Good job for getting that done. Seriously. Your initiative may help you comfortably march through the next few weeks of the COVID-19 pandemic.
But a bit of sort of bad news. Your Paycheck Protection Program loan—let’s start calling it a PPP loan–includes a day of reckoning. Roughly 2 months from now, you need to explain to the bank and the Small Business Administration how you spent the money.
And your explanation—both your accounting records and your documentation–will determine how much of the loan the bank forgives.
Example: You borrow $100,000 using a PPP loan and do a good job on the PPP loan accounting? You don’t need to pay the loan back.
Example: You borrow $100,000 using a PPP loan but do a bad job on the PPP loan accounting? You do need to pay the loan back.
Accordingly, this blog post discusses how to do good PPP loan accounting. The post also discusses how to appropriately document the loan transactions. And then the post provides some practical ideas related to you not losing forgiveness.
The laundry list format usually works pretty well. So I break the discussion that follows into a list of tips…
PPP Loan Accounting Tip #1: A Good Payroll System (Probably a Payroll Service)
Mostly, you receive forgiveness for your PPP loan based on your payroll costs over the eight weeks that follow you receiving the loan funding.
The formula limits the forgiveness you receive for non-payroll-costs to less than 25%. (Restated another way, to get a $100,000 of forgiveness, you need at least $75,000 of payroll costs.)
Accordingly, you really want a good payroll system at least over the eight weeks your PPP loan covers.
For this reason, I suggest you upgrade to a good payroll solution if you don’t already have one. Like the system offered by one of the payroll services companies. ADP. Paycheck. Gusto. Or someone else like this.
No, no, I understand. In the past, the ad hoc, informal payroll approach you’ve used? Sure, that worked. Sort of. Mostly.
But with the PPP loan forgiveness formula, your business must accurately account for its payroll costs, including timing and amounts. This is no job for an amateur. Not even if you’re trying to save a few hundred bucks.
And just to say this? I have no horse in this race. No backdoor deal, no economic incentive, nothing prompts me to push you to call one of the payroll companies.
I just want you to avoid screwing up your payroll costs. Period.
PPP Loan Accounting Tip #2: A Real Accounting System
A related suggestion: Maybe you should also use the whole PPP loan thing as the prompt to step up to a real small business accounting program: Quicken, Xero accounting, QuickBooks, FreshBooks, and so on.
By the way, full disclosure: I sort of have a horse in this race. I’m the author of QuickBooks for Dummies.
But seriously, I’m not trying to gin up my book royalties with this statement. I’m thinking about the damage of you goofing up the accounting for things like the other, non-payroll costs you get forgiveness for: rent, utilities, and the interest on mortgages and other loans.
PPP loan accounting Tip #3: Track the Funds Flow
Okay, another accounting-y tip: You want to set up a way to track the disbursements that result in forgiveness. And this may be the most important action you take.
Two good approaches exist here, I think.
One approach I saw an attorney recommend in a news article (I can’t now locate that article. Otherwise I’d give the attorney credit.) You may want to set up a new bank account for the PPP loan money. And then, what you can do is, pay amounts that trigger forgiveness from this bank account.
With a separate bank account, you can easily show the forgivable spending clearly comes from the PPP loan funds.
And if setting up a separate bank account for the PPP loan funds doesn’t work? Yeah, I think you use whatever features your accounting software provides to carefully segregate PPP loan transactions.
QuickBooks, for example, provides a feature called “classes” that you can use to track all of the transactions that connect to a PPP loan.
Note: This comment for the accountants: Nonprofits often use QuickBooks’ “classes” to do fund accounting. So, classes should prove adequate for showing the flow of funds for a PPP loan.
Tip: If you use QuickBooks classes, you would probably use a class like “PPP loan” to tag the income and the spending related to the PPP loan. The payroll costs, rent, utilities and mortgage interest funded with the PPP loan proceeds would be classified as “PPP loan.” The PPP loan’s “cancellation of debt” income would be classified as “PPP loan.”
PPP Loan Accounting Tip #4: Over-document Owner Compensation
Your small business should receive funding for paying the business owner’s payroll or compensation (up to $8,333 a month).
And the S corporation shareholder-employee W-2 wages easily get accounted for. (You just look at the wages amounts shown in your payroll records and tax filings.).
The owner compensation received by a sole proprietor or a partner, however, gets problematic.
Here’s how you handle this trickiness according to the additional eligibility criteria the Small Business Administration published on April 14, 2020..
Use the 2019 owner compensation information to document the appropriate 2020 pay rate. In other words, use the Schedule C from the sole proprietor’s 2019 tax return to document the owner’s payroll cost. Or use what a working partner’s K-1 shows in boxes 1 and 4a.
Let’s say for example this amount equals $52,o00 for 2019. Exactly. So, $1,000 a week. (I’m trying to make the math easy.) That amount equals the owner’s weekly compensation.
Then? Within the eight-week period in 2020 that the PPP loan forgiveness formula looks at? I think the sole proprietor or partner takes a $1,000 a week draw.
Just to make this point, the sole proprietorship or partnership probably loses money over the eight weeks. That’s the terrible economic reality of trying to run a business during a pandemic.
But for purposes of forgiveness, you count the owner draws during the eight weeks as payroll. Even if in 2020, firm actually loses money. (As the Small Business Administration notes in its discussion of how to treat sole proprietors and partners, this approach allows the firm to replace the owners compensation using the 2019 “pay rate.”)
PPP Loan Accounting Tip #5: Document Every Disbursement
A final tip? Document the dollar amount, timing and deductibility of every disbursement.
So, like you’re being audited by the Internal Revenue Service. And by a really suspicious auditor.
For example, for payroll costs? Document the dollar amount and the payment date with actual copies of the payroll checks or electronic payment receipts. And be sure you have any other appropriate documentation too: Timecards? W-4s? Payroll reports from the payroll service company? You see the pattern.
For employee health insurance which also counts as payroll? Same sort of stuff. Use checks and electronic payment receipts to prove the dollar amounts and payment dates. Use the monthly insurance company statement to document the deductibility.
Retirement plan contributions? Yeah, treat those like employee health insurance.
For any rent, mortgage interest, and utilities services? Again, use the actual checks or electronic payment receipts to document the amounts and dates of payments. Then collect copies of the actual rental lease, the mortgage or bank loan agreement, and the utility service contract.
This note about non-payroll costs: The legal agreement for the rent, the mortgage or the utility services needs to have been in entered into before February 15, 2020.
Note: The additional eligibility criteria published on April 14 indicate for a sole proprietor, a deduction should appear on the sole proprietor’s 2019 Schedule C in order to be a permissible expenditure during the “eight-week period following the first disbursement of the loan.”
One other point: Only the interest on the mortgage or business loan qualifies for forgiveness. So, you want to have a monthly statement or bill from the lender that breaks the payment into interest and principal.
Three Closing Comments
Let me throw out three quick comments to close…
First, do verify that your payroll schedule “runs” enough payroll within the eight weeks following the PPP loan funding to get you maximum forgiveness. Most small businesses use cash basis accounting. Which is fine. But that may mean the payroll for the last two weeks of the eight week period of forgiveness falls outside the eight weeks.
Second, make sure you quickly rehire any employees you need in your full-time employee headcount to qualify for full forgiveness. I talk about how reductions in employee headcount reduce forgiveness in the paycheck protection program loans: a small business lifesaver blog post. See that blog post if you have any questions.
A third and final tip? Stay alert to additional guidance the Small Business Administration provides as to how the forgiveness works. We have pretty good information about the math already. But surely the SBA will provide additional instructions. If the rules change, you may want to make changes to your payroll or other forgivable spending in order to optimize.
Other COVID-19 Blog Posts
If you’re still trying wrap your head about the paycheck protection program, this blog post is a good place to start: Paycheck Protection Program Loans A Small Business Lifesaver.
Interested in learning about the other tax breaks for small businesses related to the COVID-19 pandemic? See this blog post: COVID-19 Small Business Tax Breaks and also our discussion of the employee retention tax credit, which is an alternative to the PPP loan.
Finally, if you need to first figure out just what counts as payroll cost for the PPP loan formulas, this discussion should bring you up to speed: Paycheck Protection Program Loan Formula.