STOP These 10 Things If You Want PPP Forgiveness

By: Travis Watkins


So, you’re one of those lucky small businesses in America to have received your Paycheck Protection Program (PPP) loan? Remember the feeding frenzy for “free” money that swallowed all of $350,000,000 in less than two (2) short weeks. Amid the confusion, it was likely a stressful process as you anxiously awaited your banker’s communication that the Small Business Administration (SBA) had given your loan the green light and that funds were being deposited. But, there’s no time to relax. Why? Because the clock just started for you on the most important feature of PPP: loan forgiveness. 


You see, that promissory note you signed at the bank is a loan that you must pay back, unless you do all the right things to convert it to a forgivable grant. You now have a short eight (8) weeks to properly spend 250% of your monthly average payroll (or net profit if you’re a Schedule C person). Oh, and, you have little guidance for forgiveness and you're on your own to do everything right. Go!


The amount of loan forgiveness can be up to the full principal amount of the loan plus accrued interest. That’s big because, prior to the SBA’s Guidance released April 15, 2020 (13 CFR, Part 120), it was not clear that you could avoid some bank interest that accrued prior to your forgiveness request. The actual amount of loan forgiveness will depend, in part, on the total amount spent over the “covered period,” which is defined in the CARES Act as eight (8) weeks from funding. 


You’re likely familiar by now with the general forgiveness concept that you must use at least seventy-five percent (75%) of your PPP proceeds on payroll and no more than twenty-five percent (25%) on non-payroll expenses, defined as rent/mortgage interest and utilities placed in service before February 15, 2020. After that, it probably gets a little (or very) hazy. All the devils in the forgiveness details have been hiding over the last few weeks as banks scrambled to qualify small businesses for PPP before Phase 1 ran out. Now, it’s time to dig into the details to navigate forgiveness.


This article is devoted solely to PPP forgiveness and it assumes that you want to maximize 100% of your PPP loan proceeds (and interest) for forgiveness. Be aware that the SBA is expected to offer more guidance through additional notices that may change some of the information here. With those caveats in mind, consider the following: 


  1. Don’t leave it to chance. We have heard many applicants to the PPP program say that they aren’t too worried if they don’t get everything completely correct in the forgiveness process because PPP is merely a 1% unsecured loan over 2 years. My answer to that is, you probably should be. Remember how you signed under penalties of perjury in your application that “[c]urrent economic uncertainty makes this loan request necessary to support the ongoing operations of the applicant”? This certification and the others directly reflect provisions in the CARES Act (see Section 1102 at the top of page 11).  If you weren’t perjuring yourself, the mistaken expenses may still result in an aggressive monthly principal and interest payment well after the automatic six (6) month payment deferral baked into PPP. Plus, many of these mistakes can be avoided with some planning from the time your bank funds PPP or soon thereafter.


  1. Don’t consider PPP “free” money. PPP is a low-interest, quick term loan serviced by banks. Its nature is a loan, and you have signed a promissory note. PPP can be converted to a completely forgivable grant, if you do the right things. 


  1. Don’t commingle PPP funds. It’s fair to say that the SBA and private banks will be at least as stringent in the forgiveness process as they were in the qualification process. Keeping your PPP proceeds and expenditures in a separate account from your operating account is just good planning. The pain in the neck that it may be to move your payroll software to the new account (and possibly back again later) will be worth it when it comes time to reconcile the expenses during the covered period.


  1. Don’t pay anyone on your payroll more than $15,385 over the next eight (8) weeks (or $3,846.25 every 2 weeks). The Guidance spells out this hard backstop due to the PPP’s exclusion of payroll costs including salary, wages, and tip above $100,000 of annualized pay per employee. It should be your hard backstop as well. At the outset of PPP, there was some confusion as to whether an employer could use loan proceeds to pay the proportionate amount above $100,000 to high earners, despite the fact that amounts above $100,000 could not be included in the payroll calculation for PPP eligibility. You cannot pay high earners in this manner with PPP proceeds. It is clear now that forgivable payroll costs have the same meaning as eligible payroll costs in the loan application purposes. (CARES Act § 1106(a)(8).)

  2.  Don’t reduce your employee headcount during the covered period. Remember, the purpose of the PPP is to maintain your employee payroll. Here is the calculation you can use to determine if you have met this requirement:

First, determine the average number of full-time equivalent employees you had for:

  • The 8-week period following your initial loan disbursement, (A)

  • February 15, 2019 to June 30, 2019, (B1)

  • and January 1, 2020 to February 29, 2020. (B2)

Take A and divide that by B1. Do the same with B2. Take the largest number you obtain. If you’re a seasonal employer, you must divide by B1. There is no requirement that the employees in A be the exact same employees in B1 or B2.

  • If you get a number equal to or larger than 1, you have successfully maintained your headcount and met this requirement.

  • If you get a number smaller than 1, you did not maintain your headcount and your forgivable expenses will be reduced proportionately.

 

  1. Don’t reduce any employee’s pay below 25%. Again, the purpose of the program is to maintain payroll through the covered period. You have until June 30, 2019 to properly adjust upward an employee’s pay level to get forgiveness. (CARES Act § 1106(d)(5).) 


  1. Don’t keep any proceeds above your net profit if you’re a Schedule C, and you have no rent, utilities or mortgage interest expenses listed on 2019’s Schedule C. This one is especially important for self-employed individuals. If you report business earnings and expense on Schedule C (whether you have employees or not), your lender should have used line 31 of your 2019 Schedule C (net profits) to calculate your monthly “owner’s compensation” by dividing it by twelve (12) then multiplying it by 2.5, which equates to roughly 20.8% (roughly 10/52) of your annual net profits. However, the Guidance limits owner’s compensation forgiveness to only  8/52, or roughly 15.3% of your annual net profits. The Guidance then hints at a somewhat expanded list of expenses for self-employeds, with a warning: 


Mortgage interest payments (but not mortgage prepayments or principal payments) on any business mortgage obligation on real or personal property (e.g., the interest on your mortgage for the warehouse you purchased to store business equipment or the interest on an auto loan for a vehicle you use to perform your business), business rent payments (e.g., the warehouse where you store business equipment or the vehicle you use to perform your business), and business utility payments (e.g., the cost of electricity in the warehouse you rent or gas you use driving your business vehicle). You must have claimed or be entitled to claim a deduction for such expenses on your 2019 Form 1040 Schedule C for them to be a permissible use during the eight-week period following the first disbursement of the loan (the “covered period”). For example, if you did not claim or are not entitled to claim utilities expenses on your 2019 Form 1040 Schedule C, you cannot use the proceeds for utilities during the covered period. (Emphasis Added).


Best practices and logic dictate that if you’re a Schedule C self-employed person and you don’t have these expenses listed in your 2019 Schedule C, you should give that money back during the covered period. There are no prepayment penalties in the PPP. A self-employed calculator (with and without employees) is available HERE.


  1. Don’t include expenses outside the covered period. Forgiveness relates to covered costs “incurred and payments made” during the covered period. That means that the expense must be actually due (incurred) AND paid within the covered period. This likely rules out significant pre-payment of any of these expenses. This could cause problems for the payroll expense because payroll is typically at least a week or two in arrears. More SBA guidance on this is anticipated. To avoid mistakes in the meantime, it is best to use (or switch to) cash, not accrual accounting methods.


  1. Don’t hesitate to bonus your employees to reach the payroll allowance. You may spend more than 75%, up to 100% on employee payroll in PPP. In fact, you should spend 100% on payroll, if you can. If you’re running short of allowed expenses for PPP forgiveness, you should consider bonusing your employees as part of a normal payroll in the covered period. These morale boosters are “necessary to support the ongoing operations” of the business in these strange times, and your employees would undoubtedly agree, where it is more profitable in some states to stay home and draw unemployment with the supplemental $600 from the Federal government that is part of the CARES Act.


  1. Don’t forget about the SBA’s Economic Impact Disaster Loan (EIDL) Program. EIDL functions as a business line of credit. It is not forgivable, but the rates are favorable - 3.75% for 30 years. Businesses can use EIDL for virtually any type of business expense. Most importantly, and contrary to misconceptions, you can apply and receive funds for EIDL and PPP. You just can’t use funds for the same costs. To date, the SBA has only funded a comparatively slim $9 billion of the $400 billion appropriated for EIDL advances and loans. Yet, the SBA stopped taking applications for this program about the time the first round of PPP funding ran out. Congress has since given more funds to both programs. Logic tells us that EIDL will again become popular when future phases of PPP run out of money and/or businesses determine that they need more than the forgivable PPP supplements to keep their businesses afloat after the covered period. Lines for the EIDL are long, so waste no time in submitting your application if you have not done so. 


PPP loan forgiveness requests are made to your bank after the eight (8) week covered period. Your bank then has sixty (60) days to consider the request. Your first loan payment (1/24 of principal, plus 1% accrued interest) is due six (6) months from funding. About week six (6) or seven (7),  you should definitely begin auditing your forgivable expenses. This calculator (BOTTOM OF PAGE) could assist you.


*Travis Watkins is an attorney licensed in Oklahoma, Texas and Arkansas. He runs a tax resolution company that deals with IRS collections everyday. In addition to assisting troubled taxpayers, Watkins Tax quickly pivoted to also assist small businesses at the outset of the Coronavirus with Federal and local loan programs. Watkins Tax consults and strategizes with clients on these various loans and also offers fixed fee packages to help businesses audit their expenses for maximum loan forgiveness under the PPP. Watkins Tax can be reached at 405-433-7788.

 

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