Paycheck Protection Program: Borrowers Must Plan Now to Maximize Loan Forgiveness

Business Litigation Update

Date: April 24, 2020

Key Notes:

  • Loan forgiveness is the hallmark feature of the Paycheck Protection Program (PPP), and borrowers may apply for forgiveness eight weeks after receiving PPP loan proceeds.
  • Borrowers must understand Small Business Administration (SBA) limitations on use of loan funds and forgiveness formulas under the PPP.
  • Rather than wait, borrowers should be proactive now in documentation, planning and budgeting to ensure compliance and maximize efficiency once the PPP forgiveness process begins.

Through the Coronavirus Aid, Relief, and Economic Security Act (CARES Act), Congress earmarked $349 billion, which has since been raised to a total of $660 billion, for small business loans to eligible businesses seeking assistance in meeting their payroll and operating costs during the COVID-19 pandemic. Because the amount forgiven depends on how funds are spent, businesses should plan now to use the funds in a manner that enhances the opportunity for forgiveness. These Paycheck Protection Program (PPP) loans are 100% guaranteed by the Small Business Administration (SBA) and, if certain criteria are met, may be entirely forgiven without federal tax consequences. To maximize forgiveness, borrowers should understand key provisions of the CARES Act and available SBA guidance and then carefully monitor their use of loan proceeds and maintain documentation to justify their requested forgiveness amount.

What are the limitations on PPP loan uses?

According to SBA rules published after the PPP was enacted, borrowers are permitted to use PPP loan proceeds only in the following manner: 75% or more of the loan amount must be used for “payroll costs”; with not more than 25% of the loan amount permitted to be used on interest payments on certain mortgages, rent, utilities, and interest payments on other debt obligations that existed before February 15, 2020. Although not in the text of the CARES Act, the SBA guidance makes it clear that the use limitations are required and not optional. We expect further guidance the week of April 27th on this point to help clarify some inconsistencies that can result in the application of these permitted use and forgiveness calculations.

PPP borrowers should be conscientious and careful with the use of every dollar of PPP funds received to help ensure compliance with the PPP rules and their certification delivered under penalty of perjury in connection with the loan application. Consequences for borrowers running afoul of this requirement (or of knowingly falsifying other certifications or figures included in the PPP loan process) could lead to severe civil and/or criminal consequences.

For clarity, “payroll costs” consist of:

  • salary, wage, commission, or similar compensation, subject to a per-employee or per-partner cap of $100,000;
  • payment of cash tip or equivalent;
  • payment for vacation, parental, family, medical, or sick leave;
  • allowance for dismissal or separation;
  • payment required for the provisions of group health care benefits, including insurance premiums;
  • payment of any retirement benefit; or
  • payment of state or local taxes assessed on the compensation of employees.

A borrower’s “payroll costs” should include amounts to be withheld from employee compensation for federal tax purposes but exclude the employer’s share of federal payroll taxes. “Payroll costs” also do not include a business’s payments to independent contractors, compensation to employees who live outside the United States and qualified sick leave and family leave wages for which credits are allowed under the Families First Coronavirus Response Act (FFCRA).

For the other 25% of permissible PPP uses, interest payments on mortgages are limited to mortgage obligations owed by the borrower on mortgages that were in place before February 15, 2020. Similarly, rent and utilities must be obligations of the borrower arising out of rental arrangements or utility service agreements that existed before February 15, 2020.

How much of the loan is forgivable?

Pursuant to the CARES Act and SBA guidance, not all permissible loan uses are forgivable. PPP loans are forgivable up to an amount equal to certain costs incurred and payments made during the 8-week period that begins on the day the loan proceeds are disbursed. The SBA has clarified that the maximum amount of forgiveness will be equal to the amount of principal plus accrued interest. Therefore, a borrower that uses the entire loan proceeds as required during the 8-week period could have a minimal or no repayment obligation. As noted above, certain inconsistencies that currently exist in the available guidance affect the forgiveness calculation, and we expect that additional guidance forthcoming next week will address those.

Only the following costs and payments are counted for purposes of forgiveness:

  • “payroll costs” (as defined above),
  • interest payments on mortgage obligations,
  • rent payments, and
  • utility payments.

Note that payments to service interest on pre-existing debt obligations is a permissible use, but not a forgivable use of PPP loan funds.

Borrowers also must contend with the PPP rules’ limitation—consistent with its prohibitions on PPP loan use—that a borrower’s forgivable amount must consist of at least 75% payroll costs and not more than 25% non-payroll costs. Again, as part of the application process, borrowers also certified that not more than 25% of the forgivable amount will consist of non-payroll costs. These limitations apply in the same manner to businesses, self-employed individuals, and independent contractors. We will be looking to the forthcoming guidance to provide additional clarity on the application of the 75/25% split rules to both the permitted use and forgiveness calculations.

Self-employed individuals and independent contractors may receive forgiveness in an amount equal to 8 weeks’ worth of their 2019 net profits as reported on IRS Form 1040, Schedule C. Interest payments on mortgage obligations, rent obligations, and utility payments may be included to the extent that they were deductible on Form 1040, Schedule C.

For amounts that are not forgiven, all borrowers will be required to repay those amounts amortized over the remainder of the 2-year maturity period after a 6-month deferral period ends. Interest is capped at 1% and the SBA’s 100% guaranty will continue to apply.

What other factors may impact a borrower’s forgiveness amount?

The CARES Act ties forgiveness to borrowers’ retaining certain employment and compensation levels. To that end, the PPP includes two other formulas that, if applicable, may further reduce a borrower’s forgiveness amount.

First, a “headcount” reduction will reduce the amount forgiven in proportion to any reduction in the borrower’s average monthly number of full-time equivalent employees (FTEEs) during the 8-week period as compared to a prior period. Which prior period? At its election, the borrower may choose either February 15, 2019 to June 30, 2019 or January 1, 2020 to February 29, 2020. To estimate this (and choose the better timeframe), a borrower should divide the average monthly number of FTEEs during the 8-week period by the average monthly FTEEs in each election period. If the result is 1 or greater, there will be no reduction. The borrower should choose the prior timeframe that yields a number closer to 1.

Second, certain “wage reductions” will also reduce the amount forgiven when compared to wages in a prior period. This formula assesses whether a borrower’s FTEEs received a “pay-cut” during the 8-week period compared to that employee’s rate of pay from the most recent full quarter—i.e., likely 1Q 2020. If so, the forgivable loan amount will be reduced by the amount the employee’s compensation level decreased more than 25%. This must be considered for each employee who did not receive more than $100,000 in annualized compensation in 2019. To estimate this, a borrower should calculate whether the pay rate for each such employee during the 8-week period will dip below 75% of the pay rate in the prior full quarter. If it has not, this reduction won’t apply.

The precise application of these two reductions is subject to further guidance from the SBA and the SBA has stated that it intends to issue specific guidance related to forgiveness. We will continue to monitor this and provide updates as appropriate.

How can borrowers comply with PPP requirements and position themselves for maximum and efficient forgiveness?

At some point after the 8-week period ends, borrowers may apply for forgiveness with their respective lender and lenders must provide a determination within 60 days. This is the crucial step for maximizing the value proposition offered by the PPP. In anticipation of this, borrowers can take several steps even before their loan is disbursed to ensure that they stay in compliance and maximize forgiveness in an efficient manner.

  1. Borrowers should project their 8 weeks of payroll costs and non-payroll costs and determine the likely impact of the 75/25% limitations on use and forgiveness. This also will give the borrower an understanding of how much may not be forgiven and must be repaid.
  2. To best ensure compliance with the 75/25% limitations (and ease of documentation later), borrowers should consider establishing segregated accounts for their loan proceeds. By allocating 25% of the loan proceeds to a separate account, borrowers can easily track and avoid spending more than 25% of the loan proceeds on non-payroll costs. This will avoid a PPP rule violation and breach of the borrower’s certifications provided during the application process. Additionally, a segregated account exclusively for PPP loan proceeds and expenditures should facilitate efficient and complete accounting of the borrower’s PPP loan transactions—reflecting only the relevant disbursements—which will assist the lender with ease of processing and review when the borrower applies for forgiveness.
  3. Borrowers should develop a plan that allocates loan proceeds in a manner consistent with the 75/25% limitation and adjust where feasible. This may include adjusting payroll periods to ensure as many payouts as possible fall within the 8-week period. Borrowers should be careful not to include any prepayment for interest on mortgages, as those are expressly prohibited in the PPP rules. It is unclear, and likely to be the subject of further SBA guidance, whether prepayment of rent and utilities will be permitted.
  4. Borrowers should consider and prepare for the effect from headcount and wage reductions. In doing so, borrowers should consider whether it is feasible to restore any pay reductions and re-hire (or replace) employees that had been furloughed or laid-off. If this can be done before June 30, 2020, the pay-cut and headcount reduction formulas are not applicable—even if some re-hires were not employees receiving compensation during the entire 8-week period. However, only payroll costs actually paid during the 8-week covered period can be counted towards the permitted or forgivable use of the loan proceeds.
  5. Complete your FY 2019 and 1Q 2020 tax forms. Throughout the 8-week period, borrowers should keep detailed records of their payroll costs, non-payroll costs, and FTEE headcounts. As part of this, although many state and federal deadlines for filing fiscal year 2019 tax returns have been extended until July 15, borrowers should make all reasonable efforts to finalize their FY2019 and 1Q2020 tax returns prior to June 30, 2020 (i.e., the end of the covered period for PPP loans). Doing so will generate much of the data and documents required for forgiveness and will provide borrowers and their lenders a more complete picture.
  6. Use a checklist to compile the required documentation to be submitted all at once with the loan forgiveness package. Borrowers will be required to submit documents proving their payroll costs and average FTEEs during the 8-week period and for the relevant comparison periods used in determining reductions. Such documentation includes:
  • the borrower’s quarterly federal tax return on Form 941;
  • State and local tax records, including state quarterly unemployment insurance tax forms;
  • retirement and health insurance contributions; and
  • reports from payroll processors.

Borrowers will also be required to document their non-payroll costs during the 8-week period. Borrowers should prepare copies of:

  • mortgage or rental agreement;
  • utilities agreements; along with
  • copies of canceled checks, payment receipts, and account statements reflecting payments for those expenses (ideally, this would be compiled from the segregated PPP account).

As part of the forgiveness package, borrowers are also required to submit a certification that all documentation submitted is true and correct, and that the amount for which forgiveness is being requested was used in accordance with the program’s guidelines for use.


For more information, please contact:

Michael V. Coleman

Riccardo M. DeBari

Brian Lanciault

Jennifer L. Maffett-Nickelman

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