How PPP Loan Forgiveness Works for Different Business Structures
Businesses across the country have clamored to take advantage of the Paycheck Protection Program (PPP or P3) offered under the Coronavirus Aid, Relief, and Economic Security (CARES) Act. The COVID-19 pandemic resulted in an economic shutdown that left many businesses struggling and workers unemployed. The opportunity for a low-interest or even forgivable loan to continue operations during the shutdown was too good to overlook. But subsequently-issued regulations have given shape to the program in unexpected ways, in some cases limiting forgiveness.
The initial P3 rules, issued after early borrowers had already applied for and/or received a P3 loan disbursement, show that the US Small Business Administration (SBA) will handle forgiveness differently depending on the borrower’s business structure. Additional PPP rules issued May 22, 2020 further refined how the SBA will administer the program, and then early June legislation further refined the program’s terms. To get the most benefit possible, including forgiveness of your Paycheck Protection Program loan, businesses need to understand these rules and how they affect various business structures differently.
Loan Forgiveness and Business Structure: What You Need to Know
When signed into law on March 27, 2020, the CARES Act authorized forgivable loans for small businesses to continue operating or meeting payroll. Many businesses raced to apply for loans with only the Act as guidance. Subsequent rules and regulations passed by the SBA add limitations on how loan proceeds may be spent in order to qualify for forgiveness. The SBA rules define different criteria for forgiveness eligibility depending on the business structure of the borrower.
Together, the legislation, the SBA rules, and PPP loan forgiveness application provide many answers—and many questions—about how businesses may qualify for forgiveness of part or all of their PPP loan. With many borrowers nearing the end of the eight-week forgiveness deadline originally set by the CARE Act for loan spending, understanding these rules and the current P3 legislation is paramount.
The Paycheck Protection Program and the P3 Flexibility Act
Following the passage of the Paycheck Protection Program, numerous small businesses voiced complaints that the rules are too strict to make PPP loan forgiveness feasible. In response, on May 28, 2020, the US House of Representatives passed House Bill 7010, the Paycheck Protection Program Flexibility Act (P3 Flexibility Act), and the US Senate passed the same on June 3. President Trump signed the P3 Flexibility Act into law on June 5, 2020, making forgiveness more easily attainable in some ways by modifying several key requirements.
- Extending the covered period of spending eligible for forgiveness from eight to 24 weeks;
- Decreasing the amount of the loan that must be spent on compensation from 75 percent to 60 percent; and
- Extending the deadline for rehiring workers from June 30 under the original legislation to December 31, 2020.
For purposes of determining eligibility for forgiveness, borrowers may now elect to use either the original eight-week period provided in the CARES Act or the extended 24-week period provided under the P3 Flexibility Act.
Basic PPP Loan Forgiveness Information
All borrowers are eligible to have their Paycheck Protection Program loan forgiven if they meet certain conditions regarding the use of the loan proceeds and maintenance of staffing levels. Many of the PPP forgiveness requirements require businesses to keep employment and compensation within a certain range of historical staffing levels and compensation rates. For example, borrowers were required to supply basic payroll information and staffing numbers in their Paycheck Protection Program Borrower Loan Application, and those figures can serve as benchmarks for determining eligibility for forgiveness of the PPP loan unless the borrower later chooses an allowable alternative period.
The following prerequisites apply to all borrowers regardless of business structure following passage of the Paycheck Protection Program Flexibility Act:
- All of the loan proceeds must be spent on approved operational costs in either an eight-week period (under the original legislation) or a 24-week period (under the P3 Flexibility Act) following the date of the loan disbursement.
- At least 60 percent of the loan must be used for payroll, which includes salary, wage, commission, or similar compensation; cash tips; payment for vacation, medical, sick, parental, or family leave; and certain non-cash compensation amounts such as healthcare premiums, retirement benefits, and state or local taxes on employee compensation. According to a joint statement issued June 8, 2020, by US Treasury Secretary Steven T. Mnuchin and SBA Administrator Jovita Carranza, failure to meet this requirement will reduce the amount of the loan eligible for forgiveness.
- The remainder of the loan (up to 40 percent of the total) must be used for acceptable business expenses, which include mortgage interest, rent, and enumerated utilities, all of which must have been in effect before February 15, 2020.
- The total number of employees over the covered period must be the same as in the applicable benchmark or lookback period (although there are safe harbor provisions for staffing reductions that are out of the business’s control).
- The salary paid to each employee during the covered period following the disbursement is at least 75 percent of salary paid during the benchmark period.
Eligibility for forgiveness is further capped at $100,000 annualized per employee. Thus, under the original P3 legislation, the amount of an employee’s compensation in excess of $15,385 during the original eight-week period would not be eligible for forgiveness.
All businesses will be required to provide supporting documentation to show the staffing and compensation numbers from the benchmark period. Careful recordkeeping will also be required throughout the first eight weeks of the loan so that businesses can easily complete the PPP loan forgiveness application and provide supporting documentation as needed. Failure to meet any of these requirements can result in a reduction of the amount of the loan eligible to be forgiven.
How Business Structure Affects PPP Loan Forgiveness
Paycheck Protection Program loan forgiveness for corporate borrowers (including limited liability companies) is likely to be more straightforward than for other business structures. Entities that have been in existence since January 1, 2019 or earlier are likely to have the payroll records necessary to compute the number of employees and their compensation. A corporate borrower will just need to ensure it submits supporting documentation to show it used the loan proceeds in compliance with the P3 rules.
Partnerships may find calculating their eligibility for loan forgiveness a little more challenging. A partnership is limited to a single loan as opposed to loans to individual partners. Forgiveness for general partner compensation is limited to the lesser of $15,385 (75 percent of 8 weeks’ compensation at the $100,000 annual salary cap) or 8/52nds of their 2019 self-employment net earnings (again, capped at $100,000 annualized), which does not include contributions for their health care or retirement plans.
Small partnerships that do not use a payroll service would not have payroll provider records. In such cases, completing the partnership’s PPP loan forgiveness application requires reference to cash and non-cash compensation records such as 2019 IRS Form 1065 (including Schedule K-1s) and partnership contributions for retirement or health benefits.
For sole proprietors, the self-employed, and independent contractors (Schedule C filers) who do not have payroll records, the lookback period is an average of their net profit from 2019 using this formula:
2019 net profit/12 months x 2.5
Using this formula, sole proprietors and independent contractors are eligible to have eight weeks’ worth of net profit forgiven as “owner compensation replacement.” However, they may not include health care or retirement plan contributions in their compensation figures.
Regardless of the business structure, there are some special rules for owner-employees. This category includes C-corporation and S-corporation shareholders and LLC members. Compensation eligible for forgiveness for owner-employees cannot exceed the lesser of $15,385 over an eight-week period (based on a $100,000 annual compensation) or 8/52s of their 2019 compensation. This includes 2019 cash compensation plus health care and retirement plan contributions made on their behalf. Owner-employees who began operations in 2019 and did not take full salary or were not in business for much of 2019 will suffer a lower forgiveness threshold.
When to Seek Help from a PPP Business Attorney in WV, KY, or OH
Many businesses across West Virginia (WV), Kentucky (KY), and Ohio (OH) are working with their payroll providers, executive officers, and accountants to apply for and use Paycheck Protection Program loan proceeds in compliance with the P3 rules so that their loans will, in essence, become tax-free grants. But understanding the strict requirements of the Paycheck Protection Program rules on forgiveness requires consultation with an experienced business attorney in WV, KY, or OH.
Xavier Staggs at Jenkins Fenstermaker, PLLC has the business experience to help businesses in all forms successfully navigate P3 rules in their bid for maximum PPP loan forgiveness. For more information, call (304) 523-2100 or complete this online contact form.