This is the third post in a series of articles on Paycheck Protection Program loan forgiveness. Click here to read Part I: The Covered Period and Part II: Eligible Expenses. Part IV: The Application will be published in the coming weeks.
Often, the focus of Paycheck Protection Program (PPP) loan forgiveness is on whether the proceeds were used for eligible costs. However, what many borrowers fail to recognize is that maximum forgiveness depends also on maintaining your employment and wage levels during the covered period. Below, we walk through the details of these two requirements and cover the available exceptions when the requirements are not met.
Restoring Employees by the End of the Covered Period
The main purpose of PPP loans was to provide a funding source for employee wages during a time when many businesses were forced to shut their doors due to COVID-19. Therefore, maintaining employee headcount during the covered period is a key component to the forgiveness calculation. If a borrower temporarily laid off its workforce early in its covered period and does not restore those positions by the end of the year, its loan forgiveness amount may be reduced.
To determine the employee count, the CARES Act uses the “full-time equivalent” standard. Per the forgiveness application, this is calculated by taking the average number of hours paid per week to the employee and dividing it by 40, rounded to the nearest tenth. The maximum amount per each employee is capped at 1.0.
A simplified method available to borrowers allows them to assign 1.0 to any employee working 40 or more hours per week and 0.5 to any employee who works less. This method can be helpful if you have a large workforce and employees do not work consistent hours week over week. However, as with many of the PPP calculations, it may not be beneficial in all circumstances. Borrowers may want to do the math under both methods to determine which method is optimal for their situation.
Three Exceptions for FTE Reductions
The Small Business Administration understands that not all borrowers can restore their wage levels by the end of their covered period. Three exceptions to the rules are available to prevent a borrower from being penalized for failure to maintain employee levels during its covered period.
Safe Harbor 1: Required Business Closure (full or partial)
Many borrowers cannot operate at the same levels as they did prior to February 15, 2020 due to compliance requirements with various government agencies. For example, many states have limited the number of indoor patrons at restaurants or only allow outdoor dining. And often, schools are operating in a remote environment with no extracurricular activities. If the borrower cannot operate in the same pre-COVID manner between February 15, 2020 and the end of its covered period due to these agency-imposed restrictions, a safe harbor applies. The borrower will not be penalized for their FTE reduction during the covered period.
These applicable restrictions may include compliance with social distancing, sanitation standards, customer-safety requirements, and other COVID-19 related measures imposed by Department of Health and Human Services (HHS), Centers for Disease Control and Prevention (CDC), or the Occupational Safety and Health Administration (OSHA).
Note the rule requires no specific measurable decrease in business. In theory, any reduction of business activity attributable to compliance with COVID-19 related measures would allow a borrower to qualify under this safe harbor. Additionally, the reduction in business activity may be both direct or indirect. For example, if the borrower can comply with the necessary COVID-19 measures, but one of its suppliers cannot, the indirect impact to the borrower may allow the borrower to qualify under this safe harbor.
Safe Harbor 2: FTE Restoration by December 31, 2020
If the borrower experiences a reduction in FTEs during the covered period but restores the number of FTEs to the level as of February 15, 2020, the borrower will meet the safe harbor provision and not have its loan forgiveness amount reduced.
The borrower has until the earlier of December 31, 2020 or the date in which it submits its loan forgiveness application to restore its FTE levels to qualify for the safe harbor. Therefore, it may be wise to hold off on applying for loan forgiveness until 2021 if the borrower is planning to reinstate employment levels before the end of the year.
If a borrower’s average FTE between February 15, 2020 and April 26, 2020 is more than its FTE on February 15, 2020, the borrower is not eligible for this safe harbor. In other words, if the borrower experienced an increase in average FTEs during the initial weeks of the COVID-19 shut down, this safe harbor won’t apply.
Other Exception: Bona Fide Offers for Rehire
If a borrower makes a good faith offer to rehire an employee during the covered period but is turned down, the borrower is not penalized for this. This rehire includes these circumstances:
- Employee was fired for cause;
- Employee voluntarily resigned; or
- Employee requested and received a reduction of their hours.
As long as the position is not filled by a new employee by the end of 2020, the employer need not include the FTE employee in its FTE reduction calculation. The borrower must inform the applicable state unemployment insurance office of any rehire offer that is rejected by the employee within 30 days of the rejection. The borrower must also maintain written records of the efforts to rehire the employee. These documents should include a copy of the written offer, the employee’s written rejection, and a written record of efforts to hire a similarly qualified individual by the end of 2020.
Restoring Wages by the End of the Covered Period
Another way the loan forgiveness amount may be reduced is when an employee’s salary or hourly wage is reduced by more than 25% during the covered period when compared to Q1 of 2020 (January 1, 2020 – March 31, 2020). The portion that exceeds 25% reduces the forgiveness amount.
When determining the salary or wage reduction amount, only salaries and wages are analyzed. Any other forms of compensation (bonuses, tips, benefits, etc.) are not considered. This wage restoration requirement only applies to employees that earned an annualized amount of $100,000 or less during 2019 or were not employed by the borrower at any point during 2019. Additionally, the calculation should be done on an employee by employee basis.
If a borrower uses a 24-week covered period and applies for forgiveness prior to the end of the covered period, the borrower must account for the salary and wage reduction for the entire 24-week covered period.
EXAMPLE: An employee earns $1,000 per week. The employee’s weekly wage is reduced to $600 at the beginning of the covered period. A 75% salary reduction for this employee is $750. The portion that exceeds this 75% threshold is $150 ($750 – $600). The borrower’s loan forgiveness is reduced by $3,600 ($150 x 24 weeks), regardless of whether the borrower applies for loan forgiveness early or waits until the covered period ends.
When rolling economic shutdowns hit in mid-March, many hoped it would be temporary. The PPP loans provided some much-needed relief to businesses and allowed them to maintain their payroll, even if their doors weren’t open. However, as many find their PPP loan funds ending, the possibility of layoffs or furloughs is becoming a reality for many.
Maintaining wages and employees during the covered period is a critical component to achieving maximum PPP loan forgiveness. However, all factors need to be weighed when determining the timing of layoffs.
Some tips to consider:
- Be cautious for crossing the 25% wage reduction threshold. There may be ways to get creative with wage levels and offer partial hour reductions to employees during your covered period rather than laying them off entirely.
- Don’t be afraid to look for other sources of funding to get you through your covered period and maintain your workforce.
- For borrowers that received their funds prior to June 8, determine which covered period is best for you. These borrowers may use an 8-week or a 24-week covered period when applying for forgiveness. Depending on wage levels, one covered period may be more advantageous than another.
Don’t let achieving maximum forgiveness create blinders to good business. If your forgiveness amount is reduced, the balance simply converts to a loan with a 1% interest rate, some of the most favorable interest rates in history. Although you need to repay this amount, it may create some additional flexibility for your business and allow operations to continue in a reduced matter rather than shutting your doors entirely. Do the math on all potential scenarios to determine which one is optimal for your unique situation.
If you have questions as you navigate the loan forgiveness process, please reach out to your advisor at Clark Nuber for up to date information on the latest rules surrounding the program.
This article is the third in a series on the PPP Loan Forgiveness Roadmap. Click here to access Part I: The Covered Period. Click here to access Part II: Eligible Expenses.
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