There is a lot of confusion surrounding how the paycheck protection program formula actually works. It should really be no surprise.
In theory the formula is rather straightforward. But once you actually gather your information together and get ready to enter in the numbers then the challenge begins.
Well you’ve come to the right place. In this post, we will breakdown all you need to know about the Payroll Protection Program. We’ll walk you through a few examples and answer three main questions:
We’ll walk you through the payroll cost calculation and teach you a few tips and tricks along the way.
Surprisingly, this calculation is a little different than the loan calculation. We’ll give you a few examples.
Once you understand how the plan works you will be able to maximize your stimulus amount.
- Paycheck Protection Program Formula
- Paycheck Protection Program Basics
- Diving into W2 Wages
- What About Wages over $100,000?
- So what about independent contractors?
- What about shareholders of an S Corp?
- What about sole proprietors?
- How does it work for partnerships?
- How does health insurance work?
- What about retirement benefits under PPP?
- Bottom Line
But here’s another thing that complicates the issue. Your CPA or accountant cannot actually help you out. Generally speaking, they won’t have the time but the rules say they’re not allowed to do it for a fee. Not sure if that makes a lot of sense, but those are the rules.
Paycheck Protection Program Formula
The goal of this post is to give you some detail of how the paycheck protection program works. We will take a close look at the calculation used for determine how much stimulus you are eligible for under the plan. I will also provide some examples to show you the formula works in practice.
However, there’s one thing that’s important to understand. This is meant to be a comprehensive guide, but I’m not going to bore you with complex IRS code. I don’t want to put you to sleep. But I will reference statutes and other relevant guidance from the IRS, small business administration, or the treasury department as needed for clarification.
The goal is to make this as simple and easy as possible. Let’s also understand that this is meant to be a living, breathing document. Various government agencies are coming up with insights, oversight and clarification almost on a daily basis. It makes it challenging even for the accountants and attorneys to keep up, let alone the business owners.
So we will reference you to the best areas to get your information, but by all means this discussion is not meant to be complete. However, we will update this post as quickly as possible.
Paycheck Protection Program Basics
So getting to the basics of the formula, the Paycheck Protection Program (or “PPP”) provides business owners with money to pay employees (including themselves) for eight weeks. The will also give you a little bit of extra money to pay the rent and keep your operations going.
So how does the payroll cost calculation work? Let’s assume a small business pays the following:
- $100,000 in W-2 wages to employees.
- $70,000 of W2 compensation to the owner.
- health insurance costs of $10,000.
Based on the numbers above the companies total payroll costs are $180,000. That’s because you get to include the compensation for the owners and employees, along with the health insurance costs.
So assuming annual payroll of $180,000, we would then divide this by 12 months to come up with an average monthly payroll costs of $15,000. Not too tough, right?
This $15,000 of monthly payroll is what you would use as a starting point for the payroll protection program loan calculation. The allowable loan will equal 2.5 times the monthly payroll amount. In this example, that equals $37,500. Simple so far.
Diving into W2 Wages
OK so now it starts to get a little bit more challenging. Remember that we are looking at employee wages. So these would be employees that are on actual payroll and are issued a W-2 at the end of the year.
To determine this payroll, amount I would look at your form W-3. This is basically an IRS summary form of all the W-2s issued for the year. As a starting point, I would use the box 1 amount but then take out any number that is listed in box 12 as a retirement plan deferral.
So let’s look at an example. The W-3 has $180,000 in box 1 with $200,000 included in boxes 3 and 5. There is also $20,000 in box 12 for the employee 401(k) plan. In this case, the payroll costs for PPP are $200,000.
You might think it’s easy to just take the Medicare wages shown in box 5. But don’t do it. This is because you may not include some of the owners self-employed health insurance. Remember this can be included in the calculation.
Few S-Corps actually properly include the owners self-employed health insurance in box 1, but this is the way it is supposed to be done. Just make sure you include the appropriate amounts.
Note that some payroll companies and banks had initially given some inaccurate information. They stated you must deduct the federal payroll taxes that are shown on boxes 2, 4 and 6. This is an easy error to make because these amounts are subject to the loan forgiveness, but are not included in the initial formula calculation itself.
What About Wages over $100,000?
Another part of the statute you need to be careful with is limiting the funding to the first $100,000 of wage for each employee. This $100,000 equals $8,333 a month.
As an example, let’s assume a company has two employees. One earns $4,000 a month and the other one makes $12,000 a month. The actual formula itself will take the initial $4,000, but only $8,333 of the second employee to get to the monthly amount. So the qualifying payroll amount is $12,333.
The actual formula does not allow you to use average wages over the year. The statute requires that you use pro rata calculations.
So if a business opens operations on July 1st of the year and hires a single employee at an annual rate of $50,000, this person would make $$25,000 in year one.
What about independent contractors?
Many business owners “employ” independent contractors in their businesses. They typically receive form 1099 at the end of the year.
Now business owners often called these folks “employees”, but they truly don’t meet the definition of an employee. They are not issued W-2s subject to payroll taxes nor do they receive any other company benefits. So they aren’t actual employees.
Certain banks have recommended that these costs be included in the actual payroll calculation. This isn’t really accurate based on the definition of payroll. The interim rule from the SBA states that payroll costs don’t include 1099 contractors. But there is some debate on this issue. You can take a look at it yourself here on page 7.
But let’s remember that even if the independent contractors are not truly employees, they are subject to their own payroll protection program loan stimulus themselves. So they might want to read this post as well.
So if your bank who is funding your PPP loan wants to include the amounts you pay to 1099 contractors you may want to consider hiring these contractors as W-2 employees. The IRS has established criteria as to who is a contractor and who is an employee. So make sure you discuss the issue with your accountant or CPA.
The independent contractor issue becomes more important once you review the forgiveness calculation. But for purposes of the initial loan calculation, you can exclude this amount and just include your actual W-2 employees. The key is that when it comes to forgiveness the PPP amount will be adjusted only for employees, but not for 1099 contractors.
What about shareholders of an S Corp?
The compensation paid to an S-Corp shareholder employee including health insurance will count as payroll cost under PPP. So what do you include? Just include the amount in box 1 but add back any 401(k) deferral‘s that you would see in box 12.
So let’s look at an example. An S corporation shareholder pays herself $50,000 a year. This amount is reflected on box 1, 3 and 5 on the W-2. The payroll calculation for purposes of PPP is $50,000.
Let’s take that same shareholder employee and assume that they pay themselves $10,000 of health insurance premiums. The IRS states that this amount is included as wages. So now box 1 would equal $60,000. This would be the amount for PPP.
Lastly, let’s assume the same employee has paid $10,000 in health insurance, but has deducted $5,000 of an elective deferral under a 401(k) plan. The $5,000 is a reduction in box 1, but is an add back for purposes of PPP. So the loan calculation for PPP is still the $60,000.
Now let’s assume you have an S Corp. owner that pays herself zero compensation for the year, but has a profit on the K-1 of $50,000. Since this owner and employee has no payroll there is no calculation in the formula for PPP. Sorry, but that’s how it works.
What about sole proprietors?
The statute and all the corresponding guidance is somewhat vague when it describes the payroll calculation for sole proprietor’s. But guidance does reference what it calls the business owners self-employment earnings. Again see this on page 7 right here.
So what are you supposed to do? You can look at Schedule SE on the form for your self-employment earnings amount. This Schedule SE actually appears as a separate schedule to the individuals 1040 tax return.
A sole proprietor’s Schedule C (which includes the income and expenses of the business) calculates a profit of $50,000. The schedule SE reduce is this amount for the employer share of Social Security and Medicare wages and calculates $46,175 of self-employment earnings.
This amount is the business owner’s PPP payroll costs for purposes of the PPP payroll formula. If you can’t find this form yourself, your accountant can certainly help you out.
How does it work for partnerships?
Sort of like how it works for sole proprietor’s, the guidelines don’t expand on the definition that much. But it should work similar to a sole proprietor’s self-employment earnings.
So let’s assume there is a partner who is actively working in a trade or business and receives a K-1 that shows $100,000 in box 1 of the K-1. Box 1 includes the partners individual share of the partnership’s business profits. On the partners 1040 tax return, the schedule SE will report $92,350 of self-employed earnings. So this would be the payroll cost for the partner.
How does health insurance work?
So we have already stated that health insurance is included in the payroll calculation. But there are a couple questions that arise with health insurance and the PPP loan formula:
- Is health insurance included in the $100,000 employee limit?
- Can the owner include self-employed health insurance premiums?
When it comes to health insurance being included in the $100,000 limit the answer was just clarified. The Small Business Administration published an FAQ that stated the $100,000 would include only cash compensation.
As it relates to the self-employed health insurance question, I would say that it should be included in box 1 of the W2 for an S-Corp employee shareholder. We have already stated that this would be included in the payroll calculation.
But for a sole proprietor, the self-employment health insurance deduction is not a component of Schedule SE and therefore may not meet the definition of self-employment earnings. So it looks like the business owner’s earnings are used to pay for the health insurance. We’ll see if we get any updates or clarification on this one.
What about retirement benefits under PPP?
As you read the statute, it says that retirement benefits paid to retired employees are included in payroll costs. But most small businesses don’t pay retired employees under a defined benefit plan or similar retirement structure.
Many business owners assumed that this included employer contributions to retirement plans, like profit sharing and safe harbor contributions. This would not include 401k deferrals under a 401k plan.
The SBA further clarified this issue and has allowed retirement contributions to count as payroll costs. In addition, they are not subject to the $100,000 max. The SBA clarified the issue as it relates to the following:
Define benefit plans
Employer contributions to defined benefit plans appear allowable. This includes traditional defined benefit plans in addition to cash balance plans.
I don’t think the intent of the law was to be able to include large tax deductible contributions for solo plans in the definition of payroll costs. But certainly employer contributions for non-owner employees would certainly make sense under the spirit of the law. It can be a substantial employee benefit, so make sure you discuss with your accountant.
Remember that we have discussed how the loan amount is calculated. This is very different from how the loan forgiveness formula works. Make sure you understand the differences in these two calculations.