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The PPP has been one of the most popular relief programs and you need to know about its implications (if you took one out) for tax and accounting purposes.
While it is no longer available, people still need to understand its consequences and how to calculate future payroll costs. For instance, you need to know how to calculate it for filing tax returns for the year-end 2020. Otherwise, you get a fine from the IRS for incorrect tax filing.
The accounting methodology for calculating payroll costs for the PPP loan is actually very straightforward, though there are certain intricacies with the reporting requirements afterward.
PPP Qualifying Criteria
In order to qualify for PPP loan forgiveness, you must basically be able to demonstrate that you could not otherwise have gotten by during the COVID disaster. There is nothing really ‘concrete’ about the guidelines.
Hedge funds and large businesses are exempt from PPP applications, as they have the capital reserves at hand to survive. There is one main requirement, governed under section 1102 of the CARES Act that brought the PPP into effect. This section stated that:
“Current economic uncertainty makes this loan request necessary to support the ongoing operations of the Applicant.”
The other main criteria is that you accurately calculated the PPP amount you were entitled to, which is a function of how many employees you have, of what type, and how much they were paid.
If you did qualify for a PPP loan, you are required to keep documentation for a minimum of 6 years. The SBA is reviewing individual applications on a case-by-case basis. If it is determined that you do not qualify for PPP forgiveness, then you can appeal the decision.
The 3 Steps to Calculating Payroll Costs
The SBA has released a list of scenarios as to how to calculate payroll costs in relation to the PPP. However, it is still a little complicated as there are so many permutations and it is hard to figure out what the terms really mean.
Which is why we have broken it down into 4 simple steps for you to easily handle. However, you still have to understand that it depends on your legal entity type and your unique situation.
The relevant forms to keep in mind for the legal entity types include the schedule C for a Sole Proprietorship, a Schedule K for an LLC or Partnership, a Form 1099 for an independent contractor/freelancer, or a Form 1120 for a C-Corp or S-Corp. If you are unfamiliar with these forms, then it is best to get familiar with them, as they are essential for tax purposes and basic accounting.
It is actually more straightforward than you might think, despite all of the jargon. Calculate your monthly payroll costs and multiply the amount by 2.5 to determine your maximum PPP loan eligibility.
Because there are so many permutations, we have given the following example based on a partnership with employees (keep in mind that LLCs can choose to be taxed as an LLC, Partnership, or Sole Proprietorship).
Step 1 – Compute Yearly Total Payroll
The first step can be broken into a series of steps you need to take to compute your payroll costs.
- Find the total net earnings per partner (Schedule K-1 i.e. IRS Form 1065) and multiply this by 0.9235.
- Calculate the gross earnings of your employees. You can find this information on the IRS Form 941 in tandem with your payroll software. Include pre-tax employee contributions for health insurance or other fringe benefits excluded from Taxable Medicare wages & tips.
- Include 2019 employer contributions for employee health insurance, if any (IRS Form 1065).
- Include 2019 employer contributions to employee retirement plans, if any (IRS Form 1065).
- Include 2019 employer state and local taxes assessed on employee compensation, primarily state unemployment insurance tax (from state quarterly wage reporting forms), if any.
- While your rent and utility payments can be covered by this loan and help qualify you for loan forgiveness, they are not a part of the initial calculation. This could harm you if the SBA does a revision and you have miscalculated your PPP amount.
- If your net profit for 2019 is above $100,000, the maximum amount you can include for yourself is $100,000. This would give you an Average Monthly Payroll of $8,333 (provided you have no W2 employees on your payroll).
- If your net profit for 2019 was negative, meaning that you took a loss in your business last year, PPP will not be a great option for you. If your business took a loss prior to COVID-19, you will not have been considered to have a salary, and it will be more difficult for you to represent that COVID-19 has had a negative impact on your business.
- The Economic Injury Disaster Loan (“EIDL”) was a viable alternative to the PPP. This was a grant available up to $10,000. COVID 19 EIDL advances were also available, as were many other commercial grant programs. In fact, the Finimpact Squad dedicated an entire article to the huge list of resources that were available during COVID and were surprised that so few business owners knew of their available options.
- As an S-Corp, shareholder distributions do not count towards your salary. Your only way to remit payroll taxes is through payroll itself; you don’t pay any payroll taxes or self-employment taxes on your distributions.
- Salaries, tips, and commissions.
- State and local employer payroll taxes.
- Health insurance premiums.
- Employee retirement plans.
- Net profit (for the self-employed only).
- Capability to work out payroll calculations/deductions quicker.
- Capability to generate accurate payslips.
- Capability to calculate bonuses, expenses, holiday pay, etc with minimum effort.
- Capability to send returns to HMRC and print P45, P60, and other forms for employees.
- Capability to automate certain tasks, including year-end reporting.
- Reduces the complexity of compliance.
- Removes the need to understand complex tax legislation.