Paycheck Protection Program Regulation Continue to Roll Out Important Rules for Owner-Employees and Self-Renters

The Coronavirus Aid, Relief, and Economic Security (“CARES”) Act was signed into law on March 27, 2020. Among other programs, the CARES Act created the Paycheck Protection Program (“PPP”), which provided loans to enable small and mid-sized business to continue to keep workers employed during the economic downturn caused by the COVID-19 Pandemic.

The PPP program was, on its face, fairly generous to small business owners. In short, borrowers who spent the loan proceeds on payroll and certain other costs during a covered period could have all or part of their loan forgiven, with any remaining balance deferred to a later date. This covered period was originally set at 8-weeks, though further legislation allowed borrowers to elect a 24-week period.

Given the short timeframe in which the program was envisioned, drafted, and passed, and the relative brevity the CARES Act (by our count less than 20 pages of the Act were devoted to the PPP), it’s of little surprise that many holes needed to be filled and ambiguities resolved by regulation. To that end, more than seven months later, the Small Business Administration (the government agency tasked with executing the program) is still rolling out new regulations.

Owner-Employee Rules

The overall purpose of the PPP was to encourage employers to continue to pay wages despite the economic slowdown brought on by COVID-19. To that end, previous regulations have stated that when determining the forgivable amount of the loan, at least 75% of expenditures must have been for payroll costs. This was later reduced to 60% by the PPP Flexibility Act.

Included in these payroll costs is owner-employee compensation, essentially net income of a sole proprietor or partner. Previous PPP regs have limited the amount of owner-employee compensation to a pro-rated 2.5-months’ worth of 2019 net income, rather than 24 weeks of 2019 net income. The intent of this is to avoid providing full forgiveness to owner-employees who received a loan based on the payroll of other employees, and then fired said other employees, while claiming a reduction-in-business safe-harbor to avoid payroll reduction penalties. Further rules extended this owner-employee treatment to owners of C and S-Corporations, stating that they cannot include more than 8 weeks or 2.5 months (depending on covered period) worth of their 2019 compensation (in this case, wages) in the loan forgiveness amount.

New regulations, however, relax this rule somewhat to avoid penalizing companies who give employee’s an equity stake in the company. Specifically, owner-employees of C or S corporations who own less than a 5% stake in the company will not be considered owner-employees for the purposes of the prior regulations. The rationale seems to be that such employees have no actual control of the company and are in fact the type of worker wages the PPP was created to protect.

Self-Rent and Sub-Lease Rules

Under the PPP, up to 40% of the amount of loan forgiveness calculation could be for non-payroll costs, including rent or mortgage interest expenses for business property.

For a variety of business and tax reasons, it is fairly common for business owners who want to own their own real estate rather than lease from a third party, to place such real estate within a separate entity and lease the property back to their business. It is also common for businesses to buy more real estate (for instance, an office building) than they need for their own operations, either as an additional income stream or to hedge against future growth, and then to lease out the excess space to other businesses.

The Small Business Administration predicted that self-rent may allow some loan recipients to artificially alter costs to maximize their forgiveness amount or otherwise subvert the purposes of the PPP.  To that end, new regulations specify that rent paid to a related entity may only be included in the forgiveness calculation if the lease (and any mortgage on the property) was entered into before February 15, 2020, and only to the extent of the mortgage interest payments on the property attributable to the space occupied by the loan recipient. The stated purpose of this particular rule is to ensure similar treatment of companies that own their property outright and those who rent from a related entity.

Additionally, the new regulations state that if a loan recipient rents out a portion of their space to another company, they must reduce their non-payroll costs by the amounts attributable to the rented-out space. For instance, if the loan recipient rents out 40% of their space, they are barred from claiming 40% of their mortgage interest, utilities, etc. This regulation reflects the intent of the PPP to subsidize business operations that create employment, rather than subsidizing passive rental income.