Are Guaranteed Payments ‘Payroll Costs’ for New CARES Act Loans?

April 06, 2020

The definition of payroll costs in the CARES Act has some practitioners wondering if guaranteed payments to partners can count as payroll costs when determining the amount that may be borrowed under the above formula, as well as for purposes of satisfying the 75 percent use-of-proceeds test so the loans can be forgiven.

Partners who provide services to their partnerships generally can’t be employees of partnerships, so instead of receiving regular Form W-2 wages, they receive guaranteed payments that are reported on their Schedules K-1. Those payments are paid without regard to the performance of the partnership, they don’t reduce partners’ outside bases (except to the extent they reduce the partnership’s business income), and they are deductible for partnerships under section 162 as though paid to an unrelated person as an ordinary and necessary business expense.

The statute defines payroll costs broadly as any compensation to include items such as salary, wages, and commissions. However, the definition also includes “payments of any compensation to or income of a sole proprietor or independent contractor that is a wage, commission, net earnings from self-employment, or similar compensation.”

“As you can see, it does not expressly cover partners or guaranteed payments for services; it speaks to sole proprietors, independent contractors, and net earnings from self-employment,” Louis Vlahos of Farrell Fritz, P.C. said. “If partners are to be covered, we have to apply something akin to an aggregate theory of partnership tax, where every partner is treated as ‘owning’ a piece of every underlying item of the partnership.”

Vlahos pointed out that although guaranteed payments are not treated as wages, they are treated as self-employment income — and they factor into the performance of the partnership similar to wages that are paid to employees.

“This should be compared to those S corporation shareholders who also happen to be employed by their corporation,” Vlahos said. Assuming they are reasonable, those salaries are treated as regular employee wages for almost all purposes, he said, adding that he thinks they will be considered payroll costs, subject to statutory limitations under the loan program.

“Why should guaranteed payments be treated differently?” he asked.

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