Free Money? Meet the Covered SBA “Loan”

Coronavirus Relief Bill Provides Loans to Help Your Small Business Pay its Employees and Keep the Lights On, and You May Not Have to Pay it Back

On Wednesday, March 25th the United States Senate voted 96-0 to pass the 880-page Coronavirus Aid, Relief, and Economic Security Act (CARES Act), which is expected to pass quickly through the House of Representatives and be signed into law by the President.

The Act contains numerous provisions to provide relief for out of work employees displaced by the Coronavirus pandemic, including expanded unemployment payments with relaxed qualifications and expedited processing, as well as direct subsidies of up to $1,200 per taxpayer, whether or not unemployed.

The Act also contains provisions aimed to help large and small businesses alike weather the storm and continue to keep employees on payroll by providing payroll tax credits which for many employers will reduce end-of-quarter expenses. There is one provision, however, that could provide an immediate cash injection to businesses struggling to meet their ongoing operational expenses. Unlike other provisions, this provision has the potential to provide assistance to a wide segment of small and large businesses, whether or not they have suffered a direct downturn as a result of the pandemic.

Specifically, the Act makes small business loans easier to acquire and then provides what amounts to a direct subsidy to businesses by canceling a portion of the loan equal to certain operational costs the business incurs over a two-month period.

Small Business Loans Generally

Historically speaking, small businesses have often had difficulties accessing lines of credit. To help alleviate this problem, the Federal government created the Small Business Administration (SBA), which backs a portion of loans made by banks to certain small businesses, lowering the risk incurred by the banks and encouraging them to make credit more readily available.

In order to qualify for a loan under the standard SBA program, businesses must meet a number of stringent qualifications, based largely on size, capitalization, payroll, and individual liability of owners. These requirements vary by industry, ostensibly based on relative investment risk and public policy goals.

The CARES Act modifies this structure by creating, for a limited time, “covered” SBA loans which are lower risk to the bank, easier to obtain for borrowers, and which may not have to be paid back in full.

Loans Easier to Acquire

Section 1102 of the Act lays out who can qualify for a “covered” SBA loan, as defined in the legislation. It starts with the traditional definition of a small business concern, meaning that anyone who would have qualified for a small business loan before the CARES Act will qualify for a covered SBA loan.

It then adds to this definition, including business concerns with not more than 500 employees, business concerns exceeding the prior size standards for their respective industry, and sole proprietors.

Further, it waives a number of requirements, such as the fee requirement, the affiliation requirement (which disqualified many franchises and larger business groups), the personal guarantee requirement, the collateralization requirement, and the requirement that no other lines of credit be available.

Finally, it highly incentivizes banks to provide these loans by increasing the government participation rate to 100%, making them near risk-free for banks to issue.

Loan Proceeds – Amount and Use

Typically, SBA loans must be earmarked for specific purposes. For covered loans under the CARES Act, these purposes are expanded to include continuing to pay payroll, qualified rent expenses, qualified mortgage expenses (i.e., interest on loans secured by real or personal property), and covered utilities.

Payroll expenses are defined as salaries, hourly wages, commissions, a pro-rata portion of sole proprietorship income of up to $100,000 per year, and related expenses such as state payroll taxes, certain sick leave payments, health insurance premiums, and retirement benefits. They do not, however, include an employee’s wages which when annualized would exceed $100,000 per year, or payments to employees with a primary residence overseas. Finally, they do not include sick pay or family leave payments for which the employer otherwise receives a payroll tax credit under other provisions of the CARE Act.

Subject to some caveats (for instance, for seasonal businesses), the amount of a covered SBA loan under the Act is equal to two and a half times the business’ average monthly payroll expense from the prior one-year period. Further, the maximum loan amount is capped at $10,000,000.

Cancellation Amount – Maximum

Section 1106 of the CARES Act takes what would otherwise be easy to obtain credit, and turns it into a near direct subsidy for many businesses.

It does this by canceling a portion of any covered loan equal to the qualified expenses incurred within a covered period. Specifically, it cancels an amount equal to the covered mortgage interest payments, covered rent payments, covered utility payments, and covered payroll payments (see above) incurred and paid during the 8-week period following the loan origination date (generally the date on which a loan is funded).

Cancellation Amount – Full Time Employee Reduction

The amount is forgiven, however, is reduced if an employer fails to continue to employ as many full-time employees as it did prior to receiving the loan. It does this by multiplying the loan forgiveness amount by a fraction, the numerator of which is the average number of full-time employees during the 8-week covered period, and the denominator of which is the average number of full-time employees during a specific prior period chosen by the borrower. The allowable periods are 2/15/19 – 6/30/19 or 1/1/20 – 2/29/20 (although seasonal employers may only choose the former).

Cancellation Amount – Full Pay Reduction

The amount forgiven is also reduced if the borrower reduced employee pay. Specifically, it is reduced by any salary reduction in excess of 25%, determined by the most recent full quarter in which the employee was employed before the covered period. Reductions in which the employee, after reduction, still receives the annualized equivalent of $100,000 per year are not factored in to this limitation.

Cancellation Amount – Re-Hire Exception

The Act acknowledges that certain employers had no choice but to reduce full-time employees or employee pay. It therefore ignores reductions in the average number of full-time employees and/or wages if they occur during the period starting on 2/15/20 and ending 30 days after the passage of the Cares Act and the reductions are eliminated by 6/30/20 by re-hiring such employees and/or increasing employee pay to previous levels.

Cancellation – Tax Treatment

Typically, when a loan is forgiven it gives rise to “cancellation of indebtedness” income to the borrower. Fortunately, the CARES Act creates an exclusion for the amounts forgiven under the terms discussed above, meaning any amount forgiven will not be taxable.

If you feel like you’re in the midst of uncharted waters, you can reach us through the form below or call our office at 816-561-5000 to schedule a consultation.

*This post was originally published on March 27, 2020