COVID-19: What Borrowers Need to do after Receiving PPP Loan Proceeds

With many Paycheck Protection Program (“PPP”) borrowers having received their loan proceeds under the Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”), or receiving them soon, what should borrowers do after receiving their loan?

Spend the Loan Proceeds on Permissible Items

In order for repayment of your PPP loan to be forgiven, proceeds from a PPP loan only may be used for limited purposes: payroll costs (as discussed in detail in the following paragraph) ; interest on mortgage obligations incurred before February 15, 2020; rent payments on leases dated before February 15, 2020; and utility (electricity, gas, water, transportation, telephone and/or internet) payments under service agreements dated before February 15, 2020, mortgage interest payments (but not mortgage prepayments or principal payments), interest payments on any other debt obligations that were incurred before February 15, 2020, and refinancing Small Business Administration (“SBA”) Economic Injury Disaster Loans (“EIDL Loans”) made between January 31, 2020 and April 3, 2020.    The maximum amount of a PPP loan that is eligible for forgiveness is equal to the amount spent on qualifying expenses during the 8-week benefit period, beginning on the date loan proceeds are received.  

According to the SBA Interim Final Rule issued on April 2, 2020, payroll costs consist of compensation to employees (whose principal place of residence is the United States) in the form of salary, wages, commissions, or similar compensation (cash compensation for each employee  is capped at $100,000 (as prorated if necessary) - subtract the amount of cash compensation paid to each employee in excess of $100,000 for each such employee); cash tips or the equivalent (based on employer records of past tips or, in the absence of such records, a reasonable, good-faith employer estimate of such tips); payment for vacation, parental, family, medical, or sick leave; allowance for separation or dismissal; payment for the provision of employee benefits consisting of group health care coverage, including insurance premiums, and retirement; and payment of state and local taxes assessed on compensation of employees.  Excluded “payroll costs” are any compensation to an employee whose principal place of residence is outside of the United States, qualified sick and family leave wages for which a credit is allowed under the Families First Coronavirus Response Act, and federal employment taxes imposed or withheld between February 15, 2020 and June 30, 2020, including the employee’s and employer’s share of FICA and Railroad Retirement Act taxes and income taxes required to be withheld from employees.  Note that for an independent contractor or sole proprietor, “payroll costs” consist of wage, commissions, income, or net earnings from self-employment or similar compensation that do not exceed $100,000.

Borrowers need to stay abreast of Treasury Department and SBA guidance because, for example, on April 2, 2020, SBA announced that no more than 25% of the loan forgiveness amount can be attributable to non-payroll costs.  That requirement does not appear in the CARES Act.

Keep your Employees on Your Payroll

To discourage borrowers from reducing the number of employees after receiving a PPP loan, the amount forgiven will be reduced proportionally by any reduction in the number of employees retained or reduction in pay of any employee beyond 25% of their prior year compensation during the 8-week period after receipt of the loan proceeds.

Businesses that re-hire laid off workers or raise wages to make up for salary reductions during the coronavirus crisis will not be penalized.  The reduction in the amount of loan forgiveness will not apply if either of the following occurs: if the reduction in the number of full time equivalent employees between February 15, 2020 and April 26, 2020 is completely eliminated by June 30, 2020; or if the salary or wages of one or more employees was reduced between February 15, 2020 and April 26, 2020, and the employer has subsequently restored the salary or wages by June 30, 2020.  If employees are furloughed but are brought back on June 30, 2020, doing so would likely satisfy part of the test, but you may find that you are unable to spend enough of your loan on qualified expenses to obtain complete forgiveness. There are also exceptions for seasonal employers.  You should consult with your attorneys and accountants prior to receiving funds to make sure you are employing the best strategy to maximize your loan forgiveness.

Keep Good Records and Carefully Document Your Forgiveness Request

Borrowers need to ensure that they are both spending the funds on the proper categories and—just as importantly—that they are able to document and demonstrate this in the future, especially if the PPP funds are commingled with other operating funds.  

A borrower must submit a request for loan forgiveness to its lender after the 8-week benefit period.  The SBA has not yet established a deadline by which a borrower must submit a loan forgiveness request to its lender.

Lenders are required to make the forgiveness determination within a 60-day period after the application is submitted; the amount of the loan not forgiven is due and payable within 2 years at interest of 1% per annum as mentioned above.  Loans (or portions of loans) that are forgiven under the PPP are not subject to federal taxation as discharge-of-indebtedness income, as the CARES Act specifically excludes them from gross income.

The forgiveness request needs to include a number of items, such as documentation to verify the number of full-time employees and their pay rates, as well as documentation to prove expenditures on eligible mortgages, leases, and utility obligations.  This documentation may include cancelled checks, payment receipts, transcripts of accounts, and other documentation.  Many businesses use a third-party payer such as a payroll provider to process payroll and report payroll taxes.  Treasury’s April 10, 2020 “Frequently Asked Questions” release states that payroll documentation provided by the payroll provider that indicates the amount of wages and payroll taxes reported to the IRS by the payroll provider for the borrower’s employees will be considered acceptable PPP loan payroll documentation. 

What Happens If I Don’t Spend Funds Appropriately or Keep Good Records

To the extent a PPP loan is not forgiven, the PPP loan has a maturity of 2 years from the date the loan proceeds are received at a fixed interest rate of 1% per annum.  Loan payments (principal, interest, and fees) are deferred for a period of 6 months, but interest will accrue during the deferment period.  There is no prepayment penalty, meaning a borrower will be able to repay the loan at any time before the maturity date.

SBA Interim Final Rule that requires PPP applicants to certify that “[t]he funds will be used to retain workers and maintain payroll or make mortgage interest payments, lease payments, and utility payments.”  That requirement came with a warning - knowingly using the loan proceeds for unauthorized purposes may lead to charges of fraud and possibly other federal crimes that could apply for misusing funds or making false statements about the intended use of the funds.  There are other considerations as well.  If a one of a borrower’s shareholders, members, or partners uses PPP funds for unauthorized purposes, SBA may have recourse against the shareholder, member, or partner for the unauthorized use.  In addition, the recipient will not qualify for loan forgiveness, as discussed in more detail above.

If you have questions regarding PPP loans or your business operations, please contact Emerson L. Dorsey, Jr., Barry Weiskopf, or any other member of Tydings’ business department.

This information has been prepared by Tydings for informational purposes only and does not constitute legal advice.