By Kevin O’Connor & Jennifer Hart
This week, the Small Business Administration (SBA) and Treasury Department issued an interim final rule that once again updated the parameters for forgiveness of Paycheck Protection Program (PPP) loans. Specifically, the new rule provided that:
- Owner-employees who have less than a 5% ownership stake in a C- or S-Corporation are not subject to the owner-employee compensation rule;
- Nonpayroll costs may not include any amount attributable to the business operation of a tenant or sub-tenant of the PPP borrower and home-based businesses cannot receive forgiveness for household expenses; and
- Rent payments to a related party are eligible for loan forgiveness so long as they meet certain requirements
Exception to owner-employee compensation rule
Previously, the SBA had taken the position that forgiveness of any payroll compensation to owner-employees would be capped at 8/52 of the owner-employee’s compensation in the prior year. Under the new rule, owner-employees in a C- or S-Corporation who have less than a 5% ownership stake will not be subject to that cap. The SBA reasoned that owner-employees with less than 5% ownership have no meaningful ability to influence decisions over how loan proceeds are allocated and so should not be capped at amounts paid in 2019.
Forgivability of rent payments to related parties
The rule also provides that rent paid to a related party is a forgivable expense so long as:
(1) the amount of loan forgiveness requested for rent or lease payments to a related party 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
(2) the lease and the mortgage were entered into prior to Feb. 15, 2020.
For purposes of the rule, a party is related if there is any ownership in common between the business and the property owner. The borrower will be required to provide its lender with mortgage interest documentation to substantiate the amount of rent payments to related parties.
That being said, while rent or lease payments to a related party may be eligible for forgiveness, mortgage interest payments to a related party are not eligible for forgiveness. SBA’s stated reasoning is that because PPP loans were intended to help businesses cover certain nonpayroll obligations that are owed to third parties, mortgage interest payments to related parties cannot be forgiven. SBA stated that this rule will 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.
Tenant costs, subtenant costs & household expenses are not forgivable
The new rule provides that borrowers who have tenants or subtenants that pay the borrower rent cannot “double dip” and receive forgiveness for the amounts that these tenants and subtenants owe to the borrower. So if a borrower subleases its space to another business or receives rent on a property for which they are paying mortgage interest, the borrower must address the amounts of those payments when calculating the amounts of non-payroll expenses for which they are requesting forgiveness.
It is unclear from the rule how non-payment of rent owed under leases and subleases should be treated in terms of forgivability. The SBA addressed how borrowers should account for these payments in a series of hypotheticals. The full text of these hypotheticals is included below.
EXAMPLE 1: A borrower rents an office building for $10,000 per month and subleases out a portion of the space to other businesses for $2,500 per month. Only $7,500 per month is eligible for loan forgiveness.
EXAMPLE 2: 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.
EXAMPLE 3: 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.
The SBA also confirmed the forgivability of household expenses for home-based businesses, stating that borrowers must prorate their rent and utilities in the same manner as they did on their 2019 tax filings. If the business is new, the borrower should use the amounts it expects to include on its 2020 tax filings.
If you have any questions on forgiveness of PPP loans for owner-employees or related party rent, contact Kevin O’Connor at email@example.com or 216.736.7213 or Jennifer Hart at firstname.lastname@example.org or 216.736.7208.