Over the last three weeks, many small businesses have received loans under the federal Paycheck Protection Program authorized under the CARES Act last month.

Much of the focus has been on the loan eligibility and application requirements, as well as prodding bankers to push loan requests through the Small Business Administration’s clunky approval process.

Now that many companies have received their loans, the question facing them is “How do we spend it?”

A key issue for many leaders is the PPP provision allowing partial or full forgiveness of loan amount if certain criteria are met within eight weeks of receiving the loan.

In order to plan appropriately, leaders must understand the statutory and regulatory details of the Paycheck Protection Program.

However, as with many government programs, the details can be confusing.

The following is my understanding of the program after discussing it with my trusted advisors and going through the grueling process of determining how best to utilize the PPP loan my firm received.

There are still many unanswered questions about the program, particularly with regard to loan forgiveness. With any luck, the SBA will provide more guidance to employers soon, rather than after we’ve already spent all of the money.

Finally, I’m neither a lawyer nor an accountant. I’m just a guy who is trying to figure out the right thing to do for my company and my employees and thought I’d share what I think I’ve figured out.

Updated 04/29/2020: Check out our PPP Loan Forgiveness Calculator for an understanding of how different scenarios may affect your company’s PPP forgiveness!

Use of PPP Loan Proceeds Are Limited

The CARES Act limits use of PPP funds to:

  • payroll costs (as defined in the Act and paragraph 2.f of the SBA’s interim final rule)
  • Costs related to the continuation of group health care benefits during periods of paid sick, medical, or family leave, and insurance premiums;
  • Mortgage interest payments (but not mortgage prepayments or principal payments);
  • Rent payments;
  • Utility payments;
  • Interest payments on any other debt obligations that were incurred before February 15, 2020; and/or
  • Refinancing an SBA EIDL loan made between January 31, 2020 and April 3, 2020.

The SBA’s interim rules define “payroll costs” as:

  • Compensation to employees (whose principal place of residence is the United States) in the form of salary, wages, commissions, or similar compensation;
  • Cash tips or the equivalent (based on employer records of past tips or, in the absence of such records, a reasonable, good-faith employer estimate of such tips);
  • Payment for vacation, parental, family, medical, or sick leave;
  • Allowance for separation or dismissal;
  • Payment for the provision of employee benefits consisting of group health care coverage, including insurance premiums, and retirement;
  • Payment of state and local taxes assessed on compensation of employees;
  • And for an independent contractor or sole proprietor,  wage, commissions, income, or net earnings from self-employment or similar compensation.

Additionally, the SBA’s rules require that at least 75% of the PPP principal be spent on payroll costs, allowing no more than 25% be spent on non-payroll costs such as rent or utilities.

Finally, the money from a PPP loan must be spent by June 30, 2020.

Loan Forgiveness 

Companies can have the some or all of their PPP loan forgiven to the extent that, within eight weeks of loan origination (the date the loan is funded), the loan is used for the following purposes:

  • Payroll costs;
  • Any payment of interest on any covered mortgage obligation (which shall not include any prepayment of or payment of principal on a covered mortgage obligation);
  • Any payment on any covered rent obligation; and
  • Any covered utility payment.

Note that the following expenses are allowable uses of PPP loan proceeds but are not forgivable:

  • Interest payments on any other debt obligations that were incurred before February 15, 2020; and/or
  • Refinancing an SBA EIDL loan made between January 31, 2020 and April 3, 2020.

Reductions to Loan Forgiveness Amounts 

Although it is not specified in the CARES Act, the SBA regulations require that 75% of the PPP money must be spent on payroll expenses, which includes wages, benefits, and state taxes.

The remaining 25% may be spent on a few authorized non-payroll items: rent, mortgage interest, and utilities.

It is widely understood that the amount spent on these items within eight weeks of the loan’s disbursement is forgivable. I’ll call this the “forgiveness period” for brevity.

Many have been surprised to learn of two important factors that can reduced the amount of forgiveness:

  1. If the employers’ average weekly full time equivalents (FTEs: total number of hours worked divided by 40 hours per week) during the forgiveness period are lower than they were during one of two baseline periods (2/15/19 to 6/30/19 or 1/1/20 to 2/29/20, at the employers’ discretion), the forgiveness amount is reduced proportionally.
  2. If any employees’ total wages are reduced during the forgiveness period by more than 25% of their total wages during the first quarter of 2020, the dollar amount of any reduction exceeding 25% will be deducted from the forgiveness amount. This forgiveness reduction does not apply to salary reductions affecting any employee who, on an annualized basis, earned more than $100,000 in any single pay period during 2019.

Example 1:

Acme Manufacturing had 100 employees during their selected baseline period.

After receiving their PPP loan, Acme employed only 50 people because they only had enough work for those individuals.

At the end of the eight-week forgiveness period, Acme had spent $300,000 on allowed payroll expenses and another $100,000 on allowable non-payroll expenses, for a total of $400,000 potential forgiveness.

However, because Acme’s FTE count was reduced by 50%, the amount of their PPP forgiveness is also reduced from $400,000 to $200,000.

Example 2:

Acme Manufacturing had 100 employees during their selected baseline period.

After receiving their PPP loan, Acme employed 100 people even though they didn’t have any work for many of them and they just stayed home.

After the eight-week forgiveness period, Acme had spent $600,000 on allowed payroll expenses and another $100,000 on allowable non-payroll expenses, for a total of $700,000 eligible forgiveness.

Because Acme’s FTE count during the forgiveness period match the FTE count during their baseline period, there is no reduction in the amount eligible for PPP forgiveness.

Example 3:

Acme Manufacturing reduced Sarah’s salary as a supervisor by $24,000 from $80,000 to $56,000 (a 30% reduction) on April 1st and, upon receiving the PPP loan, did not increase her salary during the eight-week forgiveness period.

In Sarah’s case, Acme’s PPP forgiveness will be reduced by $4,000—the difference between a 25% salary reduction and a 30% salary reduction.

This calculation must be performed for every employee who experienced a wage reduction of more than 25%.

Example 4:

Acme Manufacturing was really busy during the first quarter of 2020 and Joe, an hourly employee, worked 10 hours of overtime each week.

With overtime, Joe’s average wages were $1,031 per week during Q1.

During the eight-week forgiveness period, Joe’s hourly rate was not reduced but he did not receive any overtime, resulting in weekly compensation of $750, a reduction in total wages of $281 per week (-27%).

Because anything beyond a 25% reduction in total wages is deducted from the forgiveness amount, Acme’s forgiveness amount will be reduced by $187.50 for the eight week period—the difference between a 25% compensation reduction and a 27% reduction.

Example 5:

Acme Manufacturing pays Patricia $1,000 a week as a bookkeeper.

She was paid a non-discretionary bonus of $10,000 on January 1st because she met her 2019 KPI’s.

Because of the bonus, Patricia’s average weekly compensation in Q1 was $1,769.

Her weekly compensation remained at $1,000 per week through the forgiveness period. She received no reduction on her normal compensation.

But because no bonuses were scheduled to be paid in Q2, her average weekly income during the forgiveness period was $769 lower (-43%).

Because anything beyond a 25% reduction in total wages is deducted from the forgiveness amount, Acme’s forgiveness amount will be reduced by $2,615 for the eight week period—the difference between a 25% compensation reduction and a 43% reduction.

Example 6:

On April 1st (and the first day of Q2), Acme hired Jessica as their new receptionist.

Acme reduced her hours on April 15th to cut costs.

Because Jessica was not an Acme employee during Q1, her reduction in wages resulting from the reduction in her hours does not reduce Acme’s forgiveness amount.

The Remedy for Reductions in Loan Forgiveness Amounts

Employers whose loan forgiveness amounts might otherwise be reduced because of a reduction in FTEs and/or some employees’ compensation still have an opportunity to receive full credit for authorized expenditures during the forgiveness period.

The CARES Act states that if by June 30th any reductions to the total FTE count and any individual employees’ salaries or wages are eliminated, the employer can receive full credit for forgivable expenses.

Clarifications Needed Regarding Loan Forgiveness 

There are at least two (and doubtless more) significant clarifications the SBA needs to provide businesses trying to determine how to most effectively use their PPP loan proceeds.

  1. The PPP’s intent seems to be that employers return laid off employees to their payroll even if there is no work for them to do or their non-essential workplace isn’t accessible because of stay-at-home orders.However, because of the federal unemployment bonus of $600 per week, many laid off employees might decline to return to the employer’s payroll and forgo the unemployment compensation because it would effectively mean a reduction in income.In other cases, the former employee may have accepted another position and is unavailable to return to work.In order the meet the FTE requirements, must an employer hire someone else, possibly to do no work and just stay at home? (Perhaps the employer could go to the homeless shelter and sign up some new employees?)This seems the only logical option available to an employer in order to ensure that they are able to maximize forgiveness. Otherwise, they would be penalized for the employee’s actions.
  2. The actual text of the wage-reduction portion of the CARES Act is very confusing. It seems to consider a “reduction in total salary or wages… during the covered period” as anything less than “total salary or wages of the employee during the most recent full quarter.”The problem is that the “covered period” is only eight weeks while the “most recent full quarter” (January through March) is 13 weeks.A literal reading of the statute suggests that a company’s forgiveness amount would be reduced if an employees’ total wages earned over the eight-week period were less than 75% of what the employee earned over the entire 13 weeks of Q1. Even if the wages were identical on a weekly basis, the total difference in wages would be 38%!In the examples above and in all other commentaries I’ve read, the assumption is that the average wages for each period should be compared. However, until the SBA gives some guidance on this, we cannot be certain.

Repayment Terms For Unforgiven PPP Loan Amounts 

Businesses are not required to spend all of their PPP loan proceeds during the forgiveness periods, although they still must limit their use of funds to the authorized purposes listed in the CARES Act by June 30th.

Although the CARES Act allows for the loans to mature in ten years, the SBA decided that the loans must be repaid in two years. From the SBA’s interim rule:

The maturity is two years. While the Act provides that a loan will have a maximum maturity of up to ten years from the date the borrower applies for loan forgiveness (described below), the Administrator, in consultation with the Secretary, determined that a two year loan term is sufficient in light of the temporary economic dislocations caused by the coronavirus. Specifically, the considerable economic disruption caused by the coronavirus is expected to abate well before the two year maturity date such that borrowers will be able to recommence business operations and pay off any outstanding balances on their PPP loans.

This seems to be an optimistic economic forecast by the SBA.

Payments on the loan are deferred for the first six months, after which the company must begin to repay any of the loan that was not forgiven.

But the size of those payments may come as a surprise to many companies because the payments are calculated on the entire amount of the loan, not the loan balance after forgiveness.

Example 7:

Acme Manufacturing received an $800,000 PPP loan on April 15th.

Acme was able to get all but $100,000 of the loan forgiven.

On October 15th, Acme must make their first loan payment of $45,018.04.

With payments that large, Acme will have paid off their loan balance within three months and the two-year loan period will be irrelevant.

Many small businesses will consider themselves fortunate to be anywhere close to returning to pre-COVID profitability in six months.

Businesses who do not plan to have all of their PPP loan forgiven should plan ahead in order have an enough cash on hand to make these payments.

UPDATE 4/30/2020: Some borrowers have shared that their loan documents allowed for amortization of their loans after forgiveness. So the bottom line here is to examine your loan documents and talk to your banker. Although the loan documents are supposed to be standard SBA forms, apparently there is some variation.

Workforce Planning Considerations 

Clearly, the intent of the Paycheck Protection Program was to protect paychecks, not small businesses.

Small businesses who are shut down due to quarantines or for whom the pandemic has significantly reduced demand for their products or services will likely not have need for the employees that they have furloughed or laid off.

While the PPP makes it possible to pay these employees to stay at home and often do nothing for eight or more weeks, adding the employees to payroll often means an income reduction for an employee who is receiving an extra $600 in federal unemployment compensation each week through July.

It also puts the employer at risk of having to again furlough or lay off the employees if the economy has not significantly recovered in eight weeks.

Those employees will be at a financial disadvantage because they moved from unemployment to the employers’ payroll and missed $4,800 in federal unemployment payments.

Employers who do not have a business need to keep all of their employees working will have to make their own ethical and business decisions about how to proceed.

They have many options, including:

  1. Use their PPP loan to bring all of their employees back on payroll, hoping that the economy and their business has recovered by the end of June.This option runs the risk of having to lay those employees off again at the end of June if business circumstances have not improved.Depending on those employees’ income level, adding them back to payroll may mean reducing their income when the additional $600 per week federal enhancement is factored in.
  2. Use the PPP loan to keep only the employees necessary to meet customer demands and sustain the business’ operations.This option will likely impact the business’ ability to obtain full forgiveness of the PPP loan because of the reduction in FTEs, unless the company is actually able to return to full FTEs by June 30th.The employer might still obtain full forgiveness if, by the pay period covering June 30th, they have returned to their full FTE count.
  3. Use the PPP loan to pay those employees who wish to return to the employer’s payroll although there is currently no work for them, but giving them the option of not being recalled (and thereby remaining on unemployment).The employer could then fill the remaining FTEs required for forgiveness with temporary employees (who they may pay at a lower rate than the employees whose FTE slot they are filling) to increase their FTE count to the level required in order to get full forgiveness.

These are but a few of the courses of action an employer might pursue.

Beyond the financial considerations, employers will need to consider hard to measure issues such as the risk of losing key skills, institutional knowledge, or relationships if employees find other positions rather than waiting on the employer to recall them.

And as the economy and business begin to recover, employers who are unable to stay attached to their laid off employees may find increased costs in time and effort of replacing departed employees and onboarding and training new employees.

Long-term employee engagement is also at risk. How well an employer communicates with its furloughed or laid off employees will affect how those who ultimately return to the workplace will feel about the company. These feelings could be an asset or liability for the employer for years to come.