How to Maximize PPP Loan Forgiveness

Axtell Haller & Slachta COVID-19 Update: April 26, 2020

You Received your SBA PPP Loan Now What Do You Do?

For those of our clients who have been fortunate to have received their PPP loan and endured the painful process of obtaining the loan we have just one word to share. Congratulations!!!!

We hate to throw cold water on your success, but you are now on the clock. You have 8-weeks to determine how much of that loan will have to be returned and how much of that loan may be forgiven.

In our opinion, we think most of our clients will be left with some amount of loan and we hope that this article will provide some guidance that can be used to help you through this 8-week time period and to maximize what your loan forgiveness will be.  

With that said, we must qualify our comments in that there remains many unanswered questions and the SBA still must provide guidance to those answers. Accordingly, some of our comments and observations could be incorrect based on our present interpretations.

Keep in mind there are two parties to the “loan forgiveness” process. You as the borrower, and the participating bank who must sign off on the forgiveness request. Based on our experience with the application process, the banking industry had developed their own due diligence rules and the documents required varied from bank to bank and how they interpreted what was includible costs. Be prepared for potential conflicts once the 8-week time period ends and you enter the “loan forgiveness” stage.

What should I do with the loan proceeds?

The SBA guidance provides that the PPP loan must be used only for qualified expenditures and if not used properly, the fine print of the loan document has a very heavy statement. “If you knowingly use the funds for unauthorized purposes, you will be subject to additional liability such as charges for fraud”.

We know that our clients would never knowingly misuse the funds, but we would be negligent if we did not share that statement with you. We think it is important to avoid commingling the loan proceeds with your regular bank account and accordingly, here are some steps we are recommending:

1. Set up a separate bank account for the loan proceeds if possible. If for whatever reason you cannot do that make sure you set up an account on your balance sheet to break down the regular operating bank account and the SBA PPP loan proceeds.
2. As you make qualifying expenditures transfer those dollars out of the PPP account to your operating account. This will at least give you some idea as to what the unused portion of the loan proceeds are. By tracking the proceeds in this manner, it will give you a “snapshot” of how much of the PPP loan may not be forgiven.   

What are qualifying expenditures for purposes of the loan forgiveness?

The good news is that the categories of what you can use the loan proceeds for are limited. They are made up of “Payroll Costs” and “Non-Payroll Costs” which are defined as follows:

Payroll Costs

• Generally, your gross payroll and for a partnership, guaranteed payments.
  • Any compensatory payments that exceed $100,000 on an annualized basis are not included as qualified payroll costs.
  • It does not include the employer portion of payroll taxes such as FICA or Medicare.
• Payments for group medical, dental, and vision insurance.
• Employer retirement plan contributions.

Non-Payroll Costs  

• Rent payments based on a lease agreement.
• Utility expenses such as gas, electricity, phone, and internet services. Services must have begun before February 15, 2020 to be included.
• Mortgage interest on real and personal property incurred before February 15, 2020.
• Interest payments on any other debt obligations that were incurred before February 15, 2020.

As mentioned in the previous section, as you incur these expenses transfer those dollars out of the PPP account into your operating account.

• What time period do I have to make these expenditures over?
• Are the qualifying costs based on paid or accrued?
• What documentation do I need to keep?

As mentioned above you have 8-weeks starting from the time your loan hits your bank account. Unlike a tax return, no extensions are allowed.

The 8-week time period & the paid vs. accrued conflict:

The SBA guidance has conflicting language that only “costs incurred, and payments made” within the 8-week time period will be included as costs qualifying for forgiveness. From an accountant’s perspective these terms are contradictory when you consider the intent of the program. It appears the method (as written) is a combination of cash basis (when the check was cut) and the accrual basis (the time period when the cost was incurred). This conflicting language creates many questions such as the following:

• If I get funded mid-month, do I lose ½ of the rent paid for the current month if the cash basis method is used?
• If the “incurred” method applies what happens if I make payment after the end of the 8-week time period? Does it still count?
• Do I need to accelerate my payroll to make sure I get the last payroll in and paid at the end of 56 days?
• How do I include my current year employee retirement contributions if I typically wait to the end of the year to declare a profit-sharing contribution?
• Can we make bonus payments to employees during the 8-week time period?
• Are there any special rules if you have members of your family working in the business?

Commentary

These are just some of the questions that we need guidance from the SBA. In the meantime, document your expenses and look at each invoice to see what measurement period they apply to. We would also suggest setting up an excel document to break those costs down that straddle the beginning and ending of the 8-week measurement periods.

Documentation requirements:

With respect to documentation, go overboard with your organizational skills and expect that you will have to provide your banker with copies of everything. Here are some of the steps we are recommending to our clients:

• First, set up a separate file for qualifying expenditures and as the expenditure is made, take a copy of an appropriate supporting document and file it away.
• Make sure you have a copy of your lease.
• Take copies of all utility payments including showing the account was in existence as of February 15, 2020. This includes traditional gas, electric but also phone and internet bills.
• Provide copies of any debt agreements as of February 15^th to show the date of the mortgage as well as any other qualifying loan document. The amount of interest can be included as a qualifying expense.

Commentary

We expect guidance to be forthcoming but here is what we are telling our clients:

• Consider using both methods as your guide
• As you get to the end of the 8-week time period make sure you write the check within the 8-week timeline for those qualifying expenditures
• Watch your payroll periods. Consider running your last payroll on day 56 and make sure the funds are disbursed.

Loan Forgiveness “Gotcha’s”

The computations for purposes of the loan forgiveness creates some traps for the unwary and could result in a significant portion of the PPP loan not being forgiven. In the mad rush to apply for the PPP Loan many businesses did not spend a lot of time on the loan forgiveness computations.

The following are some of the traps that will limit the forgiveness amount and we will spend time doing a deeper dive into each of the traps.

• Your non-payroll costs may be limited based on the above.
• Your “Full-time Equivalents (FTE)” counts come up short during the measurement periods.
• You have reduced individual employee compensation by more than 25% during a covered period.

If you maximized your PPP loan by using your “average monthly payroll” costs from 2019 and then multiplied that by 2.5 to determine your loan it will be difficult to achieve 100% of forgiveness unless everything aligns in your favor. With that said, let us address each of the above items that may limit your forgiveness.

You spend less than 75% of the PPP loan on qualifying payroll costs.

This concept is easy to explain but just as important, a trap for the unwary. To illustrate, let us assume the following:

The rules require that we spend a minimum of 75% of the PPP loan proceeds on qualifying payroll costs. Based on the above assumptions this is what we think the results are:

1. Total qualified payroll costs                       $60,000
2. Total qualified non-payroll costs              $20,000
3. Total PPP loan forgiveness                         $80,000
4. Amount of remaining loan                                        $20,000

Wait a minute, this does not make sense to me. I did what I was told and spent the $100,000 on qualified payroll and qualified non-payroll costs and now you are telling me I owe $20,000? The money has been spent and my revenues are down!

What you have just seen is the first and second trap. The forgiveness provisions indicate that no more than 25% of the total loan forgiveness can be spent on non-payroll costs. To determine this amount this is what the calculation looks like:

1. Total qualified payroll costs                     $60,000
2. Divide by                                                             .75
3. Equals the loan forgiveness                     $80,000

You then take 25% times the $80,000 and unfortunately, only $20,000 of the qualified non-payroll costs will be included in the PPP loan forgiveness as qualified non-payroll costs.

The importance of the FTE counts!!!

This is where this old guy gets confused and hopefully, we can help explain most of the computations. However, what is most important is to provide some direction on why the FTE counts are important and what you might be able to do to mitigate the damage if your FTE counts are down. Here is why the FTE calculation is important:

1. If your employee count in 2019 was the same as 2020 and, there has been no reduction in wages, you probably will not have a problem and the FTE count exercise will probably not impact you other than to calculate the FTE’s in the measurement period.
2. If your current FTE’s are less than the period starting February 15, 2019 to June 30, 2019 you need to go through this calculation to determine if there needs to be a % reduction in your qualified wages.
3. If your current FTE’s are less than the period starting January 1, 2020 through February 29, 2020 you need to go through this calculation to determine if there needs to be a % reduction in your qualified wages.

• If you reduced your FTE’s between February 15, 2020 and April 26, 2020 you need to go through this calculation to determine if the % reduction can be mitigated if you hire back by June 30, 2020
• The calculation of your FTE’s will be part of the required documentation to submit to your bank when it is time to ask for loan forgiveness.

Before we illustrate with some examples there are some key concepts to keep in mind:

• It appears that the SBA defines a “Full Time Equivalent (FTE)” as an employee that works 30 hours or more. Anyone that works less than 30-hours is considered a part-time employee. However, you can add up the total hours of your part-time employees and make a conversion to an FTE for purposes of these calculations.

• The rules regarding the computations refer to “the average FTE’s” calculated during the measurement periods. We take this to mean that you must look at each pay period and do the FTE calculation for each payroll. You then take the total of the FTE’s in each payroll and divide by the number of payrolls in the measuring period.

Loan Forgiveness Reduced if the # of Employees Drops:

The CARES Act provides that the amount of loan forgiveness is reduced if there is a reduction in the number of employees. To illustrate, let us assume the following:

• Total PPP loan of $100,000
• Total qualified payroll during the 8-week measuring period of $60,000 which works out to 60% of the PPP loan.
• You manage to spend $40,000 on qualified non-payroll costs.
• Our FTE’s during the pre-loan period is 8 determined using the period from January 1, 2020 to February 29,2020.
• Our FTE’s during the 8-week “covered” period is 6
• Total loan forgiveness of $80,000 using the previous example which included a combination of qualified payroll costs and qualified non-payroll costs.

  Based on the above, the computation would look like this.

With the FTE reduction our $100,000 initial loan is reduced to $40,000 which needs to be repaid within two years of funding.

This should be concerning to PPP borrowers in that what started out as the “group think” that all $100,000 of the PPP loan would be forgiven but the actual results can be significantly different.

Before we go to the next example, let us discuss the FTE calculations above to see if we can come up with a different result. In the example our numerator was the FTE count during the 8-week “covered period” and the denominator was our estimate using the period from January 1, 2020 to February 29,2020. In our example we assumed our client was in a hurry and just roughed out the 2020 numbers and did not want to do the 2019 FTE calculation.

The “denominator” can be determined using the lowest average FTE computed during the following periods:

• February 15, 2019 to June 30,2019, or
• January 1, 2020 to February 29, 2020

We have two pay periods per month and have a mixture of full and part-time employees. Upon a detailed review of the pay periods we realize that our payroll cost and head count was gradually increasing in 2019 because of increased business. As a result, the average FTE calculation for the period from February 15, 2019 to June 30, 2019 was 7. The good news is this FTE count is lower than the period used, and you get to use the lowest of the two measurement counts as your denominator. This is the new calculation:

1. Loan forgiveness                             $80,000
2. FTE Reduction (6/7)                           85.7%
3. Actual loan forgiven                       $68,571

This is a much better result and you have just picked up an additional $8,571 in loan forgiveness.

Commentary

It is important to make sure your payroll records are accurate, and you have the proper information. Be prepared to show the hours worked in your calculation of FTE’s. The computation has nothing to do with what you pay someone and everything to do with the hours worked.

If you look at the above result, the amount of loan forgiveness was reduced by the following two factors:

1. Your qualified payroll costs are less than 75% of the PPP loan
2. Your FTE’s during the 8-week period is less than the lowest of the two periods as illustrated above.

Now that we have this simple concept explained away is there anything else, I need to be concerned with? Unfortunately, there is one additional item that can further reduce your loan forgiveness.

Loan forgiveness further reduced from individual employee pay reductions.

If you have implemented individual employee payroll cuts during the 8-week measurement period by more than 25%, than the difference further reduces the loan forgiveness. For example:

1. Three of your FTE’s agree to take a 50% pay cut.
2. The total compensation before this pay cut would have been $50,000. The actual amount paid during the 8-week covered period was $25,000
3. The additional reduction in loan forgiveness is calculated as follows:
   1. $50,000 x 75%              $37,500
   1. Paid                                 $25,000
   1. Reduction                      $12,500

Unfortunately, we are not done explaining one additional variable that could impact the loan forgiveness but before we do that let us summarize the ways the loan forgiveness is reduced.

1. Your qualified payroll costs is less than 75% of the PPP loan
2. Your FTE’s during the 8-week period is less than the FTE’s in one of the computational periods.
3. You had individuals with an annualize pay rate of less than $100,000 take pay cuts in excess of 25% of their salary  

“The Restoration Test” may help minimize the reduction in loan forgiveness

There is one additional provision in the CARES Act that may provide some relief and is called the “Restoration Test”. The reductions caused by failing the FTE or wage reduction test may be mitigated if:

• “not later than June 30, 2020, the eligible employer has eliminated the reduction in the number of full-time equivalent employees.”
• “not later than June 30, 2020, the eligible employer has eliminated the reduction in the salary or wages of such employees.”

Unfortunately, here is where the confusion begins. The measurement periods to be compared are:

• February 15, 2020
• February 15, 2020 to April 26, 2020 which is 30 days after the enactment of the CARES Act.

The comparison is based on FTE’s as of the end of each of the dates referenced above. In many cases, companies had furloughed employees starting before the PPP loan program was available and this provision allows companies to restore their employee force to February 15, 2020 levels and to restore any reduction in compensation for employees that stayed on the payroll.

Commentary

Based on our interpretation of being able to restore the reduction in FTE’s the new FTE computation might look like this.

Assumptions:

1. Average FTE’s from the period 2.15.19 to 6.30.19                             15
2. Average FTE’s from the period 1.1.20 to 2.29.20                               17
3. FTE’s as of 2.15.20 (increase in hiring)                                                   18
4. FTE’s as of 4.26.20 (furloughed)                                                              14
5. FTE’s in the 8-week covered period (more furloughs)                       10
6. FTE’s brought back by 6.30.2020                                                                           4

Without consideration of the “restoration rules” this is what our % would be that is applied to our qualified loan forgiveness:

• Numerator is the 8-week covered period                                             10
• Denominator is the lower of (1) or (2) above                                      15
• Percentage of qualified loan forgiven (10/15)                                     66.67%

With consideration of the “restoration rules” this is what our % would be applied to our qualified loan forgiveness:

• Numerator is the 8-week covered period                                             10
  • Add employees brought back                                                     4
  • Adjusted numerator                                                                    14
• Denominator is the lower of (1) or (2) above (stays the same)       15
• Percentage of qualified loan forgiven (14/15)                                     93.33%

Commentary

I am not sure if my interpretation is correct because there are so many moving parts and periods to be measured. One professional may argue that the complete FTE adjustment is thrown out if you bring back all employees that were furloughed from 2.15.20 to 4.26.20 but logically that does not make sense. The other factor is the FTE’s used to determine your denominator. If you had a growth year and were adding employees, one period may create a lower denominator which may not accurately account for the employees that were furloughed.

A simplistic understanding of the wording would indicate that Congress is intending to waive the penalties for not meeting the FTE tests or compensation cuts if everything is brought back to pre-COVID-19 levels. Keep in mind, the waiving of the FTE differences will not eliminate the reduction in forgiveness if the total qualified payroll costs were less than 75% of the PPP loan proceeds.

The technical reading of the CARES Act is extremely confusing and additional guidance will be needed before I would feel comfortable that my conclusions above are absolutely correct. So, proceed with caution until we get final guidance.

Loan forgiveness for the Self-Employed with no employees

We have not forgotten about you and the good news the loan forgiveness computations are much simpler. To illustrate:

• Total 2019 Schedule C Income                               $80,000.00
• Total PPP loan ($80,000/12*2.5)                            $16,666.67

The SBA, in subsequent guidance, says the self-employed reporting earnings on a Schedule C will get an automatic forgiveness based on 8 weeks of 2019 profits computed as follows:

• Total profits from 2019                                           $80,000
• Divide by                                                                     52
• Multiply by                                                                 8
• Equals the PPP loan forgiveness of                      $12,307.69

Wait a minute this does not seem fair! It looks like the self-employed will end up having a loan to pay back of $4,358.97 ($16,666.67 less $12,307.69).

It appears there is an “oops” in the SBA guidance and they unintentionally left out qualifying non-payroll costs such as:

• Mortgage interest (not an office in the home)
• Rent
• Utilities
• The self-employed “home office deduction” will not count as a qualifying non-payroll cost.   

Commentary

Hopefully, we will receive guidance on this, but it is also a reminder that the self-employed should follow best practices such as segregating the loan proceeds into a separate account. The transfer of the 8/52 (the $12,307.69 computation referenced above) earnings based on 2019 can take place at any time. Subsequent transfers of non-payroll costs can be made as they are paid. In many cases, it appears that most self-employed will end up having a loan that needs to be paid back.

Other planning thoughts to help maximize the amount of the PPP Loan Forgiveness

The following is a compilation of our thoughts as well as commentary received from professionals throughout our country.

Planning considerations to maximize your loan forgiveness 

1. The 8-week period starts the day your loan is funded and is deposited in your bank account.
2. Prepare your FTE counts for the periods referenced above. If you are transferring funds from a separate PPP loan account as qualified expenses are incurred, you may be thinking that most of the loan will be forgiven but it may not be. It is better to know now while you manage your cash flow.
3. Document everything
4. Qualified non-payroll cost for utilities will include communication costs for telephone and internet services.
5. It should be ok to increase pay for employees if you can show the increases are justified. This increases your qualified wages.
6. If you have children on the payroll, make sure the hours are documented. If their wages were included as qualifying costs in determining the amount of the PPP loan you may end up losing a portion when you do the FTE calculations if the hours worked are nominal.
7. As you get close to the end of the 8-week period be prepared to run an additional payroll up through the 56-day period for any wages not yet paid.
8. Mortgage interest is a qualified non-payroll cost, but principal payments are not.
9. Talk to your employees that have been furloughed. Many of them are drawing unemployment compensation that includes the “extra kicker”. In many cases they are making more and are reluctant to come back to work early. Incentive payments may be needed.
10. If you know that a portion of your PPP loan will not be forgiven, consider bringing back your employees as soon as you can. They can work on projects that you have been putting off and this may allow you to get back to “normal” quicker.
11. Get to know your banker well. The forgiveness application must go through your bank, and you need to know what their documentation requirements will be.
12. Watch the $100,000 annual compensation test for individual employees. Do not transfer funds out of the PPP account to cover the excess per payroll period.
13. The employer portion of payroll taxes such as FICA and Medicare are not qualified payroll expenses. You cannot use the PPP loan proceeds for these costs.
14. If you own the building that is being rented to your entity be careful about increasing the rents during the 8-week period. This may or may not be allowed. However, do make sure the appropriate rents are paid during the 8-week measuring period.
15. Payments to independent contractors (1099 folks) do not count as a qualified payroll expense.
16. For the Schedule C person, it might make sense to hire your spouse to do some work if we do not receive additional SBA guidance on what non-payroll costs are eligible for forgiveness. Keep in mind he or she would have to receive an actual payroll check.
17. Finally, and maybe the most important step, is to track where you are at with the loan forgiveness. Here are the steps we would recommend:
    • Set up an excel file to create a schedule that shows the qualifying payroll expenses, the non-payroll expenses, and your FTE counts.
    • On a weekly basis update the schedule to show the cumulative qualifying payroll and qualifying non-payroll costs that have been paid.
    • Add to those totals the projected amounts to be paid in the remaining 8-weeks.
    • Using your PPP Loan proceeds as the denominator and the expected qualifying payroll costs as your numerator calculate the percentage.
    • If your percentage is on track to exceed 75% of the total loan proceeds that is a positive sign towards maximizing your forgiveness. This is the most important calculation because it impacts how much of the qualifying non-payroll costs will be considered for purposes of the loan forgiveness. If the percentage is less than 75%, start to plan accordingly.
    • Finally, review your expected qualified non-payroll costs for the 8-week period. Will the projected totals exceed 25% of the loan forgiveness? If not, look for ways to fill that gap. As a reminder, if the total qualified payroll costs exceed 75% of the PPP loan you just need to fill the gap which is the difference between the PPP loan and your qualified payroll costs. If the payroll is less than 75% of the loan you must remember to do the recalculation as illustrated in the example above.  

Questions that we need guidance on.

1. We will need guidance as to what was the intent of the “payments made” or “costs incurred” language in the present guidance.
2. We think the definition of an FTE is 30-hours of work per week. However, this needs to be confirmed.
3. The SBA still needs to provide addition guidance on the calculations related to the “Restoration Test” as discussed above. This is confusing as written and is a very meaningful part of the CARES Act.
4. The CARES Act specifically says that any PPP loan proceeds that are forgiven are not taxable income. That is the good news. However, there is a provision in the Internal Revenue Code that says that any expenses paid with non-taxable income are not deductible. Stay tuned for guidance!
5. Will the states follow federal and not tax the forgiven PPP loan proceeds?
6. Will there be rules that limit companies from increasing payroll costs for selected employees during the 8-week measurement period?
7. What happens if you receive your PPP loans on May 15^th? Do you only have 6-weeks in your “covered period”?
8. Guidance for the self-employed Schedule C borrower will need to be provided as to what non-payroll costs can be included in their computations for loan forgiveness.
9. The SBA guidance for purposes of defining a salary reduction of more than 25% for an employee during the 8-week period needs clarification. They indicate you use the previous quarter which consists of 12 weeks and compare that to the 8-week period for purposes of the computation. This does not make sense.
10. How do you handle retirement plan contributions if historically a decision is not made until year-end? It may be that only 401k matching contributions may count.

In closing

We understand the PPP Loan Forgiveness step is confusing and we are here to help you and answer any questions you may have.

Appreciatively,

Your AHS team!!!