How Loan Forgiveness Works with Paycheck Protection Program Loans

For those who secured Small Business Administration (SBA) Paycheck Protection Program (PPP) loans, the conversation is now focused on two things:

  1. How to calculate and determine loan forgiveness scenarios
  2. Loan necessity

In general, some or all of the loan granted under the program may be forgiven if used on allowable expenses over the eight-week period after receiving the loan. This is subject to several rules around the components of the expenses as well as a comparison of the level of full-time equivalent (FTE) during the eight weeks post-funding to a base period.

However, there’s some ambiguity with the criteria and almost daily the SBA is issuing frequently asked questions and responses that impact the interpretation of the CARES Act provisions.

The Coronavirus, Aid, Relief, and Economic Security (CARES) Act was signed into law on March 27, 2020. The CARES Act included $349 billion allotted to the PPP.

The initial $349 billion contribution to the program lasted less than two weeks with around 1.7 million businesses receiving loans that averaged just over $200,000 each. On April 21, 2020, Congress announced plans to provide an additional $310 billion, which has now been funded.

So how is loan forgiveness calculated and how is forgiveness granted?


It’s important to note that the SBA has been making interpretations and issuing responses to frequently asked questions at a rate of one per day. And the final interpretations are still to be determined. Keep in mind that forgiveness is subject to audit by the SBA.

The first step in addressing forgiveness is to determine the maximum allowable forgiveness amount (MAFA). The MAFA on a loan is composed of the sum of the allowable costs (listed below) incurred during the eight-week period after the loan is funded and can’t exceed the borrowed amount.

It’s also subject to limits; for example, payroll costs must be 75% or more of the MAFA.

Payroll Costs

For Individual employee whose compensation is over $100,000 annually, the amount above and beyond an annualized $100,000 is excluded from the calculation. Your MAFA will also be reduced if you decrease wages by more than 25% for any employee that made less than $100,000 from the most recent full quarter versus the eight-week period.

Payroll costs also include the following amounts paid to employees:

  • Commissions
  • Cash tip or equivalent
  • Vacation
  • Parental, family, medical, or sick leave
  • Allowance for dismissal or separation
  • Provisions of group health care benefits, including insurance premiums
  • Retirement benefits
  • State or local tax assessed on the compensation of the employees
Not Eligible for Payroll Costs
  • The compensation of an individual employee in excess of $100,000, as prorated for the covered period
  • Taxes imposed or withheld under chapters 21, 22, or 24 of the Internal Revenue Code during the covered period
  • Any compensation of an employee whose principal place of residence is outside of the United States
  • Qualified sick leave wages for which a credit is allowed under section 7001 of the Families First Coronavirus Response Act
  • Qualified family leave wages for which a credit is allowed under section 7003 of the Families First Coronavirus Response Act

Non-Payroll Costs

No more than 25% of the MAFA may be for non-payroll costs.

Non-payroll costs include:

  • Interest on the mortgage obligation incurred in the ordinary course of business (principal excluded) with origination prior to February 15, 2020
  • Rent on written lease agreements with terms beginning prior to February 15, 2020
  • Payments on utilities (electricity, gas, water, transportation, telephone, or internet) with service started prior to February 15, 2020

Once the MAFA is determined, the next step is to assess if it will be reduced based on employment levels.

Staff Reductions

If there’s a reduction in staff, loan forgiveness will be reduced by the percentage reduction in FTE over the eight-week period after the loan is received.

To calculate the amount, the average FTE over the eight-week period is divided by the lesser of the following periods below:

  • Average FTE per month between February 15, 2019, and June 30,2019
  • Average FTE per month between January 1, 2020, and February 29, 2020

This gives you a percentage that’s then applied to the MAFA to determine the forgiveness amount. There are additional special provisions for seasonal businesses that aren’t addressed here.

Note: The definition of full-time equivalent may vary by lender, so it’s important to consult with legal counsel and your lender as to the agreed-upon definition. The American Institute of Certified Public Accountants, known as the AICPA, recommended in a publication dated April 28, 2020, that FTEs should be in line with the definition under the Affordable Care Act of 30 hours per week.


There are additional provisions relating to the determination of FTEs. In particular, there’s a special exclusion under the CARES Act when it comes to rehiring.

A borrower that reduced or plans to reduce the number of full-time employees on its payroll between February 15, 2020, and 30 days after the PPP’s enactment can re-hire those employees prior to June 30, 2020, and could receive the benefit of the pre-reduction FTE count on its loan forgiveness calculation.

While this exclusion may have only a minor impact on MAFA, it could result in a significant increase to the percentage calculation above, which could result in a much higher forgiveness amount.

An interesting scenario has occurred as many furloughed employees are opting to not accept the rehire opportunity as current state and federal unemployment payments might be deemed more attractive. In response to this situation, the SBA addressed the question of what happens to the employer’s calculation if the employee refuses the offer.

The response in FAQ 40, which was published May 3, 2020, is as follows:

“As an exercise of the Administrator’s and the Secretary’s authority under Section 1106(d)(6) of the CARES Act to prescribe regulations granting de-minimis exemptions from the Act’s limits on loan forgiveness, SBA and Treasury intend to issue an interim final rule excluding laid-off employees whom the borrower offered to rehire (for the same salary/wages and same number of hours) from the CARES Act’s loan forgiveness reduction calculation. The interim final rule will specify that, to qualify for this exception, the borrower must have made a good faith, written offer of rehire, and the employee’s rejection of that offer must be documented by the borrower. Employees and employers should be aware that employees who reject offers of re-employment may forfeit eligibility for continued unemployment compensation.”

Comparison of Periods and Amounts

The period of time covered for the PPP loan calculation is an average monthly payroll cost multiplied by 2.5 versus the forgiveness that’s calculated based on an eight-week period post-funding. The amounts used for the loan request don’t include components such as rent and utilities that are part of the forgiveness calculation. As a result, it isn’t safe to assume your PPP loan will be 100% forgiven.

Loan Necessity

The PPP world was turned upside down when the SBA issued FAQ 31 addressing if businesses owned by large companies with adequate sources of liquidity to support the business’s ongoing operations qualify for a PPP loan.

Here’s the answer: “In addition to reviewing applicable affiliation rules to determine eligibility, all borrowers must assess their economic need for a PPP loan under the standard established by the CARES Act and the PPP regulations at the time of the loan application. Although the CARES Act suspends the ordinary requirement that borrowers must be unable to obtain credit elsewhere (as defined in section 3(h) of the Small Business Act), borrowers still must certify in good faith that their PPP loan request is necessary. Specifically, before submitting a PPP application, all borrowers should review carefully the required certification that “[c]urrent economic uncertainty makes this loan request necessary to support the ongoing operations of the Applicant. Borrowers must make this certification in good faith, taking into account their current business activity and their ability to access other sources of liquidity sufficient to support their ongoing operations in a manner that is not significantly detrimental to the business. For example, it is unlikely that a public company with substantial market value and access to capital markets will be able to make the required certification in good faith, and such a company should be prepared to demonstrate to SBA, upon request, the basis for its certification.”

Of particular note is that borrowers must assess their economic need for a PPP loan according to the standards in the CARES Act and PPP regulations. They also must certify in good faith that their PPP loan is necessary.

Returning Funds

Subsequently, the question was raised about private companies and the response was to refer to FAQ 31.

This created confusion for many companies, and was exacerbated further by the need to determine if the money isn’t considered necessary. If so, then the funds should be returned by May 7, 2020, to be considered as acting in good faith.

On May 5, the SBA issued FAQ 43, which extended the safe harbor deadline to May 14. In short, there are important analysis, decisions, and actions to be taken that are time sensitive to arrive at a conclusion. Reaching out to your essential business advisors and legal counsel now is prudent.

How Forgiveness Is Granted

Once a determination is made to retain funds, borrowers must apply for forgiveness through their lender, and the application must include documentation verifying maintenance in employee base, pay rates, and payroll tax filings.

Documentation also will need to verify payments on allowable costs. Certification will be required from a business representative stating that the documentation provided is true and accurate.

The application for forgiveness is due within 90 days of the expiration of the eight-week post-funding period. Then the approval process is expected to be completed within 60 days of the application.

Note on Affiliation Rule

The SBA uses the affiliation rule to decide whether a business’s affiliations preclude it from being considered small.

Generally, affiliation exists when one business controls or has the power to control another, or when a third party or parties controls or has the power to control both businesses. The determination of whether an affiliation exists is a legal matter and should be addressed by an attorney.

Here are some general guidelines that may indicate entities are affiliated:

  • Control 50% or more of voting stock
  • Control less than 50% of voting stock, but considered large compared with others
  • Common management between two companies
  • Identical or dependent businesses, with common ownership

Most private equity and venture-capital backed portfolio companies may be considered affiliated.

When Affiliation Rule Is Waived

There are three instances when affiliation rules are waived:

  • The NAICS code begins with 72.
  • A franchise with a franchise identifier code assigned by SBA.
  • A business that receives SBIC financial assistance

Tax Considerations

Debt forgiveness isn’t taxable income for federal income tax purposes. However, there is more to the story.

For example, if someone has a $1.5 million loan and gets $1 million forgiven, it’s typically taxable as cancelation of debt income (CODI). But that isn’t the case here. If you use those proceeds to pay for expenses like payroll and rent, it isn’t deductible if paid by forgiven money. As a result of the non-deductibility of the expenses, the net effect is as if the CODI is taxable income.

There are discussions in Congress now that may adjust this—to allow for deduction of the expenses paid with PPP forgiveness funds; however, at the time of this article they aren’t deductible from a federal perspective.

States, meanwhile, are expected to tax the CODI and allow for the deduction of expenses paid with the PPP funds. 

PPP Alternative

If you receive a PPP loan, there could be a loss of benefits from other programs.

This might mean that you lose the ability to:

  • Use certain tax credits, such as the employee retention tax credit
  • Defer Social Security and Medicare tax payments at the time loan forgiveness is determined or approved by the lender. However, the amount of the deposit and payment of the employer's share of Social Security tax that was deferred through the date that the PPP loan is approved to be forgiven continues to be deferred and will be due on the applicable dates.

Loan forgiveness could also be reduced by reducing your workforce or compensation.

Employee Retention Tax Credit

There are two criteria for the employee retention tax credit:

  • For businesses with 100 or less full-time employee, the credit is based on all wages paid to employees
  • For businesses with greater than 100 full-time employees, the credit only applies to wages paid to employees during the time they aren’t providing services due to COVID-19

Qualifying businesses must have experienced either of the following:

  • Partial or full suspension of operations due to governmental orders that limited commerce, travel, or group meetings due to COVID-19
  • A significant decline in gross receipts—this begins with the period in which gross receipts are less than 50% of the gross receipts of the same prior calendar-year quarter and ends with the quarter when gross receipts are 80% of the gross receipts for the same prior-calendar quarter
  • Credit is available up to 50% of $10,000 of wages per employee.
  • Credit offsets Federal Insurance Contributions Act (FICA) taxes due and the excess is refundable.

Combination with PPP Loan

Many employers were hoping to utilize the employee retention tax credit after they exhausted their PPP loan to help maximize their cash opportunities. However, the IRS provided further guidance limiting employers to only one of the immediate cash opportunities. 

Employers who received a PPP loan are ineligible for the credit regardless if their loan is forgiven or they pay the loan back in its entirety; there was a limited exception for employers who returned their PPP loan by May 14. Employers who applied for a PPP loan and were denied, meanwhile, can still utilize the credit to the extent they don’t try to apply for the PPP loan again at a future date.

We’re Here to Help

This is merely a high-level overview of the major provisions that doesn’t take into account all of the details that should be addressed.  For more insight on how to calculate PPP loan forgiveness or alternate options for cash flow or funding, contact your Moss Adams professional.

Special thanks to MaryCaitlin Willcuts, Manager, State & Local Tax Services, and Biagio Genualdi, Assurance Manager, for their contributions to this article.

Contact Us with Questions

Enter security code:
 Security code