How To Receive Forgiveness (of PPP Loans)

How to Receive Forgiveness (of PPP Loans)

By Wayne M. Lenell, CPA, PhD

Many small businesses and not-for-profit organizations benefitted from forgiveable loans granted through the Small Business Administration (SBA) agency of the Federal government, as authorized through the Payroll Protection Program (PPP). Now it is time to demonstrate that the loans were used as intended and, as such, are forgiveable. To the extent that the funds were not used to finance approved expenditures, a portion of the loan proceeds must be repaid.

The purpose of the PPP loans was to allow businesses and not-for-profit organizations, who did not have access to sufficient liquidity, to continue paying their employees and to meet their occupation expenses (i.e., mortgage payments, rents, and utilities). The government basically said, "If you keep paying your employees and do not cut their hours, we will reimburse you for eight weeks of your payroll and occupation expenses." So if an organization did just that, and borrowed funds through the PPP and maintained then-current levels of employees, the process for receiving forgiveness of the loans is quite straight forward.

Since the government designed the PPP loans to assist businesses and not-for-profit organizations who did not have access to liquidity to finance their operations during the pandemic, if an entity did not need a PPP loan to survive, the entity was not supposed to apply for a PPP loan. After launching the program, the Federal government had second thoughts about this aspect of the PPP and decided that if an entity borrowed less than $2 million, that entity was deemed to have satisfied the necessity of the loan and the SBA would not ask that entity to establish its need for the loan. This is good news for the approximate 98.5% of the entities that borrowed less than $2 million. It is not yet clear, at the time of this writing, how the SBA will determine whether a borrower of $2 million or more did not have access to other forms of liquidity.

The SBA designed two forms: a five-page Form 3508, and a three-page Form 3508-EZ, as the mechanisms to document the use of the PPP loan proceeds. The borrower may use the simpler Form 3508-EZ version if the borrower meets at least one of the following.

• The borrower is self-employed and has no employees, or

• The borrower did not reduce wages paid to employees by more than 25%, and did not reduce the number of hours of their employees, or

• The borrower experienced reductions in business activity (e.g., sales or service revenue) as a result of health directives related to COVID-19, and did not reduce the wages paid to employees by more than 25%.

If the borrower does not meet any of the three requirements listed above for the "EZ" version of the form, the borrower must use the standard five-page format. Neither form is difficult to prepare if the borrower used the funds as the borrower indicated in the application for the loan. Using the standard version of Form 3508 as an example, the borrower first completes a worksheet entitled "Table 1" in which the borrower lists each employee's name, identifying number, cash compensation, and average full-time equivalent (FTE) during the covered period. The amount from Table l is carried over to the front page of the form to which is added: business mortgage interest payments, business rent or lease payments, and business utility payments. The total of those items is the amount the borrower will submit as proof for the use of the PPP loan provided the borrower did not reduce the number of employees or their hours worked during the covered period. As a double check, the form requires a calculation of payroll costs divided by .6 and, to the extent that the calculated quotient is less than the loan amount, the borrower will have satisfied the loan requirements.

Example:

A company had 20 full-time (40 hours per week) employees who earned an aggregate gross wage amount of $120,000 during the eight weeks following the receipt of the PPP loan. The employer did not reduce the number of workers or their hours compared to the employees used in the base period. In addition, the employer paid payroll taxes (employer portion only) of $12,000, health insurance premiums of $20,000, and pension contributions of $3,000. Therefore, payroll costs for the covered period totaled $155,000.

The company leases the building it occupies at a cost of $15,000 per month and utilities run $5,000 per month so the company paid $40,000 in qualified occupation costs for the covered period.

Qualified expenses for purposes of the PPP loan total $195,000.

The amount of PPP loan forgiveness is the least of:

1. The payroll and occupation costs of $195,000, or

2. The payroll costs divided by .6 or $155,000 divided by .6 = $258,333, or

3. The amount of the PPP loan. So if the company borrowed $195,000 or less, the SBA would forgive the entire balance.

For many borrowers, it is not quite that simple. Between the time of application of the loan and the receipt of loan proceeds, things changed for many entities. State and local authorities placed many restrictions on entities that were not contemplated when applying for PPP loans. Many employers were forced to lay off employees despite the PPP loan money. Recognizing the plight of many organizations, the government softened its position on the allowable use of funds from its original stance. The loan amount was based on eight weeks of prior payroll with a 25% add-on for occupation expenses. This meant that at least 80% ofthe loan needed to be used for payroll and the remaining amount could be substantiated with occupation expenses. The SBA has loosened the requirement so that a borrower need only use 60% of the loan proceeds for payroll with the remainder used for occupation expenses. It further lengthened the period for payroll expense from eight weeks to 24 weeks. These changes have made it much easier for borrowers to demonstrate they have used the funds appropriately and, therefore, the loan amount may be forgiven.

One area in the original procedure to which the government has held relatively firm is with respect to retaining the number of employees on the payroll. The SBA defines the number of employees in terms of full-time equivalents (FTEs). For purposes of the PPP, an FTE is an employee that works 40 hours per week. A PPP loan requires that a borrower maintain the level of FTEs in its organization. To the extent that the FTEs decreased in the covered period following the receipt of PPP loan proceeds, the borrower must proportionately reduce the amount of loan forgiveness. If, for example, a borrower had 10 FTEs during the base period used to request the PPP loan, but after receiving the loan proceeds, the FTE count dropped to nine, the borrower would need to repay 10% of the loan if the borrower did not qualify for any exceptions. When comparing the current FTEs against a base period, the borrower may use one of the following three base periods.

1. February 15, 2019 to June 30, 2019

2. January 1, 2020 to February 29, 2020

3. (For seasonal employers only) any consecutive 12-week period between May 1, 2019 and September 15, 2019.

The borrower compares the number of FTEs in the base period to the number of FTEs in the covered period. The covered period is the 24-week period beginning with the receipt of PPP loan proceeds. To ease the calculations, the borrower may begin the 24-week period with the start of the next pay period following the receipt of the PPP loan proceeds. For example, if a borrower receives PPP loan proceeds on Monday, April 20", and the borrower's next pay cycle begins on Sunday, April 26", the borrower may start the 24-week covered period on April 26". Also, if a borrower received PPP loan proceeds prior to June 5, 2020, the borrower may elect to use an eight-week pay period as the covered period rather than the 24-week pay period.

SBA provided a few exceptions to make compliance with the FTE rules a little easier as follows.

• The borrower is exempt from the reduction in loan forgiveness based on a reduction in FTEs if the borrower, in good faith, is able to document that it was unable to operate between February 15, 2020, and the end of the Covered Period at the same level of business activity as before February 15, 2020, due to compliance with requirements established or guidance issued between March 1, 2020 and December 31, 2020, by the Secretary of Health and Human Services, the Director of the Centers for Disease Control and Prevention, or the Occupational Safety and Health Administration, related to the maintenance of standards for sanitation, social distancing, or any other worker or customer safety requirement related to COVID-19.

For example, if a restaurant was required to close, or cut the number of customers allowed in the restaurant, the restaurant would not need to make any reductions in loan forgiveness because of a decrease in the number of FTEs during the covered period. The borrower needs only to check a box on the loan forgiveness form to effectuate this exception, but the borrower should document the COVID-19 guidance it was relying upon for this exception and keep the documentation in the event of a future SBA audit.

• The borrower is exempt from the reduction in loan forgiveness based on a reduction in FTEs if both of the following conditions are met:

1. The borrower reduced its FTE levels in the period beginning February 15, 2020, and the end of the covered period; and

2. The borrower then restored its FTE levels by not later than December 31, 2020 to its FTE levels in the Borrower's pay period that included February 15, 2020.

This exception basically provides a few more months for the borrower to rehire laid off employees.

• The SBA provided some options for calculating FTEs based on specific employees as follows.

• If a borrower laid off an employee who was on the payroll on February 15, 2020, but then made a written offer to hire that employee and the employee refused the offer, and the borrower was unable to hire a similarly qualified employee before December 31, 2020, the borrower does not need to include the laid off employee in the base period FTE count.

• If a borrower cut the hours of an employee during the covered period, but then made a written offer to restore the reduced hours and the employee rejected the offer, the borrower may include the hours of the employee as though the employee accepted the hours.

• If a borrower terminated an employee for cause, or the employee voluntarily resigned, or the employee voluntarily requested and received a reduction of hours, the borrower may include the employee's hours as if they were not reduced.

It is evident that the SBA is trying to be as reasonable as possible, without losing the basic integrity of the program, to assist borrowers in gaining the most benefit from loan forgiveness. The SBA, however, has also put in some safeguards to prevent abuse, most notably, regarding compensation to the highly compensated employees of an organization.

In the earlier example, the company paid wages in the covered period of $120,000 plus other payroll costs of $35,000 for a total payroll cost of $155,000. The company employed 20 full-time employees. If the company was affected by a COVID-19 directive requiring the company to temporarily close, the company would be exempt from the FTE calculation. The owner of the company might be tempted to lay off the entire staff and then have the company pay the owner a bonus of $155,000. Without any safeguards, this company could receive full forgiveness of the loan but, clearly, that is not the purpose of the PPP loan program. To prevent such abuse, the SBA instituted rules regarding the amount of compensation paid to an employee in which the wages used in calculating payroll costs is limited to $100,000 per employee on an annualized basis.

When to file. A borrower may submit Form 3508 or Form 3508-EZ as soon as the borrower has accumulated enough qualified expenses for 100% of the loan to be forgiven. The rules for PPP loans have changed a few times to date, and may change again. For example, at the time of writing, Congress is considering changing the submission requirements for loans less than $150,000. The proposed bill suggests that a borrower of less than $150,000 in PPP loans would need to merely sign an affidavit and submit it to the lender. The final due date, however, for submission of Form 3508 or Form 3508-EZ is 10 months following the end of the covered period. The covered period begins with the receipt of the PPP loan and extends 24 weeks, or eight weeks if the borrower so elects, for loans received prior to June 12, 2020.

A borrower may want to file immediately after fulfilling the spending requirements to "get it over with," or so that the borrower receives approval of the forgiveness to facilitate booking the loan proceeds into income for accounting purposes. Others may want to postpone submitting the form to allow time to carefully document the amounts used, or in hopes that the SBA will ease the reporting requirements in the coming months.

What documentation to include in the submission. The SBA has provided a detailed list of the documentation required when submitting a forgiveness application. Following is a summary of the required documents.

• For payroll.

o Payroll registers or payroll summaries that list individual employee wages and hours for the covered periods.

o Quarterly Federal Forms 941 and State unemployment forms that include the covered periods. Note: The covered periods will not likely line up with the quarters reported on the Federal and State quarterly forms. Provide the overlapping quarterly forms.

o If the payroll registers or summaries do not include hours worked, provide the worksheets used to count employee hours during the covered period.

o Copies of health insurance invoices and evidence of payment.

o Evidence of payments for pension contributions.

o Net profit for covered period for sole proprietors (this represents the owner's wages).

o Documentation for any payroll exceptions such as:

• Which government order the borrower relied upon to support the exception for reducing staff as a result of a COVID-19 mandate.

• The written offer to hire back laid-off employees who did not return to work.

• The written offer to restore reduced hours to an employee who did not accept the offer.

• Evidence that an employee voluntarily resigned during the covered period.

• For utility costs:

o Copies of invoices and evidence of payment during the covered period for:

• Electricity

• Water

• Gas

• Sewage

• Telephone (cell phone and landline)

• Internet

• Transportation (mileage reimbursed to employees or actual costs of operating company vehicles)

• For business mortgage interest payments (note: only the interest payments count toward PPP loan forgiveness, not principal payments):

o Copies of the loan amortization schedule along with evidence of payment during the covered period or statements from the lender.

• For business rent or lease payments:

o Copies of the lease agreement and evidence of payment during the covered period or statements from the landlord.

N.B.: The SBA can audit an application for up to six years after the borrower submits the application for forgiveness, so it is important to document the expenses contemporaneously and maintain those records for at least six year.

What if a borrower cannot substantiate full qualified use of the loan? If a borrower falls short of spending the entire PPP loan for qualified expenses, the borrower will need to repay the unsubstantiated portion with interest. Loans issued prior to June 5, 2020 need to be repaid within two years with interest at 1% per annum. Loans issued after June 5, 2020 have a five-year payback requirement with interest at 1% per annum.

Conclusion. The government has relaxed the rules regarding qualified expenses for the purpose of PPP loan forgiveness so that most entities will have an easy time generating enough expenses to gain full forgiveness of the PPP loans. The required forms are a bit onerous, and the backup documentation is somewhat tedious, but once a borrower complies with the requirements, forgiveness of the PPP loans should be perfunctory. Those who cannot substantiate all of the loan proceeds will need to repay only the unsubstantiated balance and at very favorable terms.