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PPP Update - Summary of August 24th Interim Final Rules (“IFRs”)

September 7, 2020 | Category: Asset Protection, Corporate and Taxation, Estate Planning and Probate, News

After more than a month of silence, on the part of the SBA, they issued new FAQs on August 4, which provided some additional guidance and clarification, most of which was not borrower friendly! More recently, on August 24, the SBA issued new IFR’s, which provided additional guidance and clarification, as both borrowers and lenders prepare for the loan forgiveness process. While the IFR’s provided additional needed clarification, new guidance, as same pertains to certain related party transactions, are patently unreasonable and make little sense, whatsoever.

Below are the highlights from the new IFRs. Following the highlights is a deeper dive into specific issues addressed, relative to owner compensation, limitations on forgiveness for related-party rental payments and attributable to shared and sublease rental arrangements.

The highlights of the IFRs are as follows:

  1. Limits on the amount of owner-employee compensation that can count towards forgiveness only apply to shareholders who own 5% or more of an S or C Corporation. No clarity was provided for partners in a partnership. Thus, arguably, a partner owning any percentage may be subject to the owner-employee compensation limitations!

As a reminder, these owner-employee compensation limits are as follows: For the 8 weeks period, the lesser of: (1) $15,385 or (2) 15.385% of 2019 compensation; and for the 24 week period, the lesser of: (1) $20,833 or (2) 20.833% of 2019 compensation. For non-owner employees, the limits are, for the 8 week period, $15,385 and, for the 24 week period, $46,154. Additionally, for owner-employees, forgiveness for retirement plan contributions for such owners are now limited to 20.833% of the 2019 retirement plan contribution amount, for those contributions made during the applicable covered period.

  1. A borrower must prorate expenses that count towards forgiveness if space is shared with another business. The borrower does not qualify for forgiveness for rental payments made, to the extent reimbursed for a portion paid by a subtenant or other shared tenant.
  2. The amount of forgiveness for rent paid to a related party is limited to the amount of mortgage interest payable by the landlord/entity that owns property and only eligible for forgiveness if both the lease and the mortgage were entered into prior to February 15, 2020. Thus, if there is no mortgage on such property, the borrower would not be able to deduct any portion of the rental payment! While related party leasing transactions are quite common, for both estate planning and asset protection purposes, the SBA apparently has an issue with same and is penalizing borrowers who are parties to such arrangements, regardless of the ownership interest of the related party!
  3. Mortgage interest payments made to a related party are not eligible for loan forgiveness.

A more detailed analysis of the August 24 IFRs are as follows:

Owners

Q:  Are any individuals with an ownership stake in a PPP borrower exempt from application of the PPP owner-employee compensation rule when determining the amount of their compensation that is eligible for loan forgiveness?

A:  Yes, owner-employees with less than a 5 percent ownership stake in a C- or S-Corporation are not subject to the owner-employee compensation rule. These limits are as follows: For owner-employees, for the 8 weeks period, the lesser of: (1) $15,385 or (2) 15.385% of 2019 compensation; and for the 24 week period, the lesser of: (1) $20,833 or (2) 20.833% of 2019 compensation. For non-owner employees, the limits are, for the 8 week period, $15,385 and, for the 24 week period, $46,154. Additionally, for owner-employees, forgiveness for retirement plan contributions for such owners is limited to 20.833% of the 2019 retirement plan contribution amount.

The SBA has determined 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. This exemption is intended to cover owner-employees who have no meaningful ability to influence decisions over how loan proceeds are allocated.

Eligibility of Certain Nonpayroll Costs for Loan Forgiveness

Q:  Are amounts attributable to the business operation of a tenant or sub-tenant of the PPP borrower or, in the context of home-based businesses, household expenses, eligible for forgiveness?

A:  No, 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 examples below illustrate this rule.

Example 1: A borrower rents an office building for $10,000 per month and sub-leases out a portion of the space to other businesses for $2,500 per month. Only $7,500 per month is eligible for loan forgiveness.

Example 2: A borrower has a mortgage on an office building it operates out of, and it leases out a portion of the space to other businesses. The portion of mortgage interest that is eligible for loan forgiveness is limited to the percent share of the fair market value of the space that is not leased out to other businesses. As an illustration, if the leased space represents 25% of the fair market value of the office building, then the borrower may only claim forgiveness on 75% of the mortgage interest.

Example 3: A borrower shares a rented space with another business. When determining the amount that is eligible for loan forgiveness, the borrower must prorate rent and utility payments in the same manner as on the borrower’s 2019 tax filings, or if a new business, the borrower’s expected 2020 tax filings.

Example 4: A borrower works out of his or her home. When determining the amount of nonpayroll costs that are eligible for loan forgiveness, the borrower may include only the share of covered expenses that were deductible on the borrower’s 2019 tax filings, or if a new business, the borrower’s expected 2020 tax filings.

Related Party Rent Payments Limited to Mortgage Interest and Payment of Mortgage Interest to a Related Party Disallowed

The most surprising aspect of the new IFRs is that rent paid to a related party is only eligible for forgiveness if (1) the amount of loan forgiveness requested for rent or lease payments to a related party is 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 (2) the lease and the mortgage were entered into prior to February 15, 2020.

As a result of the above, borrowers who own their building in a separate entity free and clear with no mortgage will not receive credit towards forgiveness for rent paid to the related entity. This rule is made even more restrictive, as the above limitation applies if there is any common ownership between the two entities, meaning that the limitation applies even if an individual owns just 1% of the entity receiving rent payments.

Q:  Are rent payments to a related party eligible for loan forgiveness?

A:  Yes, as long as (1) the amount of loan forgiveness requested for rent or lease payments to a related party is 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 (2) the lease and the mortgage were entered into prior to February 15, 2020. Any ownership in common between the business and the property owner is a related party for these purposes. While rent or lease payments to a related party may be eligible for forgiveness, mortgage interest payments to a related party are not eligible for forgiveness. PPP loans are intended to help businesses cover certain non-payroll obligations that are owed to third parties, not payments to a business’s owner that occur because of how the business is structured.

Borrowers are encouraged to complete their loan forgiveness application, as soon as their lender permits them to do so, assuming such borrower is otherwise eligible for substantial or full forgiveness of their PPP loan. This is because, based upon recent SBA guidance, such future guidance will, most likely, continue to be less borrower friendly!

 

 

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