Paycheck Protection Program Offers Forgivable Loans for Eligible Small Businesses

By: Kristine A. Tidgren, Iowa State University Center for Agricultural Law

On Friday, March 27, 2020, the President signed into law H.R. 748, the Coronavirus Aid, Relief, and Economic Security (“CARES”) Act. The CARES Act contains a number of relief provisions designed to sustain Americans during the COVID-19 health and economic crisis. This post provides a general overview of a new small business loan program, the Paycheck Protection Program. Other posts detail individual tax provisions and business tax provisions.

The Paycheck Protection Program, implemented by section 1102 of the CARES Act, expands the Small Business Administration 7(a) loan program to provide up to $349 billion in federally-guaranteed loans to small employers and eligible self-employed individuals impacted by COVID-19. These loans are designed to be partially forgivable under section 1106. While a number of details must be filled in with applicable regulations, this post provides an overview of the law as set forth in the statute.

Who is Eligible?

The CARES Act amends the Small Business Act to expand the small business loan program by creating section 7(a)(36), the Paycheck Protection Program. The program, administered through the Small Business Administration, expands the definition of eligible small businesses and organizations to include many not ordinarily eligible for an SBA loan.

Eligible Businesses

Specifically, during the covered period, in addition to “small business concerns” meeting standards under current SBA regulations, any:

• business concern,
• 501(c)(3) nonprofit,
• veterans’ organization, or
• Tribal business concern

shall be eligible to receive a covered loan if the business concern, nonprofit organization, veterans’ organization or Tribal business concern employs 500 or fewer employees. The term “employee” for purposes of determining how many employees a business employs includes individuals employed on a full-time, part-time, or other basis. Additionally, businesses with a North American Industry Classification System (NAICS) code beginning with 72 are eligible to receive a loan if a multi-location business does not employ more than 500 employees per physical location. NAICS code 72 comprises lodging and restaurant businesses.

Definition: This program provides “covered loans” during the “covered period.” For purposes of section 1102, the term “covered loan” means a loan made under the program during the covered period. The term “covered period” means the period beginning on February 15, 2020, and ending June 30, 2020.

Eligible Self-Employed Individuals

During the covered period, individuals who operate under a sole proprietorship or as an independent contractor, and “eligible self-employed individuals” shall also be eligible to receive a covered loan. The term “eligible self-employed individuals” is defined as it is in the Families First Coronavirus Response Act. It includes any individual who:

• Regularly carries on any trade or business within the meaning of IRC § 1402 and
• Would be entitled to receive paid leave during the taxable year pursuant to the Emergency Paid Sick Leave Act (created by the CARES Act) if the individual were an employee of an employer other than himself or herself.

An eligible self-employed individual, independent contractor, or sole proprietorship seeking a covered loan must submit documents to establish the individual as eligible, including payroll tax filings, Forms 1099-MISC, and income expenses from the sole proprietorship, as determined by the SBA.

Affiliations

SBA rules applicable to affiliations generally continue to apply, except that these rules are waived with respect to eligibility for a covered loan for:

• Accommodation and food service industry business concerns with not more than 500 employees on the date the covered loan is disbursed
• Any business concern operated as a franchise that is assigned a franchise identifier code by the SBA
• Any business concern receiving financial assistance from a company licensed under section 301 of the Small Business Investment Act

Loan Description

Maximum Loan Amount

During the covered period, the maximum loan amount is generally the lesser of: (1) $10,000,000 or (2) 250 percent of the average monthly payroll costs incurred during the one-year period before the date on which the loan is made, plus any refinanced Economic Injury Disaster loans received after January 31, 2020.

Startups that were not in business between February 15, 2019, and July 30, 2019, calculate average monthly payroll costs based upon the period beginning January 1, 2020, through February 29, 2020. Seasonal employers may calculate the average monthly payroll costs based on the 12-week period beginning on February 15, 2019 or, alternatively, the period from March 1, 2019 through June 30, 2019.

Allowable Uses

During the covered period, recipients may use the proceeds of a covered loan for the following purposes:

• Payroll costs
• Costs related to the continuation of group health care benefits during periods of paid sick, medical or family leave, and insurance premiums
• Employee salaries, commissions, or similar compensation
• Payments of interest on any mortgage obligation (not including prepayments or the payment of principal)
• Rent (including rent under a lease agreement)
• Utilities
• Interest on any other debt obligations that were incurred before the covered period (February 15, 2020).

Payroll Costs

“Payroll costs” include compensation with respect to employees that includes:

• salary, wages, commissions, and similar compensation;
• payment of cash tips or equivalent;
• payment for vacation parental, family, medical, or sick-leave;
• allowance for dismissal or separation;
• payment required for group health benefits, including insurance premiums;
• payment of retirement benefits; or
• payment of state or local tax assessed on employee compensation;
• the sum of payments of any compensation to or income of a sole proprietor or independent contractor that is a wage, commission, income, net earnings from self-employment, or similar compensation and that is in an amount that is not more than $100,000 in one year, as prorated for the covered period.

Payroll costs do NOT include:

• compensation of an individual person in excess of $100,000, as prorated for the covered period
• federal employment or withholding taxes imposed during the covered period;
• compensation to an employee whose principal residence is outside of the U.S.;
• qualified sick leave for which a credit is allowed under section 7001 of the Families First Coronavirus Response Act; and
• qualified family leave wages for which a credit is allowed under section 7003 of the Families First Coronavirus Response Act

Loan Terms

Non-forgiven portions of these loans have a maximum maturity of ten years from the date the borrower applies for loan forgiveness. The interest rate on the loans cannot exceed four percent, and lenders must provide complete interest and principal payment deferment relief for at least six months (and up to one year). Additionally, the non-recourse loans (to the extent they are used for authorized purposes) require no personal guarantee or collateral. Borrowers are not required to prove that they cannot obtain the funds elsewhere, and there is no prepayment penalty or SBA fee.

Applications

Considerations

Potential borrowers must file their applications with an SBA-approved lender. For purposes of making covered loans, a lender approved to make loans under the program shall be deemed to have been delegated authority by the SBA Administrator to make and approve covered loans, without separate SBA approval. In evaluating the eligibility of a borrower for a covered loan, a lender shall consider whether the borrower was in operation on February 15, 2020, and (1) had employees for whom the borrower paid salaries and payroll taxes or (2) independent contractors, as reported on a Form 1099-MISC.

Those applying for a covered loan must make a good faith certification that:

• The uncertainty of current economic conditions makes necessary the loan request to support the ongoing operations,
• That the funds will be used to retain workers and pay eligible expenses,
• That the applicant does not have an application pending for another loan for the same purpose, and
• That for the period beginning on February 15, 2020, and ending on December 31, 2020, the eligible recipient has not received amounts under the program for the same purpose

Additional Lenders

The law extends the authority to make Paycheck Payment Program loans (but not other SBA loans) to additional lenders determined by the SBA Administrator and the Secretary of the Treasury to have the necessary qualifications to process, close, disburse, and service loans made with the guarantee of the SBA.

Lenders authorized to make covered loans are eligible to be reimbursed from the SBA Administrator at a rate of (based on the balance of the financing outstanding at the time of disbursement of the covered loan):

1. Five percent for loans of not more than $350,000
2. Three percent for loans of more than $350,000 and less than $2,000,000, and
3. One percent for loans of not less than $2,000,000.

Prioritization of Loans – “Sense of the Senate”

The law states:

It is the sense of the Senate that the Administrator should issue guidance to lenders and agents to ensure that the processing and disbursement of covered loans prioritizes small business concerns and entities in underserved and rural markets, including veterans and members of the military community, small business concerns owned and controlled by socially and economically disadvantaged individuals, women, and businesses in operation for less than 2 years.

Loan Forgiveness

Section 1106 outlines the loan forgiveness available for “covered loans,” which are loans guaranteed under the Paycheck Protection Program. Generally, a borrower is eligible for loan forgiveness on a covered loan in an amount equal to the sum of the following costs incurred and payments made during the covered period (which for 1106 means the 8-week period beginning on the date of the origination of a covered loan):

• payroll costs (as defined in the above section)
• any interest payment on any covered mortgage obligation (which shall not include any prepayment of or payment of principal on a covered mortgage obligation)
  • “Covered mortgage obligation” means an indebtedness or debt instrument incurred in the ordinary course of business that (a) is a liability of the borrower, (b) is a mortgage on real or personal property, and (c) was incurred before February 15, 2020.
• payment of any covered rent obligation
  • “Covered rent obligation” means rent obligated under a leasing agreement in force before February 15, 2020.
• covered utility payments
  • “Covered utility payment” means payment for a service for the distribution of electricity, gas, water, transportation, telephone, or internet access for which service began before February 15, 2020.

Amounts forgiven are cancelled indebtedness by the lender authorized under section 7(a) of the Small Business Act. Within 90 days after the date on which the forgiveness is determined, the SBA Administrator will remit to the lender the amount of the forgiven loan, plus any interest accrued through the date of the payment.

Limits on Forgiveness

The amount of loan forgiveness cannot exceed the principal amount of the financing made available. The forgiveness amount is also subject to reduction if there is a reduction in employees or a reduction in the salary or wages of any employee.

Reduction of Number of Employees

The loan forgiveness will be reduced by multiplying the presumed forgiveness amount by (the average full-time equivalent employees (FTEs) during the covered period ÷ average FTEs for the period from February 15, 2019 through June 30, 2019 or January 1, 2020 through February 29, 2020, at the election of the borrower). Special rules apply to seasonal employers.

Salary and Wage Reduction

The loan forgiveness will be reduced by any reduction in total salary or wages of any employee during the covered period that is in excess of 25 percent of the total salary or wages during the most recent full quarter during which the employee was employed before the eight-week coverage period. Employees who received, during any single pay period during 2019, wages or salary at an annualized rate of pay in excess of $100,000 are not included in this calculation.

Reductions in employees, salaries and wages that occur between February 15, 2020 and April 26, 2020, are disregarded for purposes of the forgiveness reduction as long as the reductions are eliminated by June 30, 2020.

Application for Loan Forgiveness

Borrowers must apply for forgiveness with the lender servicing the loan. The application for the forgiveness shall include:

• Documentation verifying the number of FTE equivalent employees on payroll and pay rates, including:
  • Payroll tax filings reported to the IRS and State income, payroll, and unemployment insurance filings
• Documentation, including cancelled checks, payment receipts, transcripts of accounts, or other documents verifying payments on covered mortgage obligations, payments on covered lease obligations, and covered utility payments
• A certification that the documentation is true and correct and the amount for which forgiveness is requested was used to retain employees, make interest payments on a covered mortgage, make payments on a covered rent obligation, or make covered utility payments,
• Any other documentation the SB Administrator determines necessary

No forgiveness will be granted absent the required documentation. Lenders have 60 days to review and make a determination on the forgiveness application. The lender will be held harmless for decisions made based upon erroneous documentation. Any portion of the loan that is forgiven will be excluded from the gross income of the borrower.

Guidance and Applications

The SBA Administrator is required to issue regulations within 30 days of the enactment of the law. We eagerly await further guidance. A number of questions remain regarding implementation of this important law, particularly with respect to the self-employed. Potential borrowers must also evaluate and compare other options provided by the CARES Act, including the employee retention credit and the option to defer payroll taxes. In the meantime, interested small businesses should consult with their lenders immediately regarding their specific requirements for the program.