Recently, the U.S. Small Business Administration (SBA) and Treasury issued an interim final rule addressing certain portions of loan forgiveness for the Paycheck Protection Program (PPP). This rule specifically addresses three key areas: owner-employee compensation, tenant/sub-tenant nonpayroll costs, and related party mortgage interest.
Under the previously issued rule effective June 5, 2020, those defined as owner-employees were subject to a maximum compensation forgiveness amount of $20,833 over the 24-week covered period. An owner-employee is defined as an owner who is also an employee, including situations where the owner is also the only employee in the entity. Under the new rule, S corporation and C corporation owner-employees with less than 5% ownership are no longer subject to the owner-employee compensation maximums. They are now eligible for $46,154 of compensation forgiveness under the 24-week covered period as is the existing rule with regular employees (24/52 x $100,000 compensation limit = $46,154). However, please note that partners are still subject to $20,833 limitation. The new 5 percent rule only applies to those with ownership in S corporations and C corporations.
The rule also updated limitations on forgiveness of expenses as they relate to tenants, sub-tenants, and home-based businesses. The updates are designed to clarify that there is no forgiveness for additional household expenses of home-based businesses or for tenants and sub-tenants. This is to ensure applicants are not attempting to deduct nonpayroll costs in excess of what they would typically claim a tax deduction for. The SBA provided the below examples to clarify:
- A borrower rents an office building for $10,000 per month and sub-leases out a portion of the space to other businesses for $2,500 per month. Only $7,500 per month is eligible for loan forgiveness.
- A borrower has a mortgage on an office building it operates out of, and it leases out a portion of the space to other businesses. The portion of mortgage interest that is eligible for loan forgiveness is limited to the percent share of the fair market value of the space that is not leased out to other businesses. As an illustration, if the leased space represents 25% of the fair market value of the office building, then the borrower may only claim forgiveness on 75% of the mortgage interest.
- A borrower shares a rented space with another business. When determining the amount that is eligible for loan forgiveness, the borrower must prorate rent and utility payments in the same manner as on the borrower’s 2019 tax filings, or if a new business, the borrower’s expected 2020 tax filings.
- A borrower works out of his or her home. When determining the amount of nonpayroll costs that are eligible for loan forgiveness, 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.
Related Party Rent Payments
The SBA clarified in the second example above that rent payments to a related party are eligible for loan forgiveness as long as the following criteria are met:
- The agreement and mortgage both originated prior to February 15, 2020
- The amount requested to be forgiven is no more than the amount of mortgage interest owed on the property during the covered period that is attributable to the space being rented by the business.
In other words, the borrower must first calculate the mortgage interest applicable to the 24-week covered period, then prorate this between the portion of the building (forgivable) and the portion rented out to other businesses (not forgivable). Additionally, the borrower must provide the lender with documentation to substantiate the mortgage interest they are applying to have forgiven.
Please note that rent or lease payments to a related party may be eligible for forgiveness, but mortgage interest payments to a related party are not. This is because the loans are intended to assist businesses with covering certain non-payroll costs to third parties, but are not intended to cover payments that occur because of how the business is structured. In this scenario, related parties are defined as any ownership the business and property owner have in common.
Additional guidance may be on the horizon as the SBA receives more requests for clarification. Governmental entities are also deliberating on whether to provide additional benefits, so more updates are likely to come in the near future.
Please contact an HHM CPAs professional for more guidance on PPP loan forgiveness.