If your small business was one of the lucky few, it received a Payroll Protection Program (PPP) loan with the first batch of $349B government funding from the CARES Act. Or maybe your small business just received funding as the second batch of $320B was added by Congress on April 27th. Great! Now what…? How can you ensure you’re doing the right things so your PPP loan is forgiven?
It sounds like a simple question, but the government continues to update the terms. It’s similar to the kid at recess changing the rules of dodgeball halfway through the game. Or for those who preferred the AV Club to the blacktop, like Darth Vader flexing his metaphoric robotic muscle against Lando on Cloud City, “I am altering the deal, pray I don’t alter it any further.”
The Treasury was scheduled to issue further guidance regarding PPP loan forgiveness on April 26th, but as of May 7th we’re all still waiting in limbo with no updated timetable. (Bookmark the Treasury.gov website for updates.)
Below are key PPP updates and actions a business owner can take to protect and position themselves to receive maximum forgiveness at the end of the 8-week covered period.
When does the 8-week covered period start?
Once loans are “disbursed” and hit your bank account, the 8-week covered period begins (Treasury FAQ #20). The total paid hours and cash compensation to employees during the 8 weeks determines how much of the loan is eligible for forgiveness.
The “75%” rule
The PPP loan is for 2.5x monthly payroll expenses, based on an average of the last twelve months of payroll from when the loan was originated. Proceeds for the loan can be used to cover payroll expenses and rent/utilities that were an obligation prior to 2/15/20. The SBA states “at least 75% of the forgiven amount must have been used for payroll.” In other words, the government is making the case that the loan is for two months of payroll plus an extra 25% of payroll expenses allocated towards overhead.
This was Congress’ original intent, but the legalese in the CARES Act was allowing for some maneuvering by savvy borrowers to potentially shift more of the forgivable amount from payroll to overhead, depending how their historical employee hours had shaken out. That accounting wizardry, though, has seemed to have been kiboshed.
Until the Treasury issues guidance clarifying the 75% rule, decision makers will not know for certain exactly how much will be forgiven, but two rules of thumb can be followed to ensure they’re not banking on receiving more:
- Follow the 75% rule: if the loan is $100,000, assume $75,000 must be spent on payroll during the 8 weeks to have the full $100,000 forgiven.
- Follow the original wording of the CARES Act and pay employees for the same amount of time, at the same level of cash compensation, as paid historically.
The CARES Act does not count the PPP’s forgiven amount as income for tax purposes (forgiven loans typically are counted as income). However, after passage by Congress, the IRS issued guidance that although the forgiven amount is not counted as income, a business cannot also deduct the forgiven expenses (payroll/rent/utilities) during the covered period against income. There is no “double-dip” (yes, that includes you George Costanza). Tax law typically is written to avoid double dipping incentives, so this is not a huge surprise, but since the CARES Act did not state otherwise, some hoped the program would be more generous.
Cover Your Bases
In an ever-changing landscape, it’s prudent to take precautions against the unknown; especially when dealing with the government and IRS. Three tips below to protect yourself and your business:
- Create a paper trail – The SBA has already stated it will audit PPP loans above $2M. It’s possible they will decide to audit loans below $2M, as well. The easiest way to make a future audit as painless as possible is to open a new bank account, deposit the PPP funds there, and charge all payroll, rent, and utilities out of that bank account until the loan is exhausted. You’ll make an auditor’s day with such crystal-clear accounting.
- To the extent possible, plan as if nothing will be forgiven – Of course, saving cash may not be possible as many businesses are in distress – that’s why the program is available. But, until 2020 taxes are filed, or definitive guidance is given, budget as if some of the forgivable portion of the loan is clawed back.
- Don’t be discouraged – Keep in mind, even if the loan isn’t forgiven (which it at least partially will be if the business has employees during the 8-week period) the loan is at an attractive interest rate of 1%, which is below the 1.5-2% returns currently earnable in risk-free investments, such as CDs. Considering the forgivable nature and the cost of capital, the PPP loan is a net positive for a small business experiencing financial hardship due to the pandemic, even if it means dealing with government ambiguity.