On Thursday last week the SBA closed applications for the PPP loans as all the funds appropriated by congress had been allocated. This left businesses in three different categories:
Category 1 – PPP Loan Approved and SBA number assigned
Category 2 – PPP Loan Applied for, but no SBA number yet
Category 3 – Have not applied for the PPP Loan
If you are in Category 2, you are not alone. Several bankers that I have talked to have 100s of applications that did not get SBA approval in time. The consensus between banks and other professionals I have spoken with is that a second round of funding will come. Things are moving quickly, and the program may have been expanded before you read this. Since your application is already in, you are in a great position to get funded for the second round.
If you are in Category 3 and would like to discuss how the PPP Loan would work you, please call our office. Details about the loan can be found in our prior communication.
Category 1 – “The Clock is ticking”
Category 1 businesses are currently being funded. If not funded already, funding should be complete by the 26th of April (SBA has a 10-day funding requirement). This funding process involves a loan agreement with your bank and some form of remote closing process via internet or drive through. At this stage we recommend an accounting adjustment, an 8-week budget, a documentation plan and an FTE analysis to account for the loan proceeds and optimize the amount of your loan that will be forgiven.
Since this is a loan, you need to account for it as a loan in your books. You will need to create a new long-term liability loan account in your chart of accounts. Record the deposit into the bank account that received the money and offset the deposit to your new long-term liability account. Remember to use the date the loan was funded to simplify your bank reconciliation process.
The amount that has been funded is based on 10-11 weeks of payroll. The Paycheck Protection Plan allows for forgiveness of the loan for payroll, rent, utilities and mortgage interest payments over the 8-week period commencing on the date of the loan. For most businesses running business as usual, a portion of the loan may not be forgiven because you need to cover 10-11 weeks of costs in 8 weeks. The 8-week budget analysis will help you determine what the amount of forgiveness will be and help you optimize the timing of payments.
The 8-week budget needs to consider the following categories of expenses:
- Gross Payroll
- Employer Unemployment Taxes (ER/EE FICA, Medicare and withholding taxes do not count)
- Group Health Insurance (EE portions do not count)
- Employer Retirement Plan Contributions (EE contributions do not count)
Other Qualified Expenses
- Utilities (Electric, gas, water, telephone, and internet)
- Mortgage interest
Here is an example of a forgiveness budget.
For each category you need to consider the timing of the payments. For instance, your pay period may be one week, but the pay date may be another week. By mapping out all 8 weeks, you can identify expenses that fall outside of the 8-week period. Note that the last day of the 8-week period (6/1/2020) is less than 2 months from the loan date (4/6/2020). So monthly payments need to be managed in a way that your payments fall into the 8-week period in order to optimize your deductions.
The next step is to identify those costs that can be controlled. Can you manage the timing of your expense payments to decrease your shortfall? Some areas to consider:
- Are owner’s wages being optimized during this period?
- What about holidays and vacations? Do we know our employees plans over the next 8 weeks?
- Can we pay a mid-year bonus to the employees?
- Can we make a mid-year profit sharing contribution?
- Can we pay our unemployment taxes early?
- When are the insurance payments due? Should we pay these a week sooner, so they don’t fall outside the 8-week period?
- Do our payroll costs cover at least 75% of the total amount forgiven?
- Will the regular timing of rent payments fall into our 8-week period?
- Are some of these expenses (internet and cell phone) being reimbursed to employees? Can we time those reimbursements to fall within the 8-week period?
Make a list of spending changes you plan to make to optimize your forgiveness.
At the end of the 8-week period you will need to apply for forgiveness. Your bank will be responsible for reviewing the application and supporting documentation as well as approving your forgiveness amount. What is acceptable documentation? As of today, there are very little guidelines for acceptable documentation. I don’t expect to see much from the SBA in this area and the banks will be required to make their own determinations as to what is acceptable and what is not. Generally, documentation needs to show who the expense was for and that it was paid.
Our recommendation is that you start with some sort of list of the expenses with a total. For each item on the list you should have a document or multiple documents to support that expense. Documents could be any of the following:
- Bank/Credit Card Statements
- Cancelled Checks
- Payroll Registers
- Employer contribution reports
- Payment confirmations
- Accounting transaction listing reports
Note a document that comes from 3rd party sources (banks and vendors) will be stronger support than something you can create in your accounting system or on another document. You will want to make it as easy as possible for the bank to verify your expenses and the payment for those expenses. The easier you make this process for the banks, the less likely they will challenge your expenses.
Here is an example of an expense listing.
For each expense listed you should keep a photocopy of the related documentation and set aside in a separate file. Using a tool like this will help you monitor your spending on a day to day basis and keep track of how much of the balance remains unforgiven. Be sure to not include individual employee payroll amounts that exceed $100,000 on an annual basis.
According to the program loan terms even if you cover all the costs, the forgiveness will be reduced if there is a reduction in the number of full time equivalents (FTEs) or a reduction of greater than 25% in wages paid to employees. One FTE is equal to 40 hours per week. For example, if an employee works 20 hours in one week, then that counts as ½ FTE.
The FTE requirement is for the 8-week period following the loan. The 8-week average is compared to lower of the average number of FTEs from February 15, 2019 to June 30, 2019 or the average number of FTEs TEs from January 1, 2020 to February 29, 2020.
The following example assumes the following:
- FTEs for 8-week period = 8.5
- Average FTEs from 2/15/19 to 6/30/19 = 11.92
- Average FTEs from 1/1/20 to 2/29/20 = 9.0
The following table demonstrates how you can calculate your average FTEs.
By determining the FTE requirement upfront, you will be able to schedule out your expected payroll hours over the next 8 weeks and determine if you will have a reduction due to the lower FTE amount.
The 25% reduction in wages test relates to any employees (making less than 100k annually) that are part of your wages in the 8-week period as opposed to the prior quarter. If the annualized compensation during the 8-week period is less than 75% of that employees annualized wages during the last quarter. The reduction would be the difference between the wages you paid them compared to what those wages would have been at 100% of the annualized prior quarter amount.
If wages or employment levels are brought back by June 30, 2020, then there will be no reduction the amount of loan forgiveness.
PROCEED WITH CAUTION!!!!
The information above is based on our interpretation of all the guidance we can find at this time. The SBA may come out with more guidance that could limit some of the planning opportunities identified above. That guidance may not show up before your 8-week period is over. In the end the banks will be policing all the forgiveness applications and they may have more conservative interpretations of the guidance that is out there than we do. Where guidance is vague and unclear, we are taking positions that benefit the owner. Your bank may not agree.
We are here to help
Optimizing the benefit of these loans will require extensive analysis and understanding. We are here to help you navigate and optimize them for your business. Please feel free to call or email us to schedule a consultation and obtain a proposal customized for you specific situation.