How Paycheck Protection Program's Loan Forgiveness Works

Here is some guidance on figuring out how much of your Paycheck Protection Program (PPP) loan will be forgiven.

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. Moreover, the forgiven loan amount is tax-free. This is why over two million small business owners have already applied for PPP loans.

Unfortunately, figuring out how much of a PPP loan will be forgiven is quite confusing. Moreover, the SBA has not worked out all the rules yet (and keeps changing its guidance). Here’s an overview of PPP loan 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 eight 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 eight weeks after it received the loan. However, if your business does not maintain its staff and payroll levels, the forgiveness amount is reduced.

  • 75% Rule: To obtain full forgiveness, at least 75% of the PPP loan money must be spent on payroll and no more than 25% on interest, rent, and utilities during the eight-week period. Forgiveness is reduced by the amount non-payroll spending exceeds 25%. For example, if your business spends 40% of its PPP loan on rent and utilities, its forgiveness is reduced by 15%. This particularly impacts businesses like restaurants that typically have low payroll expenses and pay high rents.
  • Number of Staff: Your loan forgiveness will be reduced if you decrease your full-time employee headcount during the eight weeks after you received the loan compared with an eight-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 eight-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 June 30th to do this.

It is unclear how some of the elements that go into PPP loan forgiveness equation are defined. For example, the definition of full-time employee is unclear. More importantly, the SBA hasn’t explained whether a business should use cash or accrual accounting in determining how much it spent during the crucial eight-week period after the PPP loan is received. With cash accounting, revenue and expenses are recognized on the date that they are received or paid. With accrual accounting, revenue and expenses are recognized on the date that they are earned and when an obligation is incurred. Larger businesses use accrual accounting.

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 your PPP loan is not fully forgiven, or is not forgiven at all, you must pay it back to the lender. PPP loans are two-year loans at a 1% interest rate, with repayment deferred for six months (but interest accrues during the 6-months). A pretty good deal, although the two-year term is quite short.

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