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Authored by Patrick Balthazor and Michael Wronsky

The Paycheck Protection Program (PPP) is a small business interruption loan initiative created by the Coronavirus Aid, Relief, and Economic Security (CARES) Act, designed to assist eligible businesses and not-for-profit organizations with retaining and paying their employees during the COVID-19 pandemic. The PPP is jointly administered by the Small Business Administration (SBA) and the Department of Treasury (Treasury). Broadly, eligible borrowers are sole proprietors, independent contractors, and employers with 500 or fewer employees (affiliation rules apply) or a maximum tangible net worth and average net income after federal income taxes for the previous two years that do not exceed certain thresholds.

To the extent loan proceeds are used to fund payroll (including certain employee benefits), mortgage interest, rent or utilities expenses within a certain time frame after the funds are received, known as the covered period, the debt can be fully or partially forgiven. Otherwise, loans approved on or after June 5, 2020, will mature in five years (two years, if approved prior to June 5, 2020), with a fixed 1% interest rate.

The CARES Act as drafted left many areas of uncertainty around the PPP. Since the law was enacted in late March, the SBA and Treasury have provided a constant stream of guidance to address these open issues, and the program has been amended by subsequent legislation. This is the first of a two-part article discussing compliance with the PPP rules based on current law and guidance, specifically, providing an overview of eligible uses for loan proceeds. The second part providing an analysis of the loan forgiveness requirements and process.

The information herein is based on the law in effect and guidance available as Aug. 21, 2020. It is critical to note that the PPP is constantly evolving pursuant to both legislative updates and the frequent provision of new rules and guidance by the SBA and Treasury. The PPP is currently closed as of Aug. 8, 2020, and, as such, the SBA is no longer accepting loan applications from lenders. It is unclear whether the program will be reinstated or modified by future legislation at this time.

Eligible costs

Overview

Borrowers will be eligible for debt forgiveness to the extent they pay or incur an amount equal to their loan proceeds on the following expenses, within their covered period:

  1. Payroll costs (discussed further below),
  2. Interest on mortgages incurred prior to Feb. 15, 2020 (though forgiveness is not available for prepayments),
  3. Rent pursuant to a lease in effect prior to Feb. 15, 2020, or
  4. Utilities, including electricity, gas, water, transportation, telephone or internet access, if service began prior to Feb. 15, 2020.

To ensure that PPP loans are used for their principal purpose of keeping a borrower’s workforce employed and paid, SBA guidance requires that no more than 40% of a loan’s forgiveness amount be attributed to the expenses outlined in items 2 through 4 above. In the event this 40% threshold is exceeded, partial forgiveness is still available.

Payroll costs

Payroll costs consist of two subcategories: cash and noncash compensation. The critical distinction between the two is that forgiveness attributable to the former is capped based on an annual salary of $100,000 per employee, prorated for the length of the covered period. For cash compensation paid to a self-employed individual (including partners if the borrower is a partnership; independent contractors; and Schedule C and F filers) or owner-employee (shareholder in a C or S corporation), a separate per-individual limitation on the forgivable amount applies, based on the lesser of their annual salary of $100,000 prorated for the length of the covered period, or a fraction of their 2019 compensation. See the second part of this article on loan forgiveness for additional details.

Cash compensation generally includes the following:

  • Salaries, wages, commissions or other similar compensation
  • Cash tips
  • Bonuses
  • Hazard pay
  • Vacation, parental, family, medical or sick leave
  • Allowance for dismissal or separation

Noncash compensation, for which forgiveness is not subject to the dollar limits described above, includes the following expenses incurred by an employer:

  • Contributions to retirement plans
  • Payments for the provision of group health care coverage, including insurance premiums (vision and dental benefits are eligible expenses)
  • Payment of state or local taxes assessed on employee compensation (does not include state or local taxes withheld from employee compensation)

While forgiveness for these payments made on behalf of employees is not subject to the dollar limits described above, it is not available for amounts paid on behalf of a self-employed individual or owner-employee, if the benefit is included in their cash compensation as required by general tax principles. See the second part of this article on loan forgiveness for additional details.

In general, payroll costs are determined on a gross basis, without including any subtractions or additions based on federal income taxes imposed on or withheld from employee wages. However, the employer’s share of payroll taxes (for example, the employer’s share of Social Security or Medicare taxes) are excluded from payroll costs.

Consider an employee who earned $10,000 in gross wages during their employer’s covered period, from which $1,500 in federal taxes was withheld. Their employer’s associated payroll cost would be the gross $10,000 amount, and the employer’s share of Social Security and Medicare taxes imposed on the $10,000 in gross wages are excluded from payroll costs. If the employee’s state of residence imposes an unemployment tax on the $10,000 amount for which the employer is responsible, payment of this tax would be eligible for forgiveness as a noncash compensation payroll cost.

Covered period

Under the CARES Act, the covered period during which borrowers needed to expend their loans on eligible costs ran for eight weeks from the date proceeds were received. Subsequent SBA guidance allowed borrowers with a biweekly (or more frequent) payroll cycle to utilize an alternative eight-week covered period for payroll costs only, which would begin on the first date of the first payroll cycle following the disbursement of the loan.

The Paycheck Protection Program Flexibility Act of 2020 (Flexibility Act), signed into law on June 5, 2020, extended the end of the covered period to the earlier of 24 weeks after the loan disbursement, or Dec. 31, 2020. Subsequent guidance clarified that an alternative covered period would similarly run for 24 weeks or until Dec. 31, 2020, whichever period is shorter. Borrowers whose loans were approved prior to the Flexibility Act becoming law can elect to use an eight-week covered period or alternative covered period.

Per SBA guidance, to qualify for forgiveness, eligible expenditures must be either paid or incurred during the covered period. The governing language appears to allow for prepayments of such costs, with the specific exception of mortgage interest. However, in a list of frequently asked questions about PPP loan forgiveness recently released by the SBA, forgiveness will not be provided for retirement plan contributions or payments for group healthcare coverage that have been accelerated from outside the covered period or alternative covered period.

With respect to costs incurred but not paid prior to the covered period ending, payment must be made by the next applicable payroll or billing date. For example, consider a borrower whose covered period ends on Dec. 31, 2020, and has a biweekly payroll cycle. Their employees are paid one week after the conclusion of each cycle. The borrower’s employees’ wages earned from Dec. 18, 2020, through Dec. 31, 2020, can still be considered payroll costs eligible for forgiveness even though they were not paid until Jan. 8, 2021, because they were incurred during the covered period.

Learn more about the requirements and process surrounding loan forgiveness in the second part of this article.

We encourage you to reach out to your Baker Tilly tax advisor to discuss how the above may affect your tax situation.

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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.

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