Calculating COVID-19 PPP Loan Forgiveness
Part 1: Small Business Administration Updates Paycheck Protection Program Guidance
Due to economic hardship caused by the ongoing COVID-19 pandemic, many businesses have become reliant on loans from the Small Business Administration’s Paycheck Protection Program to stay afloat. The PPP provides eligible businesses access to low interest loans to cover payroll costs and basic operating expenses during the pandemic, and these loans have the potential to be forgiven in full if the funds are spent in accordance with the SBA’s guidelines.
Unfortunately, the initial SBA guidance regarding loan forgiveness left many businesses guessing how various circumstances and factors might affect their ultimate eligibility for loan forgiveness. In response, the SBA recently released its PPP Loan Forgiveness Application along with clarifying instructions and two new Interim Final Rules addressing several of the most common questions concerning how businesses should use the funds, document expenses and request loan forgiveness.
Part 1 of this Legal Alert series provides an overview of the general structure for calculating loan forgiveness. Part 2, Requirements for Supporting COVID-19 PPP Forgiveness Requests, will discuss the documentation requirements for supporting loan forgiveness requests and additional takeaways.
The application incorporates the basic requirements and limitations on spending outlined in the SBA’s prior guidance, but breaks down the calculation for the final forgiveness amount into a fairly straightforward three-part process.
Payroll and Non-Payroll Costs
First, the applicant will calculate the payroll and eligible non-payroll costs paid or incurred during the 8-week covered period for the loan. For ease of calculating payroll costs, the SBA provided two allowable methods for defining the covered period:
- borrowers may choose to calculate payroll costs based on the 8-week period immediately following receipt of the loan disbursement or
- borrowers with a biweekly (or more frequent) payroll schedule may calculate eligible payroll costs based on the 8-week period starting on the first day of the pay period immediately following receipt of funds.
The application instructions also clarify that the calculation of payroll costs may include payroll costs incurred but not paid during a borrower’s last pay period of the covered period, so long as those costs are paid on or before the next regular payroll date. This clarification of paid or incurred costs (versus just paid as was previously believed) is important and also applies to non-payroll costs. The $100,000 limit still applies to annualized salary as prorated for the covered period, and any cash compensation above this should be excluded when calculating payroll costs, though the limits do not apply to non-cash benefits such as health and retirement benefits.
Eligible non-payroll costs, for the covered period may include:
- interest payments interest (not including any prepayment or payment of principal) on any business mortgage obligation on real or personal property incurred before Feb. 15, 2020
- business rent or lease payments under lease agreements for real or personal property in force before Feb.15, 2020 and
- business payments for electricity, gas, water, transportation, telephone or Internet access that began before Feb. 15, 2020. There is still little guidance on what transportation means in this context.
Non-payroll costs cannot exceed 25 percent of the total forgiveness amount or businesses may lose eligibility for forgiveness, which is addressed in greater detail in step three below.
Reductions to FTEs and Compensation
Once the borrower has calculated the total eligible payroll and non-payroll costs, the second step is to determine if the forgiveness amount will be reduced. A borrower’s forgiveness amount will be reduced in proportion to either:
- any reduction of an employee’s compensation in excess of 25 percent during the covered period as compared to the period between Jan. 1 and March 31, 2020 or
- any reduction in the average number of full-time equivalent employees during the covered period as compared to the average FTEs during the chosen reference period (Feb. 15, 2019 to June 30, 2019 or Jan. 1, 2020 to Feb. 29, 2020).
The application provides two formulas for calculating average FTEs. The simplest formula allows the borrower to assign one FTE to each employee working 40 hours or more and .5 FTE to each employee working less than 40 hours. This method may significantly round down the borrower’s true average FTEs, which may in turn reduce loan forgiveness. Borrowers should instead calculate the true average FTEs and compare to the actual FTE calculation. Do this by taking the average number of hours paid per week, divide by 40, and round the total to the nearest 10th. This is important because, for example, an employee working 30 hours would be worth .5 FTE under the simplified calculation, but .8 FTE under the true average calculation. Certain borrowers may still be eligible for forgiveness if the reductions in FTEs or compensation were made between Feb. 15 and April 26, 2020, and are corrected to pre-pandemic levels by June 30, 2020. Moreover, the application materials clarify several circumstances in which an employer will not be faulted for reductions in FTEs.
Proportion of Payroll Costs to Non-Payroll Costs
The third and final step will be to determine if the total forgiveness amount will be further reduced based on the proportion of funds used towards non-payroll costs. The PPP requires borrowers to use at least 75 percent of the loan toward payroll costs, with the remaining funds to be used toward the eligible non-payroll costs discussed above. If a borrower utilizes more than 25 percent of the loan to pay for non-payroll expenses, the borrower will need to recalculate the requested non-payroll forgiveness amount so it does not exceed 25 percent of the total requested forgiveness.
There are still many questions that remain unanswered, however, the SBA is expected to provide further guidance in the form of Interim Final Rules and FAQs in the coming weeks. In addition, the Paycheck Protection Program Flexibility Act is pending before Congress and this Act could significantly modify several key aspects of the PPP. It is still too early to predict if the bill will be enacted and what the final provisions would be, but the final bill is expected to extend the period to use PPP funds, extend loan terms and expand eligibility for forgiveness if the bill passes.
We will continue to provide updates as new guidance is issued, but if you have any questions about the PPP Loan Forgiveness Application or how COVID-19 impacts your business, please contact the authors of this Legal Alert listed at the right in the firm’s Business practice group or your BB&K attorney.
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Disclaimer: BB&K Legal Alerts are not intended as legal advice. Additional facts, facts specific to your situation or future developments may affect subjects contained herein. Seek the advice of an attorney before acting or relying upon any information herein.