In order to for your Paycheck Protection Program (“PPP”) loan to be forgiven by the Federal Government, you will need to comply with the requirements for use of funds set forth in the CARES Act (the “Act”) and elaborated upon by the Small Business Administration (the “SBA”). At Phocus Law, we have reviewed the Act, the SBA directives, and have spoken at length with lenders who will be involved in the forgiveness process. Below, we have compiled a list of the things you will need to do in order for your PPP loan to be forgiven. We have also included some practical applications and insights to better illustrate implementation of these concepts.
PLEASE NOTE: While this is a thorough review, do not rely solely on this document to ensure your full compliance. Full compliance will likely require consultation with an attorney or financial professional. Please feel free to contact Phocus Law for further assistance.
The Skinny
You are getting a “loan” from the government. The loan covers an 8-week period of your business’ operation. It is primarily to be used for payroll costs. It can be forgiven, if you follow the requirements set out in the Act and by the SBA; otherwise it must be paid back with 1% interest. The information the government will uses to determine your Loan Proceeds, and also your compliance obligations, are your business’ previous payroll and headcount information, for specific periods of time identified below.
Important Definitions
– Loan Proceeds: Money you receive from the SBA through the PPP Loan Program.
– Payroll Costs: Wages, salaries, healthcare benefits (ex: insurance premiums), covered leave, local and state payroll taxes, and certain payments to independent contractors.
– Operating Expenses: Rent/lease payments, mortgage interest obligations, utilities, or internet fees.
– Loan Period: The 8-week period beginning on the loan funding date.
– FTEs: Full-time equivalents, an employee count calculated as follows: (All employees working 30+ hours per week) + (Sum of all hours worked by all employees working less than 30 hours per week divided by 30).
– Baseline Headcount: The average number of FTEs per pay period for the Loan Period that borrower had during EITHER of the following TWO periods: 1) from February 15, 2019 to June 30, 2019; or 2) from January 1, 2020 to February 29, 2020.
– Average Headcount: The average number of FTEs per pay period during the Loan Period.
– Loan Period Income: Salary and/or wages paid to employees during the Loan Period. – Baseline Income: The average salary/wages for each employee for the three-month period preceding February 15, 2020
1. Allocation of Loan Proceeds: In order for the Loan Proceeds to be fully forgiven, no more than 25% of the Loan Proceeds may be allocated to non-payroll costs. Whatever Loan Proceeds remain after Payroll Costs have been paid, and ONLY UP TO 25% of the total Loan Proceeds, may be used for Operating Expenses.
• Practical Application: Upon receiving Loan Proceeds, borrowers should calculate their expected Payroll Costs for the eight-week period, beginning with the loan’s funding date. If those Payroll Costs do not account for 75% of the total Loan Proceeds, then only an equivalent of one-third of the calculated Payroll Cost Amount should be spent on Operating Expenses. Allocating 75% or more to Payroll Expenses is necessary for full forgiveness of the PPP loan.
2. Headcount: In order for the loan to be completely forgiven, the borrower must have the same or greater average number of FTEs per pay period for the Loan Period as borrower had during EITHER of the following TWO periods: 1) from February 15, 2019 to June 30, 2019; or 2) from January 1, 2020 to February 29, 2020. The borrower may elect which period to use in the calculation. This is your “Baseline Headcount”. If this headcount requirement is not met, the forgivable portion of the loan will be recalculated by: 1) DIVIDING the average number of employees during the loan period (the “Average Headcount”) by the average number of employees from the selected time period; and then 2) MULTIPLYING the result by the loan amount.
• Practical Application:
i. Loan value = $100,000.
ii. Baseline Headcount = 20.
iii. Average Headcount = 16.
16/20 = 0.8. 0.8*100,000 = $80,000.
$80,000 will be the maximum forgivable balance.
• Good Practices: Borrowers should consider hiring (or rehiring) FTEs sufficient to equal the Baseline Headcount, whether there is work for them or not. For every FTE below the Baseline Headcount, the forgivable amount is reduced. Once the loan period expires, borrowers can reduce their headcount as needed without jeopardizing forgiveness. A borrower should review their records and determine during which of the two periods referenced above its business had fewer FTEs. The lesser number of FTEs will be the Baseline Headcount and is the number of FTEs the borrower should strive to average over the loan period.
3. Income Reduction: In order for the Loan Proceeds to be fully forgiven, no employee’s salary/wages may be reduced by more than 25% during the loan period when compared to the average salary/wages that employee earned during their most recent full quarter of employment prior to February 15, 2020. Any reduction in an employee’s salary/wages exceeding 25% will not be forgiven, EXCEPT that a reduction for a salary down to $100,000 will be exempt from this provision. Any reduction to an individual employee’s wages that occurred between February 15, 2020 and April 26, 2020 will not be considered in reducing the forgiveness amount if the reduction is restored by June 30, 2020.
• Good Practices: Borrowers should review their payroll for three months preceding February 15, 2020 and determine the average salary/wages for each employee (the “Baseline Income”). Borrowers should then confirm that the average salary/wages that will be paid during the loan period (the “Loan Period Income”) will not result in a reduction exceeding 25% from the Baseline Income amount for any employee (a “Noncompliant Reduction”). If any Noncompliant Reductions have occurred, whether by borrower’s action or by any other cause (reduction in commissions, tips, etc.), each dollar exceeding a 25% reduction over the course of the loan period would reduce the forgivable amount of the Loan Proceeds. (ex: Employee Baseline Income: $4000/mo. Loan Period Income: $2000. $4000*.25= $1000. Total reduction less Noncompliant Reduction = $1000. $1000 of the Loan Proceeds would not be forgivable.)
• Practical Application:
i. Employee Baseline Income: $4000/mo. Loan Period Income: $2000.
ii. $4000*.25= $1000.
iii. Total reduction less Noncompliant Reduction = $1000.
iv. $1000 of the Loan Proceeds would not be forgivable.)
4. June 30 Corrections: Per the CARES Act, any Headcount noncompliance or Noncompliant Reductions that occur during the loan period will not be taken into account in reducing forgiveness if the reduction in employees or income restored by June 30, 2020.
• The June 30 Correction clause should be viewed as allowing a margin of error for borrowers who strive to comply but, in their final calculations realize a slight failure to comply. By correcting that failure to comply by June 30, they are able to avoid harsh consequences.
5. Ahead Of The Curve: While the SBA has not yet released its application or administrative procedures for forgiveness, those can be expected to be substantially similar to the initial application process in their simplicity and reliance on the borrower for honesty. Still, it will be the borrower’s responsibility to be able to show that the Loan Proceeds were allocated in a manner consistent with the forgiveness requirements. With that in mind, the following guidelines, if adhered to, will further improve the likelihood that the borrower’s Loan Proceeds qualify for forgiveness:
• Consider establishing a separate checking account to be used to receive Loan Proceeds and fund disbursements. This will simplify recordkeeping for Loan Proceeds.
• Develop accounts payable and payroll management processes to ensure Loan Proceeds are only allocated to compliant expenses.
• Create a Loan Proceeds allocation projection that forecasts Loan Proceeds uses and document actual allocations therein to maintain a firm handle on whether the 75/25 allocation will be met. If it will not, this will allow real-time adjustment.
• Establish procedures for record-keeping that will expedite the loan forgiveness process. If there are expenses for which invoices or other documentation are not typically available, work with the expense recipient to create documentation to substantiate the expense.
KEEP IN MIND: The PPP loan is just that – a loan. So, any Loan Proceeds not qualifying for forgiveness will simply need to be repaid. The PPP loan terms are VERY favorable, allowing for 2-year repayment at a 1.0% interest rate. Some Loan Proceed recipients may elect not to use the Loan Proceeds for payroll but rather to assist with other business needs in a time of minimized cashflow.
Because of the ad-hoc manner in which the PPP relief package has been created and is being administered, forgiveness terms may be clarified or reinterpreted as time moves on. Phocus Law will endeavor to notify its clients promptly upon such changes.
If you need any additional help or advice, please contact attorneys Mick McGirr or Michele Leonelli via email at mick@phocuscompanies.com / michele@phocuscompanies.com or by phone at (602)457-2191.
***This Article was originally published prior to release of the SBA Forgiveness Application. The contents will be revised upon Phocus Law’s completed review of the Application as necessary.***