SBA Changes PPP Loan Rules On August 24 – Hurting Some, Helping Others At Random

On August 24th, the SBA issued the first guidance received since August 11th in new Interim Final Rules that provide limitations in just three areas for no particular reason, including with respect to the amount of expenses a borrower can count towards forgiveness of their Paycheck Protection Program (PPP) loan. 

In a surprise to many, the SBA has indicated for the first time that payments to related entities may be limited or even worse, not count at all towards forgiveness.  Why would a business that pays normal rent amounts to related party owners be treated differently than a business that pays the same amount to unrelated parties?

Fortunately, most borrowers will be able to spend the entire amount of the loan on payroll costs, interest and utilities, in proper proportion under the 60% rule, and thus not be materially affected by this unexpected change in the rules.  It seems almost unforgivable that the SBA would come up with this one related party limitation, which does not curtail any abuse, but those who may not be able to reach full forgiveness may want to apply sooner rather than later before other limitations are published.

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In addition to this related party rent limitation, the rules clarify when a shareholder in an S or C Corporation is subject to the owner-employee limitations on compensation, and the treatment of expenses when a portion of a borrower’s leased premises are sublet to a subtenant. 

We will provide a free webinar on these new rules and their repercussions on Friday, August 28th at 12:30 PM EDT.  Please e-mail info@gassmanpa.com with the subject line “IFR” for a free view of this live 30 minute webinar or replay.  

Owner-Employee Limitations Only Apply to 5% or More Shareholders of S and C Corporations

As provided in previous rules, compensation for owners of an S Corporation or C Corporation cannot exceed the lesser of $20,833, or 20.833% of their 2019 compensation, or the lesser of $15,385 or 15.385% of 2019 compensation if the borrower elects to use an 8 week Covered Period. In addition, forgiveness for retirement plan contributions for such owners is limited to 20.833% of the 2019 retirement plan contribution amount.

The new IFRs make it clear that such expenses that are attributable to individual shareholders owning less than 5% of the borrower entity are not subject to the owner-employee limitations. It therefore appears that these limitations will also not apply to retirement plan contributions made for owners that own less than 5% of the borrower.  

As a result of the above, compensation paid to shareholders owning less than 5% of the borrower can be treated just like any other compensation and qualify for forgiveness for up to $46,154 of compensation if a 24 week period is elected, and presumably additional amounts that are paid by the business for health and retirement plan expenses for such under 5% owners. 

The above will apply to LLCs that are treated as S corporations or regular corporations for income tax purposes. 

The IFRs did not provide a similar exception for partners in a partnership, so it is safe to assume that payments made to any partner in a partnership would be subject to the owner limitations, which provide that forgiveness is limited to 20.833% of the owner’s  2019 net earnings from self-employment, with no forgiveness provided for contributions to health or retirement plans for partners.  We seen no reason that partnerships should be treated less favorably than S corporations and regular corporations, but the SBA apparently has a reason or did not think this through.  

Expenses Attributable to Business of Sub-tenant or Personal Use of Home Not Counted Towards Forgiveness

The IFRs provide that a borrower must prorate expenses that count towards forgiveness if space is shared with another business or a borrower works out of his or her home in a home office, specifically stating that “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.”  

Four helpful examples in the IFRs explain the application of this new rule: 

  • Example 1: A borrower rents an office building for $10,000 per month and subleases 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 shocking 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 penal since 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. 

Further, the IFRs provide that mortgage interest payments to a related party are not eligible for loan forgiveness. 

The SBA provided their reasoning for the above limitations in the IFRs stating that “PPP loans are intended to help businesses cover certain nonpayroll obligations that are owed to third parties, not payments to a business’s owner that occur because of how the business is structured. This will maintain 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.” 

Many borrowers will be shocked to find out that expenses paid pursuant to arm’s length lease or debt arrangements with related parties that have been in place for many years will now not be counted towards forgiveness. 

Conclusion

The SBA continues to change the rules that apply, leaving borrowers and banks that are tasked with administering PPP loans wondering what will change next, and how they are supposed to submit or accept forgiveness applications with pending legislation in Congress and rules that are continuing to change. We will continue to provide updates as the SBA issues more IFRs and FAQs so stay tuned!

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