How Paycheck Protection Program's (PPP) Loan Forgiveness Works

Here is guidance on PPP loan forgiveness, including new rules under the Paycheck Protection Program Flexibility Act.

The Paycheck Protection Program (PPP) loan program established by the Coronavirus Aid, Relief and Economic Security (CARES) Act allows businesses to borrow money from the Small Business Administration to cover payroll and other costs during the Coronavirus (COVID-19) pandemic. Businesses with fewer than 500 full-time employees may borrow up to 250% of their average monthly payroll costs for 2019 up to $10 million.

However, PPP loans contain a unique feature that has made them incredibly popular: loan forgiveness. "Forgiveness" means you don't have to pay the money back and the forgiven loan amount is tax-free. However, the rules for loan forgiveness under the PPP were so strict that many businesses were concerned they wouldn't qualify for forgiveness. The Paycheck Protection Program Flexibility Act (PPPFA) was enacted to give borrowers additional time and flexibility to use PPP loan proceeds and still qualify for forgiveness.

PPP Loan Forgiveness for the Self-Employed

PPP loan forgiveness is pretty simple if you're self-employed--that is, you're running a one-person business with no employees. You automatically get forgiven an amount equal to 24 weeks' worth of net profit you earned in 2019 as shown on your 2019 IRS Schedule C. This is called "owner compensation replacement." You don't have to spend the forgiven amount on business expenses or on anything.

You can easily calculate your owner compensation replacement amount by multiplying the 2019 net income on your Schedule C by 8/52 (0.154).

Example: Yolanda earned $60,000 in net self-employment income in 2019. She obtained a $12,500 PPP Loan. Her automatic owner compensation replacement amount is 8/52 x $60,000 = $9,240. So $9,240 of her loan is automatically forgiven.

Any remaining PPP funds must be spent on business-related utilities, rent, and mortgage interest expenses to be forgiven. This can include such expenses you paid for your home office (but you must have had the home office before February 15, 2020).

If you applied for an Economic Injury Disaster Loan (EIDL loan) from the SBA and received an emergency grant--typically, $1,000 for a self-employed applicant--you must reduce your PPP loan forgiveness by this amount. Likewise, if you obtain the sick and family leave credits established by the CARES Act for self-employed individuals impacted by the Coronavirus pandemic. The sick leave credit maxes out at $5,100 while the ceiling for the family leave credit is $10,000.

PPP Loan Forgiveness for Businesses with Employees

PPP Loan forgiveness is much more complicated for businesses with employees. To obtain loan forgiveness, businesses with employees must use their PPP loan money for:

  • Payroll: Up to $100,000 annual salary per employee, as well as vacation pay, health benefits, sick leave, parental and family leave, and taxes on compensation
  • Mortgage interest: Interest for business property on which the mortgage was signed before February 15, 2020
  • Rent: The lease must have been signed before February 15, 2020, and
  • Utilities: Service must have begun before February 15, 2020.

A business can get its PPP loan 100% forgiven if it uses all the money only for these permitted purposes during the 24 weeks after it received the loan (or by December 31, 2020, whichever is earlier). Under the original PPP rules, the loan forgiveness time period was eight weeks. This was extended to 24 weeks under the PPPFA. Anyone who obtained a loan prior to June 5, 2020 can choose to use the either eight-week period or the 24-week period.

If your business does not maintain its staff and payroll levels, the forgiveness amount will be reduced.

  • 60% Rule: To obtain full forgiveness, at least 60% of the PPP loan money must be spent on payroll and no more than 40% on interest, rent, and utilities during the 24-week period. Forgiveness is reduced by the amount non-payroll spending exceeds 40%. For example, if your business spends 50% of its PPP loan on rent and utilities, its forgiveness is reduced by 10%. This particularly impacts businesses like restaurants that typically have low payroll expenses and pay high rents. The original PPP rules required at least 75% of the PPP loan money be spent on payroll. This was changed to 60% under the PPPFA to give businesses more flexibility on how to use the money.
  • Number of Staff: Your loan forgiveness will be reduced if you decrease your full-time employee headcount during the 24 weeks after you received the loan compared with an 24-week period in 2019. For example, if you reduced your staff by 25%, your loan forgiveness will be reduced by that amount.
  • Level of Payroll: Your loan forgiveness will also be reduced if you decrease salaries and wages during the 24-week period after you received the loan by more than 25% for any employee that made less than $100,000 in 2019. For example, if you reduce your employees' salary by 30%, your total loan forgiveness will be reduced by 5%.

You can rehire any employees that were laid off or furloughed. You can also reinstate the pay of any employee whose pay decreased by more than 25%. You have until December 31st to do this (the original date was June 30th under the PPP).

How to Request Loan Forgiveness

You must submit a request for loan forgiveness to the lender that is servicing your loan. Be sure to include documents verifying the number of full-time equivalent employees and pay rates, as well as the payments on eligible mortgage, lease, and utility bills. The lender must make a decision on the forgiveness within 60 days.

What Happens If a PPP Loan is Not Forgiven?

If any portion of the loan is not forgiven, you must pay the money back within five years at an interest rate of 1% with no prepayment penalties. If you obtained your loan prior to June 5, 2020, the loan term is two years (instead of five) under the original PPP rules, although you may be able to negotiate a longer term with your bank.

The deferral period for repayment was extended under the PPPFA to six months from the time the Small Business Administration makes it loan forgiveness determination. If you don't apply for loan forgiveness, then you must begin making payments ten months after the last day of the 24-week covered period.

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