ComplianceMay 04, 2020

Calculating the amount that can be borrowed from the CARES Act Paycheck Protection Program

Note: This is an updated version of an article previously published on April 14, 2020. It has been updated to take into account additional guidance promulgated by the SBA during the week ending April 24, 2020. Readers should note that the SBA continues to publish additional guidance. Moreover, it is possible other applicable rules could be changed by law. Readers should monitor developments and consider relevant guidance not discussed herein that is made available after the date of this updated article.

Background

On Friday, March 27th, 2020, the CARES Act (Pub. L. No. 116-136) was signed into law in response to the impact of the COVID-19 pandemic in the United States of America. One important aspect of the law is the Paycheck Protection Program (PPP) established by Section 1102 of the Act. The PPP initially included $349 billion of financial relief targeted to assist small businesses. On Tuesday, April 7th, 2020, it was reported that U.S. Treasury Secretary Steven Mnuchin was requesting an additional $250 billion of financial relief for the program. On April 24th, $310 billion of additional relief was authorized for the PPP. One week after the law was signed, the Treasury began releasing guidance for implementing the program, which continues to be updated, revised and expanded.

PPP loans are intended to cover certain payroll costs and other costs, such as interest on mortgages, rent under lease agreements and utilities (provided the related obligations or services began before February 15, 2020). PPP loans provide for a low rate of interest (one percent), an initial payment deferral for six months, a two-year term, are guaranteed by the U.S. Treasury, and can be forgiven in whole or in part if certain requirements are met.

Unless an exception applies, only businesses that employ 500 or fewer employees are eligible to borrow under the program. Eligible businesses are broadly defined as including not-for profits (including faith-based organizations), veterans' organizations, tribal businesses, sole proprietors, the self-employed, and independent contractors. A business can only take out one loan under the PPP (although a separate $10,000 Economic Injury Disaster Loan (EIDL) advance that does not need to be repaid may be available through a different program under Sec. 1110 of the CARES Act).

An eligible borrower can apply for a PPP loan from a bank, community bank, credit union or other program-approved lender. The lender, in turn, submits PPP applications from borrowers to the Small Business Administration (SBA, an agency of the U.S. government) for approval and guaranty under the PPP. Once approved, the lender disburses funds to the borrower. The borrower must begin paying back the loan starting six months after it is made, however, all or a portion of a loan can be forgiven if certain requirements are met (the process and requirements that must be satisfied in order for all or a portion of a borrower’s loan to be forgiven are not discussed here).

Given the economic consequences of the pandemic, many eligible borrowers are looking to borrow under the PPP, and there has been substantial press regarding the challenges and frustrations that they have faced in trying to obtain loans under the program. Lenders are also facing their own challenges in lending under the program.

There are several conditions that must be satisfied in order to borrow under the PPP. Confirming that all the conditions necessary to borrow under the PPP can be challenging and these conditions are not discussed here. Borrowers and lenders need to fully assess and take these requirements seriously because there is a risk of monetary and criminal penalties for not complying with regulatory requirements. Additional guidance regarding details of the PPP are frequently released, and borrowers and lenders should monitor for new developments.

This article focuses on calculating the amount that can be borrowed by a small business under the PPP. It is based on SBA guidance issued as of April 17, 2020 (see the special SBA website page) and is merely a general overview. On April 24th, the SBA issued guidance explaining how to calculate maximum loan amounts by business type (the SBA Amount Explanation, available here). Because borrowers began submitting loan applications as soon as the PPP was initiated and guidance has been released on several occasions since then, borrowers and lenders may question whether amounts should be recalculated and loans should be resubmitted based on guidance issued subsequent to loan application submission. On April 25th, the SBA clarified that such applications submitted prior to subsequent guidance “do not require re-calculation.”

Calculators available from third parties may also enhance understanding and application of the rules. A borrower should always consult with their own legal advisor and check for new or updated guidance.

General rule

The maximum amount that can be borrowed under the PPP is the lower of $10 million or 2.5 times the business’s average monthly payroll costs plus any EIDL loan refinanced (but excluding the amount of any EIDL advance that does not need to be repaid). For many small businesses, the PPP loan amount will likely be limited to 2.5 times the business’s average monthly payroll costs. The law includes specific rules that certain amounts cannot be included as part of average monthly payroll costs and the SBA has issued additional guidance clarifying some important details of this computation. These important details are summarized below.

Overview of includible and excludible payroll costs

The CARES Act provides important details regarding what is included and what is excluded in computing payroll costs. The Act provides that payroll costs include: 1) salaries, wages, commissions, or similar compensation; 2) payments of cash tips or equivalents; 3) payments for vacation, parental, family medical or sick leave; 4) allowances for dismissal or separation; 5) payments required for group health care benefits including any insurance premiums; 6) payments of retirement benefits; 7) state or local taxes assessed on employees’ compensation; and 8) the sum of payments of any compensation of a sole proprietor or independent contractor that is a wage, commission, income, net earnings from self-employment or similar compensation that is in an amount not in excess of $100,000 for the year.

For computing eligible payroll costs, the CARES Act excludes:

  1. the compensation of any employee in excess of $100,000 for the year;
  2. imposed or withheld federal income taxes (under IRC Chapters 21, 22 & 24);
  3. any compensation for an employee whose principal residence is outside the U.S.;
  4. qualified sick leave wages for which a credit is allowed under Section 7001 of the Families First Coronavirus Response Act (Pub. L. No. 116-27, the Families First Coronavirus Response Act); or
  5. qualified family leave wages for which a credit is allowed under Section 7003 of the Families First Coronavirus Response Act.

However, questions have been raised regarding these inclusions and exclusions. Several documents on the SBA PPP website provide important clarifications. Many of these clarifications are provided below.

Excluding wages exceeding $100,000

Because the CARES Act excludes wages exceeding $100,000 in the calculation of average monthly payroll costs, it was initially unclear whether non-cash benefits received by those employees with wages exceeding $100,000 would also be excluded. The SBA PPP FAQ updated as of April 15th, 2020 (SBA PPP FAQ) clarifies that the answer was no:

The exclusion of compensation in excess of $100,000 annually applies only to cash compensation, not to non-cash benefits, including:

  • employer contributions to defined-benefit or defined-contribution retirement plans;
  • payment for the provision of employee benefits consisting of group health care coverage, including insurance premiums; and
  • payment of state and local taxes assessed on compensation of employees.

Excluding independent contractors

The SBA PPP FAQ also clarifies that compensation paid to independent contractors and sole proprietors is not includible in calculating average monthly payroll costs. This clarification has been controversial and widely criticized because many small businesses consider such compensation as equivalent to payroll. However, the justification for the exclusion of such compensation is that independent contractors and sole proprietors can themselves borrow from the PPP and that without this exclusion there would be double-borrowing (by both the small business that pays such contractors and proprietors, and by the independent contractors and sole proprietors themselves).

Franchisees, hotels and restaurants

As noted above, although there are limited exceptions, only businesses that employ 500 or fewer employees are eligible to borrow under the program. Importantly, this restriction does not apply to businesses with an NAICS code of 72 (which includes hotels and restaurants). And, the absolute maximum amount that can be borrowed for a single business entity under the PPP is $10 million.

There are several important and somewhat intertwined questions regarding how these two limitations impact small businesses that are franchises or franchisees or restaurants, hotels or other NAICS Code 72 businesses. The SBA PPP FAQ was updated on April 14th, 2020 to address some of the relevant questions.

In the case of franchisees, the SBA PPP FAQ clarifies that “[i]f a franchise brand is listed on the SBA Franchise Directory, each of its franchisees that meets the applicable size standard can apply for a PPP loan.” The FAQ further provides that “[t]he $10 million cap on PPP loans is a limit per franchisee entity, and each franchisee is limited to one PPP loan.”

Special considerations for franchise brands or franchisors are not generally addressed here. However, because many restaurants and hotels are franchised with multiple business locations, it is important to be aware that the SBA PPP FAQ provides additional guidance for businesses with an NAICS code of 72 (which include hotels and restaurants). There can also be additional complexities because both franchised and non-franchised hotels or restaurants (or other NAICS Code 72 businesses) may have multiple business locations. And many hotels or restaurant chains that are franchisors may also have affiliated but separate businesses that are in related or unrelated industries such as construction which could be subject to the general 500 employee limitation applicable under the PPP.

The SBA PPP FAQ also includes three examples that provide additional clarifications that are important for such businesses. Here are some highlights of these clarifications:

  1. The $10 million dollar loan limit applies at a single business entity level for those businesses (such as hotels and restaurants) with an NAICS code of 72 provided that it has no more than 500 employees per physical location.
  2. A hotel or restaurant business (or other business with an NAICS code of 72) is subject to the $10 million dollar loan limit but another affiliated business entity that is also a hotel or restaurant could separately qualify for its own PPP loan because the affiliation rules do not apply to either of the affiliated businesses. That separate business entity would also be subject to the 500 employee limit in determining whether such related business entity could borrow under the PPP and the amount it could borrow.
  3. If a hotel or restaurant business is affiliated with another business that is not a hotel or restaurant and does not classify as a business with an NAICS code of 72, the consequences of affiliation apply to the other business. Because of affiliation, the other business could be considered as having more than 500 employees. A business entity that does not have an NAICS code of 72, even if it is affiliated with other business entities and has more than 500 employees, might nevertheless be eligible for a PPP loan provided the business satisfies the existing legal definition of a “small business concern” under section 3 of the Small Business Act.

Special guidance for sole proprietors

On April 14th, 2020 the SBA promulgated an interim final rule setting forth additional eligibility criteria and requirements for certain pledges of loans (SBA PPP Additional Guidance). The SBA PPP Additional Guidance includes some additional requirements applicable to small businesses that are sole proprietorships. The SBA website includes a definition of a sole proprietorship as “…an unincorporated business owned and run by one individual with no distinction between the business and you, the owner.” A sole proprietor typically reports business income on Schedule C of his or her U.S. federal income tax return (IRS Form 1040).

The SBA PPP Additional Guidance sets forth four requirements that must be met in order for a sole proprietor who reports business income on Schedule C of his or her tax return:

  1. the business was in operation on February 15, 2020;
  2. the sole proprietor is an individual with self-employment income (such as an independent contractor or a sole proprietor);
  3. the sole proprietor’s principal place of residence is in the United States; and
  4. the sole proprietor filed or will file a Form 1040 Schedule C for 2019.

The SBA PPP Additional Guidance indicates that the SBA intends to issue additional guidance for “individuals with self-employment income who: (i) were not in operation in 2019 but who were in operation on February 15, 2020 and (ii) will file a Form 1040 Schedule C for 2020.”

The eligibility rules discussed above do not apply regarding partners and partnerships and there has been some related criticism by legal commentators. The SBA PPP Additional Guidance relating to partners and partnerships is discussed in the next section below.

The SBA PPP Additional Guidance also cautions sole proprietors that “participation in the PPP may affect your eligibility for state administered unemployment compensation or unemployment assistance programs, including the programs authorized by Title II, Subtitle A of the CARES Act, or CARES Act Employee Retention Credits.”

The amount a sole proprietor can borrow depends in part on whether the sole proprietor employs other individuals. If not, the SBA PPP Additional Guidance sets forth four steps that must be taken to determine the amount that can be borrowed:

Step 1: Go to 2019 IRS Form 1040 Schedule C line 31 to determine the sole proprietorship net profit amount (if a 2019 return has not been filed, fill it out and compute the value). If this amount is over $100,000, reduce it to $100,000. If this amount is zero or less, applicant is not eligible for a PPP loan.

Step 2: Calculate the average monthly net profit amount (divide the amount from Step 1 by 12).

Step 3: Multiply the average monthly net profit amount from Step 2 by 2.5.

Step 4: Add the outstanding amount of any EIDL made between January 31, 2020 and April 3, 2020 that the applicant seeks to refinance, less the amount of any advance under an EIDL COVID-19 loan (because it does not have to be repaid).

If a sole proprietor employs other individuals, the SBA PPP Additional Guidance sets forth the following steps that must be taken to determine the amount the sole proprietor can borrow under the PPP:

Step 1: Compute 2019 payroll by adding the following:

a. The sole proprietor’s 2019 Form 1040 Schedule C line 31 net profit amount (if the sole proprietor has not yet filed a 2019 return, he or she must fill it out and compute the value), up to $100,000 annualized, if this amount is over $100,000, reduce it to $100,000, if this amount is less than zero, set this amount at zero;

b. 2019 gross wages and tips paid to the sole proprietorship’s employees whose principal place of residence is in the United States computed using 2019 IRS Form 941 Taxable Medicare wages & tips (line 5c- column 1) from each quarter plus any pre-tax employee contributions for health insurance or other fringe benefits excluded from Taxable Medicare wages & tips; subtract any amounts paid to any individual employee in excess of $100,000 annualized and any amounts paid to any employee whose principal place of residence is outside the United States; and

c. 2019 employer health insurance contributions (health insurance component of Form 1040 Schedule C line 14), retirement contributions (Form 1040 Schedule C line 19), and state and local taxes assessed on the sole proprietorship’s employee compensation (primarily under state laws commonly referred to as the State Unemployment Tax Act or SUTA from state quarterly wage reporting forms).

Step 2: Calculate the average monthly amount (divide the amount from Step 1 by 12).

Step 3: Multiply the average monthly amount from Step 2 by 2.5.

Step 4: Add the outstanding amount of any EIDL made between January 31, 2020 and April 3, 2020 that the sole proprietorship seeks to refinance, less the amount of any advance under an EIDL COVID-19 loan (because it does not have to be repaid).

Special additional documentation requirements for sole proprietors

The SBA PPP Additional Guidance includes specific additional loan documentation requirements that sole proprietors must satisfy.

If a sole proprietor does not have employees, he or she must provide the business’s:

  1. 2019 Form 1040 Schedule C (regardless of whether a 2019 Form 1040 was filed) with the PPP loan application to substantiate the applied-for PPP loan amount; and
  2. a 2019 IRS Form 1099-MISC detailing nonemployee compensation received (box 7), invoice, bank statement, or book of record that establishes self-employment. The sole proprietor must also provide a 2020 invoice, bank statement, or book of record to establish that the business was in operation on or around February 15, 2020.

If a sole proprietor has employees, there are different documentation requirements. He or she must provide:

  1. a 2019 Form 1040 Schedule C for the business;
  2. IRS Form 941 (or other tax forms equivalent payroll processor records containing similar information);
  3. state quarterly wage unemployment insurance tax reporting forms from each quarter in 2019 or equivalent payroll processor records; and
  4. evidence of any retirement and health insurance contributions (if applicable).

The SBA PPP Additional Guidance also requires submission of a payroll statement or similar documentation from the pay period that covered February 15, 2020 must be provided to establish that the business was in operation on February 15, 2020.

The SBA Amount Explanation also provides guidance for self-employed farmers who report their net farm profit on IRS Form 1040 Schedule 1 and Schedule F. Those individuals should use Schedule F line 34 net farm profit in lieu of Schedule C net profit but the computation is otherwise essentially the same. The farmer’s 2019 IRS Form 1040 Schedule 1 and Schedule F must be included with the loan application.

Special rules and restrictions on the use of PPP loans applicable to sole proprietors

The SBA PPP Additional Guidance also includes the following specific rules and restrictions on how a sole proprietor can use PPP loan proceeds:

  1. Owner compensation replacement, calculated based on 2019 net profit as described earlier in this section;
  2. Employee payroll costs (but excluding certain types of costs as described in an earlier section set forth above);
  3. The following qualifying expenses:
  4. Mortgage interest (but not prepayments or principal) payments on any business mortgage obligation on real or personal property (such as interest on a business warehouse or business vehicle loan);
  5. Business rent payments; and
  6. Business utility payments.

Note that such amounts must be expenses that the sole proprietor claimed or could have claimed as a business deduction on the 2019 Form 1040 Schedule C for the business during the eight-week period following the first disbursement of the loan (the “covered period”). The SBA PPP Additional Guidance also provides that if a sole proprietor was not entitled to claim utilities expenses on his or her 2019 Form 1040 Schedule C, that he or she “cannot use the proceeds for utilities during the covered period.”

  1. Interest payments on any other debt obligations incurred before February 15, 2020 (such amounts are not eligible for PPP loan forgiveness); and
  2. Refinancing an SBA EIDL loan made between January 31, 2020 and April 3, 2020 (maturity will be reset to PPP’s maturity of two years). If a sole proprietor received an SBA EIDL loan from January 31, 2020 through April 3, 2020, he or she can apply for a PPP loan. If the small business’s EIDL loan was not used for payroll costs, it does not adversely affect a small business’s eligibility for a PPP loan. If a business’s EIDL loan was used for payroll costs, its PPP loan must be used to refinance its EIDL loan. Proceeds from any advance up to $10,000 on the EIDL loan will be deducted from the loan forgiveness amount on the PPP loan.

The SBA PPP Additional Guidance also provides that the SBA has also determined that:

[S]elf-employed individuals will need to rely on their 2019 Form 1040 Schedule C, which provides verifiable documentation on expenses between January 1, 2019 and December 31, 2019. For individuals with income from self-employment from 2019 for which they have filed or will file a 2019 Form 1040 Schedule C, expenses incurred between January 1, 2020 and February 14, 2020 may not be considered because of the lack of verifiable documentation on expenses in this period.

Guidance for partners and partnerships

The SBA PPP Additional Guidance also includes specific rules relating to partners and partnerships. It provides in part that:

[I]f you are a partner in a partnership, you may not submit a separate PPP loan application for yourself as a self-employed individual. Instead, the self-employment income of general active partners may be reported as a payroll cost, up to $100,000 annualized, on a PPP loan application filed by or on behalf of the partnership.

The SBA PPP Additional Guidance indicates that partnerships, rather than their partners should be the persons applying for PPP loans “to help ensure that as many eligible borrowers as possible obtain PPP loans before the statutory deadline of June 30, 2020” because this approach “will allow lenders to more quickly process applications and lower the burdens of applying for partnerships/partners.” The guidance also indicates “that permitting partners to apply as self-employed individuals would create unnecessary confusion regarding which entity, the partner or the partnership, applies for partner and LLC member income, and would generate loan proceeds use coordination and allocation issues.” It also notes that business expenses such as “[r]ent, mortgage interest, utilities, and other debt service are generally incurred at the partnership level, not partner level, so it is most natural to provide the funds for these expenses to the partnership, not individual partners.”

This approach is very different from the substantive federal income tax treatment of partners and partnerships (because those tax rules provide that for tax reporting by the partners rather than their partner in many cases).

Businesses that are organized as entities such as partnerships or limited liability companies (LLCs) as opposed to corporations have complexities relating to amounts paid to owners. It must be considered whether amounts paid to owners are for services for business conducted by the entity or are distributions of profits to owners. There are special federal income tax rules relating to such payments and the determinations of which amounts paid are services-related versus profits-related can be complex and uncertain. Compensation for such services by owners paid out as dividends or distributions may not neatly fit into one of the specified categories of items included in average monthly payroll costs. However, as indicated above the SBA PPP Additional Guidance provides that “the self-employment income of general active partners may be reported as a payroll cost, up to $100,000 annualized, on a PPP loan application filed by or on behalf of the partnership.” The good news is that such self-employment income is already regularly calculated and reported for federal income tax purposes. But this guidance may be criticized by partners and their advisors as prohibiting the inclusion of amounts as payroll that should be included. A PPP loan applicant may attempt to include partnership-related income in excess of the amount of self-employment income reported for federal income tax purposes. The SBA’s approach does make it easier for a lender to review the amount included as payroll because it should be reconcilable with the partnership’s federal income tax return. Because of the complexities, uncertainties, and conceptual differences, as well as a loan applicant’s possible desire to maximize the amount that can be borrowed under the PPP, additional questions or challenges seem likely and potential borrowers should monitor developments.

The SBA Amount Explanation summarizes a partnership’s calculation of the maximum amount that can be borrowed under the PPP as follows:

  • Step 1: Compute 2019 payroll costs by adding the following:
    • a. 2019 Schedule K-1 (IRS Form 1065) Net earnings from self-employment of individual U.S. based general partners that are subject to self-employment tax, computed from box 14a (reduced by any section 179 expense deduction claimed, unreimbursed partnership expenses claimed, and depletion claimed on oil and gas properties) multiplied by 0.9235 (this multiplication adjustment essentially removes the “employer” share of self-employment tax, consistent with how payroll costs for employees in the partnership are determined) up to $100,000 per partner (if 2019 schedules have not been filed, fill them out);
    • b. 2019 gross wages and tips paid to your employees whose principal place of residence is in the United States, if any, which can be computed using 2019 IRS Form 941 Taxable Medicare wages & tips (line 5c-column 1) from each quarter plus any pre-tax employee contributions for health insurance or other fringe benefits excluded from Taxable Medicare wages & tips, subtracting any amounts paid to any individual employee in excess of $100,000 and any amounts paid to any employee whose principal place of residence is outside the U.S;
    • c. 2019 employer contributions for employee health insurance, if any (portion of IRS Form 1065 line 19 attributable to health insurance);
    • d. 2019 employer contributions to employee retirement plans, if any (IRS Form 1065 line 18); and
    • e. 2019 employer state and local taxes assessed on employee compensation, primarily state unemployment insurance tax (from state quarterly wage reporting forms), if any.
  • Step 2: Calculate the average monthly payroll costs (divide the amount from Step 1 by 12).
  • Step 3: Multiply the average monthly payroll costs from Step 2 by 2.5.
  • Step 4: Add any outstanding amount of any EIDL made between January 31, 2020 and April 3, 2020 that the small business seeks to refinance, less the amount of any advance under an EIDL COVID-19 loan (because it does not have to be repaid).

Required documentation for a PPP loan to a partnership pursuant to the SBA Amount Explanation includes:

  • 1. The partnership’s 2019 IRS Form 1065 (including K-1s); and
  • 2. Other relevant supporting documentation if the partnership has employees, including:
    • a. the 2019 IRS Form 941 and state quarterly wage unemployment insurance tax reporting form from each quarter (or equivalent payroll processor records or IRS Wage and Tax Statements);
    • b. the records of any retirement or health insurance contributions, must be provided to substantiate the applied-for PPP loan amount.

The SBA Amount Explanation also provides that: if the partnership has employees, a payroll statement or similar documentation from the pay period that covered February 15, 2020 must be provided to establish the partnership was in operation and had employees on that date; or, if the partnership has no employees, an invoice, bank statement, or book of record establishing the partnership was in operation on February 15, 2020 must instead be provided.

The SBA Amount Explanation also sets forth the computation of the maximum amount that an eligible S Corporation or C Corporation can borrow under the PPP:

  • Step 1: Compute 2019 payroll costs by adding the following:
    • a. 2019 gross wages and tips paid to your employees whose principal place of residence is in the United States, which can be computed using 2019 IRS Form 941 Taxable Medicare wages & tips (line 5c-column 1) from each quarter plus any pre-tax employee contributions for health insurance or other fringe benefits excluded from Taxable Medicare wages & tips, subtracting any amounts paid to any individual employee in excess of $100,000 and any amounts paid to any employee whose principal place of residence is outside the U.S;
    • b. 2019 employer health insurance contributions (portion of IRS Form 1120 line 24 or IRS Form 1120-S line 18 attributable to health insurance);
    • c. 2019 employer retirement contributions (IRS Form 1120 line 23 or IRS Form 1120-S line 17); and
    • d. 2019 employer state and local taxes assessed on employee compensation, primarily state unemployment insurance tax (from state quarterly wage reporting forms).
  • Step 2: Calculate the average monthly payroll costs (divide the amount from Step 1 by 12).
  • Step 3: Multiply the average monthly payroll costs from Step 2 by 2.5.
  • Step 4: Add the outstanding amount of any EIDL made between January 31, 2020 and April 3, 2020 that the small business seeks to refinance, less the amount of any advance under an EIDL COVID-19 loan (because it does not have to be repaid).

The SBA Amount Explanation provides that the following documentation must be submitted by the borrower with the loan application: 1) the corporation’s 2019 IRS Form 941 and state quarterly wage unemployment insurance tax reporting form from each quarter (or equivalent payroll processor records or IRS Wage and Tax Statements), along with the filed business tax return (IRS Form 1120 or IRS 1120-S) or other documentation of any retirement and health insurance contributions, must be provided to substantiate the applied-for PPP loan amount; and 2) a payroll statement or similar documentation from the pay period that covered February 15, 2020 must be provided to establish that the small business was in operation and had employees on that date.

In the case of a small business organized as a limited liability company (LLC), the applicable calculations and related documentation will depend on the LLC’s federal income tax classification as a sole proprietorship, partnership, or corporation.

Inclusion of wages to clergy and other faith-based organization staff

The SBA issued a Faith-Based Organizations FAQ dated April 3, 2020 (Faith-Based Organizations FAQ), clarifying that faith-based organizations can borrow under the PPP (and the EIDL program). Importantly, it makes it clear that “[c]hurches (including temples, mosques, synagogues, and other houses of worship), integrated auxiliaries of churches, and conventions or associations of churches qualify for PPP and EIDL loans as long as they meet the requirements of Section 501(c)(3) of the Internal Revenue Code, and all other PPP and EIDL requirements” and that a letter from the IRS confirming tax-exempt status is not required. The Faith-Based Organizations FAQ also makes it clear that “loans under the program can be used to pay the salaries of ministers and other staff engaged in the religious mission of institutions.”

An important issue for faith-based organizations is whether a connection to other related religious organizations is considered “affiliation” that could cause such organizations to have more than 500 employees. Fortunately, as the Faith-Based Organizations FAQ indicates, interim guidance has clarified that “if your faith-based organization affiliates with another organization because of your organization’s religious beliefs about church authority or internal constitution, or because the legal, financial, or other structural relationships between your organization and other organizations reflect an expression of such beliefs, your organization would qualify for the exemption.” However, affiliation could be a problem if a “faith-based organization is affiliated with other organizations solely for non-religious reasons, such as administrative convenience.” The Faith-Based Organizations FAQ indicates that faith-based organizations should attach a special addendum (a sample of which was provided with the FAQ) to their PPP loan applications that addresses affiliation.

Faith-based organizations likely have other concerns and should review the Faith-Based Organizations FAQ.

The SBA Amount Explanation provides separate guidance in computing the maximum amount that can be borrowed under the PPP by both nonreligious and religious not for profit organizations. Here is the guidance for nonreligious not for profit organizations:

  • Step 1: Compute 2019 payroll costs by adding the following:
    • a. 2019 gross wages and tips paid to your employees whose principal place of residence is in the United States, which can be computed using 2019 IRS Form 941 Taxable Medicare wages & tips (line 5c-column 1) from each quarter plus any pre-tax employee contributions for health insurance or other fringe benefits excluded from Taxable Medicare wages & tips, subtracting any amounts paid to any individual employee in excess of $100,000 and any amounts paid to any employee whose principal place of residence is outside the U.S;
    • b. 2019 employer health insurance contributions (generally, the portion of IRS Form 990 Part IX line 9 attributable to health insurance);
    • c. 2019 employer retirement contributions (generally, IRS Form 990 Part IX line 8); and
    • d. 2019 employer state and local taxes assessed on employee compensation, primarily state unemployment insurance tax (from state quarterly wage reporting forms).
  • Step 2: Calculate the average monthly payroll costs (divide the amount from Step 1 by 12).
  • Step 3: Multiply the average monthly payroll costs from Step 2 by 2.5.
  • Step 4: Add the outstanding amount of any EIDL made between January 31, 2020 and April 3, 2020 that the small business seeks to refinance, less the amount of any advance under an EIDL COVID-19 loan (because it does not have to be repaid).

For required loan documentation, the SBA Amount Explanation specifies that the following items should be provided: 1) a nonprofit organization’s 2019 IRS Form 941 and state quarterly wage unemployment insurance tax reporting form from each quarter (or equivalent payroll processor records or IRS Wage and Tax Statements), along 2) with the filed IRS Form 990 Part IX or other documentation of any retirement and health insurance contributions, must be provided to substantiate the applied-for PPP loan amount. In addition, a payroll statement or similar documentation from the pay period that covered February 15, 2020 must be provided to establish that the small business was in operation and had employees on that date.

And here is the guidance set forth in the SBA Amount Explanation for religious not for profit organizations, veterans' organizations and tribal businesses:

  • Step 1: Compute 2019 payroll costs by adding the following:
    • a. 2019 gross wages and tips paid to your employees whose principal place of residence is in the United States, which can be computed using 2019 IRS Form 941 Taxable Medicare wages & tips (line 5c-column 1) from each quarter plus any pre-tax employee contributions for health insurance or other fringe benefits excluded from Taxable Medicare wages & tips, subtracting any amounts paid to any individual employee in excess of $100,000 and any amounts paid to any employee whose principal place of residence is outside the U.S;
    • b. 2019 employer health insurance contributions;
    • c. 2019 employer retirement contributions and
    • d. 2019 employer state and local taxes assessed on employee compensation, primarily state unemployment insurance tax (from state quarterly wage reporting forms).
  • Step 2: Calculate the average monthly payroll costs (divide the amount from Step 1 by 12). Step 3: Multiply the average monthly payroll costs from Step 2 by 2.5.
  • Step 4: Add any outstanding amount of any EIDL made between January 31, 2020 and April 3, 2020 that the small business seeks to refinance, less the amount of any advance under an EIDL COVID-19 loan (because it does not have to be repaid).

The SBA Amount Explanation provides that nonprofit religious institutions, veterans' organizations, tribal businesses, and eligible nonprofits that do not file an IRS Form 990 (typically those with gross receipts less than $50,000), do not have to refer to or provide IRS Form 990 Part IX. However, the following related documentation must be provided: 1) the entity’s 2019 IRS Form 941 and state quarterly wage unemployment insurance tax reporting form from each quarter (or equivalent payroll processor records or IRS Wage and Tax Statements), along with documentation of any retirement and health insurance contributions and 2) a payroll statement or similar documentation from the pay period that covered February 15, 2020 must be provided to establish that the small business was in operation and had employees on that date.

Excluding federal income taxes withheld

The SBA PPP FAQ clarifies that “payroll costs are calculated on a gross basis without regard to (i.e., not including subtractions or additions based on) federal taxes imposed or withheld, such as the employee’s and employer’s share of Federal Insurance Contributions Act (FICA) and income taxes required to be withheld from employees.” This is a “good news/bad news” answer. The good news is that by including gross payroll costs, taxes withheld are effectively included in the calculation of how much money can be borrowed. The bad news is that the employer’s share of federal payroll taxes (FICA) is also not included in the calculation.

Note that state and local employer payroll taxes are includible.

Excluding qualifying wages for COVID-19 related credits

Tax credits are allowed under the Families First Coronavirus Response Act for qualified sick leave and qualified family leave wages. Tax credits have a significant economic value because a tax credit offsets taxes that are based on only a percentage of income. However, wages taken into account to obtain such tax credits must be excluded from the average monthly payroll costs computation for determining the maximum amount that can be borrowed. A business should consider whether it would be appropriate to exclude wages that may be eligible for tax credits in cases where eligibility for the tax credit is readily determinable. Unfortunately, it may not be possible at the time a PPP loan is submitted to know whether some payroll costs include additional wages that may be eligible. Some commentators have noted this problem, but additional guidance is needed.

Relevant period for measuring average payroll costs

The SBA PPP FAQ provides:

In general, borrowers can calculate their aggregate payroll costs using data either from the previous 12 months or from calendar year 2019. For seasonal businesses, the applicant may use average monthly payroll for the period between February 15, 2019, or March 1, 2019, and June 30, 2019. An applicant that was not in business from February 15, 2019 to June 30, 2019 may use the average monthly payroll costs for the period January 1, 2020 through February 29, 2020.

Borrowers may use their average employment over the same time periods to determine their number of employees, for the purposes of applying an employee-based size standard. Alternatively, borrowers may elect to use SBA’s usual calculation: the average number of employees per pay period in the 12 completed calendar months prior to the date of the loan application (or the average number of employees for each of the pay periods that the business has been operational, if it has not been operational for 12 months).

Seasonal businesses

As noted above, the SBA PPP FAQ provided that seasonal businesses can use the average monthly payroll for the period between February 15, 2019, or March 1, 2019, and June 30, 2019. In addition, the FAQ indicates that a seasonal business may question whether it is eligible to borrow under the PPP if it “was not fully ramped up on February 15, 2020.” Fortunately, the SBA PPP FAQ provides that “a lender may consider whether a seasonal borrower was in operation on February 15, 2020 or for an 8-week period between February 15, 2019 and June 30, 2019.” On April 27, 2020, the SBA issued an interim final rule setting forth additional criteria for seasonal employers. This rule provides more flexibility than the FAQ, indicating that “a seasonal employer may alternatively elect to determine its maximum loan amount as the average total monthly payments for payroll during any consecutive 12-week period between May 1, 2019 and September 15, 2019.” The rule provides additional flexibility in determining whether a seasonal business is eligible for a PPP loan by providing that “a seasonal business will be considered to have been in operation as of February 15, 2020, if the business was in operation for any 8-week period between May 1, 2019 and September 15, 2019.”

Documentation

The SBA PPP FAQ makes it clear that attestation and documentation for calculating the average monthly payroll costs used to determine the amount of the loan are the responsibility of the borrower and limits the obligation of a lender to review the calculation and related documentation:

Lenders are expected to perform a good faith review, in a reasonable time, of the borrower’s calculations and supporting documents concerning average monthly payroll cost. For example, minimal review of calculations based on a payroll report by a recognized third-party payroll processor would be reasonable. In addition, as the PPP Interim Final Rule indicates, lenders may rely on borrower representations, including with respect to amounts required to be excluded from payroll costs.

Given the risk of fraud, lenders should carefully consider the likelihood that the documentation submitted by borrowers and the nature of the related review by lenders will be scrutinized by regulators. Moreover, lenders and borrowers must consider the additional documentation requirements included in the SBA PPP Additional Guidance as summarized above relating to PPP loans to sole proprietors.

The SBA PPP FAQ was updated on April 14th, 2020 to make it clear that a lender must have received and reviewed documentation and the borrower’s calculation of the amount that can be borrowed before the loan application is submitted to the SBA:

Before a lender submits a PPP loan through E-Tran, the lender must have collected the information and certifications contained in the Borrower Application Form and the lender must have fulfilled its obligations set forth in paragraphs 3.b.(i)-(iii) of the PPP Interim Final Rule. [Lenders should] … refer to the Interim Final Rule and FAQ 1 for more information on the lender’s responsibility regarding confirmation of payroll costs.

Lenders who did not understand that these steps are required before submission to E-Tran need not withdraw applications submitted to E-Tran before April 14, 2020, but, must fulfill lender responsibilities with respect to those applications as soon as practicable and no later than loan closing.

Electronic and wet signatures, and scanned documents

On April 15th, 2020 an additional revision to the SBA PPP FAQ added generally favorable guidance relating to electronic and “wet” signatures, and scanned documents:

All PPP lenders may accept scanned copies of signed loan applications and documents containing the information and certifications required by SBA Form 2483 and the promissory note used for the PPP loan. Additionally, lenders may also accept any form of E-consent or E-signature that complies with the requirements of the Electronic Signatures in Global and National Commerce Act (P.L. 106-229).

If electronic signatures are not feasible, when obtaining a wet ink signature without in-person contact, lenders should take appropriate steps to ensure the proper party has executed the document.

Note, however, the SBA PPP FAQ guidance clarifies that it does not necessarily give a lender carte blanche:

This guidance does not supersede signature requirements imposed by other applicable law, including by the lender’s primary federal regulator.

Accordingly, lenders must consider whether there are other signature requirements imposed by law that may inhibit such lender’s ability to accept a wet ink or electronic signature.

Conclusion

Many of the details needed by a borrower to compute average monthly payroll costs and determine the maximum amount that can be borrowed under the PPP have been addressed by the SBA. It is extraordinary and commendable that the SBA has issued important clarifications within only two weeks of the enactment of the CARES Act, having worked along with lenders around the clock to implement the program.

However, many borrowers remain frustrated with challenges in borrowing money under the PPP. It is still necessary to exclude cash compensation in excess of $100,000 per employee as well as the compensation of employees whose principal residence is outside the U.S. And although the employer’s share of state and local payroll taxes is includible in the computation, the employer’s share of federal payroll taxes is clearly excluded. Clarification is still needed to address the extent to which compensation to owners who also perform services can be included. Additionally, even though the exclusion of payments to independent contractors and sole proprietors from payroll costs makes sense to avoid double counting, this rule will likely be confusing and frustrating to many small businesses.

The Covid-19 pandemic has been challenging on a global scale and the CARES Act was enacted to in part address its impact in the U.S. Hopefully, U.S. small businesses and individuals will be able to reap the benefits of the Act’s PPP and obtain desperately needed funds during these difficult times.

DISCLAIMER: The information and views set forth in this Wolters Kluwer Financial Services’ communication are general in nature and are not intended as legal or professional advice. Although based on the law and information available as of the date of publication, general assumptions have been made by Wolters Kluwer Financial Services that may not take into account potentially important considerations to specific businesses. Therefore, the views and information presented in this Wolters Kluwer Financial Services’ communication may not be appropriate for you. Readers must also independently analyze and consider the consequences of subsequent developments and/or other events. Readers must always make their own determinations in light of their specific circumstances.

Stevie Conlon
Vice President, Tax & Regulatory Counsel: Investment Compliance; U.S. Advisory Services

Stevie D. Conlon, vice president, tax and regulatory counsel for Wolters Kluwer leads the firm’s U.S. Advisory Services group and Investment Compliance Solutions.


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