Ok so you have gone through the loan calculation and submitted your application to the bank. Then out of the blue you get your requested loan proceeds!
That’s great news. But remember that this is a loan subject to payback. The loan will only get forgiven if you meet certain criteria. In my opinion, the loan forgiveness calculation is much more challenging and ambiguous that the loan proceeds calculation.
In this post, we will look specifically at loan forgiveness and what you should do to make sure you can maximize your forgiveness. Look. Worst case scenario this will be a 1% loan. Under any other circumstances this is a great deal. But let’s see how much of that loan you can get forgiven.Table of Contents
- The PPP Loan Forgiveness Formula
- When is the start date of the forgiveness period?
- The 25% forgiveness rule
- How are utility costs defined under the PPP?
- How are changes in full-time employees treated?
- How are wage reductions treated?
- How do you define payroll during the forgiveness period?
- Do payments to independent contractors count for determining loan forgiveness?
- Exceptions to Loan Forgiveness Reductions
- Bottom Line
The PPP Loan Forgiveness Formula
So now that you have your money, you need to make sure that the proceeds were used for “approved” expenses. This includes payroll costs, rent expense, mortgage interest, and utility costs. With a few caveats, as long as you are able to document and prove these expenses, the lender will forgive the loan after 8 weeks.
It sounds simple. For example, if you borrowed $50,000 and used it to make payroll and kept your headcount consistent then you are good. None of the loan will need to be paid back.
But the devil is in the details of the formula. Most situations are not as straightforward as the example above. This has been a tough time for business owners with most experiencing a lot of employee turnover and uncertainly of when their business will come back to normal.
Let’s look closely at a few of the details so you don’t get tripped up.
When is the start date of the forgiveness period?
There has been some debate as to when the loan forgiveness period begins. Some have advised that it is the “loan origination” date or the “loan approval” date. But most have stated that it is the loan funding date. In theory, these dates should all be close together. The goal of the SBA and Treasury is to get money out immediately into the hands of business owners.
If the date between origination and funding is too long, then it just might be too late for some businesses. They will have to start laying off employees because funding is taking too long and there is too much uncertainty when it comes to keeping employees on payroll.
The Treasury clarified this date to be the date that the lender makes the first loan disbursement to the borrower. The lender is actually required to make the first loan disbursement within 10 days from loan approval.
The 25% forgiveness rule
One catch during the 8 week forgiveness period is that no more than 25% of the PPP funds you spent can pertain to non-payroll related costs. That is if you are looking for forgiveness of the entire balance.
This of course is what you would want to shoot for because there’s a reason the first work in the name of the program is “Paycheck”. The government wants business owners to keep employees on payroll. Of course, they know that you have other required bills that is why they allowed the 25% carve-out.
How are utility costs defined under the PPP?
Well there is not a lot of discussion about what constitutes utility costs. I think think most people just know it when they see it.
But if you follow the definition of utilities in IRS publication 535, you will see that utility costs are defined as:
Business expenses for heat, lights, power, telephone service, and water and sewerage are deductible. However, any part due to personal use isn’t deductible.
I think to most people that makes sense, with one comment or exception. The inclusion of “telephone service” may not make sense. I suspect that this has been language in pub 535 for many years and the IRS has not updated the language in a while. Not too surprising. Not many people have home telephone service anymore.
But I don’t think this means that you can automatically include your cell phone in PPP allowable utility costs. But there is an argument to be made to add any office lines and possibly other phone related costs. Make sure you discuss with your lender and hopefully we’ll have some updated guidance on this issue soon.
How are changes in full-time employees treated?
Now it starts to get a little trickier. If you reduce the average number of full-time employees in the company after receiving the loan, that reduced headcount also will reduce your allowable loan forgiveness.
For example, you have 10 employees and that get reduced to 7 employees during the 8 week period. This is a 30% reduction. The result is that your forgiveness will get reduced by 30%. It sounds like the goal is to keep as many people employed as possible and not just lower headcount and increase wages for a select few.
Ok that makes sense but how is it actually calculated?
In order to calculate headcount changes, you’ll look at the following:
- Compare the full-time employees during the 8 week period beginning on the loan origination date to the average number of full time employees you had from the period of February 15th through June 30th of 2019
- Alternatively, you can choose compare your current employees to the period of January 1st through February 29th of 2020.
- The nice part is that the government is giving you the choice of which comparison period to use. This gives you some flexibility to determine if the 2019 numbers are more favorable to you or the 2020 numbers. You might have to dig through your old payroll records and do some quick analysis.
How are wage reductions treated?
This is the last payroll consideration. If you lower the wages of employees earning less than $100,000 a year by more than 25%, the amount of the reduction in excess of 25% will also lower the amount of your forgiveness.
Ok this gets a little more painful to calculate. For example, if you had an employee who was earning $50,000 a year and then after you receive your loan you reduced his annual wage to $30,000. This would be a 40% reduction.
If his wage would have been lowered by 25% or less you would have been fine (subject to the other criteria). But since it was a 40% reduction you would lose loan forgiveness on the incremental amount. Since a 25% reduction would have been $37,500 and you reduced his wage to $30,000, this just cost you $7,500 of loan forgiveness.
How do you define payroll during the forgiveness period?
Remember for purposes of calculating payroll we are using gross payroll. For example, let’s assume you have an employee who made a gross wage of $5,000 over the 8 week period. But after federal and state tax withholding and employee payroll taxes, their take home pay is only $4,000. You use the $5,000 and NOT the $4,000 net pay to calculate loan forgiveness. Just like with the loan proceed calculation, you get to also include any employer state and local payroll taxes. But you can’t include any portion of federal employer payroll taxes.
Do payments to independent contractors count for determining loan forgiveness?
No. They do not. These was much debate early on the program regarding this topic. But it has been clarified that payments made to independent contractors and to 1099 “employees” are not allowed. In the truest sense, they are not employees and don’t receive a paycheck.
Exceptions to Loan Forgiveness Reductions
So if you are faced with a loan forgiveness reduction based on the payroll criteria what can you do? There are a couple exceptions.
Companies that re-hire laid off employees or even increase wages to make up for prior salary reductions during COVID‑19 are not penalized by the forgiveness reduction calculation noted above. They are therefore still entitled to full forgiveness under the program (assuming other criteria is met). This gives companies an incentive to not to lay off employees or cut wages, but instead allows them to use the loan proceeds for allowable expenses during the time period.
Accordingly, the reduction in loan forgiveness as calculated above does not apply if one of the following occurs:
- If the reduction in the number of employees (full-time equivalent) from February 15, 2020 to April 26, 2020 is entirely eliminated by June 30, 2020. The SBA will examine the number of employees on the books on February 15, 2020 (again full time equivalent) and compare this number to the number of full time equivalent employees at June 30, 2020; or
- If the wages or salary of any employees were reduced (this part does not specify the 25% pay cut requirement) between February 15, 2020 and April 26, 2020, and the company did subsequently restore pay by June 30, 2020.
But remember that you only need to look at the exemption if you are subject to a reduction in loan forgiveness based on the above reduction calculations. So it appears if the full-time employee restoration test is there is complete loan forgiveness so long as the proceeds are used for qualified expenses.
We know that calculating the loan forgiveness under the Paycheck Protection Program can be difficult. It certainly is a more cumbersome process then doing the actual loan proceed calculation. But hopefully we made it a little easier for you.