Updated May 5, 2020
The historic $2.2 Trillion CARES Act was signed into law late-afternoon on Friday, March 27. Just one week later, on Friday, April 3, banks began accepting Paycheck Protection Program (“PPP”) applications for businesses with employees. Then on Friday, April 10, banks began accepting PPP applications for independent contractors, sole proprietors, and self-employed individuals.
We put together an early overview of this program in an article, but we’re constantly learning more about the program each day, as we receive additional guidance. Here we’ll cover the specifics through a series of frequently asked questions – for both business entities, and self-employed individuals who file a Schedule C.
1. Do I qualify for this loan?
Businesses Entities – Small businesses, 501(c)(3)s and 501(c)(19)s, tribal businesses, and veterans organizations who were in business on February 15, 2020, and who either:
(1) have fewer than 500 employees whose principal place of residence is the US, or
(2) meet the applicable SBA size standards.
Note that some businesses are not eligible, including passive businesses (including some rental activities, financial businesses, government-owned entities, operations with significant gambling activities, illegal operations, etc.
Schedule C Filers – An individual with self-employment income (such as an independent contractor or sole proprietor) who was in business as of February 15, 2020, resides in the US, and has filed or will file a 2019 Schedule C.
What about Partners in Partnerships? – Partners in partnerships may not submit separate PPP loan applications as self-employed individuals. The partnership should file a PPP loan application and include each partner’s compensation as a payroll costs, up to $100,000 annualized per partner.
2. What is the maximum loan amount for which I qualify?
Businesses Entities – The lesser of (1) $10,000,000 or (2) 2.5 times your average monthly payroll costs.
Payroll costs are generally measured using the 2019 calendar year; however, a trailing twelve-month period may also be used, and alternative calculations are available for seasonal and new businesses.
Schedule C Filers– may borrow 2.5 times their average monthly earnings in addition to 2.5 times average monthly payroll costs.
Earnings and payroll costs are typically based on 2019 Schedule C filings. If a 2019 Schedule C has not yet been filed, it must be filled out for the application.
Guidance is pending for new Schedule C businesses.
3. What is included in “payroll costs”?
Businesses Entities – The following costs are included in payroll:
- Compensation including wages, salaries, and commissions up to $100,000 annually per employee
- Payments of cash tips
- Vacation, parental, family, medical or sick leave
- Allowances for dismissal or separation
- Payment for group health care benefits, including insurance premiums
- Payment of retirement benefits
- Payment of SUTA
Not included in payroll costs: compensation in excess of $100,000 annually (as prorated for the covered period), certain taxes imposed/withheld, wages for which a Families First credit is allowed (qualified sick leave or qualified family leave)
Schedule C Filers – may only include self-employment earnings of up to $100,000. Schedule C Filers will use the net profit from their 2019 filings.
4. Do I use gross payroll or net of federal taxes withheld?
There has been some confusion here! The CARES Act defines payroll between February 15, 2020 and June 30, 2020 as net of federal income tax withheld and social security taxes.
The SBA has addressed this in one of its FAQs stating payroll costs, for the purposes of loan application, allowable uses of funds, and loan forgiveness, are to be calculated on a gross basis without regard to federal taxes imposed or withheld. However, the employer portion of federal payroll taxes is not included.
5. How can loan proceeds be used?
Businesses Entities – Proceeds may be used to cover: payroll costs (as defined above), rent, mortgage interest, utility payments, and interest on other debts. The non-payroll costs must be for agreements/services/loans entered into before February 15, 2020.
Schedule C Filers – The categories of costs are the same as above but there are some additional definitions/restrictions. In addition to payroll costs, if the Schedule C has employees, owners may use funds for “owner compensation replacement,” which means replacement of 2019 net profits. Rents, mortgage interest, and utilities are allowed to the extent they are valid business deductions and were items for which deductions were taken in 2019.
Important Note for All – The SBA is asserting at least 75 percent of loan proceeds should be used for payroll costs.
6. How does forgiveness work?
In the 8-week period beginning on the date the lender makes the first disbursement of the PPP loan, to the extent proceeds are used for eligible expenses, the buyer may request tax-free loan forgiveness.
Businesses Entities – Eligible expenses are those discussed earlier: payroll costs, mortgage interest, rent, utilities, and interest on other business debts.
Schedule C Filers – may also include owner compensation replacement in addition to payroll costs for employees. They may also include other expenses, to the extent they are qualified businesses deductions and were deducted on their 2019 filing, including mortgage interest, rent, utilities, and interest on other business debts.
Per recent guidance, Schedule C Filers must calculate their income replacement for the 8-week period by taking 8/52 of their 2019 Schedule C net earnings.
Partners – each partner’s self-employment income may be treated as a payroll costs (up to $100,000 annually) on the partnership’s PPP application. Our expectation is that partnerships will be eligible for forgiveness using this same calculation, but we have yet to receive confirmation from Treasury or the SBA.
A Few Stipulations:
- 75% or more must be used on payroll items (as mentioned above)
- Loan forgiveness is reduced if there are reductions in the number of employees or if wages are reduced by more than 25% (See Question 7)
7. What are the reduction in employee and wages stipulations?
Reduction in Number of Employees – This reduction is based on full-time equivalent (“FTE”) employees, which is different than the payroll calculation based on all employees. FTEs have not yet been defined in the statute.
To the extent there is a reduction in FTES during the 8-week period as compared to average FTEs between 2/15/19 – 6/30/19 or 1/1/20 – 2/29/20, there will be a reduction in potential loan forgiveness.
Reduction in Wages – If the salaries of employees making less than $100,000 per year are reduced by more than 25%, as compared to the most recent full calendar quarter, there will be a reduction in potential loan forgiveness.
There are many questions on these topics outstanding, including definitions, calculation details, and many common yet unaddressed staffing situations. The SBA and Treasury have stated that guidance on forgiveness is pending.
8. How can I get an exception for re-hiring workers if I’ve already laid them off?
A business that laid off employees between February 15, 2020, and April 27, 2020, still has the potential for full forgiveness if they reverse the FTE reduction by June 30, 2020.
If employees making less than $100,000 took significant pay cuts (in excess of 25%) during that period, forgiveness eligibility can also be restored if the reduction is reversed by June 30, 2020.
9. What if I attempt to re-hire an employee but they refuse to come back?
The SBA has stated that this will be addressed in a forthcoming “Interim Final Ruling.” In the meantime, they have said there will be an exception for laid-off employees whom the borrower offers to rehire from the CARES Acct’s loan forgiveness reduction calculation. The rule will lay out the details of the exception, which will include that the borrower must make a good faith, written offer of rehire and must document the employee’s rejection.
The SBA also noted that employees who reject offers of re-employment may forego eligibility for continued unemployment benefit.
10. Is forgiveness really tax-free?
The CARES Act states that forgiveness will be “excluded from gross income.”
However, the IRS issued Notice 2020-32 on April 30, 2020, stating that they will disallow expenses that result in PPP loan forgiveness, citing Internal Revenue Code Section 265, which has historically been used to disallow items like interest expense incurred to create tax-free interest income.
While the guidance provided by the IRS is authoritative, this may not be the final word on the matter. Congress went to the trouble of ensuring that the PPP loan forgiveness would be excluded from gross income; if they truly intend for there to be no tax-effect, they could include an amendment to Section 265 in upcoming legislation.
11. What happens to amounts that aren’t forgiven?
The portion of the loan that is not forgiven remains a loan with an interest rate of 1% and a term of 2 years.
12. If I get the PPP, can I also use the Families First Leave, the Employee Retention Credit, and/or defer employer Social Security taxes?
Families First – Families First provides emergency paid sick leave and emergency leave (FMLA expansion). This is leave eligible employers are required to provide; employers will then receive reimbursement of these costs via a payroll tax reduction and refundable credit.
Wages paid out under Families First, for which a credit is allowed, will not be eligible for PPP forgiveness.
You can read more about the Families First act here.
Employee Retention Credit – Employers who receive a PPP loan will not be eligible to claim the employee retention credit.
Deferral of Employer Social Security Taxes – Employers who receive a PPP loan are also not eligible to defer the employer portion of Social Security taxes; however, there is a small exception.
The IRS stated that employers who have applied for but not yet forgiven may defer deposit and payment of the employer’s share of social security tax that otherwise would be required to be made beginning on March 27, 2020, through the date the lender issues a decision to forgive the loan, without incurring penalties. After the lender issues the decision to forgive, employer social security taxes may no longer be deferred.
For more discussion on business provisions included in the CARES Act, click here.
13. I’m a Schedule C Filer – Will getting a PPP loan keep me from receiving unemployment benefits?
Short answer – probably.
Longer answer – Treasury has told us that “you should be aware that participation in the PPP may affect your eligibility for state-administered unemployment compensation or unemployment assistance programs.” We await further guidance from individual states and/or Treasury. You should contact your tax advisor to determine which option is best for you.
14. What happens when the money runs out?
On April 16, 2020, the SBA ran out of funds, having used the entire $349 billion appropriated in the CARES Act. Congress is working on a CARES 2 package which is likely to include additional funding for the PPP program.
We encourage those who are interested in a PPP loan who have not yet applied to consult with their bank or non-bank processor on whether they can still apply to “get in line” for additional appropriated funds.
More Details Needed
There are several items where we are waiting on more guidance or clarification of previous guidance; the largest section of this is pending forgiveness guidance. As we learn more we will update our FAQs. Stand by!