Simple on the surface, the formula gets complicated once you collect the inputs and try to do the math.
Further complicating the effort? As practical matter, you can’t get personalized help from either your accountant or banker. Neither has time for a personalized consultation. Both are overwhelmed.
To try to help you, your accountant and your banker a bit, then, this blog post explains the paycheck protection formula. And it provides a bunch of examples to illustrate how the formula works.
Before We Start
But before we start, let me say something.
One can’t responsibly write a blog post like this without citing the relevant bits of the statutes and the other guidance from the Treasury and the Small Business Administration.
However, the usual way of doing that won’t in my opinion work very well. I can’t imagine it’s very effective, for example, if I point you to Section 1102(a)(1)(A)(viii)(I)(aa)(AA).
Accordingly, I point you to page numbers of the CAREs Act PDF document available here from the Congress.gov website.
What you want to do is print pages 6 to 21. (This range includes both the Section 1102 statute that sets up the paycheck protection loan program and the Section 1106 statute that defines how you ask for forgiveness.)
You can then refer to the appropriate page if you want to see the bit of the law I’m discussing.
And now we start.
The Basic Paycheck Protection Loan Formula
The way to understand the formula: It provides money to pay employees and then a small business’s owners for eight weeks. Plus a little extra to keep the doors open and the lights on.
For example, suppose a small business annually pays employees $60,000 in W-2 wages. Further suppose the firm generates self-employment income for the two owners equal to $40,000. In addition, the firm provides employee healthcare insurance that costs $20,000 a year.
This firm’s annual payroll costs total $120,000: $60,000 of wages + $40,000 of self-employment earnings plus $20,000 of health insurance.
That annual payroll cost equates to a $10,000 average monthly cost. (You divide the $120,000 by twelve months.)
That $10,000 monthly payroll cost determines the paycheck protection loan. The loan equals 2.5 times the monthly payroll costs. With $10,000 in monthly payroll costs, for example, the loan amount equals $25,000.
So, it sounds simple, right? We only wish. The formula gets complicated in real life. Small business owners (and their accountants and bankers) ask dozens of questions. Accordingly, in the paragraphs that follow I share the best answers I’ve heard from others or find in the statute or agency guidance.
W-2 Wages Paid Employees
The statute obviously looks at employee W-2 wages. So, you need to determine that value.
My suggestion? Use the Box 1 amount shown on the W-3 but add to that amount the retirement account elective deferrals listed in Box 12.
A W-3, in case you don’t know, summarizes the information on the W-2s an employer gives employees.
Example: The W-3 shows $120,000 in Box 1, $150,000 in Boxes 3 and 5, and $40,000 in Box 12 for employee 401(k) elective deferrals. In this situation, you might be tempted to just grab the total wages subject to Medicare shown in Box 5. That amount equals $150,000. But don’t. If you do that, you may miss the part of the wages that represents the owner’s self-employed health insurance.
A caution: The error some of the payroll services and maybe the banks made initially with regard to wages? They wanted to deduct the federal payroll taxes shown in Boxes 2, 4 and 6. That approach? Clearly wrong. (See here for the Small Business Administration’s primary guidance on this.)
Wages More than $100,000 Don’t Count
The statute specifically limits its funding to only the first $100,000 of salaries an employee or owner earns. (See page 7 if you printed the PDF pages of the statutes.)
Further, the statute converts the $100,000 annual figure, in effect, into a monthly amount of $8,333. (If you divide $100,000 by 12, you get $8333.)
Example: A firm has two employees: One earns $5,000 a month. One earns $10,000 a month. The paycheck protection formula in effect counts $5,000 as the monthly payroll cost for the first employee. The formula counts $8,333 as the monthly payroll cost for the second employee.
Tip: To calculate the “excess” wages, the small business can look at each employee’s W-2. You want to look at Box 1 but add back the elective deferrals for things like a 401(k) shown in Box 12.
Partial Year Wages
The loan formula also doesn’t let you average wages over the year. The statute requires pro rata calculations. (Page 7.)
Example: Say a business starts operations halfway through the year and hires a single employee at an annual rate of $200,000. Because the employee works only half the year, she earns $100,000. For purposes of the paycheck protection loan, however, the payroll cost equals $50,000. Only the first $8,333 of payroll paid each month counts.
Independent Contractors Receiving a 1099-MISC
Much confusion has occurred with regard to how a firm treats its independent contractors. These are the folks the business sends (or should send) 1099-MISC forms at the year-end.
The interim final rule from the Small Business Administration states payroll costs do not include 1099-MISC.
Your 1099-MISC contractors should get their own paycheck protection program loans (PPP loans.)
Note: If your bank funded your PPP loan to include amounts you pay to 1099 independent contractors, you may want to hire these contractors as W-2 employees. Talk with your accountant about this. The PPP loan forgiveness formula, something I’m not talking about in this blog post, reduces the PPP loan for employee W-2 wages but not for 1099-MISC contractor payments.
S Corporation Shareholder Payroll Costs
An S corporation owner’s compensation–including appropriately accounted for self-employed health insurance–counts as payroll cost. The amount to include then? What the W-2 shows in box 1 (as adjusted for any elective deferrals to things like a 401(k).)
Example: An S corporation shareholder-employee earns $48,000 in her business and this amount shows on her W-2 in Box 3 and Box 5. Box 1 shows $60,000 because her compensation includes $12,000 of health insurance because the IRS says the S corporation counts this amount as wages. Use the box 1 value, or $60,000, for the payroll costs.
Example: An S corporation shareholder takes no wages from his corporation. Only shareholder draws. His K-1 shows $60,000 of income and distributions. The S corporation unfortunately counts his payroll costs as zero.
The statute and the agency guidelines only precisely described how to calculate the payroll cost for a sole proprietor on April 14. (That guidance appeared in a document that discussed additional eligibility criteria related to paycheck protection program loans.)
The approach the new guidance says you use? Look at the Schedule C form’s “business income” amount. (The Schedule C tax form appears inside a sole proprietor’s 1040 tax return.)
Example: A sole proprietor’s Schedule C form inside her 1040 return calculates $52,000 of business profit. That $52,000 counts as her annual payroll cost. In combination with any other W-2 employee wages, it determines the total annual payroll costs and the average monthly payroll costs. If the sole proprietor also paid another $68,000 in W-2 wages to employees, for example, the total firm’s annual payroll costs equal $120,000. The average monthly payroll then equals $10,000. The PPP loan amount then equals $25,000 or 2.5 times the $10,000 average monthly payroll.
Partners in an Active Trade or Business
The “Additional Eligibility Criteria” document just referenced also describes how partners in an active trade or business calculate their payroll costs. For these folks, self-employment earnings count as the payroll costs.
Example: A working partner in an active trade or business receives a K-1 that reports $50,000 in Box 1 of the K-1 and another $50,000 in Box 4a of the K-1. Box 1 shows the partner’s share of the partnership’s profits. Box 4a reports on the partner’s guaranteed payments received for working in the business. Assuming both of those amounts count as self-employment earnings–they probably do–the partner’s payroll costs equal $100,000.
The statute says that group health insurance counts as a payroll. But two questions pop up regarding health insurance and the PPP loan amount formula:
- First, whether health insurance counts toward that $100,000 limit.
- Second, whether self-employed health insurance counts.
With regards to whether health insurance counts toward the $100,000 limit? The answer is “no.” On April 7, 2020, the Small Business Administration published an FAQ that said the $100,000 includes only cash compensation.
With regard to whether self-employment insurance counts, I think it doesn’t… The statute says group health insurance counts (see page 7.)
However, indirectly business owners actually do get to count it because of the way the self-employed health insurance works. Why? For a business owner, the self-employed health insurance gets baked into another “number” that explicitly counts as a payroll cost.
Example: For an S corporation shareholder-employee, self-employed health insurance gets included in the W-2 wages and so is included in payroll costs because it’s part of the wages.
Example: For a sole proprietorship, the self-employment health insurance deduction doesn’t reduce the Schedule SE calculation of “self-employment earnings.” Rather, those “self-employment earnings” provide the money that gets used to pay for health insurance.
Example: For a partner working in an active trade or business, self-employed health insurance counts as a guaranteed payment. That means it counts as self-employment income. And of course self-employment income counts as a payroll cost.
Pension costs count as retirement benefits. And further, they don’t count toward the $100,000 ceiling. (This guidance comes from that same FAQ mentioned in the preceding discussion of healthcare costs.)
Example: A small business has two employees. One makes $50,000. The other makes $100,000. The company operates a SEP-IRA plan which means 25% contributions to employee’s IRA accounts. That means a $12,500 contribution for the first employee and a $25,000 contribution for the second employee. Both pension contributions count. And that’s the case even for the second employee who makes $100,000 before the SEP-IRA contribution.
Three Quick Comments to Close
Sorry, this is another long post. But three quick comments before I close.
First, the guidance from the Treasury and Small Business Administration changes almost daily. So you want to stay alert and also show patience here.
Second, I would not make “perfect” the enemy of “good” here. If you have an easy way to calculate and then document you’re entitled to $50,000 of paycheck protection loan money, don’t waste time trying to legitimately nudge that amount up a bit to, like, $52,000.
Third, understand that the loan forgiveness formula works differently than the loan amount formula. I’ll try to write about that when good details come out. (You may want to subscribe to our email newsletter to make sure you get that information. There’s a sign-up form just below the blog post.)