A lot has already been written concerning the Flexibility Act, SBA Interim Rule modifications, and EZ Forgiveness Utility and directions with respect to the Payroll Safety Act, all of which have been enacted and printed since June 5th.
Whereas the up to date Interim Guidelines are nonetheless removed from clear or thorough, the constraints and procedures defined by the Forgiveness Functions and related formulation give us the lion’s share of what we have to know for the overwhelming majority of debtors.
Probably the most disagreeable shock from these modifications for a lot of debtors and advisors was the style during which forgiveness attributable to compensation, medical insurance, and retirement plan contribution bills for S-Company and C-Company shareholder workers are unexpectedly being restricted.
We’re presenting a free 30 minute webinar on “PPP loan Forgiveness Issues for Owner-Employees of S and C Corporations” on Tuesday, June 23 at 10:30 AM EDT. You may e mail me at [email protected] and put the phrase “PPP for me” within the topic line to obtain an invitation for the webinar.
I shall be joined by Brandon Ketron, JD, CPA, LL.M. and Kevin Cameron, CPA, and thank them for his or her tireless efforts to grasp and clarify these guidelines and to take care of the spreadsheet that’s now being utilized by tons of of CPAs and small companies. I additionally thank pension skilled Larry Starr for spending an excellent a part of Father’s Day serving to to interpret these guidelines, as talked about beneath.
We had imprecise indications that this would possibly happen in earlier iterations of SBA pronouncements, however the terminology used was unclear and extra indicative that these limitations would solely apply to individually owned companies that file a Schedule C to a Type 1040 of the proprietor or entities handled as partnerships for revenue tax functions. For many who should not tax consultants, the dialogue beneath covers how these guidelines apply particularly to LLCs and different entities which can be taxed as S companies or C companies.
Completely different guidelines apply to entities taxed as partnerships vs. people (generally known as unbiased contractors and sole proprietors) who file their taxes below the Schedule C or F of their Type 1040 private tax returns. These people have been very effectively served by the latest Interim Rule modifications and purposes, which permit them to think about the lesser of: (a) 20.833% (2.5 divided by 12) of their 2019 web revenue; or (b) $20,833 as having been spent on forgivable prices, no matter what they do with these funds. Most such people received their loans based mostly upon 20.833% (2.5 divided by 12) of their 2019 web revenue, and may rely the identical actual quantity towards forgiveness, plus permitted hire, curiosity, and utility prices, to place them clearly above the quantity of bills wanted to achieve full forgiveness.
What we now know for sure about compensation and advantages for shareholders/homeowners of S companies and C companies, which the SBA appears to be referring to as “owner-employees”, is as follows:
1. The group medical insurance prices of a person who’s an proprietor of an S company can’t be included within the forgiveness quantity.
This is sensible as a result of medical insurance premiums paid for S company shareholders who personal greater than 2% of the corporate are deductible however are reported as compensation on Type W-2, thus the quantity of the shareholder’s medical insurance prices are already included in his or her W-2 revenue.
The forgiveness credit score applies to the W-2 revenue (together with the medical insurance prices reported on the W-2) until the shareholder is over the W-2 forgiveness ceiling, which shall be $15,385 if an 8-week forgiveness interval is chosen or $20,833 if a 24-week forgiveness interval is chosen. The $15,385 and $20,833 numbers are defined below part Three beneath.
Right here is an instance of how the medical insurance guidelines will apparently work. John owns 2% or extra of ABC LLC and earns $98,000 a yr in wage. His medical insurance prices are $6,000 per yr. From an annualized foundation standpoint, these guidelines will enable all of John’s $98,000 wage and $2,000 of his medical insurance prices to rely in direction of forgiveness.
If an 8-week forgiveness testing interval is chosen, which means that the corporate can rely $15,077 of John’s wage and $308 of his medical insurance based mostly upon 8/52 of $98,000 and eight/52 of $2,000. 8/52nds of $4,000 in medical insurance ($615) can’t be counted since that might exceed the $15,385 restrict on proprietor compensation.
If a 24-month testing interval applies, then the whole mixed wages and medical insurance allowable for an worker shareholder shall be $20,833, and extra insurance coverage prices is not going to be counted in direction of forgiveness.
It’s attention-grabbing that this rule is immediately opposite to earlier SBA steerage issued in FAQ #7, which allowed shareholders of S-Companies to incorporate medical insurance prices above and past the cash compensation restrict of $15,385. Many loan Functions have been filed to incorporate medical insurance prices above the restrict on cash compensation, and now such debtors may have a mismatch between what loan quantity they acquired and the quantity that may be forgiven. Presumably this may be made up by spending cash on non-payroll prices, or possibly future steerage will enable medical insurance prices to be included above and past the proprietor compensation restrict.
Larry Starr has famous that his interpretation of the rule associated to the lack to incorporate medical insurance prices for S-Company shareholders with greater than 2% possession on line 6 of the loan Forgiveness Utility is that such shareholders can’t embody any of their medical insurance prices. I don’t imagine this to be the case for the reason that reasoning for not together with such medical insurance prices is that they’re already included in W-2 compensation, which is reported on Line 9 of the loan Forgiveness Utility, however future steerage can be useful to make clear this concern.
A better limitation and drawback would possibly apply for S-Company shareholders with lower than 2% possession and fewer than $100,000 in annualized wages as a result of the W-2 revenue doesn’t embody medical insurance prices, so the corporate presumably receives no forgiveness for the medical insurance prices for the reason that just lately launched steerage makes no distinction or exception for shareholders proudly owning lower than 2%. An aggressive place could be to incorporate medical insurance prices of shareholders proudly owning lower than 2%, based mostly upon the reasoning that since such prices should not included in W-2 compensation reported on Line 9 of the Forgiveness Utility, they need to due to this fact be reported on Line 6.
2. Compensation Counted for Proprietor-Staff Exceeds What They Had been Paid in 2019.
The above rule and instance assumes that John’s 2019 annual compensation was at the least $100,000.
What if John’s 2019 compensation was $49,000 and his medical insurance was $3,000 as a result of he solely labored 6 months in 2019 for no matter purpose?
Assuming that the corporate had important different payroll in order that it’s PPP loan was rather more than $100,000, one would have assumed that both 8/52nds or 20.833% (2.5 divided by 12) of John’s complete $100,000 quantity would rely as forgiveness, however the brand new modified interim guidelines point out that such forgiveness shall be restricted to not exceed a pro-rata portion of his 2019 earnings.
Which means many small companies that primarily relied upon non-owner staff in 2019 won’t be able to obtain full forgiveness if the first staff within the firm are homeowners throughout the testing interval.
The SBA’s reasoning for this rule is that the loan was based mostly on a most of 20.833% of 2019 compensation for homeowners, and with the extension to 24 weeks, many enterprise homeowners would possibly obtain a windfall by solely paying themselves and relying upon one of many quite a few exceptions to sustaining full employment for his or her workers.
For instance, if John’s 2019 compensation was $49,000 in 2019 as a result of he solely labored for six months, then John would obtain a loan of $10,208 based mostly on his compensation. Let’s additionally assume that John had two different workers that every made $25,000 in 2019, and that there have been no advantages or state employment taxes, in order that John’s complete loan was $20,624 (10,208 + $10,416). If not for the above talked about rule, John might lay off each of his workers and nonetheless obtain full forgiveness based mostly upon paying himself the utmost wages of $20,833 by counting on the exception that his worker headcount was lowered as a result of his enterprise couldn’t return to the identical stage of enterprise exercise. The SBA is attempting to keep away from this so-called “windfall” to homeowners by limiting forgiveness to 20.833% of 2019 compensation for the 24-week interval in order that forgiveness for homeowners will match the portion of the loan acquired for their very own compensation.
One unanswered query is whether or not or not this limitation applies to spouses or different family members of the proprietor. Underneath present guidelines, no such attribution exists, so wages exceeding quantities paid in 2019 could be paid to spouses or different relations that work within the enterprise assuming that the wages paid are respectable compensation for companies rendered to the corporate.
3. $20,833 for 8-Week Testing Versus $46,154 for 24-Week Testing and Why?
As talked about above, forgiveness for wages and medical insurance for an proprietor and worker throughout a 24-week testing interval can’t exceed $20,833. If an 8-week testing interval is elected, the limitation is $15,385.
That is based mostly upon the premise that the forgiveness for an organization shouldn’t exceed the quantity that was loaned for the wages of its homeowners (2.5 months/12 months X $100,000).
However, a non-owner worker’s compensation could be counted based mostly upon as a lot as $46,154 (24/52’s of $100,000) if the individual has wages of $100,000 or extra. Along with this, the corporate’s complete price of offering the non-owner worker with medical insurance and retirement plan advantages (paid or incurred) throughout the 24-week interval could be counted.
Whereas this limitation was not anticipated, most debtors is not going to be damage as a result of they’ll have loads of different bills to use in direction of forgiveness.
4. What About Retirement Plan Bills?
The PPP loan program was very beneficiant on the lending facet by together with an quantity equal to 2.5 instances the common annual expense for retirement plan contributions, contemplating that in lots of small corporations, the overwhelming majority of contributions are for extremely paid workers and homeowners.
The SBA might have required employers to measure how a lot of every retirement plan contribution for 2019 was attributable to salaries above the $100,000 annualized restrict, however this is able to have been extraordinarily difficult and would have considerably lowered the PPP loans going to many corporations who’re already struggling to take care of their pension advantages, not to mention holding the identical variety of staff on the payroll.
The planning alternative left open by all indications below FAQ’s, Interim Last Guidelines, and Forgiveness Functions and Directions, was that every one pension plan bills “paid or incurred” throughout the 8-week or 24-week testing interval would rely as forgiveness.
This may be interpreted to imply that at the least 8/52, or 24/52 (as relevant), of the 2020 annual pension prices could be thought of as paid towards forgiveness, whether or not paid or not throughout the 8-week or 24-week interval, for the reason that expense was incurred throughout that interval however would possible need to be paid within the regular course previous to submitting the loan Forgiveness Utility to get credit score for such prices.
By the identical token, the foundations could be learn to supply that paying your complete 2019 pension obligation throughout the 8-week or 24-week interval (which is regular in pension planning), would additionally facilitate having your complete 2019 pension contribution counted in direction of forgiveness and that paying the 2020 contribution quantity throughout the testing interval may cause 100% of the 2010 expense to be counted in direction of forgiveness.
The Utility for Forgiveness makes no reference to those planning alternatives, and there’s nothing within the revised Interim Last Guidelines that might restrict this both.
Please see the phrases we’ve got underlined beneath from the next language that’s taken verbatim from the brand new EZ Utility, and may present for a limitation on retirement plan contributions for homeowners. This language additionally gives an excellent assessment of the foundations which can be mentioned above:
Worker Advantages: The overall quantity paid by the Borrower for:
- Employer contributions for worker medical insurance, together with employer contributions to a self-insured, employer-sponsored group well being plan, however excluding any pre-tax or after-tax contributions by workers. Don’t add employer medical insurance contributions made on behalf of a self-employed particular person, normal companions, or owner-employees of an S-corporation, as a result of such funds are already included of their compensation.
- Employer contributions to worker retirement plans, excluding any pre-tax or after-tax contributions by workers. Don’t add employer retirement contributions made on behalf of a self-employed particular person or normal companions, as a result of such funds are already included of their compensation, and contributions on behalf of owner-employees are capped at 2.5 months’ worth of the 2019 contribution quantity.
- Employer state and native taxes paid by the borrower and assessed on worker compensation (e.g., state unemployment insurance coverage tax), excluding any taxes withheld from worker earnings.
This above underlined language isn’t included in the principle loan Forgiveness Utility, and we all know of no purpose why, until it’s a drafting error to incorporate it within the EZ Utility, or it was an error to not embody it within the non-EZ Utility. Alternatively the SBA may not need this “loophole” to be out there for individuals who file an EZ Utility, or will do that now to avoid wasting face and declare that this was not an error. Underneath this limitation, the utmost pension expense permitted for quantities put away for an worker shareholder shall be based mostly upon 2.5/12 (20.8%) of the annual retirement plan expense, versus the bigger quantities that might in any other case be counted within the Forgiveness Utility.
It’s unknown whether or not it was supposed that this limitation would apply just for debtors who use the EZ Utility and never for debtors who use the total loan Forgiveness Utility, or if it was supposed to use to each.
5. What Is An Proprietor-Worker and What Can Be Carried out to Keep away from this Limitation?
The foundations present no trace as to what an “owner-employee” is, however we will assume that that is any one that has an possession curiosity within the borrower firm of any measurement, and that this is not going to embody the partner or one other member of the family of the proprietor who would possibly work for the corporate. Additionally, there appears to be nothing to forestall the one who has owned the corporate up to now from promoting or gifting their possession to another person, like a partner, and whereas persevering with to work for the corporate in order to not be topic to those limitations throughout the interval of the testing weeks that the individual is now not an proprietor.
For instance, a person or part-owner of an organization who labored for the primary ten weeks of the 24-week testing interval, incomes no matter wage was paid, can switch her possession to her partner and obtain $46,154 of compensation between the date of the switch and the top of the 24-week interval, even when a part of the compensation in these final weeks is pre-paid for work the worker turns into legally accountable to carry out after the 24th week.
This could enable a complete $46,154 to rely in direction of forgiveness, assuming the compensation quantity is affordable for the work that’s being carried out.
Larry Starr has expressed his disagreement with me that an S/C Company shareholder is taken into account an “owner-employee” and thus topic to the above talked about guidelines limiting compensation to a pro-rated portion of 2019 earnings. His reasoning comes from Inner Income Code Part 401(c)(3), which defines an owner-employee for functions of certified pension, profit-sharing, and stock bonus plans guidelines as “an employee who (1) owns the entire interest in an unincorporated trade or business [a sole proprietor], or (2) in the case of a partnership, is a partner who owns more than 10 percent of either the capital interest or the profits interest in such partnership.”
I hope that Larry is true however I believe that the SBA will make clear this based mostly upon my view, notably in gentle of the beneath quoted Utility Directions that appear to place the nails within the coffin:
- “Do not add employer health insurance contributions made on behalf of a self-employed individual, general partners, or owner-employees of an S-corporation, because such payments are already included in their compensation.”
Constant therewith, the Interim Last Guidelines on loan Forgiveness present as follows:
- “Owner-employees are capped by the amount of their 2019 employee cash compensation and employer retirement and health care contributions made on their behalf. Schedule C filers are capped by the amount of their owner compensation replacement, calculated based on 2019 net profit. General partners are capped by the amount of their 2019 net earnings from self-employment.”
I don’t see how “owner-employee” doesn’t imply S and C company homeowners when the wording above particularly mentions “a self-employed individual” and “normal companions”. What else might an “owner-employee” be?
There’ll undoubtedly be extra questions and modifications in these guidelines, however PPP debtors who can attain full forgiveness whereas navigating these considerably wavy waters must be on their method to the profitable completion of an Utility for Forgiveness, and a contemporary begin in saving their enterprise or skilled apply, as supposed by Congress.
Please be at liberty to ship questions on this subject to [email protected] and put “Those Dang Employee-Owner Rules” within the topic line in order that we will both reply you immediately or cowl your questions in our free webinar.