The SBA’s and Treasury’s additional guidance on computing payroll costs, issued on April 24, concludes with a lawyer-like, but minimally helpful answer — it depends on the borrower.
Below are our key takeaways from this additional guidance:
Unemployment Insurance is a Tax
Payroll costs include state and local taxes assessed on employee compensation. It was unclear if amount paid for state unemployment insurance qualified as a tax. Many of us have wondered whether such compulsory payments were “taxes” or “insurance premiums.” The SBA clarified that state unemployment insurance payments are a tax included in payroll costs. Of course it would have been nice if the SBA had separately noted the treatment of unemployment insurance instead of burying it in a Q&A about calculating the loan amount for partnerships after the first $349 billion had already been dispensed.
Partnership’s Payroll Costs Include Partners’ Self-Employment Income
The text of the CARES Act indicated that a partnership should file a PPP based on their employee payroll, excluding amounts allocable or distributable to the partners. That text also left unclear whether each partner could file its own application for a PPP loan. In the exception to prove the rule that the SBA and the Treasury Department have been interpreting the CARES Act favorably, guidance issued on April 14 “clarified” that a partnership’s payroll costs included the partners’ self-employment income. Friday’s guidance continues such treatment, noting the need to multiply such partner-level self-employment income by .9235 to reflect the equivalent of the employer share of FICA included in SECA. This approach is consistent with the computation of self-employment income and prior guidance. As a reminder, the $100,000 cap continues to apply. But does that mean partners should also be counted as employees for purposes of the 500 employee limit?
But there are some surprises in the updated SBA approach: all a partnership needs to make the computations is their 2019 Forms 941, 1065 and K-1s. Given how many partnership tax returns are not prepared until the extended due date, we wonder how many partnerships are actually in a position to rely upon those forms to support their computations or to substantiate their entitlement to the needed loan amount. Unlike sole proprietorships, computing partnership income and allocations usually requires an accountant trained in Subchapter K of the Internal Revenue Code along with time to actually prepare the return. We suspect many partnerships are on the phone today with their accountants demanding the impossible.
The guidance breaks out the step-by-step instructions based on the tax classification of the borrower – self-employed, partnership or corporation (S corporation and C corporation). The guidance even specifies the lines of the schedules or forms used to report the borrower’s income. This guidance is especially important for LLC, which can be treated, for tax purposes, as sole proprietorships, partnerships, S corporations or C corporations. This helpful rule would have saved many clients anguish in the first PPP tranche when they agonized over which box to check.
Timing is Everything
The SBA and the Treasury Department have fairly consistently interpreted the CARES Act to increase access to PPP loans. This has been a welcome surprise for practitioners accustomed to advising clients why they cannot receive a benefit. The rules we have today greatly differ from where we started and are far more beneficial. Borrowers that already computed their maximum PPP loan amount undoubtedly computed their loan amounts very differently than they would today. Some borrowers who participated in the first $349 billion tranche would have received more if they had waited for the second $310 billion and vice versa. Of course, if Congress had not allocated additional money, those who delayed because of the lack of guidance would have been left out. In any event, the second wave of applicants now have clearer rules. Participants in either tranche will likely face the same set of rules when it comes to loan forgiveness.
Individuals who took advantage of the automatic extension to July 15 to file their 2019 tax returns may be in for a surprise. Although they have more time to file their tax return (Form 1040), they need fill out their Schedule C (or Schedule F, if applicable) to complete their PPP application. Further, they must provide the completed schedule when applying for the PPP loan. Given that the second tranche of applications will be gone in a few days, we suspect a few borrowers are rushing to finish their 2019 tax Schedule C (or Schedule F for farmers) today in order to come up with their 2019 net profit. Other than that, this new guidance seems to reiterate prior guidance on how self-employed individuals should compute their payroll costs. As a reminder, the $100,000 cap continues to apply.