PPP Loans and the 75/25 Rule

Now that PPP loans are being issued, a common question facing small business owners is how do I ensure that my loan is forgiven? The number one step towards a forgivable loan starts with an understanding of the 75/25 rule.
PPP Loans and the 75-25 Rule

Small businesses across the country are adjusting to COVID19 conditions, and are scrambling to secure funding to keep their business afloat. Government issued PPP loans are designed to help make this possible. These loans even have a forgiveness component when borrowers appropriately follow the 75/25 rule. This article is designed to help you understand the 75/25 rule to make sure your PPP loan is forgiven.

What Are PPP Loans?

In coordination with the CARES Act, the United States government has issued Paycheck Protection Program (PPP) loans through the SBA in order to support small businesses in their efforts to save jobs and keep people employed.

The initial $349 billion in funding for this program was dispersed in just 13 days, so the government has offered a second chance for businesses by issuing an additional $310 billion in funds.

Loans are given with the intent to cover up to 8 weeks of payroll expenses, and the amount your business qualifies for will be determined by the total cost of payroll over the last 12 months, or during the year 2019.

One important feature of these PPP loans is that they can be forgiven, meaning that the borrower does not have to pay the money back if certain stipulations and guidelines are followed. One critical guideline is being referred to as the 75/25 rule. Understanding the 75/25 rule in regards to your PPP loan will be critical, as it can guide the way you spend your money, and help you to know whether or not your loan needs to be repaid.

Here are the things you need to know.

What is the 75/25 Rule?

If you’ve qualified and received your PPP loan, there are steps to be taken to ensure that your loan is forgiven. The key guidance provided by the SBA is that the loan must be spent on qualified expenses within the eight week coverage period and that at least 75% of the loan must be used for payroll expenses.

What Counts as a Qualified Expense?

The following items have been identified by the SBA as qualified expenses:

At least 75% of the loan amount must be spent on the following:

1. Payroll Costs: The CARES Act states that for a business, payroll costs are payments to employees that cover: salary, wages, commissions, or similar compensation (up to an annualized $100,000); cash tips or equivalent; vacation, parental, family medical, or sick leave; group health insurance and health insurance premiums; retirement benefits; or net profit (if you’re self-employed). 

The remaining 25% of the loan amount can be spent on the following:

2. Mortgage Interest Payments: The CARES Act states that interest or indebtedness incurred in the ordinary course of business before February 15, 2020 that stems from a mortgage on real/personal property is included as a qualified expense. However, please be aware that this applies to interest payments only. Principle payments and prepayments are excluded from the CARES Act and do not count as a qualified expense.

3. Business Loan Interest Payments: In addition to mortgage interest payments, practice acquisition loans, equipment loans, and build-out loans also amount to qualifying expenses under the PPP as long as they are secured by the business personal property and the loan was incurred before February 15, 2020. Again, please note that only the interest on these loans qualify.

4. Rent Payments: The CARES Act states that payments of rent under leasing agreements in force before February 15, 2020 are considered a qualified expense. Please be aware that the expense must be incurred and paid during the 8-week period in order to qualify. This means that prior rent due or future payments will not qualify as qualifying expenses.

5. Utilities: The CARES Act states that utilities for which services began prior to February 15, 2020 are considered qualifying expenses. So what counts as a utility expense? The SBA describes utilities as phone, internet, gas, water, or electricity. To qualify, these services must have service contract agreements that predate February 15, 2020.

How Should I Spend My Loan?

Remember, that the key to getting your loan forgiven is to follow the 75/25 rule. This means that at least 75% of your loan must go towards payroll expenses. The remaining amount can be used to cover other qualified expenses as explained above.

Need help managing your
employees and payroll?

What Other Stipulations Should I Be Aware Of?

In addition to the 75/25 rule, there are a few other things you should be aware of in order to qualify for loan forgiveness.

The loan is designed to provide eight weeks of coverage. All of the qualifying expenses you spend your loan amount on must be incurred during the eight week time period. The eight week period begins on the day you receive your first payment from your lender. Depending on your payroll schedule, you may want to consider changing the dates of your payroll so as to accommodate the maximum number of payroll cycles during the eight week period.

• You must maintain the number of employees you have on payroll. At the end of the eight weeks you will need to calculate the average number of full-time equivalent employees you had during the 8-week period following the disbursement of your loan. You will then divide this number by either the count of full-time equivalent employees during the timeframe between February 15, 2019 to June 30, 2019 or by the number  during the timeframe between January 1, 2020 to February 29, 2020. The business can choose either time frame to act as the denominator (although seasonal businesses are asked to choose the former). If the number you get is equal to or greater than 1, you will be eligible for loan forgiveness. If not, your forgivable expenses will be reduced proportionately. For a more in-depth discussion on what a full-time equivalent employee is, and how to make sense of these headcount calculations, click here.

• You have to continue to pay employees at least 75% of their total salary. This is a requirement that will be assessed individually for each employee on your team that did not receive more than $100,000 in annualized pay during the year 2019. If you pay an employee less than 75% of the pay they received during their most recent quarter of employment, the forgiveness amount will be reduced by the difference between that employee’s current pay and 75% of the original pay.

How Do I Apply For Loan Forgiveness?

After the eight week period comes to a close, an application for loan forgiveness will need to be filed with your lender. Your lender should provide you instructions on what you must file, how to file it, and time restrictions that might be involved in the filing process. 

Once you’ve submitted your application and it has been processed by your lender, your lender will be required to provide you with a response within 60 days.

What If I Do Not Qualify For Loan Forgiveness?

Based on the needs of your business, it may be wise to spend some of your PPP loan on expenses that do not qualify for forgiveness. This decision is ok, as long as you understand that whatever money that does not qualify must be paid back. PPP loans have a maturity of two years from date of origination.

The terms of the PPP loan are fairly generous. For expenses that do not qualify, your balance will accrue interest at 1% for the remainder of the two-year period of the loan. PPP loans do not come with any prepayment penalties. The full balance of your loan can be paid at any time with no additional fees incurred. The 1% interest is only charged on the loan amount that is not forgiven.

Final note: EddyHR is not a law firm, and the contents of this article should not be considered as legal advice. If you have further questions about qualifying for loan forgiveness or about PPP loans, we advise you to speak with your lender, an SBA representative, or a lawyer.

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