We all just went through an incredibly difficult process of calculating and applying for our PPP Loan with the SBA. Our banks were just as confused as we were in what felt like a good old Oklahoma Land Rush. Would we do anything wrong that would push us to the back of the line? Would the government run out of money? Would we be left behind? Our concerns were justified given all the hype and misinformation floating around. One thing in the rush that we really didn’t think about all that much: If and when we got the money, what would the next steps be?

We want to help you think through possible answers to your questions and give some guidance on things we believe that you should be doing over the next eight weeks. Just as with the initial loan application period, there is a lot of noise out there about what to do with the proceeds. We want you to focus on the things that are most important.

Where should you deposit the loan proceeds?

The first thing that you will naturally want to know is where you should deposit the funds. There is a philosophy that you need to put the loan proceeds in a separate account, much like an escrow fund, so that you can prove that a dollar spent from that account went to payroll costs, rent, utilities or mortgage interest. We think on one hand this is not a bad idea. It may assist you in ultimately proving the amount of the loan that will be forgiven.

But we also think it is a very bad idea to think of these proceeds as having to be paid from an escrow arrangement. Money is “fungible”, that is, the dollar you spend for payroll versus the dollar you spend to pay down a credit line are indistinguishable. Accounting for a specific dollar, on the other hand, is very “non fungible”. A dollar spent for payroll should be accounted for as a dollar spent for payroll. Using an escrow account arrangement will take away the power of its fungible nature.

Illustration: you get $500,000 from your PPP Loan. You have a line of credit with the bank with an outstanding balance of $500,000 that you are paying interest at 6%. We would recommend paying off the line of credit with the PPP Loan proceeds, and then, when you start spending money on payroll, draw on the line of credit to do so. We are NOT saying that you don’t use the loan for payroll costs. You certified on your loan application that you would do so. We ARE saying that money is fungible – and that you should take advantage of that fact.

What should you do with your employees?

Your company may be on the front lines of the economic downturn. You may have furloughed or laid off a majority of your employees. On the other hand, you may have kept all of your employees but the woes of the companies on the front lines have already impacted your revenues and you will soon need to start layoffs. In any case, what’s the best course of action regarding your valued employees?

It’s not an easy decision and a lot of different factors need to be considered, but the first thing you should remember is the name of the loan program: Paycheck Protection Program. The intention of Congress in authorizing this loan is to keep employees employed. You may have a reasonable concern that you shouldn’t be paying employees to do nothing. Our first answer to this concern is that you’re not paying them to do nothing. You are paying them to have them around for the time when the economy turns around. And when it turns around, it will, in our opinion, take off like a rocket. Think of the pent-up demand out there right now. How hard will it be to get an appointment at your barber or hair stylist? How difficult will it be to get a reservation at your favorite restaurant or to make the big-ticket purchases that we can’t shop for right now? Sure, some segments of the economy will lag, but it will be like a whip once the slack is out of the line. Having your experienced and trusted workforce around when this happens will be crucial.

Second, don’t pay them to do nothing. Consider all the training and education that you wanted to do “when things weren’t so busy”. It’s a good time to implement new technologies, processes and soft skills and to do so on the government’s dime.

What about hiring everybody back on June 30th?

You have also inevitably heard that if you lay off employees but hire them back by June 30th, the reduction of workforce won’t be counted against you when you go to get forgiveness on your PPP Loan. There is some truth to this, but you’re only getting a little part of the picture.

The total eligible loan forgiveness amount includes payroll costs, rent, utilities and mortgage interest paid during the 8-week period beginning on the date you receive your loan proceeds. Payroll costs must be at least 75% of the amount forgiven.

There are two possible limitations on the amount of payroll costs which are forgiven. One is based on headcount. The other is based on pay rates. The headcount limit applies if your FTEs (Full Time Equivalents) during the 8-week period are less than your FTEs from 2/15/2019 through 6/30/2019 or, at the borrower’s option, from 1/1/2020 through 2/29/2020. (Other lookback periods may apply to seasonal or new employers.) If the ratio is less than 1, you multiply your potential forgiveness by that ratio.

The second limit applies on an employee by employee basis. You look for any reduction in pay rate that is greater than 25% for an employee who is paid less than an annualized salary of $100,000. You then calculate the difference between what an employee was paid during the 8-week period and what it would have been using 75% of their pay rate in the lookback period. That shortfall then reduces your forgiveness amount dollar for dollar.

There is an exception to both limitations. If between 2/15/2020 and 4/26/2020, an employee suffers either a reduction in hours or in pay rate, and if both are restored by 6/30/2020, then neither will reduce the amount of loan forgiveness.

So why not implement this strategy? Go back to the beginning of this calculation. The total eligible amount to include in loan forgiveness includes payroll costs in the 8-week period and if you don’t hire employees back until after this period ends, they won’t be counted in the total. 100% of a little is a little.

How can you maximize your forgiveness?

The best way to maximize loan forgiveness is to retain and pay your employees as much as possible during the 8-week period after loan funding. This sounds simple, but it may be a little tricky. How many payrolls do you have that land in this period? You may need to accelerate a payroll by a few days to include it in the calculation. We don’t know yet how much acceleration or “stuffing” can be done. More guidance will come on this by April 26th.

Maximizing payroll is also critical because the amount of non-payroll costs (rent, utilities and mortgage interest) that can be included is limited to 25% of the total forgiveness amount. You’re already behind on this calculation because your loan amount was based on around 11 weeks (2 ½ months) of payroll costs and your loan forgiveness is based on 8-weeks of payroll costs – less than 74% of the total. If your non-payroll costs are capped at 25% of the total, you will never get full forgiveness.

Here’s an example: you received a $500,000 loan based on annual payroll costs of $2.4 million. That same $2.4 million over 8-weeks equals approximately $369,000. This amount divided by 75% equals $492,000 – you’re shy by $8,000 even if you are maximizing payroll and non-payroll costs.

Let’s say that you pay your employees 75% of their payroll during the 8-weeks so that you won’t have to reduce your forgiveness amount by the second reduction factor described above. The maximum amount of loan forgiveness would be $369,000 – $277,000 of payroll costs plus $92,000 of non-payroll costs. You’ll still owe the bank $131,000 at 1% interest due in 2 years.

Can we fix this? Perhaps. It might be possible to pay your employees a “Covid-19 retention bonus.” This could raise the amount of forgiveness for both payroll and non-payroll costs.

Why should you maximize forgiveness?

You may be thinking that you don’t care if the loan is forgiven or not. You’re only paying 1% interest and you need to conserve the proceeds to last the duration of the downturn. We understand your concern but consider these things:

  • The purpose of the loans is to keep your employees employed. Not only is this an ethically sound choice, it also makes financial sense.
  • Congress has repeatedly stated that this is only the first part of economic relief. They basically are counting on the economy beginning to recover after 2 ½ months and if it still hasn’t, expect round 2 of PPP Loans. Don’t throw away free money to save money when more free money will most likely be available if the slump drags on.
  • The portion of the loan that is forgiven is not only “free money”, it is nontaxable.
  • Maximizing your forgiveness maximizes the benefit to your employees – your most valuable resource.

Questions? Thoughts? Contact your partner or manager. We’re here for you.


Dave Myers

Dave focuses on tax compliance and planning in the areas of income and estate tax. He is the tax partner for our automotive group but he’s also tapped for his expertise in real estate, manufacturing and professional services. He’s a whiz at estate and gift taxation and can create a customized approach to designing and implementing a successful exit plan for business owners. You can reach Dave at 714-672-0022. Read Dave's full bio.