SBA Clarifies that to Qualify for Loan Forgiveness, Employers Must Spend Three-Quarters of Paycheck Protection Loans on Payroll Costs

On April 2, 2020, the Small Business Administration (SBA) issued an interim final rule clarifying certain parts of the new Paycheck Protection Program (PPP). The new rule came just one day before PPP opened, and it includes several important clarifications. Most important, it states that borrowers must spend at least 75% of their loans on payroll costs to qualify for loan forgiveness.

PPP was created just last week, when Congress enacted the Coronavirus Aid, Relief, and Economic Security (CARES) Act. PPP offers low-interest loans to small businesses affected by the crisis, and encourages businesses not to reduce employee headcount or compensation by offering to forgive the loans in their entirety, subject to certain conditions.

In general, a business qualifies for a forgivable PPP loan if it employees 500 or fewer people. Whether a business employs that many people depends on the SBA’s “affiliation” rules. Those rules require a business to include the employees of all its “affiliates” in its own count. Affiliates include companies controlled by the business or under common control with the business.1 SBA has indicated that it may issue revised affiliation rules specific to PPP, but the agency has not done so to date.

This general rule differs for some employers. Employers in the food service and hospitality industries qualify if they employ 500 or fewer people per physical location. And franchises need not worry about the affiliation rules at all—the CARES Act explicitly waives affiliation rules for those businesses.

If a business meets the size criteria, it can borrow up to $10 million or 250% of its average monthly payroll, whichever is lower, and on more favorable terms than a typical SBA loan. The loan carries a lower interest rate, requires no payments for six months, and is potentially forgivable. In other words, if a borrower follows the SBA’s criteria, the loan conceivably is converted into a grant.

The SBA’s interim final rule explains how some of those criteria work. First, it offers more information about how borrowers should calculate their average monthly payrolls. For this purpose, the rule provides that payroll costs include salaries, wages, commissions, tips, vacation pay, parental and family leave, and allowances for dismissals or separations. Employers should add up all these costs over the 12-month period before they apply for a loan. Next, they should divide by 12 to get their average monthly payroll. Finally, they should multiply that number by 2.5 to get their maximum loan amount.

So, for example, if an employer spends $120,000 on payroll over the 12 months leading up to its loan, its average monthly payroll is $10,000. If it multiples that number by 2.5, it gets a maximum loan amount of $25,000.

The rule also clarifies the conditions for loan forgiveness. Under the CARES Act, employers can apply for forgiveness if they spend their loans on qualifying expenses over the eight weeks after receiving a loan. Qualifying expenses include payroll costs, utilities, mortgage interest (but not principal), and rent payments. The CARES Act said nothing about how employers must allocate their loan among those expenses.  In its rule, the SBA states that borrowers must spend at least 75% of their loans on payroll costs. It explains that the since the PPP’s primary goal is to keep people in their jobs, this new 75% rule, in the Agency’s view, is the best way to advance that goal.

In addition, the rule offers more detail on when loan forgiveness can be reduced. The CARES Act reduces forgiveness of a loan proportionally if an employer cuts employee headcount. To determine its baseline headcounts, an employer can use either (a) the average number of full-time equivalents (FTEs) it employed from January 1, 2020 to February 29, 2020, or (b) the average number of FTEs it employed from February 15, 2019 to June 30, 2019. Whichever average the employer chooses, it must maintain that number for at least the eight weeks after receiving a loan. If headcount falls below that number, the Act reduces loan forgiveness by a proportional amount.

The Act also reduces loan forgiveness if an employer cuts employee compensation. To get its baseline compensation figure, an employer should include all salaries and wages for employees up to $100,000 (the maximum amount of an employee’s compensation that an employer may count for monthly payroll purposes). If the employer reduces compensation below that number during the eight weeks after getting a loan, it may see its forgiveness reduced. But this reduction is more flexible than the reduction for headcount, as PPP builds in a 25% safe harbor. That is, reduction begins only after the employer reduces compensation by more than 25%.

To see how it works, assume an employer calculates its average monthly compensation to be $100,000. Because of coronavirus-related shutdowns, the employer cuts compensation to $50,000 per month—a 50% reduction. But only reductions after the first 25% count against loan forgiveness. So the employer’s forgiveness will fall by only 25%.

The SBA made a few other notable clarifications. First, it raised the interest rate on PPP loans from .5% to 1% (the Act allows as much as 4%.). It did that to encourage more lenders to participate. It also explained that lenders will issue the loans on a first-come, first-serve basis. So businesses interested in the loans should apply as soon as possible.

Though the new rule is effective immediately, the SBA is accepting public comments for the next 30 days. It will consider any comments received when deciding whether to make changes to the rule. In the meantime, however, it has already opened the PPP for applications.

Employers interested in applying for a loan should consult with a qualified lender, a CPA, and appropriate counsel. These same employers may also face issues related to the CARES Act’s expanded unemployment-insurance provisions and the Families First Coronavirus Response Act’s paid-leave requirements. Those questions can be directed to employment counsel.

With various agencies issuing new guidance daily, if not hourly, new information is coming in constantly.  Littler Workplace Policy Institute (WPI) will continue to monitor developments and provide updates.

See Footnotes

​1 The SBA’s test differs from those used under many employment laws, the Fair Labor Standards Act or the Family Medical Leave Act. These various tests may lead to different conclusions.

Information contained in this publication is intended for informational purposes only and does not constitute legal advice or opinion, nor is it a substitute for the professional judgment of an attorney.