Drafting errors & other CARES Act issues

There’s been a lot of chatter on the social media websites and between individual tax professionals about various aspects of the CARES Act. There are three items that a small group of us looked into over the past week and I volunteered to use my blog to bring them out into the open. These are issues that don’t fit neatly into a tweet or even a thread of tweets.

While most professionals have been focused on the loan amounts and the calculations that go into figuring out how much is eligible for the maximum loan amount under CARES Act section 1102, the issues we were talking about are related to the forgiveness amounts under the CARES Act section 1106.

These are issues that we all believe should/can/will be fixed by a technical correction in future legislation; however, the way the final version of the bill was written contains some pitfalls for borrowers that aren’t being reported. Here are the main issues and the links should take you to the relevant section of this blog post.

Drafting errors in “Reduction based on Reduction in Number of Employees”

OK, it appears there might be a drafting error in the way the CARES Act was written and this one seems to be the biggest and most concerning. This was brought to my attention by a TaxTwitter friend who didn’t want to share it because it came from a lawyer. Basically, the lawyer has a different reading of the bill, and after looking at the final bill, I agree with this lawyer.

Hopefully I’m wrong and someone can correct me.

This all focuses on the forgiveness of the Paycheck Protection Program loans. I’m cutting to the chase and going to assume you’re already familiar with the basics of the program.

The basics of the forgiveness are the borrowers spends the loan proceeds over an 8 week period and then is eligible to have all or a portion of the loan forgiven based on how the proceeds were spend. However there is a provision of the CARES Act that limits the amount that can be forgiven. There is plenty of chatter on how to calculate the amount eligible for forgiveness, especially as it related to the payroll costs, but I don’t see very many people looking at the forgiveness portions of the Act.

CARES Act section 1106(d)(2) covers the reduction based on the number of employees. The purpose being that if the employer reduces the number of employees, then the amount forgiven is reduced by a corresponding ratio of the number of employees. So, if an employer had 10 employees but reduced the number of employees to 9, the amount eligible for forgiveness would be reduce by 10%.

The problem is that in the final version of the legislation, the way the formula was written was changed from what appears in the House version and it creates a situation where the full amount of the expenses eligible for forgiveness are reduced to zero. How is this possible you ask? Well, look at the way the reduction amount is calculated in the final version of the CARES Act.

Reduction amount = Forgiveness Amount x (Avg # of employees that you employed during the 8 week covered period)/(one of two options that you select)

Option 1: Avg # of employees that you employed from February 15, 2019 through June 30, 2019; or,

Option 2: Ave # of employees that you employed from January 2, 2020 through February 29, 2020.

Enacted version of the CARES Act.

If you look closely at the reduction amount formula in the CARES Act Section 1106(d)(2)(A), you’ll see that if you maintain the same average number of employees during the 8 week covered period as you did during the measurement period, the quotient is 1, or 100%. Therefore, the reduction amount would equal 100% of the forgiveness amount and result in none of the loan balance being forgiven.

Now, I know this is NOT what Congress intended to happen. In fact, my guess is that when the bill was being edited by the House of Representatives, someone was working on this part at 2:00 am in the morning and just messed up. However, it is in the law, so that’s what rules right now.

If you look closely at the Senate version of the bill, which is what most people looked at because they assumed there was no material change to this part of the legislation, the formula for the reduction amount is:

Forgiveness amount x
(1 – (avg # of employees employed during the covered period)/(one of 2 option that you select))

Senate version of the CARES Act.

The Senate version gets to the answer that most people are expecting. I asked my favorite tax experts about this and their response was that this should be corrected but some of them were a little concerned that there hasn’t been more discussion about this. The thinking being, if there’s no discussion about it, then no one will know to change it.

Drafting errors in “Reduction Relating to Salary and Wages.

This issue is definitely open to interpretation and there doesn’t seem to be many people interpreting it in a way that is adverse to the borrower. However, at least one CPA ran some calculations using the text of the bill and found that there could be a problem. I am including it here to see if anyone else sees the same problem.

The CARES Act Section 1106(d)(3) covers the calculation of the amount that the forgivable portion of the loan must be reduced due to a reduction in the salary and wages paid to any employee that is greater than 25%. In general, everyone seems to assume the intent of Congress is that as long as you don’t reduce an employee’s salary and wages by more than 25%, then there is no reduction to the forgivable portion of the loan.

The problem lies in the wording of section 1106(d)(3)(A), which states:

(A) IN GENERAL. – The amount of loan forgiveness under this section shall be reduced by the amount of any reduction in total salary or wages of the employee described in subparagraph (B) during the covered period that is in excess of 25 percent of the total salary or wages of the employee during the most recent full quarter during which the employee was employed before the covered period.

For clarity purposes, let’s make sure we look at the definition of some of the terms used in section 1106(d)(3(A).

  • First is the definition of an employee in subparagraph (B). Here’s that definition:
    (B) EMPLOYEES DESCRIBED.—An employee described in this subparagraph is any employee who did not receive, during any single pay period during 2019, wages or salary at an annualized rate of pay in an amount more than $100,000.
  • The second definition to look at is the covered period. The covered period in section 1106 is defined in section 1106(a)(3) as:
    (3) the term “covered period” means the 8-week period beginning on the date of the origination of a covered loan.

The issue becomes a comparison of the amount of pay over an 8 week period being less than 25% of the pay to the same employee over the most recent full calendar quarter. For simplicity, lets assume the calendar quarter is 12 weeks long. Now let’s look at some math and see how this plays out.

Assume payroll of $100,000 per year for only one employee and there is no pay cut during the covered period.

In a 52 week year, the employee’s weekly pay is $1,923. The amount of the loan the company is allowed to take out is 10 weeks of salary, in other words, it’s 2 and one half months. The total loan would be $19,231.

Assuming there is only this one employee and no other expenses, the total amount of the loan that is eligible for forgiveness is 8 weeks of salary and wages, or $1,923 * 8 weeks = $15,384.

This is where it gets interesting.

For the full calendar quarter, the total pay is $1,923 * 12 weeks = $23,076.

The reduction amount is based on 25% of the full calendar quarter, so we have $23,076 * 25% = $5,769.

We paid the employee $15,384, so the difference between what the employee was paid during the 8 week covered period and the prior full calendar quarter is $23,076 – $15,384 = $7,692.

In this case, the amount of the reduction to the forgivable portion of the loan would be $7,692 – $5,769 = $1,923.

Therefore, instead of having $15,384 of the loan forgiven, it would be $15,384 – $1,923 = $13,461.

No one is making a big deal about this because they are annualizing the 8 week period and then taking one quarter of it when comparing the amount paid under the covered period to the amount paid in the prior calendar quarter. This is probably what was intended, but there’s at least one way to interpret the reduction provision where you end up having the forgiveness amount reduced even though you did not change the employee’s salary and wages based on the way the CARES Act Section 1106(d)(3) is written.

Issues with the Hold Harmless Clause

The hold harmless clause is included in the forgiveness section of the CARES Act Section 1106(h). The section provides that if the lender doesn’t agree with forgiving the loan, the the borrower has zero recourse because the can’t take any enforcement action against the bank. This is more of a legal question that I don’t fully understand the ramifications of but it seems like it could be a big deal if the borrower doesn’t agree with the amount of the loan that the lender agrees to forgive.

One attorney pointed out that if the law is changed after taking out the loan and the first two issues are fixed, and then the bank doesn’t agree to forgive the loan based on the way the law was written at the time the loan was made, then the borrower doesn’t have any recourse against the bank. Like I said, this is a legal question and I’ll leave it to the attorneys and legal experts to decide if this is a real issue that needs to be fixed or just accountants making assumptions that won’t matter in the real world.

This hold harmless clause also has me concerned because the section on forgiveness talks about an eligible recipient being eligible for forgiveness of debt on a covered loan. See CARES Act Section 1106(b). It doesn’t say the recipient SHALL have an amount forgiven based on specific actions, just that they are eligible for forgiveness. Then in Section 1106(e), the eligible recipient must apply to have the loan forgiven. There is a list of information that must be included in the application for forgiveness, but I don’t see any instructions on how the lender is supposed to make the decision of whether to forgive the loan or a portion of the loan.

Under Section 1106(g), the only thing that the lender has to do is issue a decision on the application within 60 days of receiving the application for loan forgiveness. If I’m missing something please let me know, because the wording has bothered me since the first time I read the act. This whole talk about being eligible and the lender getting to make a decision sounds like there is an option that the lender does not have to forgive the loan even though the borrower has complied with the actions needed to be eligible for the forgiveness. Then, given the hold harmless clause, the borrower has no method of making the lender change its mind.


These are all items that people much smarter than me seem to think will be resolved before they become big issues. However, given how well the roll-out of the Paycheck Protection Program has been, I’d like to see these issues addressed and fixed sooner, rather than later.

DISCLAIMER: This is not intended to be tax or legal advice. You should not rely on this post to make a decision for yourself or your business because this post is only informational. Please contact your tax professional and your attorney before making any decisions based on what is included in this post.

1 thought on “Drafting errors & other CARES Act issues”

  1. Brian,

    I am so glad I found someone else who actually read the bill and noticed the general sloppiness. I am appalled both at the drafting errors and the laziness of the so-called “professionals” who are guiding executives on this bill. I am reading guideline after guideline sent from law and accounting offices that are oversimplifying the whole thing with a flat “75% needs to be used for payroll rule” when in fact some people will need to use much more than that to comply with the black letter of the law (those who kept their full workforce and at the current salary rate) and some will need to use much less.

    Consider a circumstance where a business fires all of their $24/hour guys and hires $12/hour guys with no full quarter of employment history. As long as they maintain headcount, they would have a lower (possibly $0) obligation to payroll since there was no full quarter of which to base the 75% obligation. 0% of 0 is 0. The obligation would technically be $0 at best based on the black letter, half the original amount at worst if there were some ‘implied’ standard.

    Then consider anybody who got a bonus in 2019 that brought that single pay period to an annualized rate above $100k. That person is exempt as an “employee”, even if their salary was $50k as long as they had a big enough bonus. Feel free to cut that employee down by as much as you want, right?

    Now you would still have to have other qualified expenses to book the rest of the forgiveness to, but theoretically one could just jack up owner/executive compensation to cover it. This strangely is not excluded. So if you had $450k in loan amount, you could theoretically cut your workforce, hire new heads, and keep the entire $450k based on my reading. Am I missing anything? Obviously most businesses wouldn’t be able to do this and also remain viable since you need your experienced staff, but it’s not entirely out of the question.

    I wanted to add that it appears there is some confusion as to the payrolls being included in the maximum loan amount. SBA applications all seem to indicate CY 2019, but for those of us whose payroll went up in the first quarter of 2020, we’d prefer to use a rolling year up to the loan origination date, which seems to be the intent of the bill. Our bank let us use this amount, but not without some hassle.

    And lastly, anybody that scaled up between June 30 of last year can scale back down to where they were then, even if it means laying off 90% of their current workforce, and still be eligible for the full forgiveness.

    These are just issues that I have noticed on top of the ones you have. Unbelievable.

    Thanks for pointing this out.


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