Updated: Details on Loan Forgiveness Under the Paycheck Protection Program

May 19, 2020Alerts

The potential for loan forgiveness is a pillar of the Paycheck Protection Program (PPP).  Businesses receiving PPP loans must clearly understand the program’s loan forgiveness requirements, as well as its restrictions on a borrower’s use of proceeds. This article summarizes the current loan forgiveness requirements and provides a hypothetical example to help illustrate how they could work in practice.

UPDATE: On May 15, 2020, the SBA released its Loan Forgiveness Application and accompanying instructions.  We expect the Small Business Administration (SBA) to publish additional guidance on loan forgiveness, and legislative changes to the PPP remain possible. For now, this article has been updated to reflect the guidance in the Application.

Use of PPP Loan Proceeds

Under the Coronavirus Aid, Relief, and Economic Security (CARES) Act, borrowers may use PPP loan proceeds to pay any of the following:

  • “Payroll costs,” a defined term that includes all of the following:
    • salaries and wages (capped at $100,000 on an annualized basis for each employee) [UPDATE: The Application clarifies that payroll costs may include not more than eight weeks of 2019 compensation for an owner-employer or self-employed individual/general partner, capped at $15,385 per individual];
    • payments for vacation, parental, family, medical or sick leave;
    • severance payments;
    • payments required for the provision of group health care benefits, including insurance premiums;
    • retirement benefits; and
    • state and local taxes assessed on the compensation of employees.
  • Interest (but not including any prepayment or payment of principal) on any debt or mortgage obligations (whether for real property or personal property) that existed prior to Feb. 15, 2020.
  • Rent arising under a lease agreement (whether for real property or personal property) in force before Feb. 15, 2020. [UPDATE: The Application clarifies that this applies to both real property and personal property leases].
  • Utility payments (including electricity, gas, water, transportation, telephone or internet access) for which service began before Feb. 15, 2020.

The statute itself does not require any specific allocation of proceeds. However, the SBA’s Interim Rule (and all subsequent SBA guidance) requires borrowers to spend at least 75% of the loan on “payroll costs,” as defined above. The borrower is responsible for documenting use of proceeds for payroll costs in order to determine the amount of forgiveness. If a borrower uses loan proceeds for unauthorized purposes, the borrower will be required to repay those amounts and could be subject to additional charges from the SBA for knowing violations or misappropriations. If a shareholder, member or partner uses PPP funds for unauthorized purposes, the SBA may have direct recourse against such shareholder, member or partner for the unauthorized use.

Loan Forgiveness, Generally

A borrower may seek loan forgiveness by submitting the Application to its lender. The Application provides detailed instructions concerning the documentation that the borrower must submit and maintain to support its forgiveness request. To assess eligibility, the lender will evaluate the borrower’s use of proceeds during the eight-week period following the loan’s origination. This eight-week period is also known as the “covered period.”

UPDATE: The Application allows borrowers with a biweekly (or more frequent) payroll to select an “Alternative Payroll Covered Period” for payroll costs only. This is optional and for administrative convenience. The period begins on the first day of the borrower’s first payroll period after the loan’s disbursement and continues for eight weeks after that date. Borrowers who elect to use the Alternative Payroll Covered Period must apply the Alternative Payroll Covered Period wherever there is a reference to such period in the Application. All references to the “covered period” in this article are intended to include the Alternative Payroll Covered Period, where applicable.

Decrease Based Upon Reduction in Full-Time Equivalent Employees

Loan forgiveness may be reduced if the average number of full-time equivalent employees is reduced when compared to a chosen reference period. This reduction in loan forgiveness (if any) is calculated by multiplying the amount of loan forgiveness by a fraction. The numerator of the fraction is the borrower’s average number of full-time equivalent employees during the eight-week covered period. The denominator of the fraction is either:

  • (a) the borrower’s average number of full-time equivalent employees between Feb. 15, 2019 and June 20, 2019 
    OR
  • (b) the borrower’s average number of full-time equivalent employees between Jan. 1, 2020 and Feb. 29, 2020

Most borrowers can choose either (a) or (b) (presumably, whichever is lower). If the borrower is deemed a “seasonal employer” by the SBA, it also has the option to choose any consecutive 12-week period between May 1, 2019 and Sept. 15, 2019.

UPDATE: The Application clarifies that “average full-time equivalent (FTE) employees” should be calculated on a weekly basis based upon a 40-hour workweek. In the alternative, borrowers may simplify the calculation by treating all employees who work 40 hours or more per week as 1 FTE and all employees who work less than 40 hours per week as 0.5 FTE.

Decrease Based Upon Salary Reduction

The amount of loan forgiveness is also reduced if employees who made less than $100,000 in annualized wages in 2019 receive a reduction in pay of more than 25% during the covered period. 

UPDATE: The process for calculating the salary reductions is outlined in detail in the PPP Schedule A Worksheet attached to the Application. The worksheet compares each employee’s salary/wages during the covered period to the employee’s salary/wages between Jan. 1, 2020 and March 31, 2020. The worksheet provides detailed instructions for calculating any forgiveness reduction depending on whether the employee is a salaried or hourly employee. The below hypothetical provides additional information on this calculation.

Rehiring Employees or Restoring Wages

Reductions in employment or salary that occur between Feb. 15, 2020 and April 26, 2020 can be “cured” and will not reduce the amount of loan forgiveness if, by June 30, 2020, the borrower eliminates the reduction in employees or the reduction in wages, as applicable. There is no requirement that the borrower rehire the same employees; restoring the average number of full-time equivalent employees is sufficient. For purposes of rehiring employees, the Application clarifies that the borrower must restore its FTE employee levels to the borrower’s pay period that included Feb.15, 2020.

UPDATE: Confirming recent guidance, the Application clarifies that if a terminated employee rejects a good faith, written offer from the borrower to rehire the employee at the same salary and for the same number of hours, loan forgiveness will not be reduced with respect to that employee, provided that the borrower has documented the offer and the employee’s rejection of the offer. In addition, the Application states that employees who, during the covered period, (a) were fired for cause, (b) voluntarily resigned or (c) voluntarily requested and received a reduction of their hours, will not reduce the borrower’s loan forgiveness.

Reduction for Failing to Meet 75% Payroll Cost Requirement

UPDATE: A borrower must spend 75% of the loan forgiveness amount on payroll costs. The Application explains how the SBA will enforce this requirement. Specifically, it clarifies that the requirement is not an “all or nothing” calculation, and the borrower is eligible for loan forgiveness on the payroll costs it actually spends during the covered period. However, the total amount eligible for forgiveness may not exceed the total amount spent on payroll costs during the covered period, divided by 0.75.  As shown in the example below, this can decrease the total amount eligible for forgiveness, including forgiveness for amounts the borrower spends on non-payroll covered expenses. 

How Does This Work in Practice?

To illustrate how the loan forgiveness works in practice, let’s use a hypothetical example.

Company A is a non-seasonal employer whose business is significantly affected by COVID-19. As a result, Company A terminates the employment of 50 full-time equivalent employees on April 1, 2020. Later, on May 1, 2020, Company A borrows $1 million through the PPP. Company A has an average of 150 full-time equivalent employees between May 1 and June 27 (i.e., the eight-week “covered period”), as compared to (a) the average of 250 full-time equivalent employees it had between Feb. 15, 2019 and June 20, 2019 and (b) the average of 200 full-time equivalent employees it had between Jan. 1, 2020 and Feb. 29, 2020. For now, assume that Company A did not reduce the pay of any of its employees. Also, assume the borrower spent the required $750,000 on payroll costs, with the remaining $250,000 going toward non-payroll covered expenses (mortgage interest, rent payments and business utilities). 

In this hypothetical (and with all other things being equal), Company A is eligible for loan forgiveness in the amount of $750,000. Company A would elect option (b) as its “denominator,” and the $1 million would be multiplied by a fraction of 150/200 (i.e., 75%). The remaining $250,000 must be paid back by Company A under the terms of the loan (i.e., at 1% interest over a two-year term).

Now, adjust the hypothetical to assume that on April 1, 2020, Company A also reduced the annual salaries of 10 employees from $60,000 per year to $30,000 per year. Assume all 10 employees earned an annualized salary of less than $100,000 in 2019. Since this is more than a 25% reduction in annual salary from the amount earned during the first quarter of 2020, the borrower must complete the portion of the Schedule A Worksheet titled “Salary/Hourly Wage Reduction.” The loan forgiveness amount is further reduced by the amount in excess of the 25% salary reduction for each employee. If the borrower follows the worksheet instructions, the applicable annual reduction is $15,000 for each employee. This is multiplied by eight (8), and then divided by 52, to get an annualized figure of $2,307.69 per employee, or $23,076.90 for the 10 employees in the aggregate). All other things equal, the $1 million forgiveness amount would be reduced to $976,923.10. Based on the above FTE reduction, Company A’s forgiveness amount is 75% of this figure, or $732,692.33.

Now, assume that on June 1, Company A elects to rehire all the full-time equivalent employees it terminated on April 1, and rescinds the salary reductions referenced above. All other things being equal, as a result of the action taken by Company A on June 1, the entire $1 million loan is eligible for loan forgiveness.

Finally, assume Company A took all of the same steps above, including the June 1 rehires and salary restorations. However, because of its reduced headcount during the covered period, Company A could only spend $600,000 on payroll costs (instead of the required $750,000). Assume Company A spent the remaining $250,000 on non-payroll covered expenses. The total amount eligible for forgiveness would ordinarily be $850,000. However, on these facts, Company A’s forgiveness amount is reduced to $800,000 (i.e., the $600,000 in payroll costs divided by 0.75). Company A’s failure to meet the 75% payroll cost requirement reduces the amount it can spend on non-payroll covered expenses from $250,000 to $200,000.


Michael J. Meehan is a partner in Fox Rothschild’s Corporate Department.  He can be reached at [email protected]

For other updates and recent developments, refer to Fox Rothschild’s Coronavirus Response Resource Center.