The “Coronavirus Aid, Relief, and Economic Security Act” or “CARES Act,” for short, that passed the House on March 27, 2020 and was signed into law shortly thereafter by President Donald Trump, contains important legislation to provide funding for businesses through both lending programs and a special tax credit for employers. It is important to analyze these provisions together, as one of the lending programs and the tax credit are mutually exclusive. The special tax credit is the “Employee retention credit for employers subject to closure due to COVID-19” and the lending program is known as “Paycheck Protection Program” (PPP).
The PPP is an expansion of the SBA 7(a) program with the additional benefit of loan forgiveness. While you will want to consult your banker for details, we will summarize the program in this article and provide a basis for comparison.
This loan program is available to businesses in operation prior to February 15, 2020 with 500 or fewer employees. This category includes Non-Profits and businesses which operate as sole proprietors. In certain circumstances common ownership of several different businesses may force you over the 500-employee threshold, which would disqualify an applicant for this small business loans program.
The amount of the loan is limited to the lesser of the following:
i. $10,000,000 or;
ii. The borrower’s average total monthly payroll costs for the 1-year period ending on the date the loan is made, multiplied by 2.5, plus any loan under the EIDL program obtained after January 31, 2020. Payroll costs include salaries, tips, retirement benefits, health care benefits, severance and state and local payroll taxes. Payroll costs exclude foreign employees and compensation over $100,000 per year per employee or independent contractor.
For example, assume Wally and Burke, CPA’s LLC submitted an application to the PPP on April 1, 2020. The CPA firm of 125 employees (less than 500), had payroll costs of $3,000,000 for the trailing 1-year period ending on April 1, 2020. Therefore, the average monthly payroll would have been $250,000 (assuming no one had annual compensation over $100,00). Under this fact pattern and assuming the loan was made prior to December 31, 2020, the CPA firm would be allowed a loan of $625,000 fully U.S government guaranteed with terms as listed below. Proceeds of the loan should be applied toward payment of payroll costs, rental obligations, mortgage obligations and utilities.
This program includes some favorable loan terms as follows:
i. No collateral or guarantees until after December 31, 2020. After December 31, 2020 the government will only guarantee 85% of the loan balance exceeding $150,000;
ii. 4% maximum interest rate;
iii. Ten-year maximum term;
iv. No interest or principal required for a period between six months to one year; and
v. Prepayment penalties are prohibited.
Unfortunately, if businesses also receive the employee retention credit (explanation to follow), they will be ineligible for this loan program. Consequently, a comparison of the alternatives is necessary and is detailed below.
One of the most important benefits of the PPP is the borrower may apply for loan forgiveness in an amount equal to its total payroll cost (during the covered period) and payments for mortgage, rent, and utility expenditures. The period for measurement of these expenditures is the eight weeks from the date of loan origination. Other limitations on loan forgiveness are:
i. Amount of loan forgiveness is decreased by the mathematical quotient computed by dividing the average number of full-time equivalent employees (FTE) per month during the covered period (February 15, 2020 and ending 30 days after the enactment of the Act) by either average number of FTEs per month from either February 15, 2019 – June 30, 2019 or January 1, 2020 – February 29, 2020. This formula determines whether there has been a reduction in employees in comparison to the 2019 or 2020 period noted above.
ii. The amount of loan forgiveness shall be decreased by the reduction in total salary or wages of any employee (making less than $100,000 in 2019) during the covered period that is in excess of 25% of the total salary or wages of the employer during the most recent quarter in which the employee was employed.
iii. Item of note – the loan forgiveness shall be determined without regard to either the reduction in FTEs or wages if there is the reduction in FTEs or wages during the covered period and not later than June 30, 2020.
Finally, from a tax perspective, it is important to note that the loan forgiveness under the PPP is excluded from gross income for tax purposes. That means it’s tax-free!
To continue our example, Wally and Burke use the loan proceeds to pay the aforementioned payroll costs, rent and utilities in the amount of $700,000. Since this is greater than the $625,000 borrowed through the PPP, all the loan proceeds are forgiven. Had Wally and Burke used $600,000 towards these expenditures, only $600,000 would have been forgiven. The remaining $25,000 would be amortizable beginning six months later.
The alternative to the PPP is the aforementioned “Employee retention credit for employers subject to closure due to COVID-19.” It is important that borrowers compare the difference as it relates to their business.
This refundable tax credit is capped at the first $10,000 of compensation paid to employees. The credit is calculated as 50% of qualified wages paid from March 13, 2020 through December 31, 2020. The credit is available for employers who suspended operations due to COVID-19 or had gross receipts decline by more than 50% when compared to the same quarter in the prior year. It is important to note this determination is OR not AND. Thus, if your business happened to have a down quarter, you may still be eligible for this credit. The credit is available regardless of company size; however, the amount is larger for companies with an employee count equal to or less than 100.
There is additional funding available under SBA Section 7(b)(2) through the Economic Injury Disaster Loan program. Employers and sole proprietors with less than 500 employees qualify. If you obtain a loan under this program prior to December 31, 2020, and the loan is less than $200,000, you will not be required to provide a personal guarantee. If these “disaster” loans are funded prior to your application for a loan under the PPP loan program, these proceeds can be used for expenses other than payroll and will not impact your ability to also apply under the PPP.
Another option included in the Act to help with current cash flow needs is the ability to delay the payment of employer payroll taxes. The Cares Act allows employers to defer paying the employer portion of certain payroll taxes through the end of 2020. The beginning effective date is the date of the enactment of the Act and ending before January 1, 2021. 50% of these payroll taxes must be paid by December 31, 2021 and the remaining amounts by December 31, 2022.
In summary, in response to COVID-19, you have a choice between extremely favorable lending programs in which the government will subsidize your payroll costs for eight weeks versus a tax credit that amounts to 50% of payroll costs from March 13, 2020 through the end of this year. In addition, there is the SBA Section 7 (b)(2 ) discussed above.
We appreciate the complexity of the alternatives and we are available to work with you. If you have any questions, Wall, Einhorn & Chernitzer, PC can help.