A new rule incorporating recent legislative changes to the small business loan program sheds light on the amount of payroll costs that can be forgiven on a tax-free basis now that the covered period is extended.
The interim final rule released June 16 says companies can spend up to $46,154 per individual on payroll costs over the extended 24-week covered period to qualify for loan forgiveness. Payroll costs also include covered benefits for employees, but not owners, including healthcare expenses and retirement contributions.
The Paycheck Protection Program, created by the Coronavirus Aid, Relief, and Economic Security (CARES) Act (P.L. 116-136), generally provides loans to businesses with fewer than 500 employees that are forgiven on a tax-free basis if a specified portion of the loans is spent on payroll costs over a covered period.
Initially, the Small Business Administration and Treasury said that for a loan to be forgiven tax free, at least 75 percent of it must be used on payroll costs. But Congress changed that by enacting the Paycheck Protection Program Flexibility Act of 2020 (P.L. 116-142), which extended the covered period from eight weeks to 24 weeks and reduced to 60 percent the amount required to be spent on payroll to qualify for loan forgiveness.
Clarifies Owner Compensation
The latest interim final rule revises earlier rules that were released before the legislative changes. Under the newest rules, not only are the payroll costs for employees increased under the extended covered period, but the rule clarifies how much can be spent on owner compensation in that period.
According to the rule, the amount allowed to be spent on owner compensation by individuals with self-employment income who file a Schedule C or F is determined based on eight weeks of 2019 net profit up to $15,385, or two and a half months of 2019 net profit up to $20,833 for a 24-week covered period.
“This approach is consistent with the structure of the CARES Act and its overarching focus on keeping workers paid, and will prevent windfalls that Congress did not intend,” the SBA and Treasury said in the rule. “Specifically, Congress determined that the maximum loan amount is generally based on 2.5 months of the borrower’s average total monthly payroll costs during the one-year period preceding the loan.”
For example, a borrower with only one other employee gets a loan for two and a half months of his payroll plus two and a half months of payroll for the employee, for a total loan amount of five months of payroll. The government said that if it didn’t write the owner compensation replacement rule the way it did, that owner could theoretically lay off that employee, use a safe harbor in the new law, treat the entire amount as payroll, and have it forgiven.
“This would not only result in a windfall for the owner, by providing the owner with five months of payroll instead of 2.5 months, but also defeat the purpose of the CARES Act of protecting the paycheck of the employee,” the government said. “For borrowers with no employees, this limitation will have no effect, because the maximum loan amount for such borrowers already includes only 2.5 months of their payroll.”