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Calculating PPP Loan Forgiveness
In mid-June, the Small Business Administration (SBA) released new rules and application forms for Paycheck Protection Program (PPP) loan forgiveness in response to changes made to the PPP by the Paycheck Protection Program Flexibility Act (PPPFA), enacted June 5, 2020. This article provides an overview of the PPP loan forgiveness application process and offers guidance on calculating PPP loan forgiveness.
To apply for PPP loan forgiveness, borrowers must submit either the newly revised SBA Form 3508 or, if eligible, the shorter SBA Form 3508EZ to their lenders, along with supporting documentation. These revised forms replace the applications originally published by the SBA on May 15, 2020. The revised forms and their accompanying instructions are complex, so we encourage any PPP borrower to review the application and associated instructions carefully, work through their application with this guide, and consult their legal counsel or financial advisers with any questions regarding their particular circumstance.
Overview: Calculating the Loan Forgiveness Amount
Generally, borrowers are eligible for PPP loan forgiveness for payroll costs and certain non-payroll costs. The loan forgiveness amount may be reduced if the borrower cut their employee headcount, salary, or hourly wages. To determine how much of their PPP loan will be forgiven, borrowers will need to go through the following steps:
- Payroll and Non-Payroll Costs
- Step 1: Choose the Covered Period.
- Step 2: Determine the amount of eligible payroll costs.
- Step 3: Determine the amount of eligible non-payroll costs.
- Step 4: Add Step 2 and Step 3.
- Adjustments for Salary/Wage Reductions and Full-Time Equivalency
- Step 5: Determine the Total Salary/Hourly Wage Reduction.
- Step 6: Reduce the amount from Step 4 by Total Salary/Hourly Wage Reduction.
- Step 7: Determine FTE Reduction Quotient.
- Calculate Forgiveness Amount
- Step 8: Multiply Step 6 by Step 7 to find the “Modified Total.”
- Step 9: Determine forgiveness amount, which will be lesser of:
- (i) Modified Total;
- (ii) PPP Loan Amount; or
- (iii) Payroll Cost 60% requirement (divide Step 2 by 0.60)
PPP Loan Forgiveness Application: SBA Form 3508 v. SBA Form 3508EZ
Before diving into the loan forgiveness application process, borrowers should determine whether they are eligible to file the simplified application, SBA Form 3508EZ. The new simplified application allows certain borrowers to avoid calculating complicated reductions to their forgiveness amount. Borrowers eligible to file Form 3508EZ include:
- Self-employed individuals, independent contractors, or sole proprietors who did not have employees at the time they applied for a PPP loan and did not include employee salaries or wages when they determined average monthly payroll;
- Borrowers that have not reduced any employee’s salary or wages more than the permitted amount and have not reduced headcount of hours paid between January 1, 2020 and the end of the Covered Period; or
- Borrowers that have not reduced any employee’s salary or wages more than the permitted amount and were unable to operate at pre-pandemic levels due to compliance with HHS, CDC, or OSHA guidance.
If you are eligible to file Form 3508EZ, follow this guide but skip Step 5–Step 8. Any differences between the two forms are noted throughout this guide.
In-Depth: Working through Each Step
Borrowers that are prepared to apply for loan forgiveness should carefully review SBA Form 3508, which includes the PPP Loan Forgiveness Calculation Form, PPP Schedule A, and the Schedule A Worksheet, as well as the accompanying instructions. (Or, alternatively, SBA Form 3508EZ and its accompanying instructions.) This in-depth guide can be used as you prepare your loan forgiveness application.
Payroll and Non-Payroll Costs
Step 1: Choose the Covered Period. Throughout the loan forgiveness application, borrowers are asked to measure expenses and assess their workforce during the “Covered Period” or “Alternative Payroll Covered Period.” Borrowers will need to choose this period on the first page of the Calculation Form or SBA Form 3508EZ.
The Covered Period will typically be the 24-week (168-day) period beginning on the PPP loan disbursement date. If, however, the borrower received its PPP loan before June 5, 2020, the borrower may elect to use an eight-week (56-day) Covered Period. In either case, the Covered Period cannot extend past December 31, 2020.
For administrative convenience, borrowers with a biweekly or more frequent payroll schedule may elect to calculate eligible payroll costs using the 24-week or 8-week period that begins on the first day of their first pay period following their PPP loan disbursement date – the Alternative Payroll Covered Period. In no event may the Alternative Payroll Covered Period extend beyond December 31, 2020.
Although electing the Alternative Payroll Covered Period may offer some convenience, borrowers will need to pay close attention to the language in the application and instructions. Borrowers that elect to use the Alternative Payroll Covered Period must apply the Alternative Payroll Covered Period wherever there is a reference in this application to “the Covered Period or the Alternative Payroll Covered Period.” However, borrowers must apply the Covered Period –and not the Alternative Payroll Covered Period) wherever there is a reference in the application to “the Covered Period” only.
Step 2: Determine eligible payroll costs. Determine the amount of eligible payroll costs paid or incurred during the 24-week or 8-week Covered Period or Alternative Payroll Covered Period by completing Schedule A lines 1, 4, 6, 7, 8, 9 and entering total payroll costs on line 10 of Schedule A and line 1 of the Calculation Form. Those completing the simplified application only need to enter total payroll cost on line 1 of SBA Form 3508EZ.
Eligible payroll costs include cash compensation for employees whose principal place of residence is in the US in the form of salary, wages, commissions; cash tips (based on an employer’s records of past tips or a good faith estimate); payment for vacation, parental, family, medical, or sick leave; allowance for separation or dismissal; payment for the provision of employee benefits such as health care coverage or retirement; and payment of state or local taxes. For independent contractors or sole proprietors, payroll costs include wages, commissions, income, or net earnings.
For each employee, the total amount of cash compensation eligible for forgiveness may not exceed a prorated amount of a $100,000 annual salary. For those using the 8-week Covered Period, this is $15,385; for those using the 24-week Covered Period, this is $46,154. For business owners, however, there is a limit of $20,833 for those using the 24-week Covered Period or the 2.5-month equivalent of their applicable compensation in 2019, whichever is lower. For an 8-week Covered Period, this amount is capped at 8/52 of 2019 compensation (up to $15,385).
Payroll costs do not include any compensation for non-US resident employees, any compensation in excess of an annual salary of $100,000, prorated as necessary, federal employment taxes, qualified sick and family leave wages under the Families First Coronavirus Response Act (Pub. L. 116-127).
Payroll costs must be paid or incurred during the Covered Period or Alternative Payroll Covered Period. Costs are considered paid on the day that paychecks are distributed or the borrower originates an ACH credit transaction. Costs are considered incurred on the day that the employee’s pay is earned. Borrowers should count payroll costs that were both paid and incurred only once. Payroll costs incurred but not paid during the borrower’s last pay period of the Covered Period or Alternative Covered Period are eligible for forgiveness if they are paid on or before the next regular payroll date.
Step 3: Determine eligible non-payroll costs. Determine the amount of eligible non-payroll costs paid or incurred during the 24-week or 8-week Covered Period or Alternative Payroll Covered Period and enter the total costs on lines 2, 3, and 4 of the Calculation Form or SBA Form 3508EZ. Borrowers are not required to include payments that they do not want included in the loan forgiveness amount. Eligible non-payroll costs include:
- Business mortgage interest payments–payments of mortgage interest (not including any prepayment or payment of principal) for mortgage obligations incurred before February 15, 2020.
- Business rent or lease payments–payments pursuant to lease agreements in force before February 15, 2020.
- Covered utility payments–business payments for gas, electricity, water, telephone, transportation, or internet access for service which began before February 15, 2020. It is not yet clear whether internet services will be included.
The total amount of eligible non-payroll costs cannot exceed 40% of the total forgiveness amount. This is a notable change from the original application, which allowed no more than 25% of the loan forgiveness amount to be comprised of non-payroll costs.
Adjustments for Salary/Wage Reductions and Full-Time Equivalency
Step 5: Determine the Total Salary/Hourly Wage Reduction. Borrowers filing Form 3508 will then need to calculate any reductions to the amount of their PPP loan eligible for forgiveness. Under the CARES Act, the amount of a PPP loan that is forgivable may be reduced if a borrower cut employees’ salaries or hourly wages by more than 25% during the Covered Period or Alternative Payroll Covered Period as compared to the period of January 1, 2020 through March 31, 2020. In certain cases, borrowers may qualify for a safe harbor to avoid this reduction. To determine whether to reduce the amount of loan forgiveness, borrowers will need to complete the Worksheet with information about all employees, their full-time equivalency, and whether their salaries were reduced–or obtain an equivalent report from their payroll system or processor.
Borrowers will first need to complete Table 1 of the Worksheet by entering the name and last four SSN digits of any employee who was employed at any point during the Covered Period or Alternative Payroll Covered Period whose principal place of residence is the US and who received an annualized rate of total compensation of less than or equal to $100,000 in 2019 or were not employed in 2019. Borrowers shouldn’t include any independent contractors, owner-employees, self-employed individuals or partners here.
Next, borrowers will need to enter each employee’s cash compensation on Table 1. Cash compensation is the sum of gross salary, gross wages, gross tips, gross commissions, paid leave (vacation, family, medical or sick leave, not including leave covered by the Families First Coronavirus Response Act), and allowances for dismissal or separation paid or incurred during the Covered Period or the Alternative Payroll Covered Period. The amount of cash compensation eligible for forgiveness cannot exceed a prorated share of an annual salary of $100,000, which is $15,385 for borrowers electing an 8-week Covered Period or $46,154 for borrowers electing a 24-week Covered Period.
Borrowers can then determine whether they meet the Salary/Hourly Wage Reduction Safe Harbor and, if not, calculate the necessary Salary/Hourly Wage Reduction by following the steps outlined in the instructions for each employee listed on Table 1:
- Determine if pay was reduced by more than 25% by dividing the average annual salary or hourly wage during the Covered Period or Alternative Payroll Covered Period by the average annual salary or hourly wage between January 1, 2020 and March 31, 2020. If this is 0.75 or more, enter 0 in the Salary/Hourly Wage Reduction column on Table 1 for that employee. If this is less than 0.75, proceed to Step 2.
- If a borrower reduces its employees’ salaries or hourly wages but then eliminates the reduction, it may fall into the Salary/ Hourly Wage Reduction Safe Harbor. Determine if the Salary/Hourly Wage Reduction Safe Harbor is met by comparing the employee’s annual salary or hourly wage as of February 15, 2020 to their average annual or hourly wage between February 15, 2020 and April 26, 2020.
- If the average salary or hourly wage is equal or greater than the annual salary or hourly wage as of February 15, 2020, the Salary/Hourly Wage Safe Harbor has not been met. Skip to Step 3.
- Otherwise, compare the employee’s annual salary or hourly wage as of February 15, 2020 to their annual or hourly wage as of either December 31, 2020 or the date the loan forgiveness application is submitted, whichever is earlier. If the employee’s salary or hourly wage as of the later date is equal or greater than their salary or hourly wage as of February 15, 2020, the Salary/Hourly Wage Safe Harbor has been met and the borrower should enter 0 in the Salary/Hourly Wage Reduction column on Table 1 for that employee. If the safe harbor has not been met, proceed to Step 3. Notably, the PPPFA extends the deadline to eliminate any reduction to an employee’s compensation to the earlier of December 31, 2020 or the date the loan forgiveness application is filed. As such, employers should carefully consider whether they anticipate reducing salaries or hourly wages at the end of the year.
- Determine the Salary/Hourly Wage Reduction by first multiplying the average hourly salary or hourly wage between January 1, 2020 and March 31, 2020 (from Step 1) by 0.75 and then reducing the average annual salary or hourly wage during the Covered Period or Alternative Payroll Covered Period (also from Step 1).
- If the employee is an hourly worker, compute the total amount of the reduction that exceeds 25% by multiplying the average number of hours they worked per week between January 31, 2020 and March 31, 2020 by the Salary/Hourly Wage Reduction, and then multiplying by 24 if using a 24-week Covered Period or 8 if using an 8-week Covered Period. Enter this number for this employee in Table 1.
- If the employee is a salaried worker, compute the total amount of the reduction that exceeds 25% by multiplying the Salary/Hourly Wage Reduction by 24 if using a 24-week Covered Period or 8 if using an 8-week Covered Period and dividing that total by 52. Enter this number for this employee in Table 1.
- Once this process has been completed for each employee, enter the total amount of Salary/Hourly Wage Reductions in Box 3 of Table 1, line 3 of Schedule A, and line 5 of the Calculation Form.
Step 6: Reduce the amount from Step 4 by the Salary/Hourly Wage Reduction. On line 6 of the Calculation Form, borrowers filing SBA Form 3508 should add the total amount of eligible payroll and non-payroll costs (determined in Step 4, above) and subtract the total Salary/Hourly Wage Reduction calculated in Step 5, above.
Step 7: Determine the FTE Reduction Quotient. For borrowers filing SBA Form 3508, the CARES Act similarly reduces the amount of a PPP loan that can be forgiven if a borrower reduces its average number of full-time equivalency (FTE) employees during the Covered Period or Alternative Payroll Covered Period, unless either of the FTE Reduction Safe Harbors apply.
Calculate Total Average FTE. Borrowers will first need to calculate the average FTE for the Covered Period or Alternative Payroll Covered Period on Table 1 and Table 2 of the Worksheet in one of two ways. For each employee, borrowers can enter the average number of hours paid per week, divide by 40, and round the total to the nearest tenth. The maximum for each employee is capped at 1.0. Alternatively, borrowers can elect a simplified method that assigns 1.0 for employees who work 40 hours or more per week and 0.5 for employees that work fewer than 40 hours per week. The subtotals from Table 1 and Table 2 should be entered on Schedule A lines 2 and 5, respectively, and the total average FTE should be entered on Schedule A line 12.
If a borrower has not reduced the number of employees or the average paid hours of its employees between January 1, 2020 and the end of the Covered Period, its PPP loan forgiveness amount will not be reduced. These borrowers should check the appropriate box on Schedule A and enter 1.0 as their FTE Reduction Quotient on Schedule A and the Calculation Form. On the other hand, if a borrower has had to make reductions to its workforce or hours worked, it will need to determine whether it is exempt from a reduction to its loan forgiveness amount.
FTE Reduction Safe Harbors. The revised application introduces two new safe harbors that may exempt borrowers from any loan forgiveness reduction. The first FTE Reduction Safe Harbor applies to borrowers that can demonstrate, in good faith, that they were unable to operate at their pre-pandemic business level between February 15, 2020 and the end of the Covered Period due to HHS, CDC, or OSHA sanitation, social distancing, or employee and customer safety guidance. Notably, this does not cover state or local guidance.
The second FTE Reduction Safe Harbor covers borrowers who reduced their FTE employee levels between February 15, 2020 and April 26, 2020 and then restored FTE employee levels no later than December 31, 2020 to the level that existed during the borrower’s pay period that included February 15, 2020. To determine whether this applies, borrowers will need to complete the FTE Reduction Safe Harbor 2 section of the Worksheet.
If either of these FTE Reduction Safe Harbors are met, borrowers simply need to check the box on Schedule A and enter 1.0 at their FTE Reduction Quotient on Schedule A and the Calculation Form. Although no documentation needs to be submitted for either safe harbor, borrowers are required to maintain any supporting documentation for up to 6 years.
Calculate the FTE Reduction Quotient. If borrowers have reduced the number of employees or the average paid hours and are not covered by an FTE Reduction Safe Harbor, they will need to calculate their FTE Reduction Quotient. To do this, borrowers will first choose a reference period:
- February 15, 2019 to June 30, 2019;
- January 1, 2020 to February 29, 2020; or
- In the case of seasonal employers, either of the preceding periods or any consecutive 12-week period between May 1, 2019 and September 15, 2019.
Next, using the same method that was used to calculate average FTE for the Covered Period or Alternative Payroll Covered Period on the Worksheet, borrowers will calculate average FTE for each employee for their chosen reference period. The SBA has not created a worksheet for this calculation. Enter the sum across all employees during the reference period on Schedule A line 11.
Finally, borrowers will calculate the FTE Quotient by dividing the total average FTE on Schedule A line 12 (the sum of Schedule A lines 2 and 5) by the total average FTE during their chosen reference period. This figure should be entered on Schedule A line 13 and line 7 of the Calculation Form.
Exceptions. According to the PPPFA and the CARES Act, certain FTE reductions will not affect the borrower’s loan forgiveness. These include:
- Any positions for which the borrower made a good-faith, written offer to rehire an employee and the borrower was unable to hire similarly qualified employees on or before December 31, 2020;
- Any positions for which the borrower made a good-faith, written offer to restore any reduction in hours, at the same salary or wages, during the Covered Period or the Alternative Covered Period and the employee rejected the offer; and
- Any employees who were fired for cause, voluntarily resigned, or voluntarily requested and received a reduction of their hours during the Covered Period or Alternative Covered Period.
Calculate the Forgiveness Amount
Step 8: Determine the Modified Total. Borrowers filing SBA Form 3508 should then multiply the amount of eligible payroll and non-payroll costs less the Salary/Hourly Wage Reduction (calculated in Step 6, above) by the FTE Reduction Quotient (calculated in Step 7, above). This is the “Modified Total.”
Step 9: Determine the forgiveness amount. For borrowers filing SBA Form 3508, the total amount of the PPP loan that is eligible for forgiveness will be lesser of:
- the Modified Total;
- the PPP loan amount; or
- Payroll Cost 60% requirement (divide Step 2 by 0.60).
Alternatively, for borrowers filing SBA Form 3508EZ, the total amount of the PPP loan that is eligible for forgiveness will be the lesser of:
- the total payroll and non-payroll costs;
- the PPP loan amount; or
- Payroll Cost 60% requirement (divide Step 2 by 0.60).
Interest. The forgiveness of interest on PPP loans remains unclear. Although the SBA’s interim final rules refers to forgiveness of loan interest, the revised application forms do not include interest in the calculation of the loan amount to be forgiven.
Timing. Borrowers may submit a loan forgiveness application before the end of the Covered Period if they have used all of the loan proceeds for which they are requesting forgiveness. However, borrowers must submit a completed loan forgiveness application to their lenders within 10 months after the Covered Period for the loan ends. Once the lender has received the completed documents, it will have 60 days to issue a decision on loan forgiveness to the SBA.
Borrowers using Form 3508 must submit the Calculation Form, signature page, and Schedule A as their loan forgiveness application. Along with these forms, borrowers are required to submit:
- Payroll documentation, such as bank account statements, tax forms, payment receipts or account statements for benefits;
- FTE documentation showing the average number of FTE employees on payroll per week during the covered period; and
- Non-payroll documentation, such as a copy of their amortization schedules, current lease agreements, or utility invoices the corresponding receipts or canceled checks.
A borrower must also maintain certain records that they are not required to submit. These include the Worksheet, documentation supporting each employee reported on Schedule A, safe harbor reductions, any job offers and refusals, and any HHS requirements for reopening. The borrower will need to maintain these files for 6 years after the date the loan is forgiven or repaid in full and permit authorized SBA representatives to access these files upon request.
Borrowers filing Form 3508EZ do not need to provide detailed information regarding every employee and their cash compensation and hours worked, though they are still required to submit copies of bank account statements or third-party payroll service provider reports documenting the amount of cash compensation paid to employees, tax forms, and other documentation to their lenders.
Disclaimer: This article is the copyright of TKN Law and is republished on this site for the benefit of the IBA community. The original version of this article can be found here. This article is provided only for general educational and informational purposes and should not be construed as legal advice or creating an attorney-client relationship between the reader and TKN Law.
If you have questions relating to the content of this article or legal services associated with business, investment, or real estate, Tony K. Nguyen would welcome the opportunity to be a resource. Mr. Nguyen can be reached at (206) 501-1622 or firstname.lastname@example.org.
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