SBA Creates Exception to Owner-Employee Compensation Rule, Clarifies Eligibility of Certain Nonpayroll Costs for ForgivenessAugust 26, 2020
On August 24, the Small Business Administration (“SBA”) released a new Paycheck Protection Program (“PPP”) interim final rule to create a new exception to the owner-employee compensation rule and to clarify whether certain nonpayroll costs are eligible for forgiveness.
New Owner-Employee Compensation Rule Exception
Per previous SBA rules, the amount of PPP loan forgiveness for payroll compensation attributable to an owner-employee is capped at $15,385 (for borrowers who elect an 8-week covered period) or $20,833 (for borrowers who elect a 24-week covered period), as we highlighted in this previously published article. The previous rules did not provide any exception based on the owner-employee’s percentage of ownership.
Under this new rule, owner-employees who have less than a 5 percent ownership stake in a C- or S-Corporation that took a PPP loan are not subject to the previous rules capping the amount of owner-employee compensation eligible for forgiveness. The SBA explains that this exemption is “intended to cover owner-employees who have no meaningful ability to influence decision over how loan proceeds are allocated.”
As a result, the amount of forgivable compensation to an owner-employee who meets this exception is equal to the payroll costs incurred or paid to such owner-employee over the borrower’s applicable covered period (up to $100,000 annualized).
Eligibility of Certain Nonpayroll Costs for Loan Forgiveness
The SBA clarifies in this new rule that nonpayroll costs attributable to the business operation of a PPP borrower’s tenant or sub-tenant and household expenses for home-based businesses are not eligible for forgiveness. However, rent payments to a related party are eligible.
Borrowers that rent space and sublease a portion to a third party, that have a mortgage on a building and lease out a portion of the space, or share rented space with another party, may only seek forgiveness for nonpayroll costs associated with the borrower’s own business.
The SBA provides the example of a PPP borrower that rents an office building for $10,000/month but subleases a portion of the space to another business for $2,500/month. In that example, the PPP borrower may only seek forgiveness for $7,500/month in rent, not the entire $10,000. Further, if a PPP borrower with a mortgage on a space leases a portion of the space to a third party, the borrower can only seek forgiveness for a portion of its mortgage interest that is attributed to the fair market value of the space that is not leased out. The new rule also provides that a PPP borrower who shares a rented space with another party must prorate rent and utility payments in the same manner as on the borrower’s 2019 tax filings (or expected 2020 tax filings, if a new business) and can only seek forgiveness for such prorated expenses.
Finally, the SBA clarifies in this new rule that rent payments to a related party are eligible for loan forgiveness only if:
- 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 borrower’s applicable covered period that is attributable to the space being rented by the business; and
- the lease and the mortgage were entered into prior to February 15, 2020.
This new rule states that any ownership in common between the business and the property owner is a related party for these purposes. Further, the borrower must provide its lender mortgage interest documentation to substantiate these payments. This clarification impacts many borrowers who rent space that is owned by a related third party individual or entity, and who may now be limited or prohibited from seeking forgiveness for those rent payments.
Mortgage interest payments to a related party are not eligible for forgiveness.
This summary does not include or address every provision of Paycheck Protection Program under the CARES Act, which should be read in its entirety. Furthermore, pursuant to the CARES Act, the SBA continues to promulgate regulations for the implementation of the Paycheck Protection Program and, as such, there is still uncertainty relating to details of implementation.