We don’t have much to say about the relative success or failure of the PPP loan program. As many wise people have said, it is what it is. And we’ll leave it at that. However, as we’ve demonstrated in the past, we have absolutely no problem digging in deep to help you understand what PPP loans are and what they mean in the bigger accounting picture for your organization.
So, in keeping with our apolitical, purely informational stance, we now want to extend our previous discussions on the topic and hone in on accounting considerations for PPP loan forgiveness. Obviously, it’s going to be a heckuva wild ride, so buckle up. Or at least sit up straight and grab your good reading glasses.
A High-Level Look at PPP Loan Forgiveness
As we’ve already seen from much of the CARES Act and other responses to the coronavirus, this is very fluid legislation. Things can change quickly, especially in comparison to DC’s typically glacial speeds. Thus, there may very well be a few facets of PPP loans – forgiveness included – that continue to evolve. But, as always, we’ll continue to keep you posted on any accounting curveballs that lawmakers might throw our way.
The Paycheck Protection Program Flexibility Act of 2020
As if to validate the previous paragraph, legislators recently passed the Paycheck Protection Program Flexibility Act of 2020 to streamline PPP loans and the forgiveness requirements. And although you're already wearing your best set of reading glasses, we'll spare your eyes and just bullet point the recent changes:
- The new 60/40 payroll requirement means companies must spend a minimum of 60% of the loan amount on payroll costs and the remaining 40% on non-payroll eligible expenses like business rent, mortgage interest, and utility payments.
- Companies now have a 24-week time period rather than the earlier prescribed eight weeks to spend their PPP funds.
- December 31, 2020 is the cutoff date for any eligible expenses. Companies with loans disbursed after July 16 should take note that they will not have the full 24-week period available to them.
- Companies can still opt to stick with the original eight-week period to spend the loan proceeds and apply for forgiveness sooner.
- For reduced wages and layoffs, employers have until December 31, 2020 to rehire those employees and reinstate their wages to no less than 75% of their original rate.
- Payroll tax deferrals remain intact until December 31, 2020 for PPP borrowers that receive loan forgiveness.
- Companies now have up to 10 months after their covered period ends to apply for forgiveness. No repayment is necessary until the loan forgiveness application has been fully processed and completed.
- For loans approved on or after June 5, business owners will now have a five-year loan length at the same annual interest rate as the previous forgiveness rules of 1%. Also, if the borrower and lender agree, existing loans can have their loans extended to five years as well.
It's important to note that, despite these rather expansive changes, the PPP loan application deadline remains the same. Companies have until June 30 to submit their application form for a loan.
Also, for borrowers and their affiliates with PPP loans less than $2 million, the SBA's safe-harbor remains in effect, automatically certifying that the business acted in good faith when requesting the loan. In a bit, we’ll discuss additional safe harbors regarding full-time employee (FTE) calculations.
Defining Loan Forgiveness
Now that we have those recent changes out of the way, let's switch our focus to the basics. When it comes to PPP forgiveness, there's nothing exceptional about the way PPP loans are forgiven versus another type of qualified borrowing. In other words, a forgiven PPP loan is still essentially written off as long as a company accounts for it as debt under ASC 470 and has satisfied all of the underlying criteria as outlined or interpreted under the law. Alternatively, some companies are treating the loans as government grants, which require different accounting than “writing off” debt under ASC 470.
Therefore, what complicates matters for PPP loans isn't the definition of the term forgiveness itself but, instead, interpreting the many different provisions within the program. And since many companies we’ve been talking to struggle most with the headcount criteria, we thought it best to hit that subject first.
The PPP Loan Headcount Requirement
To determine if you satisfy the staffing requirements, you begin by calculating the average number of full-time equivalent employees you had for the covered period following your initial loan disbursement. Remember, this has recently changed from eight weeks to 24 weeks, but companies can still choose the original eight-week allotment.
From there, you divide that figure by your full-time equivalents from February 15, 2019 to June 30, 2019 as well as January 1, 2020 to February 29, 2020. Now, take the larger of those two figures and, if it is greater than or equal to one, then you satisfy the headcount requirement for forgiveness. If it's smaller than one, though, you must prorate your forgivable expenses, thus, reducing your amount of loan forgiveness.
Of course, those calculations assume that you have a thorough understanding of what constitutes an FTE employee in the first place. And that can get a bit tricky if you have hourly employees in the mix. To simplify matters, reduce your full-time employee calculation to this, based on the US Treasury's 40 hour workweek standard:
- For every employee that averaged more than 40 hours per week during the calculation, count as one full-time employee. Anything over 40 hours does not factor into the calculation.
- For part-time employees that worked less than 40 average hours per week, divide their average by 40 and round to the nearest tenth. The result will be your full-time employee calculation for that individual. For instance, if you have four people that consistently worked 15 hours per week, then their cumulative full-time employee count would be 1.5.
Alternatively, the Small Business Administration (SBA) also allows you to use 0.5 for employees that did not average 40 hours or more. As a best practice, we suggest you calculate your FTE number both ways to see which one works more in your favor. No matter which route you end up choosing, however, you still add your full-time and part-time figures together to arrive at your total number of full-time employees.
FTE Reduction Safe Harbors
As mentioned, the Flexibility Act also enhanced some safe harbors for employers regarding FTE counts. First, if you cut headcount or pay in 2020, you will not face a reduction in PPP loan forgiveness as long as you restore them by December 31, 2020. The original CARES Act only protected the borrower until June 30, 2020.
Also, if you cannot replace your headcount by the December 31, 2020 deadline, all is not lost. The Flexibility Act provides yet another safe harbor to protect you against a reduction in forgiveness, as long as you meet certain requirements:
- You were unable to rehire people that were employees on February 15, 2020
- You were unable to hire similarly qualified employees for your vacant positions by December 31, 2020
- Due to coronavirus-related HHS, CDC, or OSHA standards regarding social distancing or sanitation requirements beginning March 21, 2020, you were unable to return to the same level of business activity that your company operated at before February 15, 2020.
That last bullet point is an important one since it provides protection against forgiveness reduction if the pandemic continues or a second wave hits. For example, if you run a chain of restaurants and government orders prevent you from either staying open or opening in the first place, this safe harbor shields you from reduced FTE counts and, thus, forgiveness reduction.
Also, keep in mind that the CARES Act provides additional protection mechanisms from FTE headcount loss that aren’t necessarily safe harbors per se, but certainly beneficial for borrowers:
- An employee turns down a rehiring offer with the same hours and pay as before the separation or reduction in hours. You must inform the state unemployment insurance office of the employee’s decision within 30 days of the rejection
- You fire the individual for cause, the employee voluntarily resigns their position, or requests a reduced schedule
It's also important to remember that you must maintain at least 75% of total salary for every worker that didn't earn more than $100,000 in annualized pay in 2019. For example, let's say you rehire an employee at $20 per hour that was making $30 per hour before the COVID-19 pandemic hit. Since their new hourly rate is less than 75% of what you paid them during their most recent quarter of employment with you, you must reduce your forgiveness by the difference between their new rate and 75% of their original pay. In this instance, that equates to $2.50 per hour: ($30*.75)-20= $2.50.
Calculating Your Loan Forgiveness
The points we've discussed cover most of what you'll need to calculate your PPP loan forgiveness, but certainly not all. We suggest using the Forgiveness Calculation Steps from the AICPA for a more comprehensive look at the forgiveness process.
Regarding any tips and best practices, our biggest piece of advice is to be prepared and make certain you have all of the supporting files and documentation you need to complete the forgiveness application. Since the SBA audit period can stretch out to six years, it's essential that you maintain good records, even after the loan is potentially forgiven since it's impossible to tell how aggressive they'll be with the audits. And as always, Embark will be here to provide insights and updates as they arise. It's what we do.