Perspectives - Pastore

A Brief Review of Some, and Only Some, of the Nondiscrimination Tax Tests Applicable to Qualified Plans Under Section 401 of the Internal Revenue Code

Posted on July 28, 2020July 13, 2021 by Liam Mennitt

The mathematics of the annual testing for compliance with the rules requiring qualified plans to demonstrate nondiscrimination are spread though several sections of the tax law, rendering the calculations needed somewhat opaque. This note attempts to summarize some of the calculations so that plan sponsors might feel better empowered to assess the effect on compliance of both current and anticipated plan features.

Among the many compliance tests that qualified plans must meet in order to retain their qualified status are nondiscrimination tests which assure that the benefits of tax-deferred compensation do not accrue disproportionately to highly compensated employees (HCEs). There are several tests within this regime, but two of the more important tests, for our purposes, are the annual Actual Deferred Percentage (ADP) and Actual Contribution Percentage (ACP) calculations. While ADP considers only employee deferrals, ACP also includes employer contributions. Plan sponsors of non-exempt plans must conduct both tests, whether or not their results match.

The purpose of 401(k) nondiscrimination tests is to ensure that all employees are benefitting from plan participation. Otherwise, those who own the company and Highly Compensated Employees (HCEs) would stand to benefit disproportionately from being able to defer their income for tax purposes over Non-Highly Compensated Employees (NHCEs). Because, for example, a plan to increase the share of compensation that only HCEs may defer could cause a non-exempt plan to fail one or more nondiscrimination tests, thereby exposing the plan sponsor to penalties and possible loss of the qualified status of the plan, it is worth considering the calculations used in the ADP and ACP tests and how those calculations might be affected by adding the feature of increased deferral rights for HCEs.

For purposes of this testing, an HCE is an individual who either:

Owned more than 5% of the interest in the business at any time during the year or the preceding year, regardless of how much compensation that person earned or received, or
For the preceding year, received compensation from the business of more than$125,000 (if the preceding year is 2019 and $130,000 if the preceding year is 2020), and, if the employer so chooses, was in the top 20% of employees when ranked by compensation.

One of the qualifications a plan must meet to be or remain a “qualified plan” within the meaning of Code Section 401 is that it not discriminate in favor of highly compensated employees. This condition is described at §401(a)(4):[[

(4) if the contributions or benefits provided under the plan do not discriminate in favor of highly compensated employees (within the meaning of section 414(q)). For purposes of this paragraph, there shall be excluded from consideration employees described in section 410(b)(3)(A) and (C) [providing definitions for, respectively, the “year of service” and “hours of service” generally allowed as conditions for vesting]

Actual Deferral Percentage – 26 C.F.R. §1.401(k) -2

The ADP test calls for employers to compare the average annual deferral rates of HCEs and NHCEs. This test excludes employer matching and measures only employee deferrals. See, Reg. §1.401(k)-2. The ADP test also measures employee compensation only in cash and stocks. Health insurance and other fringe benefits are excluded. The employer (usually the plan administrator handles this tax, but the employer is responsible). This equation is used, separately, for both HCEs and NHCEs:

Where

n= total number of either HCEs or NHCEs

D= total employee deferrals, both pretax and Roth, for each employee

C=each employee’s total annual compensation

Actual Contribution Percentage – 26 C.F.R. §1.401(m) -2

The ACP test follows a similar patter but uses different variables. This test also measures HCE and NHCE results separately:

Where

n=total number of either HCE or NHCEs

T=total of each employee’s deferrals, after tax contributions, and employer matching

C=each employee’s total annual compensation

The largest difference between the two is that the ADP test compares relative deferrals among HCEs and NHCEs but the ACP test compares the contributions of both groups that include employer matching.

The employer then compares the test outcomes to this table:

A plan must pass both tests or the employer must take prescribed corrective action. That corrective action is not within the scope of this memo.

Using these equations, an employer can calculate its plan’s compliance at given HCE deferral rates and evaluate the effect on compliance with the nondiscrimination rules.

To be sure, the compliance tests for qualified plans are numerous, and these notes do not address the many nuances and exceptions to nondiscrimination testing. Rather, I seek here to pull back the curtain on but two often baffling, and always important, tests for qualified plans.

These notes discuss general principles only and are not intended as tax or legal advice. The reader is encouraged to discuss his or her specific circumstances with a qualified practitioner before taking any action.

A Brief Review of Just Some of the Nondiscrimination Tax Tests Applicable to 401 Qualified Plans

Posted on July 28, 2020July 6, 2021 by web

For purposes of this testing, an HCE is an individual who either:

Owned more than 5% of the interest in the business at any time during the year or the preceding year, regardless of how much compensation that person earned or received, or
For the preceding year, received compensation from the business of more than$125,000 (if the preceding year is 2019 and $130,000 if the preceding year is 2020), and, if the employer so chooses, was in the top 20% of employees when ranked by compensation.

One of the qualifications a plan must meet to be or remain a “qualified plan” within the meaning of Code Section 401 is that it not discriminates in favor of highly compensated employees. This condition is described at §401(a)(4):[[

Actual Deferral Percentage – 26 C.F.R. §1.401(k) -2

Where

n= total number of either HCEs or NHCEs
D= total employee deferrals, both pretax and Roth, for each employee
C=each employee’s total annual compensation

Actual Contribution Percentage – 26 C.F.R. §1.401(m) -2

The ACP test follows a similar pattern but uses different variables. This test also measures HCE and NHCE results separately:

Where

n=total number of either HCE or NHCEs
T=total of each employee’s deferrals, after tax contributions, and employer matching
C=each employee’s total annual compensation

The largest difference between the two is that the ADP test compares relative deferrals among HCEs and NHCEs but the ACP test compares the contributions of both groups that include employer matching.

The employer then compares the test outcomes to this table:

A plan must pass both tests or the employer must take prescribed corrective action. That corrective action is not within the scope of this memo.

Using these equations, an employer can calculate its plan’s compliance at given HCE deferral rates and evaluate the effect on compliance with the nondiscrimination rules.

How to Valuate the Start-Up Enterprise

Posted on July 23, 2020July 14, 2021 by Liam Mennitt

As with most transactions involving buyers and sellers, the valuation of a potential investment in a business is often a matter of perspective. The founder views the business equity as full of promise of future returns. The investor, holding cash and, therefore, access to alternatives as to where to deploy that liquidity, apprehends that same equity as opportunity cost, because his or her election to invest in a given enterprise ends access to alternatives. This opportunity cost looms larger for investors, and larger in proportion to their experience.

Reconciling this tension in valuation perspectives, especially with early stage ventures, between founders and investors is often left to a sort of ersatz market clearing mechanism of road shows and elevator pitches, leaving it to the experienced investors to apply their experienced, if subjective, valuation metrics to an otherwise unknown company. Less confident investors then step in behind the seasoned players to acquire an apparently lower risk, and lower value, portion of the equity.

Investors and their advisors should work with the information they have to evaluate their risk tolerance. Negotiations between the investor and the founder all too often focus on subjective hopes and dreams for the marketplace and overlooks objective calculation of the magnitude of the equity share that a startup investor should seek in exchange for a cash infusion. That is, the metric of equity share should be deployed as part of the discussions between the parties, as a goal, and not merely as an incident, of valuation. These calculations are drawn from the Venture Capital Method of valuation. Here, I briefly review this method.

Simply put, an investor that wants to obtain a desired return is obliged to follow a mathematical map to achieving that return. This calculation is accomplished using the functions of present value, future value, and percentage ownership. Let’s consider an investor who wants to deploy $1 million today in order to participate in a start-up’s anticipated $40 million exit value in five years.

The present value of the proposed $40 million exit value is calculated by discounting $40 million at the rate of 40% per year for five years. The equation for this is:

So, to accomplish the desired return on the initial investment, an investor should obtain an equity interest calculated as the initial investment divided by the present value of the exit value, or:

In other words, the investor should negotiate for about a 13.5% equity interest in order to achieve the desired return. A common way of referring to the present value of the exit value is the postmoney value of the business. We can think of it as the present value of the potential of the business if the investment is made. The term premoney value is the postmoney value less the investment, or $7,437,377 – $1,000,000 = $6,437,377.

Observe that the target rate in our calculations should be distinguished from an expected rate of return. The target rate rests on the presumption that the business grows as planned.

Next, consider what happens to our equity expectation when we raise the exit value of the enterprise to $60M.

The higher exit value raises the present value of the exit figure and reduces the equity percentage the founder will be expected to part with in return for an early stage investment. This relationship calls for both investors and founders to be aware of the incentive to under or over-estimate the likely growth of the company.

To be sure, the valuation of a startup involves as much art as it does science. Additional methods of valuation including, but not limited to, the Berkus Method, Scorecard Valuation Method, and the Risk Factor Summation Method might be productively used in addition to the Venture Capital Method to provide a broad set of metrics for understanding the potential of a new enterprise. The proper use of these tools is necessary for the success of any venture.

These notes are intended to provide a review of general principles only and are not legal or tax advice. The reader is encouraged to discuss his or her particular circumstances with a qualified professional before taking any action.

CT Department of Revenue Services’ Guidance on Effects of CARES Act on Taxpayers

Posted on July 8, 2020July 1, 2021 by Liam Mennitt

On July 6, 2020, the Department of Revenue Service (“DRS”) released initial guidance, in a Q&A format, addressing some of the issues concerning the impact of the federal Coronavirus Aid, Relief, and Economic Security Act, P.L. 116-136, on interpretation of Connecticut tax law. These notes provide a summary of some of the more important issues reviewed in the guidance.

Individual Income Tax

DRS observes that, because calculation of Connecticut state income tax begins with the individual’s federal adjusted gross income (“AGI”), which is then subjected to certain state law modifications to arrive at Connecticut adjusted gross income, and the federal economic impact payments are excluded from federal adjusted gross income, they are, therefore, not included in Connecticut adjusted gross income and not subject to Connecticut income tax.

Coronavirus Related Distributions from Qualified Retirement Accounts

Likewise, Connecticut law includes no modifications to include coronavirus-related distributions from qualified retirement accounts. Hence, insofar as federal law includes or excludes such distributions in or from income, Connecticut tax law will do the same.

Coronavirus-related distributions from a qualified retirement account, as allowed under the CARES Act, are, however, subject to the statutory 6.99% withholding unless the recipient submits a Form CT-W4P to the payor requesting that no or a lesser amount of Connecticut income tax be withheld.

Inclusion in Income of Loans Forgiven in Business or Individual Income Tax

Loans forgiven under the CARES Act Paycheck Protection Program are excluded from AGI under federal law. Because Connecticut law includes no modification of the federal treatment of AGI for state tax purposes with regard to PPP loan forgiveness, such forgiven loans are not included in Connecticut AGI for either individual income tax or corporation business tax purposes.

State Law Effects of CARES Act NOL Provisions

Corporations

Connecticut corporation business taxes are not affected by the federal carryforward and carryback rules.

Individuals

The carryback of federal net operating losses that affect an individual’s state tax liability must be done consistent with the 2014 Connecticut Superior Court opinion of Adams v. Sullivan. In that case, the court held that, because Connecticut law makes no provision for individual taxpayers to deduct federal Net Operating Losses (“NOLs”) from Connecticut AGI, those NOLs may offset Connecticut AGI for a given year only to the extent the taxpayer used those NOLs to offset federal AGI for that year. These NOLs are also subject to C.G.S. §12-727(b) (generally requiring that taxpayers filing a federal amended tax return also file with DRS a corresponding Connecticut tax return).

Note that individuals with a Connecticut source loss but with no corresponding federal loss are not affected by the NOL treatment changes of the CARES Act. Such individuals are still required to comply with Connecticut Regulation §12-711(b)(6).

Business Loss Limitation

The Tax Cuts and Jobs Act (P.L. 115-97) created a new Section l in Code Section 461. This section, among other things, disallows business losses of noncorporate taxpayers in excess of $250,000 ($500,000 for joint filers). This threshold is subject to indexing for inflation. Any amount disallowed is carried forward to the next tax year. This provision sunsets on December 31, 2025.

The CARES Act, however, repeals the excess business loss limitation for tax years 2018, 2019, and 2020. The Act also provides two additional important revisions to the law:

NOLs incurred in a year beginning after December 31, 2017 and before January 1, 2021 can be carried back for up to five years preceding the year in which the loss was incurred and
The CARES Act suspended the rule limiting NOL utilization to 80% of taxable income for tax years beginning before January 1, 2021

Because Connecticut law provides no specific statutory modifications to the excess business loss limitation, that calculation is applied to federal adjusted gross income calculations and thence to Connecticut AGI calculations under applicable state law.

The Department of Revenue Services is likely to update its guidance on this issue as more information becomes available.

These notes are intended only to review general principles and are not intended as legal or tax advice. The reader is encouraged to discuss his or her specific circumstances with a qualified professional before taking any action.

PPP Flexibility Act of 2020 Update

Posted on June 18, 2020July 12, 2021 by Liam Mennitt

As of June 17, 2020, the Small Business Association (SBA), along with the Department of Treasury, has passed revisions to the loan forgiveness application under the Paycheck Protection Program (PPP) Flexibility Act of 2020 that was signed into law by President Trump on June 5, 2020.

The newly issued application forms and instructions are available in both a full and an EZ version. The EZ application is less intensive and requires fewer calculations and documentation for borrowers. If an applicant wants to use the EZ form, it must be able to answer at least one of the three questions on the face of the EZ Instructions in the affirmative. Both applications offer borrowers the choice to use the 8-week covered period if their loan was made before June 5, 2020, or an extended covered period of 24 weeks.

It is particularly important that eligible applicants for PPP loan forgiveness have available all the necessary documentation at the time of application. Late submission of documentation will disqualify an applicant for forgiveness.

These changes were made with the intention of increasing the efficiency and availability of full loan forgiveness for businesses.

Business Interruption Insurance Update

Posted on June 2, 2020July 1, 2021 by Liam Mennitt

This is an update on the business interruption insurance claims related to the COVID-19 shutdowns as of May 29th, 2020. Across the United States, businesses are calculating both the sunk and future revenue losses resulting from the COVID-19 pandemic. Numerous businesses have filed complaints against their insurers for wrongful coverage of certain losses due to the government-mandated shutdowns of regular business operations.

As of March 16th, The Oceana Grill of New Orleans, LA was the first business to sue an insurance company on the grounds of wrongful coverage of monetary loss as a result of the Coronavirus. In the case of Cajun Conti, LLC et al. v. Certain Underwriters at Lloyd’s of London, the owners of The Oceana Grill argue that Lloyd’s is responsible for insuring their restaurant because they hold an “all risks” policy, which does not specifically exclude losses incurred from a pandemic or virus. All risk policies are most often used in reference to physical damages, however, at this time many businesses are arguing that contamination from the virus constitutes physical damage. There have not been any further proceedings with this case, however, a variety of other businesses have followed suit and filed complaints against their insurers as well.

Currently, there have been eight lawsuits in six different states, including Louisiana, Illinois, California, Texas, Florida and Oklahoma. All eight of the pending complaints are from small business owners, six of the suits being from restaurant and bar owners. A majority of these cases claim that the national government shutdowns have majorly impacted their business operations and earnings.

In Chicago, movie theatre and restaurant owners are collectively suing their insurance carrier for wrongful coverage of work interruptions due to the pandemic. In this case, Big Onion Tavern Group, LLC v. Society Insurance, Inc., the small business owners claim that Society Insurance is wrongful in denying their businesses coverage from losses incurred due to “necessary suspension” of daily business when their policies explicitly promise coverage of government shutdowns. Furthermore, Society Insurance did not conduct coverage investigation which is required under Illinois law. Insurance companies in Illinois, like other states, are claiming that the existence of COVID-19 in a business does not qualify as property damage. In the state of Illinois, this is contradictory to laws as courts have held “dangerous substances” in the past to constitute “physical loss or damage.” Insurance industries are creating specific exclusions related to losses consequential to COVID-19, which would not be necessary if, in fact, the virus did not result in “physical loss or damage.”

In California, French Laundry Partners, LP et al. v. Hartford Fire Insurance Co. et al. (Napa County), argues that the government issued stay-at-home order was instituted as a result of evidence that the Coronavirus can live on surfaces and damage property. Many state guidelines are requiring businesses to fumigate their property before reopening to the public, furthering the argument that the Coronavirus has physically impacted business and thus insurance companies should be held accountable for upholding their policies regarding damaged property. Many of the business interruption insurance cases are filing similar claims for the wrongful representation of existing policies.

As the Coronavirus continues to ebb and flow over time and affect daily business procedures, it is expected that other policyholders will take similar legal action against their insurers. Certain states such as Massachusetts, New Jersey and Ohio have acknowledged this trend and have proposed laws related to insurance companies paying certain claims to support small businesses as a result of the economic strains caused by the COVID-19 pandemic. Currently, no bill has been passed.

Are RIAs Eligible for PPP?

Posted on May 5, 2020July 2, 2021 by Liam Mennitt

Is a Registered Investment Advisor (“RIA”) eligible to participate in the Payment Protection Program (the “PPP”) administered by the Small Business Administration (“SBA”)? The short answer is “yes.”

The PPP was promulgated as part of the recently enacted Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”) which in part set aside hundreds of billions of dollars to help small businesses retain their employees during the COVID-19 crisis and the resultant work from home orders set forth by governors across the country.

Background

We understand that many RIAs applied for and were granted a loan under the CARES act, and that some of these RIAs may be unsure of whether they were granted the loan in error, how they may spend the loan funds or if they can spend the loan funds. The guidance below will hopefully answer some of these questions because applying for and receiving a PPP loan in a knowingly false fashion is a criminal offense, and we strongly encourage any RIA unsure of its PPP eligibility to seek particular legal advice.

The guidance below hinges on whether an RIA engages in speculative operations, holds any securities or other speculative assets, or is simply engaged in financial advisory services.

SBA Guidance

The SBA published an Interim Final Rule on April 2, 2020 (the “Interim Final Rule”). Specifically, the Interim Final Rule provides that “Businesses that are not eligible for PPP loans are identified in 13 CFR 120.110 and described further in SBA’s Standard Operating Procedure (SOP) 50 10, Subpart B, Chapter 2….” (the “SOP”).

Some of the ineligible financial markets and funds businesses listed in the SOP include, without limitation:

Banks;
Life insurance companies (but not independent agents);
Finance companies;
Investment companies;
Certain passive businesses owned by developers and landlords, which do not actively use or occupy the assets acquired or improved with the loan proceeds, and/or which are primarily engaged in owning or purchasing real estate and leasing it for any purpose; and
Speculative businesses that primarily “purchas[e] and hold[ ] an item until the market price increases” or “engag[e] in a risky business for the chance of an unusually large profit.”

On April 24, 2020, the SBA issued its Fourth Interim Final Rule on the PPP (the “Fourth Interim Final Rule”). The Fourth Interim Final Rule explicitly states that hedge funds and private equity firms are not eligible for a PPP loan.

Discussion

Ineligible Companies.

If the RIA is also a hedge fund or a private equity firm, then it may not be eligible to receive a PPP loan. If, however, the RIA is legally distanced from those entities through appropriate corporate structures, and the loan is only used for the RIA business, then the RIA should be eligible to receive the PPP funds.

Because most RIAs are not also banks or life insurance companies, the exclusions should not apply. However, as some RIAs also sell life insurance products, such individual situations may require more research.

Finance companies are also ineligible under the SBA guidelines to receive PPP funds. The SBA guidelines define a finance company as one “primarily engaged in the business of lending, such as banks, finance companies, and factors.” (Sec. 120.110(b) of the SBA’s Business Loans regulations). Thus, this exclusion should not apply. Similarly, an RIA may not be deemed an investment company, which is a company organized under the Investment Company Act of 1940, unless the RIA was in fact incorporated under that Act.

An RIA also may not meet the definition of a “speculative business” as defined above in the Interim Final Rule. If an RIA does not purchase or hold assets until the market price increases or engage in a risky business for the chance of an unusually large profit, then it will not meet this definition. Speculative businesses may also include: (i) wildcatting in oil, (ii) dealing in stocks, bonds, commodity futures, and other financial instruments, (iii) mining gold or silver in other than established fields, and (iv) building homes for future sale, (v) a shopping center developer, and (vi) research and development. (Sec 120.110(s) of the SBA’s Business Loans regulations, SBA Eligibility Questionnaire for Standard 7(a) Guaranty and SOP Subpart B D (Ineligible Businesses). It is our understanding that an RIA that merely provides portfolio management services would not be deemed to be involved in a “speculative” business based on the examples of such businesses provided by the SBA. If the SBA had taken the position that financial advisory services are speculative, it could easily have so indicated by including such services in its lists of speculative services.

Financial Advisory Services.

Consistent with this view, the SBA has provided clear guidance that financial advisory services are eligible for SBA loans, including loans under the PPP. In the SBA’s SOP, the SBA provides the following: “A business engaged in providing the services of a financial advisor on a fee basis is eligible provided they do not use loan proceeds to invest in their own portfolio of investments.” (SOP Sec III(A)(2)(b)(v) pp.104-105) (emphasis added).

This guidance is clear that the focus of ineligibility is at the portfolio company level, not the advisory level, and this is consistent with the guidance noted above making hedge funds and private equity firms ineligible. Hedge funds and private equity firms make money based upon speculative investments and/or appreciation of the markets. An investment advisor operates at the consulting or services level. In other words, the SBA has distinguished between true speculative operations such as wildcatting, speculative real estate development and investing in securities, and service-based operations such as the investment advisory business. Assuming that an eligible RIA did not use any proceeds of the PPP loan at any investment level, such RIA should not be deemed a speculative business and is eligible for a PPP loan.

SEC Guidance

SEC guidance affirms that RIAs are eligible for PPP loans. While the SEC imparts certain burdens on RIAs that accept PPP loans, the fact that the SEC even acknowledges such burdens should give most RIAs confidence that a PPP loan is available to them.

For RIAs who are eligible to receive PPP funds under the SBA guidance set forth above, the SEC instructs that they must comply with their fiduciary duty under federal law and make a full and fair disclosure to their clients of all material facts relating to the advisory relationship. The SEC further posits that “If the circumstances leading you to seek a PPP loan or other type of financial assistance constitute material facts relating to your advisory relationship with clients, it is the staff’s view that your firm should provide disclosure of, for example, the nature, amounts and effects of such assistance.” An example of a situation the SEC would require such disclosures would be an RIA requiring PPP funds to pay the salaries of RIA employees who are primarily responsible for performing advisory functions for clients of the RIA. In this case the SEC would require disclosure as this may materially affect the financial well-being of an RIA’s clients.

The SEC additionally provides that “if your firm is experiencing conditions that are reasonably likely to impair its ability to meet contractual commitments to its clients, you may be required to disclose this financial condition in response to Item 18 (Financial Information) of Part 2A of Form ADV (brochure), or as part of Part 2A, Appendix 1 of Form ADV (wrap fee program brochure). (SEC Division of Investment Management Coronavirus (COVID-19) Response FAQs).

Summary

While the Cares Act and PPP are recently enacted, and there is some confusion surrounding the eligibility requirements for the PPP, the SBA had a clear opportunity to deem financial advisors ineligible in the Interim Final Rule and Fourth Interim Final Rule, but specifically chose not to do so. Instead, the SBA followed the direction of its historical eligibility requirements, holding to ineligibility at the fund and portfolio company level, but continuing to permit loans to firms operating at the advisory level.

While it is possible that the SBA could interpret its own rules and regulations inconsistently with the specific guidance provided in the Interim Final Rule and Fourth Interim Final Rule, the weight of the evidence strongly suggests that an investment advisor is eligible for a PPP loan as long as it does not use the proceeds for fund or portfolio company purposes.

Managing Documentation of Your PPP Loan

Posted on May 4, 2020July 1, 2021 by Liam Mennitt

To date, nearly 18.5 thousand Connecticut businesses have received forgivable loans under the Paycheck Protection Program. This note will briefly review some of the recordkeeping requirements of the program you should keep in mind if you anticipate being able to qualify for loan forgiveness.

The program requires that borrowers meet two tests for loan forgiveness:

The loan proceeds are used to cover payroll costs, and most mortgage interest, rent, and utility costs over the 8 week period after the loan is made; and
Employee and compensation levels are maintained

The loan proceeds may only be used for four categories of business expenses:

Payroll costs, including benefits. Payroll costs include –
- Salary, wages, commissions, or tips (capped at $100,000 on an annualized basis for each employee);
- Employee benefits including costs for vacation, parental, family, medical, or sick leave; allowance for separation or dismissal; payments required for the provisions of group health care benefits including insurance premiums; and payment of any retirement benefit;
- State and local taxes assessed on compensation; and
- For a sole proprietor or independent contractor: wages, commissions, income, or net earnings from self-employment, capped at $100,000 on an annualized basis for each employee
Interest on mortgage obligations, incurred before February 15, 2020;
Rent, under lease agreements in force before February 15, 2020; and
Utilities, for which service began before February 15, 2020

Payroll costs also include employee benefits such as parental leave, family leave, medical leave, and sick leave. Note, however, that the CARES Act, P.L. 116-136, excludes qualified sick and family leave wages for which a credit is allowed under section 7001 and 7003 of the FFCRA, P.L. 116-127. You can read an IRS summary of this credit here.

The CARES Act also excludes from payroll costs the following:

Any compensation of an employee whose principal place of residence is outside of the United States; and
Federal employment taxes imposed or withheld between February 15, 2020 and June 30, 2020, including the employer’s share of FICA and Railroad Retirement Act taxes

Mortgage prepayments and principal payments are not permitted uses of PPP loan proceeds. Borrowers will need to request loan forgiveness from their lenders. The request must include:

Verification of the number of employees and pay rates
Payments made on eligible mortgage, lease and utilities
Documentation that you used the forgiven amount to keep employees and make the eligible mortgage, lease, and utility payments

This documentation will generally take the form of:

Payroll reports from your payroll provider
Payroll tax filings, including Form 941
State income, payroll, and unemployment insurance filings
Documentation of retirement and health insurance contributions
Documentation of payment of eligible expenses. This documentation should meet the same standards as your documentation of business expenses on your tax return. Invoices matched with cancelled checks, payment receipts, and account information
Documentation that you used at least 75% of your loan for payroll costs

Lenders are expected to require forgiveness documentation to be provided in digital form, so borrowers should get scanning done in advance.

Lenders must rule on forgiveness within 60 days of the borrower’s request. In some cases, borrowers may be asked to provide additional documentation.

If you are not approved for loan forgiveness, your loan balance will continue to accrue interest at the rate of 1% annually for the remainder of the two-year loan period.

These notes review general principles only and are not intended as tax or legal advice. Readers are cautioned to discuss their specific circumstances with a qualified practitioner before taking any action.

Are RIAs Eligible for PPP?

Posted on May 4, 2020July 1, 2021 by Liam Mennitt

Background

The guidance below hinges on whether an RIA engages in speculative operations, holds any securities or other speculative assets, or is simply engaged in financial advisory services.

SBA Guidance

Some of the ineligible financial markets and funds businesses listed in the SOP include, without limitation:

Banks;
Life insurance companies (but not independent agents);
Finance companies;
Investment companies;
Certain passive businesses owned by developers and landlords, which do not actively use or occupy the assets acquired or improved with the loan proceeds, and/or which are primarily engaged in owning or purchasing real estate and leasing it for any purpose; and
Speculative businesses that primarily “purchas[e] and hold[ ] an item until the market price increases” or “engag[e] in a risky business for the chance of an unusually large profit.”

Discussion

Ineligible Companies.

Financial Advisory Services.

SEC Guidance

Summary

When It Rains, It Pours: The Psychology that Makes Us More Vulnerable During a Crisis

Posted on April 22, 2020July 14, 2021 by Liam Mennitt

I received the following email alert from a cybersecurity client of mine:

“6x increase in cyber attacks over the last 4 weeks.”

“Information about COVID-19 should only come from a legitamate source. Don’t trust unsolocited emails or open unknown links”

“Really?,” I thought to myself; “We’re on lock-down, stressed about family and friends, not to mention business and jobs, and I’m getting cybersecurity alerts?” Frankly, I usually ignore them when I’m not distracted, but who has time for this now?

However, the more I thought about it, the more I realized that’s exactly what cybercriminals are thinking too and why people need to stay alert and resist the temptation to click on those compelling links.

The truth is, despite the fancy hardware and software solutions available, most cybersecurity breaches occur due to human error or phishing attacks. Unless you have relatively sophisticated automated solutions, the people IN your organization may represent your greatest internal threat.

While companies see high risks from external threat actors, such as unsophisticated hackers (59%), cyber criminals (57%), and social engineers (44%), the greatest danger, cited by 9 out of 10 firms, lies with untrained general (non-IT) staff. In addition, more than half see data sharing with partners and vendors as their main IT vulnerability. Nonetheless, less than a fifth of firms have made significant progress in training staff and partners on cybersecurity awareness (ESI ThoughtLab/WSJ Pro Cybersecurity, 2018).

And this was before COVID hit us between the eyes. Let’s take a quick look at the psychology at play that makes us even more vulnerable during a crisis.

The Neuroscience of Crisis

As humans, we are prewired for crisis.

Whether you think of this brain system as the “reptilian brain,” attributed to Paul MacLean and his Triune Theory (Sagan, 1977), or the fight-flight reaction of the sympathetic nervous system (System 1) which is our immediate, emotional reaction (Kahneman, 2011), it is clear that our brain protects us in times of danger.

This system, which is buried deep in the interior of the human brain, is both evolutionarily older and more immediate than simple cognitive thought; it is pre-cognitive. When the danger is ambiguous, System 2 thinking (which, in contrast with System 1 is slower, more deliberative and more logical) is nice; go through your options, take your time, don’t rush.

But when there is a perception of crisis, the need to ACT is immediate.

The fight-flight response makes us want to DO something, and now! From an evolutionary point of view, in times of danger, those who acted first were often safer than those who took their time.

The COVID-19 pandemic is, of course, a crisis.

Have people noticed how much more tired they are these days, even though we aren’t even leaving the house? It’s because crisis mode requires more energy. During a crisis, the thoughtful, reflective parts of our brain shut down. In other circumstances, we might hover over a suspicious link, while we process whether it seems risky or not.

But that requires fully functional frontal lobes, or executive functioning, which need time and undivided attention to work properly. In crisis mode, frontal lobe functioning is significantly diminished, or may go offline altogether, in favor of a quick (albeit less considered) action or reaction.

To make matters worse, cybercriminals know this: They know what emotional buttons to push to make you afraid (just click the link) or try to help (just click the link), or maybe even register your opinion (just click the link).

But if you do click that unfamiliar or disguised link, you may have just let criminals into your personal computer and, by default, into your company’s IT system.

Wait, consider, relax. Let System 2 kick in before you commit yourself, your computer, and your company to whatever those “black hat” cybercriminals have in mind.

Motivation During a Crisis

After the fear comes a desire to help.

This is one of the ways that cybercriminals trick well-meaning people. Whether it’s a donation, or a message of support, or some other activity to help, we are again motivated in ways that leave us open to online criminal behavior.

McClelland’s Social Motive Theory suggests there are three primary social motives: Achievement, Affiliation, and Power (McClelland, 1987).

We all have the capacity for all three, and genetics and socialization as well as cognitive choice determine which motive wins the day in a given situation. In times of individual crisis, needs for achievement (e.g., successful social distancing) or needs for power (e.g., controlling the situation) may come to the fore.

But in a social crisis, many of us are “hard-wired” to help, triggering a need for affiliation.

That desire to help may cause people to act impulsively in what they believe is a pro-social, affiliative manner. Just click the link to make your donation, just click the link to show your support, and on and on, the cybercriminals never stop trying. Like the very best advertisers, they are clever about pushing your emotional (non-cognitive, pre-cognitive) buttons to get you to act in ways that benefit them.

I am assuming everyone reading this has the best of motives. Those very motives make you susceptible to the manipulation of cybercriminals.

If your current impulse is to put this away, turn to something else, then you have experienced exactly what cybercriminals are counting on.

Information fatigue, too much bad news, or just a desire to put some positive energy back out into the world, may all leave you vulnerable.

Don’t click suspicious links, or even links that look well-meaning, without doing some simple checks and reviews first.

Hover over a link and see if the URL is the same as whom the email purports to be from.
Don’t provide any information, on any social media, whether at work or elsewhere, that can be used against you.
Hackers are clever and unscrupulous so check and double-check links that looks suspicious in any way.
Do a bit of research before you agree to anything and certainly before sending money or private information.

What’s Your Story?

Narrative is the final pillar in this little tripartite approach to cybercrime. I have come to believe that personality is a story we tell ourselves (and the world) about ourselves (Bruner, 1985).

This story comprises our identity, it is who we think we are and often these beliefs about who we are dictate how we behave in the world and how we process information.

For example, as a psychologist (not to mention a human being), I think of myself as a helpful person. I try to be kind and considerate. I don’t like to walk past beggars without giving them something (yes, yes, I know that would cause me to lose points on the WAIS IQ test but there you go, despite my cognition telling me this could be a trick, he or she will just buy cigarettes and beer, I often give in anyway).

Cybercriminals will use these ideal images we have of ourselves to manipulate our thoughts, emotions, and purse-strings.

I am good, so I give to the sick and needy.
I love children, so I’ll give to those orphaned by COVID.
I support healthy behaviors, so I’ll do most anything to protect my health.
I’m a good parent, so I will click the link that shows me 10 ways to protect my family from infection.

Your personal narrative is the core of your personal identity. We sometimes value it more than life itself (think of martyrs).

If a clever cybercriminal hacks your social media, understands what makes you “tick,” that information can be used against you in a cybercrime.

The threats are real and so are the psychological levers cybercriminals pull to manipulate your fear.

We are all overwhelmed, trying our best to hang in there, and help each other where we can. Don’t let your best intentions, and fatigue, allow you to be manipulated to behave unsafely online. COVID is real, and so is cybercrime. We must be alert to both.

Written by: Dr. Mark Sirkin, CEO at Sirkin Advisors

References

Bruner, J. (1986). Actual minds, possible worlds. Cambridge, MA: Harvard University Press.

ESI ThoughtLabs/WSJ Pro Cybersecurity (2018). The cybersecurity imperative: Managing cyber risks in a world of rapid digital change. New York: Author.

Kahneman, D. (2011). Thinking, fast and slow. New York: Farrar, Straus and Giroux.

McClelland, D. (1987). Human motivation. New York: University of Cambridge.

Sagan, C. (1977). The dragons of Eden. New York: Penguin Random House.