Understanding the Paycheck Protection Program (PPP) under the CARES Act

The Coronavirus Aid, Relief, and Economic Security (CARES) Act introduced the Paycheck Protection Program (PPP) to provide urgent financial assistance to small businesses struggling due to the COVID-19 pandemic. As a crucial component of the U.S. government’s economic response, the PPP, administered by the Small Business Administration (SBA) in collaboration with the Department of the Treasury, aimed to help businesses maintain their payroll and cover essential operating expenses during periods of economic uncertainty. This article delves into the key aspects of the PPP, drawing from official guidelines and regulations to offer a comprehensive understanding for both borrowers and lenders.

Key Aspects of the Paycheck Protection Program

Who is Eligible to Borrow?

The PPP was designed to be inclusive, targeting a wide range of businesses, organizations, and individuals affected by the pandemic. Eligibility criteria were defined to encompass various sectors of the economy, ensuring that aid reached those most in need.

Eligible entities include:

Small Businesses: Businesses with 500 or fewer employees, including sole proprietorships, independent contractors, and self-employed individuals. This broad category also extends to business concerns, tax-exempt nonprofit organizations (501(c)(3)), tax-exempt veterans organizations (501(c)(19)), and Tribal business concerns.
Larger Entities in Specific Sectors: Certain entities exceeding the 500-employee threshold could qualify, particularly those in industries designated under NAICS code 72 (Accommodation and Food Services).
News Organizations: News organizations, including certain broadcasting stations and nonprofit public broadcasting entities, meeting specific employee size standards per location and focused on producing local or emergency information.
Housing Cooperatives, 501(c)(6) Organizations, and Destination Marketing Organizations: These categories were included with employee limits of no more than 300, expanding the program’s reach to vital community and tourism-related entities.
Faith-Based Organizations: Recognizing the significant community role of faith-based organizations, these were also made eligible, with exemptions from standard affiliation rules to ensure religious freedom was protected.

Conditions for Eligibility:

Operational Status: Businesses needed to be in operation on February 15, 2020, demonstrating their established presence before the pandemic’s major impact.
Payroll or Contractor Payments: They must have had employees for whom they paid salaries and payroll taxes or paid independent contractors, or be self-employed individuals, independent contractors, or sole proprietors without employees.
Documentation: Applicants were required to provide documentation to substantiate their eligibility and payroll amounts, such as payroll records, tax filings, Form 1099-MISC, Schedule C or F, or bank records.

Who is Ineligible?

Despite the program’s broad reach, certain categories were deemed ineligible to ensure funds were directed appropriately and in line with the program’s objectives.

Ineligible entities include:

Businesses Engaged in Illegal Activities: Any business involved in activities illegal under federal, state, or local law was excluded.
Household Employers: Individuals employing household staff like nannies or housekeepers were not eligible.
Businesses with Problematic Ownership History: Businesses with owners having a 20% or greater equity stake and a criminal history (incarceration, indictment for felonies, or felony convictions related to financial misconduct within specified periods) were ineligible.
Entities with Prior Government Loan Defaults: Businesses with current delinquencies or defaults on previous direct or guaranteed loans from the SBA or other federal agencies within the last seven years, causing government loss, were not eligible.
Businesses Not Operational by February 15, 2020: Reflecting the requirement for established businesses, those not in operation by this date were ineligible (except for seasonal businesses meeting specific criteria).
Recipients of Shuttered Venue Operator Grants: To avoid double dipping, businesses that received or would receive grants under the Shuttered Venue Operator Grant program were excluded from PPP.
Businesses with Controlling Interests Held by Government Officials: To prevent conflicts of interest, businesses with controlling interests held by certain high-ranking government officials or their spouses were ineligible.
Publicly Traded Companies: Issuers of securities listed on national securities exchanges were generally ineligible, reflecting the program’s focus on smaller businesses.
Businesses that Have Permanently Closed: The program targeted ongoing operations, excluding businesses that had permanently ceased operation.
Hedge Funds and Private Equity Firms: Primarily engaged in investment or speculation, these firms were deemed outside the program’s scope of providing operational assistance.
Businesses in Bankruptcy: Applicants or owners in bankruptcy proceedings at the time of application or before loan disbursement were ineligible.

Affiliation Rules: Determining Business Size

To prevent larger entities from improperly accessing PPP funds intended for small businesses, affiliation rules were applied. These rules determine whether businesses are considered connected based on factors like ownership, management, or relationships.

General Affiliation Principles:

Combined Consideration: In most cases, a borrower was considered together with its affiliates for eligibility purposes.
Affiliation Factors: Affiliation could be determined by stock ownership, overlapping management, identity of interest, and other factors as defined in SBA regulations.
Employee Count: When determining eligibility based on employee size standards, businesses were required to include employees of their domestic and foreign affiliates, except in specific waiver scenarios.

Exceptions and Waivers:

Industry-Specific Waivers: The CARES Act provided waivers for certain industries like accommodation and food services (NAICS code 72), franchises, and businesses receiving SBIC financial assistance.
News Organizations: Specific rules and waivers applied to news organizations to ensure access to the program while considering the broader ownership structures.
Faith-Based Organizations: Exemptions were provided to prevent affiliation rules from substantially burdening their religious exercise, respecting the unique structures of faith-based entities.
ESOP Participation: Employee Stock Ownership Plan (ESOP) participation did not automatically trigger affiliation, supporting employee ownership models.

Loan Amount Calculation: How Much Could Businesses Borrow?

The PPP loan amount was based on a formula designed to cover payroll costs, with a maximum cap to ensure broad program reach.

Standard Calculation Methodology:

Aggregate Payroll Costs: Sum up payroll costs from 2019 or 2020 for employees whose principal residence is in the United States.
Cap on Individual Compensation: Reduce any employee compensation exceeding $100,000 on an annualized basis.
Calculate Average Monthly Payroll: Divide the result from Step 2 by 12 to get the average monthly payroll costs.
Multiply by 2.5: Multiply the average monthly payroll costs by 2.5 to determine the base loan amount.
EIDL Refinancing (Optional): Add any outstanding amount of an Economic Injury Disaster Loan (EIDL) made between January 31, 2020, and April 3, 2020, that the borrower sought to refinance (excluding EIDL advances).

Specific Calculation Methods for Different Business Types:

Self-Employed Individuals (Schedule C Filers): Calculation varied based on whether they had employees, using net profit from Schedule C and payroll costs if applicable.
Seasonal Employers: Loan amounts were based on average monthly payroll for any 12-week period between February 15, 2019, and February 15, 2020, to accommodate seasonal fluctuations.
Farmers and Ranchers (Schedule F Filers): Calculation methods considered gross income from Schedule F and employee payroll costs, with specific formulas for those with and without employees.
Partnerships: Loan amounts were calculated based on partner self-employment income, employee wages, and employer contributions, using Form 1065 and related payroll documentation.

Documentation Requirements for Loan Amount:

Payroll Documentation: Forms 941, state quarterly wage reports, payroll processor records, and evidence of retirement and health insurance contributions were required.
Self-Employment Income Documentation: Schedule C or F, Form 1099-MISC, invoices, bank statements, or books of record were needed to substantiate self-employment income.
Seasonal Employer Documentation: Documentation to support the 12-week period payroll calculation.
Partnership Documentation: Form 1065 (including K-1s), Form 941 (if applicable), state wage reports, and records of contributions.

Loan Terms: Interest Rate and Maturity

To ensure affordability and support long-term recovery, the PPP loans came with favorable terms.

Interest Rate: A fixed rate of 1% per year, calculated on a non-compounding, non-adjustable basis.
Maturity: Loans issued after June 5, 2020, had a maturity of five years, while those before could be extended to five years by mutual agreement between lender and borrower.

Loan Usage: What Could PPP Funds Be Used For?

PPP loan proceeds were restricted to specific categories to ensure they directly supported business continuity and employee retention.

Allowable Uses of Funds:

Payroll Costs: Salaries, wages, commissions, cash tips, paid leave (vacation, sick, family, medical), separation allowances, and group health care benefits (including insurance premiums).
Continuation of Benefits: Costs related to maintaining group health care, life, disability, vision, or dental benefits during periods of paid leave.
Mortgage Interest Payments: Interest on business mortgage obligations (not principal or prepayments).
Rent Payments: Rent on business leases.
Utility Payments: Payments for business utilities.
Interest on Pre-Existing Debt: Interest payments on debt obligations incurred before February 15, 2020.
Refinancing EIDL Loans: Refinancing SBA EIDL loans made between January 31, 2020, and April 3, 2020.
Covered Operations Expenditures: Payments for business software, cloud computing, and services facilitating business operations.
Covered Property Damage Costs: Costs related to property damage, vandalism, or looting in 2020 due to public disturbances, not covered by insurance.
Covered Supplier Costs: Expenditures for essential goods from suppliers under contracts or orders in effect before the covered period or for perishable goods.
Covered Worker Protection Expenditures: Operating or capital expenditures to adapt business activities to comply with COVID-19 related safety guidelines (sanitation, social distancing, PPE, etc.).

Specific Usage for Self-Employed Individuals (Schedule C Filers):

Owner Compensation Replacement: Based on 2019 or 2020 net profit.
Employee Payroll Costs (if applicable).
Business Mortgage Interest, Rent, and Utilities: For deductible expenses on Schedule C.
Interest on Pre-Existing Debt.
Refinancing EIDL Loans.
Covered Operations, Property Damage, Supplier, and Worker Protection Expenditures: To the extent deductible on Schedule C.

Restrictions on Loan Usage:

Lobbying Activities: PPP funds could not be used for lobbying activities, expenditures related to state or local elections, or efforts to influence legislation.
Minimum Payroll Spending: At least 60% of loan proceeds were required to be used for payroll costs to achieve full loan forgiveness.

Loan Forgiveness: Turning Loans into Grants

A key feature of the PPP was the potential for loan forgiveness, effectively turning the loans into grants if certain conditions were met.

Forgiveness Eligibility and Amount:

Full or Partial Forgiveness: Loans could be fully or partially forgiven, covering principal and accrued interest.
Forgivable Expenses: Forgiveness was based on documented payroll costs, mortgage interest, rent, utilities, covered operations expenditures, covered property damage costs, covered supplier costs, and covered worker protection expenditures incurred during the loan forgiveness covered period.
Employee and Compensation Levels: Maintaining employee and compensation levels was generally required for full forgiveness, although exemptions and safe harbors existed.
60/40 Rule: At least 60% of the loan forgiveness amount had to be attributable to payroll costs, with a maximum of 40% for nonpayroll costs.

Loan Forgiveness Covered Period:

Borrowers could select a covered period between 8 and 24 weeks, starting from the loan disbursement date. This flexibility allowed businesses to align their forgiveness period with their operational needs.

Simplified Forgiveness for Smaller Loans:

Loans of $150,000 or less benefited from a simplified forgiveness application process, reducing documentation requirements. However, borrowers were still required to retain records for potential SBA review.

EIDL Advance and Forgiveness:

The Economic Aid Act repealed the provision that required deducting EIDL advance amounts from PPP forgiveness. EIDL advances no longer reduced PPP loan forgiveness amounts.

Lender Responsibilities and Guidelines

Lenders, including banks, credit unions, and other financial institutions, played a crucial role in the PPP’s implementation.

Eligible PPP Lenders:

SBA 7(a) Lenders: Automatically approved to make PPP loans.
Federally Insured Depository Institutions and Credit Unions.
Farm Credit System Institutions.
Other Financing Providers: Depository and non-depository providers meeting specific criteria, including BSA compliance and experience in business lending.
Community Development Financial Institutions (CDFIs) and Minority/Women/Veteran-Owned Lenders: Non-bank lenders meeting lower origination thresholds were also eligible to expand access.

Lender Underwriting and Due Diligence:

Limited Underwriting: Lender obligations were streamlined, primarily focused on confirming receipt of borrower certifications and payroll documentation.
Reliance on Borrower Certifications: Lenders were generally allowed to rely on borrower certifications regarding eligibility and loan usage.
BSA Compliance: Lenders were required to comply with Bank Secrecy Act (BSA) requirements, including customer identification and suspicious activity reporting.

Lender Fees and Operations:

Processing Fees: SBA paid lenders fees based on loan amounts, incentivizing participation.
Secondary Market Sales: PPP loans could be sold in the secondary market after full disbursement.
Pledging Loans: Requirements for loan pledges were waived for borrowings from Federal Reserve Banks or Federal Home Loan Banks to facilitate liquidity.
Promissory Notes and Authorization: Lenders could use their own promissory notes and were not required to use separate SBA Authorization documents, simplifying the process.
Loan Disbursement Reporting: Lenders were required to report loan disbursements electronically using SBA Form 1502.

Important Dates and Deadlines

The PPP operated within specific timeframes, with key dates impacting application and loan availability.

Program Authorization Period: The PPP was authorized to guarantee loans through March 31, 2021.
Loan Application Deadline: The final date to apply for and receive a PPP loan was March 31, 2021.
Effective Dates of Rules: Interim final rules and amendments had specific effective and applicability dates, often with immediate effect to ensure rapid program deployment.
Comment Periods: While many rules were issued on an interim basis, public comments were generally solicited to inform potential revisions.

Conclusion

The Paycheck Protection Program, enacted under the CARES Act and amended by subsequent legislation, was a critical intervention to support small businesses during the COVID-19 pandemic. By providing forgivable loans to cover payroll and essential operating costs, the PPP aimed to mitigate economic disruption, maintain employment, and facilitate business recovery. Understanding the program’s eligibility criteria, loan terms, usage guidelines, and forgiveness provisions is essential for businesses and lenders navigating economic challenges and seeking to leverage available resources effectively. The PPP represents a significant chapter in government support for small businesses and offers valuable lessons for future economic relief efforts.