[This article now includes relevant updates based on the SBA’s release of the Interim Final Rule on Thursday evening, April 2, 2020.]

During the last week of March, the U.S. Senate blurred party lines and made a unified, bipartisan push to approve the Coronavirus Aid, Relief, and Economic Security Act (CARES Act, or the “Act”) with a 96-0 unanimous vote, which was subsequently approved by the House and then, without hesitation, signed into law by President Trump. The diversified financial, tax, and health stimulus package covers $2 trillion in relief across an 880-page Act, capturing the immediate attention of both business owners and operators of all shapes and sizes. For sake of comparison, the 2017 Tax Cuts and Jobs Act was estimated to cost $1.5 trillion over 10 years.  

While the Act introduces a litany of payroll and income tax provisions, many of these pro-taxpayer measures may take weeks, if not months, to provide material liquidity to employers; many of which are already on “economic-life-support” after revenue streams have come to a complete standstill. 

Enter the “Paycheck Protection Program” (herein, the “Program” or “PPP”), certain to be the hallmark of the Act for certain business owners. The opening performance of this Act has immediately caught the eye of many employers, with an unprecedented forgivable loan program; offering $349 billion of federally guaranteed loans earmarked for certain “small businesses and organizations.”  The Act also includes certain “sweeteners” to lenders as inducements to lend and to lend quickly. 

Within less than a week after the passage of the Act, the U.S. Treasury issued a 4-page “Fact Sheet” summarizing some key provisions of the program, clarifying some details on timing and administration of the program. Similarly the Small Business Administration released a very brief overview of the program on their webpage containing some very important details, in particular, the interest rate (.5%) [UPDATE: 1%] and term (2-years) of the loans.  The SBA has also released a sample application form which lenders have leveraged to develop their own versions of the loan application. 

Per the Fact Sheet, businesses may begin to apply for the loans on April 3, 2020, just three days after the release of the initial guidance.  At the time this article is written, we sit on the eve of “application day” for which for many banks and lending institutions is certain to be a stress-test unlike no other experienced before.  Note A&M Taxand has heard from several experts in the lending community that many banks and non-bank lenders will not be ready to take the applications on April 3, and others are reluctant to participate in the program due to many uncertainties that still exists today on how and when the loans will ultimately move off their books.  Notwithstanding, some are expecting the $349 billion in funding to dry up in as few as 1-2 days.  The bottom line is both business and lenders are filled with uncertainty on how the administration of the PPP will ultimately shake out. 

General Overview of PPP Eligibility and Features

A significant expansion of the Small Business Administration 7(a) Loan Program, the Paycheck Protection Program dramatically expands the field of eligible organizations beyond just “small businesses” and now has many other larger businesses scrambling to determine whether they may qualify under the modified definitions. 

Under the program, the question of eligibility and the determination of maximum benefits require a close look at a business’ ownership structure and organizational documents, as well as their U.S. federal income, payroll, and information tax filings.  

Some additional key features of the program are as follows: 

1. Loan forgiveness is NOT subject to Federal income tax,
2. The SBA and lenders will waive fees charged to borrowers in connection with origination,  
3. There is no requirement to demonstrate an inability to seek financing elsewhere,
4. No personal guarantees and/or collateral are required,
5. A 0.50% fixed interest rate, and [UPDATE: The IFR has now set the rate at 1%.]
6. Automatic deferral of at least 6 months (but not longer than a year). 

However, the feature that will continue to capture the attention of business owners and operators across the country is that complete forgiveness may be approved on eligible loan proceeds dedicated towards certain “allowable uses” (payroll costs (including benefits costs and state and local taxes assessed on compensation), mortgage interest, rent, and utilities).  Under current guidance, there is no suggestion that a business must demonstrate an unhealthy balance sheet or first exhaust their pre-existing working capital and reserves before accessing the PPP loans (thereby preserving future liquidity needs after the loan proceeds are depleted). Rather, as part of the application process, companies must simply certify in good faith that the current economic uncertainty makes the loan necessary to support ongoing operations.

Notwithstanding, certain “penalties” (e.g., reduction of forgiveness amount) will apply for employers that reduce their employees/payroll during the covered period in comparison to prior tested periods (in addition to other penalty provisions).  On the other hand, there are certain incentives offered to employers that re-hire employees that have been recently fired. 

PPP Loan vs. Economic Injury Disaster Loan (EIDL)

As many of our clients have or are currently in the process of applying for certain SBA loans, it’s worth distinguishing the PPP from the Economic Injury Disaster Loan (EIDL) program, which has also been modified by the Act.  Consider these important distinguishing requirements for the EIDL: 

1. Qualifying Small Businesses must generally be owner-operated (expanded to include private non-profit organizations and small agricultural cooperatives), 
2. EIDL Loans are issued via application to the SBA and the loans are funded directly through the SBA,
3. Collateral requirements are required by owner/business on the assets of such business on loans greater than $25,000,  
4. Personal guarantees are required on loans in excess of $200,000, 
5. The loan is NOT forgivable (but a prior EIDL may be eligible to be refinanced into a PPP loan), 
6. Funding may take as long as one month if approved, but will provide up to $10,000 of immediate funding upon application once eligibility has been verified, and
7. The maximum loan is capped at $2 million. 

Unlike the EIDL, the PPP Loans will be granted by direct lenders that are SBA approved.  While the loans will be underwritten by the SBA, the lending institutions will be responsible for evaluating the eligibility of applicants and determining the maximum eligible loan amounts (at least initially). 

Considering these distinguishing factors above, the two most important questions that business owners and operators have been hurriedly trying to answer: 1) do I qualify for the loan and, if so, 2) what is the maximum amount of funding that can be applied for? 

A Step-by-Step Walk Through the PPP

“Any business concern…”

The field of eligible businesses has been dramatically broadened to include “any business concern, private nonprofit organization, or public nonprofit organization which employs not more than 500 employees,”[1] tossing aside previous requirements of independent ownership and operation (among other narrow restrictions). Subsequent guidance expanded the list of eligible businesses to explicitly include veterans organizations, Tribal business concerns, sole proprietorships, self-employed individuals, and independent contractors.[2] 

Note the 500-employee rule is expanded for business concerns in the “accommodation and food services” industry.  For these businesses (confirmed with NAICS Code 72), they may still qualify if they employ fewer than 500 employees per location.  There are other additional broadened definitions for certain franchisees and businesses receiving financial investments from small business investment companies. 

The 500-employee rule requires a close look at the legal structure and organizational documents for certain businesses with complex ownership structures, particularly commonly controlled enterprises.  The private equity and venture capital markets were hoping for some relaxation on how the SBA would apply certain of its “Affiliation Rules” that require businesses under common control to aggregate employees for the 500-employee test.  Unfortunately, the SBA did not modify any of the pre-existing Aggregation Rules and commonly owned PE/VC portfolio companies have largely been left on the outside looking in.   

The current SBA affiliation regulations make it clear that affiliation is based on the concept of control, and that the SBA has a broad ability to determine control based on all the facts and circumstances.  Outside of the exceptions noted above, the Act currently does not provide any overriding or clarifying provisions on how affiliation should be determined.  

13 CFR § 121.103(a)(1) says that affiliation exists where one entity has the power to control the other.  And 13 CFR § 121.103(a)(2) says that “SBA considers factors such as ownership, management, previous relationships with or ties to another concern, and contractual relationships, in determining whether affiliation exists.”  The “such as” in (a)(2) indicates that SBA affiliation is a facts and circumstances test.  

13 CFR § 121.103(a)(5) makes the breadth of the SBA affiliation standard explicit: “In determining whether affiliation exists, SBA will consider the totality of the circumstances, and may find affiliation even though no single factor is sufficient to constitute affiliation.”

NOTE: Any business concern that is not eligible under the PPP should consider eligibility for the Employer Retention Tax Credit (ERC) which may provide relief for business that have been legally mandated to close their doors or have gross receipts below 50% as compared to the comparable quarter in 2019.  These businesses should also immediately consider deferring the employer’s portion of their Social Security taxes that are due from March 27, 2020 through the end of the year.

“Maximum Loan Amount” 

During the “covered period” between February 15, 2020, and June 30, 2020, an eligible recipient may apply for a covered loan equal to the lesser of: 

• 2.5 x average monthly payroll costs [3], or
• $10 million.  

Note per the Act, average monthly payroll costs are determined based on the 12-month period prior to the loan issuance.  Certain adjustments and election may be made for seasonal employers that were not in operation between February 15, 2019 and June 30, 2019, and for new business (provided they are in business by February 15, 2020 at the latest). The amount may be increased by loans received via the SBA Disaster Loan Program. 

However, it has been seen that many banks are currently applying a test based on payroll costs in the 2019 calendar year, as these can more easily be verifying and documented with prospective borrowers Forms 940 and 941 (and Forms 1099-MISC) that have already been filed with the IRS.  It is yet to be seen whether the SBA will force lenders to more strictly apply the testing period prescribed by the acts, which for most borrowers would pull in payroll costs from April 2019 to March 2020.  

“Payroll Costs”

While a narrow reading of “payroll costs” might lead employers to look specifically to Internal Revenue Code (“IRC”) Section 3121 Wages (what we all know as “W-2 wages”), the Act has a friendlier definition that includes the following amounts to the multiplied base: 

• Salary, wages, commissions, or tips (capped at $100,000 on an annualized basis for each employee);
• Employee benefits costs, including:
  • Costs for vacation, parental, family, medical, or sick leave;
  • Allowances for separation or dismissal;
  • Payments required for the provision of group health care benefits, including insurance premiums; and
  • Payment of any retirement benefits.
• Employer share of state and local taxes assessed on compensation; and 

For sole proprietors or independent contractors, their payroll base includes wages, commissions, income, or net earnings from self-employment, capped at $100,000 on an annualized basis for each employee.

However, expressly excluded from the payroll cost base are the following:

• Wages to employees or self-employed payees in excess of $100,000 annualized for each employee, 
• Any form of compensation paid to non-resident taxpayers,
• Payroll tax withholding [Emphasis Added], and
• Paid leave benefits and compensation under other COVID-19 relief programs.

The Act quietly snuck in the above-mentioned exclusion for “taxes imposed or withheld under chapters 21, 22, or 24 of the Internal Revenue Code” (i.e., payroll tax withholding for Federal income tax and FICA) which has caused some confusion among borrowers and lenders.  In effect, borrowers must reduce their gross W-2 wage base by any payroll tax withholding, not including state income tax withholding. 

Note, special rules should be considered for seasonal employers or entities that began business after the testing period allowing for certain prorated computations.   

“Allowable Uses of Covered Loans”

During the covered period, a loan recipient may generally only be allowed to use the proceeds for the following:

1. Payroll costs, including benefits, 
2. Mortgage interest (for mortgage obligations incurred before February 15, 2020), 
3. Rent (under lease agreements in force before February 15, 2020),
4. Utilities (for which services began before February 15, 2020), and 
5. Interest on prior debt obligations (incurred before February 15, 2020). 

“Nonrecourse” 

To the extent the loan proceeds are used for the allowable uses described above, the SBA will have no recourse for non-payment the loans.  Simply put but, a business that uses the loans for qualified expenditures that are not able to survive as a going concern will not face concerns that lenders may seek non-business assets as recourse under this program.  

“[Other] Borrowing Requirements”

A company seeking funding under the Program should be willing to certify that they are adversely affected by the current economic conditions impacted by COVID-19 and they intend to use the loan to help retain workers and stay current on the other categories of operating expenses described above.

“Loan Forgiveness”

Provided payroll and employment is maintained through the covered period and the covered loan proceeds are used for allowable uses, an eligible borrower may be forgiven for the amounts spent on a subset of allowable uses which include: 

1. Payroll costs, 
2. Mortgage interest, 
3. Rent, and
4. Utilities. 

However, the eligible forgiveness may be reduced in certain circumstances where employers reduce their employee headcount and payroll during the covered period (as compared to prior periods).  Employers can avoid any reduction in the forgiveness amount by re-hiring employees that have been recently fired at their previous pay rate.    Based on initial guidance, due to anticipated demand, the SBA anticipates that not more than 25% of the forgiven amount may be for non-payroll costs. 

Did You Say Tax?

The PPP reaches several important income and payroll-related tax topics: 

Employee Aggregation – Clients should be working with lenders and their lawyers to make preliminary assessments on their ownership structure to determine qualification under the 500-employee test, considering the aggregation rules.  While this conclusion may ultimately be based on a subjective legal interpretation of “control,” lenders are likely to look at tax returns and other corroborating evidence of ownership to determine whether certain prospective borrowers may require aggregation with other commonly controlled business.  

Payroll Costs – Business enterprises that become comfortable on eligibility for the PPP should immediately start analyzing, collecting, and documenting information and data points in connection with establishing the payroll cost base and Maximum Loan Amount.  Certain sub-categories of payroll costs are specifically tied to various types of compensation and payments that are defined within the IRC, it is important to accurately pool the qualifying amounts well in advance of entering discussions with the SBA.  Employers should also be ready to quickly and accurately support the proposed balances under the stringent documentation requirements under the PPP, which include IRS payroll tax filings, state income, payroll, and unemployment insurance filings, and financial statements verifying payment on certain debt obligations. 

Income Tax Consequences – While the forgiveness of loans is explicitly excluded from Federal income tax under the PPP, any other alternative outcome aside from full forgiveness may give rise to Federal (and likely State) income tax consequences in the future (for example, in the case of default, modification, or forgiveness outside of the covered period). Further, it is not clear as to whether the loan forgiveness may be excluded from income for State tax purposes 

Employer Retention Tax Credit (ERC) – The Act also includes a refundable payroll tax credit for employee retention.  A company that receives a PPP loan may not claim the ERC, and any ERC amounts claimed before the issuance of a PPP loan will be reclaimed.  Ineligible borrowers should also consider suspending the employer share of FICA tax. Note that A&M Taxand is helping clients to analyze both the potential ERC benefit as well as the PPP’s overall value to assess which program may be more valuable for individual clients.  Companies that are not eligible for PPP should strongly consider ERC and deferral of FICA. 

Alvarez and Marsal Taxand Says:

With food and beverage establishments, hotels, fitness studios, spa/beauty salons, commuting services, and other “non-essential” retail establishments shutting their doors indefinitely or significantly reducing operations, with no clear target to reopen or return to full capacity, business owners and operators are looking for lifelines. These businesses should be moving as quickly as possible to work with their lenders to “get in line” for the PPP loans. Generally, A&M Taxand recommends working with pre-existing banking relationships provided they are SBA approved to expedite the process (and to avoid restarting Know-Your-Customer and Anti-Money Laundering procedures).  With the finite amount of loan funding and anticipated high demand, we recommend acting fast concerning the PPP. A&M Taxand, along with our other diversified in-house consulting groups, is here for our clients in this time of need so please do not hesitate to reach out.   

[1] Alternatively, a greater threshold may apply based on the SBA’s “size standard” specific to NAICS industries: https://www.sba.gov/sites/default/files/2019-08/SBA%20Table%20of%20Size%20Standards_Effective%20Aug%2019%2C%202019.pdf 

[2]  https://home.treasury.gov/system/files/136/PPP%20Borrower%20Information%20Fact%20Sheet.pdf 

[3]  Determined based on the 12-month period prior to the loan issuance. Certain adjustments and election may be made for seasonal employers that were not in operation between February 15, 2019 and June 30, 2019, and for new business (provided they are in business by February 15, 2020 at the latest). The amount may be increased by loans received via the SBA Disaster Loan Program.