How Does the PPP Loan Forgiveness Work?

Dane Panes

Updated: November 8, 2021
How Does the PPP Loan Forgiveness Work


Key Takeaways

  • PPP Loans are 100% federally guaranteed loans that aim to help businesses maintain their employee’s paychecks and keep their business afloat amid the COVID-19 pandemic. PPP loans are forgivable as long as the proceeds go towards eligible purposes.
  • Some of the eligible expenses that can qualify for the PPP loan forgiveness include payroll costs, operating costs, supplier costs, worker protection, and property damages.
  • For the PPP loan to be fully forgivable, the SBA stipulates that at least 60% of the proceeds must go towards payroll. The remaining 40% can be used for other eligible purposes.
  • Self-employed individuals can qualify for PPP loans to pay themselves. They must follow similar guidelines as the other businesses (60% payroll; 40% other eligible costs) to qualify for the loan forgiveness.

If your business has suffered significant losses during the COVID-19 pandemic, you may have applied for a PPP loan to keep the company afloat. However, now that the SBA has stopped receiving applications, you may want to apply for the PPP loan forgiveness. So, how does the PPP loan forgiveness work?

PPP Loans Recap

The Payment Protection Program (PPP), an extension of the U.S. government’s CARES Act, provides 100% federally guaranteed loans to small businesses, non-profits, and sole proprietors affected by the COVID-19 pandemic. The PPP loans are forgivable as long as the proceeds go towards eligible purposes (more on this later).

The program’s goal is to help small businesses recoup the losses incurred due to the economic decline brought on by the pandemic. By providing financial assistance to these small business owners, they can continue paying their employees and pay for their ongoing business expenses like rent, utilities, repairs, mortgages, and more during the ongoing crisis.

Since the program’s establishment, the government opened two PPP Loan draws for eligible businesses. The first draw allowed businesses to borrow 2.5x their average monthly payroll, with hospitality businesses being offered up to 3.5x their average monthly payroll seeing as that industry was one of the hardest hit by the pandemic. The government caps the loan amount to $10 million for eligible businesses on the first draw.

The second draw offers up to $2 million worth of funding to businesses. However, to be eligible for the second PPP loan draw, you (the business owner) must show that your business lost more than 25% of its annual revenue because of the pandemic.

PPP Loan Forgiveness Terms

As mentioned, the government allows businesses to apply for the PPP loan forgiveness. However, the SBA did set some ground rules that the business must follow to qualify for the loan forgiveness.

According to the SBA’s website, first and second draw borrowers will be eligible for the full PPP loan forgiveness ONLY if they have done the following within the eight to 24 weeks coverage period of each loan:

  • Maintained employee and compensation levels
  • Used the loan’s proceeds towards eligible uses
  • Spent 60% of the loan’s proceeds towards payroll costs

Expenses Eligible for PPP Loan Forgiveness

With the PPP, you can either have the entire loan amount forgiven or just a part of it. Loan reduction can happen by the dollar if the business spends the loan’s proceeds outside the recommended uses.

Before, the use of PPP loans was limited to payroll and operating costs. However, the government since expanded the eligible uses and included three more categories to the list, namely:

  • Supplier costs
  • Worker protection
  • Property damages

Payroll costs

As mentioned, part of the PPP loan forgiveness term was to allocate AT LEAST 60% of the funds to payroll costs. This is applicable in both the first and second draw for PPP loans.

But what do the payroll costs entail?

As per the SBA’s guidelines, the payroll costs eligible for PPP loan forgiveness include all of the following items:

  • Salary, wage, commissions, and other related compensations
  • Payment of cash tips or equivalent
  • Cash bonuses
  • Medical or sick leaves
  • Separation or dismissal allowance
  • Payments for any employee benefits (i.e., health insurance premiums, retirement benefits, etc.)
  • Payments of state or local tax on employee compensation

It’s worth noting that the SBA caps PPP the reimbursement for wages at $100,000. That means if an employee earns more than that per year, any amount beyond the $100,000 threshold will not be covered by the PPP loan forgiveness.

Moreover, some of the payroll costs that are not eligible for the PPP loan forgiveness include the following:

  • Payroll taxes
  • Railroad retirement taxes
  • Income taxes
  • Salaries of employees outside the United States
  • Qualified family leave wages (as the Families First Coronavirus Response Act already covers this)
  • Payments made to independent contractors
  • S corp and C corp owners who aren’t in the company’s payroll list (i.e., shareholders that aren’t actively participating in the company’s processes)

Other Eligible Costs for PPP Loan Forgiveness

You can use the remaining 40% of the PPP funding towards other eligible business initiatives such as:

  • Operating costs. This is your business’ ongoing day-to-day expenses. It includes costs like mortgage payments, rent, utilities, as well as accounting, inventory, and payroll management programs.
  • Supplier costs. Supplier costs refer to purchase orders for perishable goods essential to the operation of your business. However, the PPP loan forgiveness will only apply to PO’s issued before or within the loan’s coverage period.
  • Health and Safety. This includes any expenses that go towards maintaining the health and safety of the company’s workers. The costs could be anything from meeting health and safety requirements (i.e., providing personal protective equipment, barrier installations, outdoor dining expansion, etc.) to allowing workers to undergo health screenings.
  • Property damage. The PPP loan forgiveness also covers any expenses made towards repairing damages caused by public disturbances that occurred at the beginning of the pandemic in 2020. For this to work, the business must ensure that these costs are not covered in any of its insurance.

Important Note:

Business owners can also use PPP loans to refinance existing debts. However, debt refinancing isn’t considered an eligible use for the loan, and therefore, will not be qualified for loan forgiveness. The owners will need to repay the portion they used to pay for their debt obligations.

PPP Loan Forgiveness Conditions

Along with the eligible expenses listed above, the PPP loan forgiveness also comes with certain conditions that business owners must meet. We’ve laid it all out for you below:

1.    8 to 24 weeks expense coverage

One of the things the government stipulates about the PPP loan forgiveness is that the business must incur all eligible expenses within the loan’s eight to 24 weeks coverage period. The loan coverage usually starts on the day the lender releases the funds and transfers them to your account.

Know that you don’t necessarily have to adjust your payroll schedule to fit into the 8 to 24 weeks coverage period. All salaries and wages that your staff earns during the entire loan coverage period are eligible for loan forgiveness, even if the actual payout falls outside the covered period.

2.    60-40 Funding Allocation Rule

The SBA also stipulates that AT LEAST 60% of your loan amount should go towards your payroll costs, and the remaining 40% can be used towards other eligible purposes, as mentioned above. Note that owners must not include payments made to individual contractors in their loan forgiveness calculation.  So, if you spend less than 60% of the loan amount on payroll, you can still qualify for forgiveness, but you just won’t be eligible to claim full loan forgiveness.

Here’s how it works: if the SBA grants you a $100,000 PPP loan, you’d have to spend $60,000 (60% of $100,000) of it on the payroll. However, you ended up paying only $50,000 on the payroll costs, which is approximately 83% of the minimum payroll costs required for full loan forgiveness. That said, the loan amount eligible for forgiveness will only be 83% of the total loan amount, which is more or less $83,000. The owners would then have to pay the difference ($17,000).

To find out your maximum forgivable amount, simply take the maximum amount you pay on your payroll costs and divide it by 0.6.

3.    Requirements for Staffing

The primary purpose of the PPP loan is to help Americans retain their jobs. With that, the SBA also requires businesses to maintain the number of staff and employees on their payroll.

To determine if you’ve met this requirement, you need to know the number of full-time equivalent employees employed in your company in the following periods:

  1. Between the eight to 24-week period following the PPP fund disbursement
  2. February 15, 2019 to June 30, 2019
  3. January 1, 2020 to February 29, 2020

Once you have the numbers, divide A with B. Do the same with A and C. Use whichever value of the two is higher as your basis. Then use this interpretation to determine whether you’ve met the employee requirement or not.

  • If you get a result of more than 1, then you’ve successfully maintained your employee headcount, and therefore, meet the staffing requirement.
  • A result of less than 1 indicates that you didn’t meet the headcount, and the forgivable amount will decrease proportionately.

Seasonal businesses usually don’t employ the same number of staff throughout the year. With that, seasonal employers typically have the freedom to choose which 12-week period (between February 15, 2019 to February 15, 2020) to use when calculating their maximum loan forgiveness.

To determine whether your seasonal business meets the requirement, you must know the number of full-time equivalent employees they had during these periods:

  1. 8-week to the 24-week period following the PPP fund disbursement;
  2. Your company’s best 12-week period

Divide A by B, then interpret the results. Use the same guidelines mentioned above to know whether you were able to meet the requirements or not.

All that being said, it would be wise to calculate the employee headcount requirement before you apply for the PPP loan forgiveness. If you don’t meet the required headcount, the SBA will require you to rehire those employees.

However, some employees may not want to continue working for the company and reject the reemployment offer. If that’s the case, the SBA will allow you to exclude this employee from the loan forgiveness calculation provided that you can meet the following qualifications for the exemption:

  • You must have made a written offer to rehire in good faith
  • Offered the same hiring terms (compensation, number of hours, etc.) before the management laid them off
  • Provide documentation of the employee’s rejection of your reemployment offer

Additionally, you can also qualify for the employee rehiring exemption if these conditions apply to an employee:

  • They voluntarily resigned from their position
  • Requested and received a reduction in the number of working hours
  • He/she was dismissed or fired for a reasonable cause (i.e., poor performance)

Furthermore, the SBA may require eligible businesses to demonstrate that they could not hire a new employee to fill in the vacant position. They will also have to explain why the company wasn’t able to go back to normal operations because of the safety requirements before they can qualify for loan forgiveness.

4.    Salary Requirements

To qualify for the PPP loan forgiveness, you should be able to retain at least 75% of your employee’s salary. This requirement applies to all your employees earning less than $100,000 per year.

If, for instance, the total salary your employee received over the loan’s covered period is less than 75% of what they received in the previous quarter, the eligible amount for loan forgiveness would be reduced. In this case, the maximum forgivable amount would be the difference between 75% of their original salary and their current salary.

5.    Grace period for rehiring

If you’re planning to reemploy the employees, you should have been able to do it before December 31, 2020, for you to qualify for 100% of the PPP loan forgiveness. That is, for PPP loans distributed in the year 2020.

For PPP loans granted in 2021, the SBA hasn’t released the official statement regarding their rehiring grace period. As of now, it would be wise to do the reemployment before the end of your loan’s covered period.

PPP Loan Forgiveness for Self-Employed Individuals

Self-employed individuals, such as independent contractors, are also entitled to a PPP loan to replace the profit loss (compensation replacement) they incurred throughout the COVID-19 pandemic. They can claim up to 2.5 months’ worth of their 2019 or 2020 net income (or gross income for loans approved after March 3, 2021) to pay themselves.

To qualify for the PPP loan forgiveness, they must follow a similar set of guidelines wherein 60% of the funds they get from the PPP loan should go towards payroll costs, capped at $100,000. The remaining 40% should go towards eligible expenses for the individual to qualify for the full PPP loan forgiveness. The independent contractor should have these qualified expenses listed as deductions on their 2019 Form 1040 Schedule C to be eligible for loan forgiveness.

The Bottom Line

There’s a lot that goes into the PPP loan forgiveness, and if you’re applying for it, the process could be a long and daunting one. However, by learning the ropes, it will be easier for you to navigate the application process. As long as you use the funds towards eligible uses, including payroll, operating expenses, and others, you’ll have better odds of increasing your chances of getting approved for the full PPP loan forgiveness.

Dane Panes
Dane Panes started freelance writing in 2017. Since then, she has written about a lot of topics for different businesses. She started writing for SMB Compass in March 2020 and has been a full-time content writer ever since. Now, she focuses mostly on topics related to entrepreneurship and business financing.

Related Articles