The Small Business Administration (“SBA”) requires borrowers to complete SBA Form 3509 (for-profits) if together with their affiliates, the borrower(s) received Paycheck Protection Program (“PPP”) loans totaling $2 million or greater. The Form was created by the SBA in order to evaluate the borrowers good-faith certification surrounding the need for funding due to current economic uncertainty at the time of the PPP application. Even though the SBA has stated a request to complete the questionnaire does not mean that the SBA is challenging a borrower’s certification, many borrowers are still uneasy on how this questionnaire will be utilized by the SBA.
An excerpt from the U.S. Department of the Treasury Paycheck Protection Program FAQs. AP … [+]
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A better understanding of the SBA questionnaire might be needed sooner than you think. Surprisingly, many of the questions being asked on the Form 3509 could affect the 2020 Employee Retention Tax Credit or filing of the 2020 federal business income tax return. If a business is required to submit Form 3509, the questionnaire should be reviewed to ensure data is being consistently communicated to the federal government on all fronts. Time should be taken to review the questionnaire to ensure 1) that accurate information is being provided, 2) the borrower’s need for PPP funding is properly reflected, and 3) the same facts are being reported to the SBA and the Internal Revenue Service.
Background Surrounding From 3509
Based on CARES Act Section 1102(a)(1)(G), that was passed on March 27, 2020, an eligible borrower applying for a PPP loan had to make a good faith certification at the time of the loan application that the uncertainty of current economic conditions made it necessary for the loan request to support the ongoing operations. Initially, the good faith certification was commonly interpreted that COVID-19 caused significant current or prospective economic harm due to materially reduced revenue and that operating would likely lead to layoffs. However, on April 23rd, the SBA clarified that borrowers must make this certification in good faith, taking into account their current business activity and their ability to access other sources of liquidity to support their ongoing operations in a manner that is not significantly detrimental to the business.
The time lapse between the CARES Act and the SBA clarification regarding which aspects should be evaluated when making a good faith certification is significant. The SBA clarification was provided almost a month after the passage of the CARES Act. While not many people are excited to revisit April of 2020, it is important to review the timeline to better understand why businesses are struggling with the SBA’s late clarification. On April 16th, prior to the SBA clarification, the initial $349 billion for PPP funding ran out after being available to businesses for less than two weeks. Businesses were scrambling to secure PPP funding, and if they did not receive funding by April 16th were frantic to make sure their PPP loan applications were first in line should additional government funding be provided. In the great words of Chicken Little, many felt that the sky was falling! By April 23rd, many businesses which already had a significant PPP loan balance were questioning whether their good faith certification at the time of the loan was sufficient, as it may not have focused on current business activity and liquidity. While many expect the SBA guidance to be challenged in the courts, at present the questionnaire must be completed. The SBA has made clear that failure to complete the form and provide the required supporting documents may result in the determination that the business was ineligible for either the PPP loan, the PPP loan amount, or any forgiveness amount claimed, and the SBA may seek repayment of the loan or pursue other available remedies.
Borrower Safe Harbor: Loan Balance less than $2 million
On May 13, 2020, the SBA provided a safe harbor for any borrower that, together with its affiliates, received PPP loans with an original principal amount of less than $2 million. These borrowers would automatically be deemed to have met the required certification that the loan request was made in good faith. More good news? On the most recently updated SBA debt forgiveness application the assessment as to whether the principal balance amongst affiliates exceeds $2 million, and therefore a Form 3509 is required, is assessed on the First Draw PPP loan balance OR the Second Draw PPP loan balance (not a combination of the two). Therefore, even if the First and Second Draw PPP loan balance were $1,100,000 each, for a total of $2,200,000, the Form 3509 would not be required as the loan balance per draw did not exceed $2 million.
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Form 3509 Questions
Part A-Borrower Information
Based on Part A, a separate Form will be required for each legal borrower listed on the loan application. If multiple affiliated business entities received a total PPP loan balance of $2 million or more, they would need to fill out a separate Form 3509 for each business. Each of the questions on the Form that reference the borrower is asking for the legal borrower’s information, and not the affiliated group, and includes the reporting of gross revenue, capital improvement projects, and cash balances. The affiliated group balances do not have to be reported. However, this does not preclude a borrower from attaching additional information regarding the affiliated group to the questionnaire if it better reflects the economic uncertainty of the larger group.
Form 3509 is divided between two sections. As the SBA is trying to assess the borrower’s good faith certification, the first section asks questions that the SBA views relevant regarding the business activity assessment at the time of the PPP loan application and the second section addresses liquidity at the time of the application and during the covered period. For purposes of this discussion, the liquidity assessment questions will take priority.
Form 3509: Liquidity Assessment (“LA”) Questions
LA Question 1
Question 1 requests that the borrower provide their cash and cash equivalents balance as of the last day of the calendar quarter immediately before the date of the PPP loan application along with supporting documentation. The supporting documentation that is most readily available is the bank statement for the cash accounts. Investments in liquid securities, such as stocks, bonds, and derivatives, are not included in cash and equivalents. Even though such assets may be easily turned into cash (typically with a three-day settlement period), they are still excluded.
Some businesses may reflect a higher cash amount on their bank statement than what is a true reflection of the businesses cash position. For example, construction companies normally will have large cash deposits when starting a contract, but that cash has already been assigned to pay for various supplies and contractors. In such a case, the borrower should consider providing additional supporting documentation reflecting the amount of cash that has already been allocated toward completing the contracted projects.
LA Question 2
The most recent issue tax professionals are reviewing with businesses who received a PPP loan relates to question 2, which asks if the borrower paid any dividends or other capital distributions to its owners between March 13, 2020 and the end of the covered period. A repetitive question received throughout the 2020 year from owners who’s businesses obtained a PPP loan was whether they should take a distribution from their business. The SBA seems to be indicate that if distributions were made to owners during the covered period, there may not have been a true concern about economic uncertainty. While the general rule seems to hold true, the SBA must also realize there are always exceptions.
Let’s dissect question 2 a bit further. Before entering the amount of distributions made between March 13 and the end of the covered period, a business is allowed to reduce the distribution amount listed for Question 2B for estimated tax payments related to pass-through entities. The SBA has provided that pass-through entities, such as S Corporations and Partnerships, can distribute an amount to cover the tax payments of its owner(s). The amount of distribution that can be excluded related to tax payments cannot exceed:
1. the tax liability on profits earned in the first three quarters of 2020,
2. 110 percent of the pro-rata share of last year’s tax liability on distributions, and/or
3. 100 percent of the pro-rata share of tax liability on total distributions in 2020
What if the exclusion of the estimated tax payment still requires a large amount to be reported as a dividend or capital contribution? REVIEW THE END DATE OF THE PPP COVERED PERIOD. For example, many borrowers are assuming that they will utilize a 24-week covered period. However, the Consolidated Appropriations Act, 2021 (“CAA 2021”) clarified that the covered period for the First Draw PPP and Second Draw PPP must be at least 8 weeks, and no longer than 24 weeks. Therefore, depending on the dividend or distribution dates and the amount of time it took the business to utilize is PPP funding on covered expenses, there may be a way to decrease the amount of dividends or distributions being reported on line 2B.
For example, lets assume that Company A received a $2,100,000 loan on March 16, 2020. In addition, Company A made owner distributions, above and beyond estimated tax payments, of $500,000 per month starting in June and ending in September. The 24-week covered period would start on March 16, 2020 and end on August 30, 2020. If the full 24-week covered period is utilized, the borrower would have $1,500,000 of owner distributions. However, upon careful examination of the payroll costs and non-payroll costs, the company realized it spent all the PPP funding on eligible expenses within 15 weeks and therefore, the end of the covered period could be accelerated to June 30, 2020. If this was the case, and the borrower properly reported the shorter covered period on their debt forgiveness application, the amount of distribution required to be reported for Question 2B would decrease significantly from $1,500,000 to $500,000.
CAUTION: The acceleration of the covered period also impacts the timing of the filing of the business debt forgiveness application which defer the loan payments. If a borrower does not apply for loan forgiveness within 10 months after the last day of the borrower’s loan forgiveness covered period, loan payments are no longer deferred, and the borrower must begin make payments on the loan. In our previous example, Company A had a covered period ending date of August 30, 2020 which would allow Company A to wait until June 30, 2021 to apply for debt forgiveness. If instead the covered period end date is shortened to June 30, 2020, Company A’s debt forgiveness application would need to be submitted by the end of April 2021.
After all that planning, is the distribution amount on Line 2B still too high? There are logical reasons that could be documented and provided as support regarding why distributions were made above and beyond the allotted amount for the owner’s estimated tax bill during the covered period. For example, the estimated tax bill may not only include the 2020 estimated tax payments that were due in June, July and September of 2020, but also the 2019 remaining tax liability that was due in July of 2020. Remember, the filing deadline for 2019 tax returns was extend from April 15th 2020, to July 15th 2020 which could be right in the middle of a businesses covered period. Businesses who did have tax distributions paid out that were greater than the amount allotted above, should consider disclosing all tax payment distributions made to owner’s during the covered period.
Another point of review it to ensure that the distributions that were made were truly a cash distribution or a loan to the owners. After careful review, and appropriate documentation, businesses should ensure the proper loan and distribution amounts are reported on the financial statements and tax return for consistency.
LA Question 4 & 5
Questions 4 and 5 attempts to identify any of the employees or owners of the borrower who were compensated during the covered period in an amount that exceeds $250,000 on an annualized basis. The SBA question seems somewhat uninformed as it is not asking for comparative salary data from 2019. Borrowers should consider disclosing 2019 comparative data in the supporting documentation, as well as highlighting those employees or owners’ salaries which stayed stagnant or decreased in 2020 in comparison to the 2019 compensation.
Form 3509: Business Activity Assessment (“BAA”) Questions
BAA Question 1
Question 1 requests the borrower’s gross revenue for the second quarter of 2020 and 2019 with supporting documentation. It is assumed that the SBA is expecting a decline in these two comparative quarters, thereby confirming the economic uncertainty surrounding the business at the time of the PPP loan application. This frustrates many borrowers who fear that the second quarter is the only information that the SBA is assessing when trying to evaluate the current business activity surrounding economic uncertainty. However, some businesses did not see the significant gross receipts decline until the third or even fourth quarter of 2020. This could be for a variety of reasons, including when the pandemic was prominent in their physical location which then led to governmental shutdowns, but also could be related to contracts still being completed in the second quarter that were entered into pre-pandemic.
Businesses who did not see a decline until after the second quarter should consider providing additional supporting documentation for the gross receipts decline that occurred in later quarters. That being said, for borrowers who clearly had a second quarter decrease there is no need, or requirement, that the entire year’s gross receipts be disclosed.
BAA Question 2
Question 2 asks the borrower if they have been ordered to shut down by a state or local authority due to COVID-19 since the COVID-19 National Emergency Declaration issued by President Trump on March 13, 2020. BE CAREFUL! While we often don’t think governmental agencies are the best at sharing information, the answer to this question would be of interest to the Internal Revenue Service if the borrower is claiming the Employee Retention Credit (“ERC”) for 2020 due to a full or partial governmental shutdown. It is important to not only answer this question yes if the 2020 ERC is being claimed due to a governmental order (State or local), but also confirm the dates being claimed for the 2020 ERC full or partial shutdown are the same dates reflected in the answer to question 2C. This question is not limited to the PPP covered period, but is referring to any time since March 13, 2020, which could also include dates in 2021 if the SBA Form 3508 has yet to be submitted. A similar thought process should be applied to BAA Question 3 as well.
BAA Question 4
Question 4 asks if the borrower has voluntarily ceased or reduced its operations due to COVID-19 at any time since March 13, 2020. Similar to question 2 and 3, if the borrower is also seeking the ERC they will want to review in detail the time that the business operations were suspended and clearly identify which dates were due to mandates by the state or local authority versus voluntary.
BAA Question 5
Questions 5 asks whether the borrower voluntarily altered its operations due to COVID-19 (other than ceasing or reducing operations) since March 13, 2020. This question could shed light on the additional eligible expenses allotted for by the CAA 2021 related to covered worker protection expenditures. Covered worker protection expenditures are defined as:
Operating or capital expenditures that facilitate the adaptation of the business activities of an entity to comply with the requirements established or guidance issued by the Department of Health and Human Services, the Centers for Disease Control, or the Occupational Safety and Health Administration, or any equivalent requirements established or guidance issued by a State or local government…related to maintenance standards for sanitation, social distancing, or any other worker or customer safety requirement related to COVID-19, but does not include residential real property or intangible property.
While a Borrower is not required to report covered worker protection expenditures as part of their PPP debt forgiveness application, if they do report covered worker protection expenditures on their application they should ensure it aligns with what is being reported on BAA Question 5.
While there is a lot to unpack with regards to the various federal stimulus packages, and the significance SBA Form 3509 will ultimately have on a borrowers uncertainty certification, the questionnaire is still required for borrowers whose principal balance, when added to affiliates, exceeds $2 million. The priority of reviewing and drafting answers to the questionnaire will escalate as amendments to 2020 quarterly payroll tax forms are made for the ERC, 2020 financial statement and federal business income tax returns are finalized, and the ten month period relating to the deferment of loan payments continues to dwindle. Businesses will need to work toward a wholistic approach to ensure that all documentation and communication is consistent amongst all returns and reports submitted to the federal government.