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PPP Rules Move the Goal Post on Forgiveness for Business Owners

Posted on May 27, 2020

The much-anticipated guidance on the tax-free forgiveness of the new small business loans contains surprises for some businesses and introduces new terms that will need to be defined in yet another round of guidance.

The interim final rules released late May 22 place new restrictions on the amounts paid to owner-employees of businesses that will be forgivable, which raises several issues, Anthony J. Nitti of RubinBrown LLP told Tax Notes.

Paycheck Protection Program (PPP) loans are generally forgivable as long as at least 75 percent of the proceeds are spent on payroll costs during the covered period, but those amounts are capped at $15,385 per employee. Everyone knew that, Nitti said, but what they didn’t know was that the amount for owner-employees would be further limited in the final rules to the lesser of $15,385 or 8/52 of 2019 compensation.

That change could affect S corporation shareholders, Nitti said. S corporation shareholders typically try to avoid paying themselves large salaries because those amounts are subject to employment taxes, so 2019 salaries may have been in the lower range.

But to maximize loan forgiveness, an owner may have increased the wages paid to himself for 2020. But under the final rules, that strategy may violate the new requirement for 8/52 of 2019 compensation.

Perhaps even more frustrating is that the government didn’t define what an owner-employee is, Nitti said.

“To mention owner-employees and not define what it means blows my mind,” Nitti said. “We’ve been through this many rounds of guidance — how hard would it be to define what an owner-employee is?”

The IRS has defined owner-employee in section 401(c)(3), but the interim final rules on PPP loans were issued by the Small Business Administration, even though it consults with Treasury on them. There’s no reason to assume that the IRS’s definitions apply for the PPP, Nitti said, so it needs to be addressed, and soon.

Any definition must address whether there’s a minimum ownership requirement and whether there will be attribution rules. For example, if an S corporation has one shareholder and the business pays wages to the owner’s family members for work performed, attribution rules could limit the forgiveness amounts paid to them as well.

The rule contains another hidden ticking time bomb: The new limits on owner-employee salaries apply to each individual across all businesses. That will come as a shock to many, Nitti said.

PPP loans were created as part of the Coronavirus Aid, Relief, and Economic Security (CARES) Act (P.L. 116-136) to help keep small businesses afloat during the coronavirus pandemic. The loans are generally available to businesses with fewer than 500 employees, and loan amounts can total up to $10 million. As long as a specified portion of the loans is spent on payroll costs, the loans can be forgiven on a tax-free basis.

More of the Same

Several rounds of guidance have been issued — interim final rules and FAQs have been released sporadically over the last few weeks to help answer borrowers' questions on how the program works.

On May 15 the SBA released the application and instructions for how loan forgiveness will be determined. The final interim rules largely follow the application and instructions, which isn’t very helpful, said Adam Markowitz of Howard L Markowitz PA CPA.

Markowitz said the final rules are “merely a fleshed-out version of the actual forgiveness application itself and do little to help borrowers figure out what to do with this application.” He said the next round of guidance should include a short form for borrowers or a blanket forgiveness for loans under a specified amount to make things easier.

“The 11-page application, as written, would take hours for professionals to do and is literally impossible for a layman to fill out,” Markowitz said. “Specifically, there is still very little guidance for sole proprietors and even less for business owners who just began working in 2020 and qualified for PPP.”

Brian Reardon of the S Corporation Association said the program needs a jolt of confidence, which could happen if Congress were to pass pending legislation expanding it.

“Businesses gave back more PPP money than they borrowed last week,” Reardon pointed out, highlighting the hesitation many businesses now have about taking advantage of the loan program.

Bonus Clarification

The final interim rules did answer one big question: whether bonuses paid to employees will count toward forgivable payroll costs. According to the rules, employee hazard pay and bonuses are eligible for loan forgiveness because they are a supplement to salary or wages and thus qualify as a similar form of compensation under the law.

Under the PPP, forgiveness amounts are reduced if the level of full-time equivalent (FTE) employees decreases during the covered period. The final rules highlight how to determine whether there has been a reduction in FTE employees: The borrower must first select a reference period and count the number of FTE employees in that period, and then compare it with the number of FTE employees in the covered period.

The rules explain that an FTE employee is one who works 40 hours or more per week, and they provide a formula for determining the average number of FTE employees during the covered period.  

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