The Small Business Administration (SBA) released an interim final rule covering Paycheck Protection Program (PPP) loan forgiveness attributable to owner-employee compensation and certain nonpayroll costs. Specifically, the guidance provides a 5% threshold for determining C and S corporation employee ownership and adds potentially significant limitations on amounts eligible for forgiveness relating to rent and lease arrangements.
Compensation paid to employees with less than a 5% ownership stake in a C or S corporation will not be subject to the more stringent forgiveness limitations. Since Congress did not intend windfalls to owners applying for PPP loans, previous guidance placed additional limits on business owner pay. The SBA explains this new 5% exception is to prevent the more strict limitations from applying to compensation of “owner-employees who have no meaningful ability to influence decisions over how loan proceeds are allocated.”
Whether this exception also applies to noncash compensation paid to such owner-employees is unknown. Pursuant to a previous interim rule, payments for noncash compensation are not forgivable if included in the owner-employee’s wages (as a matter of general tax principles). For example, health insurance premiums paid on behalf of an S corporation employee would be included in their wages if their ownership stake in the business was greater than 2% and, thus, these premiums would not be eligible for forgiveness. We expect further guidance to explain whether the exception applies solely to cash compensation.
PPP loan forgiveness applications cannot include costs attributable to tenants or subtenants of the borrower. To illustrate, the rule uses an example: a PPP borrower rents office space for $10,000 per month and subleases a portion to another business for $2,500 per month. In this instance, forgiveness for the borrower’s rent expense is limited to $7,500. This limitation would also apply to any mortgage interest or utilities expense attributable to the subtenant. Finally, loan forgiveness may not include household expenses associated with home-based businesses.
Rent or lease payments to a related-party landlord can be forgiven. However, eligible amounts cannot exceed the amount of mortgage interest owed on the property attributable to the rented space during the covered period. This can be particularly problematic as some businesses rent from related-party owners that do not have a mortgage on the property.
For these purposes, the rule considers any common ownership between the business and the property owner as constituting a related party, with no de minimis exception. Conversely, mortgage interest paid to a related party is not eligible for forgiveness. The SBA rationalizes that the PPP is intended to cover certain nonpayroll-related payments owed to third parties and should not apply to payments that arise merely due to how the business is structured. This appears to be the case whether the common ownership is 1% or 100%, although it is not certain this is the intended result. We are hopeful clarifying guidance on this, as well as the owner-employee noncash compensation issue, will be is forthcoming ahead of when 24-week covered periods will begin expiring in September.
As a reminder, while Congress continues to consider the issue, expenses related to any loan forgiveness remain nondeductible for federal tax purposes. It is unclear whether this will be addressed when lawmakers return from their August recess.
We encourage you to reach out to your Baker Tilly tax advisor to discuss how the above may affect your tax situation.
The information provided here is of a general nature and is not intended to address the specific circumstances of any individual or entity. In specific circumstances, the services of a professional should be sought. Tax information, if any, contained in this communication was not intended or written to be used by any person for the purpose of avoiding penalties, nor should such information be construed as an opinion upon which any person may rely. The intended recipients of this communication and any attachments are not subject to any limitation on the disclosure of the tax treatment or tax structure of any transaction or matter that is the subject of this communication and any attachments.