As has been well publicized, the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) is a $2 trillion economic relief package enacted to help individuals and businesses in the United States weather the severe financial impact of the COVID-19 pandemic. A key feature of the CARES Act is the creation of the Paycheck Protection Program (PPP), where the federal government will be allocating $349 billion to the Small Business Administration (SBA) to guarantee loans to small businesses. Loans will be administered pursuant to SBA’s section 7(a) loan program. OFP Shareholders Michelle DiCintio and Jennifer Banks discuss the key features of the PPP below.
Who is Eligible for a PPP loan?
Any business with 500 or fewer employees, or the number of employees the SBA has established as the size standard for the business’s primary North American Industry Classification System (NAICS) code, is eligible to apply.
The business does not have to be shut down completely or partially. Any business that applies is presumed to need the loan and will get it. The only underwriting standards are the company was in business on February 15, 2020, and had employees for whom it paid salaries and payroll taxes.
The self-employed and independent contractors are also eligible for these loans.
How do I count my total employees?
Applicants will count their own employees (including anyone employed on a full-time, part-time or other basis) and employees of their “affiliates” (as defined by the SBA), and will exclude independent contractors.
As referenced above, applicants that are deemed to be “affiliated” with other entities (including their investors) must include affiliates’ employees into their headcount for purposes of the PPP eligibility determination. Subject to certain limited exceptions, the SBA’s method of determining “affiliation” will potentially make loan eligibility challenging for venture capital and private equity backed companies.
What is the Maximum Loan Amount?
The maximum loan you can receive will equal 2.5 times your average “payroll costs” during the 1-year period before the loan is taken, up to a total maximum of $10 million.
In the unlikely event your business took a separate SBA “disaster loan” on or after January 31, 2020, then your 7(a) loan amount can be increased to include a refinancing of this disaster loan.
What Costs are Included in “Payroll Costs”?
“Payroll costs” are defined very broadly and include:
- Salaries, wages, commissions, cash tips, or similar compensation to an employee or independent contractor up to $100,000 per year, $8,333.33 per month
- Payments for vacation, parental, family, medical or sick leave
- Severance payments for dismissal or separation
- Payments for group health care benefits, including insurance premiums
- Payments of any retirement benefits, including retirement plan contributions
- Payments of state and local taxes assessed on the compensation of employees
Payroll costs do not include:
- Compensation to an individual employee in excess of an annual salary of $100,000 ($8,833 per month), prorated for the covered period
- FICA and Federal tax withholdings
- Compensation for non-US residents
- Sick leave and family leave provided by the new Families First Coronavirus Response Act for which there are already tax credits
What Can the Loan Proceeds be Used For?
During the period from February 15, 2020, to June 30, 2020, the loans can be used for:
- Payroll costs (see definition above)
- Interest (not principal) payments on mortgages
- Interest (not principal) on any other debt obligation that was incurred before February 15, 2020
How Long Can We Defer Repayment on the 7(a) Loan?
Borrowers can completely defer repayment of principal and interest for at least six months but not more than one year. Apparently, the particular deferment period will be up to the discretion of the bank that issues the loan.
Does the loan need to be repaid, or is all or a portion forgivable?
Borrowers can apply for and receive forgiveness of all or a portion of a PPP loan. Subject to some limitations (the main ones are noted below), generally forgiveness will equal the amounts the borrower can document that it incurred and paid in the eight weeks following origination of the loan for:
- Payroll costs (as broadly defined above)
- Interest (not principal) on mortgages
- Utilities, including electricity, gas, water, transportation, telephone and internet access.
The PPP allows for a maximum forgiveness of 8 weeks of approved costs. The remainder will be treated as a loan. The amount forgiven cannot exceed the original principal amount of the loan.
What Happens to the Portion of the Loan that is Not Forgiven?
The remaining balance will continue to be guaranteed by the SBA, have a maximum maturity of 10 years and bear interest at the rate of .5%.
What Must Be Done To Get the Loan Forgiveness?
The borrower has to show evidence that it actually spent money on the things that are eligible for loan forgiveness by submitting an application to the bank that includes:
- Documentation verifying the number of employees on payroll during the 8-week period of eligible loan forgiveness, including payroll tax filings reported to the IRS as well as state income, payroll, and unemployment insurance filings.
- Documentation, including canceled checks, payment receipts, accounting reports, etc. verifying payments on business debts, rent and utility payments.
- A certification from an officer or owner of the borrower that the information being submitted is true and that the amount for which forgiveness is being requested was used to retain employees, make interest payments on business debts, lease payments, and utilities.
What if the Company has or will Conduct Layoffs or Implement Salary Reductions?
The loan forgiveness concept encourages employers to keep everyone employed. The amount of loan forgiveness will be reduced proportionally by the reduction in full-time equivalent employees (FTEs) during the period of February 15, 2020 – June 30, 2020, compared to either February 15, 2019 – June 30, 2019 or from January 1, 2020, through February 29, 2020. So, if you employed 15 FTEs in 2019 and 10 now, the forgiveness will be reduced by one-third. It will be further reduced to the extent that employees making $100,000 or less are being retained but are having to take pay cuts of more than 25%. The CARES Act encourages employers to rehire workers and/or restore the pay of employees who were kept but took big pay cuts.
Note that a large pay cut to a highly paid employee won’t proportionately reduce your loan forgiveness. Say you have a highly paid executive and you can drop their pay to $8,333.33/mo. That will be fully covered by loan forgiveness and you will not have your loan forgiveness proportionately reduced. (On the other hand, if someone earning less than $100,000/yr suffers a greater than 25% pay cut, say 30%, then your loan forgiveness will be reduced by that 5% excess amount).
What Will the Tax Treatment be on the Forgiven Debt?
Even though this is debt cancellation income, which is normally taxable, in this case, the cancelled debt will be excluded from income.
What are some other important PPP loan terms?
No personal guarantee or collateral is required. The loans are fee-free, and payments of principal and interest are deferred for at least six months and up to a year. Any remaining balance on the loan after forgiveness will remain fully guaranteed by the SBA and subject to an interest rate of .5% and maturity of 10 years. Also, there will not be any prepayment penalties on these loans.
How and When Should a Company Apply?
Although the SBA is guaranteeing these loans, businesses will need to apply through banks and credit unions. Approximately 1,800 lenders are already approved to issue 7(a) loans. The bank at which you’ve set up your business banking account will be a great place to start. You can find the new SBA loan application (Form 2483) here.
Since the maximum loan amount will equal 2.5 x your average monthly payroll costs during the 12-month period preceding the loan, you will likely need to submit a sizeable amount of documentation to your bank, including:
- Employee wages for the last 12 months – contact your payroll provider for the report.
- This report must also show paid time off, vacation, sick pay, family medical pay, etc. All of this is eligible to be included. The more you can show the better, as this will increase the loan amount.
- Withholding for state and local taxes on employee compensation.
- 1099s paid to independent contractors.
- Documentation showing how much you, the employer, paid in employee group health insurance premiums for the past 12 months. Your insurance company should be able to provide this.
- Documentation showing the amount of retirement plan funding the employer made for employees over the past 12 months (profit sharing 401(k) plans, cash balance plans, SIMPLE and SEP IRAs). If your 2019 plan administration has been completed, you should use this as the basis for these figures. (Employees’ own 401(k) salary deferrals won’t count for these purposes.)
- SBA Form 2483
Be prepared to apply for and get the loan as soon as they are available. Although the SBA has now issued the initial application (Form 2483), banks are still waiting on further guidelines from SBA, which SBA has stated that it intends to issue by April 6. The CARES Act authorizes the SBA to guarantee up to $349 billion for this PPP and its other lending programs, meaning that once that monetary threshold is reached, absent further Congressional action, no further loans could be guaranteed. Because the covered period for loan uses ends on June 30, 2020, and the maximum forgiveness period is eight weeks, any loan obtained after May 5 may not enjoy the full forgiveness period.
For this reason, you should begin discussions with your lender and collecting the above documentation and information. If your existing lender does not plan to offer PPP loans, you can contact other banks in their area that are SBA loan program participants. Existing participating lenders are listed on the SBA website for the district in which your business is located, and the SBA is authorized to add additional lenders for this program.
Is it Preferable to Furlough or Layoff Staff and Send Them to Unemployment or Keep Them on the Payroll and Get a 7(a) Loan?
There are two viable approaches that you can take. The first is more conservative and less disruptive and the second more aggressive but may be better for most businesses.
If you have not already let your staff go and think that doing so will be difficult in terms of employee morale, then consider taking the 7(a) loan as early as available (hopefully the week of April 6). The benefit of this loan is a tax-free gift, via loan forgiveness, to pay 8 weeks’ worth of your payroll costs, rent, interest on your debt service and utility bills.
The best way to handle this for most businesses will be a two-part approach that takes advantage of unemployment benefits and the 7(a) loans. This is more disruptive to the business as it requires furloughing or laying off employees. However, if you’ve already done this, then that is a non-issue:
- If your business is shut down or largely shut down, then furlough staff and have them apply for unemployment. Under the CARES Act, they will get traditional unemployment benefits plus a $600 weekly kicker. This will hopefully replace all or most of their normal pay and in some cases may even give them a raise.
- When you are ready to reopen your business, rehire your staff, and obtain the 7(a) loan then. Just do this before the June 30 deadline — better yet, a couple weeks before then in order to give yourself a cushion. You will use the loan proceeds to pay your overhead when your business reopens. You should get the benefit of loan forgiveness for the 8 weeks following the date you take your loan (so into July and August), subject to any reductions as discussed above. In this way, you are taking advantage of unemployment insurance to cover your employees’ wages during the shutdown period and also getting the tax benefits of the 7(a) loan once your business reopens.
Can a Company also apply for an Economic Injury Disaster loan (EIDL) under the Act?
Yes. The CARES Act likewise expands access to SBA’s economic injury disaster loans (EIDL) program to businesses with fewer than 500 employees. Eligible businesses that suffer substantial economic injury as a result of a disaster or emergency, which now includes COVID-19, can apply for a loan under this program between January 31, 2020, and December 31, 2020.
No personal guarantee is required for EIDLs under $200,000, and the loan can be made solely upon the applicant’s credit score. Initial advances of up to $10,000 can be issued within three days and need not be repaid. The loan will bear a low rate of interest; however, unlike PPP 7(a) loans, the Act does not provide for forgiveness for EIDLs. Businesses may receive both PPP loans and EIDLs, so long as both loans are not used for the same purpose or otherwise duplicative.
This is a just a brief overview of one section of the CARES Act. We will continue to share additional details on other provisions of the CARES Act that are relevant to you and your business in the coming days and weeks. In the meantime, please don’t hesitate to contact us with questions and/ or concerns. We would be pleased to help you during this challenging time.
The borrower may choose which denominator will result in a lower forgiveness reduction. Additionally, when calculating FTEs, “the average number of full-time equivalent employees shall be determined by calculating the average number of full-time equivalent employees for each pay period falling within a month.”
Odin Feldman Pittleman is working diligently to ensure that our attorneys, staff, and clients remain safe and healthy during the COVID-19 pandemic. We have implemented our business continuity plan to ensure our continued operations so that we are available and responsive to clients while adhering to Federal and State guidelines. While most of our attorneys and staff are working from home, our office is open for scheduled appointments in a safe, clean environment, if needed. From our family to yours, be well and stay safe.
Disclaimer: The information contained herein is provided for informational purposes only and should not be construed as legal advice on any subject matter. This information contained herein is not provided in the course of an attorney-client relationship and is not intended to constitute legal advice. Any information contained in this article is not intended to be a substitute for legal counsel. No one should act or refrain from acting on the basis of any content included in this article but should instead seek the appropriate legal advice on the particular facts and circumstances at issue from a properly licensed attorney. The author expressly disclaims all liability in respect to actions taken or not taken based on any of the contents of this article. This article contains general information and may not reflect current legal developments.