Does an owner draw count as salary for the Paycheck Protection Program (PPP)?

This article was updated April 27, 2020 with additional guidance from Treasury.

The Paycheck Protection Program (PPP) offers forgivable loans to business owners who use the proceeds primarily to maintain payroll. But there is a lot of confusion among small business owners who don’t understand how the money they pay themselves—such as the owner’s draw or distributions—may impact their ability to qualify for PPP. 

Here are just a few of the questions we’ve received from business owners: 

• We are an S Corp and in the last year it was just myself and my husband on the payroll. As our income is sporadic we pay ourselves quarterly whatever we can and take shareholder draws as we need them to cover expenses. Should we include shareholder distributions as part of the annual income? 
• I am a sole member LLC working as a contract paralegal. Checks are written to my LLC and I in turn pay myself. How do I prove income? 
• My husband and I run an LLC and both own 50% of the company. We do not have employees or formal payroll. We don’t receive actual payroll checks but instead just pay ourselves what is left after the bills are paid for the month. Do we qualify for a PPP loan?

Here’s the issue. Many business owners don’t pay themselves through formal payroll. Instead, they take money out of their business for their own use when they can. (Some even use business funds to pay personal expenses, which is not a good practice in any situation.) This ad hoc approach to paying the business owner may prove problematic when it comes to qualifying for PPP.

On April 24, 2020 Treasury released guidelines for calculating the maximum loan amount by business entity, and we are sharing that information here. Unfortunately, it was released late in the process after many businesses already applied. But if you’re still considering applying for a PPP loan, it may prove helpful. Keep in mind the maximum loan amount is $10 million per PPP loan, regardless of business entity.

Please keep in mind this information is changing rapidly and is based on our current understanding of the programs. It can and likely will change. Although we will be monitoring and updating this as new information becomes available, please do not rely solely on this for your financial decisions. We encourage you to consult with your lawyers, CPAs and Financial Advisors. To review your real-time funding options with one of Nav’s lending experts, please contact us.

S Corporations

When owners of S Corporations pay themselves (or other shareholders), they may pay themselves a salary, distributions (or “owner’s draw”) or a combination of the two. Salary payments are subject to payroll taxes while owner’s draws or distributions are not taxed as salary. It’s the latter that can create problems when it comes to qualifying for PPP. 

Here’s the latest guidance describing how to calculate the maximum loan amount for corporations, including S and C corporations: 

Step 1: Compute 2019 payroll costs by adding the following: 

• 2019 gross wages and tips paid to your employees whose principal place of residence is in the United States, which can be computed using 2019 IRS Form 941 Taxable Medicare wages & tips (line 5c-column 1) from each quarter plus any pre-tax employee contributions for health insurance or other fringe benefits excluded from Taxable Medicare wages & tips, subtracting any amounts paid to any individual employee in excess of $100,000 and any amounts paid to any employee whose principal place of residence is outside the U.S;  
• 2019 employer health insurance contributions (portion of IRS Form 1120 line 24 or IRS Form 1120-S line 18 attributable to health insurance); 
• 2019 employer retirement contributions (IRS Form 1120 line 23 or IRS Form 1120-S line 17); and 
• 2019 employer state and local taxes assessed on employee compensation, primarily state unemployment insurance tax (from state quarterly wage reporting forms). 

Step 2: Calculate the average monthly payroll costs (divide the amount from Step 1 by 12). 

Step 3: Multiply the average monthly payroll costs from Step 2 by 2.5. 

Step 4: Add the outstanding amount of any EIDL made between January 31, 2020 and April 3, 2020 that you seek to refinance, less the amount of any advance under an EIDL COVID-19 loan (because it does not have to be repaid). 

Documentation: The corporation’s 2019 IRS Form 941 and state quarterly wage unemployment insurance tax reporting form from each quarter (or equivalent payroll processor records or IRS Wage and Tax Statements), along with the filed business tax return (IRS Form 1120 or IRS 1120-S) or other documentation of any retirement and health insurance contributions, must be provided to substantiate the applied-for PPP loan amount. A payroll statement or similar documentation from the pay period that covered February 15, 2020 must be provided to establish you were in operation and had employees on that date.

Conspicuously absent from this guidance is any instruction for S Corporation owners who pay themselves from owner’s draw or distributions. The SBA Administrator and Treasury have not released official guidance on whether owner’s draw counts toward the payroll calculation for purposes of qualifying for PPP. But an email from the SBA dated April 6, 2020 states, “Only payroll costs in the form of salary, wages, tips, etc. are eligible for the PPP program. Owner draws, distributions, amounts recorded on a K-1 are not eligible for the PPP program.” An SBA webinar I recently attended stated the same information so it appears to be an official position of the SBA. 

Sole proprietors and independent contractors

Sole proprietors who don’t have a formal business structure must report their business income and expenses when they file their personal tax returns. Most will use Schedule C to do that. The SBA recently issued guidance indicating that those who file Form 1040 Schedule C should use information from their 2019 Schedule C to qualify. Specifically they should use the net profit from Line 31 of their 2019 Schedule C. (The 2019 return doesn’t have to be filed but it should be completed.) 

Here is the step-by-step guidance for businesses that file Schedule C with no employees (including independent contractors, but not partnerships): 

Step 1: Find your 2019 IRS Form 1040 Schedule C line 31 net profit amount (if you have not yet filed a 2019 return, fill it out and compute the value). If this amount is over $100,000, reduce it to $100,000. If this amount is zero or less, you are not eligible for a PPP loan. 

Step 2: Calculate the average monthly net profit amount (divide the amount from Step 1 by 12). 

Step 3: Multiply the average monthly net profit amount from Step 2 by 2.5. 

Step 4: Add the outstanding amount of any Economic Injury Disaster Loan (EIDL) made between January 31, 2020 and April 3, 2020 that you seek to refinance, less the amount of any advance under an EIDL COVID-19 loan (because it does not have to be repaid). 

Documentation: Your 2019 IRS Form 1040 Schedule C must be provided to substantiate the applied-for PPP loan amount. You must also provide a 2019 IRS Form 1099-MISC detailing nonemployee compensation received (box 7), invoice, bank statement, or book of record establishing you were self-employed in 2019 and a 2020 invoice, bank statement, or book of record establishing you were in operation on February 15, 2020.

Partnerships

Here is the Treasury guidance for calculating the maximum amount that can be borrowed for partnerships. Treasury notes that “partners’ self-employment income should be included on the partnership’s PPP loan application, individual partners may not apply for separate PPP loans”: 

Step 1: Compute 2019 payroll costs by adding the following: 

• 2019 Schedule K-1 (IRS Form 1065) Net earnings from self-employment of individual U.S. based general partners that are subject to self-employment tax, computed from box 14a (reduced by any section 179 expense deduction claimed, unreimbursed partnership expenses claimed, and depletion claimed on oil and gas properties) multiplied by 0.9235* up to $100,000 per partner (if 2019 schedules have not been filed, fill them out); 
• 2019 gross wages and tips paid to your employees whose principal place of residence is in the United States, if any, which can be computed using 2019 IRS Form 941 Taxable Medicare wages & tips (line 5c-column 1) from each quarter plus any pre-tax employee contributions for health insurance or other fringe benefits excluded from Taxable Medicare wages & tips, subtracting any amounts paid to any individual employee in excess of $100,000 and any amounts paid to any employee whose principal place of residence is outside the U.S;  
• 2019 employer contributions for employee health insurance, if any (portion of IRS Form 1065 line 19 attributable to health insurance); 
• 2019 employer contributions to employee retirement plans, if any (IRS Form 1065 line 18); and 
• 2019 employer state and local taxes assessed on employee compensation, primarily state unemployment insurance tax (from state quarterly wage reporting forms), if any. 

Step 2: Calculate the average monthly payroll costs (divide the amount from Step 1 by 12). 

Step 3: Multiply the average monthly payroll costs from Step 2 by 2.5. 

Step 4: Add any outstanding amount of any EIDL made between January 31, 2020 and April 3, 2020 that you seek to refinance, less the amount of any advance under an EIDL COVID-19 loan (because it does not have to be repaid). 

Documentation: The partnership’s 2019 IRS Form 1065 (including K-1s) and other relevant supporting documentation if the partnership has employees, including the 2019 IRS Form 941 and state quarterly wage unemployment insurance tax reporting form from each quarter (or equivalent payroll processor records or IRS Wage and Tax Statements) along with records of any retirement or health insurance contributions, must be provided to substantiate the applied-for PPP loan amount. If the partnership has employees, a payroll statement or similar documentation from the pay period that covered February 15, 2020 must be provided to establish the partnership was in operation and had employees on that date. If the partnership has no employees, an invoice, bank statement, or book of record establishing the partnership was in operation on February 15, 2020 must instead be provided.

* The guidance states, “This treatment follows the computation of self-employment tax from IRS Form 1040 Schedule SE Section A line 4 and removes the “employer” share of self-employment tax, consistent with how payroll costs for employees in the partnership are determined.”

LLCs

LLCs may report their business income in various ways. Sole member LLCs typically file Schedule C and are treated as sole proprietors by the IRS. The guidance from Treasury is brief: “LLCs should follow the instructions that apply to their tax filing situation, for example, whether they file as a sole proprietor, a partnership, or a corporation.”

Nonprofits

Treasury guidance released April 24, 2020 states “the following methodology should be used to calculate the maximum amount that can be borrowed for eligible nonprofit organizations (eligible nonprofit religious institutions, see the next question): 

Step 1: Compute 2019 payroll costs by adding the following: 

• 2019 gross wages and tips paid to your employees whose principal place of residence is in the United States, which can be computed using 2019 IRS Form 941 Taxable Medicare wages & tips (line 5c-column 1) from each quarter plus any pre-tax employee contributions for health insurance or other fringe benefits excluded from Taxable Medicare wages & tips, subtracting any amounts paid to any individual employee in excess of $100,000 and any amounts paid to any employee whose principal place of residence is outside the U.S;
• 2019 employer health insurance contributions (portion of IRS Form 990 Part IX line 9 attributable to health insurance); 
• 2019 employer retirement contributions (IRS Form 990 Part IX line 8); and 
• 2019 employer state and local taxes assessed on employee compensation, primarily state unemployment insurance tax (from state quarterly wage reporting forms). 

Step 2: Calculate the average monthly payroll costs (divide the amount from Step 1 by 12). 

Step 3: Multiply the average monthly payroll costs from Step 2 by 2.5.

Step 4: Add the outstanding amount of any EIDL made between January 31, 2020 and April 3, 2020 that you seek to refinance, less the amount of any advance under an EIDL COVID-19 loan (because it does not have to be repaid). 

Documentation: The nonprofit organization’s 2019 IRS Form 941 and state quarterly wage unemployment insurance tax reporting form from each quarter (or equivalent payroll processor records or IRS Wage and Tax Statements), along with the filed IRS Form 990 Part IX or other documentation of any retirement and health insurance contributions, must be provided to substantiate the applied-for PPP loan amount. A payroll statement or similar documentation from the pay period that covered February 15, 2020 must be provided to establish you were in operation and had employees on that date. Eligible nonprofits that do not file an IRS Form 990, typically those with gross receipts less than $50,000, should see the next question.

Nonprofit religious organizations, veteran’s organizations and tribal businesses

Here are the instructions from Treasury to calculate the maximum amount that can be borrowed for eligible nonprofit religious institutions, veterans organizations and tribal businesses: 

Step 1: Compute 2019 payroll costs by adding the following: 

• 2019 gross wages and tips paid to your employees whose principal place of residence is in the United States, which can be computed using 2019 IRS Form 941 Taxable Medicare wages & tips (line 5c-column 1) from each quarter plus any pre-tax employee contributions for health insurance or other fringe benefits excluded from Taxable Medicare wages & tips, subtracting any amounts paid to any individual employee in excess of $100,000 and any amounts paid to any employee whose principal place of residence is outside the U.S; 
• 2019 employer health insurance contributions; o 2019 employer retirement contributions and 
• 2019 employer state and local taxes assessed on employee compensation, primarily state unemployment insurance tax (from state quarterly wage reporting forms). 

Step 2: Calculate the average monthly payroll costs (divide the amount from Step 1 by 12). 

Step 3: Multiply the average monthly payroll costs from Step 2 by 2.5. 

Step 4: Add any outstanding amount of any EIDL made between January 31, 2020 and April 3, 2020 that you seek to refinance, less the amount of any advance under an EIDL COVID-19 loan (because it does not have to be repaid). 

Documentation: The entity’s 2019 IRS Form 941 and state quarterly wage unemployment insurance tax reporting form from each quarter (or equivalent payroll processor records or IRS Wage and Tax Statements), along with documentation of any retirement and health insurance contributions, must be provided to substantiate the applied-for PPP loan amount. A payroll statement or similar documentation from the pay period that covered February 15, 2020 must be provided to establish you were in operation and had employees on that date.

Doing the math

The basic calculation for PPP is 2.5 time average monthly payroll. Before you apply, make sure you understand what qualifies as payroll as it may include more than simply wages. See What Does Payroll Include? in our FAQs about CARES Act PPP loans.