Understanding the Paycheck Protection Program in the CARES Act

Federal Tax

Americans are still digesting the $2.2 trillion CARES Act (H.R. 748), which passed last week as the largest financial support package in U.S. history. The law runs more than 800 pages and contains hundreds of provisions designed to dispense relief to individuals and businesses in the wake of the ongoing public health crisis. While many Americans are becoming more familiar with the rebate portion of the bill, the legislation also supports small businesses and independent contractors.

Many small business owners are seeking guidance as they apply for loans backed by the Small Business Administration (SBA) to help maintain cash flow and retain workers even as more states announce new quarantine and shelter-in-place orders. The CARES Act includes financing options for small businesses owners and independent contractors, including the Paycheck Protection Program (PPP).

Overview of the Paycheck Protection Program

To incentivize employers to maintain payroll during the crisis, the SBA is providing 100 percent federally-backed loans for certain payroll expenses through June 30, with up to eight weeks of forgiveness for small businesses, certain nonprofits and self-employed individuals. The loans are forgivable if employers retain employees at comparable salary levels prior to the crisis. The PPP also waives all SBA fees and provides deferral on loan repayments for a minimum of six months up to a maximum of one year.

Small businesses impacted by coronavirus-related issues between February 15 and June 30, 2020 may apply for loans, which will remain available through the end of June. All 501(c)(3) nonprofits, 501(c)(19) veterans organizations, tribal businesses with fewer than 500 employees, individuals who manage a sole proprietorship, and independent contractors are eligible. Each entity is limited to one loan, determined by the applicable taxpayer identification number (TIN).

The loans are categorized by how long the organization remains operable from the beginning of the crisis period (February 15) to June 30. For businesses that continue to operate and retain employees over that period, the SBA can provide a maximum loan of 250 percent of the average monthly payroll costs during that period:

  • If you are in business over the period from February 15 to June 30, you will receive a maximum loan amount that is 2.5 times your average monthly payroll expenses over that time period.
  • If you are a seasonal worker over the period from March 1 to June 30, you will receive a maximum loan amount that is 2.5 times your average monthly payroll expenses for that shortened time period.
  • If you were not in business after February 15—that is, if you were not open because of the crisis or you went out of business entirely—you will receive a maximum loan amount that is 2.5 times your average monthly payroll expenses for the two months of January and February.

Businesses that took out economic injury disaster (EID) loans between February 15 and June 30 may refinance their original loan into a PPP loan and add any outstanding loan payments to their payroll expenses.

Eligible payroll expenses for calculating PPP loan amounts include:

  • Compensation (salary, wages, commission, or similar compensation, cash tips, etc.)
  • Payment for vacation, family, medical, and sick leave
  • Allowance for employee dismissal or separation
  • Payment for group health-care benefits, including insurance premiums
  • Payment of employee retirement benefits
  • Payment of state and local taxes imposed on the compensation of employees

However, the PPP does not count the following expenses when calculating the total PPP reimbursement amount:

  • Any compensation over $100,000 per employee
  • Taxes imposed under chapters 21 (payroll taxes), 22 (railroad taxes and retirement benefits), and 24 (income taxes withheld on wages) of the Internal Revenue Code (IRC)
  • Compensation of employees whose principal place of residence is outside the United States
  • Qualified sick and family leave for which a credit is already allowed under other sections (i.e., 7001 and 7003) of the Family First Coronavirus Response Act
  • Loans used for duplicate purposes of another SBA loan program already claimed by the applicant

Once an eligible small business or contractor receives the loan, they may use it for the following:

  • Payroll costs
  • Costs related to the continuation of group health-care benefits during periods of paid sick, medical, or family leave and insurance premiums
  • Employee’s salaries, commissions, or similar compensation
  • Payments of interest on any mortgage obligations (not including prepayment fees or payment of principal on the mortgage itself)
  • Rent (including rents under a lease agreement)
  • Utilities
  • Interest on any other debt obligations that were incurred before the relevant covered period (see Table 1)

Notably, the SBA will fully forgive all loans under the PPP provided three requirements are met:

  • Loans are used exclusively for their intended purposes (see bullet points directly above)
  • Loans are used to offset no more than eight weeks (the maximum amount of time payroll expenses would be fully offset) of eligible payroll expenses
  • Businesses retain employees at salary levels comparable to before the crisis

For any amount of the loan used that does not meet the above criteria, businesses will have to repay the SBA. The Paycheck Protection Program provides businesses with a maximum repayment window of 10 years with a top interest rate of 4 percent, without loan fees or prepayment penalties. SBA will issue regulations to ensure that any fees remain capped.

Calculating which costs qualify for loan forgiveness is determined by a formula, designed to enable businesses to maintain payroll and retain employees without substantially reducing employee compensation:

Forgivable portion (FP) = Payroll costs (PC) + any applicable mortgage interest payments (MIP) + any covered utility payment (UP), or:

FP = PC + MIP + UP

To be approved for loan forgiveness, businesses must contact their lender (either SBA or whomever is relevant) and submit an application including documentation verifying the number of employees on payroll and their compensation levels, along with all relevant documents showing payments on mortgage interest and utility payments. All current SBA 7(a) lenders are eligible lenders for PPP, and the U.S. Department of Treasury is responsible for authorizing new lenders.

Further, if a business claims a PPP loan, they are not eligible for the Employee Retention Credit (which would provide a refundable payroll tax credit for 50 percent of wages paid by eligible employers to certain employees during the COVID-19 crisis) or the deferment of payment of employer payroll taxes until 2021.

Conclusion

In addition to the rebate available to individuals ($1,200 for single filers; $2,400 for married filers) and changes to business tax rules, the CARES Act is offering forgivable loans to businesses aiming to retain their employees and manage payroll expenses through the crisis. By underwriting two months of payroll expenses through the PPP, the SBA is providing more flexibility for businesses facing difficult decisions to keep their employees while watching their bottom line.

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