The “Coronavirus Aid, Relief, and Economic Security Act” (“CARES Act”) establishes a new loan under section 7(a) of the Small Business Act (“SBA”) called the “Paycheck Protection Program.”  The provisions authorize businesses with no more than 500 employees to borrow money from the federal government through the SBA (the “covered loan”) for use during the covered period, which is February 15, 2020, to June 30, 2020 (“covered period”).

During the covered period, the covered loan may be used for (1) payroll costs; (2) costs related to continuing group health care benefits during paid sick, medical, or family leave, and insurance premiums; (3) employee salaries, commissions, or similar compensation; (4) payments of interest on any mortgage obligation; (5) rent; (6) utilities; and (7) interest on debt incurred before the covered period.

Payroll costs are defined as payments of compensation with respect to an employee that is  (1) salary, wage, commission, or similar compensation; (2) cash tip or equivalent; (3) payment for vacation, parental, family, medical, or sick leave; (4) allowance for dismissal or separation; (5) payment required for group health care benefits, including insurance premiums; (6) payment of retirement benefits; or (7) payment of State or local tax assessed on the compensation of employees.  Payroll costs do not include compensation in excess of $100,000 per employee per year nor do they include federal payroll taxes and income tax withholding incurred in the covered period.

The maximum amount of the covered loan during the covered period is the lesser of (1) the average total monthly payroll costs incurred during the 1-year period before the date on which the loan is made times 2.5; or (2) $10,000,000. Additional rules exist for season employers and those who have a loan under section 7(b)(2) of the SBA.  The interest rate is capped at 4%, and there are no fees. In addition, there is no requirement that the business be unable to obtain credit elsewhere, no collateral required, and no personal guarantee required.

Sole proprietorships, independent contractors, self-employed individuals, and nonprofits are also eligible for the covered loan.  Businesses should contact an SBA lender to apply for the covered loan.  The CARES Act anticipates authorizing more lenders to provide covered loans.

Loan Forgiveness – § 1106 of the CARES Act

The covered loan can be forgiven, to an extent, under section 1106 of the CARES Act.  The loan can be forgiven for amounts paid from the proceeds of the covered loan that are incurred during the covered period (here, in this provision, the 8-week period beginning on the date of the origination of the covered loan) on (1) payroll costs (using the definition in section 7(a)(36) of the SBA, above); (2) mortgage interest; (3) rent; and (4) utilities.

The amount forgiven cannot exceed the principal amount of the covered loan.  The amount of loan forgiveness is reduced where there is a reduction in employees or reduction of compensation.  Regarding a reduction of employees, the forgiveness amount is reduced by the number obtained by dividing (1) the average number of full-time equivalent (“FTE”) employees per month during the covered period by (2) at the election of the employer, (A) the average number of FTE employees per month between February 15, 2019, and June 30, 2019, or (B) the average number of FTE employees per month between January 1, 2020, and February 29, 2020. A different test applies for seasonal employers. Regarding a reduction in compensation, the forgiveness amount is reduced by the amount of any reduction in total salary or wages of an employee (other than employees who received during any pay period during 2019 compensation at an annual rate in excess of $100,000) in excess of 25 percent of the compensation of the employee during the most recent full quarter.  These reductions will not apply if corrected by June 30, 2020.

An employer that receives a covered loan must apply for forgiveness and provide certain documentation.  While the amounts forgiven constitute canceled indebtedness income, they will be excluded from gross income for federal income tax purposes.