April 8, 2020

Dear Client,

Our own Walter Primoff recently wrote an article about the CARES Act Small Business Payroll Protection Loan program. His article was written for the New York CPA Society, and therefore was composed with that audience in mind. However, as we have seen intense interest from our clients about this particular topic, we thought it would be useful to make it available here as well. It goes into some detail about the program’s implications on small businesses, sole proprietorships, and nonprofits.

Should you have any follow-up questions on how the program could help sustain your organization, please contact us for guidance. We continue to work diligently from our respective homes and are happy to help in any way we can. Simply call or email as you always have.

Wishing you and your families well,
Sean M. Dowling, CFP, EA
President, The Dowling Group Wealth Management

CARES Act SBA Loans - A Big Deal

by Walter Primoff, CPA/PFS, CGMA
Tax and Financial Advisor
The Dowling Group

The words ‘Historic’ and ‘Big Deal’ are often overused. But the just-enacted CARES Act $350 billion SBA Paycheck Protection Loan (PPL) program qualifies for both. (This is different than the SBA’s Economic Injury Disaster Loan, and an entity cannot have an EIDL and PPL at the same time for this emergency. It appears that an entity with an EIDL loan can roll it into a PPL). For PPLs, loan size can be significant relative to a borrower’s annual costs. The loans can be forgiven for entities that essentially keep their headcount and salary level in place, and the loan forgiveness comes tax free.

The program has one goal, which is to infuse enough cash into entities with 500 or fewer employees to keep them alive and their paid workforce in place for eight weeks during this emergency.

The law is very clear in key areas but leaves gray areas in some. What will count most is the SBA’s implementation rules being developed now both for banks and borrowers. The lending banks may have some leeway as well. But here is what we know from the just-passed law itself.

Eligible borrowers meeting the 500-employee standard include small businesses, 501(c)(3) nonprofits (in a historic first eligibility for SBA lending), sole proprietors and independent contractors. Most all of them should benefit. The entire loan process will be through SBA lending banks and other lenders.

CPAs who take some time away from tax season to inform and help clients and less financially sophisticated 501(c)(3)s with these loans will likely find them very grateful. Most CPAs and lawyers (both firms and sole practitioners alike) will benefit from the program themselves.

General Overview

In order to get the cash infusion to eligible entities quickly, a way around traditional SBA lending processes had to be found. So a key to understanding these historic loans is that all of the normal sound lending practices for obtaining loans and the extra rules for SBA loans are out the window. The government is providing 100% guarantees to the lending banks. Borrowers need not provide any financial statement or tax return financial information. Nor are there any personal guaranty or collateral requirements or the use of FICO scores. In addition to the 500-employee limit, borrowers must “Certify” that they are facing hardship due to COVID-19, which unfortunately is not a major stumbling block for most entities in our region.

Instead of “best practice” lending standards, the key to loan size is the law’s definition of “payroll costs”, which includes salaries and several medical and other benefits. The annual payroll costs for calculating the maximum available loans must exclude amounts above a $100k cap for any one employee or contractor. An entity’s workers outside the US are also excluded.

In general, a qualifying entity or individual can borrow up to 250% of its average monthly “payroll costs” as defined in the law. For example, a business, nonprofit or other qualifying entity with $960,000 of annual payroll costs after the above exclusions ($80,000/month) can borrow $200,000 ($80k x 250%). The maximum an entity can receive is $10 million. If used as intended by the law, the loan is forgiven and the forgiven debt is not taxable.

To be forgiven, loan proceeds can be used only for specified operating costs, including salaries, continued medical and other benefits, mortgage interest, rent, utilities and interest on pre-existing debt. In a “forest instead of trees” simplification, if the borrower has used the funds as intended to maintain its workforce without salary reduction for 8 weeks, the loan is entirely forgiven with no tax consequences. The Act has detailed formulas for determining this.

Before finalizing the loan, it is important to understand the formulas to estimate whether 100% or a lesser amount of the loan will be forgiven. (There may be a special SBA portal for the PPL program that includes a calculator for this. In addition, the lending banks will have a say here.)

Applying the formulas to get a 100% forgivable loan may be difficult where compensation is paid unevenly throughout the year. For example, a real estate broker is trying to see if there’s a way to give funds to commission agents who often have months with closings and others without them, and right now aren’t selling anything, in a way that will fit the formula and allow the loan to be forgiven.

To the extent that all of the loan conditions are not met under the formulas, and the loan is not entirely forgiven, the unforgiven portion can become up to a 10-year government guaranteed SBA loan at 4%. If an entity does have to make significant layoffs, this loan program may not work, since the borrower will be stuck with the loan. However, some entries are likely to see a 10-year 4% interest loan as acceptable.

The unprecedented SBA program came together very quickly and there are gray areas and open questions. One is which independent contractors can be counted in the “payroll cost” definition? Does it have to be individuals, or can it be firms, and for what services? Since loan app filings are expected to begin shortly, and possibly without SBA guidance for such questions, best judgment will be necessary.

For example, a nonprofit that completely outsources its bookkeeping to a CPA firm, and regularly deals with the same assigned bookkeeping staff intends to count those independent contractor payments in payroll costs, unless there’s an SBA rule to the contrary before loan origination.

Some of the open questions involve how these loans will work for sole proprietors, both as to how loan proceeds can be spent and how the loan forgiveness will work if their monthly income is unstable. My own sense is that if it was not intended for sole owners to pay themselves under the definition, the law could easily have added a restriction to the section allowing them to get the loans or made an exclusion to the loan forgiveness provisions. What I think would be wise is to make checks or transfers from the business account to a personal account to document the use of the loan proceeds as a payroll cost. Borrowers will have to document to the bank that the loan proceeds were spent for forgivable purposes.

It is possible that SBA comes out with a rule that will not allow the self-employed to pay themselves. But again, since there is an entire separate sub-section making them eligible for the program, that would have been the logical place to put a prohibition. Such a prohibition also seems contrary to the program’s goal.

There were rumors that banks would be taking PPL applications the Monday after the Fri 3/27 signing of the law. This didn’t happen. SBA staff has likely been burning midnight oil creating the program’s rules for both banks and borrowers.

Final Thoughts

This is a big, vital program to help small businesses and nonprofits keep operating cash coming in during this emergency.

Some and possibly many eligible CPA client and non-client entities are unaware of what this program is about, and CPAs can play an important role educating clients and helping smaller nonprofits that lack accounting resources. (Under the law, the SBA will limit fees that can be charged for helping entities with loan applications. How that will work remains an open question.)

PPL applications are expected to be issued by SBA lenders shortly as pressure is building, and the number of lenders for this SBA program should significantly increase. Based on calculations that I and others have done over the weekend for some nonprofits, the proceeds from these loans may or may not cover all the losses incurred from the COVID-19 emergency; but they can go a long way to keep our small business client and nonprofit doors open and able to pay future CPA fees.

Please feel free to forward this commentary to family, friends, or colleagues. If you would like us to add them to the list, please reply to this e-mail with their e-mail address and we will ask for their permission to be added.

  • Government bonds and Treasury Bills are guaranteed by the U.S. government as to the timely payment of principal and interest and, if held to maturity, offer a fixed rate of return and fixed principal value. However, the value of fund shares is not guaranteed and will fluctuate.
  • Corporate bonds are considered higher risk than government bonds but normally offer a higher yield and are subject to market, interest rate and credit risk as well as additional risks based on the quality of issuer coupon rate, price, yield, maturity, and redemption features.
  • The Standard & Poor's 500 (S&P 500) is an unmanaged group of securities considered to be representative of the stock market in general. You cannot invest directly in this index.
  • All indexes referenced are unmanaged. Unmanaged index returns do not reflect fees, expenses, or sales charges. Index performance is not indicative of the performance of any investment.
  • The Dow Jones Global ex-U.S. Index covers approximately 95% of the market capitalization of the 45 developed and emerging countries included in the Index.
  • The 10-year Treasury Note represents debt owed by the United States Treasury to the public. Since the U.S. Government is seen as a risk-free borrower, investors use the 10-year Treasury Note as a benchmark for the long-term bond market.
  • Gold represents the afternoon gold price as reported by the London Bullion Market Association. The gold price is set twice daily by the London Gold Fixing Company at 10:30 and 15:00 and is expressed in U.S. dollars per fine troy ounce.
  • The Bloomberg Commodity Index is designed to be a highly liquid and diversified benchmark for the commodity futures market. The Index is composed of futures contracts on 19 physical commodities and was launched on July 14, 1998.
  • The DJ Equity All REIT Total Return Index measures the total return performance of the equity subcategory of the Real Estate Investment Trust (REIT) industry as calculated by Dow Jones.
  • International investing involves special risks such as currency fluctuation and political instability and may not be suitable for all investors. These risks are often heightened for investments in emerging markets.
  • Yahoo! Finance is the source for any reference to the performance of an index between two specific periods.
  • Opinions expressed are subject to change without notice and are not intended as investment advice or to predict future performance.
  • Economic forecasts set forth may not develop as predicted and there can be no guarantee that strategies promoted will be successful.
  • Past performance does not guarantee future results. Investing involves risk, including loss of principal.
  • You cannot invest directly in an index.
  • Stock investing involves risk including loss of principal.
  • The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly. Economic forecasts set forth may not develop as predicted and are subject to change. Investing involves risk including loss of principal.
  • The Price-to-Earning (P/E) ratio is a measure of the price paid for a share relative to the annual net income or profit earned by the firm per share. It is a financial ratio used for valuation: a higher P/E ratio means investors are paying more for each unit of net income, thus, the stock is more expensive compared to one with a lower P/E ratio.
  • The foregoing information has been obtained from sources considered to be reliable, but we do not guarantee it is accurate or complete.
  • Consult your financial professional before making any investment decision.

ADV & Investment Objectives: Please contact The Dowling Group if there are any changes in your financial situation or investment objectives, or if you wish to impose, add or modify any reasonable restrictions to the management of your account. Our current disclosure statement is set forth on Part II of Form ADV and is available for your review upon request.