Paycheck Protection Program: The Next 8 Weeks
Begging for Forgiveness, or at Least Guidance
On March 27, 2020, President Trump signed into law the Coronavirus Aid, Relief, and Economic Securities (“CARES”) Act, a $2.3 trillion relief package designed to help individuals and businesses weather the economic damage caused by the COVID-19 pandemic. Included in the Act was the creation of the Paycheck Protection Program (PPP), a Small Business Administration loan designed to put $350 billion into the hands of small businesses for use in paying employee wages and other critical expenses over the coming weeks and months. The program became operative on April 3 and by April 15th nearly $250 billion in cash was committed to over one million small businesses. On April 16th, the SBA announced that the program was fully funded and no more applications could be processed.
To date, the PPP program has been subject to confusion and issues. Many banks were not prepared to accept applications when the program started and others would only process applications for those with existing banking relationships. Ambiguities in the legislative text of the CARES Act and scarce regulatory guidance from the SBA frustrated applicants’ efforts. The affiliate rules, matters of foreign investment and ownership, and questions surrounding the scope of the required “necessary” certification by applicants even cast the eligibility to some applicants in doubt.
Now that the PPP program funds are currently fully committed, questions and attention are turning to the level of loan forgiveness which is perceived by most to be the greatest benefit for program participants. Under the PPP, once a borrower receives the funds, the amount spent over the next 8 weeks on payroll, mortgage interest, rent and utilities is eligible to be completely forgiven and while a cancellation of a borrower’s debt typically creates taxable income, the CARES Act provides that forgiveness of a PPP loan is completely tax free.
Even where there has been clear regulatory guidance, some PPP participants have already become frustrated. Because the program’s funds were distributed on a first-come, first-served basis, the rush of applicants and the disbursement of funds has now outpaced the economic recovery. Extended stay-at-home orders have caused many non-essential business to remain shuttered or severely curtailed. Many employees remain laid-off or furloughed. For some of those employees, the CARES Act increase of unemployment benefits may make collecting unemployment more lucrative than returning to work, at least for the short term. For those who want to return to work, there may be nothing to do as the business remains shuttered.
Yet, the limited SBA guidance to date has hampered employer flexibility: (i) the 8-week period for expending PPP funds that are to be forgiven begins on the date the borrower receives the disbursement of the loan, and (ii) the bank is required to make the disbursement within 10 days of loan approval. As a result, businesses receiving a PPP loan must start the clock immediately upon receipt of the funds, regardless of whether their business has even restarted operations. Moreover, for those PPP employers without current employee payroll hoping to use the funds instead for lease payments and utilities to avoid defaults, the SBA guidance only allows 25% of the forgivable amount of a PPP loan for non-payroll costs. This is bad news for business owners with small payroll – or who laid off workers prior to taking out the PPP loan – and large rent and utility obligations. For many employers, this 25% limitation means that a business must increase its payroll costs over the 8-week covered period relative to its 2019 pace to obtain full loan forgiveness.
The scarcity of clear SBA guidance belies many still unresolved questions and issues in regard to the calculation of anticipated forgiveness that require further guidance. For example, the CARES Act states that the sum of certain expressed “costs incurred and payments made” during the 8 week covered period will be eligible for forgiveness. The costs eligible for forgiveness are expressed, but what does “costs incurred and payments made” mean?
If “and” is truly conjunctive, costs must be both incurred and paid within the 8 week covered period. But what if “costs incurred and payments made” allows for the forgiveness of both “cost incurred” and “payments made”? A borrower could then pay amounts attributable to costs incurred before and after the period, and both would be eligible for forgiveness because the amounts were paid within the covered period. The CARES Act specifically bars prepayment of mortgage interest during the covered period, but the Act is silent with respect to other prepayments.
Further confusion persists even once the “costs incurred and payments made” are determined because a reduction of the forgiven amount is required if (i) there is a reduction in the number of full time equivalent employees, and/or (ii) if there is a reduction in any employee’s wages over the 8-week period in excess of 25% of the total salary or wages of the employee during the most recent full quarter during which the employee was employed before the covered period. Guidance for calculating the amount of such reductions is necessary, as it is for the manner of avoiding such reductions if an employee restores its employee counts and wages prior to June 30, 2020.
Among the fundamental questions left unresolved are:
(1) How is the reduction in an employee’s wages described in (ii) above supposed to be considered? This rule appears to be saying that if during the 8-week covered period an employee is paid less than 75% of the wages received during the calendar quarter prior to the covered period, the forgiven amount must be reduced. But the covered period is only 8 weeks and the prior quarter is either 12 or 13 weeks. If an employee earned $12,000 for twelve weeks in the previous calendar quarter, and $8,000 during the 8-week covered period, is the business really required to suffer a reduction of its forgivable amount?
(2) Can FTE replacements be in wholly different position and be paid at different, perhaps lower, wages? and
(3) Is reduction of the forgiven amount avoided if an employer fully restores its staff and wages with the benefit of its PPP funds prior to June 30, 2020, but then is forced to suffer another round of layoffs or furloughed employees prior to June 30, 2020?
Finally, and as if this wasn’t all confounding enough, while it is unambiguous that the amount of forgiveness “shall be excluded from gross income,” it is also well established under the Internal Revenue Code that any expenses “allocatable to” tax-exempt income are not deductible: a taxpayer cannot get both a deduction and tax-exempt income related to the same transaction or investment. At tax time, it may be determined that forgiven expenses which were once deductible are no longer deductible expenses, perhaps lessening the overall appeal of the forgiveness.
Want certainty? Forgiveness is NOT guaranteed. Once an application for forgiveness is submitted, the lender has 60 days to make its decision. As with the application process, it is anticipated that many lenders will construe and implement their own systems and requirements in the absence of clear regulatory guidance. The CARES Act immunizes lenders from SBA enforcement action and penalties if it chooses to forgive the loan only so long as the lender receives required documentation and certifications from the borrower. Consequently, the burden for forgiveness to be imposed by lenders may be higher than it was upon application.
Meanwhile, we continue to hope and anticipate that additional guidance will be forthcoming so that complete and proper applications for forgiveness may be developed and the intended benefits of the PPP program may be fully recognized. Stay tuned....