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Authored by Patrick Balthazor and Michael Wronsky

This is the second article in our two-part series discussing compliance with the Paycheck Protection Program (PPP) rules based on current law and guidance. In this article, we provide an analysis of the loan forgiveness requirements and process. The first part provides a brief background on the program and an overview of eligible uses for loan proceeds.

The information below is based on the law in effect and guidance available as of Aug. 21, 2020. It is critical to note that the PPP landscape is constantly evolving, as a result of updates to the legislation and new rules and guidance issued by the Small Business Administration (SBA) and the Department of Treasury (Treasury). The program closed as of Aug. 8, 2020, and the SBA is no longer accepting loan applications from lenders. At this time, it is unclear whether the program will be reinstated by future legislation.


Borrowers will be eligible for debt forgiveness to the extent they pay or incur an amount equal to their loan proceeds on payroll costs, mortgage interest, rent or utilities within their covered period. No more than 40% of the total amount forgiven can be attributed to nonpayroll costs (see eligible uses for loan proceeds for additional details). There is no tracing requirement; in other words, the funds used to pay these costs do not have to be the same funds provided by the lender.

Forgiveness is applied for by submitting an SBA-issued form to the lender any time after the funds for which forgiveness is being requested have been spent and before the loan matures. Applications must be submitted within 10 months of the end of the borrower’s covered period to avoid principal and interest becoming due.

In general, a lender has 60 days after receiving the borrower’s forgiveness application to render a decision on loan forgiveness and issue that decision to the SBA for processing. In turn, the SBA, subject to any review of the loan or the loan application, must remit the forgiveness amount to the lender within 90 days of receiving the lender’s decision.

Limitations on forgiveness of payroll costs

Cash compensation

The maximum forgiveness available for cash compensation paid to a single employee is $46,154 if the borrower is using a 24-week covered period ($100,000 divided by 52 weeks, multiplied by 24 weeks), or $15,385 if an eight-week covered period is used ($100,000 divided by 52 weeks, multiplied by eight weeks).

For cash compensation paid to a self-employed individual (including partners if the borrower is a partnership; independent contractors; and Schedule C filers) or owner-employee (shareholder in a C or S corporation), a separate per-individual limitation on the forgivable amount applies, based on the following:

  • For an eight-week covered period, 8/52 of the individual’s 2019 compensation (in the case of a Schedule C filer, 8/52 of the amount reported on line 31; 8/52 of the total earnings subject to self-employment tax for a partner in a partnership), or $15,385, whichever is less, or
  • For a 24-week covered period, 2.5 months of the individual’s 2019 compensation (2.5/12 of Schedule C, line 31 amount, or 2.5/12 of total earnings subject to self-employment tax), or $20,833, whichever is less.

The above limit applies across all of the individual’s businesses in which they have an ownership stake. To illustrate, a sole proprietor who operates two different businesses and files a stand-alone Schedule C for each, would be eligible for a maximum of $20,833 in loan forgiveness attributable to their compensation, rather than $41,666 ($20,833 per business). It is unclear whether attribution rules would apply or how related-party salaries are combined in calculating this limitation.

Noncash compensation

The amount of forgiveness that can be attributed to employer contributions to retirement plans, payments for group healthcare coverage (including insurance premiums) and the payments of state or local taxes assessed on employee compensation on an employee’s behalf is not subject to the above-described limit. However, there are restrictions on amounts paid on behalf of self-employed individuals and S corporation owner-employees that can be considered noncash compensation for forgiveness purposes. Specifically, neither contributions to retirement plans nor group healthcare coverage payments made on behalf of self-employed individuals are forgivable costs, as these amounts are included in determining their self-employment income and, thus, the cash compensation attributed to the individual that is eligible for forgiveness as calculated above. Payments for group healthcare coverage made on behalf of an S corporation owner-employee are not forgivable expenses based on the same rationale, but retirement contributions made on their behalf (as well as those made on behalf of a C corporation owner-employee) can be eligible for forgiveness as these amounts aren’t included in their cash compensation. Forgiveness for these contributions, though, is limited to 2.5/12 of the 2019 contribution made on the individual’s behalf.   

Reductions to loan forgiveness amount

In general, a borrower will not be eligible for full forgiveness of their PPP loan if they reduced employee salaries or hourly wages, or if they reduced their number of “full-time equivalent” (FTE) employees during the covered period or alternative covered period (ACP). Specifically, the amount of forgiveness available to a borrower will be reduced if:

  1. Any employee whose annualized 2019 pay was $100,000 or less had their pay during the covered period or ACP reduced by an amount that exceeds 25% of their Q1 2020 pay, or
  2. The borrower reduced its FTE count during the covered period or ACP as compared to its FTE count at a reference point during 2019 or 2020, of their choosing.

FTEs are generally calculated by dividing the average number of hours paid for each employee per week by 40 and capping the result at 1.0. However, FTE reductions will not result in reduced forgiveness in any of the following instances:

  • The borrower made a good-faith written offer to rehire an individual who was employed on Feb. 15, 2020, and was unable to hire similarly qualified employees for unfilled positions on or before Dec. 31, 2020,
  • The borrower made a good-faith written offer to restore an employee’s hours during the covered period or ACP and the employee rejected the offer,
  • Any employee who during the covered period or ACP:
    – Was fired for cause,
    – Voluntarily resigned, or
    – Voluntarily reduced their hours.

In addition to the above exceptions, the following safe harbors are available for borrowers to avoid a reduction in forgiveness:

  • A salary or FTE reduction that occurred between Feb. 15, 2020, and April 26, 2020, is restored by Dec. 31, 2020
  • A borrower who reduced its FTEs can document in good faith that they were unable to return to pre-COVID-19 operations due to compliance with government health and safety guidelines

Borrowers relying on any of these exceptions or safe harbors will need to maintain supporting documentation for six years after the date the loan is forgiven and submit it to the SBA upon request for review.

A borrower’s PPP loan forgiveness will also be reduced by the amount of any Economic Injury Disaster Loan (EIDL) advance they received. In the event that their EIDL advance exceeded their PPP loan amount, the latter will not be forgiven. For additional details on the EIDL program, please see our article on federal coronavirus rescue programs from our Guide to Tax Planning During and After COVID-19 series.

Tax issues created by loan forgiveness

Taxability of cancellation of debt (COD) income

The CARES Act expressly provides that PPP loan forgiveness is excluded from gross income. Generally, debt cancellation creates taxable income for the borrower unless the forgiveness is eligible for specific exclusions available under the tax code. In exchange for the escaping current taxation under these exceptions, taxpayers are required to reduce their tax attributes (net operating losses, basis in depreciable assets, etc.). The CARES Act does not address this concept. 

Arguably, the phrase “shall be excluded from gross income” can be read to mean the forgiveness is not included in income to begin with and, as such, it would not need to be excluded from income under the aforementioned exception. In turn, since these exceptions are not utilized, a borrower would not be subject to attribute reduction. Nonetheless, the matter is unclear.

Even if the cancellation is not included as gross income for federal purposes, the treatment at the state level could vary. States may require the cancellation be included in determining the borrower’s state taxable income depending on their respective rules.

Deductibility of expenses funded by forgiven loan proceeds

The CARES Act was silent regarding whether a borrower could deduct expenses funded by ultimately forgiven loan proceeds. However, in May 2020, the IRS released Notice 2020-32, which provides that no deduction is allowed for an otherwise deductible expense if the payment of the expense results in the forgiveness of a covered loan under the CARES Act, and the income associated with the forgiveness is excluded from gross income. Many ranking members in Congress on both sides of the aisle rebuked the IRS’ position, stating the intent of the CARES Act was for the expenses to remain deductible. Whether the IRS’ stance will be overridden by future relief legislation remains uncertain. Unless and until Congress acts or the IRS rescinds Notice 2020-32, taxpayers should plan on these expenses being nondeductible.

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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