While the Paycheck Protection Program initially provided welcome relief for many businesses impacted by the pandemic, it left many others out in the cold—particularly those that were forced to close and, as a result, could not spend borrowed funds on qualifying payroll expenditures within the limited 8-week covered period defined in the CARES Act.
Fortunately, with the passage of the Paycheck Protection Program Flexibility Act of 2020, the covered period was extended from 8 weeks to 24 weeks to allow some of the most significantly impacted companies enough time to ramp up operations and incur payroll costs necessary to qualify for loan forgiveness. However, if management teams do not properly consider the interplay between the covered period, the FTE reduction provisions, and the related safe harbor provisions, they could leave money on the table.
Before providing some illustrations, it’s important to first understand some of the basic loan forgiveness provisions of the PPP.
Covered Period: Under the Act, the amount of the loan subject to forgiveness is directly related to the amount of loan proceeds spent on qualifying payroll and other costs during the covered period. For borrowers whose loan was made on or after June 5, the covered period is the 24-week period after the first date of funding. However, borrowers whose loans were made before June 5 have the option of using a covered period of either 8 weeks or 24 weeks.
FTE Reductions: Loan forgiveness is also subject to a reduction if average FTE levels during the covered period are less than average FTE levels of the comparative period selected by the borrower (either February 15, 2019 to June 30, 2019; January 1, 2020 to February 29, 2020; or, in the case of seasonal employers, either of those options or any consecutive 12-week period between May 1, 2019 and September 15, 2019).
Salary Reductions: Loan forgiveness is also subject to a reduction if payroll is reduced by more than 25 percent during the covered period for any employees who made less than $100,000 annualized during every payroll period in 2019.
Safe Harbors: The PPP rules provide two safe harbors which exempt certain borrowers from reduction in loan forgiveness based on reduction in FTE levels:
- The borrower is exempt from the reduction in loan forgiveness based on a reduction in FTE employees described above if both of the following conditions are met: (a) the borrower reduced its FTE employee levels in the period beginning February 15, 2020, and ending April 26, 2020; and (b) the borrower then restored its FTE employee levels by no later than December 31, 2020 to its FTE employee levels in the borrower’s pay period that included February 15, 2020.
- The borrower is exempt from the reduction in loan forgiveness based on a reduction in salaries or wages if both of the following conditions are met: (a) the borrower reduced the salary or wages of one or more employees during the period beginning February 15, 2020 and ending April 26, 2020; and (b) the borrower then eliminates the reduction no later than December 31, 2020 to its FTE employee levels in the borrower’s pay period that included February 15, 2020.
These concepts are important to understand because each represents a variable that could adversely impact forgiveness if not carefully considered.
For example, a borrower may be able to spend all of the borrowed funds on qualifying payroll costs during a 24-week period, but still be subject to a reduction in loan forgiveness if average FTE levels fall during this extended covered period as compared to the selected historical period.
That same borrower may find its reduction in loan forgiveness could be less under an 8-week covered period if its average FTE levels during that period were higher than the 24-week covered period, despite being unable to spend all of the borrowed funds on qualifying expenses during the shorter 8-week covered period. Or, the borrower might find that even though average FTE levels were lower in the covered period than the comparable prior period, there is no reduction in forgiveness because it restored the FTE reduction by December 31, 2020.
Which covered period (8 or 24 weeks) will be better for me?
If a business expects that it may experience a slowdown after the end of the shorter 8-week covered period, and expects a corresponding reduction in FTEs, it may find that the use of the 8-week covered period is more beneficial.
Conversely, if a business experienced a slowdown during the shorter 8-week covered period and had a corresponding decrease in FTEs during that period, but expects a rebound in business and FTEs during weeks 9-24, then the longer covered period might prove more beneficial.
For example, let’s assume a business received a $1 million PPP loan and expects to spend $900,000 within the initial 8-week period. Additionally, let’s assume that the business had no FTE reductions or salary reductions during the same 8-week period. Under this scenario, $900,000 of the PPP loan will be forgiven and $100,000 will have to be repaid.
Now let’s take the same fact pattern as above and assume the business elects the 24-week period. However, beginning in week 13 and through the rest of the covered period the business needs to implement a 30 percent workforce reduction. This will result in a 15 percent FTE reduction throughout the covered period, thereby making the loan forgiveness $850,000 – $50,000 less than the 8-week scenario.
When do I need to make the decision to use 8 weeks versus 24 weeks?
The good news is you do not need to apply for forgiveness until 10 months after the end of your covered period. As a result, you can wait until the end of the longer 24-week covered period to make a final decision. Keep in mind that no covered period can extend past December 31, 2020.
Do I qualify for the Safe Harbors?
Safe Harbors are only available for borrowers that experienced FTE reductions or salary/wage reductions during the period from February 15, 2020 to April 26, 2020. If a business did not have a headcount reduction or a salary/wage reduction (in excess of 25%), then one or both of these Safe Harbors will not be available to the applicant.
What if I qualify for a Safe Harbor?
In order to benefit from a Safe Harbor, the borrower must eliminate the FTE or salary reduction in its entirety. For example, if a borrower had 100 FTEs on February 15, 2020 and averaged 70 FTEs between February 15 and April 26, the business must restore FTEs to 100 as of the earlier of December 31, 2020, or the date the forgiveness application is submitted. If the business is able to restore FTEs to 100, then the average number of FTEs over the elected covered period will not matter. Keep in mind that in this example, the borrower must still apply the Salary/Wage Reduction Test.
What if I cannot restore my FTEs to February 15, 2020 levels?
If you cannot completely restore your FTEs to the same level as of February 15, 2020, then you will not be able to use the FTE Safe Harbor.
As you can tell, there are multiple moving parts related to the PPP Loan Forgiveness Application which require attention to detail and a careful analysis to ascertain the best route a business should take when completing its Loan Forgiveness Application. However, we expect the SBA to issue further guidance in the coming weeks which could provide additional insight or possibly change the current guidelines.
As a result, we recommend that borrowers do not rush to file their PPP Loan Forgiveness Application, but rather, let the dust settle and allow the SBA time to provide further guidance.
As always, we are here to help and are happy to assist you in maximizing your loan forgiveness. If you have any questions about these or any other matters, please contact your Kreischer Miller relationship professional or any member of our team. We also continue to update our COVID-19 Resource Center, which you can access here.
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