By Andrew Smetana, Wendy Moore, and Sean Apfelbaum
In its latest interim final rule (IFR #24) providing guidance under the Paycheck Protection Program (PPP), the Small Business Administration (SBA) provided clarification on two topics impacting borrowers that are preparing to apply for loan forgiveness and, in doing so, created new limitations on PPP loan forgiveness. A summary of this latest guidance follows.
Compensation Limits for Owner-Employees
The new guidance will help some small business owner-employees understand when their compensation is subject to special limits with respect to PPP loan forgiveness. As discussed in our prior client alert (see here), the SBA announced through FAQs that special limits apply with respect to loan forgiveness for loan proceeds used to pay compensation to owner-employees. These owner-employee restrictions impose both a lower cash compensation limit on owner-employees of borrowers who use the 24-week “covered period” for PPP loan forgiveness and certain categorical restrictions that differ from the treatment for ordinary employees. However, prior guidance did not specify any ownership threshold for these compensation limits, allowing speculation as to whether these limits would apply to any business owner, only owners of more than 20% of the business, or some other category of business owners. The new guidance provides as follows:
- For S-corporations and C-corporations, owner-employees with less than a 5% ownership stake are not subject to the owner-employee compensation limits. This is intended to exempt from the owner-employee compensation limits those owner-employees who have no meaningful way to influence decisions over how loan proceeds are allocated. Instead, owners of less than 5% of S-corporations and C-corporations will be treated like ordinary employees for PPP loan forgiveness purposes. The guidance is not clear as to whether this 5% ownership threshold is calculated based on outstanding shares, on a fully diluted basis, or otherwise.
- For general partners and LLC owners, no corresponding threshold is provided. This suggests that any LLC owner or general partner, no matter their level of ownership, will be subject to the various owner-employee compensation limits. This forecloses arguments that only certain LLC owners (e.g., owners of 20% or more) or general partners would be subject to these limitations.
Limits on Mortgage Interest, Rent, and Utility Payments
The new guidance also addressed the treatment of amounts technically paid by a PPP borrower that relate to property leased or subleased to a third party, including the treatment of such payments among related parties. This new guidance provides as follows:
- The CARES Act and prior SBA guidance provided that a PPP borrower could use PPP loan proceeds to pay certain mortgage interest, rent, and utility payments and that such amounts paid or incurred during the borrower’s “covered period” would be eligible for loan forgiveness. The new guidance provides that a PPP borrower’s loan forgiveness amount may not include any amount attributable to the business operation of a tenant or subtenant of the PPP borrower, or for home-based businesses, household expenses. Some examples follow:
- For businesses that own their own property and lease it to a tenant, mortgage interest paid with respect to the leased portion of the property now cannot be included for loan forgiveness calculation purposes.
- For businesses that rent property and have sublet all or a portion to a subtenant, the rent attributable to the subtenant’s use of the property now cannot be claimed for loan forgiveness by the sublandlord.
- Similar calculations now must be applied to utility payments, such that they are allocated between the landlord/sublandlord and tenant/subtenant.
- The guidance does not preclude loan forgiveness requested for rent or lease payments to a related party. The limits above implicitly prevent double-counting in loan forgiveness by precluding both the subtenant and the sublandlord (or the property owner and tenant) from claiming expenses related to use of the same property. For example, if a parent company owns property and leases the property to an affiliated company, if the affiliated company is a PPP borrower, they could seek loan forgiveness with respect to the rent paid to their parent company, but the parent company could not seek loan forgiveness with respect to amounts it pays for the same property. If the subtenant was not a PPP borrower, however, the rules above would still preclude the landlord or parent company from obtaining loan forgiveness as to the property they leased out.
- The guidance also announced a new rule providing that loan forgiveness for rent an affiliated company pays to a parent company cannot exceed the amount of mortgage interest owned on the property during the “covered period” that is attributable to the space being rented by the business. This is described as a limit that maintains equitable treatment between a business owner that holds property in a separate entity and one that holds the property in the same entity as its business operations.
This new guidance is described as providing needed clarifications and leading to equitable results, but some borrowers may view the lines drawn by the SBA differently and see them as arbitrary—favoring S-corporation and C-corporation owners over other business owners and favoring simple single-entity business structures over structures involving affiliated companies and/or real estate holding entities.
As SBA lenders begin accepting loan forgiveness applications, it is important for borrowers to continue to monitor the updated guidance being issued by the SBA since, as here, it could change the calculus of PPP loan forgiveness and impact the borrower’s loan forgiveness application.