Understanding the CARES Act Paycheck Protection Program: A Comprehensive Guide for Small Businesses

The Coronavirus Aid, Relief, and Economic Security (CARES) Act was a landmark piece of legislation designed to inject trillions of dollars into the U.S. economy to combat the devastating economic effects of the COVID-19 pandemic. A cornerstone of this act was the Paycheck Protection Program (PPP), a vital initiative aimed at providing immediate relief to small businesses across the nation. This program, officially implemented by the Small Business Administration (SBA), offered potentially forgivable loans to help businesses maintain their payroll and cover essential operating expenses during periods of economic uncertainty.

This guide delves deep into the Paycheck Protection Program, drawing from official SBA guidelines and regulations to provide a comprehensive understanding of its key features, eligibility criteria, loan terms, and forgiveness provisions. Whether you are a small business owner, a lender, or simply interested in understanding this critical economic relief program, this in-depth analysis will equip you with the knowledge you need to navigate the complexities of the Cares Act Paycheck Protection Program.

Decoding the CARES Act and the Paycheck Protection Program

The COVID-19 pandemic, declared a national emergency on March 13, 2020, triggered unprecedented economic disruption. Businesses, particularly small businesses, faced mandated closures, reduced customer traffic, and significant financial strain. In response to this crisis, the U.S. government enacted the CARES Act on March 27, 2020. Within this sweeping legislation, Sections 1102 and 1106 specifically established and defined the Paycheck Protection Program.

The core objective of the PPP was to provide swift financial assistance to small businesses. The program was designed to enable businesses to:

• Maintain Payroll: Keep workers on the payroll during business disruptions, preventing mass layoffs and supporting employee income.
• Cover Operating Expenses: Address essential costs like rent, utilities, and mortgage interest, ensuring business continuity during mandated shutdowns and economic slowdowns.

The SBA was tasked with the rapid implementation of the PPP, aiming to get funds into the hands of struggling businesses as quickly as possible. This urgency led to the program being rolled out as an interim final rule, effective immediately on April 15, 2020, with a request for public comment to further refine the program.

Key Provisions of the Paycheck Protection Program

The PPP was structured as a temporary modification to the SBA’s existing 7(a) Loan Program, but with significant adaptations to meet the emergency needs of the COVID-19 crisis. Here are the critical elements of the program:

1. 100% SBA Guarantee

Loans under the PPP were 100% guaranteed by the SBA. This removed a substantial layer of risk for lenders, encouraging them to participate actively in the program and expedite loan processing. This full guarantee was a departure from the typical 7(a) loan program, where SBA guarantees a lower percentage of the loan.

2. Loan Forgiveness Potential

A defining feature of the PPP was the potential for loan forgiveness. Borrowers could have their loans forgiven up to the full principal amount and accrued interest if the loan proceeds were used for specific eligible expenses and if employee and compensation levels were maintained. This loan forgiveness aspect transformed the PPP from a traditional loan program into a grant-like emergency relief mechanism.

3. Streamlined Application Process

Recognizing the urgency and the need for widespread access, the SBA streamlined the PPP application process significantly. Traditional SBA lending criteria were relaxed, and lenders were empowered to rely heavily on borrower certifications and minimal documentation to expedite loan approvals. This approach aimed to remove bureaucratic hurdles and get funds flowing quickly.

4. Delegated Authority to Lenders

To further accelerate loan distribution, the SBA granted delegated authority to all existing SBA 7(a) lenders and expanded eligibility to include other federally insured depository institutions, credit unions, and certain non-depository financing providers. This broadened the network of lenders capable of processing PPP loans, increasing access for small businesses nationwide.

5. Limited Timeframe

The PPP was established as a temporary program with a deadline. Loans were authorized to be guaranteed under the PPP only through June 30, 2020, or until the allocated program funds of $349 billion were exhausted. This limited timeframe emphasized the program’s emergency nature and the need for businesses to act quickly to apply.

Eligibility: Who Could Apply for a PPP Loan?

The eligibility criteria for the Paycheck Protection Program were designed to be inclusive, targeting a broad range of small businesses impacted by the COVID-19 pandemic. To be eligible for a PPP loan, businesses generally needed to meet the following criteria:

a. Size Standards

• 500 or Fewer Employees: The most common size standard was having 500 or fewer employees whose principal place of residence was in the United States. This included full-time, part-time, and other employees.
• Industry-Specific Size Standards: Businesses operating in certain industries could be eligible if they met the SBA’s industry-based size standards, even if they had more than 500 employees. These size standards are defined by the North American Industry Classification System (NAICS) codes and are based on either employee count or annual revenue.

b. Business Type

Eligible entities included:

• Small Business Concerns: As defined by section 3 of the Small Business Act and SBA’s affiliation rules (unless specifically waived).
• Tax-Exempt Nonprofit Organizations: Described in section 501(c)(3) of the Internal Revenue Code (IRC).
• Tax-Exempt Veterans Organizations: Described in section 501(c)(19) of the IRC.
• Tribal Business Concerns: Described in section 31(b)(2)(C) of the Small Business Act.
• Sole Proprietorships, Independent Contractors, and Self-Employed Individuals: Individuals operating under these structures were also eligible.

c. Operational Status

• In Operation on February 15, 2020: Applicants needed to be in operation on or before February 15, 2020, demonstrating an established business presence prior to the pandemic’s major impact.
• Payroll or Independent Contractor Payments: Businesses needed to have either paid employees’ salaries and payroll taxes or made payments to independent contractors (as reported on Form 1099-MISC). Sole proprietors, independent contractors, and self-employed individuals needed to have been in operation at that date.

d. Documentation Requirements

Applicants were required to submit documentation to verify their eligibility, including:

• Payroll Processor Records: Reports from payroll processing services.
• Payroll Tax Filings: Forms like IRS Form 941 (Employer’s Quarterly Federal Tax Return).
• Form 1099-MISC: If applicable, to show payments to independent contractors.
• Income and Expenses from Sole Proprietorship: For self-employed individuals, documentation of income and expenses.
• Bank Records: If other payroll documentation was unavailable, bank records could be used to demonstrate qualifying payroll amounts.

e. Ineligibility Factors

Certain conditions could make an otherwise eligible business ineligible for a PPP loan:

• Illegal Activities: Engaging in any activity illegal under federal, state, or local law.
• Household Employers: Individuals employing household staff like nannies or housekeepers.
• Criminal History of Owners: Owners with a 20% or greater equity stake with certain criminal histories (incarceration, probation, parole, indictment, felony convictions within the last five years).
• Prior SBA Loan Defaults: Businesses with owners who had defaulted on or were currently delinquent on a previous SBA or other federal agency loan within the last seven years, causing a loss to the government.

Calculating Your Maximum PPP Loan Amount

The Paycheck Protection Program loan amounts were capped and calculated based on a payroll-based formula. The maximum loan amount was the lesser of $10 million or the amount calculated using the formula. The standard calculation method was as follows:

1. Aggregate Payroll Costs: Calculate the total payroll costs from the previous twelve months for employees whose primary residence is in the United States.
2. Exclude High Salaries: Subtract any compensation paid to an employee exceeding an annualized salary of $100,000. Similarly, exclude payments to independent contractors or sole proprietors exceeding $100,000 per year. This $100,000 cap applied to individual employee/owner compensation.
3. Calculate Average Monthly Payroll: Divide the result from Step 2 by 12 to determine the average monthly payroll costs.
4. Multiply by 2.5: Multiply the average monthly payroll costs by 2.5. This represented approximately 2.5 months of payroll coverage.
5. Add EIDL Refinancing (if applicable): If the business had an Economic Injury Disaster Loan (EIDL) made between January 31, 2020, and April 3, 2020, add the outstanding loan amount (excluding any EIDL advance, which was essentially a grant). This allowed businesses to refinance existing EIDL loans into the PPP.

Examples of Loan Amount Calculation:

• Example 1: No high earners, no EIDL.

  • Annual payroll: $120,000
  • Average monthly payroll: $10,000 ($120,000 / 12)
  • Multiply by 2.5: $25,000 ($10,000 x 2.5)
  • Maximum loan amount: $25,000

• Example 2: Some high earners, no EIDL.

  • Annual payroll: $1,500,000
  • Compensation above $100,000 excluded: $300,000 (Example: 3 employees at $200,000 each, excess is $100,000 per employee x 3)
  • Qualifying payroll: $1,200,000 ($1,500,000 – $300,000)
  • Average monthly qualifying payroll: $100,000 ($1,200,000 / 12)
  • Multiply by 2.5: $250,000 ($100,000 x 2.5)
  • Maximum loan amount: $250,000

• Example 3: No high earners, with EIDL.

  • Annual payroll: $120,000
  • Average monthly payroll: $10,000
  • Multiply by 2.5: $25,000
  • Outstanding EIDL loan: $10,000
  • Maximum loan amount: $35,000 ($25,000 + $10,000)

• Example 4: Some high earners, with EIDL.

  • Annual payroll: $1,500,000
  • Qualifying payroll (after high earner exclusion): $1,200,000
  • Average monthly qualifying payroll: $100,000
  • Multiply by 2.5: $250,000
  • Outstanding EIDL loan: $10,000
  • Maximum loan amount: $260,000 ($250,000 + $10,000)

What Constitutes “Payroll Costs”?

Understanding what qualified as “payroll costs” was crucial for both loan amount calculation and loan forgiveness. Payroll costs included:

• Salaries, Wages, Commissions, and Similar Compensation: Payments to employees whose principal place of residence was in the United States.
• Cash Tips or Equivalents: Based on employer records or a reasonable good-faith estimate.
• Payments for Leave: Vacation, parental, family, medical, or sick leave.
• Allowance for Separation or Dismissal: Severance payments.
• Employee Benefits: Costs for group health care coverage (including insurance premiums) and retirement contributions.
• State and Local Taxes: Taxes assessed on employee compensation.
• For Sole Proprietors/Independent Contractors: Wages, commissions, income, or net earnings from self-employment.

Exclusions from Payroll Costs

Certain items were specifically excluded from the definition of payroll costs for PPP purposes:

• Compensation to Non-US Residents: Compensation for employees whose primary residence was outside the United States.
• High Individual Salaries (above $100,000 annually): The portion of an employee’s salary exceeding $100,000 per year, prorated as necessary for the covered period.
• Federal Employment Taxes: Federal employment taxes imposed or withheld between February 15, 2020, and June 30, 2020, including both employee and employer shares of FICA and Railroad Retirement Act taxes, and withheld income taxes.
• Qualified Sick and Family Leave Wages (under FFCRA): Wages for which a tax credit was already claimed under the Families First Coronavirus Response Act.

It is important to note that independent contractors did not count as employees for PPP loan calculations for the businesses that paid them. Independent contractors were eligible to apply for their own PPP loans as self-employed individuals.

PPP Loan Terms: Interest Rate, Maturity, and Deferment

The terms of PPP loans were intentionally favorable to borrowers to maximize their effectiveness as a relief mechanism:

• Interest Rate: A fixed interest rate of 1% per year. This exceptionally low rate was significantly below market rates and designed to minimize the cost of borrowing for businesses in crisis.
• Maturity: A two-year maturity. While the CARES Act allowed for loans up to ten years, the SBA, in consultation with the Treasury Secretary, set a two-year term, anticipating that the economic disruption would be relatively short-term.
• Payment Deferral: No payments (principal or interest) were required for the first six months from the date of loan disbursement. Interest, however, did accrue during this deferment period. The CARES Act authorized deferment for up to one year, but a six-month deferral was implemented initially.

Key Loan Conditions

• No Collateral Required: PPP loans did not require any collateral from borrowers, further reducing barriers to access.
• No Personal Guarantees: Personal guarantees, typically required for SBA loans, were waived for PPP loans, protecting the personal assets of business owners.
• Single Loan per Borrower: Businesses were generally limited to one PPP loan. This was intended to distribute the limited program funds as widely as possible.
• “First-Come, First-Served”: The PPP operated on a first-come, first-served basis, emphasizing the need for businesses to apply promptly.

Loan Forgiveness: Turning a Loan into a Grant

The loan forgiveness aspect was the most compelling feature of the Paycheck Protection Program. Borrowers could have their PPP loans forgiven, effectively converting them into grants, if they met certain requirements.

Forgiveness Amount Calculation

The amount of loan forgiveness could be up to the full principal amount of the loan and accrued interest. The actual forgivable amount was based on the borrower’s spending of loan proceeds during the 8-week period following loan disbursement on the following eligible expenses:

1. Payroll Costs: As defined previously (salaries, wages, benefits, etc.).
2. Mortgage Interest Payments: Interest payments on business mortgage obligations incurred before February 15, 2020. Principal prepayments and principal payments were not forgivable.
3. Rent Payments: Rent payments on leases dated before February 15, 2020.
4. Utility Payments: Payments for utilities under service agreements dated before February 15, 2020. Utilities included electricity, gas, water, transportation, telephone, or internet access.

Important Limitation: The 75/25 Rule

A critical rule for loan forgiveness was the “75/25 rule”. To maximize loan forgiveness, borrowers were required to use at least 75% of the loan proceeds for payroll costs. No more than 25% of the loan forgiveness amount could be attributed to non-payroll costs (mortgage interest, rent, and utilities). This rule underscored the program’s primary goal of payroll protection and job retention.

Reductions in Loan Forgiveness

The loan forgiveness amount could be reduced in two primary scenarios:

1. Reduction in Full-Time Equivalent (FTE) Employees: If the borrower reduced their FTE employee count during the 8-week covered period compared to a reference period (either February 15, 2019, to June 30, 2019, or January 1, 2020, to February 29, 2020), the loan forgiveness amount would be reduced proportionally. There were exceptions for businesses that rehired employees or could not rehire similarly qualified employees.
2. Reduction in Salary or Wages: If salaries or wages were reduced by more than 25% for any employee earning less than $100,000 annually (in 2019), loan forgiveness could be reduced. Safe harbor provisions existed if salary/wage reductions were reversed by a certain date.

Loan Forgiveness Application Process

To apply for loan forgiveness, borrowers needed to submit an application to their lender, along with documentation verifying eligible payments made during the covered period. Lenders were expected to review the application and documentation and make a decision on forgiveness, subject to SBA review. The SBA provided guidance and forms for the loan forgiveness application process.

Permitted Uses of PPP Loan Funds

PPP loan proceeds were restricted to specific uses to align with the program’s objectives. Permitted uses included:

1. Payroll Costs: As defined in the program.
2. Continuation of Group Health Care Benefits: Costs related to maintaining health benefits during periods of leave and insurance premiums.
3. Mortgage Interest Payments: As defined for loan forgiveness eligibility.
4. Rent Payments: As defined for loan forgiveness eligibility.
5. Utility Payments: As defined for loan forgiveness eligibility.
6. Interest Payments on Other Pre-Existing Debt: Interest on debt obligations incurred before February 15, 2020.
7. Refinancing EIDL Loans: Refinancing SBA EIDL loans made between January 31, 2020, and April 3, 2020 (as discussed earlier).

Important Usage Rule: The 75% Payroll Requirement

Just as with loan forgiveness, borrowers were also expected to use at least 75% of the loan proceeds on payroll costs. While the CARES Act listed a broader range of potential uses, the SBA imposed this 75% payroll requirement to ensure that the majority of funds went towards payroll protection.

Misuse of Funds

Using PPP funds for unauthorized purposes had consequences. The SBA could require borrowers to repay misused amounts. Knowingly using funds for unauthorized purposes could lead to additional liabilities, including fraud charges. Shareholders, members, or partners could also be held liable for unauthorized use of funds by individuals within the business.

Lender Responsibilities and Fees

Lenders played a crucial role in the Paycheck Protection Program, acting as the primary point of contact for borrowers and processing loan applications. Their responsibilities were streamlined but included key verification steps:

• Confirming Borrower Certifications: Ensuring receipt of required borrower certifications on the PPP application form.
• Verifying Operation and Payroll: Confirming documentation showing the business was operating and had payroll on or around February 15, 2020.
• Reviewing Payroll Documentation: Assessing payroll documentation to confirm average monthly payroll costs.
• BSA Compliance: Following Bank Secrecy Act (BSA) requirements for customer identification and anti-money laundering. For lenders not typically subject to BSA, establishing equivalent AML compliance programs was required.

Lender Fees

The SBA provided processing fees to lenders to incentivize their participation in the PPP. These fees were based on the loan size:

• 5% for loans up to $350,000
• 3% for loans between $350,000 and $2,000,000
• 1% for loans of $2,000,000 or more

These fees were paid by the SBA, not the borrower. Agents assisting borrowers were also to be paid by the lender out of these fees, with limits on agent fees set by the SBA. Agents could not charge borrowers directly or be paid from loan proceeds.

Certifications Required by Borrowers

To apply for a PPP loan, authorized representatives of businesses had to make several critical certifications in good faith on the application form. These certifications were legally binding and essential for program integrity. Key certifications included:

1. Operational Status and Payroll: Certification that the applicant was in operation on February 15, 2020, and had employees or paid independent contractors.
2. Economic Uncertainty Necessity: Certification that current economic uncertainty made the loan request necessary to support ongoing operations.
3. Use of Funds for Permitted Purposes: Certification that funds would be used for payroll, mortgage interest, rent, and utilities to retain workers and maintain payroll. Acknowledgement of potential legal liability for unauthorized use.
4. Documentation Provision for Forgiveness: Agreement to provide documentation for FTE employees, payroll costs, and eligible non-payroll costs for the 8-week period for loan forgiveness.
5. Loan Forgiveness Understanding: Acknowledgement that loan forgiveness was based on documented costs and adherence to the 75/25 rule.
6. No Dual Dipping: Certification that the applicant had not and would not receive another PPP loan during the period from February 15, 2020, to December 31, 2020.
7. Truthfulness and Accuracy: Certification that all information provided in the application and supporting documents was true and accurate. Acknowledgement of potential criminal penalties for false statements.
8. Tax Document Verification: Acknowledgement that the lender would verify loan amounts using submitted tax documents and affirmation that these documents were identical to those submitted to the IRS. Consent for the lender to share tax information with the SBA for compliance and review purposes.

Conclusion: The CARES Act Paycheck Protection Program as a Lifeline

The CARES Act Paycheck Protection Program was a rapid and substantial intervention designed to mitigate the economic fallout of the COVID-19 pandemic on small businesses. By offering forgivable loans, the program aimed to keep employees on payroll, cover essential operating costs, and help businesses weather unprecedented economic disruption.

While the PPP was a temporary program with a limited application window, its impact was significant. It provided a crucial lifeline to millions of small businesses across the United States, helping to stabilize the economy during a period of immense uncertainty. Understanding the intricacies of the PPP – its eligibility rules, loan terms, forgiveness provisions, and permitted uses – is essential for businesses that participated in the program and for anyone studying the government’s response to the COVID-19 economic crisis. The Paycheck Protection Program remains a key case study in emergency economic relief and the role of government in supporting small businesses during times of national crisis.