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Additional Information on Paycheck Protection Program Loans and Forgiveness

Posted by Richard G. Pearce, Jr. | Apr 08, 2020 | 0 Comments

As expected, the Paycheck Protection Program (“PPP”) created by the CARES Act rolled out on April 3, 2020 with a thud.  Without regulations, we thus far only have an “interim final rule” from the SBA to explain a little more about the PPP and the fact that many banks either are not ready to implement the PPP or else they are currently only willing to process loans for pre-existing business customers.

Although the CARES Act stated that the PPP could have a loan term of up to ten years and an interest rate of up to 4%, the interim final rule states that the term of the loans will be 2 years and the interest rate only 1%. In addition, the SBA has said that loan payments will be deferred for the first six months, but that interest will accrue during that time.

Here are some other updates and considerations:

  • Independent contractors and self-employed individuals can begin applying on April 10.
  • We still have no real guidance on s-corporation owners and owners of entities taxed as partnerships, but they are certainly intended to benefit from the PPP. 
  • Not more than 25% of the loan forgiveness amount may be attributable to nonpayroll costs such as rent and utilities. This is from the interim final rule and not from the Act, so while I would follow this rule, it would not surprise me if litigation ensues from the contrary decision.  This is a perfect example of why even when these types of rules and the regulations come out, there will still be questions and likely litigation from how the regulations misinterpret the CARES Act. 
  • I recommend using the AICPA's PPP calculator to determine how much you can borrow.
  • Still consider borrowing under the EIDL program first if you need those funds, but it is not necessarily the best idea to roll them into the PPP.  Rather it depends on the amount you borrow and your EIDL loan terms compared to the PPP.  Keep in mind that you cannot borrow money under the two programs for the same purposes.
  • The interim final rule states that if your EIDL loan was not used for payroll costs, then it does not affect your eligibility for a PPP loan, but if the EIDL funds are used for payroll costs, then your PPP loan “must” be used to refinance your EIDL loan. 

Finally, I want to talk through one example of how much you can borrow under the PPP, how much should be forgiven and why, under some circumstances, it may be best to terminate employees even if it would reduce the amount that is ultimately forgiven. Here are the background facts of our example:

  • A dental practice s-corporation had 5 FTE employees for all of 2019 and 6 FTE employees from January 1, 2020 through February 29, 2020, including the dentist. 
  • The dentist made $200,000 ($150,000 salary and $50,000 profit distribution) and the rest of his staff had annual compensation in the aggregate of another $200,000 over the 12 month period preceding the PPP loan. 
  • The dentist terminated 2 FTE employees on April 1, 2020, leaving 4 FTE employees, including the dentist, on the books going forward.
  • As a result, the dentist's average monthly payroll starting April 1, 2020 is $11,666.66 based on an annual compensation rate of $140,000 per year for the staff, and for purposes of this situation, we will treat the dentist as receiving compensation at the annual rate of the maximum $100,000 for the year starting April 1, 2020, or a monthly rate of $8,333.33.  These two amounts mean that the total monthly payroll is $20,000.
  • The dentist's rent and utilities during the eight week forgiveness period are $12,000. 

The payroll costs for PPP loan purposes are $300,000, because only the first $100,000 of any employee's compensation is counted for PPP purposes.  Divide $300,000 by 12 to get the average monthly payroll of $25,000 and then multiply it by 2.5 to get the maximum loan amount of $62,500. 

Because the dentist terminated 2 FTEs on April 1st, his payroll over the eight week forgiveness period is $40,000 ($20,000 per month x 2 months).  I understand that two months is not the exact same as eight weeks, but it makes the math much easier to simplify the timing.  This amount, plus the $12,000 of rent and utilities would result in a total loan forgiveness of $52,000, leaving $10,500 to be repaid over two years at 1% interest. This complies with the interim final rule requirement of not more than 25% of the loan forgiveness amount being attributable to non-payroll costs, as $13,000 is 25% of the $52,000 of forgiveness being sought.

Next, we have to determine whether the $52,000 to be forgiven is reduced as a result of terminating the 2 FTEs on April 1, 2020.  The PPP states that the loan forgiveness is reduced based on the average number of FTEs per month during the eight week forgiveness period divided by either i) the average number of FTEs per month from February 15, 2019 through June 30, 2019; or ii) the average number of FTEs per month from January 1, 2020 through January 29, 2020.  The borrower gets to choose which of i) or ii) is to be used.  In our case, the dentist had 4 FTEs during the 8 week forgiveness period, 5 FTEs from February 15, 2019 through June 39, 2019, and 6 FTEs from January 1, 2020 through January 29, 2020.  The dentist would choose the February 15, 2019 through June 30, 2019 period, because that results in a 4/5 ratio instead of a 4/6 ratio.  That 4/5 ratio would be multiplied against the $52,000 forgiveness sought and result in only $41,600 being forgiven.

There is, however, an option to rehire employees and therefore improve the above ratio.  It only applies if the employer has i) reduced the number of FTEs between February 15, 2020 and April 26, 2020 compared to the number of FTEs the employer had on February 15, 2020; and ii) not later than June 30, 2020 “eliminated the reduction” in FTEs, meaning that the employer has rehired the same number of FTEs.  The rehires do not necessarily have to be the same people for the same jobs or at the same pay rate. This would apply to our dentist since he terminated two FTEs on April 1, 2020, and it means that so long as he rehires two FTEs by June 30, 2020, then he would still be eligible for the full $52,000 of forgiveness instead of $41,600.

This raises an interesting question.  Is it better to have the additional $10,400 forgiven, or is it better to owe that $10,400 over two years at 1% interest but then save $5,000 a month on payroll because of the two FTEs that the dentist terminated on April 1, 2020?  If the loan is obtained on May 1, 2020 and then the eight week forgiveness period runs through essentially July 1, 2020, then the dentist has saved $15,000 during that three month period alone. 

Why wouldn't the dentist save effectively all of that $15,000 by waiting until June 30, 2020 to rehire the two FTEs and get the best of both worlds by still getting the full loan forgiveness?  That will likely be the best way to proceed if the dentist can rehire two FTEs at the last second (expect some craziness there in terms of fighting over obtaining FTEs at the last second and employees perhaps demanding a raise to be rehired).  But then there is a provision, buried elsewhere in the CARES Act, that states that the loan programs may require that until September 30, 2020, the eligible business must maintain its employment levels as of March 24, 2020, to the extent practicable, and in any case shall not reduce its employment levels by more than 10% from the levels on March 24, 2020.  At first, many interpreted this provision to be yet another requirement on loan forgiveness, although I am not seeing that interpretation as much now.  That said, such a requirement would be consistent with the goal of encouraging maintaining employment levels, and the SBA has already overreached at least once as mentioned above, so do not be surprised if the dentist has to maintain employment levels for some period of time as a condition of forgiveness.  If we interpret this requirement as another forgiveness requirement, and the dentist can rehire the 2 FTEs at the same compensation of $5,000 per month, then the dentist would have to pay these employees $15,000 from July 1, 2020 through September 30, 2020 in order to have $10,400 forgiven.  Perhaps at that point, if this situation applies, the analysis becomes whether those employees are actually needed at that time?  If so, then rehire the employees by June 30, 2020, get the full forgiveness and then keep them through September 30, 2020 and hopefully beyond.  But if those employees are not needed, then it may be best to save the payroll but lose some forgiveness. 

That may be a good example of why this situation is so fluid and so difficult to set out in stone right now.  Not only will the law likely change over the next few months as this is implemented, but your needs will also likely change.  The key is to take the time to understand the PPP now and then stay on top of it throughout the process, so that you can make decisions that are best for your situation.  Just understand that the best decision may not always be to rehire employees.

Also, keep in mind that virtually all of the above analysis regarding the reduction in the number of employees will also apply to the reduction in the compensation by an amount greater than 25% of any employee retained during the 8 week period compared to what he or she earned during prior full calendar quarter.  If you terminate an employee during that 8 week period, then your formula will be harmed significantly, but the same rehire opportunity by June 30, 2020 applies. 

Please do not hesitate to contact me if you have any questions or want to work through your situation.  This is a very difficult time for everyone and we all need to stay informed to take advantage of this opportunity.

About the Author

Richard G. Pearce, Jr.

Richard G. Pearce, Jr. is a Chattanooga native, having attended Boyd Buchanan for elementary school and McCallie for high school, graduating in 1997.  He then attended Samford University in Birmingham, Alabama, graduating in 2001 with a bachelor's degree in business administration.  More importan...


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