New Interim P3 Rules Address Owner-Employee Compensation, Subtenants, and Related Party Rent Payments | Hinshaw & Culbertson LLP
The Small Business Administration (SBA) and the United States Department of the Treasury released a new interim rule on the Paycheck Protection Program (PPP) on August 24, 2020. The rule covers changes involving owner compensation- employee, subtenants and related party rent payments. We explore these new interim rules below.
The current rules place a limit on the amount of loan forgiveness for salary compensation attributable to an owner-employee. There is no exception to the rule based on owner-employee percentage ownership. The rule caps the amount of loan forgiveness attributable to an owner-employee for:
- borrowers who received a P3 loan before June 5, 2020 and choose to use a covered period of eight weeks, eight weeks of 2019 compensation, or $ 15,385 per person, whichever is less; and
- all other borrowers, to 2.5 months of 2019 indemnity or $ 20,833 per person, whichever is less.
Under the new rule, compensation paid to individuals who own less than 5% of the PPP borrower that is an S corporation or C corporation is not subject to the owner-employee compensation remission limits mentioned above. -above. The Agencies indicated that this exemption is adopted for owner-employees who, in reality, have no significant ability to influence decisions on how loan proceeds are allocated.
Shareholders holding 5% or less of an S corporation or C corporation will be entitled to a rebate of up to $ 46,154 – assuming the PPP borrower uses a 24 week covered period – as well as amounts payable for health insurance and pension contributions.
Although the new rule does not say so directly, it should also apply to an LLC which is, for tax purposes, treated as an S corporation or a C corporation. In particular, this rule does not apply to partners of a partnership.
Eligibility of Certain Non-Salary Fees for Loan Cancellation: Subtenants
The new rule also addresses non-wage costs attributable to tenants or subtenants. The agencies have stated that the loan cancellation amount requested for non-wage costs cannot include any amount attributable to the commercial operation of a tenant or sub-tenant of the PPP borrower or, for home businesses, household expenses.
The following examples illustrate this rule:
Example 1: A borrower rents an office building for $ 10,000 per month and sublets part 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 that he uses and leases part of the space to other businesses. The portion of mortgage interest eligible for loan forgiveness is limited to the percentage of the fair market value of the space that is not rented to tenants. For example, if the rented space represents 25% of the fair market value of the office building, the borrower can only claim a discount on 75% of the mortgage interest.
Example 3: A borrower shares a rented space with another company. When determining the amount eligible for loan forgiveness, the borrower should pro-rate rent and utility payments in the same manner as on the borrower’s 2019 tax returns or, if s This is a new business, the borrower’s expected tax returns for 2020.
Example 4: A borrower works from his home. When determining the amount of non-salary costs eligible for loan forgiveness, the borrower may include only the portion of covered expenses that were deductible on the borrower’s income tax returns for 2019 or, if it is of a new business, the borrower’s expected tax returns for 2020.
Rent payments to a related party
The Agencies have also imposed limits on the cancellation of rent payments to related parties. These charges can be waived as long as:
- the amount of loan forgiveness requested for rent or related party lease payments does not exceed the amount of mortgage interest due on the property during the covered period that is attributable to the space leased by the business; and
- the lease and the mortgage were concluded before February 15, 2020.
Any common property between the business and the owner is a related party for these purposes. No threshold has been set for what constitutes joint ownership.
The borrower must provide the mortgage interest documentation to his lender to justify these payments. While rent or lease payments to a related party may be eligible for rebate, mortgage interest payments to a related party are not eligible for rebate. This new rule will also prohibit a borrower who owns his building in a separate entity without any mortgage from benefiting from a reduction in rent paid to this entity.
Agencies believe that PPP loans are intended to help businesses meet certain non-salary obligations that are owed to third parties, and not payments to the business owner that occur due to the structure of the business.