CARES Act Update: Forgivable Loans Explained and Other Expert Advice
Industry accountant Mitch Reitman delivers SBA loan insights for installing security and fire/life-safety businesses to consider.
On March 27, after many sectors of the economy had come to a virtual standstill and millions of Americans had filed for unemployment as a result of the coronavirus pandemic, the U.S. Congress passed, and President Trump signed, the Coronavirus Aid, Relief and Economic Security Act (CARES Act).
Among other things, the CARES Act is an unprecedented financial assistance package for small and midsize businesses. Although this article focuses on issues specific to the security, alarm, fire detection, physical security and systems integration professions, it is equally applicable to most small and midsize businesses.
There are many rumors floating around about the loan provisions included in both the CARES Act and earlier legislation that was adopted in March. We received a flyer from a U.S. Small Business Administration (SBA) lender on March 31 that was most probably prepared before the CARES Act was finalized, and it contained a considerable amount of misinformation. The press is trying to be helpful, but you should refrain from getting your information from media, especially social media. Also, beware of scammers as even seemingly legitimate outlets may be out for a quick buck.
In this article I will be discussing: (1) what businesses should do now; (2) the expanded SBA Section 7(a) loan program and the SBA Economic Injury Disaster Loan (EIDL) program; and (3) other business favorable elements of the CARES Act.
What Should You Do Immediately?
First, you should contact your banker(s). The expanded SBA Section 7(a) loans, sometimes referred to as the “Paycheck Protection Program,” will be administered by banks and other financial institutions. Some reports state that banks will prioritize existing customers first and loans to new customers second. Although rules for the expanded SBA Section 7(a) loans have not been released as of the date of this post, they will be released within a week according to current expectations. Now is the time to “get in line.”
Second, speak with your professional advisors, to determine if your company qualifies for expanded SBA Section 7(a) and/or EIDL loans (see below for more information).
Third, assemble company documents, such as certificates or articles of incorporation, bylaws, operating agreements, and certificates of good standing (make sure that the company is in good standing – taxes filed and paid current, lien free, etc.).
Finally, assemble financial information of a type that borrowers would ordinarily expect a lender to want to review, including financial statements, tax returns and payroll information. As you will see below, payroll information is of particular importance for the expanded SBA Section 7(a) loans.
While the documentation requirements for the loans are still unclear, the SBA is notorious for requesting voluminous amounts of documentation prior to funding a loan, and midway through the process is no time to find that you need to furnish additional documents.
In our experience, underwriting of this type of loan can be seriously impaired and delayed by lack of, or questions about, documentation. The people underwriting these loans are going to be overwhelmed and, once your loan “package” is placed on the back burner, it may remain there for a while.
Types of Loan Programs Explained
SBA Section 7(a) loans are the typical SBA loans that are commonly available through numerous banks and other lenders. The CARES Act created a new loan program — the “Paycheck Protection Program” Loans. Paycheck Protection Program loans may have a principal loan amount of up to $10 million (see below for limitations).
Loans may have a term of up to 10 years and bear interest at a rate of no more than 4% per annum (with payments to be deferred for at least six months and at most one year). The loan can be prepaid without penalty. In addition, paycheck protection loans will be allowed to be used for the following additional purposes:
- Payroll support (including paid sick or medical leave);
- Employee salaries;
- Mortgage, rent and utility payments;
- Insurance premiums; and
- Other debt obligations.
The Paycheck Protection Program covers businesses with 500 or fewer employees (unless the covered industry’s SBA size standard allows more than 500 employees), which were operational on Feb. 15, 2020. The size standards are tested on an affiliate basis — combined with all businesses under common control (50% ownership or contractual control) — counting on an aggregate basis towards the size test.
The affiliation test may disqualify venture or private equity backed borrowers, other than those hospitality and restaurant businesses, and recipients of Small Business Investment Co. (SBIC) investment. I mention this because some regional security, fire and systems integration companies may fall under these definitions.
Many venture and private equity investors hold capital stock that have so-called “protective provisions” which permit the investors to block certain corporate actions. These protective provisions, therefore, would result in the employees from the investors’ other “controlled” investments to be deemed affiliated with the borrower, unless expressly excluded from the affiliation tests. Borrowers should consult their bankers and professional advisors to evaluate the affiliation rules.
How Much Can Be Borrowed
The maximum loan amount available to a borrower will be the lesser of $10 million or the average total monthly payments for payroll costs of the business during the one-year period before the loan is made by 2.5. Payroll costs include salary, wage, vacation, parental, family, medical or sick leave, severance, health care benefits, and local taxes. Thus, payroll costs include much more than aggregate salary.
For example, if the loan is made on April 1, 2020, and payroll costs for the period April 1, 2019, to April 1, 2020, were 50,000, the maximum loan amount would be $125,000.
Under the Paycheck Protection Program Borrowers may be eligible for loan forgiveness in an amount equal to the amount spent by the borrower during the eight-week period following the origination date of the loan on:
- Payroll costs (which may include employees that make over $100,000 but prorated);
- Interest payment on any mortgage incurred before Feb. 15, 2020;
- Rent on any lease in force before Feb. 15, 2020; and
- Utilities for which service began before Feb. 15, 2020.
The amount forgiven would be reduced in proportion to (1) any reduction in employees retained during the eight-week period as compared to the average number of employees from either (as determined by the borrower) Feb. 15, 2019, to June 15, 2019, or from Jan. 1, 2020, and Feb. 29, 2020, and (2) any reduction in the pay of any employee beyond 25% of prior year’s compensation. For purposes of calculating the amount of the reduction, employees that received annualized wages or salary of more than $100,000 are not counted.
Borrowers that rehire workers laid off prior to the origination of the loan will not be penalized for having reduced payroll at the beginning of the period. Also, and this is a huge benefit, the forgiveness would not cause recognition of cancellation of indebtedness income for tax purposes.
Typically when a debt is forgiven, the IRS requires the amount to be reported as income, the Bill contains specific provisions that allow it to be excluded from income if the rules are followed.
Lenders must decide whether to accept a borrower’s application for forgiveness within 60 days of receipt of the application for forgiveness.
Detailed accounting and complete and accurate recordkeeping will be vital to taking advantage of these provisions.
Special Terms for Paycheck Protection Loans
No personal or collateral guarantee will be required. The eligible recipient does not have to certify that it is unable to obtain credit elsewhere. Eligible borrowers must make a good faith certification that the loan is necessary due to the uncertainty of current economic conditions caused by COVID-19, the diseased caused by the coronavirus. Other obligations mandate that funds will be used for a permitted purpose, and that they are not receiving fund from another SBA program for the same uses (see below for further information on this last point).
In the case of a fire detection company, the fact that many of your restaurant customers have closed their doors keeping you from performing inspections, and that AHJ’s are extending inspection deadlines, may be justification of economic uncertainty.
Existing SBA Disaster Loan Program
Congress’s second emergency bill, the Coronavirus Preparedness and Response Supplemental Appropriations Act signed into law on March 6 included the SBA’s disaster assistance loans. Under the law, the SBA expanded the ways in which businesses could obtain an Economic Injury Disaster Loan (EIDL).
The SBA issues the EIDL loans directly at a low interest (3.75% for small businesses) for up to $2 million and a maturity of up to 30 years. Terms are determined on a case-by-case basis, based upon each borrower’s ability to repay the loans. Applications are available now on the SBA’s website.
Importantly, under the CARES Act, a borrower that receives a Paycheck Protection Program loan for employee salaries, payroll support, mortgage payments and/or other debt obligations would not be able to receive an EIDL for the same purpose, or co-mingle funds from another loan for the same purpose. However, the Paycheck Protection loan may be used to repay an EIDL loan. The CARES Act waives the requirement for personal guarantees on EIDL loan amounts less than $200,000, and the borrower is not required to have been in business for at least one year. The requirement that borrowers are unable to obtain credit from other sources is also waived on EIDL loans.
EIDL loans, as modified by the CARES Act, will be available until Dec. 31 where the Paycheck Protection loan program runs only until June 30. For purposes of the EIDL loans the definition of “small business,” for the purposes of EIDL loan, include a company with no more than 500 employees, but does not waive the affiliation rules for Sector 72 businesses (hospitality and restaurant businesses).
A $10,000 emergency advance (within three days of submitting an application) will be paid while an applicant’s loan application is pending. This advance is not required to be repaid.
EIDL loans may be used to pay fixed debts, payroll, accounts payable and other costs; however, they are not intended to replace lost sales or profits and cannot be used for certain purposes. These include to refinance debt, make payments on loans owed to another federal agency, to pay tax penalty obligations, repair physical damages or to pay dividends to stockholders.
SBA Express Loan
The CARES Act increases the maximum SBA Express loan — a loan whose application SBA will process in 36 hours — from $350,000 to $1 million through Dec. 31.
Other Elements of the CARES Act Favorable to Business
Employee Retention Tax Credit — Small businesses may be eligible for refundable payroll tax credit for 50 percent of wages paid by employers to employees from March 12 to Jan. 31, 2021. The credit is available to employers whose (1) operations were fully or partially suspended, due to a COVID-19 related shut-down order, or (2) gross receipts declined by more than 50 percent when compared to the same quarter in the prior year.
Advanced Tax Credits for Paid Leave —The CARES Act allows employers to receive an advance tax credit for required paid sick leave (under the Families First Coronavirus Response Act) instead of having to be reimbursed. NOTE: For a complete explanation, see my March 25 article here.
Delay of Payment of Employer Payroll Taxes — Employers and self-employed individuals may defer payment of the employer share of the Social Security tax they otherwise are responsible for paying. Note, this is only the employer share (6.2%) of payroll subject to limitations.
Net Operating Loss Modifications — The provision relaxes the limitations on a company’s use of losses. Net operating losses (NOLs) are currently subject to a taxable-income limitation, and they cannot be carried back to reduce income in a prior tax year.
The provision also temporarily removes the taxable income limitation to allow an NOL to fully offset income. These changes will allow companies to utilize losses and amend prior year returns, which will provide critical cash flow and liquidity during the COVID-19 emergency.
We Shall Overcome
Now, more than ever, get to know your bankers and other financial professionals. There is a lot going on. We are in the middle of not only a health crisis, but an economic one as well. Small businesses are the backbone of the American economy and we have a big job ahead of us.
We are all going to suffer setbacks but we will persevere, take advantage of these programs as the shift the burden from the government to those small businesses that are able to step up to the plate and work our way through this.
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