Last month, the Coronavirus Aid, Relief, and Economic Security (CARES) Act was passed by Congress, introducing a $2 trillion emergency fiscal stimulus package to provide relief to individuals, businesses, healthcare providers, and government entities from the economic damage resulting from the Coronavirus pandemic. While many advisors have become intimately familiar with the $349 billion Paycheck Protection Program (PPP) relief package provided for by the CARES Act in the past few weeks, the Economic Injury Disaster Loan (EIDL) program is another potential solution for small businesses and offers loans up to $2 million for business owners whose businesses suffered economic injury as a result of the Coronavirus. Eligibility is open to many small businesses (with 500 or fewer employees), including sole proprietors and independent contractors.
EIDL loan amounts will be based on the size and type of the business, and loan proceeds can be used to pay fixed debts, payroll, accounts payable, and other bills that the business owner would have been able to pay had the disaster not occurred. Borrowers may be granted a repayment period of up to 30 years, though repayment terms will be determined based on each individual borrower’s ability to repay the loan. Interest rates will be 3.75% for small businesses and the deadline to submit applications using the expanded rules as provided by the CARES Act, is December 31, 2020.
Additionally, borrowers will be allowed to request up to $1,000 per employee (with a total maximum cap of $10,000) as an “Emergency EIDL Grant”, which is estimated to be distributed within no more than three days of the borrower’s request. The amount received as an Emergency EIDL Grant does not have to be paid back and will be fully forgiven, even if the borrower is denied an EIDL loan. While small business owners have the option to supplement PPP Loans with EIDL loans, any amounts received as Emergency EIDL Grants will reduce the amount of forgiveness of any PPP loan balances.
Further, business owners (regardless of size) whose operations have been fully or partially suspended by government order, or who have seen a significant drop in income of more than 50% compared to the same quarter in the previous year, may be eligible for the Employee Retention Credit. The credit consists of “50% of up to $10,000 in wages paid by an eligible employer whose business has been financially impacted by COVID-19.” Qualifying wages include those paid between March 12, 2020, and January 1, 2021. Notably, though, accepting a loan from the SBA via the PPP will negate an employer’s ability to claim this credit. This can be particularly problematic for some business owners who actually stand to benefit more from this credit than they would by taking a loan via the PPP!
The CARES Act provides further relief for employers (including self-employed individuals) by deferring 2020 payroll tax payments due between March 27, 2020, and December 31, 2020. However, business owners who have debt forgiven under the PPP are ineligible for this benefit. Essentially, employers must pay 50% of the deferred payroll taxes by December 31, 2021, and the remaining 50% by December 31, 2022. Self-employed individuals will have 50% of the ‘employer equivalent’ of their self-employment taxes deferred as well, with 25% due by December 31, 2021, and the remaining 25% due by December 31, 2022.
Ultimately, the key point is that many business owners across the country (including self-employed individuals and independent contractors) who have suffered economic injury due to the Coronavirus crisis have several options of emergency relief available to them provided by the CARES Act. From the Payroll Protection Program to the Economic Injury Disaster Loan Program and the deferral of current-year Payroll Taxes, financial advisors with clients who own businesses (and even financial advisors themselves) have some tools to help their clients cope with the ongoing crisis.
On March 27, 2020, President Donald Trump signed into law the Coronavirus Aid, Relief, and Economic Security (CARES) Act into law. The law represents the third piece of Federal legislation, to date, aimed at addressing the current coronavirus/COVID-19 crisis, and is, by far, the most significant, coming in with a whopping price tag of more than $2 trillion.
Much of the relief provided by the CARES Act is targeted at helping small businesses, which as John Oliver once so effectively illustrated on Last Week Tonight, are widely considered to be the “backbone of the American economy.” Notably, many of those small businesses, and the advisors who work closely with them, have their attention on the CARES Act-created Paycheck Protection Program (PPP)… and for good reason. The PPP offers small businesses the opportunity to receive loans of up to 2.5 times their average monthly payroll (up to a maximum of $10 million), and to (potentially) have the full amount forgiven!
But while the PPP is an intriguing opportunity that small business owners who are experiencing economic fallout from the COVID-19 crisis should consider, it’s far from the only relief available to them under the CARES Act. More specifically, such business owners should also be aware and consider the benefits of an Economic Injury Disaster Loan (EIDL), the Employee Retention Credit, and the option to defer the employer portion of payroll taxes.
CARES Act Creates Emergency EIDL Grants
Section 1110(e) of the CARES Act creates Emergency Grants under the EIDL program. Under this provision, through December 31, 2020, the SBA is instructed to provide up to $10,000 to any business which self-certifies that it is eligible for an EIDL loan (as discussed below) within three days after the SBA has received the business’s EIDL application. Furthermore, regardless of whether the business’s EIDL application was ultimately approved (or denied), the applicant does not have to repay the advanced amount.
In a bulletin released on Monday, April 6, 2020, the SBA has indicated that applicants should use the streamlined online application that was made available last week on their website to request funds, and has stated that advances will be distributed beginning this week.
The SBA’s Massachusetts office also released guidance indicating that grants would be subject to a “$1,000 per employee up to $10,000 max” requirement. The SBA’s website, however, does not yet reflect this information, nor has the SBA confirmed this per employee cap in other official guidance. As a result, it’s not yet entirely clear how the SBA will calculate these grant advances.
Economic Injury Disaster Loans
In addition to the creation of the Paycheck Protection Program (PPP), the CARES Act also expands the Small Business Administration’s (SBA’s) longstanding Economic Injury Disaster Loan (EIDL) program. Unlike loans issued under the PPP, loans via the IEDL program are only available directly via the SBA, and are applied for directly through its website, at https://covid19relief.sba.gov/.
Loans made under the EIDL program may be issued up to a maximum of $2 million, but will often be issued for less as determined by the Small Business Administration, based on a borrower’s need and ability to repay the loan.
All loans issued via the EIDL program will carry a fixed interest rate of 3.75% (2.75% in the case of non-profits) and have a maximum maturity of 30 years. Furthermore, payments for such loans may be deferred for up to one year from the date the loan is originated.
Eligibility For Economic Injury Disaster Loans
While typically more restrictive, loans issued under the EIDL program from January 31, 2020, through the end of 2020 – the so-called “covered period” under the CARES Act – may be issued to most businesses with 500 or fewer employees, including Sole Proprietors and Independent Contractors (certain businesses, such as certain ‘sin’ businesses, as well as those engaged in illegal activity, are ineligible for such loans). And while such businesses need to have been in operation by January 31, 2020, in order to qualify for such relief, the typical (and longer) 1-year-in-business rule is waived by Section 1110(c)(2) of the CARES Act.
In addition, businesses must also be able to provide evidence of an economic injury, or a likely economic injury (essentially, a temporary loss of revenue as a result of the pandemic), as this will ultimately be used to determine the amount of the loan that the business receives. Notably, economic injury does not mean that a business is on the brink of disaster. Rather, such injury may consist of less severe harm caused by the crisis, such as a decrease in working capital, or increased expenses.
Furthermore, seeking a loan under the EIDL program does not require a business to make the same certification that such a loan is “necessary” due to economic uncertainty as a result of the COVID-19 crisis, as is required when submitting a PPP application.
The EIDL Program Streamlines The Loan Process For Borrowers
Recognizing the need to get money out to small businesses as quickly as possible, the CARES Act also simplifies and streamlines loans under the EIDL program in a variety of ways. To begin with, while applicants seeking loans in excess of $25,000 will have to provide collateral to secure such loans, only loans in excess of $200,000 will require the business owner(s) to provide a personal guarantee.
Even the underwriting process, itself, is simplified by the CARES Act. Notably, the ‘regular’ EIDL requirement that a borrower exhaust other credit options prior to seeking a loan under the EIDL program is waived. Furthermore, the SBA is authorized to approve applicants based solely on their credit score (or other “alternative appropriate method”).
Eligible Uses Of EIDL Program Loan Proceeds
Proceeds of EIDL program-issued loans may be used as working capital to pay a variety of expenses, such as payroll liabilities, accounts payable, fixed debts (e.g., rent, mortgage, and equipment and vehicle leases), and other bills that would have been able to be paid in absence of the COVID-19 crisis. Just as important, however, is a sound understanding of what such loan proceeds cannot be used for.
The use of EIDL proceeds to refinance long-term debt, or for the acquisition of new fixed assets is prohibited. Additionally, and perhaps somewhat surprisingly, the proceeds of loans issued under the EIDL may not be used to repair any physical damage to property or to replace such property. Less surprising, however, are the restrictions on using such funds for bonuses, or for a variety of owner-related “compensation”, including dividends, disbursements to owners (other than for the performance of services [i.e., wages]), or to pay most outstanding shareholder loans.
Coordinating Loans Received Under The Economic Injury Disaster Loan Program And The Paycheck Protection Program
The Economic Injury Disaster Loan program and the Paycheck Protection Program are not mutually exclusive. Rather, the same business can qualify for and receive loans under both programs.
Notably, under the SBA's Interim Final Rules regarding the coordination of loans with the PPP, if a business received an EIDL loan between January 31, 2020, and April 3, 2020, and the EIDL loan was not used for payroll costs, it does not affect eligibility for a loan under the PPP. If, however, the same loan was used for payroll costs, the business must use a PPP loan to refinance the EIDL loan. The refinanced amount is added to the amount of the PPP loan the business would otherwise be eligible to receive, up to the $10 million cap.
Example #1: Pete’s Pets is a small business that has been struggling in light of the current COVID-19 crisis. In February, in an effect to maintain his staff, Pete applied for and received an EIDL loan from the SBA for $50,000, which he has used for payroll purposes.
Pete has since decided to apply for a PPP loan. His average monthly payroll costs for the previous year are $30,000 per month. As such, if approved, Pete would receive a PPP loan for ($30,000 x 2.5) +$50,000 = $125,000.
In addition, regardless of whether the proceeds of such loans are used for payroll expenses or otherwise, a business cannot ‘double-dip’, by using the proceeds of a loan under the PPP and EIDL program for the same costs. The reality, though, is that this restriction really isn’t that limiting, as a business can use a PPP loan to cover one type of cost, such as payroll, and use the proceeds received from a loan under the EIDL program to cover different costs, such as rent. To that end, it’s worth remembering that loans issued under the EIDL program are eligible for a wider array of expenses than those issued under the PPP. Accordingly, there may be some expenses of a business for which only the proceeds of an EIDL may be used.
Nerd Note: Under the PPP program, only qualifying expenses incurred in the first eight weeks following loan origination are available for forgiveness. And since the total loan may be up to 2.5 times the average monthly payroll (or roughly ten weeks), that may mean some businesses have to spend some money on qualifying expenses, other than payroll, to have the full loan forgiven (or else they won’t spend enough on payroll costs in the only-8-week forgivable period to have the full amount of the loan forgiven!). However, a business that has seen growth or has otherwise expanded payroll over the last year may have current payroll costs sufficient to ‘eat up’ 2.5 times the average of the prior year’s monthly payroll.
In addition, the maximum loan available under the PPP is limited to ‘only’ 2.5 times the business’s average payroll expenses for the previous year (up to a maximum of $10 million). But there’s no guarantee that the economic damage to the business will be limited to that amount, even when looked at with respect to only payroll.
Thus, a business trying to maintain its employee headcount, but for which economic hardship as a result of the COVID-19 crisis persists well into the summer, or beyond, may ‘need’ additional capital to fund payroll expenses once the proceeds of an initial PPP loan have been used up!
When The Employee Retention Credit Beats A Forgivable PPP Loan
It’s been widely repeated (including by me!) that the Paycheck Protection Program may offer business owners the closest thing to 'free money' that they’ll ever see in their lifetimes. But while that may be true for many small business owners, for others, a separate provision of the CARES Act may actually provide a better opportunity!
More specifically, Section 2301 of the CARES Act creates a new “Employee Retention Credit.” The credit is a fully refundable credit against an employer’s payroll taxes for wages paid from March 12, 2020, through December 31, 2020. Self-employment taxes, however, while ostensibly meant to replicate the combined employer-employee payroll taxes, are NOT eligible for this credit (in neither their entirety nor for just the ‘employer’ portion of the tax).
The amount of the credit is equal to 50% of wages paid to employees, up to a maximum of $10,000 of wages per employee. Thus, the maximum credit that may be attributable to any single employee is capped at 50% x $10,000 = $5,000.
But there’s an additional catch.
In order to qualify for the credit in the first place, a business must either:
- Be fully or partially shut down in any calendar quarter in 2020 due to Federal, state, or local restrictions limiting commerce, travel, or gatherings of large numbers of people; or
- Experience a significant decline in gross revenue as compared to the same calendar quarter from the prior calendar year. For purposes of ‘triggering’ the Employee Retention Credit, a significant decline is a drop in revenue of more than 50% compared to the same calendar quarter in the previous year.
If an employer qualifies for the credit because of a full or partial government-ordered shutdown, then the credit will remain available until the business experiences a quarter in which it is not fully or partially shut down. By contrast, if an employer qualifies for the credit because of a significant decline in revenue, then they will continue to qualify for the credit until the quarter after the first quarter in which 2020 revenue exceeds 80% of revenue from the same calendar quarter in 2019.
Note that the various ways in which the credit may be ‘triggered’ to start, and stop, can create some really interesting dynamics. More specifically, it's possible for some businesses to never become eligible for the credit despite meaningful and sustained drops in revenue, while other businesses, which actually have much better 2020 outcomes, may qualify for the credit in multiple quarters!
Example #2: Abe’s Apples, Brianna’s Bananas, and Claude’s Coconuts are three businesses which each had quarterly revenue of $250,000 per quarter in 2019. Furthermore, in 2020, each of them is, in at least some way, impacted by the COVID-19 crisis.
More specifically, as shown in the image below, Abe’s Apples experiences a sizeable drawdown in Q2 2020 ($112.5K in 2020 vs $250K 2019, reflecting a 55% reduction in revenue in Q2, which qualifies him for the Employee Retention Credit). He recovers relatively strongly in Q3 and his revenue exceeds 80% of last year's Q3 revenue. As a result, Q3 is the last quarter in which he remains eligible for the Credit.
Brianna’s Bananas, on the other hand, experiences a more sustained drawdown throughout 2020, but one which never reaches the severity (as measured on a quarterly basis) as was experienced by Abe’s Apples. Her lowest quarter was in Q2, reflecting a revenue reduction of 45% ($137.5K in 2020 vs $250K in 2019).
Meanwhile, local government placed restrictions on Claude’s Coconuts, preventing the business from serving customers within its dining room from the beginning of March 2020 through the end of the year. The, restaurant, in which all the menu items feature coconut, pivoted nicely to take-out and delivery service, and experienced only minor declines in revenue (15% revenue reduction in each quarter throughout 2020).
As is apparent from the image above, despite the fact that Claude’s Coconuts had the best year out of all three businesses, it was the only business eligible for the Employee Retention Credit in all four calendar quarters, due to its government-imposed restriction to close its dining room.
Conversely, Brianna’s Bananas had the worst year out of all three businesses. However, since the business was not shut down due to government order, nor did its revenues in any single quarter ever dip below 50% of the revenues from the same quarter during 2019, it never qualified for the Employee Retention Credit. Not in even a single quarter!
And because revenue for Abe's Apples dipped below 50% in Q2 and did not exceed 80% of 2019 revenue until Q4, Abe was eligible for the Employee Retention Credit for both Q2 and Q3 in 2020.
Choosing Between A Paycheck Protection Loan And The Employee Retention Credit
It is critically important for small business owners to understand that the Employee Retention Credit and loans via the Paycheck Protection Program and/or Economic Injury Disaster Loan program don’t ‘play nicely’ with one another. Rather, simply receiving a business interruption loan under either program makes a business ineligible for the Employee Retention Credit.
More specifically, Section 2301(j) of the CARES Act states:
RULE FOR EMPLOYERS TAKING SMALL BUSINESS INTERRUPTION LOAN.— If an eligible employer receives a covered loan under paragraph (36) of section 7(a) of the Small Business Act (15 U.S.C. 636(a)), as added by section 1102 of this Act, such employer shall not be eligible for the credit under this section.
In most instances, the ‘free money’ option provided for by the Paycheck Protection Program will result in a better outcome for a business than using the Employee Retention Credit. Despite that general rule, however, there are times where forgoing a PPP loan in lieu of the Employee Retention Credit can actually result in a net benefit for a small business owner!
This is particularly likely in situations where a business has had to lay off employees (and does not anticipate being able to rehire them soon enough to avoid being penalized with respect to PPP loan forgiveness), and where average salaries of employees are relatively modest.
Example #3: Dave’s Delightful Diner is a small business located in an area that has been hit hard by the COVID-19 crisis and is partially shut down (delivery only) as a result of government orders during Q2 and Q3 of 2020. Prior to the Q2 2020, Dave’s Delightful Diner employed 30 workers, who each made $36,000.
However, as a result of the crisis and the inability to serve customers ‘in-house’, the restaurant currently only employs 10 workers, who each continue to earn $36,000. Furthermore, Dave’s Delightful Diner does not anticipate a change in employee headcount before mid-Q3 2020, at the earliest.
The maximum loan available to Dave’s Delightful Diner under the PPP program would be 30 x ($36,000 / 12) x 2.5 = $225,000. Sounds pretty good, right?
But as we begin to impose the restrictions on loan forgiveness under Section 1106 of the CARES Act, that loan begins to look a lot less attractive.
Consider, for instance, the at the current employee level, Dave’s Delightful Diner will have only 10 x ($36,000 / 52) x 8 = $55,384.62 of payroll cost during the first 8 weeks after the PPP loan is received. But remember, Dave’s Delightful Diner has also cut payroll by two-thirds, which means the amount spent on otherwise forgivable expenses must be reduced by two-thirds as well!
As a result, the most ‘free money’ from a PPP loan that Dave's can qualify for would be $52,384.62 / 3 = $18,461.54. Not a deal. But certainly not the best Dave’s Delightful Diner can do!
Consider, for instance, if instead of receiving a loan under the PPP, Dave’s Delightful Diner just decided to use the Employee Retention Credit to help shore up cashflow. During Q2 and Q3, total salary paid to each employee would be $36,000 / 2 = $18,000. For purposes of determining the Employee Retention Credit, however, those salaries are capped at $10,000 each.
Nevertheless, applying the 50% Employee Retention Credit on 10 worker’s salaries who each earned at least $10,000 in wages, results in a 10 x $10,000 x 50% = $50,000 Employee Retention Credit! That’s nearly three times(!) the ‘free money’ that Dave’s Delightful Diner would have received if it had forgone the Employee Retention Credit and opted for a forgivable loan under the Paycheck Protection Program.
Of course, each situation must be evaluated on its own merits. For instance, while the Employee Retention Credit clearly results in more net dollars to Dave’s Delightful Diner in the example above, that would be irrelevant to the business if it didn’t have the money to pay the ten employees left in the first place. Thus, even in some situations where opting for the Employee Retention Credit makes more financial sense in the long-run, a cash-strapped business may still benefit more from an SBA loan to make sure they stick around long enough to see the long-run!
Nerd note: In situations where the Employee Retention Credit would provide more net dollars to a cash-strapped business than the ‘free money’ available via the Paycheck Protection Program, the business should make an extra effort to try and secure a non-SBA loan. Such a loan would not impact their eligibility for the Employee Retention Credit.
Enhancing Another Available Small Business Relief Option With Payroll Tax Deferral
Yet another benefit created by the CARES Act that small business owners can consider as part of their planning is the allowable deferral of payroll taxes through the end of 2020. More precisely, eligible employers are able to defer half of their remaining 2020 payroll taxes until December 31, 2021, while the other half will be due on December 31, 2022.
Notably, the Employee Retention Credit is disallowed for businesses receiving loans under the PPP programs; similarly, the ability to defer payroll taxes as described above is only eliminated for those who have any or all of their PPP forgiven (or who have debt canceled under the Treasury Program Management Authority). More specifically, Section 2302(a)(3) of the CARES Act states:
EXCEPTION.—This subsection shall not apply to any taxpayer if such taxpayer has had indebtedness forgiven under section 1106 of this Act with respect to a loan under paragraph (36) of section 7(a) of the Small Business Act (15 U.S.C. 636(a)), as added by section 1102 of this Act, or indebtedness forgiven under section 1109 of this Act.
Furthermore, while Self-Employed persons may not use the Employee Retention Credit for self-employment taxes, the payroll tax deferral option is available to self-employed persons for the employer portion (half) of their 2020 self-employed tax liability under Section 2302(b)(1), which states:
IN GENERAL.—Notwithstanding any other provision of law, the payment for 50 percent of the taxes imposed under section 1401(a) of the Internal Revenue Code of 1986 for the payroll tax deferral period shall not be due before the applicable date.
Accordingly, 50% of 2020 self-employment taxes are due as ‘normal’, 25% of 2020 self-employment taxes are due on December 31, 2021, and the remaining 25% of 2020 self-employment taxes are due on December 31, 2022.
Small business owners, including self-employed persons, who do not have loan amounts forgiven as described above, can combine the payroll deferral benefit with other relief available to them. For instance, a small business could decide to combine the use of a loan under the EIDL program with the ability to defer payroll taxes as allowed under this provision. Similarly, a business which opts to use the Employee Retention Credit could use the credit to offset as much payroll tax as possible while delaying payment of 50% of tax in excess of the credit to December 31, 2021, and payment of the other 50% to December 31, 2022.
The coronavirus/COVID-19 crisis has created unprecedented challenges for small business owners in what is seemingly the blink of an eye. Thankfully, though, Congress acted quickly and decisively with the creation of the CARES Act.
The good news is that the CARES Act creates a variety of potential opportunities for relief for small business owners. The bad news is that the myriad of opportunities can create confusion, and many business owners may not select the best option – or options – to meet their business needs. Complicating matters further is the fact that due to the limited ‘supply’ of certain relief, such as the currently available amount of PPP loans, there is an urgency to act as quickly as possible.
Ultimately, the key point is that during these challenging times, advisors have an even-greater-than-usual ability to help small business owner clients understand their complex options and to guide them towards an appropriate solution. Getting this ‘right’ has the potential to help both business owners, themselves, and the many families they may support via their business’s employment of others.