The SBA’s Latest Guidance Analyzed: Why Borrowers May Have to Rethink Their Approach to Loan Forgiveness

by Michael J. Greenwald, MPPM, CPA, Friedman LLP | September 2, 2020

Just when you thought it was safe to proceed with applying for Paycheck Protection Program (PPP) loan forgiveness, the Small Business Administration (SBA) — which had been quiet since early August — changed the rules again. Specifically, the SBA issued another Interim Final Rule (IFR), effective as of Aug. 25, defining who is an owner-employee of a C corporation or S corporation, and whether certain non-payroll costs involving transactions with related parties are eligible for forgiveness.

These two areas have been of great concern to borrowers and their advisors, and we had hoped that guidance would be forthcoming sooner — especially since some borrowers may have already applied for forgiveness. Moreover, the new guidance may place some borrowers in jeopardy of not realizing full forgiveness of the loan since funds may have been used to pay for expenses now deemed to be ineligible for forgiveness. Finally, the new IFR has some internal inconsistency (discussed below).

Owner-Employee Determination

Previous guidance limited the amount of owner-employee compensation that can be included in payroll costs for determining the amount of PPP loan forgiveness. Unfortunately, that guidance never defined who is an owner-employee. The loan application defined owner to mean:

  • a general partner;
  • any limited partner owning 20 percent or more of the equity of a partnership; or
  • any owner of 20 percent or more of a corporation or LLC. 

However, it was never clear if those definitions were applicable in the loan forgiveness computation.

The new guidance specifies that owner-employees with less than a 5-percent ownership stake in a C corporation or S corporation are exempt from the owner-employee compensation rules. The guidance says that such owner-employees have “no meaningful ability to influence decisions over how loan proceeds are allocated.”

Observation: The IFR is silent as to partners and members of LLCs. It would be inappropriate, given the guidance issued for corporations, to assume that the higher limits in the loan application should be used here. Until additional guidance is issued, ANY partner or member who is actively involved in the business of the partnership or LLC should be considered an owner-employee for purposes of the loan forgiveness calculation.

Nonpayroll Costs of Tenants, Subtenants or Home-Based Businesses

Certain costs incurred or paid during the covered period — rent, mortgage interest, utilities — are eligible for inclusion as forgivable expenses. The new guidance clarifies that, to the extent such costs are attributable to the occupancy of space by tenants or subtenants, a PPP borrower may not include them in its forgiveness application.

Even more limiting, a borrower who works out of his or her home may include only the share of covered expenses that were deductible on their 2019 tax return. A new business may use the amount expected to be deducted on their 2020 return.

Rent or Mortgage Payments to a Related Party

This has been a question of great concern to borrowers since the program was enacted over five months ago. Until now, the SBA and Treasury have been remarkably silent on the subject. 

Under the IFR, rent payments to a related party are eligible for loan forgiveness only if the lease and mortgage were entered into prior to Feb. 15, 2020, and only to the extent that the payment doesn’t exceed the amount of mortgage interest owed on the space being rented during the covered period. Furthermore, borrowers must provide lenders with mortgage interest documentation along with the loan forgiveness application.

Even more draconian, the IFR says that mortgage interest owed to a related party is not eligible for forgiveness on the theory that “PPP loans are intended to help businesses cover certain non-payroll obligations that are owed to third parties, not payments to a business’s owner that occur because of how the business is structured.”

The term “related party” is not defined in the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) or any previous SBA guidance. The IFR defines related party for this purpose as “[a]ny ownership in common between the business and the property owner…” This is clearly a much stricter standard than the ownership relationship for owner-employees of C and S corporations in the same IFR.

And, while the IFR mentions only real property, since PPP allows forgiveness for both rent and mortgage interest for real and personal property, it is reasonable to assume that these new limitations apply to both.

Observation: While commentators have been quick to criticize the related-party guidance, it is not clear that it will be reversed. Therefore, borrowers who have already submitted loan forgiveness applications should review them to see if they should be revised. Other affected borrowers may wish to use the 24-week covered period to ensure that they have sufficient payroll costs to offset a shortfall in nonpayroll costs in achieving 100-percent forgiveness.

Comment: The SBA and Treasury have been issuing guidance or making public pronouncements throughout the PPP program, often changing previously issued guidance to the detriment of PPP borrowers. This IFR goes beyond changing the rules in midstream as it is likely too late for many borrowers to change the way they use loan funds.

This article was reprinted with permission of Friedman LLP and originally published on

Michael  Greenwald

Michael Greenwald

Michael Greenwald, MPPM, CPA, is partner and Business Entity Tax Practice Leader at Friedman LLP.

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