As businesses rush to apply for Paycheck Protection Program loans (PPP Loans) on a first-come, first-serve basis under the Coronavirus Aid, Relief, and Economic Security Act, or the CARES Act (H.R. 748) signed into law on March 27, each business should consider another alternative provided under the act called the employee retention credits (the credits). A business may choose either a PPP loan or the credits, not both. If a business takes the credits and obtains a PPP loan, the credits are recaptured and must be repaid to the Internal Revenue Service. The question each business should ask itself is, "What will provide the most economic benefits, a PPP loan or the credits?" The answer is not so obvious.

PPP Loan and Its Forgiveness Component

Among many other provisions in the act was the creation of PPP Loans. A PPP Loan is 100% guaranteed by the U.S. Small Business Administration and is designed to assist businesses with fewer than 500 employees (a small business) impacted by the COVID-19 pandemic by providing immediate liquidity to fund a small business' payroll costs, health insurance, salaries, mortgage payments, rent and utilities for two and a half months. A PPP loan will have a term of two years and a 1% interest rate. Seventy-five percent of the PPP Loan proceeds must be used by the small business to fund payroll costs and the remaining 25% of the PPP loan proceeds must be used to fund overhead costs (insurance, salaries, mortgage payments, rent and utilities). If a small business spends the PPP Loan proceeds within eight weeks of receipt in accordance with this 75:25 ratio and does not reduce its workforce or employee wages during this time, the obligation of such small business to repay the PPP loan is forgiven. If a small business does not adhere to this 75:25 ratio or reduces its workforce or employee wages, then a portion of the PPP loan will not be forgiven and the small business will be required to repay such portion. The act further provides that any portion of a PPP loan that is forgiven is excluded from the small business' gross income for federal income tax purposes.

The portion of the PPP loan that may be forgiven is based on the number of employees retained on certain testing dates. For example, if a small business receives a PPP loan on May 1 and maintains eight full-time employees through June 30, and the small business had an average of 10 full-time employees for the period Feb. 15, 2019, through June 30, 2019, and the period Jan. 1, 2020, through Feb. 29, 2020, (the small business may choose which period to use), only 80% of the PPP loan is forgiven and the small business is required to repay the remaining 20%. A similar pro-rata computation is made for salary and wages reduced by more than 25%.

Employee Retention Credit Eligibility

In general, a business (regardless of the size) that has suffered certain financial harms due to COVID-19 can claim the credits against the employer share of such business' employment taxes (not the employee's share that is withheld by the employer) for calendar quarters in 2020 in an amount equal to 50% of the qualified wages with respect to each employee of such business, capped at $5,000 per employee for all such calendar quarters. Such financial harms are, in general, having the business fully or partially suspended due to a COVID-19 related governmental order or suffering a significant decline in gross receipts (based on a mathematical formula applied each calendar quarter). The type of wages that qualify depend on whether the business had an average of 100 or less full time employees (FTEs) in 2019— if 100 or less FTEs, all wages paid while the business is suffering financial harm qualify for the Credits; if its more than 100 FTEs, only the wages paid while the business is suffering financial harm to employees who are not working because of COVID-19 related issues qualify for the Credits.

The credits are, unlike the PPP loans, available to businesses of any size and may be applied toward qualified wages paid after March 12, 2020, and before Jan. 1, 2021. The credits operate to create liquidity for businesses by freeing up cash flow that would otherwise be paid to the Internal Revenue Service. To the extent the credits exceed the employment taxes of a business for any given calendar quarter, such excess is refunded to the business. For more information on the credits and other changes the act made to the IRS Code to provide businesses and individuals with liquidity, please refer to [CARES Act: Important Tax Code Changes, dated March 30, 2020.]

Small Businesses Forecasting a Reduction in Workforce or Employee Pay

If a small business foresees a reduction in either workforce or employee pay that would result in the requirement to have a significant portion of the PPP loan repaid, then such small business should consider whether it will be able to repay the portion required to be repaid without significant hardship or whether the small business should take the credits rather than the PPP loan. However, a key consideration for a small business considering the credits, rather than a PPP loan, is the effect COVID-19 had and will have on such small business. Since the credits may only be used for qualified wages paid after March 12, 2020, while suffering financial harm, and since the gross receipts test is applied quarterly and government-manded suspensions may be lifted, the ability to obtain the credits may be limited for certain small businesses from quarter to quarter. A small business who has been partially or fully suspended should consider when such suspension may be lifted for purposes of eligibility for the credits going forward. A small business who otherwise has not been fully or partially suspended should consider its forecasted gross receipts on a quarterly basis and apply the mathematical formula for purposes of determining eligibility for the credits going forward. In addition to gross receipts and government orders, the number of employees should be considered by a small business in deciding between a PPP loan or the credits, because a small business may be limited to the credits only on wages paid to employees who are not working due to COVID-19 (where more than one hundred (100) FTEs). As the forgoing illustrates, in deciding between a PPP loan and the credits, forecasting is paramount and it's important for small businesses to get as much data as it can and to speak with its advisers in order to make an informed decision (to the best it can). However, as the old saying goes, "You don't know, what you don't know." Forecasting the uncertain is difficult, particularly in these uncertain times.

Large Businesses

Consider a business with more than 500 employees (a large business). A large business is not eligible for a PPP loan (since eligibility for PPP Loans is capped at 500 employees, subject to some exceptions). Fortunately, the act provides a similar loan (the non-PPP loan) to a Large business without the forgiveness component. A large business must decide: a non-PPP loan under the act, which is a presumably significant in size and required to be repaid (albeit on favorable terms) terms, or the credits at $5,000 per employee. The credits may sound more appealing, particularly where the large business has a critical mass of employees. However, a large business still has to consider to what extent it is eligible for the credits in the first place (business is wholly or partially suspended or significant decline in gross receipts, and the duration to which it anticipate these hardships to continue) and, because it has more than 100 FTEs, what wages qualify for the credits.

Which Option Is Better: PPP Loans or the Credits?

In sum, for those small businesses who can reasonably anticipate satisfying all PPP loan requirements to have 100% of the PPP loan forgiven, even if it loses some employees for reasons beyond its control, the PPP loan and its debt forgiveness and exclusion from gross income features are, to use a technical term, a "no-brainer." For other businesses, careful consideration should be given whether the PPP loan, the non-PPP Loan under the act, or the credits is the most beneficial choice.