Last week, a huge amount of applications for loans under the Paycheck Protection Program (PPP) were submitted to banks all over the country, and it’s likely that many more  will be submitted in the coming weeks.  So far, businesses have been focused rightfully on receiving the PPP loan.

The CARES Act lists the expenses that are subject to forgiveness and establishes a calculation to determine how much of your loan should be forgiven. Understanding each component of this calculation is important to maximize the benefit companies are entitled to receive.

What is forgivable?

The CARES Act lists four categories of expenses that are forgivable. This means that your PPP loan is forgivable to the extent you spend the proceeds of your loan on these four categories, provided you maintain the headcount and salaries of employees at the same pre-COVID-19 level, the loan will be forgiven. Another important requirement is that you actually pay for these expenses during the “covered period,” which is defined as the 8-week period immediately after your receipt of the loan proceeds. Amounts spent outside the 8-week period, or outside one of the four permitted categories of expense, are not forgivable and will need to be repaid within two years.

  1. Payroll costs – What constitutes “payroll costs” was a hot topic as companies were applying for PPP loans. When the dust settled, the SBA clarified that payroll costs include gross salaries and wages of employees up to a cap of $100,000 per year, employer-paid health insurance, employer-paid 401k matching contributions, and employer-paid state and local taxes on payroll (e.g., unemployment insurance), among other things. Payroll costs do not include the employers portion of payroll tax expenses such as Social Security and Medicare. The SBA issued Interim Final Rules on April 2, 2020, and these rules added a requirement that at least 75% of the loan forgiveness amount must be attributable to payroll costs.
  2. Rent Obligations – This includes payments under a lease agreement in force before February 15, 2020. This most likely refers to leases of real property, such as office space.
  3. Utilities – The CARES Act defines utilities narrowly to include: electricity, gas, water, transportation, telephone, or internet service for which service began before February 15, 2020.
  4. Interest – The CARES Act uses a term “covered mortgage obligation,” to describe which interest payments could be subject to forgiveness. Interest payments can be for any debt obligation that is a liability of the borrower incurred before February 15, 2020. It does not include payments or prepayments of principal. The Act does stipulate however that the underlying debt must be a “mortgage on real or personal property.” This would include debt on real property that is secured by a traditional mortgage lien as well as working capital lines of credit and other indebtedness where a UCC-1 is filed on the borrower’s personal property. This definition does not appear to include unsecured debt.

What are the tax implications?

The CARES Act states that the forgiveness of debt under the PPP program will not be taxable to the borrower.

How to calculate your maximum forgiveness

Once your business has determined the payments eligible for forgiveness, you will need to complete two additional calculations to determine if such amount is ultimately forgivable. Both calculations are based on your payroll: the first is a measurement of your number of Full Time Equivalents (“FTEs”), and the second is a measurement of your actual salary expense. The purpose of these calculations is to ensure that debt forgiveness is directly related to the purpose of the CARES Act – to keep employees working at wages comparable to pre-COVID-19 levels.

Calculation Example:

• Loan amount: $250,000, (assuming you spent all of the funds on qualifying expenses)
• Average number of FTEs from February 15, 2019 to June 30, 2019: 50
• Average FTEs during “covered period” following your first loan disbursement: 35
PPP Calculation: 35/50= 70%
Maximum loan forgiveness: $250,000 * 70% = $175,000
The company will need to repay $75,000 of the loan.

This is just an overview. Please contact your financial institution for other terms and conditions that may apply.

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