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Forgiveness is Divine: Insight for PPP Borrowers to Maximize Loan Forgiveness

Mike Miller and Kathryn Hesman
May 2020
April 30, 2020 – Subject to Continuing Updates and Correction
(Updated May 8, 2020 to reflect FAQ 40 and clarify FICA’s roll in “payroll costs” definition)

As businesses that have received funds (“Borrowers”) under the CARES Act’s Paycheck Protection Program (“PPP”) execute their COVID-19 survival strategies, it is important that these survival strategies are designed to take advantage of PPP program’s defining feature for Borrowers: loan forgiveness.  The PPP provides that loans made under the PPP (“PPP Loans”) may be forgiven if the Borrower meets certain criteria for the use of the PPP Loan proceeds and maintenance of employee headcount and compensation levels.  Although the Federal government has endeavored to disburse funds into accounts of Borrowers as quickly as possible, many questions remain regarding the details of the forgiveness regime, which is governed by Section 1106 of the CARES Act.  In its first Paycheck Protection Program Interim Final Rule, issued on April 2, 2020 (“IFR #1”), the SBA provided limited initial guidance for PPP Loan forgiveness but explicitly stated that further guidance regarding forgiveness will be forthcoming.  Borrowers struggling to survive the COVID-19 crisis cannot wait for further Treasury Department or Small Business Administration (“SBA”) guidance to execute their survival plans; as such, this article will summarize for entity Borrowers (i.e., not sole proprietors or independent contractors) the permitted forgivable uses of PPP Funds, the process of applying for PPP Loan forgiveness as articulated to date and best practices for maximizing PPP Loan forgiveness.  It is important to reiterate that the aforementioned further SBA or Treasury Department guidance regarding forgiveness has not yet been issued and, once issued, may require different conclusions and analyses than those presented herein.  As such, this article will be updated as more information is disseminated and digested.

Forgivable Uses of PPP Funds

For Borrowers, understanding how the proceeds of PPP Loans (“PPP Funds”) can be used to maximize the forgivable amount of such loans (the “Forgivable Amount”) is paramount; however, as discussed in the next section, proper use without proper evidence and documentation can subject Borrowers to unintended outcomes when they apply for forgiveness.  As Borrowers know, operational metrics such as payroll costs and employee headcount have been an important part of the PPP Loan eligibility and borrowing limit analysis.  Permitted uses of PPP Funds include a different list of business expenses than are used to determine eligibility and borrowing limits, while the forgivable permitted uses are limited to a separate, third subset of business expenses.  As such, Borrowers should keep in mind that certain categories of expenses are not forgivable despite being either permitted uses of PPP Funds or used to determine PPP eligibility or borrowing limits. 

This section focuses on forgivable uses only.  If a Borrower needs to use its PPP Funds for a purpose that is not forgivable, all is not lost – PPP Funds used for permitted uses that are not forgivable must be repaid, but repayment terms contemplate six months of deferred interest and a two-year maturity at one percent annual interest.

Generally.  The four categories of “Forgivable Expenses” are payroll costs, interest on certain mortgage obligations, certain rent payments and certain utility payments, each of which is discussed further below.  Importantly, to be forgivable, the Forgivable Expenses must consist of “costs incurred and payments made” during the “Covered Period” – that is, the eight-week period beginning on the date that the PPP Loan was originated – and even then the Forgivable Amount is subject to reduction as detailed below.  Guidance has not yet been issued as to whether (a) costs incurred prior to the Covered Period but paid during the Covered Period or (b) costs incurred during the Covered Period but paid following the Covered Period, in each case, are forgivable.  To plan conservatively, Borrowers should deploy as much of their PPP Funds as possible to Forgivable Expenses both incurred and paid during the Covered Period. 

Payroll Costs.  By far the most complicated of the four types of Forgivable Expenses, payroll costs consist of the following types of employee compensation payable to U.S.-based employees: salary, wages, commission and tips; vacation, parental, family, medical or sick leave; severance-type payments; payments required for provision of group health insurance, including insurance premiums; retirement benefits (including employer contributions to defined-benefit or defined-contribution plans); and payment of state and local taxes on employee compensation. 

The calculation of payroll costs is then reduced by the amount of compensation of an employee exceeding a prorated annual salary (excluding non-cash benefits) of $100,000, railroad wages and federal income tax, and certain wages that are eligible for tax credits under the Families First Coronavirus Response Act.

Many questions have arisen with respect to payroll-related taxes and withholdings and how they are treated in the “payroll costs” regime. With respect specifically to the employee’s and the employer’s share of FICA and income taxes, the SBA has clarified that a PPP Borrower’s payroll costs are calculated on a gross basis, without subtracting federal taxes that are imposed on the employee and withheld from employee wages and without adding the PPP Borrower’s share of FICA. This means if an employee earns gross wages of $3,000 per month (from which employee side FICA and income taxes were then withheld), the full $3,000 would count as payroll costs (subject to other limitations) and the employer’s portion of the FICA tax (which is equal to 7.65% of the employee’s wage) would not be included as a payroll cost.

As the Covered Period will most likely start in the middle of a payroll cycle, the question of whether payroll costs need to be “costs incurred and payments made” during the Covered Period in order to be Forgivable Expenses is an important one that the SBA or Treasury Department needs to answer.  Further, there has been little guidance regarding whether and to what extent certain types of payroll-related costs would be included for the purpose of Forgivable Expenses (e.g., payments by businesses that self-insure for group health care programs in respect of employee claims, retention or hazard bonuses paid to employees in excess of current compensation levels, etc.).  For now, to ensure maximum forgivability and to the extent they are able, Borrowers should consider only those payroll expenses incurred and paid during the Covered Period to be Forgivable Expenses and use PPP Funds to pay only expenses that are clearly defined as payroll costs.

Interest on Certain Mortgage Obligations.  The remaining categories of Forgivable Expenses are more straightforward.  Payments of interest incurred and paid with respect to a mortgage that is a liability of the Borrower and secured by real or personal property, which mortgage was incurred in the ordinary course of business prior to February 15, 2020, are Forgivable Expenses.  The “ordinary course of business” qualifier has not been explained and it is unclear what types of mortgages this would exclude, but payments with respect to principal and any prepayments have been specifically identified as unforgivable.

Certain Rent Payments.  Payments of rent under a lease that was entered into before February 15, 2020 are Forgivable Expenses.  If the Borrower was not occupying a leased premises prior to February 15, 2020 but the lease for such premises was in effect before February 15, 2020, rent payments thereunder are still Forgivable Expenses. 

There is no specific guidance regarding prepayment of rent under a lease entered into prior to February 15, 2020.  Although prepayment is specifically addressed in the mortgage context, the absence of reference to prepayment in the rent context may tempt some Borrowers to use PPP Funds to prepay rent.  If rent prepayment is an option for a Borrower after considering the restrictions limiting non-payroll cost forgiveness to 25% of the loan (detailed below), such Borrower should not rely on those prepayment amounts being forgiven absent further confirmatory guidance.

Certain Utility Payments.  Payments for a service for the distribution of electricity, gas, water, transportation, telephone or internet access service, which service began prior to February 15, 2020, are Forgivable Expenses.  The only unclear component of this category is what constitutes a “distribution of transportation” service payment, which would benefit from further SBA or Treasury Department guidance.

Reduction of Forgivable Amount.

Even if the entire amount of the PPP Funds are used on Forgivable Expenses, Borrowers can still be left with unforgiven amounts based on three types of forgiveness reductions (“Forgiveness Reductions”): the non-payroll cost use reduction, the reduction in number of employees reduction, and salary and wage reductions.  Each are discussed below.  Different rules, which are not discussed here, may apply for qualifying seasonal employers, employers of tipped workers.  Further, a new Interim Final Rule published the morning of this article (“IFR #6”)  limits the maximum Forgiveness Amount to $20,000,000 for a single “corporate group” of businesses that is majority owned, directly or indirectly, by a common parent.  Borrowers that are a part of a “corporate group” should discuss the implications of IFR #6 with their ultimate parent entities and their respective legal advisors.

Non-Payroll Cost Use Reduction.  In order to ensure that PPP Funds flow to employees, IFR #1 set a limit such that “not more than 25 percent of the loan forgiveness amount may be attributable to non-payroll costs.”  As such, PPP Funds should be used primarily for payroll costs and proper accounting and projecting of expenses should be undertaken during the Covered Period so that Borrowers do not face unintended consequences when they apply for forgiveness.  If non-payroll costs comprise more than 25% of the use of PPP Funds, the total Forgivable Amount will be reduced accordingly.  For example, if a Borrower has a PPP Loan of $1,000,000 and spends $600,000 on payroll costs and $400,000 on qualified rent and utilities expenses during the Covered Period, the Forgivable Amount will be reduced from $1,000,000 to $800,000, with $600,000 (75% of the Forgivable Amount) being allocated to payroll costs and $200,000 (25% of the Forgivable Amount) being allocated to non-payroll costs.

Reduction in Number of Employees Reduction (“RNE Reduction”).  In order to ensure that Borrowers use their funds to retain their current workforce, the Forgivable Amount will be reduced by a percentage based on employee headcount reductions that occurs during the Covered Period.  This percentage is calculated by taking the Borrower’s average number of full time equivalent employees (“FTEs”) per month during the Covered Period and dividing it by, at the Borrower’s option, either (i) its average number of FTEs per month from February 15, 2019 – June 30, 2019 or (ii) its average number of FTEs per month from January 1, 2019 through February 29, 2019.  These calculations should be made using the average number of FTEs for each pay period of a given month.  For example, consider a Borrower that has an otherwise forgivable PPP Loan of $1,000,000 and had an average of 200 FTEs for the period from January 1, 2019 through February 29, 2019.  If the Borrower decides to lay off 75 FTEs such that it has an average of 125 FTEs during the Covered Period, the Forgivable Amount will be reduced from $1,000,000 to $625,000 (which is 125/200, or 62.5%, of the otherwise forgivable $1,000,000 loan).

Salary and Wage Reduction (“SWC Reduction”).  In order to ensure that Borrowers use their funds to maintain their employee compensation at comparable levels, the Forgivable Amount will be reduced by the amount of any reduction in total salary or wages of certain classes of employees that exceeds 25% of the total salary or wages of such employee(s) during the most recent full quarter during which the employee was employed before the Covered Period.  The employees that are subject to measurement for the SWC Reduction are those who did not receive, during any single pay period during 2019, wages or salary at an annualized rate of $100,000+. 

There has been no guidance issued regarding the SWC Reduction and it is sorely needed.  Generally speaking, a Borrower that institutes a 25% or less reduction in compensation for all of its employees but keeps them employed during the Covered Period should not have its Forgivable Amount reduced.  To the extent a reduction exceeds 25%, the reduction to the Forgivable Amount would be calculated on a dollar-for-dollar, employee-by-employee basis.  However, the SBA or Treasury Department needs to clarify at least two important details of how to calculate the amount of an SWC Reduction.  The first is to what extent, if any, bonuses are considered in calculating the SWC Reduction and the employees that the SWC Reduction measures  – based on the current language, and assuming all Borrowers’ Covered Period begins in the second calendar quarter of 2020, “year-end” bonuses that relate to 2019 but are paid in the first quarter of 2020 will be included in the calculation of the “normal salary or wages” for such employee on which the 25% reduction limit is based.  The second is with respect to terminated employees – if an employee is terminated during the Covered Period, does the SWC Reduction consider the reduction in that employee’s compensation during the Covered Period as a reduction to the Forgivable Amount?  What if the employee is terminated “for cause”?  Borrowers should watch for future guidance on these topics but, in the meantime, should manage compensation levels and headcount to the extent practicable to avoid an SWC Reduction.

Exceptions for Re-Hires and De Minimis Actions.  Borrowers can remedy potential Forgiveness Reductions due to the RNE Reduction or SWC Reduction in certain limited circumstances.  If a Borrower reduced its number of FTEs or employee salaries at any time from February 15, 2020 to April 27, 2020, it can, in the case of an FTE reduction, re-hire the FTEs that it eliminated by June 30, 2020 and, in the case of a salary reduction, eliminate such salary reduction by June 30, 2020.  If the Borrower takes either of these actions, the RNE Reduction or SWC Reduction, as applicable, will not be applied (the “Re-Hire Exception”). As discussed in the de minimis section below, there is also an exception for unsuccessful attempts to re-hire employees. We expect that the Re-Hire Exception will be clarified in future guidance; as such, Borrowers considering temporary layoffs or furloughs should proceed cautiously if they are contemplating availing themselves of the Re-Hire Exception in the course of their Forgiveness Amount planning and strategy.

In addition, the CARES Act allows the SBA to grant de minimis exceptions to the Forgiveness Reductions, but details regarding such exceptions were not set forth in the CARES Act itself.  The SBA issued updated guidance on May 3, 2020 in the form of FAQ #40, stating that it intends to issue an interim final rule under the power to make de minimis exceptions providing relief under the RNE Reduction if the borrower makes a “good faith, written offer of rehire” to a terminated employee (for the same salary/wages and number of hours) and the employee rejects such offer, as documented by the borrower.  A practical concern with respect to this exception is obtaining a documented rejection from an employee of the re-hire offer – the issued guidance specifically states that employees who reject offers of re-employment may forfeit unemployment compensation eligibility, so employees may choose to simply not respond to such offers. We expect future guidance to provide the framework and qualifications for other de minimis exceptions, which we anticipate will include “for cause”-type terminations and the exclusion of certain ordinary course bonuses from the SWC Reduction calculations.

Forgiveness Application Process

To begin the forgiveness process, Borrowers are required to make an application directly to their lender (not the government) for the forgiveness of their loan (the “Forgiveness Application”).  However, in public comments made in the days leading up to the publication of this article (and reiterated in guidance in the form of FAQ #39), Treasury Department Secretary Mnuchin indicated that recipients of PPP Loans in excess of $2 million would be audited by the SBA prior to forgiveness, while adding that all recipients could face such audits through SBA spot-checks.  Based on the calculations required in the forgiveness application, a Borrower cannot apply for forgiveness until after the Covered Period.  Absent guidance as of the date of this article, the text of the CARES Act itself governs the requirements of the Forgiveness Application; however, as Borrowers likely recall from their initial PPP Loan applications, the SBA issued (and subsequently changed) forms and guidance that significantly reframed the plain meaning of the CARES Act.  Included in these forms and guidance was the “Necessary Certification” (see prior MVA commentary on the “Necessary Certification”) on the PPP Loan application, which shows that even the form of application can have critical impacts on the requirements and limitations on the PPP.  As of publication of this article, the Forgiveness Application must include the below components.

FTE and Expense Documentation.  The Borrower must include documentation (i) verifying the number of FTEs on payroll and pay rates for such FTEs during the periods contemplated by the various tests for Forgiveness Reductions detailed in the prior section of this article – such documentation may include federal payroll tax filings and state income, payroll and unemployment insurance filings; (ii) verifying payments on covered mortgage obligations and covered lease obligations and covered utility payments – such documentation may include cancelled checks, payment receipts and account transcripts or statements and (iii) not covered in (i) or (ii) that the SBA determines is necessary.

Certification.  Borrowers requesting forgiveness must also include a certification from a representative that (i) the documentation provided as part of the Forgiveness Application was true and correct and (ii) the Forgivable Amount that is the subject of the Forgiveness Application was used to retain employees and pay other Forgivable Expenses.  Importantly, this certification does not require a Borrower to re-make the “Necessary Certification” at the time of the submission of the Forgiveness Application.

Best Practices to Maximize Forgiveness

Although the final forgiveness rules may eventually differ from those currently reflected in the text of the CARES Act, Borrowers can take steps today to maximize their Forgivable Amounts and maintain flexibility when new regulations, guidance or commentary is disseminated.  We believe the below-described “best practices” should be followed by all Borrowers; however, we realize that different Borrowers may have different funding needs, strategic goals and tolerance for the risk of lower Forgivable Amounts.  Individual Borrower planning and strategy should be discussed with competent legal counsel.

Separate Accounts.  Borrowers should segregate PPP Funds into bank accounts separate from their normal operating accounts.  Although cash is fungible from a balance sheet perspective, the CARES Act’s emphasis on the specific use of PPP Funds for Forgivable Expenses makes separate accounts advisable.  Holding PPP Funds in separate accounts also makes collecting the documentation required for the Forgiveness Application more straightforward for both the Borrower and the eventual reviewer.

Keep Great Records.  Although keeping great records seems intuitive in light of the Forgiveness Application requirements, what constitutes “great” records deserves careful attention.  Because of the requirement that, to be a Forgivable Expense, a cost must be incurred and payment made during the Covered Period, the dates of payments and the incurrence of the associated obligation to pay will be necessary to document.  As such, simple cleared checks may not suffice without the dated versions of the payroll statements, timecards or invoices to which such checks relate – Borrowers should keep these records and organize them in a way that facilitates easy matching.  With respect to Forgivable Expenses that may not include payroll statements, timecards or invoices (e.g., mortgages or rent payments), Borrowers should have a redacted copy of their mortgage or lease on file as supporting documentation in case requested. 

Manage Your Headcount.  If any FTE headcount or compensation changes are contemplated during the Covered Period, Borrowers should prepare a comparison analysis among its headcount and compensation levels (i) pro forma giving effect to such contemplated changes and (ii) during the periods contemplated by the SWC Reduction and RNE Reduction.  Once such analysis is prepared, Borrowers can calculate the Forgiveness Reduction, if any, and make a business decision as to whether to proceed with such changes with full knowledge of the impact on the Forgivable Amount.  If a Borrower terminates an employee “for cause,” it should document the reasons for such termination in detail in case further guidance on the “de minimis” exception to the Forgiveness Reductions permits such terminations without a corresponding reduction.

Comply with Loan Documents.  PPP Loans are evidenced by promissory notes issued by lenders.  Although the SBA provides a form of promissory note for lenders to use, its FAQ guidance confirmed that lenders may use their own form of promissory note.  Though the promissory note should be in simple form, there may be certain restrictions or notice requirements in the promissory note that may require notice of certain events or, in some cases, repayment in full of the loan to the lender based on actions taken by the Borrower (e.g., consummation of a change of control transaction).  Similarly, Borrowers that have credit from other sources should be sure to discuss their PPP Loan with their current lenders.  Although not directly related to forgiveness, Borrowers should avoid or proactively remedy any conflict between their PPP Loans and their incumbent credit facilities.  Despite many Borrowers viewing their PPP Loans as grants, PPP Loans are debt instruments until they are forgiven and may cause Borrowers to run afoul of their incumbent credit facilities, creating a cascade of issues that should be the least of Borrowers’ concerns during this crisis.

When in Doubt, be Conservative.  Different Borrowers will have different levels of tolerance for the risk that a portion of their PPP Loans will be unforgivable  Indeed, some Borrowers may have already made plans for their loans that contemplate certain amounts being unforgivable, as even the unforgivable portion of PPP Loans provide Borrower-friendly terms for needed capital. 

This article discusses a number of aspects of the PPP forgiveness regime that would benefit from further guidance from the SBA or Treasury Department.  As such, Borrowers that are basing their projections on 100% forgiveness should prioritize the use of PPP Funds on their expenses that are most clearly Forgivable Expenses and, to the extent their projections leave them with additional PPP Funds, allocate those funds to expenses that are less clearly Forgivable Expenses, remembering to avoid actions that could cause Forgiveness Reductions that function independently of using funds for Forgivable Expenses.  This strategy will best position Borrowers to be nimble in responding to future guidance and allocate their PPP Funds in the most efficient, forgivable way possible.

Monitor New Guidance

The Treasury Department updates its CARES Act guidance website frequently.  Although news media outlets do a good job of covering the PPP from a high level, the nuance needed for Borrowers to make good strategic decisions with respect to their PPP Funds will require a close read of future guidance.  Borrowers should also maintain consistent communication with financial, accounting and legal advisors to distill the impact of the future guidance on the any actions or plans that Borrowers are executing. 

For Further Counsel

Moore & Van Allen’s attorneys remain actively engaged in counseling businesses and individuals through the COVID-19 crisis, including through tracking updated guidance like FAQ 31 and providing timely analysis and strategic advice.  The Moore & Van Allen COVID-19 Resource Center, containing all Moore & Van Allen guidance and commentary related to the COVID-19 crisis, can be accessed by visiting

Mike Miller
Member, Moore & Van Allen PLLC
Kathryn Hesman
Associate, Moore & Van Allen PLLC
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