SBA's New PPP Interim Rule Regarding Owner-Employee Compensation Loan Forgiveness
SBA’s New PPP Interim Final Rule Regarding Owner-Employee Compensation and Eligibility of Certain Nonpayroll Costs for Loan Forgiveness
The U.S. Small Business Administration (SBA) has issued additional guidance in the form of another Interim Final Rule (IFR) relating to the percentage of a borrower’s ownership that triggers the treatment of an employee as an owner. The IFR also provides for limitations on certain rental and mortgage interest expenses a borrower might otherwise have considered to be eligible expenses for forgiveness.
The First Loan Forgiveness Rule, as revised by the Revisions to Loan Forgiveness and Loan Review Procedures Interim Final Rules, 85 FR 38304, 38307 (June 26, 2020), capped the amount of loan forgiveness for payroll compensation attributable to an owner-employee to either eight weeks’ worth (8/52) of their 2019 compensation (up to $15,385) for an eight-week covered period or 2.5 months’ worth (2.5/12) of their 2019 compensation (up to $20,833) for a 24-week covered period per owner in total across all businesses. There was no exception in the rule based on the owner-employee’s percentage of ownership.
The new IFR provides that an owner-employee in a C- or S-corporation who has less than a 5 percent ownership stake will not be subject to the owner-employee compensation rule, justifying the exemption on the basis that it is intended to cover owner-employees who have no meaningful ability to influence decisions over how loan proceeds are allocated. Note that the IFR applies this exception only to corporate entities and does not provide an exception for partnerships or limited liability companies.
Eligibility of Certain Nonpayroll Costs for Loan Forgiveness
Shared Rent, Mortgage Interest and Utilities
The IFR clarifies that the amount of loan forgiveness requested for nonpayroll costs may not include any amount attributable to the business operation of a tenant or sub-tenant of the PPP borrower or, for home-based businesses, household expenses. The IFR provides four examples that illustrate this rule: (a) rent paid to the borrower from a subtenant reduces the eligible rent expense; (b) mortgage interest for a mortgage that covers property subject to a lease to a third party must be reduced pro rata by the percentage (by fair market value) of the property which is leased out; (c) for shared spaces, utility payments must be similarly allocated (i.e., in accordance with the borrower’s 2019 tax filings or, if a new business, expected 2020 tax filings); and (d) home office expenses must be prorated as set forth on the borrower’s 2019 tax filings, or if a new business, the borrower’s expected 2020 tax filings.
Related Party Rent and Mortgage Interest
While many borrowers operate on real estate leased to the borrower by a company owned by a related party (see the discussion below about the meaning of a “related party”), until now the SBA’s guidance did not provide any express restrictions on the use of rent expense under related party leases as a forgivable use of loan proceeds. The IFR places a new cap on loan forgiveness available for rent paid to related parties to no more than the amount of mortgage interest owed on the property during the covered period in question that is attributable to the space being rented by the business, and only to the extent that both the lease and the mortgage were in place prior to February 15, 2020, on the theory that if the property was held directly by the borrower, the borrower would only be entitled to obtain forgiveness for this amount of mortgage interest. The IFR also provides that any mortgage interest owed to a related party is not eligible for forgiveness.
Application to Personal Property
Finally, recall that the PPP allows for forgiveness for rent and mortgage interest for both real and personal property (i.e, vehicles and equipment). Although the IFR used only real property examples, there is no reason to assume that these limitations would not apply equally to any rent or mortgage interest with respect to personal property.
The IFR refers to a “related party” frequently when discussing eligibility of the above costs for loan forgiveness. However, the term “related party” is not addressed in the statutory language of the CARES Act or previously in prior rules. For purposes of the eligibility of the above costs for loan forgiveness, the IFR describes a related party as including “[a]ny ownership in common between the business and the property owner….” Interestingly, the SBA did not exempt less than 5% owners for this purpose as it did in the same IFR for purposes of the above owner-employee compensation rule. Accordingly, the safest approach is to treat any amount of co-ownership as creating a related party relationship, even if the amount is less than 5% or if the ownership is indirect in nature.
If you have any questions regarding the PPP or this IFR, please contact me at email@example.com or 847-705-7555.