We’re now about six weeks into the CARES Act and in round two of the Paycheck Protection Program. The $310 billion allotted to the program in round two is beginning to dwindle, but has lasted longer than most bankers expected.
There could be another round of stimulus that replenishes the program over the next few months, of course. There seems to be widespread effort in Washington to ensure that businesses that need PPP funds are able to get them. Who knows whether that will eventually happen.
For many of the businesses the most pressing question is no longer how they can access the program & obtain funds to keep their operations going. It’s what must I do to have this loan forgiven? This post will cover what we know so far.
PPP Forgiveness: Here’s What We’ve Got
Like the rest of the legislation, we’re still in the dark on many gory details that live in the margins of the bill. While the SBA and Treasury Department have commented on some of the specifics, we are still wondering how others will be handled.
This will come over the next few weeks. The typical cycle that occurs whenever new laws like this are passed. Practitioners read the law, try their best to interpret its meaning, look for opportunities, and ask for further guidance from regulators where further clarification is needed.
At this point we’ve had a few rounds of Q&A type guidance from the SBA. (Here is the most recent back and forth). To date, most guidance has revolved around what businesses are eligible, how the loan amounts are calculated, and how banks should handle applications. Now that a good number of businesses have received funds, more are starting to ask about the details surrounding forgiveness.
As you likely know, PPP funds may be used to pay any of the following:
- Health care
- Retirement Benefits
- Mortgage Interest
The forgiveness feature of the paycheck protection program wipes out funds spent on any of the above items in the eight weeks following when loan funds were disbursed.
While many businesses are seeking this forgiveness, it is not the right strategy for everyone. Thinking out longer term, it doesn’t make a whole lot of sense to spend the funds haphazardly on staffing now if you’re unable to open your doors until July. You may need the liquidity later in the year. Especially if consumer demand doesn’t snap back immediately, like many economists are forecasting.
Plus, the terms of PPP loans are very generous if yours isn’t forgiven. Interest is only 1%, loans are amortized over two years, and no payments are due in the first six months. While it’d be nice to have the debt wiped clean, not every business should pursue it.
PPP Forgiveness & The FTE Calculation
As you’re probably aware, paycheck protection program loans are not automatically forgiven. Eight weeks after receiving fund from your lender you may apply for forgiveness. Just as every lender handles applications differently, so too will they handle forgiveness differently.
The maximum amount of forgiveness offered is what you spend on payroll, rent, or utilities in the eight weeks after receiving loan funds. This forgiveness can be reduced if your employee headcount falls or if you cut employee pay by more than 25%. 75% of the funds must be spent on payroll and payroll related costs.
Full Time Equivalent Employees
Headcount is monitored by the ratio of full time equivalent employees (FTEs) during the eight week period in question to FTEs during the previous 12 months. A full time employee, in the eyes of the SBA, is anyone working more than 30 hours per week. To calculate FTEs, sum the number of employees working more than 30 hours per week. Then add up the monthly hours of all your employees working less than 30 hours per week, and divide by 120.
Here’s an example:
You have 4 full time employees, including yourself. You have 2 part time employees who all work 10 hours per week. The monthly hours of your part timers would be 2*10*4 = 80. 80 / 120 = 0.67. Your FTEs for the month are 4 (from the full timers) + 0.67 (from the part timers) = 4.67.
To calculate the ultimate amount of forgiveness on your PPP loan, start with the amount spent on eligible expenses in the first eight weeks. Then, multiply it by the ratio of average monthly FTEs over the eight “forgiveness” period to the baseline period.
For the numerator of this ratio you can determine monthly FTEs using the calculation above. Then take the average over the two months after you receive loan funds. You can use the same calculation for the baseline period (the denominator), but you have two time periods to choose from:
- 2/15/2019 to 6/30/2019
- 1/1/2020 to 2/29/2020
The ratio is simply your monthly average FTEs over the eights weeks after you received funds, to your FTEs over one of the two periods above. My best suggestion is to calculate your average monthly FTEs during both of these periods, and use the number that’s lower.
This means that if your headcount went down substantially in the last couple weeks your forgiveness ratio will be less than 100%:
Here’s an Example:
Your monthly average FTEs between 2/15/19 and 6/30/19 were 8.5. You saw some growth last year & added to headcount, meaning that your monthly average FTEs rose to 11.5 from 1/1/20 to 2/29/20. Since the Coronavirus pandemic set in you’ve had to lay off 4 people. Right now your monthly average FTEs sit at 7.5.
If you do not adjust head count, your forgiveness ratio will be 7.5 / 8.5 = 88.2%. (Since you’d want to use the lower of the two numbers). This means that if you obtained a $50,000 loan, up to $44,117.64 could be forgivable ($50,000 * 88.2%).
There is a caveat to the FTE calculation above. Anyone you laid off between 2/15/20 and 4/26/20 can be rehired by 6/30/20 and count toward your FTEs over the entire period. Using the example above, all you’d need to do is hire back one FTE by 6/30/20 and you’d boost your forgiveness ratio back up to 100%. The key here is to know what your “baseline” FTEs were over each of the two periods you can choose from, and adjust your staffing strategy as necessary.
I should also mention that there was an interesting question posed in the most recent FAQs from the SBA. Elsewhere in the CARES Act, weekly unemployment benefits were increased by 150%. As many people are pointing out in the media these days, this is a disincentive for some to return to work. (If you’re making more money by NOT working and collecting unemployment benefits, why would you return to work, risk your health, and make less?).
The question was how to handle employees who’ve been offered their jobs back but declined. According to the SBA, any employee who declines a rehire offer may be used in the FTE calculation as well. If you plan on doing so, just make sure you have everything in writing.
The other reason forgiveness may be reduced is if you cut covered employee pay by more than 25%. (Not counting any employee comp above $100,000). Rather than looking at your total payroll (like FTEs), this stipulation examines employee compensation at the individual level. Any employee seeing a pay cut of more than 25% over the most recent completed quarter will reduce your eligible forgiveness.
We don’t have many details on this yet, nor do we know exactly how much forgiveness you’ll lose if you do cut employees’ pay by more than 25%. But, we do know that you can bring employee pay back up to prior levels by 6/30/20, and have that level count for the entire eight week period. Similar to the FTE rehire option.
But what if you don’t have payroll? PPP loans for sole proprietors without employees are based on your net profit from 2019. Just like businesses with employees are eligible for loans of 2.5x their average monthly payroll, sole props without employees are eligible for loans of 2.5x your average monthly net profit from your 2019 schedule C. (Take the annual number, divide by 12, multiply by 2.5).
Forgiveness for sole proprietors without employees is based on “owner’s compensation replacement”. Take your 2019 schedule C net profit, and multiply by 8/52. This amount is your “owner’s compensation replacement”, and is automatically forgivable. The remainder of the loan may be forgivable if its spent on qualifying expenses (rent, mortgage interest, utilities, etc.).
Here’s an Example:
Let’s say you made $150,000 in schedule C net income in 2019. Only the first $100,000 is considered for the paycheck protection program. You would be eligible for a PPP loan of $100,000 *2.5 / 12 = $20,833. The owner’s compensation replacement portion of the loan would be $100,000 * 8/52 = $15,385. The remaining amount ($20,833 – $15,385 = $5448) could be forgivable if spent on eligible items like rent/utilities/mortgage interest.
Sole Proprietorships With Employees
For those of you with sole proprietorships AND employees on payroll, the SBA has communicated that payments to working partners or working LLC members may be treated as payroll for the purpose of forgiveness.
- Park your PPP funds in a separate bank account
- Track all the expenses out of the PPP funds
- Calculate your FTEs over the two different baseline periods above, and adjust strategy accordingly
- Don’t undermine your business’s long term liquidity by shooting for forgiveness now
- Work with your lender to maximize forgiveness. Every bank will function a little differently.