How To Get Your Paycheck Protection Program Loan Forgiven: An FAQ Guide for Small Businesses and Self-Employed Individuals

By Zack R. Gardner, Esq. and Law Clerk Zach Kiffmeyer

On March 27, 2020, President Trump signed the Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”) to provide emergency assistance for individuals, families, and businesses affected by the coronavirus pandemic.  The Small Business Administration (“SBA”) received funding and authority through the CARES Act to modify existing loan programs and establish a new loan program to assist small businesses nationwide. Section 1102 of the Act temporarily permits the SBA to guarantee 100 percent of 7(a) loans under a new program titled the Paycheck Protection Program (“PPP”).  Notably, section 1106 of the Act provides for forgiveness up to the full principal amount of qualifying loans guaranteed under the PPP.

So now that you have received your loan, how do you ensure that you take the correct steps to have that loan forgiven?  What are other issues that you should be concerned about?  Below you will find a series of questions and answers Kennerly Montgomery has prepared regarding the necessary steps to help small businesses stay “healthy” during these rather unhealthy times.

To begin, let’s go over the general terms of the loan under the PPP. The loan amount you received was based on your average monthly payroll cost for 2019. You could have received up to 2.5 times that amount to help cover eight weeks of payroll. The day your lender distributed your first loan payment is when your eight-week period begins covering those expenses. Please note: it is expected that you spend 100% of the loan proceeds in that eight-week period.

1) Can you spend your loan proceeds on anything related to your business? 

No. These are the acceptable uses of your loan proceeds if you want your loan to be forgiven:

1. Payroll costs: salary and wages; vacation pay, parental, and family leave; sick leave; medical and health benefits; retirement benefits; and state and local taxes assessed on employee compensation.
2. Mortgage Interest: as long as the mortgage was signed before February 15, 2020.
3. Rent: as long as the lease agreement was in effect before February 15, 2020.
4. Utilities: as long as the service began before February 15, 2020.

2) Will the loan be forgiven if proceeds are used for any combination of amounts for the above reasons?

No. Thus, it is very important for small business owners to remember the 75/25 Rule; this rule is the foundation of the PPP.  The 75/25 Rule states that in order to receive loan forgiveness after the eight-week period, you must have spent at least 75% of your loan proceeds on payroll costs and no more than 25% toward the three other permitted expenses.

Note: Payments to independent contractors cannot be included in the payroll costs.

3) When do you need to contact your lender to apply for loan forgiveness?

Essentially, you can send the required documents to your lender after the eight-week period ends.  Since the principal and interest payments on the loan are deferred for six months, there is likely a two-to-three month period after the covered period ends when you should make your loan forgiveness application available to your lender, but we recommend compiling the documentation and submitting as early as possible.

Once the lender has received your documentation, it will then provide you with instructions on how to apply specifically within their organization. After you submit your application for loan forgiveness, your lender is required by law to give you a response within 60 days.

4) What information needs to be presented to your lender to have the loan forgiven?

These are the required documents you will need to collect to provide with your PPP forgiveness application. Your lender may have additional requirements, and it is good practice to immediately contact your lender at the end of your 8-week covered period to confirm documentation for forgiveness.  Below are the requirements set forth under the Act:

• Documents verifying the number of full-time equivalent (“FTE”) employees on payroll and their pay rates for the periods used to verify you met the staffing and pay requirements:
   
  • Payroll reports from your payroll provider;
  • Payroll tax filings (Form 941);
  • Income, payroll, and unemployment insurance filings from your state; and
  • Documents verifying any retirement and health insurance contributions.
     
• Documents verifying your eligible interest, rent, and utility payments such as canceled checks, payment receipts, or account statements.
   
• Certification from a representative of the eligible recipient, such as a payroll manager, authorized to make a certification which states that:
   
  • The documentation presented is true and correct; and
  • The amount for which forgiveness is requested was used to retain employees, make mortgage interest payments, make rent payments under a qualified lease agreement, and/or make utility payments.
     
• Any other documentation the SBA administrator determines necessary.

Here is an example of what a Tennessee SBA lender has drafted in order to help you, the borrower, stay on top of what you need in order to have all documentation prepared for loan forgiveness:

• Create a separate bank account for the loan proceeds for easy expenditure tracking.
   
• Document how loan proceeds are spent by:
   
  • Creating a spreadsheet listing all employees on payroll during the eight-week covered period following the loan distribution with the dollar amount of payroll costs; and
  • Providing evidence of mortgage interest payments, rent payments, and utility payments by providing: copies of cancelled checks, bank statements with ACH info, utility bills, mortgage statements, and lease agreements.
     
• Maintain evidence that workers were kept on payroll or rehired once loan was received, including:
   
  • A calculation of the average monthly number of full-time equivalent employees for the period February 15, 2019 through June 30, 2019 or January 1, 2020 through February 29, 2020—you select the time period; and
     
  • The average monthly number of full-time equivalent employees for the eight-week period following the date of the loan.
     
• Maintain evidence of restoration by June 30, 2020 of pay for any individual whose pay was reduced by 25% or more.
   
• Maintain evidence of payroll costs, utilities, rent/lease payments, and mortgage interest paid before February 15, 2020 to compare to what is paid or incurred during the eight weeks following the loan closing to ensure it aligns.  
   
  • Note: If self-employed, these expenses are allowed to the extent they are deductible on Form 1040 Schedule C.
     
• Maintain a copy of paperwork submitted to bank for the initial PPP loan.
   
• Maintain evidence you were in business on February 15, 2020 and paid employees or independent contractors—of which the Payroll Tax Filing for Quarter 1, 2020 qualifies.

5) What happens if any of your employees leave, retire, or you choose to reduce the number of employees on your payroll after you received your loan money? Will the loan still be able to be forgiven if that portion of your loan proceeds are no longer needed since those employees are no longer on the payroll?

There are two key provisions of the Act related to this question of employees: staffing and salaries.

Staffing: You must maintain the number of employees on your payroll during the eight-week period.  Here’s a calculation, step by step, you can use to determine if you’ve met the staffing requirement.

First, determine the average number of full-time equivalent employees (“FTEs”) for three baseline periods as provided in the Act:

1. FTEs for the eight-week period following your initial loan (X);
2. FTEs from February 15, 2019 to June 30, 2019 (Y); and
3. FTEs from January 1, 2020 to February 29, 2020 (Z). 

The SBA has not yet definitively stated how to calculate FTE employees. The general consensus is that it will be similar to the Affordable Care Act (“ACA”), such that FTE refers to a combination of employees, each of whom individually is not a full-time employee because they are not employed on average at least thirty hours per week, but who, in combination, are counted as the equivalent of a full-time employee.  For example, two employees, each of whom works 15 hours per week, are the equivalent of one full-time employee.

Second, take X and divide by Y, then also take X and divide by Z; whichever equation has the larger answer is the one you will use.

Note: If you are a seasonal employer, you must divide by Y.

Third, determine the results:

1. If you get a number equal to or greater than 1, you successfully maintained your headcount and met the staffing requirement.
2. If you got a number less than 1, you did not maintain your headcount and your forgivable expenses will be reduced proportionately.  For example, if you had 10% fewer FTEs in the eight-week period than in your chosen baseline period, then your loan forgiveness is proportionately reduced by that same 10%.

Salaries: you must maintain 75% of the total salary on your payroll. Here is another step-by-step process.

First, identify all employees employed during the covered eight-week period that you also employed at any point during 2019. The qualifying employees for this calculation are those that made less than $100,000 on an annualized basis during these periods.

Second, determine the average wage/salary rate for the most recent full quarter they were employed.

Third, if 1/8^th of the total amount of salary/wages paid to that employee for the covered eight-week period is at least 75% of her average weekly rate during Q1 of 2020, then there is no further reduction in loan forgiveness. But if the employee experienced a reduction in salary/wages by more than 25%, then the dollar amount of the portion beyond 25% reduces, dollar-for-dollar, the amount of loan forgiveness.

Here’s an example: One employee earns $18,000 during Quarter 1 of 2020. Her average weekly salary in Quarter 1 is $1,285.71. Now, during your eight-week period of using loan proceeds, you paid this employee $8,000 over eight weeks, therefore her weekly pay during the period is $1,000. 

Now, to determine whether your forgiveness will be affected, divide 1,000/1285.71: this gives you a percentage of 77%.  Here, your forgiveness would not be affected, meaning that the loan proceeds you used for this employee’s salary would be fully forgiven, because 1/8^th of the total amount of salary you paid to that employee for the eight-week period was at least 75% of her average weekly rate during Quarter 1 of 2020.

Notably, for both of the staffing and salary issues, the CARES Act provides an exemption for each scenario.

For the staffing requirement, if you experienced a reduction in employees during the eight-week period, you have until June 30, 2020 to bring your FTE count back up to where it was on February 15, 2020. If you do that, the reduction in forgiveness that would have been attributable to a decrease in staffing between February 15, 2020 and April 26, 2020 is excused.

For the salary requirement, if you restored the salary/wage level of the employees who earn less than $100,000 by June 30, 2020 to their salary/wage level on February 15, 2020, then that excuses any reduction in forgiveness that would have been attributable to a decrease in salary/wages for any changes made between February 15, 2020 and April 26, 2020.

6) Can I defer payments on my loan under the Paycheck Protection Program?

Yes. The SBA, in its Second Interim Final Rule on April 15, stated, “You will not have to make any payments for six months following the date of disbursement of the loan. However, interest will continue to accrue on PPP loans during this six-month deferment. The Act authorizes the Administrator to defer loan payments for up to one year.”

In other words, you won’t have to make payments for six months, but interest will still accrue.  That being said, the interest that accrues during that six-month period is also eligible for forgiveness.

7) What happens if you don’t get approved for forgiveness by your lender?

Your lender may allow you to provide additional documentation so they can reevaluate your request. Otherwise, your outstanding balance will continue to accrue interest at 1% for the remainder of the two-year repayment period. You can pay off the outstanding balance at any time with no additional fees.

8) I’m self-employed, can my loan be forgiven?

Yes. If you are a self-employed individual, your loan is designated for certain purposes, just like business recipients, and your loan may be forgiven.

To begin, when you applied for the loan, you had to determine your “Owner Compensation Replacement” figure which is determined by:

(i)             dividing the net profit amount listed on line 31 of your 2019 Form 1040 Schedule C (up to $100,000) by 12 to determine the average monthly net profit amount; and

(ii)           multiplying that average monthly net profit amount by 2.5.

This would have equated to your total loan amount that you could have borrowed. This is an important reminder because there are implications on this amount when it comes to forgiveness. We have outlined that under “Loan Forgiveness” below.

Permitted Uses for Self-Employed Individuals:

1. The self-employed individual’s compensation replacement, based on Schedule C 2019 net profits;
2. Payroll costs;
3. Mortgage interest payments on any business mortgage obligation—not including prepayment or principal payments, business rent payments, and business utility payments; and
4. Interest payments on debt obligations incurred before February 15, 2020—however, these payments are not eligible for forgiveness.

As with other PPP loan recipients, the 75/25 Rule applies: 75% of the loan proceeds spent must be used toward payroll costs including self-employment income (up to $100,000 annualized).

Loan Forgiveness: The full loan proceeds used during the eight-week period plus its accrued interest are eligible for forgiveness, and the actual amount of forgiveness will be calculated based on:

1. Payroll costs, including salary with a maximum of $15,385 per individual during the eight-week period, and covered employee benefits, but not including the owner’s;
2. The self-employed individual’s “Owner Compensation Replacement,” but only up to an amount limited to eight weeks’ worth (8/52 weeks) of the 2019 Schedule C net profit amount;
3. Mortgage interest payments incurred before February 15, 2020 to the extent deductible on Form 1040 Schedule C;
4. Rent payments under a covered lease agreement entered into before February 15, 2020 to the extent deductible on Form 1040 Schedule C; and
5. Utility payments under an agreement entered into before February 15, 2020 to the extent deductible on Form 1040 Schedule C.

Lastly, during these unusual and unprecedented times, there may be instances where you cannot, or have difficulty, spending 75% of your loan proceeds on the permitted payroll costs due to ever-changing circumstances with operations and personnel.  Note that loan forgiveness is not all or nothing. If you have not met all of the requirements for loan forgiveness, a portion of the loan will be forgiven based on what you were able to spend on permitted expenses in the period.

That being said, the loan forgiveness provisions of the Paycheck Protection Program are complex and will require detailed planning, precise execution, and careful documentation.  Our attorneys at Kennerly Montgomery will gladly advise you and assist you in that planning, execution, and documentation.  Please call us at (865) 546-7311 for any of your needs related to the PPP loan forgiveness provisions under the CARES Act or any of your related business needs.

Please Note:  The information provided in this article does not, and is not intended to, constitute legal advice; instead, all information and content is for general informational purposes only. 

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• CARES Act: Small Business Loans
• We've Got Your Six (Reasons for Paid Sick Leave Under the FFCRA) Covered.
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• DOL Provides Limited Guidance on New Families First Coronavirus Response Act
• A Summary of the Family First Coronavirus Response Act for Employers and Employees
• Leave Policy Review: Coronavirus (COVID-19)