Paycheck Protection Program Offers Forgivable Loans for Eligible Small Businesses

April 5, 2020 | Kristine A. Tidgren

Update: On April 24, Congress replenished the PPP fund. Additional guidance was also provided: Congress Authorizes More Funds for PPP and EIDL and Says Farms Can Apply

Update: As of April 16, 2020, funds allocated to the PPP have been exhausted. We are watching to see if additional funds will be authorized.

Update: On April 14, SBA released interim guidance detailing calculation of loans and forgiveness for those who file Schedule Cs and partnerships. No reference to Schedule F, but same principles should apply. More to come! Total reliance on 2019 return (doesn't have to be filed, but must be prepared).

Update: On April 8, SBA released a few more questions and answers. In particular, the new information states that the "covered period" for the 8-week forgiveness period begins when the disbursement is made.

Note: This is an update to our March 30 article, incorporating guidance from the Small Business Administration's interim final rule (issued late in the day on April 2). The Treasury Department and the Small Business Administration continue to post new guidance on their websites. We will update this post as new developments unfold.


On Friday, March 27, 2020, the President signed into law H.R. 748, the Coronavirus Aid, Relief, and Economic Security (“CARES”) Act. The CARES Act contains a number of relief provisions designed to sustain Americans during the COVID-19 health and economic crisis. This post provides a general overview of a new small business loan program, the Paycheck Protection Program. Other posts detail individual tax provisions and business tax provisions

The Paycheck Protection Program, implemented by section 1102 of the CARES Act, expands the Small Business Administration 7(a) loan program to provide up to $349 billion in 100% federally-guaranteed loans to small employers and eligible self-employed individuals impacted by COVID-19. These loans are designed to be forgivable under section 1106 if requirements are met. While a number of details must still be filled in, this post provides an overview of the law as set forth in the statute. It also incorporates provisions from the interim final rule issued by the Small Business Administration on April 2.

Who is Eligible?

The CARES Act amends the Small Business Act to expand the small business loan program by creating section 7(a)(36), the Paycheck Protection Program. The program, administered through the Small Business Administration, expands the definition of eligible small businesses and organizations to include many not ordinarily eligible for an SBA loan. The SBA is authorized to guarantee loans under the Paycheck Protection Program, through June 30, 2020, although the loans are issued on a first-come, first-served basis. (page 13)

Definition: This program provides “covered loans” during the “covered period.” For purposes of section 1102, the term “covered loan” means a loan made under the program during the covered period. The term “covered period” under section 1102 means the period beginning on February 15, 2020, and ending June 30, 2020. For purposes of section 1106 (loan forgiveness), the covered period is the 8-week period beginning on the date of the origination of a covered loan. “Covered loan” has the same definition in each section.

Eligible Businesses

Specifically, during the covered period, in addition to "small business concerns" meeting standards under current SBA regulations, any:

  • business concern,
  • 501(c)(3) nonprofit,
  • veterans’ organization, or
  • Tribal business concern

shall be eligible to receive a covered loan if the business concern, nonprofit organization, veterans’ organization or Tribal business concern employs 500 or fewer employees. Additionally, a business that operates in a certain industry and meets the applicable SBA employee-based size standards for that industry is also eligible, even if it employs more than 500 employees. The term “employee” for purposes of determining how many employees a business employs includes individuals employed on a full-time, part-time, or other basis. Additionally, businesses with a North American Industry Classification System (NAICS) code beginning with 72 are eligible to receive a loan if a multi-location business does not employ more than 500 employees per physical location. NAICS code 72 comprises lodging and restaurant businesses.

Note: The interim final rule states, “You are eligible for a PPP loan if you have 500 or fewer employees whose principal place of residence is in the United States.” (page 5) FAQ Number two clarifies that a business can have more than 500 employees if it also meets the definition of a "small business concern."

Observation: There is no additional restriction on agricultural businesses applying for PPP loans. Although agricultural enterprises have been ineligible for SBA 7(b) loans, section 7(a) has no such restriction. Nor does the statute place a revenue limit on these businesses. Businesses do not count workers with a principal place of residence outside of the U.S. Nor do they get to include those employees’ wages in payroll costs (see below). It is currently unclear whether agricultural enterprises are eligible for the expanded EIDL 7(b) loans within the CARES Act. We are awaiting further guidance. It seems to have been the intent of Congress to include them, but 7(b) states that the SBA is authorized to provide disaster loans, except as to "agricultural enterprises." That language was not changed by the CARES Act.

Note: The interim final rule states that if you meet the above criteria you must also have been in operation on February 15, 2020, and either (1) had employees for whom you paid salaries and payroll taxes or (2) paid independent contractors as reported on Form 1099-MISC. These requirements are found in section 7(a)(36)(F)(ii)(II)(BB) in the statute informing lenders of a borrower’s eligibility requirements. (page 6) This certification is also required on applications. (page 17)

Observation: The purpose of the requirement to have paid independent contractors is not clear since the interim rule specifies that borrowers are not allowed to count 1099-MISC payments in their payroll costs because independent contractors are eligible in their own right to apply for the loan. (pages 11, 15)  If businesses are not allowed to consider payments made to independent contractors, why is this an eligibility consideration? Or, conversely, if businesses are eligible if they make payments to independent contractors, why do those payments not count as “payroll costs?” See also the discussion in the next section (“Eligible Self-Employed Individuals”) regarding this section’s application to self-employed individuals and independent contractors in their own right.

Eligible Self-Employed Individuals

During the covered period, individuals who operate under a sole proprietorship or as an independent contractor, and “eligible self-employed individuals” shall also be eligible to receive a covered loan. The term “eligible self-employed individuals” is defined as it is in the Families First Coronavirus Response Act. It includes any individual who:

  • Regularly carries on any trade or business within the meaning of IRC § 1402 and
  • Would be entitled to receive paid leave during the taxable year pursuant to the Emergency Paid Sick Leave Act (created by the Families First Coronavirus Response Act) if the individual were an employee of an employer other than himself or herself.

An eligible self-employed individual, independent contractor, or sole proprietorship seeking a covered loan must submit documents to establish the individual as eligible, including payroll tax filings, Forms 1099-MISC, and income expenses from the sole proprietorship, as determined by the SBA.

Note: In discussing the eligibility for individuals operating as a sole proprietor, independent contractor, or eligible self-employed individual, the interim final rule does not reference the requirement that you must have (1) had employees for whom you paid salaries or (2) paid independent contractors. In this section, the rule states only that you must have been in operation on February 15, 2020, and that you must submit documentation necessary to establish eligibility such as payroll processor records, payroll tax filings, or Form 1099-MISC, or income and expenses from a sole proprietorship. If these borrowers do not have the required documentation, the rule states that the borrower must provide other supporting documentation, such as bank records, sufficient to demonstrate the qualifying payroll amount (page 6).

Observation: The statute and the rules lack clarity with respect to the eligibility requirements for partners, owners of LLCs taxed as partnerships, sole proprietors, and self-employed individuals who do not have true “employees” or do not engage independent contractors. It seems clear that such businesses qualify and can include their own self-employment earnings as “payroll costs” if they either (1) had employees for whom they paid salaries and payroll taxes or (2) paid independent contractors, as reported on a Form 1099-MISC (the current application requires such an affirmation, as directed on page 17 of the interim rule). It is unclear, however, how the law applies to those who cannot make this affirmation. It appears that the interim rule may not be imposing this eligibility requirement on the self-employed. (See page 6)

Many lawmakers have also spoken of the PPP program helping gig economy workers and self-employed workers like hair salon owners with no employees. It remains unclear, however, how this interpretation aligns with the statutory language and the current loan application. It would not seem to be Congress’ intent that an owner of an S Corporation could qualify, but a partner would not, in an otherwise identical business environment. Nor would it seem logical that a self-employed person who sent a 1099-MISC to an attorney would qualify, but another self-employed person who sent no 1099-MISC would not. It is also unclear the distinction among these categories and “sole proprietors” who were eligible to apply April 3. We must await further guidance; no doubt being created in anticipation of the April 10 application start date for the self-employed and independent contractors. Perhaps the guidance will consider these individuals “employees” for purposes of meeting the section 7(a)(36)(F)(ii)(II)(BB) eligibility requirement.

Affiliations

SBA rules applicable to affiliations generally continue to apply, except that these rules are waived with respect to eligibility for a covered loan for:

  • Accommodation and food service industry business concerns with not more than 500 employees on the date the covered loan is disbursed
  • Any business concern operated as a franchise that is assigned a franchise identifier code by the SBA
  • Any business concern receiving financial assistance from a company licensed under section 301 of the Small Business Investment Act

Note: The interim final rule states that the SBA intends to promptly issue additional guidelines with regard to the applicability of existing affiliation rules. (page 7) These rules were published on April 3.

Who is Ineligible?

The interim final rule states that potential borrowers are ineligible for PPP loans if, for example:

  • They are engaged in any activity that is illegal under federal, state, or local law;
  • They are a household employer (individuals who employ household employees such as nannies or housekeepers) (this restriction is in place because this is not a “business”);
  • They are an owner of 20 percent or more of the equity of the applicant is incarcerated, on probation, on parole; presently subject to indictment, criminal information, arraignment, or other means by which formal criminal charges are brought in any jurisdiction; or has been convicted of a felony within the last five years; or
  • They, or any business owned or controlled by them has ever obtained a direct or guaranteed loan from SBA or any other federal agency that is currently delinquent or has defaulted within the last seven years and caused a loss to the government. (page 7)

Note: The interim final rule states that ineligible businesses are specifically identified in 13 C.F.R. 120.110, described further in SBA’s Standard Operating Procedure (SOP) 50 10, Subpart B, Chapter 2, except that nonprofits authorized under the CARES Act (501(c)(3)’s are eligible). (page 8)

Loan Description

Maximum Loan Amount

During the covered period, the maximum loan amount is generally the lesser of: (1) $10,000,000 or (2) 250 percent of the average monthly payroll costs incurred during the one-year period before the date on which the loan is made, plus any refinanced Economic Injury Disaster loans received after January 31, 2020.

Startups that were not in business between February 15, 2019, and July 30, 2019, calculate average monthly payroll costs based upon the period beginning January 1, 2020, through February 29, 2020. Seasonal employers may calculate the average monthly payroll costs based on the 12-week period beginning on February 15, 2019 or, alternatively, the period from March 1, 2019 through June 30, 2019.

Note: The interim final rule states that the following methodology, which is one of the methodologies contained in the CARES Act, will be most useful for many applicants.

Step 1: Aggregate payroll costs from the last twelve months for employees whose principal place of residence is the United States.

Step 2: Subtract any compensation paid to an employee in excess of an annual salary of $100,000 and/or any amounts paid to an independent contractor or sole proprietor in excess of $100,000 per year.

Step 3: Calculate average monthly payroll costs (divide the amount from Step 2 by 12).

Step 4: Multiply the average monthly payroll costs from Step 3 by 2.5. 

Step 5: Add the outstanding amount of an Economic Injury Disaster Loan (EIDL) made between January 31, 2020 and April 3, 2020, less the amount of any “advance” under an EIDL COVID-19 loan (because it does not have to be repaid).

(The interim rule also contains a number of examples, beginning on page 9.)

Observation: This methodology (and the statutory language) suggest that payroll costs “from the last twelve months” are to be considered.” On page 21 of the rule, however, lenders are directed to verify average payroll costs for the “preceding calendar year.” And, the application states, “for purposes of calculating ‘Average Monthly Payroll,’ most Applicants will use the average monthly payroll for 2019, excluding costs over $100,000 on an annualized basis for each employee.” Future guidance should clarify. FAQ number 14 states that "borrowers can calculate their aggregate payroll costs using data either from the previous 12 months or from calendar year 2019. For seasonal businesses, the applicant may use average monthly payroll for the period between February 15, 2019, or March 1, 2019, and June 30, 2019. An applicant that was not in business from February 15, 2019 to June 30, 2019 may use the average monthly payroll costs for the period January 1, 2020 through February 29, 2020." Borrowers may use their average employment over the same time periods to determine their number of employees.

Payroll Costs

Payroll costs” include compensation with respect to compensation to employees (whose principal place of residence is the United States) that includes:

  • salary, wages, commissions, and similar compensation;
  • payment of cash tips or equivalent;
  • payment for vacation parental, family, medical, or sick-leave;
  • allowance for dismissal or separation;
  • payment required for group health care coverage, including insurance premiums and retirement;
  • payment of state or local tax assessed on employee compensation;
  • the sum of payments of any compensation to or income of a sole proprietor or independent contractor that is a wage, commission, income, net earnings from self-employment, or similar compensation and that is in an amount that is not more than $100,000 in one year, as prorated for the covered period.

Note: The interim final rule summarizes the statutory language in the last bullet point as follows, “for an independent contractor or sole proprietor, wage, commissions, income, or net earnings from self-employment or similar compensation.” (page 10)

Note: The interim final rule states that independent contractors do not count as employees for purposes of PPP loan calculations. The rule explains that “independent contractors have the ability to apply for a PPP loan on their own so they do not count for purposes of a borrower’s PPP loan calculation.” (page 11) FAQ number 15 affirms this statement.

Payroll costs do NOT include:

  • compensation of an individual employee in excess of an annual salary of $100,000, as prorated for the covered period;
  • federal employment or withholding taxes imposed during the covered period;
  • compensation to an employee whose principal residence is outside of the U.S.;
  • qualified sick leave for which a credit is allowed under section 7001 of the Families First Coronavirus Response Act (other sick leave qualifies (FAQ number 8); and
  • qualified family leave wages for which a credit is allowed under sections 7001 and 7003 of the Families First Coronavirus Response Act

Note: The interim final rule specifies that federal employment or withholding taxes include, “Federal employment taxes imposed or withheld between February 15, 2020, and June 30, 2020, including the employee’s and the employer’s share of FICA and Railroad Retirement Act taxes, and income taxes required to be withheld from employees.” (page 11)

Observation: A significant and unfortunate ambiguity in the law was how payroll costs are to be calculated, both for the purpose of determining the loan amount and for the purpose of loan forgiveness.  FAQ number 16 addresses this issue by stating that "payroll costs are not reduced by taxes imposed on an employee and required to be withheld by the employer, but payroll costs do not include the employer’s share of payroll tax." This interpretation applies for loan qualification, loan use, and loan forgiveness purposes. The footnote in the FAQ explains, "because the reference period for determining a borrower’s maximum loan amount will largely or entirely precede the period from February 15, 2020, to June 30, 2020, and the period during which borrowers will be subject to the restrictions on allowable uses of the loans may extend beyond that period, for purposes of the determination of allowable uses of loans and the amount of loan forgiveness, this statutory exclusion will apply with respect to such taxes imposed or withheld at any time, not only during such period."

It is also unclear at this point, whether the costs of health insurance and other benefits count toward the $100,000 cap on employee compensation that can be considered “payroll costs.” The interim final rule that references “annual salary” in its calculation examples (pages 10-11), perhaps suggests that only excess salary is excluded. Other sections in the statute and the rule, however, seem to suggest that overall compensation, including benefits costs, apply to the cap. FAQ number seven answers this question by stating that only cash compensation, not non-cash benefits, in excess of $100,000 must be excluded from payroll costs.

Allowable Uses

During the covered period, recipients may use the proceeds of a covered loan for the following purposes:

  • Payroll costs (as defined above)
  • Costs related to the continuation of group health care benefits during periods of paid sick, medical or family leave, and insurance premiums
  • Employee salaries, commissions, or similar compensation (the interim rule does not separately list this provision as the statute had)
  • Payments of interest on any mortgage obligation (not including prepayments or the payment of principal)
  • Rent (including rent under a lease agreement)
  • Utilities
  • Interest on any other debt obligations that were incurred before the covered period (February 15, 2020).

Note: The interim final rule provides that those who received an SBA EIDL loan from January 31, 2020, through April 3, 2020, can apply for a PPP loan. If the EIDL loan was not used for payroll costs, it does not affect eligibility. If the EIDL loan was used for payroll costs, the PPP loan must be used to refinance the EIDL loan. Proceeds from any advance up to $10,000 on the EIDL loan will be deducted from the loan forgiveness amount on the PPP loan. (page 15)

75 Percent of the PPP Loan Proceeds

The interim final rule states that at least 75 percent of the PPP loan proceeds shall be used for “payroll costs.” (page 16) For purposes of determining percentage of use, the amount of any refinanced EIDL will be included. For purposes of loan forgiveness, however, the borrower will have to document the proceeds used for payroll costs in order to determine the amount of forgiveness. The rule states that this guidance is warranted based upon the limited amount of funds available and Congress’ overarching goal of keeping workers paid and employed.

Misuse

If PPP funds are used for unauthorized purposes, SBA will require the borrower to repay the loan, and the borrower may be subject to additional liability, such as charges for fraud.

Loan Terms

The statute provided that the non-forgiven portions of these loans have a maximum maturity of ten years from the date the borrower applies for loan forgiveness. The interest rate on the loans could not exceed four percent, and lenders must provide complete interest and principal payment deferment relief for at least six months (and up to one year). Additionally, the non-recourse loans (to the extent they are used for authorized purposes) require no personal guarantee or collateral. Borrowers are not required to prove that they cannot obtain the funds elsewhere, and there is no prepayment penalty or SBA fee.

Note: The interim final rule establishes the actual specifics of the PPP loan terms as follows:

  • Interest rate of 1 percent
  • Maturity date of two years
  • One loan per borrower
  • e-signatures may be used
  • Loans are first-come, first-served
  • Recipients will not have to make payments for six months following disbursement, although interest will continue to accrue

(pages 12-13, 25)

Applications

Considerations

Potential borrowers must file their applications with an SBA-approved lender. For purposes of making covered loans, a lender approved to make loans under the program shall be deemed to have been delegated authority by the SBA Administrator to make and approve covered loans, without separate SBA approval. In evaluating the eligibility of a borrower for a covered loan, a lender shall consider whether the borrower was in operation on February 15, 2020, and (1) had employees for whom the borrower paid salaries and payroll taxes or (2) paid independent contractors, as reported on a Form 1099-MISC. (pages 17, 21)

Those applying for a covered loan must make a good faith certification that:

  • The uncertainty of current economic conditions makes necessary the loan request to support the ongoing operations, 
  • That the funds will be used to retain workers and pay eligible expenses,  
  • That the applicant does not have an application pending for another loan for the same purpose, and
  • That for the period beginning on February 15, 2020, and ending on December 31, 2020, the eligible recipient has not received amounts under the program for the same purpose

Note: The interim final rule adds additional certifications, as does the final application, which was posted on April 2. One certification says, “The applicant was in operation on February 15, 2020, and had employees for whom it paid salaries and payroll taxes or paid independent contractors, as reported on Form 1099-MISC.”

Observation: It is unclear how this certification (which is a requirement set forth in section 7(a)(36)(F)(ii)(II)(BB)) of the statute applies to the self-employed. It is possible that a different application may be made available in anticipation of the April 10 application date for independent contractors and the self-employed. See above sections for additional discussion of this requirement.

Additional Lenders

The law extends the authority to make Paycheck Payment Program loans (but not other SBA loans) to additional lenders determined by the SBA Administrator and the Secretary of the Treasury to have the necessary qualifications to process, close, disburse, and service loans made with the guarantee of the SBA.

Lenders authorized to make covered loans are eligible to be reimbursed from the SBA Administrator at a rate of (based on the balance of the financing outstanding at the time of disbursement of the covered loan):

  1. Five percent for loans of not more than $350,000
  2. Three percent for loans of more than $350,000 and less than $2,000,000, and
  3. One percent for loans of not less than $2,000,000.

(page 24)

Prioritization of Loans - "Sense of the Senate"

The statute states:

It is the sense of the Senate that the Administrator should issue guidance to lenders and agents to ensure that the processing and disbursement of covered loans prioritizes small business concerns and entities in underserved and rural markets, including veterans and members of the military community, small business concerns owned and controlled by socially and economically disadvantaged individuals, women, and businesses in operation for less than 2 years.

Loan Forgiveness

Section 1106 outlines the loan forgiveness available for “covered loans,” which are loans guaranteed under the Paycheck Protection Program. Generally, a borrower is eligible for loan forgiveness on a covered loan in an amount equal to the sum of the following costs incurred and payments made during the covered period (which for purposes of section 1106 means the 8-week period beginning on the date of the origination of a covered loan):

  • payroll costs (as defined in the above section)
  • any interest payment on any covered mortgage obligation (which shall not include any prepayment of or payment of principal on a covered mortgage obligation)
    • “Covered mortgage obligation” means an indebtedness or debt instrument incurred in the ordinary course of business that (a) is a liability of the borrower, (b) is a mortgage on real or personal property, and (c) was incurred before February 15, 2020.
  • payment of any covered rent obligation
    • “Covered rent obligation” means rent obligated under a leasing agreement in force before February 15, 2020.
  • covered utility payments
    • “Covered utility payment” means payment for a service for the distribution of electricity, gas, water, transportation, telephone, or internet access for which service began before February 15, 2020.

Note: The interim final rule states that independent contractors do not count as employees for purposes of loan forgiveness (page 15)

The amount of loan forgiveness can be up to the full principal amount of the loan and any accrued interest. That is, the borrower will not be responsible for any loan payment if the borrower uses all of the loan proceeds for forgivable purposes and employee and compensation levels are maintained. (page 13) Amounts forgiven are cancelled indebtedness by the lender authorized under section 7(a) of the Small Business Act. Within 90 days after the date on which the forgiveness is determined, the SBA Administrator will remit to the lender the amount of the forgiven loan, plus any interest accrued through the date of the payment.

Limits on Forgiveness

The amount of loan forgiveness cannot exceed the principal amount of the financing made available.

Note: The interim final rule also imposes the requirement that not more than 25 percent of the loan forgiveness amount may be attributable to non-payroll costs. This requirement, the rule states, ensures that finite program resources are devoted primarily to payroll. (page 14)

The forgiveness amount is also subject to reduction if there is a reduction in employees or a reduction in the salary or wages of any employee.

Reduction of Number of Employees

The loan forgiveness will be reduced by multiplying the presumed forgiveness amount by (the average full-time equivalent employees (FTEs) during the covered period ÷ average FTEs for the period from February 15, 2019 through June 30, 2019 or January 1, 2020 through February 29, 2020, at the election of the borrower). Special rules apply to seasonal employers.

Salary and Wage Reduction

The loan forgiveness will be reduced by any reduction in total salary or wages of any employee during the covered period that is in excess of 25 percent of the total salary or wages during the most recent full quarter during which the employee was employed before the eight-week coverage period. Employees who received, during any single pay period during 2019, wages or salary at an annualized rate of pay in excess of $100,000 are not included in this calculation.

Reductions in employees, salaries and wages that occur between February 15, 2020 and April 26, 2020, are disregarded for purposes of the forgiveness reduction as long as the reductions are eliminated by June 30, 2020.

Note: The interim final rule states that the SBA will issue additional guidance on loan forgiveness.

Application for Loan Forgiveness

Borrowers must apply for forgiveness with the lender servicing the loan. The application for the forgiveness shall include:

  • Documentation verifying the number of FTE equivalent employees on payroll and pay rates, including:
    • Payroll tax filings reported to the IRS and State income, payroll, and unemployment insurance filings
  • Documentation, including cancelled checks, payment receipts, transcripts of accounts, or other documents verifying payments on covered mortgage obligations, payments on covered lease obligations, and covered utility payments
  • A certification that the documentation is true and correct and the amount for which forgiveness is requested was used to retain employees, make interest payments on a covered mortgage, make payments on a covered rent obligation, or make covered utility payments,
  • Any other documentation the SB Administrator determines necessary

No forgiveness will be granted absent the required documentation. Lenders have 60 days to review and make a determination on the forgiveness application. The lender will be held harmless for decisions made based upon erroneous documentation. Any portion of the loan that is forgiven will be excluded from the gross income of the borrower.The statute does not reference section 108 regarding this exclusion.

Guidance and Applications

A number of questions remain regarding implementation of this important law, particularly with respect to the self-employed, payroll cost calculations, and forgiveness. The SBA continues to release guidance. Potential borrowers must also evaluate and compare other options provided by the CARES Act, including the employee retention credit and the option to defer payroll taxes (Paycheck Protection Program borrowers are not eligible for the ERC, and those who receive loan forgiveness are not eligible to defer payroll taxes). Interested small businesses should consult with their lenders immediately regarding their specific requirements for the program. Applications began April 3, 2020, for small businesses and sole proprietorships. Starting April 10, 2020, independent contractors and self-employed individuals can apply.