Every American has been impacted in some form by the COVID-19 pandemic, and small business clients and their employees may be among those who could be hit by the economic fallout for years to come.
Many are facing sharp declines in revenue and unprecedented operational challenges, if not complete shutdown. Small business employees are facing similar challenges—and the federal government has stepped up to require paid leave for impacted employees. The Coronavirus Aid, Relief and Economic Security Act (CARES Act) provides a fresh batch of new aid, including help for small businesses struggling to stay afloat and for employees who need access to funds in employer-sponsored retirement accounts.
This article addresses two key areas likely impact small business clients the most: the expanded availability of direct cash loans and penalty-free access to retirement funds.
Direct Cash: Small Business Loans
Even small business clients who diligently plan for future downturns may not have the cash flow to weather the fallout from COVID-19. The CARES Act provides opportunities for small business owners to get direct cash loans to keep their businesses afloat—even without a formal, documented showing of financial loss, which is being presumed under the new law. Two primary types of loans are available under the law: (1) expanded Economic Injury Disaster Loans (EIDLs) and (2) Paycheck Protection Loans.
EIDLs are available through the Small Business Administration (SBA), and, even pre-COVID-19, contained favorable terms such as 30-year repayment periods, 3.75% interest rates and deferral of the first month’s payments. The expanded relief makes it easier to qualify as long as the business existed as of January 31, 2020. The SBA can grant the loan based on the business’ credit score without a tax return and regardless of past bankruptcies—and the average annual receipts tests will not apply. For loans of less than $200,000, no personal guarantee or real estate collateral is required.
Up to $10,000 can be borrowed and later forgiven if it is spent on providing employees with paid leave or meeting payroll, paying mortgage interest or rent or dealing with increases in cost caused by supply chain issues. The law also extends the loan availability to businesses who are able to obtain credit elsewhere, and waives loan fees, guarantee fees and early prepayment fees.
Payroll protection loans are primarily available to employers with fewer than 500 employees that were in operation before February 15, 2020. These loans max out at (a) $10 million or (b) 2.5 times the employer’s average monthly payroll costs during the one-year period ending the date the loan is made. Loan terms for amounts not forgiven include: interest rates of up to 4%, 10-year repayment terms, payment deferrals for six to 12 months and waiver of personal guarantee and collateral requirements.
Part of the payroll protection loan can be forgiven when used during the 8 weeks following the loan origination date for operating costs like payroll costs, rent, mortgage interest, interest on outstanding debt, utilities, employee retirement benefits and health insurance costs. Compensation that exceeds $100,000 per employee, as pro-rated for the period, is excluded from the definition of payroll costs.
Loan forgiveness does require the employer to maintain the same average number of employees during the first 8-weeks of the loan, based on the 8-week period spanning from February 15, 2019-June 30, 2019 or January 1, 2020-February 15, 2020 (loan forgiveness will be pro-rated, not entirely eliminated, for employers who reduce staffing). Reducing compensation for employees earning under $100,000 by more than 25% can also reduce the amount forgiven.
The CARES Act allows employees to take up to $100,000 in distributions from an employer-sponsored retirement plan (401(k), 403(b) or defined benefit plan) or an IRA without becoming subject to the 10% early distribution penalty. Unless the participant elects otherwise, inclusion of the distribution in income is spread over three years, beginning with the tax year of distribution.
The law also provides for repayment options to allow employees to repay eligible distributions during the three-year tax period beginning with the tax year of distribution (whether in a lump sum or installments over time). Although not specifically noted in the law as written, the repayment seems to be repayable to any type of plan that will accept the repayment, in which case it will be treated as a nontaxable rollover via direct transfer.
The penalty waiver is effective for distributions made on or after January 1, 2020 and before December 31, 2020. The waiver is available for any “coronavirus affected individual”, which includes both those who have been diagnosed (or had a spouse diagnosed) with the virus and those who have suffered financial consequences caused by layoffs, work reduction or being unable to work because of the need to provide child care.
Employers can rely upon employees’ certifications that they satisfy conditions related to the hardship distribution.
Similarly, plan loan rules are expanded to increase the available loan limit from $50,000 to $100,000 during the 180-day period beginning March 27, 2020. The due date for repaying loans taken before December 31, 2020 is delayed one year. RMDs for the 2020 tax year have also been waived.
The retirement-related provisions in the CARES Act essentially mirror those that typically apply after localized natural disasters—albeit on a much larger scale, and whether plans are required (or simply permitted) to implement the expanded hardship rules remains to be seen.
The small business loan provisions, while streamlined in operation, are more complex and will likely generate much more detailed guidance in the coming days. For advisors, the key will be remaining current with respect to rapidly emerging guidance under unprecedented circumstances.