On March 27, 2020, President Trump signed H.R. 748, the Coronavirus Aid, Relief, and Economic Security Act (Public Law No: 116-136, the “CARES Act” or the “Act”).  Title I of the CARES Act creates the Paycheck Protection Program (discussed in more detail here).  Generally speaking, the Paycheck Protection Program permits certain small businesses to apply for a small business loan which may be forgiven, in whole or in part, if the loan proceeds are used to pay for certain eligible expenses, e.g., the payment of certain payroll costs, interest on a covered mortgage obligation, payments under a covered rent obligation, and the payment of certain utilities.

This blog post summarizes significant uncertainties created by tax and accounting issues related to the Paycheck Protection Program.  A separate blog post containing a more detailed review of the tax changes contained in the Act is available here.  Additional details regarding the employment and employee benefits changes is available here.  Additional guidance related to the CARES Act is forthcoming.  All of Kean Miller’s guidance related to the coronavirus pandemic is located here.

Tax and Accounting Issues Raised by the Paycheck Protection Program

Determination of Expenses Eligible for Forgiveness – While the preliminary hurdle for any taxpayer will be the amount of the loan that they are eligible for, it is just a loan unless eligible for forgiveness.  Therefore, of greater importance will be the manner and time within which the loaned funds must be spent to be forgiven.  Otherwise, it is simply a loan that must be repaid.  Section 1106 of the CARES Act defines the expenses that, if paid with the loan proceeds, are eligible for forgiveness.  Payments of eligible expenses related to covered mortgage or rent obligations and covered utility payments must relate to mortgage or lease obligations incurred or in force before February 15, 2020 and utility payments for which service began before February 15, 2020.  The amount eligible for forgiveness is calculated with reference to costs incurred and payments made related to an eligible expense during the 8-week period beginning on the date of the origination of the covered loan.  By computing the amount eligible for forgiveness based on both costs incurred and payments actually made the Act appears to create a hybrid-accounting accrual/cash method of accounting rule for the determination of eligible expenses.

The hybrid accounting method appears to indicate that certain costs, notably payroll costs related to eligible self-employed individuals, need not be actually paid during the covered period.  This may also make sense because it is possible that the date payroll checks are issued for services performed during a portion of the 8-week covered period could fall outside of the 8-week period.  For example, if the 8-week period ends on a Wednesday and the payroll for the week is paid on the following Friday, it appears the Act permits the portion of payroll costs incurred for services performed Monday through Wednesday to be eligible for forgiveness.

Because the amount of the loan is computed with reference to actual payroll costs, it is likely the majority of forgivable expenses paid will relate to payroll actually paid but based on the statutory language as written, it also appears that it may be possible to pre-pay certain eligible expenses.  While unlikely, this situation could arise if, for some reason, a borrower’s covered expenses did not equal or exceed the amount borrowed.  Absent additional guidance, in that situation, a borrower might read the statute to permit the borrower to pre-pay a covered expense.  At this time, it is not clear whether additional guidance will be issued to clarify or impose additional limitations on the calculation of the amount of covered expenses that are eligible for forgiveness.  One practical step a borrower should consider is timing the origination of the loan to coincide with payroll dates to avoid the potential payroll issue discussed above.

Uncertainty Regarding How Certain Business Concerns Should Apply for Relief – The CARES Act should be clarified, ideally by swift legislative action, to make it clear that partners and partnerships are not excluded from the relief provisions.  The Act contains a poorly worded definition of payroll costs that could be read so as to defeat the purpose of the statute.  Specifically, the Act refers only to the net self-employment earnings of a sole proprietor or an independent contractor in the definition of payroll costs, which language may be read to exclude the self-employment of partners in a partnership.  That is, as written the Act does not clearly specify that the net self-employment earnings of certain eligible self-employed individuals, such as partners, should be included in the definition of payroll costs, thereby, creating uncertainty as to the availability of loans to these otherwise eligible individuals and creating uncertainty as to the computation of the amount of loans available to these particular business organizations which constitute a significant part of the United States economy.

As a result of what appears to be at worst, a drafting error, the Act could be read to suggest that a partnership that is a small business concern could not include the net earnings from self-employment of its partners in its payroll costs.  Thus, if the partnership had no employees, under this interpretation, its payroll costs would be zero, and the applicant would effectively be ineligible for relief under the Paycheck Protection Program.  In contrast, if that partnership was structured as an S corporation for tax purposes and its owners received a combination of W-2 wages (included in payroll costs) and dividends (likely excluded from payroll costs) it would be eligible for a higher loan amount since the wages would be considered payroll costs.

The “payroll costs” of an owner of  a single member limited liability company on the other hand, is more clearly covered by the statute even if the limited liability company has no employees and thus no “payroll costs.”  This type of eligible small business concern and is no different in practice than a sole proprietorship operated by an individual in their individual capacity and for tax purposes, assuming no elections are made for an alternative tax treatment, they are indistinguishable.  A limited liability company with a single member is simply “disregarded”.  Nevertheless, while the “payroll costs” of such a limited liability company would not ordinarily include net self-employment income, the Act itself defines “payroll costs” as “the sum of payments of … income of a sole proprietor or independent contractor that is … net earnings from self-employment,…”  In contrast, if that individual did business as a sole proprietor (without the interposition of a limited liability company) his or her  net earnings from self-employment would be included in payroll costs and would more clearly be eligible for relief.

Some of the confusion in the Act is caused by the loose use of terms that have more specific meanings for tax purposes.  While the term “sole proprietor” has a unique meaning for income tax purposes, the term “independent contractor” is not an income tax classification for income tax imposition purposes.  The latter term relates more generally to whether or not a payor is required to withhold the recipient’s income taxes from payments to the recipient and also to whether the payor has to chip in for payroll tax purposes.  It is not an income tax classification like sole proprietor.

Additional confusion results because the Act does not make it clear as to who among possible applicants, in certain circumstances, is entitled to apply for a loan or whether all possible applicants may file.  That is, the Act is drafted in a manner that appears to permit both an eligible self-employed individual, such as a partner or the owner of a single member limited liability company, and the associated partnership or limited liability company to apply for a loan.  However, in both of those instances the unfortunate terminology in the Act used to define “payroll costs’ could cause the loan amount to be zero regardless of whether the individual owner or the entity applied for the loan because in either case the individual owner or owners’ net earnings from self-employment are not defined as payroll costs, for the reasons mentioned above.  Thus, in the case of an entity with no employees that suffered losses related to the pandemic, depending on how the language is interpreted by a decision-maker lender, neither the entity nor its individual owner(s) would be eligible for meaningful relief.

It is not clear how lenders will interpret the definition of payroll costs in this context.  Given the pressing need to distribute cash to business owners quickly, it may be that lenders include payroll costs related to an eligible self-employed individual in the loan calculation.  But issues may arise when the applicant seeks loan forgiveness depending on how the lender interprets the immunity provisions in Section 1106 of the CARES Act.

There is no indication that Congress intended to preclude a large swath of the American economy doing business in partnership form from receiving Paycheck Protection Program loans based solely on their choice of business organization.  It is our understanding that the Small Business Administration is in the process of drafting detailed regulations that will address the computation of “payroll costs” as it relates to partners and partnerships and other businesses as well as their owners, for a Paycheck Protection Program Loan.  As we understand it, the Small Business Administration intends to release that guidance on Friday, April 3.  What is not clear at this point is whether the apparent drafting error will be clarified by regulation or, ideally, a technical corrections act.  It should be noted that, if needed, Congress could pass a statute containing the necessary technical corrections, making the corrections retroactive to the passage of the CARES Act.  Although Congress is not currently in session, ideally any such action could take place prior to the time applicants began seeking loan forgiveness.  Nevertheless, uncertainty about loan eligibility for certain businesses and self-employed individuals may remain for some period of time.

Hopefully the regulations to be issued tomorrow will mitigate at least some of the uncertainty.

Determination of Payroll Costs for a Sole Proprietor, Partner, or Owner of an S corporation – The amount of compensation paid to an eligible self-employed individual is relevant to both determining the amount of the Paycheck Protection Program loan as well as the amount of the loan that may be forgiven.  The term eligible self-employed individual is defined with reference to Section 7702(b) of the Families First Coronavirus Response Act (Public Law No: 116-127).  The Families First Coronavirus Response Act defines an eligible self-employed individual as an individual who:

  1. Regularly carries on any trade or business within the meaning of [IRC Section 1402], and
  2. Would be entitled to receive paid leave during the taxable year pursuant to the Emergency Paid Sick Leave Act if the individual were an employee of an employer (other than himself or herself).

IRC Section 1402 defines self-employment income and generally includes income received by a sole proprietor or a partner in a partnership.

With respect to eligible self-employed individuals, the definition of payroll costs includes net earnings from self-employment.  Taken together with the reference to IRC Section 1402 in the definition of eligible self-employed individual, the reference to net earnings from self-employment appears to mean that the amount of a sole proprietor or partner’s payroll costs is the amount reported on their tax return that is subject to self-employment tax.   Thus, for purposes of determining the payroll costs related to a sole proprietor or an individual partner in a partnership, it appears appropriate to reference the amount of income reported on their individual income tax return that was subject to self-employment tax, which generally includes the gross income derived by an individual from any trade or business carried on by the individual, less deductions allocated to the business, and also includes a partner’s distributive share of income or loss from a trade or business carried on by a partnership.  This position appears to be supported by the Paycheck Protection Program Information Sheet for Borrowers, which was released by the Treasury Department on March 31, 2020.  That said, as noted above, at present a partner is not included in the definition of an eligible self-employed individual and it is not clear how a partnership (or its partners) should apply for a Paycheck Protection Program loan.

Generally speaking, the owner of an S corporation would receive wages (reported on Form W-2) from the S corporation.  It appears those wages would likely be considered to be the S corporation owner’s payroll costs, i.e., it is unlikely the owner of an S corporation could include dividends received in the payroll costs for purposes of the Paycheck Protection Program.

Because the determination of payroll costs for a sole proprietor, partner, or owner of an S corporation is not entirely clear, additional guidance is required.  The lack of guidance is problematic because the amount of a sole proprietor or partner’s payroll costs may be directly related to previously made tax elections or decisions or to decisions currently being considered for their 2019 return.  As a result, it may be necessary to amend previously filed returns or carefully consider decisions related to a 2019 return after additional guidance is released.

Loan Forgiveness –Section 1106 of the Act provides a mechanism under which certain indebtedness related to these loans can be forgiven.  Unless an exception applies, Internal Revenue Code (“IRC”) Section 61 requires a taxpayer to include cancellation of indebtedness income in its taxable income.  Section 1106 creates an exception to IRC Section 61 and provides that loan forgiven under the Act shall be excluded from a taxpayer’s taxable income for purposes of the Internal Revenue Code.  It should be noted that the Act is silent on whether a borrower’s tax attributes will be reduced under IRC Section 108 in the amount of the forgiven debt.  Additional guidance may be necessary to clarify this issue.

Employee Retention Credit for Employers Subject to Closure Due to COVID-19 – Section 2301 of the CARES Act provides an employee retention credit to employers, based on wages (and a proportionate amount of qualified health plan expenses) paid to employees, which is discussed in more detail here.  It is important to note that an employer taking a small business interruption loan under the Paycheck Protection Program is not eligible for the credit.

Deferral of Payment of Employer Payroll Taxes – Section 2302 of the Act also permits an employer to defer the payment of certain employer payroll taxes, which is discussed in more detail here.  The ability to defer payment of payroll taxes may not apply if the employer had indebtedness forgiven under the under the Paycheck Protection Program.

Interplay with the Families First Coronavirus Response Act – It should be noted that for purposes of the Paycheck protection Program payroll costs do not include qualified sick leave wages or qualified family leave wages for which a credit is taken under Sections 7001 or 7003 (respectively) of the Families First Coronavirus Response Act.


The CARES Act contains an unprecedented economic stimulus and the tax provisions are designed to facilitate getting cash to individuals and businesses as soon as possible. Unfortunately, the CARES Act requires many small businesses to make decisions quickly but because of the uncertainty created by the loose language of the Act and the lack of guidance to-date it is not clear how some businesses and business owners can make the decisions most appropriate for their businesses. The apparent drafting error and lack of guidance is particularly problematic for certain business organizations, such as partnerships, because previously taken tax positions or tax positions currently being evaluated may directly impact the amount of their potential Payroll Protection Program loan, including the amount eligible for forgiveness.

Until additional guidance is released, if possible, it may make sense for a business refrain from taking action, which is unfortunate because many businesses are struggling or are in the midst of an existential crisis due to the coronavirus pandemic. It is our hope that the Small Business Administration will release comprehensive guidance on these issues quickly that will mitigate the uncertainty.

For additional information, please contact the Kean Miller Tax Group:  Jaye Calhoun at (504) 293-5936; Kevin Curry at (225) 382-3484; Jason Brown at (225) 389-3733; Angie Adolph at (225) 382-3437; J. Mark Miller at (318) 562-2701; Phyllis Sims at (225) 389-3717; Robert Schmidt at (225) 382-4621; or Willie Kolarik at (225) 382-3441.