On August 24, 2020, the U.S. Small Business Administration (“SBA”) posted a twenty-fourth Interim Final Rule on Treatment of Owners and Forgiveness of Certain Nonpayroll Costs. This Interim Final Rule supplements previously posted interim final rules for the Paycheck Protection Program (“PPP”) by providing additional guidance concerning the ownership percentage that triggers the applicability of the owner-employee compensation rule for forgiveness purposes, as well as limitations on the eligibility of certain nonpayroll costs for forgiveness. This Interim Final Rule is effective without advance notice and public comment because section 1114 of the CARES Act authorizes SBA to issue regulations to implement title I of the CARES Act without regard to notice requirements.
Our summary will focus on the sections of this Interim Final Rule which supplement previous regulations and provide guidance on discrete issues related to loan forgiveness:
Owners
Question: Are any individuals with an ownership stake in a PPP borrower exempt from application of the PPP owner-employee compensation rule when determining the amount of their compensation that is eligible for loan forgiveness?
Answer: Yes, owner-employees with less than a 5% ownership stake in a C- or S-Corporation are not subject to the owner-employee compensation rule. This exemption is intended to cover owner-employees who have no meaningful ability to influence decisions over how loan proceeds are allocated.
Previously issued guidance provided limited ownership percentage exceptions when capping the amount of loan forgiveness for payroll compensation attributable to owner-employees. FAQ #8 on loan forgiveness issued on August 4 by the SBA (updated on August 11) indicated that employer contributions for health insurance are not eligible for forgiveness for S-Corporation employees with at least a 2% stake in the business, including for employees who are family members of an at least 2% owner under the family attribution rules of 26 U.S.C. 318, because those contributions are included in cash compensation.
It is unclear whether this Interim Final Rule supersedes FAQ #8 (i.e., whether the ownership exception is now 5%, rather than 2%, with respect to employer contributions for health insurance for S-Corporation employees).
Eligibility of Certain Nonpayroll Costs for Loan Forgiveness
Question (a): Are amounts attributable to the business operation of a tenant or sub-tenant of the PPP borrower or, in the context of home-based businesses, household expenses, eligible for forgiveness?
Answer: No, 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. The examples below illustrate this 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.
The guidance in this Interim Final Rule is similar in nature to prior guidance that indicates that borrowers may not claim loan forgiveness for expenditures that are not attributable to the business which received the PPP loan or for amounts reimbursed or credited by third party, or for which such reimbursements or credits are anticipated.
Question (b): Are rent payments to a related party eligible for loan forgiveness?
Answer: Yes, as long as (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. Any ownership in common between the business and the property owner is a related party for these purposes.
The borrower must provide its lender with mortgage interest documentation to substantiate these payments. 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.
SBA guidance with respect to related party rent payments has been long-awaited by borrowers. The guidance in this Interim Final Rule is similar in nature to prior guidance that indicates 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 rule maintains that there is equitable treatment for forgiveness between a business owner that holds property in a separate entity, compared to one that holds the property in the same entity as its business operations.
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