Guidance on PPP Loans for the Self-Employed is Helpful, but Incomplete
Update:On April 24, Congress replenished PPP funds and made farmers eligible for EIDLs. Late that night, Treasury provided guidance on calculating loan amounts for different business types, including Schedule F farmers, partnerships, S corporations, and LLCs.
Four days after lenders were authorized to begin accepting Paycheck Protection Program loans for the self-employed, the SBA issued an interim final rule providing some much needed guidance for these loans. Presented in a Q & A format, the guidance provides much clarity, but leaves some key questions unanswered. We've reprinted highlights from the guidance below, along with some observations.
I have income from self-employment and file a Form 1040, Schedule C. Am I eligible for a PPP Loan?
You are eligible for a PPP loan if: (i) you were in operation on February 15, 2020; (ii) you are an individual with self-employment income (such as an independent contractor or a sole proprietor); (iii) your principal place of residence is in the United States; and (iv) you filed or will file a Form 1040 Schedule C for 2019.
Observation: This guidance clarifies that self-employed individuals are not required to have employees to qualify for a PPP loan. Although this guidance specifically addresses Schedule C filers, in the absence of additional guidance, it is reasonable to apply the same general rules to a Schedule F filer.
The guidance warns that participation in the PPP may affect your eligibility for state-administered unemployment compensation or unemployment assistance programs, including the programs authorized by Title II, Subtitle A of the CARES Act (pandemic unemployment insurance), or CARES Act Employee Retention Credits.
What if I was not in business in 2019?
SBA will issue additional guidance for those individuals with self-employment income who: (i) were not in operation in 2019 but who were in operation on February 15, 2020, and (ii) will file a Form 1040 Schedule C for 2020.
What if I’m a partner in a partnership or a member of an LLC taxed as a partnership?
If you are a partner in a partnership, you may not submit a separate PPP loan application for yourself as a self-employed individual. Instead, the self-employment income of general active partners may be reported as a payroll cost, up to $100,000 annualized, on a PPP loan application filed by or on behalf of the partnership. Partnerships are eligible for PPP loans under the Act, and the agencies have determined that limiting a partnership and its partners (and an LLC filing taxes as a partnership) to one PPP loan is necessary to help ensure that as many eligible borrowers as possible obtain PPP loans before the statutory deadline of June 30, 2020.
Observation: It is not clear what “self-employment income of general active partners” comprises. It is also not clear how the rules are applied to those who are partners in multiple partnerships.
How do I calculate the maximum amount I can borrow?
How you calculate your maximum loan amount depends upon whether or not you employ other individuals.
How do I calculate my loan amount if I have no employees?
Step 1: Find your 2019 IRS Form 1040 Schedule C line 31 net profit amount (if you have not yet filed a 2019 return, fill it out and compute the value). If this amount is over $100,000, reduce it to $100,000. If this amount is zero or less, you are not eligible for a PPP loan.
Step 2: Calculate the average monthly net profit amount (divide the amount from Step 1 by 12).
Step 3: Multiply the average monthly net profit amount from Step 2 by 2.5.
Step 4: Add the outstanding amount of any Economic Injury Disaster Loan (EIDL) made between January 31, 2020 and April 3, 2020 that you seek to refinance, less the amount of any advance under an EIDL COVID-19 loan (because it does not have to be repaid).
Observation: The amount of the loan for those without employees is wholly dependent upon 2019 net income, as reported on the business tax return. Businesses with no employees and zero or negative net income in 2019 are ineligible for a loan. The rule does not specially consider depreciation or Section 179. Nor is there an option to include gain reported on Form 4797. Since the Tax Cuts and Jobs Act eliminated like-kind exchange treatment for personal property exchanges, net income on a farmers' Schedule F has been driven lower by the need to offset newly recognized recapture gain with additional depreciation or cost recovery. This will prevent some farmers from qualifying for a PPP loan.
What is my required application documentation if I have no employees?
Regardless of whether you have filed a 2019 tax return with the IRS, you must provide the 2019 Form 1040 Schedule C with your PPP loan application to substantiate the applied-for PPP loan amount and a 2019 IRS Form 1099-MISC detailing nonemployee compensation received (box 7), invoice, bank statement, or book of record that establishes you are self-employed. You must provide a 2020 invoice, bank statement, or book of record to establish you were in operation on or around February 15, 2020.
How do I calculate my loan amount if I have employees?
Step 1: Compute 2019 payroll by adding the following:
- Your 2019 Form 1040 Schedule C line 31 net profit amount (if you have not yet filed a 2019 return, fill it out and compute the value), up to $100,000 annualized. If this amount is over $100,000, reduce it to $100,000. If this amount is less than zero, set this amount at zero;
- 2019 gross wages and tips paid to your employees whose principal place of residence is in the United States computed using 2019 IRS Form 941 Taxable Medicare wages & tips (line 5c- column 1) from each quarter plus any pre-tax employee contributions for health insurance or other fringe benefits excluded from Taxable Medicare wages & tips; subtract any amounts paid to any individual employee in excess of $100,000 annualized and any amounts paid to any employee whose principal place of residence is outside the United States; and
- 2019 employer health insurance contributions (health insurance component of Form 1040 Schedule C line 14), retirement contributions (Form 1040 Schedule C line 19), and state and local taxes assessed on employee compensation (primarily under state laws commonly referred to as the State Unemployment Tax Act or SUTA from state quarterly wage reporting forms).
Step 2: Calculate the average monthly amount (divide the amount from Step 1 by 12).
Step 3: Multiply the average monthly amount from Step 2 by 2.5
Step 4: Add the outstanding amount of any EIDL made between January 31, 2020 and April 3, 2020 that you seek to refinance, less the amount of any advance under an EIDL COVID-19 loan (because it does not have to be repaid).
What application documentation is required if I have employees?
You must supply your 2019 Form 1040 Schedule C, Form 941 (or other tax forms or equivalent payroll processor records containing similar information) and state quarterly wage unemployment insurance tax reporting forms from each quarter in 2019 or equivalent payroll processor records, along with evidence of any retirement and health insurance contributions, if applicable. A payroll statement or similar documentation from the pay period that covered February 15, 2020 must be provided to establish you were in operation on February 15, 2020.
How can PPP loans be used by individuals with income from self-employment who file a 2019 Form 1040, Schedule C?
The proceeds of a PPP loan are to be used for the following.
- Owner compensation replacement, calculated based on 2019 net profit
- Employee payroll costs (as defined in the April 2 PPP Interim Final Rule) for employees whose principal place of residence is in the United States, if you have employees
- Mortgage Interest, Rent, and Utility Payments
- Mortgage interest payments (but not mortgage prepayments or principal payments) on any business mortgage obligation on real or personal property
- e.g., the interest on your mortgage for the warehouse you purchased to store business equipment or the interest on an auto loan for a vehicle you use to perform your business
- Business rent payments
- e.g., the warehouse where you store business equipment or the vehicle you use to perform your business
- Business utility payments
- e.g., the cost of electricity in the warehouse you rent or gas you use driving your business vehicle).
- Mortgage interest payments (but not mortgage prepayments or principal payments) on any business mortgage obligation on real or personal property
Note: You must have claimed or be entitled to claim a deduction for mortgage interest, rent, and utility expenses on your 2019 Form 1040 Schedule C for them to be a permissible use during the eight-week period following the first disbursement of the loan. For example, if you did not claim or are not entitled to claim utilities expenses on your 2019 Form 1040 Schedule C, you cannot use the proceeds for utilities during the eight-week period following the first disbursement of the loan.
- Interest payments on any other debt obligations that were incurred before February 15, 2020 (such amounts are not eligible for PPP loan forgiveness).
- Refinancing an SBA EIDL loan made between January 31, 2020 and April 3, 2020 (maturity will be reset to PPP’s maturity of two years).
- If you received an SBA EIDL loan from January 31, 2020 through April 3, 2020, you can apply for a PPP loan. If your EIDL loan was not used for payroll costs, it does not affect your eligibility for a PPP loan. If your EIDL loan was used for payroll costs, your PPP loan must be used to refinance your EIDL loan.
- Proceeds from any advance up to $10,000 on the EIDL loan will be deducted from the loan forgiveness amount on the PPP loan.
Are there any other restrictions on how I can use PPP loan proceeds?
Yes. At least 75 percent of the PPP loan proceeds shall be used for payroll costs. For purposes of determining the percentage of use of proceeds for payroll costs (but not for forgiveness purposes), the amount of any refinanced EIDL will be included.
What amounts are eligible for forgiveness?
The amount of loan forgiveness can be up to the full principal amount of the loan plus accrued interest. The actual amount of loan forgiveness will depend, in part, on the total amount spent over the eight weeks following disbursement on:
- Payroll costs including salary, wages, and tips, up to $100,000 of annualized pay per employee (for eight weeks, a maximum of $15,385 per individual), as well as covered benefits for employees (but not owners), including health care expenses, retirement contributions, and state taxes imposed on employee payroll paid by the employer (such as unemployment insurance premiums)
- Owner compensation replacement, calculated based on 2019 net profit, with forgiveness of such amounts limited to eight weeks’ worth (8/52) of 2019 net profit, but excluding any qualified sick leave or family leave for which a credit is claimed under the Families First Coronavirus Response Act
- Payments of interest on mortgage obligations on real or personal property incurred before February 15, 2020, to the extent they are deductible on Form 1040 Schedule C (business mortgage payments)
- Rent payments on lease agreements in force before February 15, 2020, to the extent they are deductible on Form 1040 Schedule C (business rent payments); and
- Utility payments under service agreements dated before February 15, 2020 to the extent they are deductible on Form 1040 Schedule C (business utility payments).
Observation: The guidance explains that "it is appropriate to limit the forgiveness of owner compensation replacement for individuals with self-employment income who file a Schedule C to eight weeks’ worth (8/52) of 2019 net profit...many self-employed individuals have few of the overhead expenses that qualify for forgiveness under the Act…As a result, most of their receipts will constitute net income. Allowing such a self-employed individual to treat the full amount of a PPP loan as net income would result in a windfall...Finally, 75 percent of the amount forgiven must be attributable to payroll costs for the reasons specified in the First PPP Interim Final Rule.” The eight-week limitation on the owner compensation replacement means that a self-employed person will likely receive forgiveness for just less than 100 percent of the loan.
What documentation will I be required to submit to my lender with my request for loan forgiveness?
- In addition to the borrower certification required to substantiate your request for loan forgiveness, if you have employees, you should submit Form 941 and state quarterly wage unemployment insurance tax reporting forms or equivalent payroll processor records that best correspond to the eight-week covered period (with evidence of any retirement and health insurance contributions).
- Whether or not you have employees, you must submit evidence of business rent, business mortgage interest payments on real or personal property, or business utility payments during eight-week covered period if you used loan proceeds for those purposes.
- The 2019 Form 1040 Schedule C that was provided at the time of the PPP loan application must be used to determine the amount of net profit allocated to the owner for the eight-week covered period.