The U.S. Small Business Administration (SBA) and the U.S. Department of the Treasury issued a new interim final rule on August 24, 2020, pertaining to owner-employee compensation and the eligibility of non-payroll expenses.
One of the new guidelines states an owner-employee in a C- or S-corporation with less than a 5% ownership stake will not be subject to the owner-employee compensation rule, which sets a cap to the amount of loan forgiveness on owner-employee compensation. Prior to the change, the owner-employee compensation rule stated anyone with a stake in a company—regardless of size—which took out a PPP loan was eligible for forgiveness of the lesser of $20,833 or 20.833% of their 2019 compensation, or $15,385 or 15.385% if the borrower elected to use an eight-week covered period. The update to this guidance conveys if you have an equity stake under 5% in your company, you are now eligible for more salary forgiveness—up to $46,154 per individual over 24 weeks. In addition, covered benefits like health care expenses, retirement contributions and state taxes imposed on employee payroll and paid by the employer would also be eligible for forgiveness.
With respect to non-payroll costs and their eligibility for coverage under the PPP, the SBA and Treasury have made two decisions.
Non-payroll costs may not include any expenses credited to the business of a tenant or sub-tenant of the borrower. The new guidance demonstrates this with four separate examples:
- If a borrower had rented space for $10,000 per month, and sub-leases some of the space for $2,500 per month, only $7,500 per month is eligible for forgiveness.
- Similarly, if a borrower has purchased a building—which now carries a mortgage— and rents some of the space to a tenant, the mortgage interest is only deductible to the extent of the percentage of fair market value (FMV) attributable to the non-rented-out space. E.g., if the leased-out space represents 35% of the FMV, then only 65% of mortgage interest is eligible for forgiveness.
- If two or more businesses have conjoined to be tenants in common in a shared space, a borrower must pro-rate rent and utilities in the same manner as was done on the 2019 tax filings, or as is expected to be done on 2020 tax filings if this is the business’ first year of operation, to determine eligible forgiveness amounts.
- For those working out of a home office: in determining non-payroll cost eligibility, as above, only the portion of covered expenses deducted on 2019 tax filings, or expected to be deducted in 2020, if this is the first year the business is in operation, is eligible for forgiveness.
Note, to be eligible as a PPP-covered expense, lease, rental, or mortgage payments must be incurred under a lease or mortgage entered into prior to February 15, 2020.
This decision pertains to “relative-party” lease or rental payments and mortgage interest payments:
- The new interim final rule provides lease or rental payments to a related party are eligible for PPP loan forgiveness, as long as 1) the amount of loan forgiveness does not exceed the portion of the mortgage interest paid by the related party for that portion of the mortgaged space which is rented by the business, and 2) both the mortgage and the lease in question were entered into prior to February 15, 2020.
- Mortgage interest payments made directly to a related-party are not eligible for forgiveness. The SBA and Treasury clarify in this decision the purpose of PPP loans is to help businesses meet non-payroll obligations to third parties, not payments made to a business owner because of the business’s structure.
There are two proposals which would impact PPP loan forgiveness, and the application process, which are being considered in Congress:
- Most PPP loans issued were in amounts less than $150,000. Congress is considering blanket forgiveness for loans under this threshold, which could itself change as the process moves forward.
- Per Notice 2020-32, the IRS has determined that, while the forgiven proceeds of a PPP loan will not count as taxable income, the forgiven eligible expenses are not tax deductible. A number of Congress members are unhappy with that determination, and are considering legislation to explicitly render such expenses fully deductible.
Due to the temporary nature of this guidance, we advise not to rush to apply for this forgiveness since the deadline to apply for PPP loan forgiveness extends 10 months from the end of the 24-week covered period, and for many borrowers this period has not yet concluded.
As more updates emerge to clarify the uncertainty surrounding PPP, we will be happy to answer your questions. Contact us here or reach out to your Trusted Advisor directly for help.
Rigby, Eric. “PPP Loans — Updated Guidance.” Last modified September 30, 2020. https://therigbygroup.com/ppp-loans-updated-guidance/