SBA ISSUES IMPORTANT NEW PPP FORGIVENESS GUIDANCE – OWNER COMPENSATION AND NON-PAYROLL EXPENSES, INC
On August 24, 2020, the U.S. Small Business Administration (“SBA”) issued an interim final rule (“IFR”) with important guidance on previously unanswered questions about certain Payroll Protection Program (“PPP”) loan expenses eligible for forgiveness.
After months of silence from the SBA, the IFR, titled Treatment of Owners and Forgiveness of Certain Non-payroll Costs, addresses who is subject to the owner-employee compensation rules and limits certain non-payroll costs from eligibility for forgiveness, including related-party rent payments and expenses of home businesses.
5% Ownership Triggers the Owner-Employee Compensation Rules
The IFR provides guidance about the ownership percentage of a borrower that will trigger treatment of an employee as an owner of the borrower for purposes of PPP loan forgiveness. Owner-employees with less than a 5% stake in a C or an S corporation are exempt from the PPP owner-employee compensation rules for purposes of determining the amount of their compensation eligible for loan forgiveness. This exemption is intended to cover owner-employees “who have no meaningful ability to influence decisions over how loan proceeds are allocated.”
Because there was no prior guidance on who was subject to the owner-employee compensation rules, some borrowers had referred to the PPP loan application form itself, which defined “owner” to mean a general partner and any limited partner owning more than 20% of the equity of a partnership, and any owner of 20% or more of a corporation or LLC – and extrapolated that only an owner of 20% or more of a borrower would be subject to the owner-employee compensation rules. The SBA, however, never stated that this test would apply beyond the PPP loan application, and has now clarified that 5% is the ownership trigger for the owner-employee compensation rules.
The IFR makes no reference to partners in this context, so it appears that a general partner with any ownership in a partnership is an owner for purposes of the PPP owner-employee compensation rules. It is also likely that a manger of an LLC with any ownership would be considered an owner for this purpose.
Under the PPP, as previously provided, owner-employee compensation is only eligible for forgiveness in an amount capped at the lesser of the portion of the 2019 compensation or $100,000 allocated to the covered period selected. For example, for pre-June 5 borrowers that elect an eight-week covered period, the cap is the lesser of $15,385 or 8/52 of the 2019 compensation. For borrowers with a 24-week covered period, the cap is the lesser of $20,833, or 24/52 of the 2019 compensation.
Eligibility of Certain Non-payroll Costs for Loan Forgiveness
Mortgage Interest Payments to Related Parties
Answering a significant pending question, the IFR denies treatment as eligible non-payroll costs to certain rent payments and mortgage
interest expenses made to a related party. It applies a look-through rule to space leased from a related party, capping eligible expenses based only on the mortgage interest owed on the property during the covered period. To explain, the IFR limits the amount of rent or lease payments made to a related party that are eligible for loan forgiveness to “no more than the amount of mortgage interest owed on the property during the Covered Period that is attributable to the space being rented by the business,” and then only if the lease and the mortgage were entered into before February 15, 2020. For this purpose, any “ownership in common” between the borrower and the property owner creates a lease between related parties.
Mortgage interest payments to a related party are not eligible for forgiveness at all. The IFR states that this exclusion is because PPP loans are intended to help businesses cover non-payroll obligations owed to third parties, not payments to a borrower’s owner because of how a business is structured. The SBA intends to make loan forgiveness equitable between a business owner that holds property in a separate entity and a business owner that holds property in the same entity as its business operations.
By treating rent payments as payments of mortgage interest, the IFR in effect eliminates prepaid related-party rents from eligibility for forgiveness, since prepaid mortgage interest is not eligible.
Expenses Relating to a Tenant or Sub-Tenant of the PPP Borrower, and to Home-Based Businesses
The IFR provides that loan forgiveness for non-payroll costs may not include any amount attributable to the business operation of a tenant or sub-tenant of the PPP borrower. In the case of home-based businesses, no household expenses are eligible for forgiveness. The IFR sets out four essentially intuitive examples:
If a borrower rents an office building for $10,000 a month and subleases part of the space for $2,500 a month, only $7,500 is eligible for forgiveness.
If a borrower operates out of a building on which it has a mortgage, and leases out a part of that space to unrelated businesses, mortgage interest eligible for forgiveness is limited to the borrower’s percentage share of the fair market value of the space not leased out. For example, if the leased space represents 25% of the FMV of the building, the borrower may only claim forgiveness on 75% of the mortgage interest.
If a borrower shares a rented space with another business, the borrower must prorate rent and utility payments in the same way as on its 2019 tax filings, or if it is a new business, on its expected 2020 tax filings.
If a borrower works out of the home, non-payroll costs eligible for forgiveness may only include the share of covered expenses that were deductible on the borrower’s 2019 tax filings, or if a new business, on its expected 2020 tax filings.
If you need assistance in understanding these and other rules relating to the PPP, Distinct Tax Consulting Group is here to help.
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