IMPORTANT UPDATE: SINCE THE ORIGINAL PUBLISHED DATE OF THIS BLOG POST, FURTHER GUIDANCE FROM TREASURY HAS BEEN RELEASED. DO NOT FOLLOW THE INSTRUCTIONS BELOW — THIS POST IS OUTDATED. I HAVE FOUND THIS COLLEAGUE’S WRITE-UP WORTH READING INSTEAD, AND I RECENTLY RECORDED A FREE WEBINAR ON HOW TO APPLY.
Note: this post is about partners in a partnership — those filing Schedule SE on their personal tax returns due to flow-through income from a Form 1065 K-1. For information on sole proprietors (who are also considered self-employed for the purposes of the PPP), please see this post instead.
There has been so much back-and-forth and conjecture and guidance on how to calculate W-2 payroll for purposes of the PPP loan, but very little on the subject on how to include partner income in these calculations. The reason is that partners in a partnership (or, more commonly, multi-member LLC taxed as a partnership) are by law prohibited from paying themselves as an employee, through a payroll system. They therefore do not receive W-2 forms and are not included in quarterly “941” payroll reports.
The key here is that this is a “Paycheck Protection Program” — the goal is to keep people working instead of going onto the unemployment rolls. Why? Because it’s better for 1) business owners, 2) workers, and 3) the economy. Business owners are able to keep their companies afloat in a challenging environment (to put it mildly), continuing to produce products or services and maintain revenues at some level; workers generally earn more in their jobs than on unemployment (and if not, this means they are low-paid workers and probably deserve a raise for hazard pay); and the economy of course benefits because companies spend money on their vendors and landlords, and individuals spend their money on other products and services, and all of this helps to keep other businesses going, too.
So what constitutes a “paycheck” if you aren’t allowed to be on payroll?
The key here is “payroll taxes” — which are the portion of taxes that go to Social Security and Medicare programs, often known as FICA. Employees have 7.65% of each paycheck withheld for these purposes (and their employers match this amount for a total of 15.3%). Partners, on the other hand, pay estimates quarterly toward this and other taxes, and reconcile them on their annual personal tax return, using Schedule SE (Self-Employment) to calculate “self-employment tax”. This tax is the same as “payroll tax” for employees — with the painful added cost of having to pay both sides of the tax… the employee 7.65% and the matching 7.65% as they are their own “employer”. (Yes, ouch. Being self-employed is expensive.)
For self-employment tax purposes, both guaranteed payments to partners for services and their ownership-percentage allocation of net income are included.
Initially, many of us assumed that only guaranteed payments qualified as “payroll” for the PPP calculation, as these are in theory the amounts paid for services rendered. However, many partnerships do not use guaranteed payments, and instead split all of the profits (for various reasons, including increasing the Sec 199A deduction). Since all income to an active member of a partnership is taxed for self-employment/payroll tax purposes, it should not matter whether it is due to guaranteed payments or an allocated portion of net income — that is a distinction left to the partnership agreement and says nothing about whether it is “payroll” for these purposes or not.
So, based on the above perspective, I have been suggesting that partners take the amount on Line 4 from Schedule SE on their personal tax returns to substantiate the amount of income from the partnership on which they paid “payroll taxes”. And to clarify: this is still the easiest approach for most people!
But here are the potential problems with that approach for some. If you fall into one of these groups, then keep reading for an alternative method:
- Tax deadlines have been moved to July 15th — for many small businesses, preparing their books for taxes is the last thing on their minds, and CPAs such as myself are scrambling to help their clients apply for relief, so we’re behind on the returns from folks who have found time to submit their info. As such, many partners simply don’t have their personal returns yet.
- Some partners have self-employment income from other businesses as well, such as another partnership or a Schedule C sole proprietorship. Well, Schedule SE adds all businesses together. Guidance has not been forthcoming here, but it is likely that those in this situation will need to apply for PPP separately for each business — or at least the businesses that also have employees.
So for partners in either of these situations, here’s what you can do instead:
- Pull up your client copy of the 2019 partnership tax return — Form 1065.
- Scroll down to the K-1 forms — there’s one set for each partner.
- Line 14A of each of the K-1 forms shows self-employment earnings for each partner. This includes guaranteed payments as well as the flow-through portion of net income.
- Take that amount and multiply it by 92.35% to back out the deductible portion — which is the Employer part of self-employment tax. Treasury regulations for the PPP do not allow the employer portion of payroll taxes to be included in the calculation.
In a partnership where all partners are actively working for the company — rather than one or more being silent investors — you’ll see that the total of Line 14A for all partners, equals Form 1065, Line 10 (Guaranteed payments to partners) + Line 22 (Ordinary Business Income).
However, if you have investor-partners, these folks usually are allocated their ownership-percentage of net income on which they do not pay self-employment taxes. And because they do not work for the business, they also will not receive guaranteed payments (which are also taxable for self-employment purposes). Therefore they are not eligible to apply for the PPP, and these amounts should not be included in the calculation. This is why I suggest sticking to Line 14A of the K-1 schedules, rather than using the amounts from the front of the 1065.
And if you are one of the unlucky partners whose 2019 1065 partnership return is still on extension, and therefore does not yet have a Schedule K-1, Treasury regulations allow you to use a reconciled Profit & Loss from your bookkeeping software to calculate these totals. (Make sure your banker knows this, as I have had some requiring 1099-MISC forms as substantiation, which is nothing short of ludicrous for many reasons — I won’t go into that here, as this post is plenty long already.) You would in this case simply add together the row for Guaranteed Payments and the final row, Net Income, and multiply by 92.35% to back out the employer portion of self-employment tax, as mentioned above. Again, if you have any silent investors, you would need to back out their percentage portion of net income.
If you already submitted an application and did not use the correct period or amounts, it’s by no means too late. Based on recent clarifications by the SBA and Treasury, you will be given an opportunity to revise your application — just explain the situation to your banker. It’s only “too late” once your application has already been approved — and in that case, Treasury says anything submitted based on older guidance is still considered accurate as long as it was consistent with the rules in place at the time of the application.
Keep in mind that this is only my personal interpretation of the Treasury regulations concerning what constitutes “payroll” for the purposes of the PPP, and ultimately your banker or lender will be the person with final authority on the matter. However, the Treasury is clear that they will allow lenders to rely on borrowers’ representations. Furthermore, the American Bankers Association is still in the process of seeking SBA and Treasury clarification for many issues, and as they receive it, they have to communicate it to member institutions, who then have to pass it along to the bankers themselves — who are overworked and have scarce little time for daily continuing education. You can do a favor for your banker by organizing your calculations and documents in such a way as to make their job easier, especially if you include a brief note explaining why you used the data you did, and as in middle-school math class: always show your work.
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Excellent post!!! I have been looking everywhere for this type of info on K-1 flow through inclusion as “payroll” for PPP application. Nicely written.
One more curve ball for you (I am not an accountant so the following is just my “guess” after research!) If a 1065-K1 reports rental income, that doesn’t make it to Schedule SE line 4, instead it goes to Sched E pg 2 to sort out passive losses if any… then shows up on Sched 1 for Form 1040. In this case I think the “right” # of lost payroll to include in PPP application would be this Sched 1, Line 5 amount. What do you think?
Great question, but you won’t like the answer. Rental income is NOT considered self-employment income — it’s investment income. Therefore, self-employment taxes are not paid on it… which is great when you’re paying taxes. But it also means it’s not considered payroll for the purposes of the PPP. Guidelines have been very clear so far that rental income, whether pass-through or otherwise, do not qualify. So — I stick to my original calculation!
Thank you for the information. Very helpful. I am an active member in a two partner LLC with individual K1 income of approx. $95,000 each. I should take that amount times 0.9235 to calculate eligible income for PPP. I also think each partner needs to file individually. But on the PPP form should I check sole or LLC also on the top of the form do I use the LLC name and TIN or my personal info. If I use the LLC name and TIN my application and my partners will look identical therefore look duplicate. I would appreciate any guidance. Thank you.
My understanding is that you’d need to take (95000*.9235)*(8/52) to determine what you’d be able to pay yourself during the 8 week loan period. I’ll defer to Nancy to confirm or refute that statement.
I have an llc we file a 1065 and also pay out commission to 1099 employees can I file for the ppp and also what information from my k1 is needed for me to apply. I have been told by several banks that since we file as a 1065 instead of as a 1040c we are eligible for the ppp.
As I said in the post: “Line 14A of each of the K-1 forms shows self-employment earnings for each partner.”
You will not be able to use any commissions you pay to your 1099 employees. Instead, they should follow instructions for applying for PPP themselves, as sole proprietors.
I am a partner in a partnership formed as an LLC and my PPP loan was just approved based on my 1065. We do not pay out a commission. But, the loan was based on 92.35% of our ordinary business income. It took a while to find a bank that was accepting PPP loan applications from a partnership. I must have called 15 banks on the SBA List. None of the banks that I had an existing relationship with were taking loan applications from partnerships.
Yes, I’ve had the same experience! And as you just noted, the ones that you do find who are accepting partnership applications often don’t do the calculation correctly. I have had to educate many of my clients’ bankers to the proper calculation — 92.35% times guaranteed payments PLUS net income (which in the blog post above I also point out is the same as K-1 Box 14a added together for all the active partners). Why I am having to explain this to lender after lender when the SBA has made it perfectly clear in their April 25th guidance is beyond me. I have found that Cross River Bank is accepting these, however, so hopefully others will benefit from that information. (I have a link to them in this blog post.) Their application is a bit less streamlined than some, but it works.
Thanks so much for this information! My husband and I have a partnership LLC with no employees and didn’t know we could apply for PPP. Glad I came across with your article! Hope it’s not too late to apply.
I tried an online application with cross river bank but it asked to add numbers of employees and payroll amount. So I just called the bank but were told that they don’t take applications over the phone and the person I spoke to wasn’t familiar with partnership’s eligibility. It’s frustrating.. Do you have any suggestions? Should I try other banks?
Thanks so much!
I’m happy you found this information, too! Unfortunately, with a partnership, it is difficult to find banks that know how to handle them. I am doing all my partnerships through the Cross River Bank online application, but you do have to know what to put where — it’s not obvious at all. You would enter two employees and the payroll amount would be your total guaranteed payments plus your net income. Both of those items are on the front of your Form 1065. Then when you have to upload payroll documentation (which it says are 1099s or 941s), you want to upload your 1065 instead (rather than uploading it as an optional tax return). Hope that helps!
What if your bank refused to allow the partner k1 amounts to be included in the PPP? are we just shut out?
No, you find another bank!!! Your bank is completely wrong, but we’re seeing it a lot with partnerships. SBA was very clear that you use Line 14a on the K-1s. Did you see my reply about Cross River Bank?
Thank you so much for explaining this is a simple straight forward way! I feel much more confident applying for the PPP loan.
What to do if the amount on Line 14A is a negative???
Unfortunately, this means you would not qualify, as you had a net loss the prior year — which means you paid no “payroll” (self-employment) taxes.
If a large depreciation deduction caused Line 14A to be negative does that change the end result? In other words, does it matter if the small business has a positive EBITDA but a net loss for 2019? Does it matter that three prior years showed net income? What about the EIDL? Is that program then out of the question as well? Is their any COVID19-related relief available for partners of a business with a net loss?
Unfortunately, only net income counts, because as I explained in the post — the only amounts they consider are “paycheck” totals, which means dollars on which payroll/self-employment taxes were paid. A net loss means no taxes paid. So, it really has nothing to do with EBITDA or operating income — just taxable income on which self-employment taxes were paid.
As for the EIDL, I would guess (but don’t know, because they do not share their rules for approval with anyone) that a net loss company could still apply for it — I can’t see any reason that would affect the outcome.
I am struggling with the net loss issue with a few of my clients as well… startups or struggling businesses without payroll costs do not have many options available to them, unfortunately. Our country simply does not have a safety net.
I applied for the EIDL on the very first morning it was available. Just got an email over the weekend saying it was in process and they would email again. Last week, the SBA did a hard pull on our credit report. We are a couple years into a business with a seven-figure investment in PPE and gross revenue around $250K each of the first few years but some aggressive tax accounting along with depreciation and the fact that my wife and I do the lion’s share of the work ourselves has left us with zero government assistance, one of the highest property tax bills in the county and a State order prohibiting us from opening the doors. If I had a white flag, I would waive it.
Update re EIDL. $1,000 from SBA showed up via direct deposit. I suppose that’s better than zero but I also assume it’s the end of the road for this LLC that files a 1065 with only independent contractors and no payroll. I will let you know if more happens so you can share with others.
I’m so sorry, Jay. Yes, self-employed folks and partnerships with low or no net income are hit hardest so far. Have you looked into private grants yet? Especially those specific to your industry?
I’m confused. I have employees and paid payroll taxes, but suffered an overall loss as an organization (hence the negative self-employment number). Why would this make the LLC ineligible for PPP loan? I received a first draw PPP from Cross River based n the same 2019 numbers…
I’m not sure exactly what you’re referring to with this comment, so forgive me if I don’t hit the mark here. But there’s nothing preventing you from applying with the same exact payroll information as the last time. The rules for the second round of PPP are the same as last time — slightly more generous in certain situations.
To clarify: for a partnership, you have TWO sources of data that you need to add together for your PPP application:
1) Your W-2 payroll to staff — 2.5 months’ of the 2019 average.
2) Your self-employment income in Box 14a of all the K-1s. If you had a loss, this amount should be considered zero. (Not negative.)
Add these together and you’ll have your application total.
So if you had a negative amount on Line 14a of all the partner K-1s, then ignore that total and only use the W-2 payroll amounts.
I read that in testing the use of the funds, the SBA will use a weekly pay analysis. The partners in my client’s businesses take sporadic draws. Do you think it wise to pay the draws out of the PPP funds on a weekly basis?
I’m interested to know where you’ve read that — could you provide a link? There is nothing in the regs to support that assumption that I can see. In fact, the lists that banks are sending out so far show that payroll substantiation for W-2 employees will be based on the 941 reports, which are quarterly. Since both funding and the 8-week forgiveness periods have/will happened/happen entirely within the 2nd-quarter (for the first round of funding, anyway), only one 941 will be needed. So I would assume (don’t quote me) that they will only required substantiation for the entire 8-week period. Nothing in the regs indicates it has to be expended evenly throughout the forgiveness period — though of course, it wouldn’t hurt your case to do so. For most folks, it makes more sense to spend as little of it now as possible and then make up the difference in the final 2-4 weeks. Again — no official, specific guidance one way or the other on this.
Does the $100,000 per person limit also apply as it does with the salaries for small businesses?
Correct, the same $100k per person limit is in effect for partners and other self-employed people.
And if the $100,000 limit applies, can you take the $100,000 as your basis or do you have to apply the 92.35% to that amount to calculate the eligible PPP asking amount?
In other words, our partnership has three partners who earn approximately $185,000 each. Do we multiply $185,000 times .9235 and then apply the $100,000 cap (yielding a full $100,000 salary for each partner) or do you apply the cap and THEN multiply times 0.9235?
Unfortunately, the regs released after I wrote this article do not explain how to calculate partner payroll… simply that partners will apply not as self-employed individuals, but that the partnership should apply on their behalf. My inclination to match the way this is being handled for other businesses would be the former — yielding the full salary per partner. But I’m not seeing anyone making this adjustment in real life.
Where does the law say this? “The reason is that partners in a partnership (or, more commonly, multi-member LLC taxed as a partnership) are by law prohibited from paying themselves as an employee, through a payroll system. “
“Partners are not employees and should not be issued a Form W-2 in lieu of Form 1065, Schedule K-1, for distributions or guaranteed payments from the partnership.”
https://www.irs.gov/businesses/small-businesses-self-employed/paying-yourself
Can I add the cost of the pension and Health insurance for the partner when calculating the PPP loan amount?
Please see the link I provided — it is very detailed.
“Employee payroll costs include 2019 gross wages limited to an annualized $100,000, employer-paid health insurance premiums, employer-paid retirement contributions, and employer-paid state & local unemployment insurance taxes.”
I came across your post today about applying for the PPP as a 1065 partnership. I’ve applied through my bank, but I am struggling to provide the documents they are requesting….they don’t seem to apply to my business. Do my partner and I need to turn in our personal 2019 Schedule Cs?
I greatly appreciate your time. I’ve been searching for answers and so far your article is the best I’ve come across!!
No, your bank is just confused. I’ve been AMAZED at how many banks are clueless where it comes to partnerships. I have had to educate many of my clients’ bankers to the proper calculation — 92.35% times guaranteed payments PLUS net income (which in the blog post above I also point out is the same as K-1 Box 14a added together for all the active partners). Why I am having to explain this to lender after lender when the SBA has made it perfectly clear in their April 25th guidance is beyond me. I would point your lender to the SBA guidance here — you’ll want them to look at #4. I mean… sigh. A partner doesn’t even have a Schedule C. Ugh.
My business was started in July, 2019 so the k1 shows a much smaller annual income than it would over a 12 month period. How should we handle this?
Unfortunately, there is no guidance for this situation — the SBA said they would release guidance for partnerships and sole proprietors open less than a year (as they did for corporations), but it never came. I would say the only way to deal with this would be to find a real-person banker/lender who you can explain your situation to, and have them help you annualize that income. They are the only ones who can say what documentation would be acceptable, since SBA has not.
I did what you suggested by adding 2 employees and numbers from 1065 through Cross River bank online application. It was just approved by them within a couple hours. Hope to receive the loan soon. Thanks so much for your big help!
I have one more question to ask. As a partnership with no employees, how can we have 75% of the loan forgiven which is supposed go to “payroll”? Can it be used for owners’ compensation? If so, does that mean we pay to ourselves?
Yes, that’s exactly right. You’ll want to take the 2019 payroll you used in the application (guaranteed payments + net income), divide it by 12 to get your average monthly payroll, and then make sure to pay yourselves two months of payroll with the PPP funds. The rest can be used for rent/mortgage interest and utilities.
I’m curious where you found your guidance to “make sure to pay yourselves two months of payroll with the PPP funds”. Partners are not on payroll. Are you saying they need to take draws or cash distributions during the 8 weeks in order to qualify for forgiveness? I’ve been scouring the internet for information on this. A few interpretations I’ve seen indicate the forgiveness will be the same as for self-employed, which will have automatic forgiveness for 8 weeks “owner compensation replacement”. This figure will be based on the net earnings from self employment as used to determine the monthly figure for the 2.5x max loan amount. (For partnerships, that would the 2019 K-1 L 14a multiplied by 0.9235 ). This money does not have to be “spent” or drawn or disbursed.
They were very clear for Schedule C folks that this was the case: automatic forgiveness for 8/52 x Line 31 of the Schedule C from 2019. However, the guidance where partners are concerned is murkier. In both the PPP Forgiveness Application and the guidance released a week later, they clearly are limiting partners (and owner-employees as well, interestingly enough) to 8/52 x 2019 compensation (K-1 Line 14a x 0.9235 in the case of partners)… but they do not give the same indication that it will be automatic. In fact, the guidance reads as “the lower of” 8/52 of 2019 pay vs actual amount paid during the 8 weeks. So it may be the case that it’s automatic for partners (as they are technically self-employed) but not owner-employees, but I am not inclined to take a chance here. I’m recommending partners pay out the full amount and then hang onto it in case they need to reinvest it in the company as additional contributed capital. Just my personal approach to play it safe.
My daughter and I started an LLC 01/01/2020 do we qualify for the PPP? Just her and I no employees
Yes — but oddly enough, you still have to prepare a Draft Schedule C as part of the application. I do not have any clients in this situation, but take a look at this article:
https://www.womply.com/blog/can-i-get-a-ppp-loan-if-i-just-started-my-business-this-year/
Do you have any suggestions as to which lender we should apply with, that understands partnership guaranteed wages and forms 1065 and K1? We tried Blue vine but received a message stating they can’t validate our application? No other explanation. Not sure what that means but we don’t have much time to get an application in to SBA?
Absolutely — this program has been such a “FAIL” for partnerships! No one seems to understand how to deal with them, even though the SBA guidelines are quite straightforward and clear.
https://home.treasury.gov/system/files/136/How-to-Calculate-Loan-Amounts.pdf
Applying with Cross River Bank DIRECTLY is the only place I’ve found that works with partnerships… and the trick is that you have to upload your 1065 & K-1s in the “payroll” document slot (even though it asks for 941s or 940s or W-2s). Then you can upload the same file in the optional tax return slot. Hope that helps!
-Nancy
Absolutely — Cross River Bank is the one I have found that handles partnership returns properly, but you have to do the calculations yourself and upload the 1065 + K-1s in the place of the “payroll returns” they request.
We have a 2 partnership LLC but all of our income on the K-1 is in line 2 (Net Rental Real Estate Income). Our bank (Bank of America) is saying that this does not qualify since its not in 14A. Anyone have any experience with this?? Thanks!
Unfortunately, that is correct. Rental real estate is considered investment income, not self-employment income. You don’t pay any payroll (Social Security & Medicare) taxes on this income, and therefore it is not eligible. Same with Schedule E rental income on an individual tax return.
Hi Nancy,
I just came across your blog. Outstanding content, thank you! I missed out on the 1st round of PPP financing but hope to get a loan this time. My question is this: I own a multi member LLC with my husband. There are no other member/owners. The LLC is taxes as a partnership. When I apply, should we apply as a partnership or as an LLC? I’ve heard both, so quite confused. Hope you can help. Thanks!
Hi Nancy,
I just came across your blog. Outstanding content, thank you! I missed out on the 1st round of PPP financing but hope to get a loan this time. My question is this: I own a multi member LLC with my husband. There are no other member/owners. The LLC is taxed as a partnership. When I apply, should we apply as a partnership or as an LLC? I’ve heard both, so quite confused. Hope you can help. Thanks!
A multi-member LLC is just a state designation — at the federal level, you are taxed as a partnership, so that is what you should apply as. I really wish they had just left the “LLC” option off the application form, as it just confuses the issue. An LLC is not a tax designation, so it shouldn’t even be considered for PPP purposes. Good luck!
Hi,
My company is S corp( Travel agency)
We have 3 shareholders and all shareholders working in the company as an employee. ( no other employees). We take every month’s fixed payroll amount and issue w2 at the end of the year. Apart from Payroll, we take business profit on K1 schedule ( form the 1120s) Line 1 -as Ordinary business income.
Question: 1) Can I list both W2 and K1 amounts in the PPP loan application?
2) In the first PPP loan we listed only W2 and our CPA said our K1 not eligible for a PPP loan. We are trying to apply for 2nd PPP loan
Is that ok to inlcude both W2 and K1 income in the 2nd PPP loan application? Thanks you
No, for an S-Corp you may ONLY use the amount from the W-2s for payroll purposes. Do NOT use the K-1s. Those instructions are only for Partnerships, since Partners are not allowed to draw W-2 salary, whereas S-Corp Shareholder-Employees are required to be paid via W-2. So to be specific:
1) No. Only W-2.
2) No. It is not. Your CPA was right. This article is about Partners, not S-Corp Shareholders.
Hi Nancy! I have a question on the calculation for the PPP using your .9235 formula.
For example on our K-1 we have on line 14 it shows a profit of $20,000.
(20000*.9235)*(8/52) = $2841.54
The $2841.54 is the total amount we can receive on the PPP loan? Thanks for your help!
Interestingly enough, the SBA decided not to make partners reduce their income by these taxes before applying (this is a “very old” post in pandemic terms), so you don’t have to reduce it by anything. Just use the full amount on Line 14 of Schedule K (unless you have some partners who earned over $100k in 2019, in which case you need to look at each individual K-1 and limit theirs accordingly). I did a webinar about this topic last night… the partnership section is maybe 1/3 of the way through?
https://fb.watch/3KBylch77H/
I have income (small) on line A of box 14 and then a large income amount on line 14C. Can that income be included in the amount calculated for PPE? Need the help!! Thanks!
I’m sorry, no — only the amount on Line 14a is taxed for self-employment purposes, so it’s the only amount that qualifies as “payroll” for PPP.
Thank you. Not the answer I wanted as we clearly don’t and can’t live on that amount :(
I understand — but the idea of the program is to replace the income you made in 2019. If 2019 was a low-profit year, then that is what they are using. Have you filed for unemployment as a self-employed person? That is what my clients in this situation have done. Partners qualify under the Covid-19 relief rules as self-employed who are eligible for unemployment. I wrote a blog post about it when the program opened — https://www.thedancingaccountant.com/?p=1611