With many PPP borrowers now working their way through the intricacies of the forgiveness calculations and related analysis, the SBA and Treasury Department announced on August 24, 2020 new clarifications on certain aspects of the program, some of which could have significant effects on the way many borrowers have been thinking about the use of their PPP funds.
Owner-Employee Compensation Rules
In our prior advisory, we discussed the cap on the ability of borrowers to obtain forgiveness on payments made to “owner-employees”. By way of reminder, for borrowers using the 24-week covered period, forgiveness for compensation of owner-employees is limited to the lesser of $20,833 or 2.5/12 multiplied by the owner-employee’s 2019 compensation. The SBA has now clarified that, for corporations (whether C- or S-corporations) if an employee owns less than five percent of the corporation’s equity, then such employee will not be deemed an owner. This is a sensible result given the use of equity to incentivize employees in many businesses, which generally does not exceed this threshold. As a result, employees with these equity interests will not be subject to the lower payroll expense cap, which will increase the amount includable in the forgivable expense category. We do note that the advisory does not specify whether this calculation is done on an “issued” basis or a “fully-diluted” basis (where you would need to include convertible securities, such as stock options), but based on the context we believe that the SBA’s intention is only to include issued equity.
Related Party Leases
A significant number of PPP borrowers lease space from related parties, whether it be from a parent entity or an entity owned commonly with the borrower. The SBA has determined that payments of rent to these related parties will be limited to no more than the amount of mortgage interest owed by the landlord during the covered period. Additionally, the borrower must provide evidence of the landlord’s mortgage obligations. This means that if the related party landlord owns the property outright without any mortgage obligations, the lease payments by the PPP borrower may not be included as a forgivable expense. For purposes of this analysis, any overlap in ownership of the entities constitutes a related party.
This change is a bit of a surprise, as there had not been a suggestion to this point that there would be any limitation on the ability to obtain forgiveness for payments related to rent expense. Prior to this advisory, we had advised that, so long as there was a true lease in place and the expense was reasonable, there was no indication that the SBA would disregard these payments to landlords. Based on this advisory, borrowers that have related party landlords should carefully review the expenses they are including in their forgiveness application.
In the event that a PPP borrower subleases space to third parties, the borrower may only claim the portion of their rent expense that is not subleased. For example, if the monthly rent owed by the borrower is $10,000 and the borrower subleases a portion of their space for $2,500, the borrower may only claim $7,500 as a forgivable expense pursuant to PPP. Similarly, if a borrower owns a building on which it is paying mortgage interest and leases a portion of the space to a third party, the borrower may only obtain forgiveness on the percent of the fair market value of the property which the borrower occupies. Basically, if you operate out of space that is shared with another party resulting from your leasing or sub-leasing activities, you should clarify with your advisors the extent to which you are able to seek forgiveness for certain of these expenses.
While the frequency of these clarifications and advisories has dropped precipitously since June, there remain ambiguities in the PPP for which we may get further regulation from the SBA. Furthermore, it is possible (as in the related party lease clarification) that changes will be made to the program that run contrary to common interpretation. To the extent you have any questions about what the program permits, you should reach out to your accountants and attorneys for the most up-to-date analysis.