On Monday, August 24, 2020, the U.S. Small Business Administration (SBA) and the Treasury Department released an interim final rule (IFR) entitled, “Treatment of Owners and Forgiveness of Certain Nonpayroll Costs.” This IFR addresses important guidance related to Paycheck Protection Program (PPP) loan expenses eligible for forgiveness, owner-employee compensation, the eligibility of nonpayroll costs, including related party rents, and rent-related costs.
Notably, the newly released IFR includes the following three clarifications regarding previous guidance impacting PPP loan borrowers:
- Certain individuals are exempt from owner-employee compensation limits;
- Having tenants or sub-tenants can impact the eligibility of certain non-payroll costs; and
- Limitations on related party rent when applying for loan forgiveness.
In addition, the guidance includes several decisions that are designed to maintain equitable treatment between a business owner that holds property in a separate entity and one that holds the property in the same entity as its business operations. To follow are additional details regarding this new PPP forgiveness guidance:
This newly-released IFR states that owner-employees with less than a 5% stake in a C- or S- corporation are exempt from the PPP owner-employee compensation rule in terms of determining the amount of their compensation for loan forgiveness. According to the IFR, the exemption’s intention is to cover owner-employees who do not have the ability to influence decisions over how loan proceeds are allocated.
- In the first decision, the SBA and Treasury state that the amount of loan forgiveness requested for nonpayroll costs may not include any amount attributable to the business operation of a tenant or subtenant of the PPP borrower.
- In the second decision, regarding certain nonpayroll costs, SBA and Treasury state that rent or lease payments to a related party are eligible for loan forgiveness provided that:
- the amount of loan forgiveness requested for those payments 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; and
- the lease and the mortgage were entered into prior to Feb. 15, 2020.
However, mortgage interest payments to a related party are not eligible for forgiveness. Per the ruling, PPP loans are intended to assist businesses cover nonpayroll costs owed to third parties, not payments to a business’s owner that occur because of how the business is structured.
Additional Clarification Is Needed
This IFR clarifies who qualifies as an owner; however, it is unclear if ownership attribution of close family members applies in defining who is an owner-employee. In addition, clarity is required related to the eligibility of health benefits of S-Corp owners with between 2% and 5% ownership.
Related Party Rents
Whether or not limitations apply to related party rents has been a significant question for many PPP borrowers. This new IFR provides guidance by limiting the amount of loan forgiveness requested for rent or lease payments to a related party to “no more than the amount of mortgage interest owed on the property during the Covered Period” to the space being rented by the business, assuming both the lease and the mortgage were entered into prior to February 15, 2020. For this purpose, “any ownership in common” between the business and the rented property creates a related party lease.
Treating the lease payments as payments of mortgage interest eliminates the eligibility of prepaid related party rents since prepaid mortgage interest is not eligible for forgiveness. This is an important consideration for some business owners.
Certain Other Nonpayroll Costs
This IFR limits the amount of rent, interest, and utility costs that are eligible for forgiveness where some or all of the property on which the rent, interest, or utilities are being paid is leased or sub-leased to others.
When a borrower operates out of an owned building on which it has a mortgage, the eligible mortgage interest is limited to the percent share of the fair market value of the space that is not leased out to other businesses. Utilities must be prorated in the same manner.
For home-based businesses, nonpayroll costs are limited to the prorated share of covered expenses that were deductible on the borrower’s 2019 tax return. For new businesses, the amount expected is to be deductible on the borrower’s 2020 tax return.
Tarlow is Here to Help – Please Contact Us with Questions
Tarlow Partners and staff members are closely monitoring the PPP rules, tax-related legislation and regulations, and guidance from the SBA and the Department of Treasury. We are readily available to assist business owners and will continue to send updates about relevant news and changing guidelines. If you have any questions about this update or any tax matter, please contact your Tarlow advisor for assistance.