Last week, Congress passed the Coronavirus Aid, Relief, and Economic Security (CARES) Act, a $2 trillion emergency fiscal stimulus package with the aim of mitigating the economic damage created by the Coronavirus pandemic by introducing a wide range of provisions for individuals, businesses, healthcare entities, and state and local governments to meet short-term cashflow demands. For financial advisors with clients who are small business owners (including self-employed individuals and independent contractors), or for financial advisors who are business owners themselves, one of the most compelling provisions of the Act is the Paycheck Protection Program, which authorizes up to $349 billion in forgivable loans, allowing small businesses to pay their employees during the crisis.
Small business owners who have 500 or fewer employees (with limited exceptions), including self-employed individuals, may be able to benefit from the program and can request loans for up to 2.5 times the average monthly payroll expense over the previous year (with total loan amount capped at $10M). Applicants must make a good-faith certification that the loan is necessary due to the uncertainty of current economic conditions caused by COVID-19.
For small businesses and sole proprietorships, applications will be accepted beginning on April 3, 2020, and for independent contractors and self-employed individuals, applications will be accepted beginning on April 10, 2020. Loans will have a maturity period of 2 years and a fixed interest rate of 0.50%. Notably, any amounts spent on certain items during the first 8 weeks after the loan is made may be eligible for forgiveness. As an added benefit, amounts that are forgiven will even be excluded from taxable income for the year! Expenses that will be eligible for forgiveness include:
- Payroll costs, including benefits, which include:
- Wages and other compensation capped at $100K per employee;
- Vacation, parental, family, medical, and sick leave benefits; and
- State/local tax on compensation.
- Rent pursuant to a lease in force before February 15, 2020;
- Utilities which began before February 15, 2020; and
- Interest on mortgage obligations incurred before February 15, 2020.
In order to qualify for forgiveness of these expenses, the business must maintain the same number of employees in the eight weeks following the date of loan origination that it had from either February 15, 2019, through June 30, 2019, or from January 1, 2020, through February 29, 2020. However, business owners have the opportunity to restore employment and salary levels until June 30, 2020, for any changes that occurred between February 15, 2020, and April 26, 2020. Additionally, compensation for employees who receive less than $100,000 annually cannot be reduced by more than 25% relative to the most recent quarter. To the extent these requirements are not met, the amount eligible for forgiveness will be reduced.
While loan payments will be deferred for a period of six months, interest on outstanding amounts will accrue during this time. Loans are provided by lenders approved by the SBA and will be guaranteed by the SBA.
Of particular importance is the first-come, first-serve nature of the Paycheck Protection Program. Ultimately, this means that applying soon, as early as tomorrow, April 3, 2020, may give a business the best chance to receive a loan that may ultimately be forgiven.
Thankfully, the Paycheck Protection Program loan application is a fairly straightforward 4-page document that is already available online. Institutions that will be able to accept the applications and originate these loans on behalf of the SBA include SBA-approved lenders, Federally insured banks and credit unions, and other lenders that who are specially approved by the SBA to offer Paycheck Protection Loans.
Advisors should also consider how Paycheck Protection Program loans may impact other benefits available via the CARES Act. Notably, acceptance of such a loan makes a business ineligible for the Employee Retention Credit (of up to 50% of up to $10,000 of wages per employee), while forgiveness of such a loan makes a business ineligible for the deferral of payroll taxes (through the end of 2020) that would otherwise be allowed.
Ultimately, the key point is that the Paycheck Protection Program offers advisors and other small business owners an incredible opportunity of relief from the crisis at hand, and financial advisors can play a key role in helping their clients navigate the process of applying for and managing the use of loan proceeds.
*** Michael's Note: Be sure to check out our brand new Advisor’s Guide To The Paycheck Protection Program resource page for a run-down of all the important PPP provisions!
#OfficeHours with Nerd's Eye View Video Transcript
What we really want to focus on tonight is how the Paycheck Protection Program and the forgivable loans impact advisory firms. Obviously, advisory firms work with all sorts of businesses; tonight we're going to focus mainly on how this impacts advisory firms but certainly, an overwhelming majority of the stuff that we're going to talk about applies across the board.
So with that said, let's start from the beginning, which is that on March 27th, just last week, the Coronavirus Aid Relief And Economic Security (CARES) Act was passed into law by Congress, signed into law by President Trump after it was passed relatively quickly by Congress. It's over 800 pages, and it has a tremendous amount of information inside it, lots of provisions, everything from recovery rebate checks to RMD suspensions, unemployment loans. Our full article on this was put up at Kitces.com last Friday. So if you haven't had a chance to see that already, you can.
But again, today we're going to focus on the Paycheck Protection Program. In summary, it's a $349 billion program. And that is what was allocated specifically for this; it's 100% backed by the SBA and is potentially forgivable. We'll get into the nitty gritty details there. It's being kind of jointly put out there (the rules), by both the SBA and the Treasury Department. So on Wednesday evening, the Treasury Department came out with an FAQ or base rundown of the rules we should expect to get some more guidelines from the SBA relatively soon.
Notably, the CARES Act actually requires the Small Business Administration to provide regulations within 15 days of the date of enactment. Essentially, within the next two weeks, we should be seeing some regulations from the Small Business Administration as to how these loans work. There are actually a lot of questions that I received today where, frankly, we just don't know the answer. To that end, I would tell you to take everything that I'm going to tell you this evening, as well as everything that you hear from other places with a grain of salt, as it may change over the coming weeks because of those regulations.
Now, the problem is that while regulations may not be out for several weeks, perhaps, the first applications are going to begin to be accepted this Friday, which is just incredible, right? The speed at which this is taking place is absolutely amazing. So we're going to have loans being taken, presumably, unless regulations come out within the next day - the next 24 hours - we're going to have applications for loans being taken before we actually understand all of the rules for the loans that are being applied for. It's just the unique situation that we happen to be in right now.
So again, small businesses and sole proprietorships need to begin, or 'can' I should say, begin filing for these loans beginning Friday. So this Friday, April 3rd, just one day from now. And independent contractors and self-employed persons can begin by the following Friday.
Now one question, I'm sure one question that was asked, which I frankly have no idea and hope maybe someone could give me the answer to this is, what is the difference between a sole proprietor and an independent contractor who is self-employed? I'm not really sure. The only thing I can think of here is maybe a large partnership where the partners would be considered self-employed persons. But if somebody knows the answer to that, I'd love to know.
Who Qualifies For A Paycheck Protection Program Loan? [04:05]
So with that said, let's start with who qualifies for this loan. One of the questions that has been asked most frequently, in fact, has been, “Do sole proprietorships qualify?” And the answer is, absolutely, yes. Based on the way the law was written at first, I was confident that sole proprietorships were eligible. However, now it's clear that not only are sole proprietors eligible, but they're also eligible to receive benefits based on their own net income from self-employment. So that is a huge benefit for sole proprietors. And notably, there are a lot of sole proprietor investment advisors out there. So this can apply to a number of individuals.
In addition, one of the other questions that was asked earlier today was, does this apply to non-profits? And the answer is yes, in a very similar fashion as it does to for-profit businesses. Basically, we've got to look at things like what's your rent, what's your payroll, etc. But, ultimately, what we're talking about here are just two factors. One, you have a business and that you are a 500-employee-or-less business. That's typically going to be the requirement.
There are very few exceptions there. So for instance, some businesses that in general have large numbers of employees, the Small Business Administration may have a special exemption for those entities. In addition, certain restaurants have been given a little bit of relief here if they have less than 500 employees per location, etc. There is some wiggle room here. But again, as it applies to advisors, we're talking about less than 500 employees, which let's face, is basically almost every registered investment advisor, right? There are very few firms out there with more than 500 employees.
Now, the second thing that you have to do in order to qualify for this loan, it's A) be a business of qualifying size, and B) you've got to meet certain certifications. You have to certify certain things. The most important of these is the following: that there's an economic uncertainty as a result of this crisis that makes the loan necessary to support ongoing operations. And that's really important, right? Because are advisors going to be subject to economic uncertainty right now? I can't imagine the advisor that's not. You've got account balances down for those who bill based on AUM. For advisors who do a monthly recurring retainer model, individuals may not have the ability to pay them. They may be worried about paying their own mortgage or going out for food, so clearly there's going to be uncertainty there for an overwhelming majority. I mean for those in the financial profession, it's hard to imagine a scenario where there isn't at least some economic uncertainty.
Also, you've got to certify that you're going to use these funds for certain specified purposes. Things like payroll, mortgage lease payments, we'll cover that in greater detail in just a bit. And you've also got to certify that you're not going to get any other loan under the program.
So one of the questions that was asked by a number of individuals is, “Can you apply for other loans?” And I believe the answer to that question is going to be yes. Provided you use those other loan funds for purposes of something other than what you're going to use the Paycheck Protection Program loan for. It's a little bit unclear, but I believe the answer to that will be yes.
Okay. So now that we understand who qualifies... again, they're fairly liberal terms, right? A business with 500 employees or less, generally. Again, that's covering just about all registered investment advisors. And some economic uncertainty, which again, I would say you could make a pretty good argument for just about any investment advisory firm having economic uncertainty as a result of this crisis.
What Are The Terms Of These Loans? [07:59]
So with that said, let's talk about what the terms of the loan are. Now, the terms of the loan have confused a lot of people because when the law came out, the law used a lot of things like, “up to this or a maximum of this.” For instance, the law said the loans would be at a maximum of 4% interest. Well, the Treasury Department came out yesterday and said, everybody's getting the same type of loan.
So everybody gets up to a 0.5% interest rate on their loan. In addition, the CARES Act said that payments for the loans would be deferred anywhere from six months to 12 months. The Treasury came out yesterday and said, everybody gets a six-month deferment.
And finally, the CARES Act said that the loans will be up to a maturity length of 10 years. Well again, the Treasury Department yesterday came out and said, “No, even though it's up to 10 years, it’s going to be two years for everyone.”
So all of those things are in accordance, or in conformity, I should say, with the way the law was written. It's just that the confusing part was the law said up to this and everybody just assumed that it was going to be for that specific amount.
What Can The Loans Be Used For? [09:08]
Now in terms of using the loan; note that we're going to talk use of loan first here - what can you get the loan for - and then we're going to shift and talk about how much of the loan can be forgiven. Okay.
So first what can you actually get a loan for? Because some places may get loans and not have them forgiven. What the loan can be used for is a rent that was in force before February 15th; you had to have a lease agreement already in place by that time. Interest on mortgages that were in place before that time, utilities that were in service. So a broad array of utilities. So things like heat, electric, oil, gas, if you happen to have your own if you have to pay those things, if not. Also, things like phone, internet, etc., can be included in those utilities. So there's a lot of flexibility there.
In addition, the big one, right? The one that is going to be of greatest importance for people is payroll costs. Now payroll costs are absolutely the big one here and it's up to a hundred thousand dollars ratably per employee. Up to a hundred thousand dollars ratably per employee for all payroll costs. That's how I read the bill.
Some questions have come out that said, is it $100,000 of salary plus other amounts for compensation? I believe the law to read that it's up to $100,000 of total payroll costs for the individual. And payroll costs here include the obvious, so wages, right? But they also include certain benefits such as sick leave, family leave, health insurance premiums that are paid on behalf of the employee, even state and local taxes that are assessed on the individual's compensation.
And finally, the big one that I mentioned before, specifically for those of you who are sole proprietor advisors, is net earnings from self-employment.
So it appears pretty plainly at this point that you can actually apply for a loan to pay yourself an amount for your own net income from self-employment. Now, what is a little bit less clear as to whether or not it is included in payroll costs are guaranteed payments to partners. My inclination there is yes, that they would be.
On the other hand, S corporation profits - a lot of advisors will set up their RIA to be an S corporation because they're able to pay themselves a salary and then they can also avoid the payroll taxes on the profits of that. Well, while that might have worked really well in the past to help you avoid payroll taxes, it might actually work against you here because I do believe that the S corporation profits will not qualify. I think it's only going to be the salary that an advisor paid themselves.
Now I don't really think that's going to impact too many advisors because you got to pay yourself a fair salary anyway. And for many advisors, that fair salary is going to be somewhere along the lines of, you know, well, it's going to be a significant salary. Let's face it, financial advisors do well in most instances. And if that's the case, you've got to pay yourself a reasonable salary. If you got to $100,000 of compensation, that equates to about $20,833.33 of compensation over a two and a half month period, which is essentially the maximum amount that you're going to be able to take into consideration here for forgivable loan in the first place.
How Big Of A Loan Can You Get And How Much Can Be Forgiven? [12:36]
Now what is the size of the loan? So far we've covered who qualifies, we've talked about what costs you can use to get the loan.
Now how much of a loan can you get? The maximum amount is $10 million, but almost every advisor is going to be well below that because the loan is the lesser of $10 million or 2.5x the average payroll costs for the prior year. Okay, so let's think about that. 2.5x the average payroll costs for the prior year, you essentially need to have a more than $4 million monthly payroll net in order to see your loan here kept by the $10 million overall cap. Otherwise it's going to be capped out based on that two and a half months of average payroll costs. That's the maximum loan.
Now it can be used for those other things. But again, it's based on two and a half months of the prior year of payroll. Now for self-employed individuals, I don't think it's entirely clear how it works, although I would venture to guess that a very simple way of going about this would be, what is your net income at the end of the year? Let's just divide that by 12. Right? That's probably a fair way of going about that. Perhaps the regulations will view it differently, but I think that's the way we should probably approach it for the time being.
Now, the big question, the one that probably many of you are still waiting to hear, which is how much of this loan can be forgiven? How much free money am I going to be able to get out of Uncle Sam? How big is the dump truck that they're backing up? Which, let's face it, it's a pretty big dump truck. And the amount that can be forgiven is equal to the amount that you spend on qualified expenses in the eight weeks following the time that you get the loan. So from the time a loan is originated, the following eight weeks will be looked at, and we're going to look at the big one: payroll. So payroll costs are the big one here.
It is estimated by the Treasury that because so many people are going to be applying for these loans, they actually expect that only about 25% of the costs that aren't attributable to payroll costs will be able to be forgiven as part of this program.
And I should mention one other thing. There's a ton of urgency surrounding actually applying for this loan and getting information out to advisors, which is why we're kind of doing this Office Hours session. And the reason for that is it's a limited amount of money. It's $349 billion. Now granted that's not a small amount of money, but anytime someone hears free money, which is essentially what this is, there's going to be a long line. And guess what? It is on a first-come, first-served basis. So for those individuals who are not applying Friday, you're putting yourself in jeopardy already.
So again, what are the forgivable expenses? It's payroll, it's mortgage interest, it's rent, and it's utilities. Those are the amounts. The amounts that you spend on those things within the first eight weeks after the loan has been originated is the amount that can be forgiven.
Now, of course, there is a catch, and the catch here is that the whole purpose of this is to keep your staff there, right? To keep people employed. So there are two things that you can't do. Otherwise, you're going to see that forgivable amount of your loan reduced. The first is that your 2019 compensation for employees who made $100,000 or less of total compensation, you cannot reduce their compensation by more than 25% otherwise you take a hit on the forgivable portion of your loan. So again, that's people who made $100,000 or less in 2019 in terms of total compensation, you can't reduce their compensation by more than 25%. So yes, times may be tough and you are eligible to potentially reduce their compensation, but not by more than that amount. The other thing that you have to do is not decrease your full-time employee equivalent headcount.
You do get to choose the better of two time frames. Either from February 15th of last year through June 30th last year. So February 15th, 2019 through June 30th, 2019; or from January 1st, 2020, the beginning of this year, through February 29th - you can pick the better of those two options for your business.
Now of course, some of you may be saying, “But Jeff, I didn't know this was going to come out. How did I know? And I had these business issues beforehand. I need to hire. I've already let people go. What do we do now?” Well, the rules are going to allow you to hire back those people through June 30th of this year and then you will not be affected. So you have some leeway here to hire back individuals in order to still allow you to qualify for this forgivable portion of the loan.
How Do I Actually Apply For And Receive These Loans? [18:05]
Now having said that, let's talk meat and potatoes, which is, “How do I actually get my hands on this money? Like where do I go? What do I do? Who do I see?” The mechanics of this is that it's going to be done and put out through SBA approved lenders.
So a lot of lenders already have SBA approved status. They're going to be your first choice. If not, federally insured banks, credit unions, etc., will also qualify. The CARES Act also authorizes the Small Business Administration to authorize other lenders.
So you may see that and obviously we would think that would happen relatively quickly because I have a feeling that this is going to be subscribed really fast. And to that point, one thing I would note here is that there is a possibility… Secretary Mnuchin has already said like if we fully subscribed this and there's a lot of interest, which again, free money, I think there's going to be an interest here.
I think what's going to happen is they're going to go back to Congress and ask for more money. But you don't want to leave yourself at the mercy of Congress allocating more funds here because, you know Congress, somebody at some point is going to say, “You know what, we've already allocated too much money. We are running up the deficit.” There's going to be friction at some point.
Now maybe it's now, maybe it's two rounds from now. We don't know. So you don't want to leave yourself at that mercy and you want to apply is as soon as possible. And to that end, the application is super easy. There's a four-page document out there, the Paycheck Protection Program application, it's a four-page document, super, super simple and you can actually have someone like a consultant or your CPA help you to fill that out if you're not sure how to do it.
And the compensation for that service actually will come from the loan originator. It's part of the law that you can't be charged for those services. It has to be provided for free. All right, let's talk about some miscellaneous items, some questions that have come up.
How Do These Loans Interact With Other CARES Act Provisions? [20:08]
How does this interact with other parts of the CARES Act and other items? For instance, there are other payroll benefits under these under the CARES Act. One is the credit that is applied, right? The Employee Retention Credit - that's one benefit that's under the CARES Act. The way it interacts with that is the credit is not allowed if you take a loan under this provision… period, end of story. So if you get Paycheck Protection Program loan, you are not eligible for the employee retention credit. You have to actually look at that.
The free money of the Paycheck Protection Program, and I know I keep using the term free money, it's not really free. I know it has a cost, but it's as free as free gets when it comes to this stuff. Right? The free money of the Paycheck Protection Program is going to be very alluring for a lot of people and that's going to be like the light that draws flies.
However, for some businesses, the financially better alternative is actually going to be to forego taking a Paycheck Protection Program loan, and to take some other sort of loan and use the Employee Retention Credit. Now notably, the Employee Retention Credit - and I don't want to get too into in-depth in that now because we'll just be here forever - is up to a 50% credit on up to $10,000 of an employee's wages. It's kept at that $10,000 amount per employee. So the, the more you have average salaries for a business that are low, the more that may make sense.
My suspicion is that most financial advisory practices are going to be better off taking the Paycheck Protection Program loans if they can get them because their average salaries tend to be higher. The higher the salary, the more it makes sense to take the Paycheck Protection Program. The lower the average salary - because again, it's capped at that 50% of up to $10,000 of wages - the more it may make sense to look at that Employee Retention Credit; it's worth running the numbers. But we're in a short timeframe here, so you better run the numbers very quickly.
Now the second potential benefit of the CARES Act that might interact with the Paycheck Protection Program is the deferral of payroll taxes. Under the CARES Act, an employer may be eligible to defer half of their payroll taxes for 2020 through the end of the year, until 2021 the end of the year, December 31st of 2021, and the other half until as late as December 31st of 2022, essentially like three years from now. So a pretty long time. Now if you have indebtedness forgiven, the laws are a little bit different under the CARES Act. It's not if you take a loan. This section says if you have indebtedness forgiven, you're not eligible to use the deferral.
And then finally there is a question as to how this interacts with other SBA loans. Again, as I mentioned earlier, I believe my interpretation of these rules is that if you have another SBA loan, you should be able to qualify for that loan, and this loan, provided you use that other loan for other expenses that the Paycheck Protection Program loan is not used for. That's my interpretation. Hopefully, we get guidance on that relatively soon.
Can You Get Unemployment Compensation In Addition To A Paycheck Protection Loan? [23:37]
And then the last one here that I would say is another question that advisors have asked is, “Do I get unemployment compensation as well as qualify for this Paycheck Protection Program?”
And again, I would say it's a little bit gray. Especially for those of you who are self-employed, I think there's an unemployment pandemic assistance program that was created by the CARES Act for unemployed self-employed individuals, essentially the equivalent of unemployment because self-employed individuals typically don't apply or qualify for that.
In many States, an S corporation owner-employee doesn't qualify as well. So you've got to know your own state rules. The bottom line is there's this fund set up for individuals who need money who haven't gotten it via other unemployment compensation benefits.
I would believe that if you receive a loan and you're using it to pay yourself a salary or to give yourself that employment, I would assume that you would not then be able to double-dip and qualify. Again, there is no clear guidance on this, but that just seems to make sense.
Now accordingly, though, if you run out of the Paycheck Protection Program funds... so we've gone the two and a half months and you've paid out all of those funds and you've kept regular payroll, then at that point you may be able to, if your business is struggling, qualify for these unemployment compensation benefits that are not normally available.
Notably, a lot of advisors are not going to qualify for that to begin with. One of the benefits of being an RIA is that you typically have a recurring income stream. Obviously for hourly planners, this might be a little bit more of a challenging time. Although remote work is still possible, typically, as an RIA, you're going to have recurring revenue streams, whether that be from subscription fees or whether that be from AUM. So while your income may be significantly reduced now because of what's going on, either with the market or hardships of clients, you're not unemployed. Your income is just lower. So it's going to be hard to qualify for a lot of those benefits to begin with.
Should You Really Take A Paycheck Protection Program Loan And How Should You Be Advising Your Clients? [25:48]
And so finally, I'll leave you with this. And that is, I think as advisors, there's a question that we need to ask ourselves that there's a moral dilemma here. And the moral dilemma is right now there's a pot of money that is $349 billion big. The Treasury Department and other government officials have essentially turned to us, meaning the American public, not just financial advisors and said, “Please, if you're not really struggling, leave these funds for those who need them the most.”
And the question is, do we really need them the most? Should we be applying for these? And you know, it's one thing when it comes to our own financial businesses and our own practices. But it's another thing when we're advising clients.
I think that's going to be a real struggle for us as advisors because, on the one hand, we might know that a client is perhaps seeing a struggle compared to previous years and has some economic uncertainty. But they're not really at the point where they desperately need these funds like some other businesses do. And so on the one hand we might be encouraged to say to them, “You should wait.”
On the other hand, our fiduciary duty to clients would almost obligate us to say, “There's free money here. You qualify for this, go and apply for it now. Take this money while you can because we don't know whether it's going to be around.” So I don't know that there's a great answer for that, but I do think that that's a really interesting question for us as an industry, as to how we guide clients here.
And so with that, I certainly hope that you found this information helpful and valuable. And I know there's going to be a lot of questions. Hopefully, this has helped you. I want to thank you all for joining me. I want to wish you and your family, your clients and all your loved ones, a healthy rest of 2020 and beyond.
Thank you so much, and keep doing the wonderful work that you as advisors do - guiding clients in these tough and trying times. Have a great evening everyone, and I'll speak to you soon.