Retirement

Extension Act For PPP Loan Applications: Clarifications And Explanations

Potential borrowers still hoping to get a cut of the PPP pie have been given until August 8th to apply for their initial PPP loan.  President Trump signed the “PPP Extension Act” on July 3rd, which consists of the same exact language that passed the Senate on June 30th, mere hours before the window to submit applications for the PPP was set to close. 

This article was written to help PPP borrowers and their advisors understand what the rules are today for small business owners, and what guidance is still needed to clarify uncertainties. Over the past few weeks, we have fielded hundreds of questions from small business owners and advisors and and have had thousands attend free webinars on the PPP program.  Our next free webinar will be on Wednesday, July 8th at 12:30 p.m. for 30 minutes entitled PPP Forgiveness Basics For Owners and Employees of Small Businesses: Where Are We Now. You can sign up for this by emailing me at info@gassmanpa.com and putting “end the confusion” in the subject line. If you are an advisor, please feel free to share this article, and our empathy, for you and your clients.  This has been a very hard road for those trying to save their businesses while spending money to get forgiveness under rules that have changes just about as fast…and furiously…as a roller coaster at a now shut down amusement park. 

Special thanks to Brandon Ketron, J.D., CPA, LL.M., who works for me and is the real brains behind our law firm’s ability to help with these questions, and Kevin Cameron, CPA, who has created a spreadsheet that Brandon and I have helped to improve that is being used by hundreds of CPAs and thousands of borrowers to track and navigate forgiveness.  Free videos on how spreadsheeting forgiveness works can be found at the following links, (4 minute video) and (47 minute video).  The AICPA also has a spreadsheet that is free for its members, and can be found on its website.  

More than 4.8 million small businesses have already applied for PPP loans designed and implemented to keep businesses afloat and keep paychecks in employees’ hands. The Program was set to wind down with nearly $130 billion still in its coffers and thousands of borrowers still confused or unable to find lenders who would cooperate to enable them to borrow.  Most of these borrowers consist of individuals who are known as “independent contractors” and “sole proprietors” because they file a Form Schedule C as a small business or a Schedule F as a farmer, as part of their Form 1040 individual tax returns, and own their own trade or business individually or through a wholly owned Limited Liability Company (“LLC”) that is “disregarded” for income tax purposes. For convenience, I am referring to these individuals as “Schedule C Filers” below. Many of them have been called by worse names. 

Many small businesses use LLCs or companies that have elected to be treated as “S corporations” which file Form 1120S income tax returns, and therefore different rules apply to them.  Other companies are treated as “C corporations” and file Form 1120 tax returns, with other rules applying to them.  Finally, some joint owners of businesses and some LLCs and other entities file a Form 1065 tax return as “partnerships” for income tax purposes, with even different rules applying to them. 

Since the vast majority of questions are coming from Schedule C Filers and S corporation borrowers, we are not covering the special considerations that apply for partnerships or C corporations in any great detail herein. 

Forgiveness for Independent Contractors and Proprietors.  The most commonly asked – and easiest to answer – question from Schedule C Filers is how much they have to pay themselves to get full forgiveness.  The SBA has been very kind to Schedule C Filers by providing in the June 11th  Interim Rules and the Forgiveness Applications that they are considered to have paid themselves an amount equal to 20.833% of their 2019 Schedule C net income, as indicated on Line 31 of their Schedule C.  Since 20.833% is equal to 2 ½ divided by 12, which is and has been the formula for what could be borrowed, a Schedule C Filer who had no employees can simply apply for the loan based on 20.833% of his or her 2019 Schedule C net income, and it is automatically forgiven in that amount by the filing of the Form EZ Application for Forgiveness, and nothing else has to be done.  The 20.833% is based on up to $100,000 of 2019 income so that the most that can be borrowed, and the amount that will be forgiven, is limited to $20,833. 

This applies regardless of whether the trade or business is still open and there is no need to keep track of rent, interest, or utilities.  Schedule C taxpayers may have to report this compensation to unemployment, however, this is not entirely clear.  The only official guidance we have gotten comes from the April 14th Interim Final Rules, which provide that Schedule C taxpayers “should be aware that participation in the PPP may affect your eligibility for state-administered unemployment compensation or unemployment assistance programs, including the programs authorized by Title II, Subtitle A of the CARES Act, or CARES Act Employee Retention Credits.” Although a Schedule C taxpayer’s receipt of a PPP loan may disqualify them from unemployment benefits during the period the loan is outstanding, there does not seem to be any prohibition that would prevent a Schedule C taxpayer from receiving unemployment benefits before receipt of the PPP loan and then re-applying after the PPP loan is forgiven.  

The rules are more complicated for Schedule C taxpayers who received loan monies based upon the sum of their 2019 net income and 20.833% of wages they paid to employees of the business.  In this situation, they need to have wages paid to employees (other than themselves), and possibly rent, interest and utilities, to have their loans completely forgiven under rules that are very similar to what applies for S corporations, C corporations and partnerships. 

Reduction in Workforce Penalties and Safe Harbors.   One common question posed to and by advisors is whether the deadline change from June 30th to August 8th also applies to the now-modified rule that was going to permit borrowers that reduced their work force to avoid a reduction in forgiveness if they returned to normal workforce levels by June 30, 2020.  A great many borrowers re-hired a large part of their workforce after April 26th based upon this prior safe harbor, which basically said that if a borrower had a reduction in workforce before April 26th and restored it by June 30th there would not be a reduction in forgiveness.  The June 30th re-hire deadline was extended to December 31st and borrowers who were acting in reliance upon it perhaps spent some money inefficiently, but many jobs were saved (or at least extended), and forgiveness will be available to the vast majority of these borrowers based upon the new safe harbors below. 

Can Restore Workforce by Date of Application for Forgiveness Filing or by December 31st.  The PPP Flexibility Act passed on June 5th extended this June 30th safe harbor testing date to December 31st, and the new extension for borrowers to apply for loans by August 8th instead of by June 30th has nothing to do with this, but has caused some confusion. 

While many borrowers were exasperated that they had been putting the workforce back together to have it at full capacity on June 30th even though many businesses were not ready for this, the reduction workforce hours requirement is much easier to navigate because the June 5th Flexibility Act provides that such reductions will be disregarded to the extent that the workforce is restored by the date that the Forgiveness Application is filed, or by December 31st. It seems that the borrower will have to file the Forgiveness Application by December 31st, and not before then, if the workforce is not restored, although it is not entirely clear under current guidance whether borrowers can apply prior to December 31st and get credit for the number of employees they have restored, even if not restored to the full pre-virus level. 

The two other safe harbors that can be used in lieu of the above for borrowers with reduced workforces are as follows:  

  1. Governmental Guidelines Caused Reduction. Compliance with CDC, HHS, and OSHA rules and guidelines that compel an employer to reduce their workforce, which include state and local laws by reference in such guidelines; or 
  2. Good Help Is Hard to Find Reduction.  An inability to re-hire individuals previously employed in the same position when the individuals are no longer available for reasons beyond the control of the borrower, as properly documented, and cannot be replaced due to a lack of qualified individuals available for hire. The lack of qualified applicants is understandable and common, given that many workers are able to receive both state and Federal unemployment benefits, and are reluctant to leave their young children, or risk their lives in the workforce right now given the high infection and death rate being experienced in the general public.  One requirement for this exemption is that the borrower must report the workers not willing to come back to unemployment officials, known to animal lovers as “ratting them out.”  

In fact, corporate and estate planning paralegals can email me at agassman@gassmanpa.com and put “desperately seeking paralegals” in the subject line.  Early Thursday morning, our remote third shift paralegal of over 15 years, Carolyn, died in her sleep, possibly of Covid-19, and falls under exception (2) above.   She sent me an email just before 6 a.m. on Thursday morning that she did not see any more work to do and was going to sleep after a few days of trouble with her arthritis and never woke up to enjoy the Fourth of July weekend with her grandchildren, or to type this article. She will be sorely missed, and we have a lot to be thankful for.  

8 Versus 24 Week, or Somewhere In Between, Testing Period. The June 5th Flexibility Act provides that borrowers can elect to use an 8 week or 24 week testing period to determine the amount of expenses that can count towards forgiveness.  The June 11th Interim Rules and Forgiveness Applications provide that a shorter than 24 week period can be elected so that borrowers can simply apply as soon as they have spent enough. 

Most lenders are not yet accepting Forgiveness Applications, and are waiting for further guidance from the SBA, but some are. 

As discussed below, S corporation and C corporation owners’ compensation for forgiveness purposes can only be counted based upon no more than the lessor of 20.833% of their 2019 W-2 compensation, or $20,833 if the 2019 income was over $100,000, and presumably must wait until at least 10.83 weeks has passed from when they received the loan, because 10.83 divided by 52 is 20.833%. 

Compensation paid to non-owner employees is not subject to the 20.833% limitation and can instead amount to as much as $46,154 per non-owner during the 24 week period. It is unclear under current guidance if non-owner employee compensation counted towards forgiveness will be limited to $887.58 ($46,154 / 52 = $887.58) times the number of weeks compensated for during the testing period, or if up to $46,154 can be paid to a non-owner employee during the testing period if the borrower applies for forgiveness prior to the end of the full 24 week period.  Our best guess is that SBA guidance will provide that an employer will likely need to use the entire 24 week testing period to be able to count the full $46,154 towards forgiveness, while, for example, an employer needing only half of that amount would be able to apply for forgiveness after 12 weeks have elapsed. 

To explain what remains to be told I have rewritten parts of my article of June 22nd entitled Why New PPP Loan Rules For Owner-Employees Of S And C Corporations Are Bad News to include what we have concluded since then, to read as follows:

1. The group health insurance costs of an individual who is an owner of an S corporation cannot be included in the forgiveness amount.

This makes sense because health insurance premiums paid for S corporation shareholders who own more than 2% of the company are deductible but are reported as compensation on Form W-2, thus the amount of the shareholder’s health insurance costs are already included in his or her W-2 income.

The forgiveness credit applies to the W-2 income (including the health insurance costs reported on the W-2) unless the shareholder is over the W-2 forgiveness ceiling, which will be $15,385 if an 8 week forgiveness period is chosen or $20,833 if a 24 week forgiveness period is chosen. The $15,385 and $20,833 numbers are explained under section 3 below.

Here is an example of how the health insurance rules will apparently work:

  • John owns 2% or more of ABC LLC and earns $98,000 a year in salary. His health insurance costs are $6,000 per year. From an annualized basis standpoint, these rules will allow all of John’s $98,000 salary and $2,000 of his health insurance costs to count towards forgiveness. 
  • If an 8 week forgiveness testing period is selected, this means that the company can count $15,077 of John’s salary and $308 of his health insurance based upon 8/52 of $98,000 and 8/52 of $2,000. 8/52nds of $4,000 in health insurance ($615) cannot be counted since that would exceed the $15,385 limit on owner compensation.
  • If a 24 week testing period applies, then the total combined wages and health insurance allowable for an employee shareholder will be $20,833, and excess insurance costs will not be counted towards forgiveness.

It is interesting that this rule is in direct opposition to previous SBA guidance issued in FAQ #7, which allowed shareholders of S Corporations to include health insurance costs above and beyond the cash compensation limit of $15,385. Many PPP applications were filed to include health insurance costs above the limit on cash compensation, and now such borrowers may have a mis-match between what loan amount they received and the amount that can be forgiven. Presumably this can be made up by spending money on non-payroll costs, or maybe future guidance will allow health insurance costs to be included above and beyond the owner compensation limit. 

A greater limitation and disadvantage applies for S Corporation shareholders with less than 2% ownership and less than $100,000 in annualized wages, because the W-2 income does not include health insurance costs, so the company receives no forgiveness for the health insurance costs since the updated rules make no distinction or exception for shareholders owning less than 2%. An aggressive position might be to include health insurance costs of shareholders owning less than 2%, based upon the reasoning that since such costs are not included in W-2 compensation that is reported on Line 9 of the Forgiveness Application, these costs should be reported on Line 6. Definitely talk to your CPA or lawyer before taking this position.  

2. Compensation Counted for Owner-Employees Cannot Exceed The Pro -Rata Portion of What They Were Paid in 2019.

This is already explained above but more detail never hurts. 

Suppose that John’s 2020 annual compensation was at least $100,000.

What if John’s 2019 compensation was $49,000 and his health insurance was $3,000 because he only worked 6 months in 2019 for whatever reason?

Assuming that the company had significant other payroll so that it’s PPP loan was much more than $100,000, one would have assumed that either 8/52nds or 20.833% (2.5 divided by 12) of John’s entire $100,000 amount would count as forgiveness, but the new modified interim rules indicate that such forgiveness will be limited to not exceed a pro-rata portion of his 2019 earnings.

This means that many small businesses that primarily relied upon non-owner workers in 2019 will not be able to receive full forgiveness if the primary workers in the company are owners during the testing period. 

The SBA’s reasoning for this rule is that the loan was based on a maximum of 20.833% of 2019 compensation for owners, and with the extension to 24 weeks, many business owners might receive a windfall by only paying themselves and relying upon one of the numerous exceptions to maintaining full employment for their employees.  For example:

  • If John’s 2019 compensation was $49,000 in 2019 because he only worked for 6 months, then John would receive a loan of $10,208 based on his compensation. Let’s also assume that John had two other employees that each made $25,000 in 2019, and that the company paid  no benefits or state employment taxes, so that John’s total loan was $20,624 (10,208 + $10,416).
  • If not for the above mentioned rule, John could lay off both of his employees and still achieve full forgiveness based upon paying himself the maximum wages of $20,833 by relying upon the exception that his employee headcount was reduced because his business could not return to the same level of business activity. The SBA is trying to avoid this so-called “windfall” to owners by limiting forgiveness to 20.833% of 2019 compensation for the 24 week period so that forgiveness for owners will match the portion of the loan received for their own compensation.

One unanswered question is whether or not this limitation applies to spouses or other relatives of the owner. Under current rules, no such attribution exists, so wages exceeding amounts paid in 2019 can be paid to spouses or other family members that work in the business, assuming that the wages paid are legitimate compensation for services rendered to the company. 

3. $20,833 for 8 Week Testing Versus $46,154 for 24 Week Testing and Why?

As mentioned above, forgiveness for wages and health insurance for an owner and employee during a 24 week testing period cannot exceed $20,833. If an 8 week testing period is elected, the limitation is $15,385.

This is based upon the premise that the forgiveness for a company should not exceed the amount that was loaned for the wages of its owners (2.5 months/12 months X $100,000). 

On the other hand, a non-owner employee’s compensation can be counted based upon as much as $46,154 (24/52’s of $100,000) if the person has wages of $100,000 or more. In addition to this, the company’s entire cost of providing the non-owner employee with health insurance and retirement plan benefits (paid or incurred) during the 24 week period can be counted.

While this limitation was not expected, most borrowers will not be hurt because they will have plenty of other expenses to apply towards forgiveness. 

4. What About Retirement Plan Expenses?

The PPP loan program was very generous on the lending side by including an amount equal to 2.5 times the average annual expense for retirement plan contributions, considering that in many small companies, the vast majority of contributions are for highly paid employees and owners.

The SBA could have required employers to measure how much of each retirement plan contribution for 2019 was attributable to salaries above the $100,000 annualized limit, but this would have been extremely complicated and would have significantly lowered the PPP loans going to many companies who are already struggling to maintain their pension benefits, let alone keeping the same number of workers on the payroll.

The planning opportunity left open by all indications under FAQ’s, Interim Final Rules, and Forgiveness Applications and Instructions, was that all pension plan expenses “paid or incurred” during the 8 week or 24 week testing period would count as forgiveness.

This can be interpreted to mean that at least 8/52, or 24/52 (as applicable), of the 2020 annual pension costs can be considered as paid toward forgiveness, whether paid or not during the 8 week or 24 week period, since the expense was incurred during that period but would likely have to be paid in the normal course prior to filing the Loan Forgiveness Application to get credit for such costs.

By the same token, the rules can be read to provide that paying the entire 2019 pension obligation during the 8 week or 24 week period (which is normal in pension planning), would also facilitate having the entire 2019 pension contribution counted towards forgiveness and that paying the 2020 contribution amount during the testing period can cause 100% of the 2020 expense to be counted towards forgiveness.

The Application for Forgiveness makes no reference to these planning opportunities, and there is nothing in the revised Interim Final Rules that would limit this either.

Please see the words we have underlined below from the following language that is taken verbatim from the new EZ Application, and may provide for a limitation on retirement plan contributions for owners. This language also provides a good review of the rules that are discussed above:

Employee Benefits: The total amount paid by the Borrower for:

Employer contributions for employee health insurance, including employer contributions to a self-insured, employer-sponsored group health plan, but excluding any pre-tax or after-tax contributions by employees. Do not add employer health insurance contributions made on behalf of a self-employed individual, general partners, or owner-employees of an S-corporation, because such payments are already included in their compensation.

Employer contributions to employee retirement plans, excluding any pre-tax or after-tax contributions by employees. Do not add employer retirement contributions made on behalf of a self-employed individual or general partners, because such payments are already included in their compensation, and contributions on behalf of owner-employees are capped at 2.5 months’ worth of the 2019 contribution amount.

Employer state and local taxes paid by the borrower and assessed on employee compensation (e.g., state unemployment insurance tax), excluding any taxes withheld from employee earnings.

This above underlined language is not included in the main Loan Forgiveness Application, and we know of no reason why, unless it is a drafting error to include it in the EZ Application, or it was an error not to include it in the non-EZ Application. Alternatively the SBA may not want this “loophole” to be available for those who file an EZ Application, or will do this now to save face and claim that this was not an error. Under this limitation, the maximum pension expense permitted for amounts put away for an employee shareholder will be based upon 2.5/12 (20.8%) of the annual retirement plan expense, as opposed to the larger amounts that would otherwise be counted in the Forgiveness Application.

It is unknown whether it was intended that this limitation would apply only for borrowers who use the EZ Application and not for borrowers who use the full Loan Forgiveness Application, or if it was intended to apply to both.

5. What Is An Owner-Employee and What Can Be Done to Avoid this Limitation?

The rules provide no hint as to what an “owner-employee” is, but we can assume that this is any person who has an ownership interest in the borrower company of any size, and that this will not include the spouse or another family member of the owner who might work for the company.   Also, there seems to be nothing to prevent the person who has owned the company in the past from selling or gifting their ownership to someone else, like a spouse, and while continuing to work for the company so as to not be subject to these limitations during the period of the testing weeks that the person is no longer an owner.      

For example, an individual or part-owner of a company who worked for the first ten weeks of the 24 week testing period, earning whatever salary was paid, may be able to transfer her ownership to her spouse and receive $46,154 of compensation between the date of the transfer and the end of the 24 week period, even if part of the compensation in those last weeks is pre-paid for work the employee becomes legally responsible to perform after the 24th week.

This would allow an entire $46,154 to count towards forgiveness, assuming the compensation amount is reasonable for the work that is being performed.

Some have questioned whether the term “owner-employee” for this purpose includes a S or C Corporation shareholder.  The current guidance does not answer this specifically but does provide the following: 

“Do not add employer health insurance contributions made on behalf of a self-employed individual, general partners, or owner-employees of an S-corporation, because such payments are already included in their compensation.”

Consistent with the above, the Interim Final Rules on Loan Forgiveness provide as follows:

“Owner-employees are capped by the amount of their 2019 employee cash compensation and employer retirement and health care contributions made on their behalf. Schedule C filers are capped by the amount of their owner compensation replacement, calculated based on 2019 net profit. General partners are capped by the amount of their 2019 net earnings from self-employment.”

I do not see how “owner-employee” does not mean S and C corporation owners when the wording above specifically mentions “a self-employed individual” and “general partners”. What else could an “owner-employee” be?

Thanks very much for reading this article and for providing any questions, comments or questions you might have for yourself or others as we continue to do our best to keep up with this and to help those in need. 

Other articles on the following related topics may be of interest:

It has been announced that PPP loan applications will be audited, which raises the question of what the meaning of the words “necessary to support the on-going operations of the applicant” actually mean.

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