As guidance in this area is being released regularly, we recommend you read all of our blogs on this subject. All the blogs in the Paycheck Protection Program series are here: Updates#1, #2, #3, #4, #5, #6, #7,#8,#9,#10,#11,#12,#13,#14,#15, #16, #17,#18,#19, #20, #21, #22
Since our last comprehensive Paycheck Protection Program (PPP) update, the Treasury and Small Business Administration (SBA) have continued to issue new guidance for the PPP. The continuous stream of new guidance caused most banks to delay opening their PPP forgiveness portals until recently. Now that forgiveness applications are being accepted by most banks, and as promised in our recent PPP Update #16, today we will address general guidance issued since we covered the initial Forgiveness FAQs and applications in PPP Update #15.
Today we’ll address:
- 24th Interim Final Rule
- 25th Interim Final Rule
- Updates to the Frequently Asked Questions (FAQs) and Forgiveness FAQs
24th Interim Final Rule - “Owner” for Payroll Costs Purposes
In PPP Update #15, we discussed payroll costs for owners at length and provided our readers a chart to help determine how the rules apply to their businesses. The information in the chart was based upon the Forgiveness FAQs issued on August 4 and later updated on August 11. The chart laid out various limitations based upon how a business was structured for tax purposes. When that blog was issued, there was no exemption from the “owner” limitations.
With issuing 24th IFR, the Treasury introduced an exemption based upon the level of ownership. Specifically, owner-employees with less than a 5% ownership stake in a C or S Corporation are not subject to the owner-employee compensation rule. Treasury indicated that the minimum threshold was introduced to cover owner-employees who have no meaningful ability to influence decisions over how loan proceeds are allocated.
24th Interim Final Rule - New Strings for Nonpayroll Costs
Recall that nonpayroll costs include covered rent, utilities, and mortgage interest obligations. The 24th IFR addresses all three items and how they apply in very specific circumstances.
First, if a PPP borrower has a tenant or sub-tenant, they must reduce any eligible nonpayroll costs by amounts received from the tenant or sub-tenant. For example, if the PPP borrower rents an office building for $10,000/month and subleases a portion of the building for $2,500/month, only $7,500 of the rent expense is eligible for forgiveness under the PPP.
Similarly, if a PPP borrower has a mortgage on an office building that it uses for business purposes and leases a portion of the building to another party, the mortgage interest eligible for forgiveness is limited to the portion of the interest allocable to the space being used by the PPP borrower on a relative fair market value (FMV) basis. For example, if the leased space represents 25% of the FMV of the building, the PPP borrower can only claim 75% of the mortgage interest as a nonpayroll cost.
Two additional examples are provided relative to a PPP borrower who shares a rented space (rent & utilities are prorated in the same manner as 2019) and a PPP borrower that works out of his or her home (nonpayroll costs limited to amounts deducted in 2019 and home office expenses are not eligible).
24th Interim Final Rule - Related Party Rent/Mortgage Interest
In our first PPP blog, we indicated we were receiving multiple inquiries regarding related party rent or mortgage interest and whether or not it was eligible for PPP fund usage. Apparently, our tax Spidey Senses were tuned in because we indicated guidance was expected on this issue...eventually. It only took 24 IFRs for Treasury to address it and few would have guessed the hard line they took. Before reading on, because it gets a bit complicated, know that we expect most borrowers should be able to qualify for full forgiveness on payroll costs alone. If you anticipate full forgiveness without related party rent or mortgage interest, we recommend you skip to the next section.
In addressing related party rent, the Treasury specifies the lease and mortgage must have been entered into prior to February 15, 2020, and the amount of forgiveness requested in relation to related party rent is limited to no more than the amount of mortgage interest owed on the property during the Covered Period attributable to the space being rented by the business. A few layers to unpack here:
- The 24th IFR states that any ownership in common between the business and the property owner is a related party for these purposes.
- Recall that in prior IFRs, the Treasury specified if a mortgage was refinanced after February 15, 2020, it would be considered a continuation of a mortgage that existed prior to February 15, 2020. We do not interpret the 24th IFR to remove this flexibility.
- The 24th IFR does not address what happens if there is no mortgage on the underlying property. In explaining the limit on related party rent and mortgage interest (see below), the Treasury indicates the PPP loans are intended to help businesses cover certain nonpayroll obligations owed to third parties, not payments to a business owner that occur because of how their business is structured. Further, this treatment maintains equitable treatment between a business owner that holds property in a separate entity and one that holds the property in the same entity as its business operations. Given Treasury’s intent, it is assumed that if there is no underlying mortgage, there is no eligible rent expense for the PPP borrower to claim as a nonpayroll cost.
- The PPP borrower must provide the lender with mortgage interest documentation to substantiate the mortgage interest payments made by the underlying related party.
In addressing related party mortgage interest payments, the 24th IFR specifically states that mortgage interest payments to a related party are NOT eligible for forgiveness. Many have questioned what authority the Treasury has to distinguish between related party and non-related party mortgage interest.
25th IFR – New Loan Forgiveness Application
In our next blog, we will cover the new application, Form 3508S, in more detail along with the other available applications. The 25th IFR contains the associated regulations describing the new form in detail and its intended use. Spoiler alert: if you borrowed $50,000 or less, this new form is for you! There are no required calculations, and you are exempt from the wage and full-time equivalent reductions that could reduce your loan forgiveness.
The 25th IFR also addresses what the banks should do if a borrower submits documentation supporting amounts exceeding the requested forgiveness. In summary, the bank need only review information up to the amount of requested loan forgiveness ignoring the excess costs. However, a borrower should still consider presenting all costs incurred during the covered period in the event some costs are disallowed upon review or if the wage or full-time equivalent reductions apply.
Updates to the Frequently Asked Questions (FAQs) and the Forgiveness FAQs
Surprisingly, only two additional FAQs have been issued in the last 3 months:
- FAQ #52 – This FAQ was issued on October 7 and covers the extended deferral period enacted by the Paycheck Protection Program Flexibility Act of 2020. The FAQ clarifies that the change in deferral period (see PPP Update #11 for full details) is automatic and the lenders need not modify the original promissory notes to provide this extension.
- FAQs on PPP Loan Forgiveness, General Loan Forgiveness FAQs, #4 – You may not have realized, but the original forgiveness applications released listed an expiration date of October 31, 2020, in the top right corner. This caused some confusion relative to whether or not borrowers had to apply by October 31, 2020, to receive loan forgiveness. This FAQ confirms the expiration date is a requirement for the SBA to comply with the Paperwork Reduction Act and that the normal rules for applying for forgiveness apply.
We will continue providing PPP updates when significant relevant information becomes available. If you have questions about how to navigate the PPP Forgiveness Application process, or how other CARES Act incentives may apply to your business, please call on us. You can stay up to date on PPP guidance and tax issues relating to the coronavirus at our COVID-19 Tax Resource Center.