COVID-19 Update: April 15, 2020

Breaking News!

SBA Payroll Protection Program (PPP) Loan Guidance for Schedule C Taxpayers & Partnerships

To our clients and friends.

In our last update, we indicated there were several unanswered questions on which we were waiting for guidance from the SBA. We are happy to report the SBA has issued some additional “Interim Rules” late Tuesday afternoon (April 14^th).

The rules primarily impact businesses operating as partnerships and the self-employed filing as a “Schedule C” reported within the individual income tax returns. The changes are significant, and we will attempt to condense and explain the rules in this communication.

Businesses Operating as a Partnership:

There had been significant confusion with how to handle a business operating as a partnership when applying for the SBA PPP Loan. We were receiving conflicting views from the SBA and the banking industry as to how to handle owner compensation. To explain the issue, it is best to do a comparison between two of the most common business entities. They are the partnership entity (filing an annual Form 1065) and the S Corporation entity (filing an annual 1120S).

If an entity was operating as an S corporation the calculation of payroll was quite easy.

• Take the total annual gross payroll of all employees (including owners) plus qualifying benefits
• Divide by 12
• Multiply by 2.5 and the result was the amount of our PPP loan.

If an entity was operating as a partnership the calculation of payroll was quite easy.

• Take the total annual gross payroll of the employees (excluding owners) plus qualifying benefits
• Divide by 12
• Multiply by 2.5 and the result was the amount of our PPP loan.

As you can see from the above, the result of being an S corporation was an advantage over operating as a partnership. Clearly, the resulting difference was not the intent of Congress. The guidance and options presented to us by various banks included:

1. The partners share of self-employment income (subject to the $100,000 limitation) could not be included as payroll costs and as a result, they were simply a casualty of the drafting and interpretation of the SBA guidance by the individual banks, or
2. Each partner could then individually apply for a PPP Loan using the self-employment income allocated to them, or
3. Some banks were combining traditional employee payroll cost with the partners share of net self-employment income.

We have spent countless hours over the last week attempting to find guidance not only from the SBA but from the banks our clients were submitting applications to.

We now have great news!

If you are a partner in a partnership, you may not submit a separate PPP loan application for yourself as a self-employed individual. However, your compensation can now be included in the Partnership application.

So why is this such great news? The SBA has simplified the PPP loan application process because of the following reasons:

• The self-employment income of general active partners may be reported as a payroll cost, up to $100,000 annualized, on a PPP loan application filed by or on behalf of the partnership.
  • This is now combined with regular employee payroll
• Partnerships are eligible for PPP loans under the Act, and the Administrator has determined, in consultation with the Secretary of the Treasury (Secretary), that limiting a partnership and its partners (and an LLC filing taxes as a partnership) to one PPP loan is necessary to help ensure that as many eligible borrowers as possible obtain PPP loans before the statutory deadline of June 30, 2020.
• This limitation will allow lenders to quickly process applications and lower the burdens of applying for partnerships and their partners.
• Rent, mortgage interest, utilities, and other debt service are generally incurred at the partnership level, not partner level, so it is most natural to provide the funds for these expenses to the partnership, not individual partners.

We do have a word of caution that you need to be aware of. The guidance clearly states:

“You should be aware that participation in the PPP may affect your eligibility for state administered unemployment compensation or unemployment assistance programs, including the programs authorized by Title II, Subtitle A (Unemployment Insurance Provisions) of the CARES Act, or CARES Act Employee Retention Credits.”

I am not an expert on the Minnesota or Wisconsin rules related to applying for unemployment compensation, but I think what they are saying is you will not be able to “double dip”. If you receive funding under the PPP program and meet certain work requirements, you may be eligible for unemployment insurance benefits.

Individuals with Self-Employment Income who File a Form 1040, Schedule C:

I have income from self-employment and file a Form 1040, Schedule C. Am I eligible for a PPP Loan?

You are eligible for a PPP loan if:

• You were in operation on February 15, 2020.
• You are an individual with self-employment income (such as an independent contractor or a sole proprietor).
• Your principal place of residence is in the United States; and
• You filed or will file a Form 1040 Schedule C for 2019.
• You were not a partner in a partnership and had self-employment earnings.

If you can answer “yes” to the questions above, you are eligible to apply for the PPP Loan. However, the devil is always in the details.

How do I calculate the maximum amount I can borrow and what documentation is required?

The calculation method is new and supersedes any prior interpretations or guidance previously provided.

How you calculate your maximum loan amount depends upon whether you employ other individuals. If you do not have employees, the following methodology should be used to calculate your maximum loan amount:

• Step 1: Find your 2019 IRS Form 1040 Schedule C line 31 net profit amount (if you have not yet filed a 2019 return, fill it out and compute the value). If this amount is over $100,000, reduce it to $100,000.
  • If this amount is zero or less, you are not eligible for a PPP loan. In other words, if your schedule C shows a net loss for the year you are not eligible.
• Step 2: Calculate the average monthly net profit amount (divide the amount from Step 1 by 12).
• Step 3: Multiply the average monthly net profit amount from Step 2 by 2.5.
• Step 4: Add the outstanding amount of any Economic Injury Disaster Loan (EIDL) made between January 31, 2020 and April 3, 2020 that you seek to refinance, less the amount of any advance under an EIDL COVID-19 loan (because it does not have to be repaid).

Commentary

A major change from the original guidance was the elimination of two benefits that we typically see with Schedule C clients. The following items cannot be included in the loan computation.

1. Retirement plan contributions.
2. The deduction for self-employment health insurance.

Is this fair? If you are the 100% owner of an S Corporation you get to include these benefits. However, you do not get to include your share of pass-through income. Whereas, if you are operating as a single member LLC, reporting your income on a Schedule C, you do get to include all net profits. Indirectly, maybe we get to the same result.

Simple enough? Now here comes the “devil is in the details” requirement regarding the supporting documentation that will be required.

• Regardless of whether you have filed a 2019 tax return with the IRS, you must provide the 2019 Form 1040 Schedule C with your PPP loan application to substantiate the applied-for PPP loan amount and,
• The 2019 IRS Form 1099-MISC detailing nonemployee compensation received (box 7), invoice, bank statement, or book of record that establishes you are self-employed.
• You must also provide a 2020 invoice, bank statement, or book of record to establish you were in operation on or around February 15, 2020.

This is where we have some heartburn. Even if you have not filed your 2019 return due to delays because of the impact that the COVID-19 crisis has had on the accounting firm you are still required to prepare a Schedule C. Hmmmm, Houston we have a problem. The SBA has basically told us to hurry up and rush!

If you are a client of our office and have a Schedule C, we will do everything we can to either complete your tax return or get it to a point where we have an accurate Schedule C that can be used for the PPP loan application.  

If you have employees, it gets more complicated. The following methodology should be used to calculate your maximum loan amount:

• Step 1: Compute 2019 payroll by adding the following:
  • Your 2019 Form 1040 Schedule C line 31 net profit amount (if you have not yet filed a 2019 return, fill it out and compute the value), up to $100,000 annualized, if this amount is over $100,000, reduce it to $100,000,
    • if this amount is less than zero, set this amount at zero.
  • 2019 gross wages and tips paid to your employees whose principal place of residence is in the United States computed using 2019 IRS Form 941 Taxable Medicare wages & tips
    • (line 5c- column 1) from each quarter
    • plus, any pre-tax employee contributions for health insurance or other fringe benefits excluded from Taxable Medicare wages & tips.
    • subtract
      • any amounts paid to any individual employee in excess of $100,000 annualized
      • any amounts paid to any employee whose principal place of residence is outside the United States.
      • 2019 employer health insurance contributions (health insurance component of Form 1040 Schedule C line 14),
      • retirement contributions (Form 1040 Schedule C line 19),
      • and state and local taxes assessed on employee compensation (primarily under state laws commonly referred to as the State Unemployment Tax Act or SUTA from state quarterly wage reporting forms).
• Step 2: Calculate the average monthly amount (divide the amount from Step 1 by 12).
• Step 3: Multiply the average monthly amount from Step 2 by 2.5.
• Step 4: Add the outstanding amount of any EIDL made between January 31, 2020 and April 3, 2020 that you seek to refinance, less the amount of any advance under an EIDL COVID-19 loan (because it does not have to be repaid).

The documentation you will need to provide includes:

• You must supply your 2019 Form 1040 Schedule C,
• Form 941 (or other tax forms or equivalent payroll processor records containing similar information) and state quarterly wage unemployment insurance tax reporting forms from each quarter in 2019 or equivalent payroll processor records,
• Evidence of any retirement and health insurance contributions, if applicable.
• A payroll statement or similar documentation from the pay period that covered February 15, 2020 must be provided to establish you were in operation on February 15, 2020.

How can PPP loans be used by individuals with income from self-employment who file a 2019 Form 1040, Schedule C?

The proceeds of a PPP loan are to be used for the following. If not used for the appropriate use it may result in a loan that needs to be paid back within two years.

1. Owner compensation replacement based on 2019 net profit as described above in determining how much PPP loan you were eligible for.
2. Employee payroll costs (as defined in the First PPP Interim Final Rule) for employees whose principal place of residence is in the United States. This only applies if you have employees.
3. Mortgage interest payments (but not mortgage prepayments or principal payments) on any business mortgage obligation on real or personal property (e.g., the interest on your mortgage for the warehouse you purchased to store business equipment or the interest on an auto loan for a vehicle you use to perform your business). This does not include your share of mortgage interest if you are claiming a deduction for an office in the home.
4. Business rent payments (e.g., the warehouse where you store business equipment or the vehicle you use to perform your business).
5. Business utility payments (e.g., the cost of electricity in the warehouse you rent or gas you use driving your business vehicle).
6. For items 3, 4 & 5 above you must have claimed or be entitled to claim a deduction for such expenses on your 2019 Form 1040 Schedule C for them to be a permissible use during the eight-week period following the first disbursement of the loan (the “covered period”).
   1. For example, if you did not claim or are not entitled to claim utilities expenses on your 2019 Form 1040 Schedule C, you cannot use the proceeds for utilities during the covered period.
7. Interest payments on any other debt obligations that were incurred before February 15, 2020 (such amounts are not eligible for PPP loan forgiveness).
8. Refinancing an SBA EIDL loan made between January 31, 2020 and April 3, 2020 (maturity will be reset to PPP’s maturity of two years).

Are there any other restrictions on how I can use PPP loan proceeds?

The short answer is “Yes”.

• At least 75 percent of the PPP loan proceeds shall be used for payroll costs.
• For purposes of determining the percentage of use of proceeds for payroll costs (but not for forgiveness purposes), the amount of any refinanced EIDL will be included. The rationale for this 75 percent floor is contained in the First PPP Interim Final Rule.

What amounts shall be eligible for forgiveness?

The amount of loan forgiveness can be up to the full principal amount of the loan plus accrued interest. The actual amount of loan forgiveness will depend, in part, on the total amount spent over the covered period on:

1. Payroll costs including salary, wages, and tips, up to $100,000 of annualized pay per employee (for eight weeks, a maximum of $15,385 per individual), as well as covered benefits for employees (but not owners), including health care expenses, retirement contributions, and state taxes imposed on employee payroll paid by the employer (such as unemployment insurance premiums).
2. Owner compensation replacement, calculated based on 2019 net profit as described above, with forgiveness of such amounts limited to eight weeks’ worth (8/52) of 2019 net profit, but excluding any qualified sick leave equivalent amount for which a credit is claimed or qualified family leave equivalent amount for which a credit is claimed.
3. Payments of interest on mortgage obligations on real or personal property incurred before February 15, 2020, to the extent they are deductible on Form 1040 Schedule C (business mortgage payments).
4. Pent payments on lease agreements in force before February 15, 2020, if they are deductible on Form 1040 Schedule C (business rent payments), and
5. Utility payments under service agreements dated before February 15, 2020 to the extent they are deductible on Form 1040 Schedule C (business utility payments).

Commentary

There will be one additional step that needs to be taken into consideration that seems to be overlooked as we read the provisions related to the forgiveness calculation.

The number of full-time equivalent employees you have during the 8-week period from the date the loan was funded will play into the formula for forgiveness. The formulas illustrated in the SBA examples have some flaws in them and we will send out a separate communication once we are more comfortable with the formulas.

 It is our understanding that if the employee count stays the same before and during the 8-week period there should not be an issue. However, if there is a reduction in the number of employees before the application is approved or compensation has been reduced during the 8-week period, and you do not bring employees back, the forgiveness amount could be drastically reduced.

What documentation will I be required to submit to my lender with my request for loan forgiveness?

We are of the opinion that the time that we will have to help our clients on the “forgiveness calculations” will be a factor of 4 x the amount of time we have spent on the front end helping clients determine their eligibility for a PPP Loan. It is critical that we encourage clients to understand the rules for forgiveness and the documentation they will have to keep. We would strongly encourage that any PPP loan proceeds get deposited into a separate bank account. As qualifying costs are incurred transfer the funds into the operating account. As you get closer to the end of the eight-week time period you will be able to tell how much of a loan you will have to pay back. The PPP is first a loan and then a portion or all may be forgiven depending on the use of the proceeds.

With that said, this is the documentation that will be required based on the guidance we now have:

• In addition to the borrower certification required by Section 1106(e)(3) of the Act, to substantiate your request for loan forgiveness,
• If you have employees, you should submit Form 941 and state quarterly wage unemployment insurance tax reporting forms or equivalent payroll processor records that best correspond to the covered period (with evidence of any retirement and health insurance contributions).
• Whether or not you have employees, you must submit evidence of business rent, business mortgage interest payments on real or personal property, or business utility payments during the covered period if you used loan proceeds for those purposes.
• The 2019 Form 1040 Schedule C that was provided at the time of the PPP loan application must be used to determine the amount of net profit allocated to the owner for the eight-week covered period.
  • Commentary: Does this mean you should transfer funds out of the business account to your personal account during this measurement period equal to your share of the 2019 net profit as calculated above? We do not know the answer to this question, but it probably makes sense to do so.

We hope this update helps and if you are confused about some of the language and requirements do not feel bad, we are too!!! However, we will do our best to find answers to your questions and be a resource to you.

We will all get through this and better times lie ahead. We should all be thankful for friends and family and how important they are to us when we are threatened by a virus that could take them away from us.

We are optimistic that we will all be stronger when we come out of this crisis. A big thank you should go to our health care workers and first responders. They are on the front line daily and are most at risk. We appreciate all they have done for us!!

From

Amy, Linda, Rod, and the AHS team: Angela, Bethe, Bob, Jonel, Juli, Katie, Mary, Eric, Eileen, Phil, Rick, Spencer, Tracey, Chantel, Angie, Bobbi, Janet, John, Dave & Dan