The latest instructions to help ensure the maximum amount of your church’s loan converts to a nontaxable grant.
Ted R. Batson, Jr. and Brent BaumannUpdate: CARES Act section 1106(i) specifically excludes any amount of PPP loan forgiveness from inclusion in taxable income, including unrelated business taxable income. Accordingly, a church or other nonprofit organization that receives full or partial PPP loan forgiveness is not required to report the loan forgiveness amount as taxable income on Form 990-T.
One of the most valuable features of the CARES Act’s Paycheck Protection Program (PPP) loans is the ability for employers with 500 or fewer employees, including nonprofits and churches, to apply to have its loan forgiven, in full or in part, essentially converting the forgiven portion into a nontaxable grant if certain criteria are met.
On June 5, 2020, President Trump signed the Paycheck Protection Program Flexibility Act of 2020 (PPP Flexibility Act) into law. This new statute amends several key criteria of the CARES Act, including:
Since the passage of the PPP Flexibility Act, the SBA has released 4 new interim final rules (IFRs), 2 new versions of the PPP Loan Forgiveness Application, and 1 new FAQ, with more FAQs anticipated. These publications are all available on the SBA’s Paycheck Protection Program webpage.
This article provides a comprehensive look at PPP loan forgiveness, including changes arising from the enactment of the PPP Flexibility Act and subsequent SBA guidance.
PPP loan forgiveness is accomplished by completing SBA Form 3508 or SBA Form 3508EZ and submitting it to the lender servicing your PPP loan at the time of application. You can also use an equivalent substitute form or application provided by the lender, if available.
Loan forgiveness is determined by reference to several key factors that are discussed in greater detail below, including:
This article will describe each of these factors before discussing the loan forgiveness application process and the two different forms.
The CARES Act, as originally enacted, created an 8-week (56-day) Covered Period that the SBA determined begins on the date PPP loans are first disbursed to the borrower. The PPP Flexibility Act extended this 8-week period to a new Covered Period of 24 weeks (168 days) that similarly begins on the date PPP loans are first disbursed to the borrower. However, for borrowers whose loan was issued prior to June 5, 2020, the PPP Flexibility Act permits the borrower to elect either the original 8-week Covered Period or the new 24-week Covered Period.
Change in law. The PPP Flexibility Act extends the Covered Period from 8 weeks to 24 weeks. For loans issued prior to June 5, 2020, the borrower may elect to use either period.
The extension of the Covered Period from 8 weeks to 24 weeks will greatly increase the ability of many borrowers to aggregate forgivable costs without scrambling to include amounts for which there is limited guidance.
In the Loan Forgiveness IFR, the SBA created an Alternative Payroll Covered Period (APCP) intended to align with a borrower’s payroll cycle. As originally defined, the APCP begins on the first day of the first payroll period that begins after the commencement of the Covered Period and extends 55 days for a total of 56 days (8 weeks). The Amended Loan Forgiveness IFR allows the APCP to also extend 167 days, for a total of 168 days (24 weeks). A borrower with a biweekly or more frequent payroll cycle is permitted to choose the APCP.
Example. Maple Grove Church uses a biweekly payroll schedule (every-other-week). The church’s standard Covered Period begins on June 1, 2020, the date its PPP loan was disbursed. The first day of the church’s first payroll cycle that begins after June 1, 2020, is Sunday, June 7, 2020. Maple Grove Church may elect to use an 8-week APCP that commences on June 7 and ends on Saturday, August 1, 2020 (56 days) or a 24-week APCP that commences on Sunday, June 7, 2020, and ends on Saturday, November 21, 2020.
The Revised Loan Forgiveness IFR provides that a borrower may apply for loan forgiveness before the end of the Covered Period (either the 8-week or 24-week Covered Period) if the borrower has used all of the loan proceeds for which it is requesting forgiveness. However, if the borrower applies for loan forgiveness before the end of the selected Covered Period and has reduced the salary or wage of any worker by more than 25 percent, then the borrower must compute the salary and wage reduction amount based on the full 8- or 24-week Covered Period.
As a practical matter, if a borrower is not eligible for the reduction in level of business operations safe harbor discussed below, it is unlikely it will make sense to file for loan forgiveness before December 31, 2020. Future FAQs published by the SBA may address this question more fully.
As described in the First Interim Final Rule, qualifying payroll costs consist of a variety of items, including:
Allowable payroll costs do not include:
A few words of explanation are useful here. In the First Interim Final Rule, the SBA set out a requirement that at least 75 percent of the loan proceeds must be used for payroll costs. In practice, as shown on the original PPP Loan Forgiveness Application, the intent is that at least 75 percent of the costs submitted for forgiveness (i.e., the combined total of payroll and non-payroll costs) must be payroll costs, even if this amount is less than the total of the loan proceeds. The PPP Flexibility Act revised the 75 percent threshold to 60 percent.
Change in law. To achieve 100 percent loan forgiveness, the PPP Flexibility Act reduced the amount that must be expended on payroll costs from 75 percent to 60 percent.
Second, FAQ 32, published on April 24, 2020, clarified that all cash compensation is includible in payroll costs, including a “housing stipend or allowance.” Based on this FAQ, it is clear that a minister’s housing allowance is includible in payroll costs for both the purpose of the PPP loan application and the PPP Loan Forgiveness Application.
Third, the definition of payroll costs for the purpose of applying for a PPP loan is identical to the definition of payroll costs for the purpose of applying for PPP loan forgiveness. While the SBA has not specifically addressed the question of whether payroll costs omitted during the loan application process may nonetheless be included in payroll costs submitted for loan forgiveness, it does not appear that this omission will be a barrier to including such otherwise eligible payroll costs in your church’s loan forgiveness calculation.
Example. If your PPP loan application did not include the minister’s housing allowance, there is nothing (yet) in the PPP Loan Forgiveness Application that would preclude you from including the minister’s housing allowance in the payroll costs submitted for forgiveness.
Fourth, the PPP Loan Forgiveness Application instructions clarify that the exclusion of salary and wages paid in excess of $100,000 on an annualized basis means the maximum amount of salary and wages that can be included for an individual employee for the 8-week Covered Period is $15,385 ($100,000 ÷ 52 × 8 = $15,385). If an employer uses the 24-week Covered Period, the maximum amount of salary and wages that can be included for an individual employee for the 24-week Covered Period is $46,154 ($100,000 ÷ 52 × 24 = $46,154). This limit only applies to salary and wages. It does not apply to an employee’s allocable share of group health care benefits and retirement benefits.
Fifth, in FAQ 16, the SBA clarified that payroll costs begin with gross wages and are not reduced for an employee’s federal income tax withheld or an employee’s share of FICA and Medicare tax (payroll taxes). However, the FAQ makes it clear that the employer share of payroll taxes is not includible in payroll costs.
Sixth, the Loan Forgiveness IFR clarified that bonuses and hazard pay are includible in payroll costs as salary and wages. In addition, wage payments to furloughed employees are includible in payroll costs, even if paid to employees who are not providing services. Note that the $100,000 annualized limit on salary and wages applies to these payments.
Also note that an additional salary or wage payment made during the Covered Period for hours worked during the Covered Period for the purpose of restoring a cut in an employee’s pay rate, or for the purpose of paying an employee for hours they did not work due to a reduction in work hours, should be includible in eligible payroll costs. The basis for this conclusion is that a principal purpose of the PPP loan program is to keep employees employed at their full pay rate for their regularly scheduled number of work hours.
Seventh, the SBA has yet to address the scope of benefits that qualify as group health care coverage. From the quoted text above it is clear this includes employer-paid premiums for group health insurance. It is likely the term includes employer-paid premiums for group vision and dental insurance plans to the extent they are separate policies from a group health insurance plan.
However, it is unclear how employer payments to the following plans are treated:
Eighth, it is clear that employer costs related to a self-insured health plan are includible. However, the SBA has not provided guidance regarding how these costs are to be computed.
Ninth, it is clear that “state and local taxes assessed on compensation of employees” include state unemployment tax. In the absence of guidance to the contrary, it is likely this provision includes state programs such as California’s Employment Training Tax (ETT). New York’s disability insurance premium may be includible if it is incurred and paid during the Covered Period. However, New York’s paid family benefit amount may be paid by an employer or the employee and it is not clear if it is a tax. Therefore, it is likely not includible. Finally, workers’ compensation insurance is not a tax assessed on employee compensation. Therefore, in the absence of guidance it to the contrary, it is unlikely to be an includible expense.
Tenth, not all employee benefits are includible payroll costs. Employer-paid group term life insurance, disability insurance, gym memberships, and other similar benefits are not includible payroll costs.
The CARES Act specified three different categories of non-payroll costs which may be forgiven:
The Loan Forgiveness IFR states that mortgage loan interest on any business mortgage obligation—whether for real estate or personal property—is includible so long as the mortgage itself was in place on February 15, 2020. Only interest is includible, not the principal payment portion of a mortgage payment or any prepayment of principal or interest. In addition to interest on real property mortgages, interest on personal property mortgages (e.g., a loan for the purchase of an automobile, office equipment, or manufacturing equipment) is includible. Note that to be eligible for inclusion in forgivable expenditures, the mortgage or other loan must be an obligation of the applicant.
The SBA has yet to release guidance regarding mortgages or construction loans in existence on February 15, 2020, that were subsequently refinanced or converted to permanent mortgages after February 15, 2020.
Rent is includible so long as the rental agreement was in place on February 15, 2020. This includes rent on real property and rent paid for the rental of equipment. The SBA has yet to provide clarity as to whether payments for certain services billed by a landlord along with rent (e.g., property insurance) and sales tax are includible. Note that to be eligible for inclusion in forgivable expenditures, the lease agreement giving rise to the rent payment must be an obligation of the applicant.
While the SBA has not addressed this specific question, it is our belief that rent must be paid to a third party. It would be an aggressive position to treat an internal allocation that is characterized as “rent” (such as between a church and the church’s preschool program that is not a separate legal entity) as rent for purposes of both a PPP loan application and an application for PPP loan forgiveness.
Payments for the following utilities are included in forgivable PPP loan expenses:
The utility service must have been in place on February 15, 2020. The SBA has yet to provide a definition of what is includible in transportation costs. Further, the SBA has not stated whether sewer service, trash collection, cell phone allowances for bring-your-own-device programs, or allowances for home internet service supporting work-from-home environments are allowable expenses.
Payments for church parsonage utilities have not been addressed in specific SBA guidance. It would appear that a reasonable argument could be made that these utilities are either part of the cash compensation paid to a minister (in which case they would count as payroll costs in satisfying the 60 percent payroll cost threshold) or as the payment of utilities on church property.
The Loan Forgiveness IFR states that “[i]n general, payroll costs paid or incurred during the eight consecutive week (56 days) covered period are eligible for forgiveness.” (Emphasis added.) The Revised Loan Forgiveness IFR clarifies that this rule extends to the 24-week Covered Period or, if elected, the 8-week Covered Period. In addition, the instructions to Line 1 of the application state that the applicant should enter “total eligible payroll costs incurred or paid during the Covered Period or the Alternative Payroll Covered Period.” (Emphasis added.)
The Loan Forgiveness IFR further states that “[p]ayroll costs are considered paid on the day that paychecks are distributed or the Borrower originates an ACH credit transaction.” This means that payroll is paid on the date when it is paid to employees and not on the date that funds are remitted to a payroll processing firm. In addition, “[p]ayroll costs are considered incurred on the day that the employee’s pay is earned.” This appears to be a reference to the employee having actually worked on that day. If a borrower pays employees who are not actually performing services (e.g., a borrower continues to pay furloughed employees), then payroll costs are incurred based on the schedule established by the borrower. This will typically be each day the employee would have performed work had the employee not been furloughed or otherwise not called in to perform services.
Based on this explanation of the rule, payroll costs paid during the Covered Period or the APCP are includible, regardless of when the payroll costs are incurred.
Example. Harbor Light Ministries received its PPP loan funds on April 28, 2020. Harbor Light pays its employees semimonthly (twice each month), on the 15th of the month and on the last day of the month. Harbor Light’s April 30 payroll is fully includible in its forgivable payroll costs as payroll costs paid during Harbor Light’s Covered Period, despite the fact that most of the payroll was incurred prior to April 28, 2020.
Example. Castle Heights Youth Services received its PPP loan funds on May 5, 2020. Castle Heights pays its employees biweekly (every-other-week). Castle Heights’ next biweekly payroll after May 5, 2020, was May 8, 2020. Hourly employees paid during this payroll were paid for the biweekly period of April 18, 2020, through May 1, 2020. Salaried employees were paid for the biweekly period of April 25, 2020, through May 8, 2020. The full amount of the May 8, 2020, payroll is includible in Castle Heights’s forgivable payroll costs, notwithstanding the fact that none of the hourly employee payroll costs were incurred during the Covered Period.
The Loan Forgiveness IFR also states that payroll costs incurred during the Covered Period, but not paid until the first regularly scheduled payroll after the Covered Period, are includible.
Example. Harbor Light Ministries received its PPP loan funds on April 28, 2020. Accordingly, the last day of Harbor Light’s 24-week Covered Period is October 12, 2020. Payroll costs incurred between October 1, 2020, and October 12, 2020, are includible as forgivable payroll costs if they are paid with the October 15, 2020, semimonthly payroll.
Example. Castle Heights Youth Services received its PPP loan funds on May 5, 2020. The last day of Castle Heights’s 24-week Covered Period is October 19, 2020. Castle Heights’s first biweekly payroll after October 19, 2020, is payable on October 23, 2020. Hourly employees paid during this payroll will be paid for the bi-weekly period of October 3, 2020, through October 16, 2020. Salaried employees will be paid for the bi-weekly period of October 10, 2020, through October 23, 2020. The full amount of hourly employee payroll costs were incurred on or before October 19 and are therefore includible in forgivable payroll costs. However, with respect to the salaried employees, only the payroll costs incurred between October 10, 2020, and October 19, 2020, and paid on October 23, 2020, are includible in forgivable payroll costs.
The Loan Forgiveness IFR states that non-payroll costs are includible in forgivable costs if they are either paid during the Covered Period or incurred during the Covered Period and paid on or before the next regular billing date, even if that date is after the Covered Period. Based on this statement of the rule, non-payroll costs paid during the Covered Period are includible even if incurred before the Covered Period.
Example. Hillcrest Community Church’s 24-week Covered Period begins on June 1, 2020, and ends on November 15, 2020. Hillcrest pays its May, June, July, August, September, and October electricity bills during the Covered Period. Hillcrest pays its November 2020 electricity bill on the next regular billing date, December 10, 2020. Hillcrest can include the full amount of the May through October bills in its forgivable non-payroll costs, notwithstanding the fact that no portion of the May electricity bill was incurred during the Covered Period. The portion of the November bill that covers November 1, 2020, through November 15, 2020, is includible because it was paid on the next regular billing date after the end of the Covered Period.
While the ability to pay on the next regular billing date will assist in some cases, it does not address amounts that are paid in advance. For example, rent is generally paid in advance. As the rule is worded, a tenant that pays a quarterly rent payment in advance on April 1 and whose 8-week Covered Period begins and ends within the second calendar quarter (i.e., April 1–June 30) would not meet the condition of incurring the expense within the Covered Period and paying for those incurred expenses on the next regularly scheduled billing date (i.e., July 1). However, the extension of the Covered Period to 24 weeks means the July 1 and October 1 payments would be includible.
As previously noted, to help determine the amount of the loan that can be forgiven (and turned into a nontaxable grant), the PPP Flexibility Act reduced the required percentage spent by recipients on payroll costs from 75 percent to 60 percent. The PPP Loan Forgiveness Application mechanically applies this rule at Line 10 by dividing the total payroll costs reported on Line 1 by 0.60 (60 percent). The resulting amount is then compared to (a) the PPP loan amount and (b) the sum of payroll costs (adjusted by the salary/wage reduction amount and headcount reduction factor) and non-payroll costs. The smallest of these three amounts then becomes the loan forgiveness amount.
The bottom line is that a borrower must spend at least 60 percent of its total PPP loan forgiveness includible expenditures on payroll.
Example. Assume the following:
PPP loan amount
Total payroll costs (before adjustments for salary/wage reduction or headcount adjustment factor)
Dollar amount of salary/wage reduction and headcount adjustment factor
