COVID-19

On Friday May 15, 2020, the Small Business Administration (“SBA”) released the application borrowers will use to request forgiveness of their Paycheck Protection Program (“PPP”) loans.  On Friday May 22, 2020, the SBA and Treasury jointly issued an Interim Final Rule clarifying some portions of the forgiveness application.  PPP borrowers have been awaiting additional guidance regarding the forgiveness portion of the program for well over a month.  While the application and interim final provides some additional guidance, many questions remain.

BACKGROUND

As our readers already know, the PPP loan program was enacted pursuant to the CARES Act as a tool to help small businesses keep employees on their payroll.  The draw of the program is the ability for borrowers to have the loans forgiven.  In other words, the loans can be essentially converted into tax-free grants.  One caveat is that borrowers are permitted to spend PPP loan proceeds on very limited types of expenditures.  PPP loans must be spent only on payroll, rent, utilities and interest on certain pre-existing obligations during an eight-week period following loan origination.

SBA had previously required that borrowers certify that 75% of their PPP loans would be expended on payroll.  Moreover, subject to one large exception, a portion of loan forgiveness will be lost for borrowers who reduce the number of full-time equivalents on their payroll OR reduce the average hourly wage or annual salary of an employee by more than 25%.  The aforementioned exception to loan forgiveness applies where (i) reductions in full-time equivalents or average hourly wages and salaries took place between February 15 and April 26, 2020 and (ii) the number of full-time equivalents and compensation are restored by June 30, 2020 (the “June 30 Restoration Exception”)

THE APPLICATION

As noted above, many questions remain unanswered but the application does provide clarification of certain issues, including the following.

Eight Week Testing Period / Covered Period

In order to qualify for forgiveness, amounts must be spent during the eight-week period commencing upon the date the loan proceeds are disbursed to the borrower (the “Covered Period”).  For administrative convenience, borrowers who pay employees at least as often as biweekly may elect to calculate eligible payroll costs using the eight-week period that begins on the first day of their first pay period following the loan disbursement date (the “Alternative Payroll Covered Period”).  Note that this alternative eight-week period only applies to payroll costs and not to other qualifying expenditures.

Expenses Paid or Incurred

One question that tormented borrowers was whether eligible costs had to be paid and incurred during the Covered Period or whether they could be incurred and/or paid during the period.  With respect to payroll costs, the application provides:

Borrowers are generally eligible for forgiveness for the payroll costs paid and payroll costs incurred during the eight-week (56-day) Covered Period (or Alternative Payroll Covered Period) (“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 paid on or before the next regular payroll date. Otherwise, payroll costs must be paid during the Covered Period (or Alternative Payroll Covered Period).

Similarly, with respect to eligible non-payroll costs, the application provides:

An eligible nonpayroll cost 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.

However, the May 22 Interim Final Rule clarifies that pre-payments of interest are not eligible for forgiveness.  Accordingly, it appears that any eligible payroll or non-payroll costs (other than prepayments of interest) paid during the Covered Period count towards loan forgiveness despite when the cost was incurred.  Additionally, costs incurred during the Covered Period and paid in accordance with the usual schedule for payment can also be forgiven even if the payment date falls after the conclusion of the Covered Period.

Calculating Full-Time Equivalents

Recall that a reduction in full-time equivalents (“FTEs”) during the Covered Period will result in a proportionate reduction in loan forgiveness.  The application permits borrowers to calculate the number of FTEs in one of two manners.  The first way to calculate FTEs is to determine the average number of hours worked by each employee per week during the Covered Period and divide that number by 40.  The resulting quotient is rounded to the nearest 1/10^th and capped at 1.0.  Alternatively, borrowers can count all employees who average 40 or more hours per week as 1.0 and each employee working less than 40 hours as 0.5.  Once the borrower has calculated each employee’s FTE status, the results are aggregated.

The average number of FTEs during the Covered Period is then compared against the number of FTEs during one of the following periods (at the Borrower’s election): (i) February 15, 2019 to June 30, 2019; (ii) January 1, 2020 to February 29, 2020; or (iii) in the case of seasonal employers, a consecutive twelve-week period between May 1, 2019 and September 15, 2019.  The number of FTEs for the Covered Period and the number of FTEs during the reference period chosen by the borrower must be calculated using the same methodology.

Additionally, any FTE reductions resulting from one of the following reasons will not impact loan forgiveness: (i) employees who were terminated prior to April 26, 2020 and who rejected a good-faith, written offer of rehire during the Covered Period (the employee’s rejection of the offer to rehire must be reported to state unemployment insurance offices); and (ii) any employees who (a) were fired for cause, (b) voluntarily resigned, or (c) voluntarily requested and received a reduction of their hours.

Calculating Salary and Wage Reductions

As noted above, borrowers who reduce their employees’ salaries by more than 25% will suffer a loss in the amount of loan forgiveness.  This calculation is made on a per employee basis.  Meaning, each employee’s compensation during the Covered Period is measured against that employee’s compensation from January 1, 2020 to March 31, 2020.

It is unclear how this rule would apply if the borrower terminated a number of employees and rehired lower wage workers.

June 30 Restoration Exception

Any reductions in FTEs or compensation that are restored on or before June 30, 2020 will not result in a reduction of loan forgiveness.  The application does not specify how this rule operates.  For example, for how long do employees need to be rehired?  How does one test FTEs on June 30, 2020?  Is it a one-day test or do we test based upon a payroll period ending or starting on June 30, 2020?

Owner Compensation

Pursuant to prior SBA guidance, compensation payable to owners is limited to 8/52 weeks of 2019 net profits.  Additionally, healthcare expenses and retirement contributions attributable to self-employed individuals, general partners and other Schedule C filers are not eligible for forgiveness.  It appears that health and retirement contributions made on behalf of shareholder-employees are eligible for forgiveness.

The application requires a certification that the amount for which forgiveness is requested “does not exceed eight weeks’ worth of 2019 compensation for any owner-employee or self-employed individual/general partner, capped at $15,384 per individual.”  Accordingly, it appears that borrowers cannot receive full loan forgiveness if they use PPP funds to increase compensation to owner-employees, including corporate shareholder-employees.

Loan Forgiveness Process

In order to receive loan forgiveness, borrowers must submit the PPP loan forgiveness application linked in the introductory paragraph above to its lender.  Within 60 days of receiving the application, the lender must issue a decision to SBA regarding loan forgiveness.  Within 90 days of receiving the lender’s decision and subject to the SBA’s additional review of the original loan and/or forgiveness application, the SBA will remit payment of the appropriate forgiveness amount to the lender together with accrued interest on such amount.  Accordingly, it can take up to 150 days to receive final notification of loan forgiveness.

CONCLUSION

While these new rules do provide some additional guidance, the answers to many important questions (particularly with regard to the June 30 Restoration Exception) still remain unclear.

Some practitioners expect that SBA will promulgate further guidance concerning PPP loan forgiveness.  However, it is unlikely that such guidance will be issued soon enough to be helpful for borrowers who have already received loans.  Additionally, there are many proposals being discussed in Congress to amend the Paycheck Protection Program.  We will be sure to provide additional updates in the event additional guidance is issued or amendments are enacted.

*This alert was initially published on May 18, 2020 following the release of the PPP loan forgiveness application and has been updated to include certain clarifications provided by the May 22, 2020 Interim Final Rule.

NOTE: This article has been updated from the original publication on May 18, 2020 to reflect new information provided by the SBA on May 22, 2020.

Small Business Administration (SBA) guidance published on May 13, 2020 adds clarity to the “necessity” certification that borrowers were required to make when applying for Paycheck Protection Program (PPP) loans.  According to this guidance, borrowers that received PPP loans of less than $2 million will be deemed to have made the necessity certification in good faith.  As to borrowers with loans greater than $2 million, if the SBA notifies the borrower that the SBA has determined that the borrower lacked an adequate basis for the necessity certification, the borrower will be able to avoid enforcement action by repaying the loan.

Background

Every PPP loan application requires that the borrower certify that current “economic uncertainty makes this loan request necessary to support the ongoing operations of the Applicant.”  In April 2020, Treasury Secretary Steven Mnuchin and the SBA announced that the SBA would audit select PPP loans, including all loans in excess of $2 million.  These audits will include an examination of whether the aforementioned necessity certification was made in good faith.  Our previous post on this topic is available here.

SBA Guidance

Borrowers are likely to find the following two portions of the May 13 guidance especially significant:

Safe harbor for <$2 million borrowers: “Any borrower that, together with its affiliates, received PPP loans with an original principal amount of less than $2 million will be deemed to have made the required certification concerning the necessity of the loan request in good faith.”

Notice-and-cure opportunity for other borrowers: “SBA has previously stated that all PPP loans in excess of $2 million, and other PPP loans as appropriate, will be subject to review by SBA for compliance with program requirements set forth in the PPP Interim Final Rules and in the Borrower Application Form. If SBA determines in the course of its review that a borrower lacked an adequate basis for the required certification concerning the necessity of the loan request, SBA will seek repayment of the outstanding PPP loan balance and will inform the lender that the borrower is not eligible for loan forgiveness. If the borrower repays the loan after receiving notification from SBA, SBA will not pursue administrative enforcement or referrals to other agencies based on its determination with respect to the certification concerning necessity of the loan request.”

Our Observations

As the necessity certification is rather subjective, many PPP borrowers were rightfully concerned over potential second-guessing by the SBA.  Borrowers with loans of less than $2 million should take comfort in this new guidance.  PPP borrowers with loans of $2 million or more can avoid enforcement actions by repaying loans in the event of an audit.  However, because the funds will likely be spent prior to an audit, larger borrowers must still consider the prospect of a review of whether the loans were “necessary” and factor that into their spending plans.  These borrowers would also be well advised to document their company’s need for liquidity and the impact of Covid-19 on their industries in general.  As a final note, borrowers should be advised that the May 13 SBA guidance does not bind other federal agencies.

Like most estate planners, we always remind clients that tax and estate planning laws are subject to change and frequently do. As busy practitioners, it is impossible for us to reach out to every client when a change might affect him or her, so we remind all clients to come back to see us if they have questions or are concerned about how recent developments affect their plans (and in any event, at least every three to five years).

January 1, 2020 saw one such key change in the law—the implementation of the SECURE Act. The “Setting Every Community Up for Retirement Enhancement” Act made a number of changes to federal retirement program regulations, such as repealing the maximum age at which one can contribute to a traditional IRA and raising the required minimum distribution age from 70 ½ to 72. From an estate planning perspective, however, the biggest change was the partial elimination of what is often called “stretch” treatment for IRAs.

Before the SECURE Act, a person who inherited an IRA could base his or her annual distributions on his or her life expectancy. This allowed for continued tax-free growth and smaller annual distributions, reducing the likelihood of an IRA distribution raising one’s income tax bracket or a person outliving his or her inherited IRA. The SECURE Act eliminated this “stretch” treatment for all but four categories of beneficiaries. Spouses, individuals not more than 10 years younger than the plan owner, chronically ill or disabled individuals, and minor children of the plan participant are now the only beneficiaries allowed to use their life expectancies to determine their annual distributions.

In general, everyone else must distribute their entire inherited IRA over a period of 10 years, although they have complete flexibility to choose when to take distributions within the 10-year period. This change does not allow the IRA to function as an income stream for life, as many IRA owners would want for their successor beneficiaries; and if the IRA is large, this could move a beneficiary into a higher income tax bracket.

So, that’s the law, like it or not (and many do not like the new options). Many people have named their trusts as beneficiaries of their IRAs so that the trustee can elect lifetime treatment on behalf of beneficiaries. Before the SECURE Act, if the trust was drafted accordingly, it would function as what is commonly referred to as a “conduit” trust payable over the beneficiary’s life expectancy. Distributions would be immediately passed out to the beneficiary and taxed as income to the beneficiary (not the trust). This allowed trustors to know that a certain beneficiary would receive a certain benefit for life and avoided the IRA distribution being taxed as income to the trust (trusts often pay the highest rate of federal income tax). Relying on a conduit trust was preferable to naming the beneficiary directly on the IRA because in the latter case the beneficiary could choose to take a lump sum distribution, possibly contravening the decedent’s intent. Now, except for the four categories named above, relying on a conduit trust approach for a beneficiary’s lifetime stretch of an IRA is no longer an option.

For some, this will not be a catastrophe. It eliminates some attractive options, to be sure, but utilizing the conduit trust still allows a stretch of the retirement assets to the beneficiary over ten years (as opposed to the beneficiary taking a lump sum distribution, for example). However, some estate plans are specifically designed to hold retirement assets in trust because an individual beneficiary has serious health or addiction issues that would be significantly worsened if the person received a large sum of money. Other people know a beneficiary of theirs will never be able to support himself or herself or manage his or her own accounts, so they’ve set up what they believe is a lifelong trust to accomplish this on the beneficiary’s behalf. In these situations, having a conduit trust in one’s plan might result in what previously was expected to be a lifetime gift being paid over ten years instead. This really could be a catastrophe.

Fortunately, there are options. A different type of retirement trust called an “accumulation” trust can still hold IRA benefits for the life of a beneficiary, although there are generally less desirable tax consequences. What is right for your plan will depend on your unique situation, so if you have any concerns at all, you should reach out to your attorney for specific advice. The ramifications of the SECURE Act are complicated, and this post has merely highlighted one potential issue. An estate planning attorney, working in tandem with your CPA and/or financial advisor, will be able to help you maximize your retirement plan assets given the current law.

If your business received a Paycheck Protection Program (PPP) loan, now may be a good time to look at the new guidance from the Small Business Administration (SBA) to see whether the business should consider returning the money if the business did not really “need” it.  If, after considering the guidance, the business determines it does indeed need the loan, the business should ensure it has documentation demonstrating such need.

Background

On April 24, 2020, President Trump signed the Paycheck Protection Program and Health Care Enhancement Act.  This refilled the PPP with $320 billion.  The PPP is a forgivable loan program for “small” businesses.  The Small Business Administration (SBA) administers the PPP.  Earlier in April, a deluge of applications exhausted the PPP’s initial pool of $349 billion.

PPP loan applicants are required to certify that current “economic uncertainty makes this loan request necessary to support the ongoing operations of the Applicant.”  Civil and criminal penalties attach to such certifications if they are not accurate.  Many PPP loan applicants were therefore concerned about making such “necessity” certification.  The SBA has published PPP Frequently Asked Questions, which it is updating on a regular basis.  FAQ 31 addresses the “necessity” certification.  FAQ 39, following up on public comments by Treasury Secretary Steven Mnuchin, states that the SBA “will review all loans in excess of $2 million, in addition to other loans as appropriate, following the lender’s submission of the borrower’s loan forgiveness application.”

SBA Guidance

FAQ 31, published on April 23, provides guidance from the SBA regarding the “necessity” certification.

One of the most important things to take away from this guidance is that existing PPP borrowers that made the certification before FAQ 31 became available will be deemed to have made the necessity certification in good faith IF the borrower repays the PPP loan in full by May 18, 2020.*  In other words, if your business borrowed money under the PPP and you now determine in light of the new guidance that the “necessity” certification was questionable, the business can protect itself by paying back the loan before May 18.

How can a borrower determine whether it can make the “necessity” certification in good faith?  FAQ 31 essentially tells borrowers to ask themselves whether, in light of “their current business activity and their ability to access other sources of liquidity,” they can access enough liquidity “to support their ongoing operations in a manner that is not significantly detrimental to the business.”  FAQ 31 says that, for example, “it is unlikely that a public company with substantial market value and access to capital markets will be able to make the required certification in good faith, and such a company should be prepared to demonstrate to SBA, upon request, the basis for its certification.”  The preceding example does two things: (1) puts public companies on notice that they will be subject to scrutiny (for example, Shake Shack, which said it will return its PPP loan), and (2) highlights that documentation will be important in a borrower’s ability to justify its “necessity” certification.

Conclusion

FAQ 31 raises questions that are difficult for borrowers to answer without further clarification from the SBA or other authorities.  Exactly how much pain would a borrower need to sustain from getting non-PPP funding before it reaches the “significantly detrimental” threshold that justifies a PPP loan?  There is no bright-line or one-size-fits-all answer.

If a PPP borrower did not consider alternative sources of liquidity when submitting their PPP application, the borrower should now do so.  If funding is available from sources other than the PPP in a manner that is not significantly detrimental to the business, the business should consider returning all PPP loan proceeds before May 18 to avoid facing penalties based on an inaccurate “necessity” certification.  If the borrower concludes that the PPP loan was necessary, the borrower should have documentation supporting the business’s reasonable determination that accessing funding from such alternative sources would be significantly detrimental to the business.

Please note

*In FAQ 47, published May 13, 2020, the SBA stated that this deadline was being extended from May 14, 2020 (which was an extension of the original May 7 deadline) to May 18, 2020. The original post of this article contained the May 7 date.