Borrower-Friendly Changes Don't Solve All PPP Issues

By Phil Jelsma
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Law360 (July 21, 2020, 6:11 PM EDT) --
Phil Jelsma
Phil Jelsma
Rife with confusing deadlines and restrictions, the new Paycheck Protection Program — part of the unprecedented $2.2 trillion Coronavirus Aid, Relief and Economic Security, or CARES, Act — has left many small-business owners reluctant to spend their funds. 

With forgiveness criteria still unclear and evolving, some businesses have even elected to return proceeds rather than face the many issues associated with loan forgiveness.

As a result, on June 5, President Donald Trump signed the Paycheck Protection Program Flexibility Act into law, addressing the flaws in the original program and making it easier for borrowers to qualify for forgiveness.

Offering further clarity on the program's rules and restrictions, subsequently the Small Business Administration — with the U.S. Department of Treasury — released a revised borrower-friendly PPP loan forgiveness application. This newest version of the application reflects the changes from the PPP Flexibility Act.

Despite these latest changes, many of the issues surrounding the administration of the PPP loan program remain unresolved, particularly for those electing a 24-week covered period to spend loan proceeds, versus the original eight-week covered period.

The 24-week period applies to all loans made on or after June 5. Borrowers who received loans before June 5 can choose to elect an eight-week period, which for some may be less risky. 

However, there are downsides to both options, with concerns that filing using an eight-week covered period precludes a borrower from later electing a 24-week covered period. This could transpire in the event some amounts paid with the PPP loan are not forgivable during the eight-week covered period or if the borrower has a reduction in full-time equivalent employees.

Along with revising the full forgiveness application, the SBA also introduced a new EZ form requiring fewer calculations and less documentation, streamlining the application process for eligible borrowers.

EZ Version Further Simplifies the Process

To make the loan forgiveness process less challenging, the SBA's new short application for forgiveness, Form 3508EZ, applies to borrowers who:

  • Are self-employed and have no employees;

  • Did not reduce the salaries or wages of their employees by more than 25% and did not reduce the number or hours of their employees; or

  • Experienced reductions in employees as a result of health directives related to COVID-19, and did not reduce the salary or wages of their employees by more than 25%.

Requiring less documentation for eligible borrowers, the EZ version does not include the multiple worksheets that are a part of the longer form. However, it remains to be seen whether borrowers can determine the information that's required for the short form without utilizing the related worksheets.

On the other hand, the long form complicates the process by requiring the borrower to list the employees by name, identification number, cash compensation, average full-time equivalents and any wage or salary reduction during either a covered period or alternative payroll covered period.

The short form requires the borrower to make one of the two following certifications in order to use it:

1. The borrower did not reduce the number of employees or the average number of paid hours of employees between Jan. 1 and the end of the covered period other than reductions that arose from an inability to rehire individuals who are employees on Feb. 15, if the borrower was unable to hire similarly qualified employees for unfilled positions on or before Dec. 31, 2020, and the reductions in the employee's hours that a borrower offered to restore and were refused; or

2. The borrower was unable to operate between Feb. 15 and the end of the covered period at the same level of business activity as before Feb. 15, due to compliance with requirements established for guidance issued between March 1, and Dec. 31, by the secretary of Health and Human Services, director for the Centers for Disease Control and Prevention or the Occupational Safety and Health Administration, related to the maintenance of standards of sanitation, social distancing or any other work or customer safety requirement related to COVID-19.

Again, one decision all borrowers will need to carefully consider is whether to use the eight-week covered period allowed under the initial PPP loan program or the longer 24-week period brought about by the PPP Flexibility Act. The 24-week period may provide a benefit to a borrower who has not been able to spend all of the PPP loan proceeds because the business has either been shut down or has been adversely impacted by COVID-19.

However, using the longer time period means the testing date for measuring a potential reduction in full-time equivalent employees will shift from June 30 to Dec. 31. A reduction in the average number of full-time equivalent employees from Feb. 15 to either June 30 or Dec. 31, can adversely affect the borrower's ability to obtain complete loan forgiveness.

Electing to spend the PPP loan proceeds over 24 weeks means the borrower will have to have the same average number of full-time equivalent employees on Dec. 31 as Feb. 15. Given the uncertainty in the economy, this creates a higher level of risk in choosing the longer 24-week covered period.

In theory, even if a borrower did not use all of the PPP loan proceeds in the eight-week period he/she can return the portion which isn't forgiven — but exactly how this impacts the forgiveness calculation is not resolved. In addition, the treatment of employees who may be transferred from one borrower to another isn't discussed in the SBA PPP materials.

New Interim Rules Raise More Questions

On June 12, the SBA posted new interim final rules that address a problem with how congress reduced the portion of the loan that must be spent on payroll costs.

Under the original PPP loan program, if a borrower failed to meet the 75% threshold, it only reduced the amount which would otherwise not be eligible for forgiveness. But under the PPP Flexibility Act, it is not clear whether failing to meet the 60% requirement allows for any forgiveness.

The PPP Flexibility Act states:

[T]o receive loan forgiveness under this section, an eligible recipient must use at least 60% of the covered loan amount for payroll and may use up to 40% of such amount for the payment of interest on any covered mortgage obligation (which shall not include the prepayment of or payment principal on a covered mortgage obligation), any payment on a covered rental obligation or any covered utility payment.

Yet it does not answer this key question: If a borrower fails short of the 60% threshold, is the entire loan not subject to forgiveness or only the portion below 60%? The interim final rules include this example providing that only the portion below 60% is not forgiven:

If a borrower receives a $100,000 PPP loan, and during the covered period the borrower spends $54,000 (or 54 percent) of its loan on payroll costs, then because the borrower used less than 60 percent of its loan on payroll costs, the maximum amount of loan forgiveness the borrower may receive is $90,000 (with $54,000 in payroll costs constituting 60 percent of the forgiveness amount and $36,000 in non-payroll costs constituting 40 percent of the forgiveness amount).

The materials from the SBA suggest that limitations continue to apply for self-employed owners, that is the amount of payroll which can be paid including salary, wage and tips is limited to $100,000 annualized per employee — for 24 weeks, a maximum of $46,154 per individual or for eight weeks, a maximum of $15,385 per individual.

Unlike shareholders of a C corporation, members of an LLC, sole proprietorships and partners of a partnership are treated as being self-employed. Borrowers who are not C corporations need to carefully account for the payments made on behalf of self-employed owners.

One thing to consider is that many states, such as California, Arkansas, Indiana, Wisconsin, Massachusetts, Kentucky and Georgia, have not yet conformed to CARES Act tax provisions.

Although the forgiveness of the PPP loan is excluded from gross income for federal income tax purposes, it appears to be fully taxable in many states. This means the expenses paid with PPP loan proceeds will be nondeductible for the federal income tax purposes as set forth in IRS Notice 2020-32, but the loan forgiveness will be nontaxable for federal income tax purposes.

For the states that do not conform to the federal tax treatment, the expenses paid with PPP loan proceeds will be deductible, but the loan forgiveness will be taxable income.

On a more positive note, for the borrowers who can use the new short form, these new changes make the forgivable portion of the program much easier to access and understand. Yet, while overall the PPP program is a boon for small business, a number of questions pertaining to the implementation of the PPP loan program and how borrowers can maximize the amount of loan forgiveness remain unanswered.

Phil Jelsma is a partner and chair of the tax practice team at Crosbie Gliner Schiffman Southard & Swanson LLP

The opinions expressed are those of the author(s) and do not necessarily reflect the views of the firm, its clients, or Portfolio Media Inc., or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice.

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