To describe the CARES Act as expansive is an understatement of monumental proportions. But as well-intentioned as it is, its massive scope makes it challenging to distill the information into something digestible. And for businesses reeling from this horrific pandemic, many just trying to keep the doors open with an SBA loan or some other form of relief, there isn't a lot of spare time to ponder over the nuances and repercussions of this dense, 335-page piece Washington-ese.
But that's where Embark comes in. We've gone through the CARES Act so you can concentrate on running your business and making sure your team remains safe. Granted, the SBA loan provisions under the Paycheck Protection Program (PPP) are, once again, quite expansive, so it's still wise to do your own research. However, whether you’re a distressed company looking for a lifeline or just trying to shore up your financial position in the face of immense uncertainty, the following basic information and accounting considerations of PPP-backed SBA loans are a good place to start.
The Basics of SBA Loans Under the CARES Act
Under the new legislation, businesses with fewer than 500 employees could potentially qualify for SBA administered relief loans through the PPP. However, according to the most recent guidance, the PPP excludes PE-backed organizations that, in conglomerate, are part of an investing pool exceeding that 500-person threshold.
For those that do qualify, these are essentially low-interest (1%) forgivable loans as long as a company meets certain criteria:
- The business maintains wages and headcount through June 30, 2020
- The money goes toward qualifying expenses, including payroll, rent, mortgage interest, or utilities in the eight weeks following the origination date
- The company uses a minimum of 75% of the forgiven amount on payroll
- The qualifying expenses were in place as of February 25, 2020
Businesses should take note that the loans require them to maintain or rehire their employees. If headcounts fall, then the PPP reduces the amount forgiven. Also, although interest accrues for the initial six-months, companies can defer payments for that period. Loans under the PPP have a maturity of 2 years with a maximum loan amount of 2.5x the average monthly payroll costs over the past twelve months.
Preparing for the SBA Loan Application Process
From recent conversations over the past couple of weeks, companies with a solid existing relationship with their bank should find the process much easier than those who don't. In other words, if you already have a go-to representative that you work with, you should be in good shape for this first round of funding, at least from a procedural perspective. Since these loans are first-come, first-served, a healthy working relationship with your bank can expedite the process and give you a definite advantage over companies starting from scratch.
Zooming in on ways to streamline everything, the first thing to do is understand what you can and cannot include as a payroll cost, which, over the last couple of weeks, is something we've spoken to a number of our clients about.
While the calculation itself isn't terribly complex, it does require specific information, including accurate payroll records and a list of employer-paid benefits going back a rolling twelve months. The application uses your Form 941s – the Employer's Quarterly Federal Tax Return – to drive the allowable wage portion of the payroll cost calculation.
To summarize what you'll need going into the application process:
- Accurate payroll records
- Employer-paid benefits over a rolling twelve-month period
- Form 941 filings
- Articles of Incorporation
- EIN letter from the IRS
- Operating agreements
- Recent tax returns
Here at Embark, we've developed a template to help our clients navigate these potentially confusing waters. Whether you choose to work with a third-party for guidance or fend for your own, though, thorough preparation – starting with these required documents – is critical for efficiency and, ultimately, success.
Accounting, Finance & Tax Considerations
As we said, as long as you meet the bill's particular criteria, these loans are entirely forgivable. But even if you don't meet those criteria, a two-year loan at 1% with six months of deferred payments is certainly nothing to scoff at – and that's just on the loan amount that doesn't meet the qualifying expense guidelines. But just because the loans are attractive doesn't mean there won't be any accounting and finance considerations to keep in mind.
For example, since these are government-sponsored loans and not market-driven, companies won't have to impute any interest as noted in ASC 835, even though the 1% interest rate on the loans is significantly below prevailing market rates. Put another way, even if the loan isn’t forgiven and you’re on the hook for the interest, you don’t have to impute a higher interest charge based on prevailing market rates.
On the income tax side of the coin, after the loan is forgiven and migrates from your balance sheet to your P&L, the IRS will not consider the forgiven amount as a taxable event. Therefore, companies with qualifying expenses don't have to plan around a larger tax bill in 2020 due to debt forgiveness.
Walk a Fine Line With Your Disclosures
Many companies will have to tip-toe a bit with their disclosures. Naturally, you always want to be transparent and thorough with them. After all, that's why they exist in the first place. But because the impact of COVID-19 has come on so suddenly and forcefully, the actual accounting for that impact is still playing some catch-up.
If a company applies and qualifies for one of these relief SBA loans, they should disclose the nature of the loan in their reporting as well as a brief description of how the coronavirus pandemic impacted it. Also, if the loans are part of management’s plan to overcome their substantial doubt and continue as a going concern, then they must disclose:
- The events and conditions that gave rise to the substantial doubt
- Management's evaluation of those events and conditions on their ability to meet their obligations
- A description of the plan that alleviates the doubt
Remember, going concern assessments are required for both interim and annual reporting periods. Likewise, companies must still include all of the necessary debt disclosures as outlined in ASC 470, just as they would with any other loan.
Therefore, while exceptional events might be triggering the need for these loans – and, thus, these disclosures – companies must still abide by the same framework and guidance they’re already accustomed to using. And that's where a fine line exists, where companies must still provide investors and other users of the financial statements with forthright, complete information in their disclosures, but not paint the circumstances in such a negative light that it actually scares away those parties.
Of course, this isn't an exhaustive list of considerations to take into account. In fact, the possible tax implications alone could fill more than a few pages worth of small-font print. But between the basics of the PPP SBA loans and these accounting and finance considerations, a company should feel sufficiently informed, at least as it enters the application process and begins to look a bit down the reporting road.