We are receiving a number of questions about PPP forgiveness and the PPP Flexibility Act, signed by President Trump on June 5. This Q&A is intended to answer some of those questions, but remember, your individual circumstances may impact your forgiveness application and organizations should consult with their tax attorney before making decisions.
A summary of the PPP Flexibility Act is available on our Tax Law Blog.
Q: I know we can use our PPP funds for some non-payroll expenses including utilities. What are the acceptable categories for utilities?
A: These include electricity, gas, water, transportation, telephone, or internet access which began before February 15, 2020.
Q: How do I submit my forgiveness application?
A: You will submit a forgiveness application to the lender which originally approved your loan. The lender will submit the information to the SBA.
Q: What does it mean that the forgivable portion of the loan may result in extra tax?
A: While the CARES Act provides that the forgiven loan amount is excluded from gross income, the IRS issued guidance indicating that any expenses covered by a forgiven PPP loan will not be allowed as a tax deduction.
For example, let’s say a corporation has revenue of $2 million and its only expense is $1.5 million of payroll expenses. Typically, at the end of the year, the corporation would have $500,000 taxable income (revenue minus expenses) which would result in a tax of $165,000 (federal tax rate of 21% and Iowa tax rate of 12%).
If the corporation received $1 million in PPP money, spent all of it on payroll and all of the $1 million was forgivable, then at the end of the year, the corporation cannot deduct $1 million of its payroll from its revenues. Thus, the corporation’s taxable income would be $1.5 million and the tax would be $495,000.
While the corporation received $1 million in free money, it also paid an additional tax of $330,000 resulting in a net benefit to the corporation of $690,000.
Q: If a borrower knows that it did not do any wage reductions, does it still have to go through a safe harbor calculation or can it just skip the test?
A: If a borrower knows that it did not have any wage reductions, it would not have to compute the safe harbor computations. However, if audited, the borrower would likely have to prove that no wage reductions occurred. It would be a good idea to keep copies of the payroll data from the beginning of the year through the end of the covered period to be able to prove that was true.
Q: When you are calculating the average FTE for the selected time periods, should you use pay periods “paid” during this time or do you calculate using hours worked during this period?
A: Guidance suggests that the forgivable loan portion is only reduced by either the reduction in FTEs or the reduction in salaries and hourly wages, but not both. The interim rules say that the salary and hourly wage reduction applies only to the portion of the decline in employee salary and wages that is not attributable to the FTE reduction. Therefore, you should calculate the average FTE for the selected time period based on hours actually paid for work. For example, if you had an employee that was salaried and got paid for working 40 hours a week but actually only worked 20 hours, then they are still considered a 1.0 FTE.
Q: If there are enough eligible payroll costs to spend all the loan proceeds, do you need to compile documentation for the non-payroll costs such as utilities, interest, rent, etc.?
A: No. If you use all the eligible payroll expenses and are able to fully get your PPP loan forgiven with just those eligible expenses, you do not need to record any of the non-payroll expenses and therefore will not need to show supporting documentation for those expenses.
Q: With the passage of the PPP Flexibility Act, is the 60% payroll cap required or can the 75% can still be used if favorable in the forgiveness calculation?
A: The cap is just the minimum amount of expense that can be used by the borrower towards payroll expenses in order to be able to forgive a portion of the loan. With the new cap at 60%, a borrower could meet that by having 70%, 75%, 85%, or 100% of its loan go towards payroll costs.
Q: If the 60% payroll expense spending requirement is not met, does that mean the entire loan is not forgivable, or just a portion of it?
A: The SBA’s April 15 rules specifically stated that not more than 25% of the loan forgiveness amount could be attributed to non-payroll expenses. The PPP Flexibility Act states that in order to receive loan forgiveness, an eligible recipient must use at least 60% of the covered loan for payroll costs and may use up to 40% for payment of non-payroll costs. The SBA’s June 9 guidance states that if a borrower uses less than 60% of the loan amount on payroll costs during the covered period, the borrower will be eligible for partial loan forgiveness, subject to at least 60% of the loan forgiveness amount having been used for payroll costs. It is also worth noting that the original forgiveness application seemed to limit forgiveness to 75% of payroll costs, when the statute allowed all covered loan proceeds to be used to pay payroll costs. We believe this mistake would have been or will be corrected with any other additional application changes.
Q: What do I do now if my PPP loan monies were all expended within the original 8-week covered period?
A: If you applied for and received the PPP loan funds prior to June 5, 2020 (the date the PPP Flexibility Act was signed), and you were able to expend all of the proceeds within the original 8-week covered period, you may elect for the covered period to end 8 weeks after the date of origination. You can work with your lender on submitting documentation after the original 8-week period.
Q: If the covered period is extended to 24 weeks but we meet the forgiveness requirements after 12 weeks, can we submit the forgiveness application at that time or do we have to wait to ensure our FTEs/salaries have not decreased on December 31, 2020?
A: At a minimum, you will need to wait at least until the end of the 24-week period because you have to calculate your average FTE number during the covered period to see if you have any reduction in your forgivable amount. Only if that number at the end of the covered period is less than the average FTEs during the reference period (which is the lower of the average FTEs during either Feb. 15, 2019 - June 30, 2019 or Jan. 1, 2020 - Feb. 29, 2020) would you need to wait until after December 31 to determine if you otherwise met the safe harbor standard. Details on calculating the FTE number are in the next question.
Q: Under the safe harbor rule and the 24-week covered period extension, when do we need to meet the FTE number?
A: This can be confusing, we broke it out by steps.
Step 1: Calculate your average FTE numbers for February 15, 2019 to June 30, 2019 and then also from January 1, 2020 to February 29, 2020 and use the smaller of the two numbers as the denominator of the following calculation. Seasonal employers can use an alternative method for this calculation.
There are two methods to calculate an average FTE. The first method is dividing the number of hours each employee is paid for by 40 hours and rounding the total to the nearest tenth. The maximum for each employee is capped at 1.0 (can’t use a number higher than 40 hours a week).
The second method is to assign all employees that work 40 hours a week a 1.0 and any employee that works fewer a 0.5. You can use either method as long as it is consistently used to compare.
Step 2: Calculate your average FTE numbers during the covered period (now the 24-week period starting on the date the loan was dispersed and ending 24 weeks later). This is the numerator.
Before the extension of the covered period from 8 weeks to 24 weeks, the SBA had allowed an alternate payroll covered period. We are unclear if this will remain as the extension will likely allow all borrowers to maximize their forgivable portion of the loan and it may no longer be necessary.
Step 3: For purposes of this step we have assumed that the SBA’s rules will be extended from 8-weeks to 24-weeks to align with the new rules. This step adds back into the numerator certain employees which are known on the application as FTE Reduction Exceptions. FTEs can be added back for any of the following:
(a) the borrower made a good-faith, written offer to rehire during the 24-week period which was rejected by the employee, as long as the position was not filled by a new employee
(b) any employees who, during the 24-week period, were fired for cause, voluntarily resigned, or voluntarily requested and received a reduction of their hours, as long as the position was not filled by a new employee
(c) where the borrower is able to document an inability to rehire individuals who were employees of the eligible recipient on February 15, 2020, and the borrower was unable to hire similarly qualified employees for unfilled positions on or before December 31, 2020
(d) where the borrower is able to document an inability to return to the same level of business activity it was operating at before February 15, 2020, due to compliance with requirements established or guidance issued by the Secretary of Health and Human Services, the Director of CDC, or OSHA during the period beginning March 1, 2020 and ending December 31, 2020 related to the maintenance of standards for sanitation, social distancing, or any other worker customer safety requirement related to COVID-19
Step 4: If the numerator, after adding back FTEs under Step 3, is equal to or greater than the denominator, then you have no reductions in your forgivable amounts due to the FTE numbers and you may file your application after the 24-week covered period.
If the numerator is less than the denominator, then proceed to Step 5 to see if a safe harbor exists which will require a borrower to wait until the end of the year to determine if the safe harbor is met.
Step 5: Determine if Safe Harbor applies.
a. Calculate the average FTE between February 15 and April 26, 2020. We will refer to this as the “Reduction Period FTE” even though it doesn’t have a technical name.
b. Calculate the average FTE for the pay period which includes February 15, 2020.
c. If (b) is greater than (a), go to (d). Otherwise, the safe harbor is not met.
d. Compute the total FTE number as of December 31, 2020. You can add back those employees into the numerator who were rehired by December 31, 2020 up to the amount of (b) minus (a).
Q: Now that the covered period is 24 weeks, will the $100,000 cap be changed as it currently only allows for $15,385 per individual?
A: Yes. The law seems to indicate that compensation of an individual employee in excess of an annual salary of $100,000 as prorated for the covered period is not included in eligible payroll costs. Thus, as the covered period under the PPP Flexibility Act is extended from 8 weeks to 24 weeks, the new cap on individuals making a salary of more than $100,000 should increase from $15,385 to $46,155. This needs to be confirmed by SBA in the next version of the application but it seems as though this would be the only appropriate interpretation.
Q: Does an employee-owner’s pay below $100,000 count towards forgiveness and where is an owner’s pay entered on the forgiveness application?
A: Yes. On the current application, this would be recorded on Schedule A, line 9. An owner’s salary is limited not only by the $100,000 annual salary cap but also further limited to only the equivalent annual salary paid during 2019. An owner of a business cannot record their wages on any other line other than line 9 of Schedule
If an owner’s cash compensation is less than the $100,000 annual salary cap and they are also an employee of the company, then the employer contributions for retirement and health care can be added into line 9. However, owners who are self-employed or are general partners cannot include any retirement or health contributions in line 9 even if they are below the $100,000 annual salary cap. All non-employee payroll expenses are included on lines 1 through 5 of Schedule A.