Be Careful of the Hidden Impact of PPP Loan Forgiveness on FAR Overhead Rates

At first glance, it may seem like a no-brainer for architecture, engineering or construction (“AEC”) companies to apply for forgiveness of their Paycheck Protection Program (“PPP”) loan. If the loan qualifies for forgiveness, the forgiveness is not taxable, and, thanks to recently passed legislation, the expenses paid with the loan proceeds are deductible. In effect, this would be tax-free money from the government.

However, an AEC company that participates in government contracts has other considerations related to PPP loan forgiveness – primarily the potential impact of forgiveness on Federal Acquisition Regulation (“FAR”) overhead rates. An AEC company that participates in government contracts must frequently calculate indirect costs (overhead) rates before submitting a bid for a contract. These rates must be compliant with the FAR, a complex set of rules governing the federal government’s contract process and the rates to be billed under the contract.

How Can PPP Loan Forgiveness Impact FAR Overhead Rates?

FAR 31.201-5 states that the applicable portion of any income, rebate, allowance, or other credit relating to any allowable cost received by an AEC company shall be credited to the government. This credit is not in the form of a direct payment to the government. The credit will be used to reduce the overhead expenses of that company, in turn reducing the FAR overhead rate.

FAR guidance combined with publications from various regulatory bodies indicates that the income received from PPP loan forgiveness will need to be recognized in the year the loan is forgiven. Under generally accepted accounting principles (“GAAP”) the income from the loan forgiveness is not recognized until actual forgiveness takes place, even if the loan proceeds were utilized in a prior year. For example, a loan received in 2020 but not officially forgiven by the SBA until 2021, will be reflected as a liability on the company’s balance sheet at December 31, 2020, and recorded as income in 2021, even if the application for forgiveness was submitted in 2020. Since a company’s financial statements form the basis for the FAR overhead rate calculation, the FAR guidance on the recognition of loan forgiveness income is consistent with GAAP.

How Can PPP Loan Forgiveness Impact My Company if I have Government Contracts?

The potential reduction in the FAR overhead rate in the year the loan is forgiven could be substantial. The overall magnitude of the impact on profits will depend on the balance of a company’s government vs. private work. A higher percentage of government work could even result in a company “paying back” in reduced overhead rates a large portion of the actual loan forgiveness. In addition, the reduced overhead rate will also affect the rates for the length of the contract. A longer-term contract with an overhead rate reduction will have a greater impact on reducing the company’s revenue for the duration of that contract.

This means that applying for forgiveness should be evaluated very carefully. It is extremely important to have a detailed analysis performed of estimated overhead rates taking into account loan forgiveness prior to requesting this forgiveness. Companies should consider their current overall contract portfolio and projections of the mix of new work that would be subject to the reduced overhead rates. Companies with long-term contracts that have the majority of their work subject to these rates could be significantly hurt because their future revenue reductions could equal or exceed their loan forgiveness.

The guidelines and regulations surrounding the PPP program continue to evolve. There is some industry support for legislative relief that would allow AEC companies performing government work to not have to reduce their overhead expenses for the loan forgiveness. However, based on what is known at this point, companies should assume that any loan forgiveness will result in a reduced overhead rate.

Please contact Phillip Ross, David S. Rubin, or your Anchin Relationship Partner for further information on this critical topic or any other related matters. We are here to help.