eligibility requirement that borrowers must be unable to obtain credit elsewhere, the SBA’s subsequent guidance redefined the good faith standard requiring that borrowers must take into account “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 intended significance of this regulatory shift was emphasized by SBA’s establishment of a “safe-harbor” for those businesses who promptly returned their loan proceeds. Under SBA guidance, borrowers that had received a PPP loan and subsequently determined that they had adequate sources of liquidity at the time of application and that accessing such sources would not have been significantly detrimental to their business were allowed to repay their loans before May 7 (now extended to May 14) without penalty. This “safe harbor” was established by SBA to ensure prompt repayment of PPP loan funds that were obtained “based on a misunderstanding or misapplication of the required certification standard.” 

This “misunderstanding” becomes complicated because no standard for determining “good faith” had been laid out by the CARES Act for loan applicants, the perceived risk of enforcement action is now elevated, and prior to the issuance of this subsequent SBA guidance many companies had already used some or all of their loan funds to satisfy payroll obligations and pay other fixed costs allowed under the PPP. Now perceived as a “bait and switch,” lawsuits have already resulted attacking the SBA’s regulations including one in the U.S. District Court, Central District of California[1], alleging that the SBA regulatory guidance contradicts certain provisions of the CARES Act and, therefore, is ultra vires and void.

IRS Notice Regarding Deductibility

On April 30, 2020, the IRS issued a notice that said no tax deduction is allowed for an expense that is otherwise deductible if the payment of the expense results in forgiveness of a PPP-covered loan. “This treatment prevents a double tax benefit,” the agency said in the notice. “This conclusion is consistent with prior guidance of the IRS.”

The tax code generally permits companies to write off businesses expenses, such as wages, rent and transportation expenses, but generally doesn’t allow write-offs for tax-exempt income. The CARES Act establishes that the forgiven loan amount won’t be taxed but didn’t specify whether companies could still write off the expenses they covered with that money.

Now, this ruling adds to the list of stumbling blocks facing businesses under the Paycheck Protection Program loans as they may lose the benefit of valuable tax breaks even after the loan funds have already been expended.

Congress is quickly responding with efforts to nullify the notice. Several lawmakers, including Senate Finance Committee chairman Chuck Grassley, R-Iowa, ranking member Ron Wyden, D-Ore., and Marco Rubio, R-Fla, pointed out that the notice runs contrary to congressional intent and introduced a bill that would effectively nullify the IRS notice.

“When we developed and passed the Paycheck Protection Program, our intent was clearly to make sure small businesses had the liquidity and the help they needed to get through these difficult times,” Grassley said in a statement. “Unfortunately, Treasury and the IRS interpreted the law in a way that’s preventing businesses from deducting expenses associated with PPP loans. That’s just the opposite of what we intended and should be fixed. This bill will do just that.”

Wyden’s own statement concurred: “Treasury's guidance barring deductions for expenses paid by PPP loans is a gut punch for businesses struggling to stay afloat. It defies common sense for Treasury to provide help on the front end, but then take it away on the back end. Our bipartisan bill would fix this mistake and ensure businesses feel confident using PPP funds to keep their workers employed.”

Is the Curtain Rising or Falling? 

In response to this mounting program pressure and the looming deadlines, SBA has gone largely silent.  After issuing regulatory guidance regarding the PPP in the form of Frequently Asked Questions (“FAQs” ) on April 3, 6, 8, 13, 14, 15, 17, 23, 24, 26, 28, 29 and May 3, 5 and 6th, at the time of this writing (May 12th) there has been no further guidance issued despite SBA’s regulatory assurance that “SBA intends to provide additional guidance on how it will review the certification prior to May 14, 2020.” 

There is a widely-held perception that during this period of silence the SBA and Treasury may be working to revise its rules on forgiveness and the 8 week period, but "Right now, the rules are the rules as they exist," says Bernard Paprocki, director of the SBA office that covers upstate New York. "You can't speculate on what someone else is going to do or change in this program going forward. Make sure you’re keeping accurate records, especially the payroll piece."