Not All PPP “Forgivable” Loans Will be Forgiving

In the face of the global pandemic and the subsequent economic crisis it has spurred, the federal government has taken several steps to protect small business owners including forgivable loans. One of the most notable of these steps is the offering of Paycheck Protection Program (PPP) loans, which are being trumpeted as forgivable loans. Though the loans are indeed forgivable, the requirements for forgiveness are not as broad as many borrowers originally thought.

Requirements for PPP Loan Forgiveness

At first glance, the qualifications for a loan to be forgivable are fairly simple. A minimum of 75% of whatever amount is borrowed must be used to cover payroll, though up to the remaining 25% of the loan can then be used on other specific expenses incurred or viewed as a liability prior to the crisis unfolding. Those other qualified expenses included mortgage interest, utilities and rent.

Though the details above are correct, what was not immediately understood by those seeking the loans was that there is an additional requirement that may be present more of a challenge. In order for the loan to be fully forgivable the business must end the pandemic period with the same number of employees as they began with — even if they are using 75% of the loan to pay workers, if a business doesn’t end the pandemic with the same number of employees as they had before the crisis hit then the forgivable portion of their loan will be modified.

To understand the effect that this additional restriction has on a small business and its PPP loan, consider a company that had employed 20 workers before the virus first struck the United States. The business takes out a loan and uses 75% of it for payroll expenses, but at the end of the pandemic they have only retained or rehired 12 of their employees. This would result in only 60% of the expenses being eligible to be forgivable. If, on the other hand, the business had either kept their staff to 20 employees or rehired staff to bring them back up to 20 after the crisis had passed, then their loan could be fully forgiven.

Though it is understandable that a program that is specifically identified as a Paycheck Protection Program would have this type of requirement, that doesn’t make the issue any less tenable for companies whose businesses have been hard hit by the virus. If there are no customers or no demand, then retaining or rehiring employees makes little sense.

Calculating Your Forgivable Loan Equation

If you have taken out a PPP loan or are considering doing so and want more information on the considerations involved in the forgiveness equation, the most important information for you to be aware of is the time period that the government will use to assess the number of employees you had pre-pandemic.

There will be two time periods used: either January 1, 2020 to February 29, 2020 or February 15, 2019 to June 30, 2019. Smart employers who have had to cut back on their number of employees will take the time to analyze their employment records to determine when they had a smaller number of full-time equivalent employees.

For an even more detailed example of how the PPP loan forgiveness program will be calculated, let’s look at the calculations involved in a $100,000 loan taken out by a company that had 20 full-time equivalent employees prior to the crisis. When the company’s 8-week loan period comes to an end, they are no longer able to support ten employees and have cut back to 12.

Using this example, let’s go through both the 75% Payroll Cost Rule and the Full-time Equivalent Employee Rule to see what amounts a small business borrower would be eligible to have forgiven. If the company spent a total of $60,000 on payroll and another $12,000 on rent and utilities, that would bring their total amount spent up to $72,000.

The first step in determining qualifying expenses is to calculate what percentage of the total qualifying amount went to payroll. In this case $60,000 represents 83% of the $72,000 in expenses that qualify, so it exceeds the 75% threshold and fully qualifies for forgiveness.

However, under the adjacent full-time equivalent employee rule that is part of the program, the government will also compare how many full-time equivalent employees the business had before the pandemic to the number on staff after. If their pre-pandemic staffing level was 20 full-time equivalent employees but after the 8-week period they only had retained 12 full-time employees, then the amount eligible to be forgiven will be reduced by the same ratio as that of their reduction in full-time equivalent staffing.

The total loan spend of $72,000 will be multiplied by 60%, leaving them with only $43,200 qualifying as forgivable. Carrying the calculation to its logical conclusion, the original $100,000 PPP loan that paid out $72,000 in qualifying expenses (including 83% of qualifying expenses being dedicated to payroll) will only be able to have $43,200 forgiven because they only retained or rehired 60% of their pre-pandemic staffing level. The balance of their loan – $56,800 – will need to be repaid within two years at an interest rate of 1%.

The same calculation is done if the same number of employees are retained or rehired, but their compensation is reduced by more than 25%.

It is important to remember when doing these calculations that in the event that the business’ non-payroll expenses go beyond the allowable 25%, that also reduces the forgiveness of the borrowed money. The amount that can be forgiven will be reduced until the ratio reaches the required levels and non-qualifying expenses represent no more than 25% of the total.

Understanding the Pros and Cons of PPP Loans

Though small business owners had looked to the PPP program as something of a lifeline, they also need to remember that this particular program was specifically meant to incentivize them to retain their employees – that is why it was called the Paycheck Protection Program. It can be disappointing or even upsetting to be penalized for not being able to bring back all of your employees, especially when there are some employees who would rather not come back because the unemployment compensation that they are receiving may be greater than the amount that they were originally being paid.

Of course, there is also the matter of whether there is work for those employees. Does it make sense to bring back workers and pay them when there is no work to justify doing so? According to Regional SBA Administrator Robert Scott, the Small Business Association is hamstringed by the language included in the CARES Act and must comply by the rules that Congress has imposed.

There is a potential lifeline for businesses that were forced to cut their employment levels during the worst weeks of the pandemic: if the economy reopens and they are able to bring back their original pre-pandemic contingency of workers by June 30, 2020, the forgiveness reduction will be eliminated. Whether that is doable or not is another question, and one that the SBA and Treasury are likely to review as the situation progresses.

If you have any questions, please contact this office. We are here to help you make a plan for achieving a forgivable loan.