By: Colleen Lyons
May 18, 2020
On Friday, May 15th, the United States Small Business Administration (“SBA”) and the Treasury Department released an initial draft of SBA Form 3508, Paycheck Protection Program, Loan Forgiveness Application (the “Forgiveness Application”) https://home.treasury.gov/system/files/136/3245-0407-SBA-Form-3508-PPP-Forgiveness-Application.pdf. This is the form that must be completed by each PPP loan borrower and submitted to the lender in order for the loan to be forgiven. In addition to providing more detailed information on the prescribed methods of computation and the requirements for the supporting documentation that each borrower will be required to produce and maintain, the Forgiveness Application provides some useful additional guidance in a number of key areas where borrowers have had questions.
Option to Elect Alternative Payroll Covered Period for Certain Purposes
The period during which PPP loan proceeds were to be used for forgiveness purposes was defined in the CARES Act and existing interim regulations as the eight-week (56-day) period (the “Covered Period”) beginning on the date the borrower’s PPP loan proceeds were disbursed (the “Loan Disbursement Date”). The instructions to the Forgiveness Application provide that a borrower with a biweekly or more frequent payroll schedule may opt for an “Alternative Payroll Covered Period” to align with its payroll cycle. The Alternative Payroll Covered Period begins on the first day of the first pay period following the PPP Loan Disbursement Date. For example, if a borrower received its PPP loan proceeds on Monday, April 20, and the first day of its first pay period following its PPP loan disbursement is Sunday, April 26, the first day of the Alternative Payroll Covered Period would be April 26 and the last day of the Alternative Payroll Covered Period would be Saturday, June 20. Any borrower who elects to use the Alternative Payroll Covered Period must apply the Alternative Payroll Covered Period consistently wherever there is a reference in the Forgiveness Application to “the Covered Period or the Alternative Payroll Covered Period.” However, borrowers must still use the Covered Period (not the Alternative Payroll Covered Period) wherever the reference in the Forgiveness Application is to “the Covered Period” only (e.g. for purposes of determining eligible non-payroll costs).
Clarification of Costs Incurred and Payments Made Requirement
The CARES Act and prior guidance stated that borrowers are eligible for loan forgiveness for eligible “costs incurred and payments made” within the Covered Period. The instructions to the Forgiveness Application provide some helpful clarifications on this concept.
Payroll Costs: Payroll costs are considered paid on the day that paychecks are distributed or the borrower originates an ACH credit transaction. Payroll costs are considered incurred on the day that the employee’s pay is earned. Payroll costs incurred but not paid during the borrower’s last pay period of the Covered Period (or Alternative Payroll Covered Period) are eligible for forgiveness if they are paid on or before the next regular payroll date. Otherwise, payroll costs must be paid during the Covered Period (or Alternative Payroll Covered Period).
Nonpayroll costs: Eligible non-payroll costs (such as rent and utilities) must be paid during the Covered Period or incurred during the Covered Period and paid on or before the next regular billing date, even if the billing date is after the Covered Period.
Confirmation of Elements of Eligible Payroll Costs
The Forgiveness Application confirms the types of eligible payroll costs eligible for forgiveness as follows:
- Cash Compensation consisting of the sum of gross salary, gross wages, gross tips, gross commissions, paid leave (vacation, family, medical or sick leave, not including leave covered by the Families First Coronavirus Response Act), and allowances for dismissal or separation paid or incurred during the Covered Period or the Alternative Payroll Covered Period. For each individual employee, the total amount of cash compensation eligible for forgiveness may not exceed $15,385 (annual salary of $100,000, as prorated for the Covered Period).
- Cash Compensation paid to owners (owner-employees, a self-employed individual, or general partners) is capped at $15,385 (the eight-week equivalent of $100,000 per year) for each individual or the eight-week equivalent of their applicable compensation in 2019, whichever is lower.
- The total amount paid by the borrower as 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.
- The total amount paid by the borrower as employer contributions to employee retirement plans, excluding any pre-tax or after-tax contributions by employees.
- The total amount paid by the borrower for employer state and local taxes assessed on employee compensation (e.g., state unemployment insurance tax); but not any taxes withheld from employee earnings.
At least 75% of the loan forgiveness amount must be for eligible payroll costs.
Some Additional Guidance on Eligible Non-Payroll Costs
The Forgiveness Application details the nonpayroll costs eligible for forgiveness as follows:
- covered mortgage obligations consisting of payments of interest (not including any prepayment or payment of principal) on any business mortgage obligation on real or personal property incurred before February 15, 2020;
- covered rent obligations consisting of business rent or lease payments pursuant to lease agreements for real or personal property in force before February 15, 2020; and
- covered utility payments consisting of business payments for a service for the distribution of electricity, gas, water, transportation, telephone, or internet access for which service began before February 15, 2020.
The Forgiveness Application confirms that eligible nonpayroll costs cannot exceed 25% of the total forgiveness amount.
Salary/Hourly Wage Reduction
The loan forgiveness amount will be reduced in the event the salary or hourly wages of employees whose annual salary or wages were less than $100,000 are reduced by more than 25% during the Covered Period or the Alternative Payroll Covered Period as compared to the period from January 1, 2020 to March 31, 2020. The Forgiveness Application provides a worksheet and instructions which detail the calculations to be used to determine whether a borrower’s loan forgiveness amount must be reduced and if so, the amount of the reduction. If by June 30, 2020, the borrower restores the salary/hourly wage level of an affected employee to its level as of February 15, 2020, the borrower may be eligible to eliminate the portion of the reduction amount with respect to that employee.
Basis of FTE Computation
The CARES Act and earlier guidance had provided for a reduction in the forgiveness amount for changes in average full-time equivalency (FTE) but did not provide specific guidance as to how FTEs should be computed for this purpose. According to the Forgiveness Application, FTEs during the Covered Period or the Alternative Payroll Covered Period are to be determined as follows:
For each employee, divide the average number of hours paid per week by 40, and round the total to the nearest tenth. The maximum for each employee is capped at 1.0.
Alternatively a simplified method that assigns a 1.0 for employees who work 40 hours or more per week and 0.5 for employees who work fewer hours may be used at the election of the borrower.
Adjustment for Reduction in FTEs
To determine the amount of any reduction in the loan forgiveness amount based on a reduction in FTEs, the borrower’s average weekly number of FTE employees during the Covered Period or the Alternative Payroll Covered Period is compared to the number of FTE employees during the borrower’s chosen reference period. For purposes of this calculation, the reference period is, at the borrower’s election, either (i) February 15, 2019 to June 30, 2019; (ii) January 1, 2020 to February 29, 2020; or (iii) in the case of seasonal employers, either of the preceding periods or a consecutive twelve-week period between May 1, 2019 and September 15, 2019 (the “Chosen Reference Period”).
Unless the borrower qualifies for the FTE Reduction Safe Harbor described below, the amount of the forgiveness reduction will be based on the FTE Reduction Quotient if less than one (1) determined as follows:
Average Weekly FTEs during the Covered Period or Alternative Payroll Covered Period
Average Weekly FTEs during the Chosen Reference Period
As referenced in earlier guidance, FTE reductions during the Covered Period or Alternative Payroll Covered Period attributable to the following will not reduce the amount of loan forgiveness:
- any positions for which the borrower made a good-faith, written offer to rehire an employee during the Covered Period or the Alternative Payroll Covered Period which was rejected by the employee; and
- any employees who during the Covered Period or the Alternative Payroll Covered Period (a) were fired for cause, (b) voluntarily resigned, or (c) voluntarily requested and received a reduction of their hours.
In each of these cases, the employee will be included as an FTE for purposes of this computation unless the position was filled by a new employee.
FTE Reduction Safe Harbor
The CARES Act and the related interim regulations referenced a safe harbor exempting certain borrowers from a loan forgiveness reduction based on reductions in FTE employee levels. Specifically, the Forgiveness Application indicates that a borrower is exempt from the reduction in loan forgiveness based on the number of FTE employees described above if both of the following conditions are met:
- the borrower reduced its FTE employee levels in the period beginning February 15, 2020, and ending April 26, 2020; and
- the borrower then restored its FTE employee levels by not later than June 30, 2020 to its FTE employee levels in the pay period that included February 15, 2020.
Documentation Required to be Submitted with Forgiveness Application
The Forgiveness Application sets forth in some detail the materials that each borrower will be required to submit to its lender as follows:
Payroll: Documentation verifying the eligible cash compensation and non-cash benefit payments from the Covered Period or the Alternative Payroll Covered Period consisting of each of the following:
- Bank account statements or third-party payroll service provider reports documenting the amount of cash compensation paid to employees.
- Tax forms (or equivalent third-party payroll service provider reports) for the periods that overlap with the Covered Period or the Alternative Payroll Covered Period:
- Payroll tax filings reported, or that will be reported, to the IRS (typically, Form 941); and
- State quarterly business and individual employee wage reporting and unemployment insurance tax filings reported, or that will be reported, to the relevant state.
- Payment receipts, cancelled checks, or account statements documenting the amount of any employer contributions to employee health insurance and retirement plans that the borrower included in the forgiveness amount.
FTE: Documentation showing the FTE computation for the Chosen Reference Period selected by the borrower:
- the average number of FTE employees on payroll per month employed by the borrower between February 15, 2019 and June 30, 2019;
- the average number of FTE employees on payroll per month employed by the Borrower between January 1, 2020 and February 29, 2020; or
- in the case of a seasonal employer, the average number of FTE employees on payroll per month employed by the borrower between February 15, 2019 and June 30, 2019; between January 1, 2020 and February 29, 2020; or any consecutive twelve-week period between May 1, 2019 and September 15, 2019.
Documents may include payroll tax filings reported, or that will be reported, to the IRS (typically, Form 941) and state quarterly business and individual employee wage reporting and unemployment insurance tax filings reported, or that will be reported, to the relevant state. Documents submitted may cover periods longer than the specific time period.
Nonpayroll: Documentation verifying existence of the obligations/services prior to February 15, 2020 and eligible payments from the Covered Period.
- Business mortgage interest payments: Copy of lender amortization schedule and receipts or cancelled checks verifying eligible payments from the Covered Period; or lender account statements from February 2020 and the months of the Covered Period through one month after the end of the Covered Period verifying interest amounts and eligible payments.
- Business rent or lease payments: Copy of current lease agreement and receipts or cancelled checks verifying eligible payments from the Covered Period; or lessor account statements from February 2020 and from the Covered Period through one month after the end of the Covered Period verifying eligible payments.
- Business utility payments: Copy of invoices from February 2020 and those paid during the Covered Period and receipts, cancelled checks, or account statements verifying those eligible payments.
PPP Loan Documentation Must Be Maintained
All records relating to the PPP loan, including documentation submitted as part of the original PPP loan application, documentation supporting the borrower’s certifications as to the necessity of the loan request and its eligibility for a PPP loan, documentation necessary to support the borrower’s loan forgiveness application, and documentation demonstrating the borrower’s material compliance with PPP requirements must be retained for six years after the date the loan is forgiven or repaid in full. Authorized representatives of the SBA, including representatives of its Office of Inspector General, shall be granted access to such files upon request.
Additional Guidance Expected
While the Forgiveness Application and related instructions are helpful in answering a number of substantive questions concerning forgiveness, many additional questions remain. Additional guidance in the form of interim regulations or as responses to frequently asked questions are expected. There are also a number of legislative initiatives concerning elements of the PPP loan program which may result in changes to the existing law and the issuance of additional guidance. Accordingly it will be important for borrowers to continue to monitor these developments.