Almost 6 months into the PPP program and after the forgiveness application process has started, the SBA has issued new guidance that can have a big impact on what expenses are eligible for some businesses. The EDGe team has summarized the three changes below. The first two we consider to be negative impacts to forgiveness, but the third will be a positive change for owners with <5% ownership.
Three Major Changes
1: Limits to businesses that pay rent to a related company they also have ownership in
2 : Limits to expenses if you share space with another tenant or have a home based business
3 : Clarifies payroll treatment for business owners with <5% ownership
Here is an in-depth look at each change:
1.) Related Party Rent Payments Limited to Mortgage Interest and Payment of Mortgage Interest to a Related Party Disallowed
This is a big one for many businesses who have a separate real estate holding company that they pay rent to. Previously, the guidance was interpreted that business owners could deduct the full rent amount even if paid to another business that was also owned by the same owner. The new guidance limits the deduction to the amount of mortgage interest owed on the property during the Covered Period that is attributable to the space being rented by the business
As a result of the above, borrowers who own their building in a separate entity free and clear with no mortgage will not receive credit towards forgiveness for rent paid to the related entity. This limitation applies if there is ANY common ownership between the two entities, meaning that the limitation applies even if an individual owns just 1% of the entity receiving rent payments.
Further, the guidance states that mortgage interest payments to a related party are not eligible for loan forgiveness.
Here is the SBA's rationale:
"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 will maintain equitable treatment between a business owner that holds property in a separate entity and one that holds the property in the same entity as its business operations."
2.) Expenses Attributable to Business of Sub-tenant or Personal Use of Home Not Counted Towards Forgiveness
A borrower must prorate expenses that count towards forgiveness if space is shared with another business or a borrower works out of his or her home in a home office, specifically stating that "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."
Here is an example the SBA provided:
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.
Recall that if a borrower works out of his or her home 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.
3.) Owner-Employee Limitations Only Apply to 5% or More Shareholders of S and C Corporations
Compensation paid to shareholders owning less than 5% of the borrower can be treated just like any other compensation and qualify for forgiveness for up to $46,154 of compensation if a 24 week period is elected, and presumably additional amounts that are paid by the business for health and retirement plan expenses for such under 5% owners. Compensation for owners (>5%) of an S Corporation or C Corporation cannot exceed the lesser of $20,833, or 20.833% of their 2019 compensation, or the lesser of $15,385 or 15.385% of 2019 compensation if the borrower elects to use an 8 week Covered Period. In addition, forgiveness for retirement plan contributions for such owners is limited to 20.833% of the 2019 retirement plan contribution amount.
The above applies to LLC's that are treated as S corporations or regular corporations for income tax purposes.
If you need to talk through specific options for your business, Molly, Paula, Myra, and I are here to help. Schedule a 30 minute consultation via Zoom where we will discuss your specific business situation for only $49. If you have any questions, feel free to reach out to any of us or email PPPHelp@EDGeBusinessPlanning.com. And keep checking our emails, blog, and social media for updates.