Small Business Administration (SBA) Issues New Paycheck Protection Program (PPP) Rulemaking regarding “Owner-Employee” Exemption, Forgiveness Limitations on Related-Party Lease Payments and More
On August 24, 2020, the U.S. Small Business Administration (SBA) issued an interim final rule (IFR) addressing several important Paycheck Protection Program (PPP) loan forgiveness-related issues and considerations.
Exemption to Owner-Employee Compensation Rules
First, the IFR provides guidance concerning the ownership percentage (at least in the context of a C-corporation or S-corporation) that triggers the applicability of the more restrictive “owner-employee compensation rules” for loan forgiveness purposes. Specifically, the rule provides that owner-employees with less than a 5% ownership stake in a C-corporation or S-corporation are not subject to the “owner-employee compensation rules,” which cap the amount of loan forgiveness for payroll compensation attributable to owner-employees at lower levels than those applicable to non-owner employees.
The SBA stated that the exemption is intended to cover owner-employees who “have no meaningful ability to influence decisions over how loan proceeds are allocated.” While this aspect of the IFR will be welcomed by smaller shareholders in C-corporations and S-corporations (and the borrowers themselves), it is not immediately clear why the SBA’s rationale for the exemption was not extended to partners or members in partnerships and limited liability companies with similarly small ownership percentages. For now, these individuals appear to remain subject to the more stringent limitations of the “owner-employee compensation rules.”
Considerations for Borrowers who Lease or Sub-Lease Space to Third Parties (or Share Space)
Second, the IFR addressed forgiveness considerations for amounts attributable to the business operations of a tenant or sub-tenant of a PPP borrower. Here, the SBA has determined that the amount of loan forgiveness requested for non-payroll costs may not include any amount attributable to the business operations of a tenant or sub-tenant of the borrower.
For example, if a borrower rents an office building for $10,000 per month and sub-leases out a portion of the space to another business for $2,500 per month, then only $7,500 per month would be eligible for PPP loan forgiveness. The same concepts would apply in the context of mortgage interest payments attributable to a property where the borrower leases or sub-leases portions of the property to third parties. Similar proration concepts apply to borrowers that rent “shared space” with another business or use a portion of their home or other property for the conduct of their business. In all these cases, the goal of the new rulemaking is to permit forgiveness only for those amounts that relate to the space (or portion thereof) actually used by the borrower.
Limitation on Forgiveness for Related-Party Lease Payments
Lastly, the SBA finally addressed a long-lingering question relating to rent forgiveness in the context of related-party property leasing arrangements. In particular, the SBA has determined that rent payments to a related-party are only eligible for loan forgiveness if: (1) the amount of loan forgiveness requested for rent or lease payments to the 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 borrower, and (2) the lease and the mortgage were entered into prior to February 15, 2020.
Importantly, any ownership in common between the borrower and the property owner will be sufficient for the SBA to treat an arrangement as a “related-party” lease for these purposes. The IFR does not address if or when ownership by, for example, a family member in a landlord or lessor paid by the borrower may be sufficient to trigger this new “related-party” limitation.
This new rule places significant limitations on loan forgiveness eligibility for lease and rental amounts paid to another entity in which there is any common ownership with the borrower. In addition, even if the borrower is eligible for some amount of forgiveness on such payments, it must provide its lender with mortgage interest documentation to substantiate the amount of eligible forgiveness. The SBA also stated that while rent or lease payments to a related-party may be eligible for forgiveness, mortgage interest payments to a related-party are not eligible for forgiveness.
PPP audit and Compliance Preparedness Program; Upcoming Webinar
We will continue to track guidance from SBA and Treasury as well as legislative developments related to the PPP. We also encourage PPP borrowers to reach out to their Miller Johnson contacts to learn more about our flat-fee PPP Audit and Compliance Preparedness Program. This program offers clients a strategic solution to identify, gather and organize relevant documents and performance data to ensure their business is best positioned to comply with the ever-changing forms and rules governing the PPP. The program will also involve identifying key legal arguments so that clients are prepared for any potential enforcement action or inquiry. Additional details regarding this program are available here.
Finally, we invite you to join Erik Daly and Jeff Muth on Thursday, August 27, 2020 at 8:00am for a webinar covering key takeaways from SBA’s recently-adopted rulemaking regarding the appeals process PPP borrowers must follow after an adverse loan eligibility or forgiveness determination by SBA: Click here to register.