On August 24th, the U.S. Treasury issued another interim final rule (“IFR”) on the Paycheck Protection Program (“PPP”). It seems the timing of Congress being out of session allowed for further release of guidance before perhaps Congress extends the program again, introduces PPP 2.0, etc.
SC&H’s Key Takeaways
The SBA issued some additional guidance on the details of loan forgiveness in 2 key areas: the definition of owner-employee and the impact of related party rent and interest expenses. However, as has happened with each issuance of guidance, many questions remain, and the guidance itself creates new questions. Let’s dive in and work through the details.
Owner-employee definition
SBA has finally defined owner-employee, but only for S Corporations and C corporations. The ownership threshold is 5%, so owner-employees who own less than 5% are treated the same as non-owners and are not subject to the owner-employee compensation rule, which limits their forgivable compensation totals and disallows certain fringe benefits as forgivable.
They did not, however, make mention of a de minimis threshold for partnerships. Absent further guidance, we must assume that all partners are deemed to be owner-employees. Their rationale for the 5% threshold for corporations easily applies to partnerships; that is “the exemption is provided to cover owner-employees who have no meaningful ability to influence decisions over how loan proceeds are allocated.” We would argue that a 2% owner of a limited liability company taxed as a partnership has the same lack of influence as a similarly situated owner of a corporation.
Related party rent and interest expenses
Treasury stated with this IFR that sublease expenses are not to be included as part of the tenant expenses on the PPP loan forgiveness application. For example, a borrower leases space and sublets 40% of the space. Only 60% of the rent is eligible for loan forgiveness, or the net rent paid. Which seems reasonable, as the subtenant, if also a PPP borrower, would be claiming the 40% rent on their application.
If a borrower is sharing space in a building with another tenant, the rental and utility expenses claimed on the loan forgiveness application must mirror the allocations of those expenses reported on the borrower’s 2019 tax filing, or if a new business in 2020, how those filings will be prepared.
If a borrower has a mortgage on an office building and some portion of that building is leased to another business, the mortgage interest expense must be prorated when computing PPP forgivable expenses. If 30% of the building is leased to other parties, then only 70% of the interest is allowable.
For those businesses operating out of the owner’s home, there are some new rules in play. Only nonpayroll covered expenses that were deductible on the borrower’s 2019 tax filings, or if a new business, would be deductible on the 2020 filing, will be eligible. This again makes sense to us, as the nonbusiness portion of household expenses related to rent, utilities, or interest should not be a factor in PPP loan borrowings or forgiveness.
In a more interesting twist to the guidance around related parties and rent, with this IFR Treasury created a new limitation on eligible rent expense. If there are related party lease payments being made, the amount available for loan forgiveness is limited to the mortgage interest owed on the property during the covered period attributable to the space, and one might assume equipment, being leased by the business. By way of example:
ABC, Inc. leases property from a related party for $20,000 per month, which over the 24-week covered period equals $120,000 in rent expense. The related party has a loan with a third party, but the building has been owned for many years, there was a substantial down payment made on the property when it was acquired, and thus the mortgage balance is rather low, relative to the rental value. Mortgage interest paid to the third party during the 24-week covered period is only $20,000. The rent for this borrower is now capped at $20,000.
SBA reminded us that said leases need to have been entered into prior to February 15, 2020. They went on to say that if there is any (therefore, even if less than 5%) common ownership between the rental entity and the borrowing business, these rules will apply. Further, the borrower will need to provide their PPP lender documentation regarding the mortgage interest incurred by the related rental entity.
Finally, it was noted that mortgage interest payments made to a related party are not eligible for forgiveness. The stated goal here was to keep businesses on a level playing field whether they own the building in a separate entity, or it is owned by the entity which houses the operating entity.
Please let us know if you have questions, and keep our Coronavirus Resource Center bookmarked for further guidance.
