Small businesses have been substantially affected by the rippling effects COVID-19 has had our society and the actions taken by federal, state, and municipal authorities to help minimize the spread of the virus in the United States. In Wisconsin, Governor Tony Evers issued a Safer at Home order on March 24, 2020 which classified some businesses as “essential”, allowing them to continue to operate, while classifying others as non-essential, prohibiting them from continuing operations, with some very limited exceptions. With the economic downturn this virus has caused, even “essential” businesses are hurting, resulting in employee layoffs and the legitimate possibility of businesses defaulting on ongoing overhead obligations such as rent, utilities, or mortgage payments.
To combat the potentially catastrophic effects this sudden economic downturn has had on small businesses, their owners, their employees, and the American economy as a whole, the Coronavirus Aid, Relief, and Economic Security Act (also known as the CARES Act), was enacted into law on March 27, 2020.
The CARES Act is over 880 pages. However, this post will focus only on the portion of the CARES Act that applies to small businesses in the form of small business loans through the Paycheck Protection Program. The intent of this program is to simultaneously assist small businesses by helping them avoid defaulting on ongoing overhead obligations, while also encouraging employers to retain and pay employees—thereby ensuring that employees can continue to support themselves and their families. While a loan may not seem much like a “stimulus,” there is potential for forgiveness of the loan so long as the business receiving the loan meets certain standards regarding employee retention and continued payment of those employees. The rest of this post will summarize the basic points of how this loan program works for small businesses.
How Does the Loan Work?
- Who is Eligible? Eligible businesses are those that have less than 500 employees, and also includes very small businesses, such as sole proprietors, independent contractors, and self-employed individuals. The business must also certify to the lending bank in writing that the uncertainty of current economic conditions makes the loan necessary to support its ongoing operations, acknowledge that the loan funds will be used to retain workers and maintain payroll, or make mortgage payments, lease payments, and utility payments. Additionally the business cannot get multiple Paycheck Protection Program loans and must make a certification to that effect to the lending bank.
- Where does my business get the loan? Local banks/financial institutions will be the sources of the funds. The funds are authorized under the SBA 7(a) program, which is typically used for startups, business acquisitions, and other SBA funded loans. Remember, the SBA does not pay the money directly to the business, they just provide a guarantee to the bank up to a certain percentage of the loan amount. In this crisis, for loans granted under the Paycheck Protection program, the loans are going to be backed 100% by the SBA (up from typically lower percentages). This means that if the business defaults on the loan, the SBA will reimburse the bank for their loss.
- How much interest will my business be charged? Interest rates cannot exceed 4%. Subsequent regulations have been issued since the original posting of this article. The interest rate on PPP loans will be 1%.
- How much of a loan can my business get? The maximum loan amount is $10 Million, but will be limited to 2.5 times the business’ average total monthly payments for payroll costs during the 1 year period before the date of the loan. If the business hasn’t been in business for a year, the loan amount is limited to 2.5 times the average monthly payroll costs incurred by the business during the period of January 1, 2020 through February 29, 2020.
- What is included in “payroll costs” for determining how much my business can borrow?
- Salary, wages, commission or similar compensation (except to the extent that an employee’s salary, wage or commission exceeds $100,000.00 annually, determined based on prorating the amount that would be paid from February 15, 2020 to June 30, 2020);
- Payment of cash tip or equivalent;
- Payment for vacation, parental, family, medical, or sick pay (except for those amounts paid for paid leave under the Families First Coronavirus Response Act, because those amounts are credited against an employer’s payroll tax liability);
- Allowance for dismissal or separation;
- Payment required for provision of group health benefits, including insurance premiums,
- Payment of any retirement benefit;
- Payment of state or local tax assessed on the compensation of employees; and
- Sum of payment of any compensation to any sole proprietor or independent contractor not to exceed $100,000.00 per year prorated over the period of February 15, 2020 to June 30, 2020.
- Subsequent regulations have been issued since the original posting of this article. Independent Contractor pay is not included for purposes of determining payroll costs.
- What can the loan funds be used for?
- payroll costs (as defined above);
- Payments of interest on mortgage obligations but NOT principal incurred prior to February 15, 2020;
- Rent obligations for obligations incurred prior to February 15, 2020;
- Utility costs for utility service beginning prior to February 15, 2020;
- Interest on any other debt obligations that were incurred prior to February 15, 2020.
- Are personal guarantees required and will collateral be required? The SBA will not require any personal guarantee from the business owner. This does not mean that the particular bank will not require a personal guarantee or require the pledging of collateral!
- Aren’t there fees with SBA loans? There is no (or to the extent possible) fee for the SBA loan;
- Will there be a penalty if my business pays back the loan early? There is no prepayment penalty;
- How long does my business have to pay it back? The loan amortization will be over no longer than a 10 year period if the loan is not forgiven. Subsequent regulations have been issued since the original posting of this article. The loan will be due in 2 years with monthly payments not due for six (6) months.
How would loan forgiveness work?
Businesses in financial trouble due to the COVID-19 crisis may be thinking, why would I take on more debt right now? A critical part of the Paycheck Protection program is eligibility for loan forgiveness for the loans issued under this program. This may be an extremely useful resource for qualifying businesses wishing to take advantage of this program. However, businesses contemplating obtaining the loans should make sure they understand what they are getting into prior to taking on the loan.
- How much of the loan can be forgiven? A business seeking a Payroll Protection Program loan can have its loan forgiven up to the amount (but not exceeding the loan amount) equal to costs incurred and payments made by the business during the period starting with the date the loan is made and 8 weeks after that, for the following expenses:
- payroll costs (as defined above);
- payment of interest on a mortgage obligation (the mortgage must have been in place before February 15, 2020);
- payment of rent (under a lease arrangement entered into prior to February 15, 2020); and
- payment of utilities (service must have begun prior to February 15, 2020).
- Note: the initial SBA application for Paycheck Protection Program loans indicates that “due to likely high subscription, it is anticipated that not more than 25% of the forgiven amount may be for non-payroll costs.”
- Is the forgiveness of debt taxable income? If there is loan that is forgiven, it is NOT included in gross income for income tax purposes (forgiveness of debt generally is taxable as income).
- Are there limits on the forgiveness? There are limits/standards that must be met for the business to receive forgiveness on the loan for payment of the above amounts:
- Employee retention: the amount of forgiveness for the above payments will be reduced if the business has fewer full time equivalent employees during the 8 week period after the loan is issued compared to the business’ average monthly full time equivalent employees during the period of February 15, 2019-June 30, 2019, or, if the business wasn’t open during that period, compared to the average number of full time equivalent employees per month during the period of January 1, 2020 through February 29, 2020. It is not clear from the Act what the SBA defines as a “full time employee equivalent”, as well as how part time employees fit within that definition. The SBA will need to issue guidance on these definitions in its regulations that are forthcoming.
- Employee Compensation. The amount of forgiveness will also be reduced by every dollar of pay reduction of more than 25% of the employee’s normal wages/salary paid during the most recent full quarter that the employee was employed before the covered period. (For employees making $100,000.00 or more annually, the reduction would only occur to the extent those employees had their pay reduced less than 75% of $100,000.00).
- Tipped workers: The Act states a business with tipped employees “may receive forgiveness for additional wages paid to those employees”. Unfortunately, this language is far from clear on how this will work. Does this mean that the business must pay an equivalent to 75% of average tips to those tipped employees in order to avoid reduction in loan forgiveness? Further guidance from the SBA will be needed on this point in upcoming regulations.
- Exemption for Re-hires. The Act also allows for a grace period for the business to get employee employment levels and employee compensation levels to a position where they would be eligible for the forgiveness without regard to the reductions described above. If the employee reduction and/or the compensation reduction occurs between February 15 and April 26, 2020, so long as the business has eliminated the reduction in employment of employees or reduction in pay by June 30, 2020 then there shall not be a reduction in the loan forgiveness. This allows businesses that may have already laid off employees or reduced employee pay to get employment levels and pay levels back up to appropriate levels and still qualify for forgiveness.
- Subsequent regulations have been issued since the original posting of this article. Not more than 25% of the forgiveness can be based upon non-payroll costs.
- The Payroll Protection Program under the CARES ACT provides small businesses the possibility of avoiding defaulting on mortgage payments, rent, and utility obligations, while also ensuring that their employees continue to get paid. Overall, it is a great help for both businesses and employees alike during this extremely difficult time.
- However, businesses should understand that this program is done via a loan. Businesses should not go into the loan process expecting to automatically get loan forgiveness. There is risk that they may not qualify for the forgiveness (or may not qualify for 100% forgiveness), and therefore will have debt to pay back, though it will be over a 10 year period at a maximum of 4% interest.
- Businesses will have to take extra care with their record-keeping to ensure that that they maximize their likelihood of obtaining loan forgiveness as these records will be heavily scrutinized in order for businesses to obtain that forgiveness. Additionally, businesses should understand that detailed records of the business, especially related to employees, must be kept in order to qualify for forgiveness.
- Because some provisions are not entirely clear and need further explanation from the SBA, there may not be answers on these questions before a business needs the funds. If businesses take the plunge with a loan, they should understand the risk that they may not necessarily qualify for loan forgiveness. The subsequent regulations may have impact on eligibility. Further, banks may not necessarily be able to provide substantial guidance on forgiveness eligibility until those regulations are issued. Businesses getting loans before regulations are issued should keep this in mind and understand the risk.
- With the initial SBA application and now issued regulations on the PPP indicating the loans are payable over 2 years, and that not more 25% of the forgiven amount can be for non-payroll costs, businesses should understand how much they may have to pay back, the monthly payment amounts if that were the case, and also determine what their anticipated payroll and non-payroll costs will be, so they can more accurately project the extent of forgiveness they will receive. If they will not receive complete forgiveness, businesses should determine how the projected monthly payments will affect cash flow.
- Practically speaking, this Act doesn’t change the fact that some businesses’ operations are substantially or completely reduced due to Stay at Home orders. As such, there may not be any work for employees or the same level of work for those employees. With that being said, the Payroll Protection Program may allow businesses to keep paying employees even if they are not working so the business can qualify for forgiveness for other overhead costs necessary to be paid to keep the business in business. Business owners will have to make the decision as to whether they wish to continue to make payments to those employees despite no or reduced services being provided in order to obtain loan forgiveness.
The attorneys at Schober Schober & Mitchell, S.C. are keeping up to date on the quickly changing laws regarding the COVID-19 crisis. Overall, we feel that the Payroll Protection Program under the CARES Act will be of benefit to many of our small business clients and hope that this will help all businesses weather this storm. We are available and happy to assist businesses who have questions on how they may be able to take advantage of this Paycheck Protection Program, as well as compliance with the other flurry of laws that have been passed recently related to COVID-19. Contact me, Attorney Jeremy M. Klang at firstname.lastname@example.org and any of our business attorneys at 262-785-1820, or by visiting our website at www.schoberlaw.com.