The COVID-19 pandemic may create tax benefit opportunities for you and your family members.
For example, you could hire your under-age-18 children, pay them, say, $10,000 each, and they could pay zero federal income taxes. And you or your corporation, the employer, would deduct the $10,000 you paid to each of the children. The child wins. You win. There’s more.
Schedule C Business
What if My Business Is Incorporated?
What if I Hire a Family Member over the of Age 21?
Tax Advantages for Your Business
- If you operate the business as a sole proprietorship, a single-member LLC that’s treated as a sole proprietorship for tax purposes, a husband-wife partnership, an LLC that’s treated as a husband-wife partnership for tax purposes, or an S corporation, the wage expense deduction reduces (a) your individual federal taxable income, (b) your individual net self-employment income, and (c) your individual state taxable income (if applicable).
- If you operate the business as a C corporation, the corporation deducts the wages paid to a child or other family member. The deductions reduce the corporation’s federal taxable income and probably the corporation’s state taxable income (if applicable).
- If your business will be unprofitable this year due to the COVID-19 fallout, deductions for wages paid to a child or other family member can create or increase a net operating loss (NOL) for 2020. If so, you can carry back the 2020 NOL for up to five tax years—back to 2015. The NOL carryback can trigger a refund of income taxes paid for the carryback year. That can really help. An NOL carried back to a pre-2018 tax year can be especially helpful because tax rates were generally higher in those days.
Keep payroll records just like you would for any other employee to document hours worked and duties performed (e.g., timesheets and job descriptions). Issue W-2s just like you would for any other employee.
As we write this, current law says the Payroll Protection Program (PPP) cash infusion is going to expire on August 8, 2020.
Approval takes time. For example, when June 30, 2020, was the deadline, lenders stopped taking applications on or before June 28 so they would have time to submit applications and obtain approval on or before June 30.
Many small business owners have not applied for the PPP cash infusion because there’s a four-letter word associated with it.
That word? Loan!
Yep. That four-letter word (loan) has caused many business owners to say I don’t want to play the PPP game.
That’s wrongheaded. The PPP deal is not really a loan. It’s a cash infusion to help you through COVID-19.
Works Like This
For the self-employed and owner-employees of S and C corporations who have SBA-defined earnings of $100,000 or more, here’s the deal:
- I’m going to give you $20,833 today.
- I’m going to call it a loan.
- Sometime after the first 10.8 weeks or so, you will send me some paperwork.
- When I receive the paperwork, I’ll forgive your loan.
- You walk away with the $20,833, no strings attached.
What if your defined earnings are less than $100,000? Then you will receive less. For example, let’s say you are a Form 1040 Schedule C taxpayer with net profits of
- $75,000: you pocket $15,625, tax-free.
- $50,000: you pocket $10,417, tax-free.
- $25,000: you pocket $5,208, tax-free.
The results above come from the COVID-19 PPP. When you are a self-employed taxpayer with no employees, the PPP treats you as the one and only employee and treats your 2019 net profits as your payroll.
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The rules that apply to you do not apply to the rank-and-file employee group. The government puts you, the owner-worker, in a separate “owner-employee” category to limit your business’s PPP benefits.
There are four types of owner-employees:
- General partners in partnerships
- S corporation shareholder-employees
- C corporation shareholder-employees
- Form 1040, Schedule C filers (e.g., the self-employed, sole proprietors, 1099 recipients, single-member LLCs, and husband and wife LLCs treated as single-member LLCs)
If you own all or part of your business and work in the business, you fall into one of the four categories.
The maximum loan attributable to and forgiveness available for the “compensation paid” to any owner-employee across all businesses is
- $15,385 for borrowers who received a PPP loan before June 5, 2020, and elected to use an eight-week covered period, or
- $20,833 for borrowers under the 24-week covered period.
If you have ownership interests in more than one business, you need to consider that the owner-employee loan maximums apply to all your businesses.
The new interim final rule puts the $15,385 or $20,833 deemed compensation cap on the loan forgiveness for the defined owner-employee, but contains no guidance on how to allocate or otherwise deal with the caps when you have ownership interests in multiple businesses.
Example. You operate an S corporation and a proprietorship. You receive your PPP loan on June 17. The cap on your combined S corporation and proprietorship loan forgiveness attributable to (a) your employment in the S corporation and (b) your profits from the proprietorship is $20,833.
We know you can obtain loan forgiveness for up to $20,833, but we have no guidance on how you would allocate the forgiveness between the S corporation and proprietorship. Perhaps by the time you apply for PPP loan forgiveness, we will have some directions.
The PPP loan forgiveness begins for general partners at the amount of their 2019 net earnings from self-employment (reduced by claimed Section 179 expense deductions, unreimbursed partnership expenses, and depletion from oil and gas properties) multiplied by 0.9235.
You then take the lesser of the amount determined above or $100,000, divide by 12, and multiply by 2.5 to find the loan amount. With this calculation, the maximum loan is $20,833.
The maximum forgiveness attributable due to the partner’s self-employment income is
- $15,385 if the partnership obtained its loan before June 5, 2020, and elected the eight-week regime, or
- $20,833 if the partnership is under the 24-week program.
Planning note. Under the 24-week program, the partnership with no employees does not need to spend any amounts on interest, rent, or utilities to obtain full forgiveness. It can obtain full forgiveness in 11 weeks using the calculated self-employment income of up to $20,833 for each partner.
As with any owner-employee, the PPP loan and its forgiveness for “compensation” is capped at $15,385 under the eight-week covered period and $20,833 under the 24-week covered period.
Reminder. The $20,833 cap is based on the maximum defined compensation of $100,000 divided by 12 and then multiplied by 2.5.
Under the 24-week program, the S corporation whose only employee is an owner-employee obtains full loan forgiveness after 11 weeks when using the 24-week covered period without spending anything for interest, rent, or utilities.
If the S corporation with no employees other than the owner-employee elects the eight-week covered period, the corporation has to spend money on interest, rent, and utilities to rise above the compensation cap and create full forgiveness.
The Paycheck Protection Program Flexibility Act of 2020 created a new statutory 60 percent payroll rule that can make it easier to qualify for full forgiveness with payments for interest, rent, and utilities when electing the eight-week covered period.
S corporation owner-employees are capped by the amount of their 2019 employee cash compensation and employer retirement contributions made on their behalf, but employer health insurance contributions made on their behalf cannot be separately added because those payments are already included in their employee cash compensation.
Example. You operate your solo busines as an S corporation. Your 2019 W-2 compensation of $68,000 included $18,000 for medical insurance. Your payroll cost for the PPP loan and its forgiveness includes the full $68,000 plus what the S corporation paid into your retirement plan and to the state for unemployment insurance. The total of these amounts is capped at $100,000, which creates the $20,833 maximum loan amount as explained above.
C corporation owner-employees are capped by the amount of their 2019 employee cash compensation and employer retirement and health insurance contributions made on their behalf.
Example. You operate your business as a C corporation where you are the only employee. In 2019, the corporation paid you a salary of $60,000, contributed $12,000 to your retirement plan, paid $20,000 for your family’s medical insurance, and paid $350 to the state for unemployment insurance.
Your corporation has $92,350 in qualifying payroll costs. Your loan and forgiveness are capped at $19,240 ($92,350 ÷ 12 x 2.5).
Form 1040 Schedule C Businesses
Your PPP loan and its forgiveness for “compensation” are capped at $15,385 under the eight-week covered period or at $20,833 under the 24-week covered period. The cap amounts are computed using your net profit from line 31 of your 2019 Schedule C.
Your easy-peasy road to 100 percent loan forgiveness is the 11-week program. With 11 weeks of taking the loan amount out of the business, you obtain full forgiveness without paying any rent, utilities, or interest.
When Can the Owner-Employee’s Business Apply for Forgiveness?
According to SBA guidance issued on June 22, 2020, you may submit your loan forgiveness application anytime on or before the maturity date of the loan—including before the end of the covered period—if you used all the loan proceeds for which you requested forgiveness.
Example. You receive a $20,833 PPP loan on May 19, 2020. During the 11 weeks beginning with May 19, 2020, your corporation pays qualified payroll costs that total $20,833. You can apply for $20,833 of loan forgiveness anytime beginning with week 11.
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Spencer Accounting Group, LLC does not provide investment, tax, legal, or retirement advice or recommendations in these blogs. The information presented here is not specific to any individual's personal circumstances.
To the extent that this material concerns tax matters, it is not intended or written to be used, and cannot be used, by a taxpayer for the purpose of avoiding penalties that may be imposed by law. Each taxpayer should seek independent advice from a tax professional based on his or her individual circumstances.
These materials are provided for general information and educational purposes based upon publicly available information from sources believed to be reliable — we cannot assure the accuracy or completeness of these materials. The information in these materials may change at any time and without notice.
Keana Spencer is an Accountant, Entrepreneur, and Educator to her clients, with a strong passion. Keana has over 10 years of experience and through her practice, she is a source of knowledge and strategies to her clients.
Keana founded this website and decided and created this blog page to offer a space for those seeking knowledge to understand, however not to be confused with advice or planning strategies.