Risks and Rewards of Accessing Government Financial Assistance During COVID-19

Published By Otto S. Shill, III

Risks and Rewards of Accessing Government Financial Assistance During COVID-19

This article summarizes the most recent government efforts to assist businesses during the COVID-19 emergency, and the benefits and pitfalls of each. This is a very fluid situation with new guidance coming out weekly, and sometimes daily. 

The government’s stated goal is to keep workforces connected with their employers so that economic recovery will be easier. This can place a heavy burden on businesses that are trying to understand how to get through the economic problems related to COVID-19, while taking care of their employees at the same time.  

On Friday, March 27, 2020, the President signed the Coronavirus Aid, Relief, and Economic Security (CARES) Act.  A week earlier, he signed the Families First Coronavirus Response Act (FFCRA), each offering different programs and incentives to businesses trying to survive during the COVID-19 crisis. Not all of these tools can be used together and not every tool is right for every business.  Each business should consider the overall structure including its financial condition and its economic outlook in determining which tools to use and how to combine those that can be combined. Below is a summary of the key programs and announcements that the federal and Arizona governments have announced as of April 28, 2020, that may be of assistance to your businesses.

Business Loans

In addition to its traditional offerings, the U.S. Small Business Administration (SBA) provides a number of loans that can be helpful including, Paycheck Protection Loans, Disaster Assistance Loans, and Loans for Medium-Sized Businesses.

  1. SBA Paycheck Protection Loans

Paycheck Protection Loans are available to most small businesses with fewer than 500 employees (as of February 15, 2020). Subject to narrow exceptions that primarily apply to the hospitality industry, SBA affiliation rules still apply to treat related businesses as a single company for determining eligibility for these loans. The loans provide up to the lesser of (i) $10,000,000; or (ii) 2.5x the average monthly payroll (limited to U.S. employees and limited to $100,000 per employee) of the business over the last year. No collateral or guarantees are required.  Recipients of Paycheck Protection Loans may also apply for and receive Disaster Assistance Loans described below.

Paycheck Protection loans are forgivable loans when loan proceeds are used for payroll costs, healthcare and retirement benefits, rent, utilities, and mortgage interest with respect to a mortgage incurred before February 15, 2020, (excluding leave payments made pursuant to the Families First Coronavirus Response Act) the U.S. Government may forgive the loan principal amount for up to 8 weeks of such qualified expenditures incurred after the date of loan funding. Note that the statute reduces the forgivable amount if an employer reduces either (i) wages or (ii) the number of the employer’s full-time equivalent employees, below defined thresholds based on the company’s historic performance. A company does not suffer the forgiveness reduction if it laid off employees or reduced compensation between February 1, 2020, and April 26, 2020, and rehires employees or eliminates the compensation reduction by June 30, 2020. Independent contractors cannot be counted as employees for determining the amount of a loan. However, an independent contractor may make its own application for a Paycheck Protection Loan. Any forgiven loan is excluded from the company’s taxable income. Any part of a loan that does not qualify for forgiveness is payable over 10 years at 4% or less.  These loans employ borrower certifications and a basic review of documentation by lenders rather than a rigorous underwriting process.

The SBA continues to update its guidance in the form of “Frequently Asked Questions” and a series of Interim Final Rules, however, questions still remain. Specific documentation is required to support loan applications, and a second round of loans have restarted after the first round exhausted appropriated funds. Any company that intends to rely on this source of capital should be working with its current lender to process its application as soon as possible, as even the second round of funding is expected to be exhausted in the next few days.

But Paycheck Protection Loans come with strings attached. First, the guidance makes it clear that the primary purpose of these loans is to support payroll that a borrower might not otherwise be able to repay. Qualified rent, mortgage payments, and utilities can be satisfied from up to 25% of the loan proceeds, with the remainder going to play allowable payroll expenses to avoid forgiveness reduction.  But the U.S. Treasury Department and the SBA have made it clear that the borrowers making the certifications to obtain these loans will be responsible for their promises. Borrowers must make several certifications to the federal government, including, among others, that they need the loans to satisfy qualified obligations including payroll expenses during the covered period and that they satisfy the SBA size standards. Borrowers making unsupportable certifications may not only lose the benefit of loan forgiveness, but may also have civil and criminal liability under federal laws, such as the False Claims Act. On April 28, 2020, the U.S. Treasury Department announced that it would audit forgiveness applications for loans in excess of $2,000,000.00 to ensure compliance with the rules, including the certification that the loan was made necessary by COVID-19.

See more details and a sample application at https://www.sba.gov/funding-programs/loans/paycheck-protection-program. We encourage businesses to consult with their SBA approved lenders and counsel regarding Paycheck Protection Loans and other SBA loan programs.

  1. SBA Disaster Assistance Loans and Advances; Bridge Loans.

Disaster Assistance Loans are available to businesses that qualify as small businesses under SBA’s normal standards. These loans provide up to $2,000,000 in assistance to allow small businesses to overcome temporary revenue loss due to a federally declared disaster. Currently, businesses located in all U.S. states and territories may receive Disaster Assistance Loans. Terms are determined on a case-by-case basis with a maximum term of 30 years and rates of 3.75% for small businesses and 2.75% for non-profit businesses. In addition, businesses with fewer than 500 employees may apply for disaster assistance loan advances of up to $10,000 which must be used for sick leave pay, payroll for retained employees, increased materials costs, rent, mortgage payments, and repayment of certain obligations. In addition, the SBA provides express Bridge Loans of up to $25,000 to assist small businesses bridge the gap in cash flow while they apply for other loans and assistance during a declared emergency. Some businesses may seek both Disaster Assistance Loans and Payroll Protection Loans. Also, the SBA offers other similar loan programs. Unlike Paycheck Protection Loans, other SBA programs employ normal SBA underwriting standards that may require guarantees or collateral, or may have longer which were reduced or eliminated in the case of Paycheck Protection Loans. For more information, go to https://www.sba.gov/disaster-assistance/coronavirus-covid-19. We encourage businesses to contact their SBA-approved lenders to determine what works best in their respective situations.

  1. Loans for Medium-Sized Businesses

Finally, under the CARES Act, the Secretary of the Treasury is authorized to extend loans and loan guarantees to eligible businesses having between 500 and 10,000 employees. The annual rate for such loans is capped at 2%, and the Secretary of Treasury can waive interest and principal payments for the first 6 months. Businesses applying for these loans must meet several conditions, some of which may be quite challenging. The borrower must certify, among other things:

  • its need to support ongoing operations due to economic conditions;
  • that it will use the loan proceeds to retain at least 90% of its workforce at full compensation and benefits;
  • that it will restore at least 90 percent of its workforce as constituted on February 1, 2020;
  • it will not pay dividends or repurchase its own stock on a national securities exchange; and
  • that it will not abrogate a collective bargaining agreement and will stay neutral in a union organizing effort.

Please note that these loans and the required certifications apply only to businesses having between 500 and 10,000 employees. We expect more details about these loans in future guidance from the government.

  1. U.S. Federal Reserve Main Street Lending Program.

Authorized under the Federal Reserve Act, the Main Street Lending Program offers recourse loans through authorized lenders to U.S. small and medium-size businesses with up to 10,000 employees or up to $2.5 billion in 2019 annual revenues. These are recourse loans of between $1 million and $25 million, but are limited to 4 times a business’ earnings before interest, taxes, depreciation, and amortization. Like other emergency assistance, these loans require that borrowers certify their eligibility, that COVID-19 has created an emergent need for funds to maintain payroll and retain employees. Borrowers must meet certain debt ratio requirements and must agree to follow restrictions on compensation, stock repurchase, and capital distributions. These adjustable rate loans have a 4-year term. For more information, see, https://www.federalreserve.gov/monetarypolicy/mainstreetlending.htm.

Not all companies will qualify for SBA-administered loans. For example, companies with passive income such as real estate investment companies, may not qualify for some SBA 7(a) and 504 loans.

Finally, potential borrowers are well advised to conduct a comprehensive review of their respective financial situations as they enter into agreements for one or more of these loan facilities. Each program comes with its own set of conditions, fees, and requirements. In particular, the Paycheck Protection Loan Program has been inundated with loan requests. Lenders are required to verify basic information and documentation. A more thorough review is almost certain to be required when the borrower applies for loan forgiveness. The federal government has significant enforcement alternatives at its disposal, and unwary borrowers may face significant penalties for being too casual during the application process. Government agencies have started to reach beyond the statutory language to indicate which companies should and should not be entitled to Paycheck Protection Loans. We encourage companies that desire to seek these loans to work closely with a qualified lender and counsel to ensure qualification with the requirements of any program of interest. Companies that have already applied for one or more of these loans should review their certifications and compliance status with counsel, and make any adjustments or, if necessary, repayment, in order to avoid punitive regulatory results later on.

Tax Deferrals and Refunds

  1. Tax Deferral

Recent guidance from the Internal Revenue Service and Arizona Department of Revenue has clarified that both federal and state income tax returns and federal gift tax returns are now due July 15, 2020.  Likewise, payments that were due on April 15, 2020, (including final payments for 2019 income tax and 1st quarter estimated payments for 2020 income tax) are now due on July 15, 2020, as well.

Businesses required to close due to COVID-19 can defer FICA taxes (SECA Tax for self-employed individuals) to their 2021 and 2022 tax years. However, these deferrals are not available to businesses accepting Paycheck Protection Loans that are forgiven.

  1. Tax Credits

In addition to tax deferral, new statutes and guidance offer several tax credits.

  • Businesses that have not received forgiveness of Paycheck Protection Loans can receive a credit of 50% of employer FICA tax if the company has experienced a decline of more than 50% in gross revenue. This credit considers up to $10,000 of wages per employee plus related health plan expenses;
  • Under the FFCRA, businesses with fewer than 500 employees may receive a refundable tax credit equal to:
    –  paid FMLA leave they provide due to COVID-19 absence by an employee caring for a child
    –  federal paid sick leave they provide due to COVID-19 related sick leave.

Businesses paying these benefits during a calendar quarter can directly offset the amount of benefits paid against their liability for income tax, Medicare tax, and FICA tax withheld from employees together with the employer’s share of FICA and Medicare tax for that calendar quarter. If qualified benefits exceed the amount of payroll tax liability for the company’s entire workforce, the company may seek a refund from the Internal Revenue Service, which should be processed in approximately 2 weeks. So, while a company has to fund the benefits upfront, the government pays 100% of these benefits in the end.

  1. Rolling Back Benefits Removed by the Tax Cuts and Jobs Act of 2017

In exchange for lower corporate federal income tax rates, the Tax Cuts and Jobs Act of 2017 took away several important deductions, which Congress has temporarily restored. Designed to put money directly into the hands of businesses, these temporary changes include:

  • Limitations on business losses are removed and net operating losses from 2018, 2019 and 2020 can now be carried back 5 years to general new refunds;
  • Corporations entitled to Alternative Minimum Tax credits can now apply them in 2018 or 2019 rather than in 2021; and
  • Limitations on deductions for business interest are increased to 50% rather than 30% of a company’s adjusted taxable income.
  1. Federal Paid Sick Leave

Beginning April 1, 2020, employees became eligible to make paid sick leave requests based on certain qualifying criteria. Conditions for the leave generally include quarantine due to a government order or a healthcare provider’s suggestion, experiencing symptoms, or caring for a child subject to one of the foregoing, or who experiences a school closure. Paid sick leave is limited to 10 days at $200 per day for absence related to child care, or at $511 per day for personal absence due to quarantine or exhibition of symptoms.  

  1. Federal Paid FMLA Leave

Employees may also request paid FMLA leave in order to care for a child whose school is closed and no childcare is available due to a COVID-19 declared emergency. Following the first two weeks (10 workdays) of leave, this FMLA leave is limited to 10 additional weeks of paid leave at two-thirds of an employee’s regular rate of pay not to exceed $200 per day or $10,000 in the aggregate.

  1. Arizona Sick Leave

Under Arizona law, employees are also entitled to up to 40 hours of sick leave (for employers with 15 or more employees) at the employee’s regular rate of pay. In additional to personal illness, the closure of a workplace or the need to care for a child due to a public health emergency qualify as the basis for such leave.

Employers who fail to provide required leave or who violate prohibitions against termination risk penalties and enforcement under §§ 216 and 217 of the federal Fair Labor Standards Act and/or A.R.S. § 23-364. Both the U.S. Department of Labor and the Arizona Industrial Commission, require employers to post notices regarding these benefits.  Sample posters are available at https://www.dol.gov/agencies/whd/posters and https://www.azica.gov/posters-employers-must-display.

Health Insurance Plans

Under the FFCRA, most group health insurance plans are required to provide testing and treatment for COVID-19 without applying normal cost-sharing measures.  Businesses should consult with their insurers to understand what terms and conditions apply to their plans. Also, employees are likely to experience at least some time away from work as a result of the COVID-19 situation. For this reason, businesses should review their health plans to understand at what point of absence an employee may lose health insurance coverage, and should ensure that employees are informed of plan requirements

Choosing Which Tools to Use

In just weeks, the government has provided a number of alternatives for keeping employees connected with their employers at a time when work and revenue may be reduced for both. However, as noted, not all of these alternatives can be used together. Also, businesses must capitalize on some benefits, like paid leave under the FFCRA upfront, whereas Paycheck Protection Loans provides direct support to businesses and their employees with little to no cost to the companies that apply.  ther loans and grants may also help, but may not become available for several weeks.  Tax changes may also provide sources of capital, but applying them could take time. Overlaying all of that is a high likelihood of enforcement after the end of this crisis. Currently, the government is concerned about getting funds to businesses and people that need them. However, that trend will inevitably subside and we expect significant audit and enforcement activity. This means that borrowers need to be prepared to demonstrate that they accessed funds in good faith.

In the end, each business must review its financial circumstances and determine which tools meet its needs and those of its workforce. Businesses should consult with their legal, accounting advisors, and lenders to balance and prioritize the application of these tools.

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