Guidance for Pass-through Entities; PPP Loan Data

Good morning and happy non-tax day.  Just a reminder that the IRS has extended the 2019 tax filing and payment deadline from today until July 15, 2020.  On a related note that may be relevant to those of you who use profits interests or restricted stock, Ali Nardali in our benefits and executive compensation group reminded me that the IRS also extended the deadline for filing 83(b) elections.  Any such election that was otherwise due between April 1 and July 15 is now due on July 15.

Yesterday, SBA again updated its FAQ (yes again, and no it didn’t solve affiliation or address forgiveness) and also released a new IFR Three, with a somewhat misleading link title, which contains an important change on how partnerships and LLCs may include partner compensation in their PPP payroll costs, as discussed below.

But first, SBA yesterday released the first table of PPP loan data, showing that it has approved, through Monday, April 13:

· 1.035 million loans,

·         Totaling $247.5B (for an average loan size of ~$240k),

·         Via 4,664 participating lenders. 

The table also includes an interesting analysis of PPP loans by:

·         State:

o   Texas is leading the way, with 88k loans for $21.8B,

o   California is second with 55k loans totaling $20.8B (no other state has received more than $13B),

o   All the way down to the Mariana Islands (“MP” with 29 loans for $7.5M) and American Samoa (“AS” with 1 loan for $389k) (Full disclosure:  I had to look up what the abbreviations MP and AS meant);

·         Industry

o   Construction thus far has received the most dollars at $34B on 115k loans,

o   Professional, scientific and technical services firms have received the most loans at 126K for a total of $30B, and

o   NAICS code 72, which received special attention in the CARES Act, has been the fifth most active subsector, receiving 108k loans for nearly $23B; and

·         Loan Size

o   The average loan size is just under $240k, with more than 70% of loans being for less than $150k; and

o   There have been just over 50k loans >$1M, which represent almost exactly 5% of loan count, but account for more than 46% of the total loan dollars

o   After-the fact FOIA or FCA whistleblowers or perhaps even OIG investigations might focus at least initially focus on these $1M loans, because they represent (a) a more manageable number to review and also provide the most bang for the buck.

On the topic of volume, senior White House economist Larry Kudlow made a statement yesterday that through noon on April 14, SBA had approved $253B of PPP loans, and that the remaining $96B could run out this week, which may be an attempt to increase pressure on congress to cut a deal on the additional PPP funding as noted in the update below from our Policy team.  In any event, that means the funding chart now looks something like this:

Turning to the SBA regulations and guidance, the new “IFR Three” (so named because it follows the Initial PPP IFR from April 2 and the IFR on Affiliation from April 3_ addresses three questions:

1.       Treatment of Self Employed Individuals and PARTNERSHIPS.  Most of the first section focuses on individuals with self-employment income and how to calculate payroll costs and “owner compensation replacement” for such individuals, which are likely less relevant for this audience, so I will skip those. But if you have questions there, please let me know.

a.       However, in what is almost an aside, the SBA notes that partnerships and LLCs taxed as partnerships can treat as a PPP “payroll cost” the “the self-employment income of general active partners” up to the $100k annualized limit:

“However, if you are a partner in a partnership, you may not submit a separate PPP loan application for yourself as a self-employed individual.Instead, the self-employment income of general active partners may be reported as a payroll cost, up to $100,000 annualized, on a PPP loan application filed by or on behalf of the partnership.Partnerships are eligible for PPP loans under the Act, and the Administrator has determined, in consultation with the Secretary of the Treasury (Secretary), that limiting a partnership and its partners (and an LLC filing taxes as a partnership) to one PPP loan is necessary to help ensure that as many eligible borrowers as possible obtain PPP loans before the statutory deadline of June 30, 2020.”

b. This goes well beyond what most commentators had thought a partnership could include as a payroll cost. There had been a consensus that amounts treated as “guaranteed payments” were eligible, but not amounts otherwise distributed to “general active partners.” I am told that the term “general active partners” is not generally a well-defined term under tax law, but has some lore behind it that would seem to mean individuals actively engaged in the business of the partnership, even if they receive a only K-1 relating to their partnership income. This could significantly expand the amount of PPP borrowing capacity for many partnership borrowers, such as professional services firms (which, as noted above, were the second most active borrowing sector).

c.       Prior SBA guidance makes it clear that borrowers can only apply for one PPP loan, so partnership borrowers who have received their PPP loans cannot go back to get a second PPP loan to cover these additional amounts.  It is not clear whether an applicant who applied under a more narrow reading of this could effectively amend or resubmit its application to upsize the requested loan amount.  Such applicants may want to contact their banks to see whether this is possible.

d.      Note that these amounts would also appear to count as payroll costs for the forgiveness calculation.  Partnerships who distribute interim draws at less than 100% of the annualized comp rate, or who make distributions only quarterly, may want to evaluate their draw/distribution schedule in light of the applicable forgiveness calculations, though it may be best to do so after we receive the pending SBA guidance on forgiveness.

e.       Note that I’m using the term “partnership” above in the tax sense, to pick up both partnerships and LLCs taxed as partnerships.

2.       Potentially Ineligible Businesses.

a.       Borrowers Affiliated with Bank Directors or Owners.  The SBA has determined that despite potential conflicts of interest, PPP lenders may lend to borrowers in which a director of the PPP lender or a holder of up to 30% of the equity of the PPP lender either holds equity or serves as a director (i.e., of the borrower), so long as the borrower receives no favoritism and follows the same process as other borrowers.  Those of you familiar with bank-strategic investments under Section 4(c)(6) may recognize, and cringe at, that “30% equity” limit.

b.       Gambling Businesses.   Under existing SBA regulations, businesses that derive more than 1/3 of their gross revenue from legal gambling revenues have not been eligible for SBA loans.  IFR Three relaxes that standard for PPP loans to allow borrowers who exceed that 1/3 limit to obtain a PPP loan if:

i. “the business’s legal gaming revenue (net of payouts but not other expenses) did not exceed $1 million in 2019; and

ii. legal gaming revenue (net of payouts but not other expenses) comprisedless than 50 percent of the business’s total revenue in 2019.”

SBA also notes that “Businesses that received illegal gaming revenue are categorically ineligible.”

3.       Pledge of PPP Loans.   SBA clarifies the PPP loans may be pledged as collateral to the Fed or a FHLB, and that SBA need not approve any loan documents etc.

The SBA FAQ update on April 14, adds:

·         FAQ #26 and 27, which clarify that PPP loans are available to businesses in which members of congress, and other federal officials and employees, or their families members have a >10% ownership interest or serve as officers or directors, etc., and

·         FAQ #28, which clarifies that before a bank submits a borrower application to SBA via the E-Tran loan portal, the bank is required to collect all required borrower information and certifications contained in the application form and comply with the bank’s obligations under Sections 3.b.(i-iii) of the first PPP IFR, which relate to confirming that the borrower has submitted the required certifications and payroll information. 

·         NOTE: FAQ 28 does not reference 3.b.(iv) of the initial IFR, which requires that lenders “Follow applicable BSA requirements.” 

o   It seems unlikely that this is merely an oversight by SBA, thus signaling that lenders can submit borrower applications to SBA before conducting any required BSA or FinCEN ownership verifications.  It does not exempt lenders from complying with those required verifications, presumably before the loan is disbursed to the borrower. 

o   It does not address what would happen if SBA approves a loan, but a lender is unable to complete the required BSA and FinCEN verifications.   We are aware of a few borrowers that have had loans approved by SBA but ultimately not funded by a lender for other reasons, such as a borrower determining that it does not need or want the loan or may not actually be eligible for the loan.  It remains unclear as to how lenders can return such funds to SBA and whether such loans “count” against the $349B limit.

That’s it for today.