How Forgiveness Works for PPP Loans

How Forgiveness Works for PPP Loans

By |2020-05-04T20:08:58+00:00May 4, 2020|Business Law|

Thousands of small businesses swarmed to the Government’s Paycheck Protection Program (PPP) when it became law, as the cornerstone of the Government’s $2 trillion relief package designed to address the economic suffering caused by the COVID-19 pandemic. The funds allocated to the program were quickly depleted. Last Friday, on April 24th 2020, the President signed an additional relief measure that provided an additional $310 billion in funding for the PPP. The program offers many benefits and entices small businesses with the prospect of receiving much needed cash relatively quickly, and with the promise that all PPP proceeds shall be forgiven.

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As businesses receive their PPP loan proceeds, the next consideration becomes forgiveness of those debts. Business owners should be cognizant of certain key rules when they begin using the loan proceeds, and preparing to apply to their lenders for forgiveness. Forgiveness under the PPP is not a mere formality that simply requires checking certain boxes.

I. General Requirements for Forgiveness under the PPP

Loans issued under the PPP may be forgiven “up to the full principal amount of the loan and any accrued interest.” 85 FR 20814. The statute and the regulations issued by the Small Business Administration (SBA) set forth specific requirements that businesses must satisfy; otherwise, the PPP reduces the amount of the loan eligible to be forgiven.

Threshold Requirement: The 75 / 25 Rule

In applying for the PPP loan, the recipient business calculated the maximum possible loan amount as 2.5 times the average gross monthly payroll cost for either the prior 12-month period or for the calendar year 2019. The statute allows the loan proceeds to be used for (a) payroll costs; (b) interest payments on covered mortgage obligations; (c) payments on covered rent obligations; and (d) covered utility payments. See Sec. 1106(a)(7) (explaining the sum of those items is the
“expected forgiveness amount”). Under the CARES Act, all amounts of the PPP loan “shall be eligible for forgiveness” if the small business uses those amounts for these four delineated purposes. See Sec. 1106(b).

The SBA regulations, however, impose an additional threshold requirement. In order for the borrower to be eligible for forgiveness “at least 75 percent of the PPP loan proceeds shall be used for payroll costs.” 85 FR 20814 (emphasis added). According to the regulations, “applying this threshold to loan forgiveness is consistent with the structure of the Act,” and “the Act’s overarching focus on keeping workers paid and employed.” Id.

During the 8-week covered period, the business must use 75% of the PPP loan for payroll costs; otherwise, the loan cannot be forgiven. This permits the business to use only 25% of the loan proceeds for the other permissible purposes. The SBA has imposed a bright-line threshold requirement. Unlike the issues related to reduction in forgiveness, using less than 75% of the PPP loan for payroll costs will prohibit any amount of the proceeds from being forgiven. Although the SBA guidance could provide greater clarity, this rule does not merely reduce the amount eligible for forgiveness.

II. Reduction of the Amount Eligible for Forgiveness

The CARES Act reduces the amount of the PPP loan eligible for forgiveness based upon (1) the number of full-time equivalent employees (FTEE) during the 8-week covered period and (2) any wage or salary reductions to the remaining employees’ earnings. See Sect. 1106(d).

Reduction based on Average Number of FTEE

Congress passed the CARES Act, in part, as an effort to protect employees from the dire economic circumstances caused by the COVID-19 pandemic. The Act links the PPP loan forgiveness with employee retention. All amounts used for authorized purposes under the PPP are “expected” to be forgiven. This amount is then reduced based on whether the recipient business has – in fact – retained all or most of its employees.

The CARES Act decreases the amount eligible for forgiveness by the percentage the recipient business reduced its workforce when compared either:

  1. to the same period during the prior year; or
  2. to the early period of 2020 before government orders imposed mandatory business closures.

See Sect. 1106(d)(2). The “headcount” for FTEEs is the controlling metric. The statute provides two formulas for calculating the reduction amount.2

1. Reduction = Total Amount x Average FTEEs per month for 8-Week Covered Period Eligible for Forgiveness


Average FTEEs per month from February 15, 2019 to

2. Reduction = Total Amount x Average FTEEs per month for 8-Week Covered Period Eligible for Forgiveness


Average FTEEs per month from January 1, 2020 to

Who Qualifies as “Full-time Equivalent Employee” for Purposes of PPP Forgiveness?

Employers must determine the average “headcount” for FTEEs, or more specifically, which employees are properly included as FTEEs. The CARES Act does not define FTEEs, and the SBA has also been slow to provide explicit guidance on the topic.

On a number of occasions, The CARES Act references full-time employees (and full-time equivalent employees) as such employees are defined under the IRS Code (IRC). First, Section 1106(e) delineates the documentation a recipient business must produce in order to apply for loan forgiveness. See Sec. 1106(e). It specifically cites “payroll tax filings reported to the Internal Revenue Service” as required documentation. Sec. 1106(e)(1)(A). Aside from establishing the
wage and salary amounts, it appears Section 1106(e) also references this documentation as a method of establishing the “headcount” for FTEEs. Second, Section 2301(c)(3) of the CARES Act expressly cites Section 4980H of the IRS Code (IRC). This section of the CARES Act sets forth the provisions for the Employee Retention Tax Credit (ERTC) and defines “full-time employee” as it appears under Section 4980(H). Accordingly, recipient businesses would be advised to consult the IRC’s definitions of the relevant terms in assessing loan forgiveness.

The IRC provides workable definitions under Section 4980H for both “full-time employee” and “full-time equivalents treated as full-time employees.” See 26 U.S.C.A. § 4980H(c). Section 4980H(c)(4) defines “full-time employee” as, “with respect to any month, an employee who is employed on average at least 30 hours of service per week.” 26 U.S.C.A. § 4980H(c)(4)(A). Thus, the “headcount” for FTEEs must include all employees who work 30 or more hours per week. Id. In addition, Section 4980H(c)(2)(E) discusses “[f]ull-time equivalents treated as full-time employees” for the purpose of calculating a headcount to determine whether an employer is a “large employer.” 26 U.S.C.A. § 4980H(c)(2)(E). It specifies that the monthly headcount should include “a number of full-time employees determined by dividing the aggregate number of hours of service of employees who are not full-time employees for the month by 120.” Id. In other words, the headcount includes a number of “[f]ull-time equivalents” equal to the aggregate number of hours worked by part-time employees in a month divided by 120. Id. In calculating the total FTEEs for purposes of the PPP loan forgiveness headcount, recipient businesses should follow the same formula.

Reduction based on Salary and Wages

If the recipient business decreased certain employees’ total wages or salaries during the covered 8-week period, Section 1106(d)(3) may reduce the amount of the PPP loan eligible for forgiveness. A reduction to the amount eligible for forgiveness occurs only when two conditions exist.

i. Decrease “in excess of 25 percent”

First, the decrease to the employee’s salary or wages must be “in excess of 25 percent” in comparison with “the total salary or wages of the employee during the most recent full quarter during which the employee was employed before the covered [8-week] period.” See Sect. 1106(d)(3)(A). The analysis examines the pertinent employee’s compensation for “the most recent full quarter” before the 8-week period beginning with the PPP loan’s origination. Id. The decrease
to the employee’s total salary or wages must be greater than 25 percent. If the employee’s salary or wages are diminished by 24 percent or less, no reduction to the amount eligible for forgiveness occurs.

ii. Excludes Highly Compensated Employees

Second, the employee must be an employee who falls within the scope of Section 1106(d)(3)(B). The provision excludes all employees who earned “during any single pay period during 2019, wages or salary at an annualized rate of pay in an amount more than $100,000.” See Sect. 1106(d)(3)(B). A recipient business is free to decrease the compensation of any employee who received compensation for any pay periodat an annualized rate of pay greater than $100,000 – even if that employee was not paid in excess of $100,000 for the entire year of 2019. The exclusion would apply to any employee who earned, for a minimum of one pay period in 2019, a gross amount that equates to $100,000 in annual compensation if the amount was received for every pay period. The section does not – in fact – require the employee to receive that amount for every pay period in 2019.

The following formula provides the amount of reduction for one individual employee, whose wages or salary was reduced “in excess of 25 percent[.]” The amount eligible for forgiveness must be reduced for each such employee separately. The amounts must be aggregated to discern the total amount of reduction.

Percentage of Employee’s Historic Wage/Salary = Wage/Salary for 8-Week Period


Wage/Salary for Most Recent Full Quarter

If rate of decrease is greater than 25%, then…
Reduction Total Amount Reduction in Dollar Amount of Wage/Salary for 8-Week Period Eligible for Forgiveness [compared to the employee’s wage/salary during most recent full quarter]

III. Exemption for Re-Hire as of June 30, 2020

Under the PPP, a safe harbor exists for any recipient business which, at any time between February 15, 2020 and thirty (30) days after enactment of The CARES Act, (i) reduced its number of FTEEs and/or (ii) decreased the wages or salaries of employees “in excess of 25 percent[.]” Sect. 1106(d)(5)(A). Despite decreasing wages, reducing the headcount for FTEEs, or undertaking both actions, the CARES Act saves recipient businesses from reducing the amount of the PPP loan eligible for forgiveness. “Not later than June 30, 2020,” the recipient employer must:

… eliminate[] the reduction in the number of full-time equivalent employees … [and/or] … [must] eliminate[] the reduction in the salary or wages of such employees[.] See Sect. 1106(d)(5)(B)(i)-(iii). Therefore, June 30th, 2020 is a date of critical importance. The business could pursue policies and practices that would otherwise substantially inhibit its ability to have the PPP loan forgiven, so long as it ‘cures’ those circumstances by June 30, 2020.

This provides recipient businesses with wider latitude; however, the safe harbor only pertains to reductions stemming from cuts to the headcount of FTEEs and decreases to employee compensation. In order to be eligible for forgiveness, businesses must still use 75% of the PPP loan for payroll costs. Likewise, only amounts used for items specifically authorized by The CARES Act are eligible for forgiveness (i.e., payroll costs, interest on mortgage, rent payments, utility payments).

IV. Documentation Required to Apply for PPP Loan Forgiveness

In order to seek loan forgiveness, a recipient business must apply to its lender and submit certain documentation. The recipient becomes eligible to submit the application beginning once the covered 8-week period has elapsed. Section 1106(e) of The CARES Act sets forth the documents that the recipient shall provide to the lender when applying:

  1. documentation verifying the number of full-time equivalent employees on payroll and pay rates for the periods described in subsection (d), including—
    1. payroll tax filings reported to the Internal Revenue Service; and
    2. State income, payroll, and unemployment insurance filings;
  2. documentation, including cancelled checks, payment receipts, transcripts of accounts, or other documents verifying payments on covered mortgage obligations, payments on covered lease obligations, and covered utility payments;
  3. a certification from a representative of the eligible recipient authorized to make such certifications that
    1. the documentation presented is true and correct; and
    2. the amount for which forgiveness is requested was used to retain employees, make interest payments on a covered mortgage obligation, make payments on a covered rent obligation, or make covered utility payments; and
  4. any other documentation the Administrator determines necessary.

See Sect. 1106(e) (emphasis added). Section 1106(f) makes clear that all documents cited under subsection (e) must be included with the recipient’s application for forgiveness. See Sect. 1106(f) (“No eligible recipient shall receive forgiveness under this section without submitting to the lender that is servicing the covered loan the documentation required under subsection (e).”). Although the statutory language at times suggests that the cited documents are merely illustrative, this does not appear to be the case. Each document explicitly delineated under Section 1106(e) must be included in the application.

The certification requirements are, perhaps, the most significant requirement. Any type of false or misleading statement could expose the recipient or its signatory to significant liability.3 Section 1106(h) insulates the lender from any type of enforcement action, if the recipient provides the documents required by subsection (e), including the certifications. See Sect. 1106(h).

As subsection (e)(4) indicates, the SBA may impose additional documentary requirements in regard to applications for PPP loan forgiveness. See Sect. 1106(e)(4). Currently, the SBA has specified the following regarding documentation requirements:

  1. Documentation verifying the number of full-time equivalent employees on payroll as well as the dollar amounts of payroll costs, covered mortgage interest payments, covered rent payments, and covered utilities for the eight week period following this loan will be provided to the lender.
  2. Loan forgiveness will be provided for the sum of documented payroll costs, covered mortgage interest payments, covered rent payments, and covered utilities. As explained above, not more than 25 percent of the forgiven amount may be for non-payroll costs.

85 FR 20814(t)(v). The statute also gives individual lenders the freedom to require certain additional documents. The Act bestows decision-making authority upon the individual lenders to determine whether recipients should receive forgiveness for their PPP loans (and, presumably, the extent of the forgiveness also). See Sect. 1106(g). The lender must make these decisions within sixty (60) days of receiving the application.

V. Closing Thoughts

The PPP is not the only option available for small business. The appeal of the PPP loans is their promise of forgiveness. Forgiveness, however, is far from guaranteed and complete forgiveness may be near impossible for many small businesses forced to make difficult choices over the past several weeks. The Employee Retention Tax Credit (ERTC) is an attractive alternative, which may work better for businesses forced to reduce headcounts or wages. Remember, the ERTC is not available for any business that received a PPP loan (a loan under SBA Section 7(a)(36)). Furthermore, if your small business is eligible for a tax credit under the Families First Coronavirus Response Act (FFCRA) for either qualified sick or family leave time, those amounts cannot be included as “payroll costs” for purposes of the PPP (including calculation of loan forgiveness under the PPP).

[The recipient] understand[s] that if the funds are knowingly used for unauthorized purposes, the Federal Government may hold [it] legally liable such as for charges of fraud. As explained above, not more than 25 percent of loan proceeds may be used for non-payroll costs.

85 FR 20814(t)(iii).

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Mr. Rodgers is an associate at Goldstein Law Partners. He concentrates his practice in the areas of constitutional law and civil rights, complex litigation and employment law.  As an experienced litigator, he appears before federal and state courts at both the trial and appellate levels.

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