Navigating Loan Forgiveness Under the Paycheck Protection Program

For many borrowers, the most attractive feature of the Paycheck Protection Program (“PPP”) is the loan forgiveness mechanism, which turns all or a portion of the loan received into a grant without creating cancellation of indebtedness income. Once the proceeds of the loan are received, borrowers frequently have questions about what amounts are eligible to be forgiven and what actions by the borrower could result in a reduction of that forgiveness. Questions have also been raised about whether there are restrictions on the use of loan proceeds. Below we will answer those questions to better help borrowers navigate the days ahead.

I have received my PPP loan. Now what?

Once a borrower receives its loan disbursement, only amounts spent in the eight-week period beginning on the date of receipt are eligible for forgiveness. In order to qualify for forgiveness, the loan proceeds must be spent on (i) payroll costs[1], (ii) rent, (iii) mortgage interest[2] and (iv) utilities. In the cases of (ii)-(iv), the underlying lease or loan obligation or relevant utility service must have been incurred or started before February 15, 2020.

As a borrower deploys the loan proceeds, it is important to note that at least 75% of forgivable amount must have been allocated to payroll costs. Correspondingly, no more than 25% of the forgivable amount may be used for rent, mortgage interest and utilities. Therefore, to use an example, if a borrower uses its loan proceeds solely for utilities and rent in the first eight weeks, then that borrower would not be eligible for any loan forgiveness. The Small Business Administration has stated it requires this 75%/25% allocation because it believes it furthers the CARES Act’s overarching focus on keeping workers paid and employed.

Assuming that the 75%/25% allocation is satisfied, the amount of loan proceeds actually spent during that eight-week period on eligible costs becomes the expected loan forgiveness amount for that PPP loan.

Are there restrictions on what the PPP loan can be used for?

Yes. PPP loans may only be used for (i) payroll costs, (ii) mortgage interest, (iii) rent, (iv) utilities and (v) interest on any other debt obligations incurred before February 15, 2020.  It is important to note, however, that item (v) is not eligible for loan forgiveness under the PPP program. Regardless of whether any or all amounts of the PPP loan are forgiven, at least 75% of the loan must be used for payroll costs.

What actions may result in a reduction of my expected loan forgiveness amount?

Assuming the loan proceeds are used for permitted purposes, there are two principal actions by which the borrower’s loan forgiveness amount can be reduced: (i) reducing the salary or wages of employees and (ii) reducing the number of full-time employees.

Reduction in Salary and Wages

A borrower may reduce the salary or wages of an employee during the eight-week period by no more than 25% as compared to the most recent full quarter during which that employee was employed by the borrower. The amount of the expected loan forgiveness is reduced dollar-for-dollar for each dollar the borrower reduces that employee’s salary or wages in excess of 25%.

For example, if on an annualized basis the employee made a salary of $50,000 dollars in the previous full quarter and a salary of $37,000 on an annualized basis during the covered eight-week period, then the loan forgiveness amount would be reduced by $500 (prorated for the eight-week period) because that $500 represents the amount of that 1% of the 26% reduction beyond 25%.

There are two important caveats to this rule. First, any reductions in salary or wages beyond the allowable 25% threshold that occurred between February 15, 2020 and April 26, 2020 but are restored by no later than June 30, 2020 will not result in a reduction in loan forgiveness. Second, any employees making more than $100,000 a year are not covered by this rule. Therefore, it is possible to reduce the salary of an employee making more than $100,000 a year by more than 25% and not incur a reduction in loan forgiveness.

Reduction in the Number of Full-Time Employees

A borrower’s expected loan forgiveness amount may also be reduced proportionately for a reduction in the number of full-time employees. The amount of the reduction is arrived at by multiplying the expected dollar amount of the loan forgiveness by the quotient obtained by dividing (i) the average number of full-time employees during the eight-week period by (ii) either at the election of the borrower (A) the average number of full-time employees for the period of January 1, 2020 to February 29, 2020 or (B) the average number of full-time employees for the period of February 15, 2019 to June 30, 2019.  The following formula illustrates the above calculation:

Forgiveness $ Amount * (8 Week Avg. FTE/Previous Period Avg. FTE) = $ Reduction

For further illustration, if the anticipated amount of loan forgiveness was $1,000,000 and the borrower had half the amount of employees during the eight-week period (5) compared with the previous period selected (10), then the amount of loan forgiveness would be reduced by half or $500,000.

There are also two important caveats to this rule. First, any reductions in the number of full-time employees made during the period from February 15, 2020 to April 26, 2020 that are restored by no later than June 30, 2020 will not result in a reduction in loan forgiveness. Second, unlike the rule for the reduction of salary or wages, the number of full-time employees includes those making more than $100,000 per year.

What happens to the amount of the PPP loan that is not forgiven?

Any amounts of the PPP loan that are not forgiven continue as a loan with a 2-year maturity and 1% interest rate. Interest begins to accrue on the date of disbursement but no payments are due for the first six months. The same use of proceeds restrictions apply as outlined above.

As always, you should feel free to contact us if we can assist in any way.


[1] “Payroll costs” are (i) salary, wage, commission or similar compensation; (ii) payment of cash tip or equivalent; (iii) payment for vacation, parental, family, medical or sick leave; (iv) allowance for dismissal or separation; (v) payment required for the provisions of group health care benefits, including insurance premiums; (vi) payment of any retirement benefit; or (vii) payment of state or local tax assessed on the compensation of employees. Any amount of compensation for an employee in excess of $100,000 shall not be included in item (i).

[2] Under its definition in the CARES Act, eligible mortgages upon which interest can be forgiven include both “mortgage[s] on real or personal property.” The inclusion of mortgages on personal property leaves open the possibility that interest payments on secured lines of credit could be forgiven. However, it is unclear at this time whether the SBA will forgive such interest payments on secured debt and further guidance will be needed to clarify the SBA’s position.