PPP Loan: Questions Answered (Part I)
PPP Loan: Questions Answered (Part I) On May 19, 2020, we held a webinar on loan forgiveness under the Paycheck Protection Program (PPP). With more than 800 attendees, there were…
June 1st, 2020
In the second installment of of the blog series answering your questions on the paycheck protection program (PPP), Tom looks at a correction on the calculation of basic loan forgiveness. He also answers the following questions:
Check out Part I of the series here.
by Tom O’Saben, EA
I want to begin though, with a mea culpa. Apparently, we had a wrong calculation, and thank you to a couple of our attendees who brought it to our attention.
We talked about the fact that we know that there’s a 75/25 rule that the SBA uses, I think we’re all aware of that. What I did talk about was – other qualified expenses outside of payroll cannot make up the difference if, for example, we don’t have 75% spent on payroll. Other qualified expenses can be no more than 25% of the PPP loan amount. What I didn’t realize and what I didn’t see in the calculations is that if your borrower doesn’t hit 75% of the loan amount in payroll, then the 25% of qualified expenses, in fact, also gets reduced. So let’s look at what I did here. I gave an example that says we have a $100,000 PPP loan; $50,000 was used for payroll and $50,000 was used for other qualified expenses. Now we already know the other qualified expenses are already limited. So that’s not the point of my calculation. But let’s take a look here.
So the payroll component ended up being 50% of the loan amount, not 75%. So since it didn’t hit that benchmark, we’ve got to look at what percentage of 75% was the payroll. In this case, as we show you on the slide, it ends up being 67% (or 66.66667) of the 75%. That’s the $50,000 that we had, divided into the $75,000 target, which is 75% of $100,000. Then step two – that 66.67% target has to reduce the other maximum 25%; not the expenses that were actually spent, but the 25% limiter. Remember that the expenditure that we gave you in the illustration on the slide was, in fact $50,000. Okay, the maximum we can look at is $25,000. What’s going to happen is, because we didn’t spend 75%, on payroll, we only spent 67% of what we needed to spend, we’re only going to get 67% of the maximum qualified expenses to treat for forgiveness. In this case, as I show you in the illustration, that means that out of $25,000, we’re stuck with $16,666.67. Add that on to the actual payroll that was spent, and the maximum to consider for loan forgiveness is $66,666.67. Now, I will remind you as the slide also says, that does not take into consideration other adjustments that would have to be made. For example, the notion that we may have to have a percentage reduction because of not having as many full time equivalent employees, or even though we had an equal number of full time equivalent employees, salaries were less during the covered period. So keep that in mind. So that’s the first slide, kind of a mea culpa to begin this blog session, and let’s go on then with our questions. I’ve got six more questions for you in this blog session.
What constitutes rents as qualified expenses? I’ve given you the web link to the SBA Loan Forgiveness Form and its instructions. It really is a wealth of knowledge for us. So I took this right off of line three of the instructions for the loan forgiveness form, and it says, enter the amount of business rent or lease payments for real or personal property. There’s the key. Remember, we defined covered period, both in the webinar and also in last week’s blog. But just to remind you, that’s the 56 days or eight weeks that goes from the date your client received the loan proceeds to when it has to be spent. During the covered period and this would be pursuant to lease agreements that are in force before February 15. I also want to throw the caveat out there – Tte first place to start with this mentally is would these expenses as you as a tax professional, allow them as an ordinary and necessary business expense on a schedule C or a schedule F. So keep that in mind when you’re looking at it too. But let’s throw some examples out there. Leases on buildings – that makes sense. I think when we think rents, we automatically think of someone who is renting their office space. How about vehicles? That question actually came up in the webinar – What about vehicle leases? Well, as I show you on the slide, the documentation is telling us that lease payments for real or personal property. Automobile is personal property, so I would think that a leased vehicle would count. Now it also makes me think – what about when we’ve got travel expenses, and we’ve got a rental car. We don’t have a lease, and maybe that’s a stretch but some more thought, and we’ll look for additional guidance. How about equipment leases? I have a copier sitting right here in the office that I pay $300 a month for. I have two of them, actually. Let me tell you that as a lease, a full blown lease. I think that expense would qualify. How about storage unit rentals? Well, isn’t that the rental of some kind of real estate? So you can keep this in mind as a possibility of what you could consider. As I mentioned in the webinar, and I’ve mentioned in other sessions, be certain to have a written lease in effect, and it needs to be an effect before February 15, 2020. You know, I didn’t put this in the slide here. But what about our folks with office use of the home? Don’t we tell a lot of our S corp shareholders to rent their home office to the corporation? Again, get a lease in effect, and have it before February the 15th, in effect, and I think paying rent for that office use of the home would also fall under this category.
Going to go on with our next question. It came up several times, both on Facebook and during the webinar. What is “payroll” for a self-employed person? For sole proprietors and independent contractors, payroll costs are defined as net earnings from self employment, capped at $100,000 on an annualized basis, per individual employee. We should also have employee in quotes because we’re talking about that self-employed person. So if we have a sole proprietor that has no other employees, what is going to be the payroll for that individual? It’s going to be the net profit on line 31 of schedule C, that’s the net profit, or line 34 of a schedule F. Now that gave us what that sole proprietor could borrow. In other words, to go back and look at what was the average over the last 12 months? Average monthly times 2.5, that gave us the loan amount. Now during this covered period – is there a limitation on what would qualify for our self-employed person to use for payroll? The answer is yes, but it’s a big number. It’s that $100,000 annualized number. And we have to take that divided by 52 times eight weeks, which gives us $15,385. That’s how much our self-employed person could use during that eight week period to count as that self-employed person’s payroll during that time. We’re really not going to have a reflection back on what 2020 performance might be like on the schedule C or the schedule F. Remember we use the net profit from the schedule C or schedule F from 2019 or 2018 to go back and determine how much money that self-employed person could borrow. So keep that in mind. I also will mention here that the business has other employees that are paid regular W-2 wages. And that would be the key – not independent contractors, but W-2 wages – those wages could be added on as qualified payroll expenses, on top of the part that the owner takes for themselves. And I’m going to talk about that a little bit later with documenting what we do for self-employed people as another question.
So let’s go ahead and move on to our next to our next question. What is payroll for an S corp shareholder employee? Listen, that S corp shareholder employee is no different than any other employee. If you don’t have W-2 wages on that S corp return, then your shareholder employee has no payroll. That’s last year, you know, that may have been used to determine the loan. What I’m saying here is – can we use these proceeds to pay the shareholder employee officer wages during the covered period? The answer is yes. But I will tell you don’t add into that the S corp net profit. I had one situation where an actual client, a sole shareholder/officer/employee of his corporation… I don’t know how he got more than $20,000. Because again, the most they would look at is $100,000 divided by 12 months for the loan amount, which is $8,333 times 2.5 is roughly $20,000. You get where I’m going. He got a loan for $28,000. Where did they get that number? The bank went by the bottom line profit on the S corp, which is not the way it’s supposed to be done. So let’s come around here and talk about what can the S corp shareholder treat as payroll? The W-2 wages that are paid to that shareholder employee. So that may help to solve the age old problem we have of reasonable comp going out to that shareholder employee. Remember, again, we have that cap. So during the covered period based on $100,000 annualized, that would be $15,385. But can we add anything to that? Sure. We could add the health benefits and retirement plan benefits and I’m gonna go out on a limb here, be conservative and say paid during that 56 day period. So I know a lot of times with businesses, when we’re doing retirement plan contributions, for example, the employer share is not contributed until the next year by the due date of the tax term plus extension, I would strongly encourage that we look at that payroll that’s allocated for that 56 day period. And for example, if we’re going to do a SEP plan, based on 25% of payroll, then we should pay that 25% of SEP contribution for this year during this 56 days, and that can be added. The same is true of health insurance premiums paid by the corporation. Those can be added when they are paid as long as they’re paid right around this 56 days. Don’t use the S corp profit just like I described to you and also don’t add distributions to the shareholder dividends as we like to call them out there. That has nothing to do with payroll. Think payroll, payroll payroll for that shareholder in an S corporation. For a self-employed person, think bottom line profit. And I didn’t mention on that previous slide that when that individual uses the compensation when they’re a sole proprietor, we can’t add on self-employed health insurance or their estimated tax payments or any of those types of numbers. But we could for the S corp shareholder employee. And we could also add on unemployment tax. Now the difficulty of that is, for a lot of folks, the states will not accept the money early unless they’re on a monthly payment. So the issue of it being incurred, but not yet paid, could be an issue as well.
Okay, let’s go on to our next question. So then what can be added to gross payroll for employees during the covered period? Again, this question comes up, and I’ve kind of answered it for the S corp shareholder employee, but let’s let’s cover it again, just so we’re driving the point home. Employer contributions for employee health insurance, just like I mentioned, employer contributions to employee retirement plans, state and local taxes assessed, this would typically be unemployment. And I want you to put next to each one of those: “for the covered period” (the eight weeks, the 56 days from the date of receipt or of loan disbursement of the PPP money). As I mentioned with the S corp shareholder, and for the self-employed person also, don’t exceed the $15,385. But these other amounts I mentioned can be added on to the payroll of those W-2 persons beyond the $15,385. But everything I read says we can’t do that for the self-employed sole proprietor.
Let’s go on to the next question and I got this off of Facebook just today. How does one prove payroll when there is no payroll? So what I took that to mean, what about self-employed persons who don’t have any employees?. Now I’d already defined how we determine what they could borrow. And I put that here on the slide just to help you remember it because this is such a moving target all the time and we know it could change next week. So on the loan repayment during that covered period, the sole proprietor – and I’m going to go out on a conservative limb here and say, I believe the sole proprietor should write himself or herself checks out of the business account. It would be owners compensation, which in this case is draw (don’t get that confused with dividends within an S Corp…remember that S corp shareholder employs an employee and gets W-2 wages). You never see a sole proprietor’s compensation on a schedule C or schedule F, do you? You don’t. It’s going to be the draw they take. So they should write themselves checks during the 56 day period. Indicate on the check that it is owners draw, for example, and then those funds should go ahead and be deposited into their personal account. And that would be the documentation to support it. Because you know, when you think about it, I think this was the spirit of the person’s question on Facebook is that, well, we’re not going to have this number on a 941. We don’t file 941s for self-employed people do we, for their own earnings that they take? So I’d like to see checks in a check register from the business. And then I’d like to see those deposits going into a personal account, again, for that owner’s own personal use.
I’m going to do one more question here. What is included in the definition of utilities? Now I did a lot of research out on the internet, and I’m telling you, it’s really kind of broad. Now, the definition comes in from the instructions as business payments for the service or distribution of electricity, gas, water, transportation, telephone, or internet access for which service began before February 15, 2020. So the questions have come along – What about trash service? What about sewer? You know what I’m thinking on this, and maybe I’m going out on a limb, and you’re welcome to put your comments to the blog, I always appreciate those. I would say that if you’re treating these expenses as utilities on a schedule C or a schedule F, I’m going to go back to the reasonable and necessary that you would do normally in the preparation of a tax return. And I would say those are in fact, utilities. What about cell phone? I think cell phone falls right under the definition of telephone. What about cable or satellite you have in your office? I would consider those also to be utilities. They’re not specifically stated. But if you would have put those under the utility category in the preparation of a tax return, I think those could could be included. Remember, again, that utilities fall under that qualified expenses area, so they can’t be more than 25% of the PPP loan amount. And if that PPP loan amount wasn’t used at least 75% of payroll, then that 25% is going to be reduced as well.
So we’re going to keep on giving you as much current information as we can. If you’re not a member of the Facebook page, I’d strongly suggest that you join. That’s where we posted the very first comment I had so we could give that information out to you just as quickly as possible. Wow, there is lots going on. We can expect more action out of Congress. We certainly have the likelihood of another round of stimulus happening. And we could have some more to talk about and I’m also going to continue to compile your questions and share them in future blogs. So for all of us from the University of Illinois Tax School, this is Tom O’Saben hunkering down in the safe harbor, we’ll call it in my office in Maryville, Illinois, saying we’ll say goodbye for just a while.
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