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Small Business Advisory: Paycheck Protection Program

Congress created the Paycheck Protection Program (PPP) under the Coronavirus Aid, Relief, and Economic Security (CARES) Act which was signed into law on March 27, 2020. The PPP provides small business loans backed by the U.S. Small Business Administration (SBA).

Loan proceeds are meant to pay employee wages, although a certain portion of the funds may be used for other eligible business expenses. If the funds are used as intended, the entire loan can be forgiven by the federal government. Businesses must apply for these loans through a bank or other approved lender (such as certain “fin-tech” companies).

As of early July there was still nearly $138 billion available for loans through this program. However, businesses hoping to take advantage of this program are advised to apply for a loan as soon as possible. While recently legislation extended the PPP application deadline from June 30th to August 8th, 2020, there is no guarantee that the program will be extended or that any additional money will be allocated to the program once existing funds are expended.

Although a PPP loan can be a great help to a small business struggling through the pandemic, the application process can be difficult to navigate. Our Office has spoken with numerous small businesses, many of which have suffered frustrating experiences in dealing with the Paycheck Protection Program. To be prepared for the process, small businesses should consider the following questions.

Table of Contents

Is My Business the Right Size for this Loan?

The rules for PPP loans are complicated and determining whether you are eligible can be difficult as well. The program’s general rule is that businesses with no more than 500 employees can qualify. However, the SBA will also allow loans to any entity that fits the SBA standard for a “small business concern,” as well as employers that meet an industry-specific size threshold. Businesses need to be careful about how they count their employees—the SBA will aggregate together all staff of what it considers ‘affiliated’ companies in certain circumstances. This size limit will not apply to restaurants or hotels (or other businesses with an NAICS code of 72) under SBA rules, but otherwise it can be tricky to navigate. Businesses that the SBA considers too large may not be entitled to loan forgiveness. The SBA offers a tool to help you determine if your business is small enough to qualify. You can access the tool here.

I’m a Sole Proprietor or Independent Contractor, Can I Apply?

Individuals who operate under a sole proprietorship or as independent contractors are eligible to apply for a PPP loan so long as they were in operation on February 15, 2020 and meet the other eligibility requirements for the program.

Do I Have All the Documentation that I Need?

Each applicant seeking a PPP loan must submit a Paycheck Protection Program Borrower Application Form (SBA Form 2483) to a participating lender (together with any other documentation required by the lender as part of the application process). This form can be found here.

Lenders have generally been requiring the following documentation from PPP loan applicants:

  • IRS 940, 941, or 944 payroll tax forms for 2019, and if available, for Q1 2020;
  • payroll processor records and other payroll reports/ledger for 2019 and YTD 2020 with corresponding bank statements (which should capture salary, wages, commission, or similar compensation; tips; vacation; parental, family, medical or sick leave; group healthcare benefits; retirement benefits; and state or local taxes on employee compensation);
  • IRS form 1099s for independent contractors for 2019;
  • documentation evidencing health insurance premiums under a group health plan;
  • documentation evidencing the sum of all retirement plan funding paid for by the applicant;
  • organizational documents (articles of incorporation/organization, bylaws, operating agreement, partnership agreement, owners’ driver’s licenses, etc.); and
  • tax identification numbers (EINs or SSNs, as appropriate).

The SBA is allowing lenders to ask for additional documentation, so you might need to provide further information as part of the application process.

Is the Loan ‘Necessary’ for My Business?

As part of the loan process, small businesses are required to make a number of certifications before submitting their applications. Most pertinently, applicants are required to certify that the “current economic uncertainty makes this loan request necessary to support the ongoing operations of the Applicant.” Borrowers who provide false certifications not only could lose their eligibility for loan forgiveness but also could be subject to federal prosecution for fraud. Over the life of the program so far, the SBA has given mixed messages about how to interpret this certification. Originally, a variety of large publicly traded restaurant chains were approved for PPP loans. More recently, the SBA has noted “it is unlikely that a public company with substantial market value and access to capital markets will be able to make the required certification in good faith.” While a borrower may still have insufficient guidance about what it means to ‘need’ a PPP loan, the SBA has provided a safe harbor. As announced in Question 46 of the SBA’s FAQs (published May 13, 2020), a borrower that, together with its affiliates, received PPP loans with a principal amount of less than $2 million will be deemed to have made the ‘necessity’ certification in good faith. But just because the SBA believes that you made your statement in good faith does not mean the SBA believes your statement was correct; if the SBA determines your loan was not ‘necessary,’ it may demand immediate repayment and/or reject your application for loan forgiveness. Also, even if the SBA believes you made your statement in good faith, other law enforcement agencies might still be free to review your certification for fraud. 

How Much Should I Borrow?

The answer to this question will vary depending on the business. The maximum available loan amount for any business is 2.5 months’ worth of payroll with a ceiling of $10 million. This is calculated by multiplying 2.5 times the business’ prior 12-month average monthly payroll costs. Alternatively, businesses may use 2019 as the payroll period for calculating their maximum loan amount and take a 2.5-month fraction of that number. Seasonal businesses are permitted to use specified shorter time periods for purposes of calculating their payroll costs. The SBA has published a step-by-step guide for calculating the maximum loan amounts based on the applicant’s business type, available here. But just because you can borrow the money does not mean that you should. It is important to remember that the rules for loan forgiveness are still being refined, and you may not qualify for loan forgiveness. You may want to take this into account when figuring out whether to apply or how large a loan to seek.

Once I Submit My Application, Can I Still Lose My Loan?

Simply because you submit an application does not mean you will receive a loan. Many small businesses submitted applications in the first round of funding, only to be told later that their loans still had not been processed. Even once your loan has been approved for funding, there are still risks. Lenders must make a one-time, full disbursement of a PPP loan within 10 calendar days of SBA approval (the date on which the SBA assigns a loan number). Loans that have not been disbursed because a borrower fails to submit required loan documentation within 20 days of loan approval are cancelled.

How Can I Use the Proceeds from My PPP Loan?

Proceeds from PPP loans are designed to be used primarily for payroll costs, including employee salaries, commissions, cash tips or similar compensations as well as costs related to the continuation of group health care benefits during periods of paid sick, medical, or family leave, and insurance premiums. Specifically, payroll costs include the following for employees (excluding independent contractors) with a principal place of residence in the U.S.:

  • (i) salary, wages, commissions, or similar compensation;
  • (ii) cash tips or equivalents;
  • (iii) payment for vacation, parental, family, medical, or sick leave;
  • (iv) allowance for dismissal or separation;
  • (v) payment required for the provision of group health care benefits, including insurance premiums;
  • (vi) payment of any retirement benefit; and
  • (vii) payment of state or local taxes assessed on employee compensation.

Compensation costs for any given employee (exclusive of non-cash benefits) are capped at an annualized salary of $100,000.

Loan proceeds can also be used for payments of interest on any mortgage (but not prepayment of interest or payment of principal), rent, utilities, and interest on certain other debt obligations. These other uses are restricted to contracts or indebtedness that existed prior to February 15, 2020. Thus, if you want to use the loan to pay for mortgage interest, you need to have taken out that mortgage before February 15th. Similarly, if you want to use the loan to pay utility bills, you need to have started utility service for your business before February 15th.

How Does Loan Forgiveness Work?

Many businesses plan to seek forgiveness of their PPP loans. If you do, you will want  to apply for forgiveness within 10 months after your covered period ends (i.e., before the loans deferral period ends and you have to start making loan payments). Once you apply, you will need to show that you have used the loan proceeds for forgivable purposes, and that at least 60% of the loan forgiveness amount was spent on payroll costs that are eligible for loan forgiveness. In addition, your forgiveness amount may be reduced in certain circumstances if you are paying employees less, or have fewer employees, than you did before the pandemic. If you qualify, the SBA will forgive the loan, or part of the loan, and your bank will discharge the forgiven debt.

If I Don’t Qualify for Loan Forgiveness, What Are My Terms?

If a PPP loan is not forgiven, or only partially forgiven, you will need to pay interest on the unforgiven part of the loan at a rate of 1%. You don’t need to make these payments if you are going to apply for forgiveness, but the interest will accrue during that grace period (remember, you will want to apply for forgiveness within 10 months after your covered period ends). In any event, you must fully pay off your loan within five years. If you received a loan prior to June 5, you must pay off the loan within two years. However, nothing prevents borrowers with existing loans from mutually agreeing with their lender to extend the loan maturity date to five years. No collateral or personal guaranty is required. While the key items of interest rate, time to repay, etc., will be the same for any loan under the PPP, other terms may vary between lenders. Ask your bank how it alters the standard SBA promissory note, so you understand any terms unique to your loan.

What Are the Biggest Pitfalls I’ll Face in Getting My Loan Forgiven?

This will vary borrower by borrower. As already mentioned, the certifications on the application are very important. In addition, the SBA recently published interim rules for loan forgiveness (though there may be additional guidance issued in the future). However, some key things are clear. Most importantly, to receive loan forgiveness, borrowers are required to use at least 60% of the loan forgiveness amount for payroll costs paid or incurred during the relevant “covered period” (and not more than 40% for non-payroll costs). Under the most recent law passed by Congress, a borrower’s covered period begins on the loan disbursement date and ends either 24 weeks later or on December 31, 2020, whichever is earlier. Borrowers who received a loan prior to June 5, 2020 may elect to retain the original covered period of 8 weeks instead of 24 weeks. Currently, if more convenient to align with a borrower’s payroll schedule, the borrower can choose an alternative covered period beginning on the first day of the borrower’s first pay period following the loan disbursement date.

Even applying your loan monies to payroll will not necessarily mean the whole loan will be forgiven. The SBA has put rules in place that will reduce loan forgiveness in certain circumstances. For instance, for any worker employed by the borrower during the relevant 24-week period, the loan forgiveness amount is reduced dollar-for-dollar by the amount of any salary cut over 25% from what the worker was paid on average earlier in the year (January 1 to March 31, 2020). In addition, the loan forgiveness amount is reduced proportionally for reductions in the average number of full-time equivalent employees during the relevant 24-week period as compared to the average number of full-time equivalent employees during a reference period selected by the borrower.

There are certain exceptions to these reductions in the loan forgiveness amount, including where the borrower made a good-faith written offer to rehire an employee or restore reduced hours at the same salary or wages, which offer was rejected by the employee. Also, if an employer has re-raised salaries or increased their number of employees back to pre-COVID levels by December 31, 2020, this may also qualify the business for the full amount of forgiveness. Another way to get the full level of forgiveness even if you don’t have the same level of staffing is to show that your business cannot return to the same level of activity it was operating at before February 15, due to compliance with requirements or guidance issued by HHS, CDC, or OSHA.

There are many other details that impact whether the SBA will forgive your loan. Many will apply only to businesses in certain situations. Such details can be found here.

If My Loan Is Forgiven, How Do I Avoid a Big Tax Bill?

Debt forgiveness on PPP loans is not subject to federal income tax. At the same time (not surprisingly), the IRS has held that a borrower whose PPP loan is forgiven may not deduct the expenses that relate to the forgiven amount (i.e., the wages, employee benefits, interest, rent, and utilities that determined the forgiven amount) from gross income as a business expense. Massachusetts state taxes may be a bit more complicated. Under state law, your forgiven loan may count as income, depending on the structural form of your business (i.e., small businesses that are corporations may not pay tax on the forgiven loan but businesses that are taxed through the personal income tax may be responsible for it).

PPP borrowers are also ineligible for the Employee Retention Tax Credit made available under the CARES Act. You may want to consult your accountant about these issues before seeking loan forgiveness.

About What Else Should I Be Concerned?

The PPP program continues to refine its rules, and many of the governing standards remain unclear. The Attorney General’s Office led a group of 24 states in writing to Congress to seek further clarity in the program and we have submitted a variety of comments to the SBA on its interim program rules. Among other things, these include requests for:

  • fairer access for small businesses to PPP funds;
  • clearer guidance for less sophisticated borrowers and the unbanked;
  • better communication from the SBA to borrowers about loan status;
  • more flexibility on deadlines, acceptable usage of proceeds, and loan disbursement schedules;
  • longer repayment terms for businesses that do not qualify for loan forgiveness;
  • limitations on additional terms that banks can add to PPP loans;
  • better barriers to prevent hedge funds and large business entities from diverting PPP funds meant for small businesses;
  • more clarity on what happens if banks fail to disburse loans in a timely manner;
  • better notifications for small businesses before loans are cancelled;
  • stronger safeguards against pre-payment penalties;
  • more clarifications regarding funding limits;
  • better guidance on how the ‘necessity’ clause applies to borrowers;
  • clearer consequences for SBA program violations;
  • removal of traps for the unwary from SBA program rules; and
  • elimination of program structures that leave room for mischief by those set on abusing the program.

If you need assistance with your PPP application or the PPP process, please fill out a Small Business Experience Form and let us know what questions you may have. Our Office can provide direct guidance and is also a member of the COVID Relief Coalition, a group of government agencies, non-profits, and law firms which offer help and information for small businesses during the pandemic. The Coalition also offers free legal advice for small businesses in need of assistance.