FINALLY!!! . . . SBA Guidance on the Forgiveness Math
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The Punch Line: On Friday, May 15, the Small Business Administration published a new form entitled Loan Forgiveness Application Instructions for Borrowers which, at long last, provides a great deal of guidance on how to calculate loan forgiveness.
The Background: Section 1106(b) of the CARES Act famously provides for potential forgiveness in a maximum amount equal to “the sum of [eligible] costs incurred and payments made during the covered [8-week] period.” There previously was only scant guidance on how to tie the covered costs to the 8-week period, or even whether a recipient should apply a cash method or accrual method in so doing. The April 2 Interim Final Rule promised “SBA will issue additional guidance on loan forgiveness.” In an April 8 FAQ, SBA said “The amount of forgiveness of a PPP loan depends on the borrower’s payroll costs over an eight-week period . . . . The eight-week period begins on the date the lender makes the first disbursement of the PPP loan to the borrower.” In an April 29 FAQ, SBA said “. . . SBA has decided . . . that it will review all loans in excess of $2 million, in addition to other loans as appropriate, following the lender’s submission of the borrower’s loan forgiveness application. Additional guidance implementing this procedure will be forthcoming.”
Effects on Prior Advice: In the absence of official guidance, advisors to small businesses filled the void with speculations about how best to protect a recipient’s claim to forgiveness. I won’t speak ill of others, but here is some of our own prior advice that can now pretty much be discarded:
1. OLD ADVICE: “Set up a separate account for the PPP funds.” Worried about a statute that speaks about the “use” of PPP loans to fund a limited subset of expenses, we advised recipients to set up a separate account so that they could prove that these particular monies were spent on those particular expenses.
NEW ADVICE: “Never mind.” The Forgiveness Application requires that the recipient incurred a sufficient quantity of covered expenses during the relevant period (more on this below) and that payments for those expenses got made by certain dates. No tracing of funds is required.
2. OLD ADVICE: “Meticulously plan the timing of your 8 weeks’ worth of expenditures.” Worried about a statute that speaks in terms of costs that are both “incurred and paid” during an 8-week period, we advised recipients to map out their anticipated expenditures to see what portion of the loan amount was at risk for not being spent during those 8 weeks.
NEW ADVICE: “Timing issues have been simplified, although not eliminated.” The Forgiveness Application requires less attention to the timing of payments, if made in the ordinary course on their normal due date. In the case of eligible nonpayroll costs, it generally will be sufficient for the costs to be incurred within the 8-week period (and then paid in due course) or paid in due course within the 8-week period (even if relating to an earlier or later period – but no double-counting). Eligible payroll costs, however, must be both incurred and paid within the 8-week period, except that payments made slightly outside the 8-week period would still count (see below).
NOTE: In regard to planning, it is still the case that a recipient will want to make sure it knows how much of the loan proceeds will be spent on “payroll costs” – the desired target being at least 75% of the loan amount. If the recipient will otherwise fall short of 75%, it might consider paying special bonuses (e.g. “combat pay” or “thank you for not abandoning us for an expanded unemployment compensation check”) to make up some or all of the difference. Certainly, if such a bonus is under consideration, it makes sense to pay it inside the 8-week period and thus obtain forgiveness of the amount.
3. OLD ADVICE: “No you can’t delay the start of the 8-week period.” This advice was backed by an FAQ that, in clear and unambiguous English, said the 8-week period begins on the loan funding date, and no other.
NEW ADVICE: “Generally okay to delay the start of 8-week period for payroll cost purposes.” If the recipient regularly funds its payroll weekly or bi-weekly (i.e. not monthly or twice-per-month or randomly), it can pick an “Alternative Payroll Covered Period” that lines up with its actual payroll dates over an 8-week period. Nonpayroll costs still must be tied to the 8-week period that starts on the loan funding date. (But see above for flexibility on incurred or paid.)
4. OLD ADVICE: “It’s easy – just split the first and last payroll funding amounts into days earned within and days earned outside the 8-week period, paying the rest from non-PPP sources, while allocating overhead hours by some reasonable method, but being careful to distinguish between wage reductions and hours cutbacks.” The statutory emphasis on wages and payments “during” an 8-week period meant that most employers had about a 1-in-14 chance of having their loan funding date line up with the beginning of a payroll period.
NEW ADVICE: “Did I really say that?” By allowing the recipient to pick an “Alternative” 8-week period that starts on the first day of the next payroll period following the loan funding date, SBA is helping preserve the mental health of CFOs around the country. The “Alternative” period applies for payroll costs, but not for nonpayroll costs.
FURTHER EXPLANATION: SBA confirms that “payroll costs” are deemed “incurred” on the day the employee’s pay is earned, and are deemed “paid” either on the date that payroll checks are distributed to employees or on the date the recipient originates an ACH credit transaction with the payroll service. By allowing the Alternative period to start on the first day of the next payroll period, that pulls the normal weekly or bi-weekly tallies into line with the 8-week measurement period. On the payments side, SBA will allow the last of the payment installments to fall outside the period “if paid on or before the next regular payroll date.”
CAUTION: “Payroll date” is not defined but likely means the date on which payroll is regularly funded by the employer. In contrast, “pay period” (a term used to define the Alternative period) likely means the period over which a given payroll check is earned.
The following other prior guidance from us seems to be holding up pretty well:
5. OLD ADVICE: “We don’t really know, but it seems reasonable to treat monthly benefit costs as incurred on the date they normally fall due.”
NEW ADVICE: “Benefits payments count if made within the period, but it remains unclear whether proration is required.” For benefit payments not made in monthly increments (such as retirement costs funded once or twice per year), it is debatable whether a payment that happens to fall due within the period can be counted for more than a prorated 8-week amount. (Our guess is not.) It does seem likely that prepayments made within the 8-week period will count, at least on a prorated basis. Whether the recipient can wait until a December due date to fund those annual retirement costs seems doubtful – PPP loan amounts not spent before the application date would seem ineligible for forgiveness.
6. OLD ADVICE: “If payroll costs reach only 70% of the loan amount, then the maximum forgiveness is cut to 70/75ths (93.3%) of the loan amount.”
NEW ADVICE: “Ditto.” The new Instructions make clear that nonpayroll costs cannot make up more than 25% of the forgiveness amount applied for. This contradicts speculation by others that reaching 70% instead of 75% means just a 5% reduction in forgiveness, and contradicts speculation that the 75% target is an all-or-nothing condition to forgiveness.
7. OLD ADVICE: “‘Covered rent obligations’ include equipment leases; ‘covered mortgage obligations’ include equipment financing loans.”
NEW ADVICE: “Ditto.” There still is little guidance about whether working capital loans or inventory loans (generally secured by a lien – subordinated or not – in all assets) count as “covered mortgage obligations.” We continue to think that the term “mortgage” was intended only to reach financing arrangements that constitute purchase money financing of equipment or that are functionally similar to equipment leases. Note that equipment lease payments count 100% as covered obligations, whereas only the interest component of equipment loan payments counts as a covered obligation.
8. OLD ADVICE: “The wage-related reduction to forgiveness is computed on the basis of wage rates, and would not include compensation cuts attributable to a reduction in hours. (But a reduction in hours could result in a headcount-related reduction.)”
NEW ADVICE: “Ditto, pretty much.” The Instructions confirm that an employee’s wages are computed as “hourly” wages, not as “total” or “annual” wages. But it remains unclear whether overtime wages are ignored. In all likelihood, probably not. It appears that the recipient should compute the employee’s total wages for either period (i.e. the 8 weeks or the January-March quarter) and then divide by the total number of hours worked in that period. In most cases, the variations due to overtime pay will not be meaningful since only wage reductions exceeding 25% are counted against forgiveness.
It is worth noting that determinations of “average annual salary” generally don’t present this same issue of weekly variability. And of course, the offset calculation does not apply to any employee who in any pay period during 2019 “received compensation” [which probably means who “earned compensation”] at an annualized rate exceeding $100,000.
CAUTION: If we apply the instructions literally, a highly compensated person first hired in 2020 is not excluded from the offset calculation. If her average annual salary during the 8-week period was less than 75% of her average annual salary during the January-March quarter, does her dollar reduction (a not insubstantial number) offset the forgiveness amount?
9. OLD ADVICE: “Count full-time equivalents (FTEs) applying a 40-hour work week standard.” Our advice in this respect was a distinctly minority view. Most commentators pointed to the 30-hour standard adopted in the Affordable Care Act (there, for determining entitlement to employer-provided health insurance coverage).
NEW ADVICE: “Ditto.” According to the Instructions: “For each employee, enter the average number of hours paid per week, divide by 40, and round the total to the nearest tenth” (but never more than 1.0). The Instructions also allow a second method: “A simplified method that assigns a 1.0 for employees who work 40 hours or more per week and 0.5 for employees who work fewer hours may be used at the election of the Borrower.” Except for recipients with many part-time employees who work fewer than 20 hours a week, the first method will produce the higher average FTEs, and thus will usually be preferable.
The CARES Act offers a pair of June 30 safe harbors (the “Hail Mary” fixes) by which FTE-related reductions and wage-related reductions can be overcome. Until the May 15 Instructions, the SBA had given virtually no guidance on these provisions.
10. OLD ADVICE: “Not really relevant until we get closer to June 30, so best to wait for SBA guidance.”
NEW ADVICE: “We do now have guidance, and it is quite complex.” If the total FTE headcount on June 30, 2020 equals or exceeds the total FTE headcount for the pay period that included February 15, 2020, that generally will satisfy the headcount Hail Mary. And if wage levels on June 30, 2020 for all “under $100,000” employees are at least equal to those on February 15, 2020, that generally will satisfy the wages Hail Mary. But that is only approximately correct. The wages Hail Mary in particular is highly complex. Unexpected (to many of us, anyway) is that under the new Instructions, (i) this safe harbor is applied employee-by-employee and thus can reverse a substantial portion of the wage-related reduction even if satisfied only as to some employees but not all and (ii) wage restoration is not needed for employees whose pay was cut by 25% or less. There are enough concurrent factors at play, however, that rather than try to explain these Hail Mary’s in terms that work for all situations, it is far easier to apply them to a given set of facts. So over the next few weeks, seek advice on your particular circumstances so that you can decide whether – and, importantly, to what extent – you wish to rely on either or both Hail Mary’s come June 30.
The Forgiveness Application form recites that the recipient’s eligibility for loan forgiveness “will be evaluated in accordance with the PPP regulations and guidance issued by SBA through the date of this application.” Most recipients won’t be applying until after June 30. Which is still a ways away. And so:
11. OLD ADVICE: “The guidance to date has been the subject of frequent revisions (and a few outright reversals). Companies should continue to stay alert for new guidance.”
12. NEW ADVICE: “Ditto.” It seems highly likely that further guidance from SBA on forgiveness will be forthcoming before June 30.
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