By Janell Wilson, CPA – Partner
April 21, 2020
A couple of weeks ago, many of our small business clients were anxiously waiting for banks to begin accepting Payroll Protection Program (PPP) loan applications. Fast forward two weeks, and many of you have the loan proceeds in your bank accounts available for use. Once PPP loan proceeds have been received, your 8-week covered period begins. Amounts spent from the loan proceeds on qualified expenses are eligible for loan forgiveness. From what we have been hearing, the support for these expenses will be looked at very carefully as part of the due diligence process. Although we are still awaiting further guidance from the Small Business Administration on the specifics of the loan forgiveness calculations and documentation needed, we have several recommended best practices to follow.
- We recommend that you set up a separate bank account for the loan proceeds. This will make it easier to show that the proceeds were spent for qualified purposes.
- Loan proceeds may be used to pay the following payroll costs:
- Wages, salaries, commissions (not exceeding $100,000 annual salary per year per employee, as prorated)
- Payment for vacation, parental, family, medical, or sick leave
- State and local taxes on employee compensation (i.e. SUTA)
- Group health care benefits (employer portion)
- Retirement benefits
- Loan proceeds may be used for the following non-payroll costs:
- Interest on mortgage debt secured by real or personal property incurred before February 15, 2020
- Interest on other debt incurred before February 15, 2020 (not allowable for forgiveness)
- For maximum loan forgiveness, at least 75% of the loan proceeds should be spent on payroll costs. The definition of payroll costs for determining forgiveness appears to mirror the definition used for the loan application process, although we are still waiting for additional guidance to confirm. The other 25% can be spent on rent, utilities and mortgage interest as indicated above.We recommend that as you receive payroll reports for each pay period, you transfer from the new bank account that holds the loan proceeds the amount equal to gross payroll and SUTA. Do not include amounts for the employer portion of payroll taxes (Social Security and Medicare) or Federal Unemployment tax, as these are not an allowable use of the funds.
- Rent, utilities, and mortgage interest can be paid directly from the new bank account. If you previously had direct debit set up, you may choose to continue to pay these expenses from your operating account, and then transfer funds from the new account to the operating account for reimbursement.
- You should start putting together a file of supporting documentation for the use of the loan proceeds, including payroll reports during the covered period, health insurance bills, and invoices for utilities paid. To support rent payments, documentation should include a copy of the lease as well as check copies. Bank statements from the new account will show the disbursements of the loan proceeds.
- At the end of the 8-week period, you may need to transfer funds between the new bank account and the operating account to adjust for certain disallowed costs, such as wages, salaries, and commissions exceeding the maximum threshold of $15,385 for the 8-week period ($100,000 annualized.)
The intention of the PPP was to allow small businesses to continue to employ and pay employees. For maximum loan forgiveness, in addition to the 75/25 rule discussed above, there are two metrics that will impact the amount of the loan forgiveness: headcount and level of pay.
- Headcount – A reduction in employee headcount can trigger a reduction in the amount of loan forgiveness. In general, a lower headcount during the 8-week forgiveness period compared to the headcount for the base period will result in a pro rata reduction in the amount forgiven. The base period can be either the period January 1, 2020 to February 29, 2020 or the period February 15, 2019 to June 30, 2019, whichever is more favorable for the company. The headcount used for this purpose is the average number of full-time equivalent employees for each pay period falling within a month.
- Level of Pay – A reduction in individual employee pay levels can trigger a reduction in the amount of loan forgiveness. In general, a decrease in employee pay levels during the 8-week period relative to an earlier period will result in a reduction in the amount forgiven. This calculation applies to employees who earned less than $100,000 on an annualized basis.
The good news is that the headcount and/or a level of pay reductions can be avoided if by June 30, 2020 you have restored headcount and/or level of pay to the same levels as at February 15, 2020.
As we await further guidance from the Small Business Administration on many questions raised with respect to the information presented above, we will continue to closely monitor these developments and keep you informed. If you have any questions, please contact your MichaelSilver tax professionals at 847.982.0333.