After months of silence on the topic, the SBA has issued guidance on the percentage of ownership of a borrower that triggers the treatment of an employee as an owner in an August 24, 2020 Interim Final Rule.[1]  The IFR also provides for limitations on some rental and mortgage interest expenses a borrower might otherwise seek to treat as nonpayroll costs for forgiveness.  But the guidance also gives the go-ahead for the use of certain office in home expenses for this purpose, so long as they are allowed as a deduction on the taxpayer’s tax filings for the years in question.

Ownership Percentage for Employee to Be Subject to Owner PPP Limitations

A number of times in the prior IFRs and FAQs the SBA had imposed special limitations that applied to employees who were owners in the computation of payroll costs that counted towards forgiveness, as well as providing that a person who was an owner of multiple businesses was subject to a single overall limitation on cash compensation.  Due to the lack of guidance, some advisers had latched onto a reference on page 3 of the PPP loan application form that provided, in instructions that:

All parties listed below are considered owners of the Applicant as defined in 13 CFR § 120.10, as well as “principals”:

…

• For a partnership, all general partners, and all limited partners owning 20% or more of the equity of the firm;

• For a corporation, all owners of 20% or more of the corporation;

• For limited liability companies, all members owning 20% or more of the company; …[2]

On the application form, this primarily impacted qualification for the loans, since owners with, for instance, certain felony convictions would render the borrower ineligible for the loan.  And, certainly, the SBA never stated that this test applied outside the context of the questions on the application.  But it was the one place the SBA had provided for an amount of ownership interest necessary to be treated as an owner, even if not in the context of the debt forgiveness rules.

The August 24, 2020 IFR does not use the 20% ownership test, rather using a 5% ownership trigger.  The IFR provides:

1. Owners

Are any individuals with an ownership stake in a PPP borrower exempt from application of the PPP owner-employee compensation rule when determining the amount of their compensation that is eligible for loan forgiveness?

Yes, owner-employees with less than a 5 percent ownership stake in a C- or S-Corporation are not subject to the owner-employee compensation rule. The First Loan Forgiveness Rule, as revised by the Revisions to Loan Forgiveness and Loan Review Procedures Interim Final Rules, 85 FR 38304, 38307 (June 26, 2020), caps the amount of loan forgiveness for payroll compensation attributable to an owner-employee.[3]

The SBA does not see this as lowering the limit—rather, the agency believes the prior ruling applies to any ownership, no matter how miniscule.  So, in the view of the agency, the new rule is a significant relaxing of the original rule.

There is no exception in the rule based on the owner-employee’s percentage of ownership. The Administrator, in consultation with the Secretary, has now determined that an owner-employee in a C- or S-Corporation who has less than a 5 percent ownership stake will not be subject to the owner-employee compensation rule. This exemption is intended to cover owner-employees who have no meaningful ability to influence decisions over how loan proceeds are allocated.[4]

Note that the question and answer makes no reference to partners in this context, meaning a general partner with any interest in a partnership appears to be an owner under these rules.

Additional Clarification on Rental and Mortgage Interest Costs

The August 24 IFR also provides guidance on certain rent and mortgage interest payments.  The first clarification denies treatment as eligible nonpayroll costs to certain rental and mortgage interest expenses.

A key bit of information found in the fourth example, though, clarifies that office in home expenses deducted on a home-based business’ 2019 or expected 2020 tax filings will qualify as such expenses.

The IFR provides:

2. Eligibility of Certain Nonpayroll Costs for Loan Forgiveness

a. Are amounts attributable to the business operation of a tenant or sub-tenant of the PPP borrower or, in the context of home-based businesses, household expenses, eligible for forgiveness?

No, the amount of loan forgiveness requested for nonpayroll costs may not include any amount attributable to the business operation of a tenant or sub-tenant of the PPP borrower or, for home-based businesses, household expenses.[5]

The IFR provides the following four examples:

Example 1, August 24 IFR, 2.a

Lease of a Portion of Rented Office Building to Other Businesses

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, August 24 IFR, 2.a

Lease of a Portion of Owned Office Building to Other Businesses

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, August 24 IFR, 2.a

Borrower Shares Rented Space with Another Business

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.

Example 4, August 24 IFR, 2.a

Office in the Home Expenses

A borrower works out of his or her home. When determining the amount of nonpayroll costs that are eligible for loan forgiveness, the borrower may include only the share of covered expenses that were deductible on the borrower’s 2019 tax filings, or if a new business, the borrower’s expected 2020 tax filings.

Another issue that arises quite often, but which the SBA had been silent on prior to the August 24, 2020 IFR, involved items leased from a related party,  The SBA introduces a look through rule to deal with this case, capping eligible expenses based on only the mortgage interest owed on the property during the covered period.  As well, in this case, any common ownership between the lessor and the lessee is enough to trigger this limit.

The IFR provides in Section 2b:

b. Are rent payments to a related party eligible for loan forgiveness?

Yes, as 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 February 15, 2020. Any ownership in common between the business and the property owner is a related party for these purposes. The borrower must provide its lender with mortgage interest documentation to substantiate these payments. 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. PPP loans are intended to help businesses cover certain nonpayroll obligations that are owed to third parties, not payments to a business’s owner that occur because of how the business is structured. This 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.[6]

In a footnote to answer 2.b the SBA provides for a rule to prevent counting the same expense twice, once by the tenant and once by the landlord:

In this context, the related party itself would not also be eligible to request forgiveness for this amount.[7]

[1] RIN 3245-AH56, “Business Loan Program Temporary Changes; Paycheck Protection Program – Treatment of Owners and Forgiveness of Certain Nonpayroll Costs,” Small Business Administration, August 24, 2020 https://www.sba.gov/sites/default/files/2020-08/PPP%20IFR%20-%20Ownership.pdf (retrieved August 24, 2020)

[2] Paycheck Protection Program Borrower Application Form Revised June 24, 2020, Small Business Administration, June 24, 2020, p. 3 https://www.sba.gov/sites/default/files/2020-07/PPP-Borrower-Application-Form-508.pdf (retrieved August 24, 2020)

[3] RIN 3245-AH56, “Business Loan Program Temporary Changes; Paycheck Protection Program – Treatment of Owners and Forgiveness of Certain Nonpayroll Costs,” Small Business Administration, August 24, 2020, Section 1

[4] RIN 3245-AH56, “Business Loan Program Temporary Changes; Paycheck Protection Program – Treatment of Owners and Forgiveness of Certain Nonpayroll Costs,” Small Business Administration, August 24, 2020, Section 1

[5] RIN 3245-AH56, “Business Loan Program Temporary Changes; Paycheck Protection Program – Treatment of Owners and Forgiveness of Certain Nonpayroll Costs,” Small Business Administration, August 24, 2020, Section 2.a

[6] RIN 3245-AH56, “Business Loan Program Temporary Changes; Paycheck Protection Program – Treatment of Owners and Forgiveness of Certain Nonpayroll Costs,” Small Business Administration, August 24, 2020, Section 2.b

[7] RIN 3245-AH56, “Business Loan Program Temporary Changes; Paycheck Protection Program – Treatment of Owners and Forgiveness of Certain Nonpayroll Costs,” Small Business Administration, August 24, 2020, Section 2.b, Footnote 1