How to Spend PPP Funds Wisely: Complete Guide to Eligible Expenses and Forgiveness

The Paycheck Protection Program (PPP) provided crucial financial relief to millions of small businesses during unprecedented economic challenges. If you received PPP funds, understanding how to spend them correctly isn't just important—it's essential for maximizing forgiveness and avoiding compliance issues.

This comprehensive guide breaks down exactly what you can (and can't) spend PPP funds on, how the forgiveness rules work, and how to track everything properly for complete peace of mind.

The Core Purpose: Retaining Workers and Maintaining Payroll

When you accepted PPP funds, you certified that the money would be used to "retain workers and maintain payroll" or other approved expense categories. This wasn't just paperwork—it's a legal commitment. Misuse of PPP funds can trigger serious fraud liability, so understanding eligible expenses is crucial.

The good news? The eligible expense categories are broad enough to cover most essential business operations, especially if you approach spending strategically.

The 60% Payroll Rule: Your Forgiveness Foundation

The single most important rule to understand: at least 60% of your forgiveness amount must come from payroll costs.

This doesn't mean you lose all forgiveness if you spend less than 60% on payroll. Instead, your forgiveness gets reduced proportionally. For example, if you spend only 50% on payroll, you won't receive full forgiveness, but you'll still qualify for partial forgiveness based on what you did spend on eligible expenses.

According to the SBA's official guidance, payroll should be the major use of the loan, and this threshold ensures funds primarily support workers rather than other business expenses.

Eligible Payroll Expenses: What Counts

Payroll is more than just salaries. Here's everything that qualifies:

Employee Compensation:

• Gross salaries and wages
• Tips and commissions
• Bonuses, hazard pay, and incentive compensation
• Severance and allowance payments

Employee Benefits:

• Paid leave (vacation, family, medical, sick days)
• Health insurance premiums
• Retirement plan contributions
• State and local payroll taxes

Important Compensation Cap: Employee compensation is capped at an annual rate of $100,000 per employee. For a 24-week covered period, this translates to $46,154 maximum per employee. Any compensation above this threshold won't count toward forgiveness.

What Doesn't Qualify as Payroll

• Independent contractor payments: 1099 workers and contractors cannot be covered by your PPP funds. They should apply for their own PPP loans if eligible.
• Owner compensation beyond documented amounts: Personal draws and distributions don't qualify
• Federal employment taxes: You can pay employer-side taxes, but not federal unemployment or withholding taxes

Eligible Non-Payroll Expenses: The Remaining 40%

While payroll must be your primary focus, up to 40% of your forgiveness can come from these categories:

Traditional Core Expenses

Mortgage Interest Payments: Business mortgage interest payments on mortgages incurred before February 15, 2020. Important: only the interest portion counts, not principal payments.

Rent and Lease Payments: Rent or lease payments for business property under agreements in effect before February 15, 2020. This includes office space, retail locations, equipment leases, and vehicle leases used for business.

Utilities:

• Electricity
• Gas
• Water and sewer
• Telephone (landline and mobile)
• Internet access
• Transportation costs (fuel for business vehicles)

Expanded Eligible Categories (2021 Update)

The second stimulus bill expanded PPP to include four additional expense types:

Operations Expenses:

• Software subscriptions (accounting, payroll, CRM systems)
• Cloud computing services
• Payment processing fees
• Human resources services
• Delivery costs

Property Damage Costs: Uninsured property damage from 2020 civil disturbances, including vandalism and looting (but only costs not covered by insurance).

Supplier Costs: Expenditures to suppliers for goods that are essential to current operations, provided contracts or purchase orders were in place before receiving the loan.

Worker Protection Expenses:

• Personal protective equipment (masks, gloves, sanitizer)
• Plexiglass barriers and partitions
• Air filtration systems
• Thermometers and temperature screening equipment
• Cleaning supplies and services
• Other modifications to comply with COVID-19 safety guidelines

What You Absolutely Cannot Use PPP Funds For

Understanding prohibited uses is just as important as knowing eligible expenses:

Prohibited Expenses:

• Credit card payments or merchant cash advance obligations
• Outstanding business taxes (federal, state, or local)
• Federal employment tax payments (though employer-side is okay)
• Prepayment of expenses beyond the covered period
• Owner compensation above documented levels
• Capital improvements or expansion costs
• Debt principal payments (though mortgage interest is allowed)

If you have PPP funds remaining after covering all eligible expenses, return the excess to your lender rather than using them for prohibited purposes. The temporary benefit of using funds inappropriately isn't worth the risk of fraud liability.

The Covered Period: Timing Your Spending

Your covered period determines when expenses must be incurred or paid to count toward forgiveness. You can choose either:

• An 8-week covered period (56 days), or
• A 24-week covered period (168 days)

The period begins on the date your lender disburses the PPP loan. Most businesses benefit from the longer 24-week period, as it provides more flexibility to reach the spending thresholds and account for business fluctuations.

Tracking and Documentation: The Forgiveness Foundation

Proper documentation isn't optional—it's required for forgiveness approval. According to experts on PPP compliance, you'll need to maintain:

For Payroll Expenses:

• Payroll reports showing gross pay, taxes, and deductions
• Payment receipts (cancelled checks, ACH confirmations)
• Tax forms (940, 941, state quarterly wage reports)
• Documentation of health insurance and retirement contributions

For Non-Payroll Expenses:

• Copies of lease agreements or mortgage documents
• Cancelled checks or payment receipts
• Utility bills showing service period and payment
• Invoices for operations, supplies, and worker protection expenses

For Headcount Maintenance:

• Payroll reports showing employee numbers throughout the covered period
• Documentation of any FTE (full-time equivalent) reductions and applicable exceptions

Many businesses find that proper bookkeeping from the start prevents scrambling during the forgiveness application process. Accurate financial tracking helps ensure you can substantiate every dollar spent and makes the application straightforward rather than stressful.

The Forgiveness Application Process

If you don't apply for forgiveness within 10 months after the last day of your covered period, your PPP loan payments are no longer deferred, and you'll begin making payments to your lender at 1% interest.

The application itself requires:

• Calculations showing how funds were allocated across eligible categories
• Documentation proving you spent at least 60% on payroll
• Proof of employee headcount maintenance
• Evidence of wage level maintenance for lower-paid employees

Good news on taxes: According to the Consolidated Appropriations Act of 2021, expenses paid with forgiven PPP funds are fully tax-deductible. This means payroll, rent, utilities, and other eligible expenses all count as deductible business expenses, even though the loan itself is forgiven tax-free.

Strategic Spending: Maximizing Forgiveness

To maximize your forgiveness:

1. Prioritize Payroll: Ensure at least 60% (ideally more) goes to W-2 employee compensation
2. Maintain Staff Levels: Keep FTE counts consistent with pre-pandemic levels where possible
3. Document Everything: Save all receipts, reports, and proof of payment immediately
4. Use the Full Period: Don't rush spending—spread expenses across your chosen covered period
5. Separate Tracking: Keep PPP funds in a separate account or track them meticulously in your books
6. Consult When Uncertain: When questions arise about eligible expenses, ask your lender or accountant before spending

Common Mistakes to Avoid

Mistake 1: Paying Independent Contractors 1099 workers don't count. Only W-2 employees qualify for PPP payroll.

Mistake 2: Exceeding Compensation Limits Bonuses and raises are fine, but remember the $100,000 annual cap per employee.

Mistake 3: Paying Yourself Too Much Owner-employees and self-employed individuals have specific compensation calculation rules—don't just pay yourself whatever remains.

Mistake 4: Using Funds for Debt Payments While mortgage interest qualifies, credit card payments and loan principal don't.

Mistake 5: Poor Documentation "I know I spent it correctly" won't fly. You need documentation for every dollar.

Moving Forward With Confidence

The PPP program helped millions of businesses survive extraordinary challenges. By understanding eligible expenses, maintaining proper documentation, and spending strategically, you can maximize forgiveness while ensuring full compliance.

Remember that the program's core intent was worker retention and business continuity. If your spending aligns with these goals and falls within eligible categories, you're on the right track.

Keep Your Finances Clear and Compliant

Tracking PPP expenses properly requires accurate, detailed bookkeeping from day one. Trying to reconstruct months of transactions during the forgiveness application creates unnecessary stress and increases the risk of errors or missed documentation.

Beancount.io provides plain-text accounting that gives you complete transparency over every transaction. Tag PPP-related expenses as they occur, generate reports instantly, and maintain the documentation trail you need for confident forgiveness applications. Get started for free and experience financial tracking built for clarity and control.