August 20, 2020
Authored by: Robert Klingler
Self-employed Schedule C (and Schedule F) filers, general partners, and other PPP borrowers that utilized 2019 IRS Form 1040 Schedule C line 31 net profit amount in calculating the amount of their PPP loan are clearly subject to these limitations. However, the SBA guidance also indicates that owner-employees of C-Corporations, S-Corporations and LLCs are subject to the owner-employee compensation limits, and the SBA guidance is silent on limited partners.
Update (8/24/20): The Treasury and SBA published a new Interim Final Rule that confirms the initial guidance did not include any exception based on the owner-employee’s percentage of ownership. However, the new rule also provides that “an owner-employee in a C- or S-Corporation who has less than a 5 percent ownership stake will not be subject to the owner-employee compensation rule.” While limited partners are not addressed in the new rule, we note the original Interim Final Rule which limited owner-employees only referenced general partners; accordingly presumably no formal exception for limited partners is necessary. This would also be consistent with the reasoning for less than 5% shareholders, as limited partners would generally “have no meaningful ability to influence decisions over how loan proceeds are allocated.”
(Note: This is the third in what we anticipate to be a series of posts regarding questions about the Paycheck Protection Program and Loan Forgiveness. A list of questions addressed so far is also available on our PPP Resources page. These questions and our answers are based on discussions with colleagues and clients, both lenders and borrowers. Our intention is to cover issues that, while potentially frequently asked, are not explicitly addressed in official FAQs or directly in Interim Final Rules. Our answers may ultimately be subject to change as additional guidance is provided, but reflect our view of the regulations at the time of posting.)
The current Paycheck Protection Program Forgiveness Application asks all borrowers to certify as follows:
- if a 24-week Covered Period applies, the forgiveness amount requested does not exceed 2.5 months’ worth of 2019 compensation for any owner-employee or self-employed individual/general partner, capped at $20,833 per individual; and
- if the Borrower has elected an 8-week Covered Period, the forgiveness amount requested does not exceed 8 weeks’ worth of 2019 compensation for any owner-employee or self-employed individual/general partner, capped at $15,385 per individual.
While the concept of owner-employee compensation was initially used by the SBA to calculate the amount that a small business with no employees was eligible for, with the expansion of the eligible covered period, the Treasury and SBA have also added restrictions on the use of compensation to “owner-employees” in calculation of the amount of payroll costs eligible for forgiveness. See, for example, the “Interim Final Rule on Revisions to Loan Forgiveness Interim Final Rule and SBA Loan Review Procedures Interim Final Rule” and the Frequently Asked Questions about Loan Forgiveness.
Unfortunately, to date, neither the Treasury nor the SBA has meaningfully defined what constitutes an “owner-employee” or provided any guidance as to whether borrowers need to limit W-2 compensation paid to an employee that happens to have an ownership interest (however small) in the borrower. The Frequently Asked Questions “defines” an owner-employee as “an owner who is also an employee.”
We are hopeful that the Treasury and SBA will ultimately provide guidance that any compensation reported on IRS Form W-2 could be excluded from being considered “compensation for any owner-employee.” We also note the definition of “owner-employee” found in Section 401(c)(3) of the Internal Revenue Code which provides that the “term ‘owner-employee’ means an employee who— (A) owns the entire interest in an unincorporated trade or business, or (B) 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.” However, we note there is no universal definition of an “owner-employee” in income tax laws and that the language is sometimes used interchangeably.
Pending further guidance from the SBA and the Treasury, and recognizing the availability of the 24-week covered period, our current advice is to consider whether the borrower could be entitled to 100% forgiveness while limiting any employee with an ownership interest in the borrower to the caps applicable to “owner-employees.” While we acknowledge that this will require additional work to prepare the documentation and may ultimately prove more conservative than necessary, it can also be a relatively easy means to counter the uncertainty of interpretations under the PPP loan forgiveness program, particularly for borrowers that should expect further SBA review due to the size of their PPP loan.