Congress passed the CARES Act and signed into law on March 27th, 2020 as a Phase 3 recovery package for assisting businesses and individuals impacted by the economic fallout of the novel coronavirus, also known as COVID-19. For small businesses, which the act defines as businesses with less than 500 employees, there were three primary avenues of relief: 1) a Small Business Administration (SBA) backed “loan” dubbed the Paycheck Protection Program (PPP), 2) expansion of Economic Injury Disaster Loans (EIDLs) granted by the SBA, and 3) a deferral of the employer’s portion of the social security payroll tax deferral. The government has a habit of making things overly complicated; for the “too long; didn’t read” version of this post and what you should do for your business there’s three summary bullets at the end and a quick flowchart.
Background on the Paycheck Protection Program (PPP) Loan
The Paycheck Protection Program (PPP) loan is the most substantial program in the CARES Act for providing direct bottom line relief to small businesses. $349B was set aside for the SBA to make these special loans to businesses with less than 500 employees. As of today, all of the $349B has already been reported to be spoken for, but Congress and the White House stated they will push for additional funding so all eligible businesses may participate (Update: An addittional $310B was made available on April 27th, 2020). This SBA loan is not like the typical 7(a) SBA loan. It is forgivable if paid employee hours are kept at previous levels 8 weeks after the loan’s origination date and salaries do not drop in excess of 25%. The loan is forgivable. No guarantees/collateral. No marks on credit. No expectation to pay the forgivable portion. It’s less a loan and more the government giving cash to small businesses to keep people employed. It is the most substantial portion of the CARES Act for providing direct bottom line relief to small businesses. Banks started accepting applications for companies on April 3rd and self-employed individuals could start applying on April 11th. Key details:
- Loan can be taken up to 2.5x monthly payroll costs as averaged across the previous 12 months from the date the loan is originated (e.g., if monthly payroll was $100k, the loan can be up to $250k). The loan can’t exceed $10M.
- Payroll costs include wages (excluding any compensation above $100k/year), health benefits, and retirements benefits. Payroll taxes (social security/Medicare, also known as FICA) is excluded.
- Proceeds from the loan can only be used to pay for payroll costs, rent/mortgage, and utilities.
- The loan requires zero personal guarantee/zero collateral and is nonrecourse, unless loan proceeds are used for items not listed in 3) above.
- Requires a good faith certification that a) uncertainty of current conditions makes the loan necessary (e.g., decrease in revenues), and b) loan proceeds go to the items listed in 3) above.
- There is a “covered” period for the loan that starts when the loan is originated and extends for 8 weeks.
- The principal of the loan will be “forgiven” up to the amount of payments during the covered period (8 weeks) towards payroll costs, rent/mortgage, and utilities such as electricity, water, gas, phone, and internet (not to exceed the amount of the loan).
- The amount forgiven will reduce if average full-time equivalent employees (FTE, 1 FTE = 40 paid hours/week) during the 8 week covered period are less than the average FTEs during 2/15/19 – 6/30/19 or 1/1/20 – 2/29/20 (the time period to measure against is the business’ choice).
- The amount forgiven will reduce if salaries of employees making less than $100k/year are reduced by 25% or more.
- Loan forgiveness will not be counted as income by the IRS (typically forgivable loans are counted as income). However, any forgiven expenses (i.e., payroll, rent, utilities) cannot be deducted from income.
- The loan will not exceed an interest rate of 4%. Banks have been issuing these loans at 1% annual interest rates.
- No prepayment penalties on the loan.
- Lenders must allow deferment of principal/interest payments for no less than 6 months, but no more than 12 months.
- The Paycheck Protection Program can be applied to through June 30, 2020.
Should a small business take a Paycheck Protection Program loan?
If a small business is continuing to keep any of its employees on payroll, and is facing economic uncertanity due to the pandemic, then the owner should apply with their bank for the Paycheck Protection Program (PPP). Even if the business must employ less employees on payroll than they did in previous periods, a portion of the loan is still forgiven. The amount forgiven isn’t all or nothing, it is a ratio between employees on payroll during the 8-week covered period and employees on payroll during the chosen measurement periods (see bullet 8 above). In addition to payroll, rent or a mortgage paid for a facility/office and utilities are included in the amount forgiven providing further relief. Since there are zero prepayment penalties, if a portion of the loan isn’t forgiven and the business owner is not seeking to take on debt then the loan can be immediately repaid without cost.
When a PPP loan may not make sense is when a business’ demand is essentially zero and there is nothing for an employee to contribute. Since the PPP covers payroll costs for 8 weeks, an argument could be made that employees could be kept on payroll for an additional 8 weeks even though they don’t have any productive work. Unfortunately, since the PPP definition of payroll costs excludes payroll taxes, which total 7.65% of compensation for a business owner, that cost is still absorbed. If rent/mortgage payments and utilities, which will have to continue to be paid even if the business isn’t in operation, during the 8 weeks are greater than 7.65% of employee compensation during the 8-week period, then even with nothing for an employee to work on, keeping them on payroll could still be a net positive for the business with a PPP loan. If rent/mortgage/utilities payments don’t outweigh payroll tax costs during the 8 weeks and there is nothing productive for an employee to do, then a PPP loan may not be the right relief method.
How is an Economic Injury Disaster Loan (EIDL) different than a PPP loan?
EIDLs are historically available to any area the government declares a disaster area. Due to the current pandemic, all of the United States has been declared a disaster area, which means just about any small business can apply. In addition, the CARES Act has expanded upon their benefits. EIDLs are available up to $2M and their size is based on the SBA’s determination of a business’ economic damage. For loans less than $200k there is no personal guarantee, and for loans less than $25k there is no required collateral. The loan is set at a fixed 3.75% annual interest rate. It can be paid off early without any penalties. If shown to be necessary, a business can request a $10k advanced grant to cover working capital costs. The $10k does not have to be repaid and can be kept by the business even if the EIDL is subsequently denied. Funds from the EIDL are to be used for current operating expenses.
If a business is also taking a PPP loan, the funds cannot be used for the same purpose (e.g., both cannot go to paying rent). The $10k advanced grant from the EIDL also counts against the forgivable amount in the PPP loan. In other words, if a PPP loan was forgiven for $100k, a business could not receive an additional $10k as an advanced grant; the $10k would reduce the PPP loan’s forgivable amount to $90k.
Should a small business apply for a PPP loan and/or an Economic Injury Disaster Loan (EIDL)?
As discussed above, if FICA costs are too burdensome a PPP loan may not be appropriate for a small business. If FICA costs are outweighed by the forgivable amount of a PPP loan, then businesses should be applying for a PPP loan. An EIDL is not as cut and dry. Since the forgivable amount of the PPP loan and $10k grant from the EIDL cannot be double-dipped, taking an EIDL is not about receiving a grant from the government. An EIDL can be a useful tool for a business in need of a loan at a low fixed interest rate of 3.75%. If the extra cash from the loan will help to keep purchasing supplies, inventory, etc. until receivables can come due or demand increases then an EIDL can be extremely useful. The business owner needs to consider that like a conventional loan, this one is expected to be paid back with interest. If a business isn’t receiving a PPP loan, then they should certainly apply for an EIDL to receive the $10k grant.
How does the CARES Act payroll tax deferral work?
Per the IRS, employer paid social security payroll taxes, totaling 6.2% of an employee’s gross pay, that would’ve been paid starting March 27, 2020 through December 31, 2020 may now be deferred. Fifty percent of the deferred amount is due to the IRS and must be deposited by December 31, 2021 and the other 50% is due December 31, 2022. If a PPP loan is taken and forgiven, the tax cannot be deferred after the loan was forgiven, but can be deferred up until the forgivable date. In other words, if a PPP loan is originated on May 1st and after the 8-week period the lender notifies the borrower that the loan is forgiven on June 26th, then 50% of payroll taxes from March 27th to June 26th can be deferred until December 31st, 2021 and 50% can be deferred until December 31st, 2022. Delaying payments interest free is historically a wise working capital strategy and in turbulent times it only becomes more prudent.
For the “too long; didn’t read” version on what do next, ask and answer the questions in the three bullets below for your own business. For those who believe a picture is worth a thousand words (or 1,900 in the case of this post), consult the flowchart.
- My business is facing uncertainty due to the pandemic, should I apply for a Paycheck Protection Program (PPP) loan?
- Are you a self-employed individual with no employees?
- Will your small business employ people between now and 6/30/2020?
- If you weren’t planning for your business to employ people between now and 6/30, but you did decide to employ some, would your rent/mortgage/utilities cost be greater than the FICA cost of those employees?
If either of those answers are “yes,” then your business should be applying for a Paycheck Protection Program (PPP) loan.
2. Should my business apply for an Economic Injury Disaster Loan (EIDL)?
- Does a PPP loan not make sense for your small business due to FICA costs?
- Could your small business utilize a loan at a fixed 3.75% annual interest to pay for operating expenses?
If either of those answers are “yes,” then your business should be applying for an Economic Injury Disaster Loan (EIDL).
3. How long should my business defer payroll taxes for in 2020?
- Will any of your PPP loan be forgiven?
Defer payment of payroll taxes from 3/27/20 through the date of forgiveness and pay 50% of the deferred amount on 12/31/2021 and 50% of the deferred amount on 12/31/2022.
- Did you not receive a PPP forgivable loan?
Defer payment of payroll taxes from 3/27/20 through 12/31/2020 and pay 50% of the deferred amount on 12/31/2021 and 50% of the deferred amount on 12/31/2022.
See the below flow chart that incorporates all of these ideas. If you have any questions, please reach out to us at firstname.lastname@example.org and we’d be happy to help!