Overview of PPP Loan Forgiveness

Now that the initial wave of PPP loans are being submitted and all the calculations of maximum loan amounts have been made we need to start looking at how these loan proceeds need to be used and how these loans can be forgiven as outlined in the CARES Act. This portion mainly applies to those who have employees. If you are self-employed feel free to contact me directly about the technicalities of the PPP loans for the self-employed.

Background of PPP loan forgiveness.

All PPP loans are forgivable if used for what is called covered costs. Covered costs include payroll costs, interest on mortgages and/or other debt incurred before 2/15/20, rent, and utilities. At least 75% of the loan proceeds has to be used for payroll costs and no more than 25% can be used for non-payroll covered costs. You also have to maintain employment and pay levels during the 8 week period.

Risks of certification

When you apply for a PPP loan you are personally certifying that the loan funds will be used for the covered expenses only. Not only will using PPP loan funds for non-covered purposes cause the SBA to not forgive those proceeds of the loan, it can open up the potential for fraud charges. Knowingly using PPP funds for non-covered expenses is considered fraud and not something that should be risked.

Loan terms on non-forgiven portions of the loan
If you have any part of your loan not forgiven, the terms of the loan are full amount due in 24 months at 1%. This can be quite a large cash outlfow if not planned for properly even with the 6 month deferment period.

Income Tax Effects

One of the issues with forgivable debt is that the amount forgiven is typically taxable, but in this case it is not. So there is no income to be reported from the forgiveness of this loan. If there is any portion not forgiven any interest paid will be deductible just like normal interest.

Reductions In the Amount Forgiven

  • The 75/25 rule: In order to receive full forgiveness, loan proceeds must be used for no more than 25% on non-payroll allowable costs. The way this works is that you are limited to only 25% of the loan proceeds on non-payroll costs so that amount plus what was used on payroll costs will end up being less than the full loan amount. That difference is what will need to be repaid.

  • Staffing requirement: You must maintain your staff in order to obtain full loan forgiveness. This is based on maintaining full-time equivalent (FTE) staff. This is calculated by taking your total hours paid in a week to hourly workers divided by 40 hours plus the number of salary workers you have. You will need to determine this number for the following periods:

    • The 8 week following the date of funding

    • From February 15, 2019, to June 30, 2019

    • January 1, 2020, to February 29, 2020 (if seasonal employer do not use this number)

    You will use either the 2019 number or the 2020 number depending on whichever is smaller. You will then divide the FTEs for the 8 week period into the FTEs for the period you chose and if the number is larger than 1 you have met this requirement. If it is less than 1 you may need to repay a portion of your loan back.

  • Pay level requirement: This is taken on an employee by employee basis. For every employee whose wages are included in the calculation of payroll costs, they cannot make less than 75% of what they made in the most recent quarter (this will likely be the first quarter of 2020). This is done on an annualized basis since there are more than 8 weeks in a quarter. The loan forgiveness amount is reduced by the total wage reduction of any employee who makes less than 75% of what they did in the previous quarter.

  • Rehiring and wage restoration grace period: You have until June 30, 2020, to rehire FTEs to their required levels and/or increase wages on those whose wage were decreased by more than 25%.

Strategies to Maximize Forgiveness Potential

One of the benefits to the PPP loans is that they are forgivable but only to the extent you use at least 75% of the loan funds for payroll costs, maintain your staff, and maintain wage levels. Here are some strategies to make sure you can maximize your forgiveness amount.

Built in Budget

The PPP loan forgiveness rules stipulate a simple budgeting mechanism to ensure that it gets used for covered expenses. 75% of the loan proceeds has to go towards payroll costs. So right there you know to take 75% of the loan proceeds and expect to spend at least that much on payroll costs over the next 8 weeks. 

For example, a bi-weekly payroll payer gets a loan for $25,000. They will need to pay at least $18,750 in payroll costs over the next 8 weeks. Therefore, they will need to pay payroll of at least $4,688 each pay period. 

The same methodogy can be applied to the non-payroll costs component which comprises of 25% of the loan proceeds. In our example above, the borrower can expect to use at most $6,250 towards these other expenses.

Track Expenses, FTEs, and Wage Comparisons Weekly

Borrowers only have 8 weeks from the closing of the loan to use these funds correctly in order to have the loan amount forgiven. Tracking your progress over the next 8 weeks is essential in ensuring the funds get used for the intended purposes. Otherwise borrowers could be stuck with some loan conditions that aren’t favorable from a cash flow perspective.

I will be releasing a calculator to help track these things in the coming days.

Open a New Bank Account

It is highly advisable for all PPP borrowers to open a new bank account. This will not only make it easier to only pay covered expenses from, it will also provide simple documentation that the loans was use for it’s intended purposes. Granted there will be additional supporting documentation, likely to be similar to what was used for the PPP loan application process, but having bank statements showing only covered loans shows that the borrower intended to use the loan only for covered purposes.