PPP Loans for The Self-Employed: New Guidance
April 15, 2020
The SBA published a new interim rule under the CARES Act regarding the application of the PPP to individuals who are self-employed. (Interim rule published April 14th)
Individuals with Self-Employment Income who File a Form 1040, Schedule C
An individual is eligible for a PPP loan if:
- They were in operation on February 15, 2020;
- They are an individual with self-employment income (such as an independent contractor or a sole proprietor);
- Their principal place of residence is in the United States; and
- They filed or will file a Form 1040 Schedule C for 2019.
The SBA indicated that it 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.
However, a partner in a partnership may not submit a separate PPP loan application for themselves as a self-employed individual, notwithstanding that their distributive share of partnership income may be treated as self-employment income.
Partnerships are eligible for PPP loans under the Act. They may report the self-employment income of “general active partners” – which is not defined – as a payroll cost, up to $100,000 annualized, on a PPP loan application filed by or on behalf of the partnership. Rent, mortgage interest, utilities, and other debt service incurred at the partnership level may also be reported on the application.
An individual’s maximum loan amount will depend upon whether or not they employ other individuals in their business.
If an individual has no employees, the following methodology should be used to calculate their maximum loan amount:
Step 1: The individual should find their 2019 IRS Form 1040 Schedule C, line 31, net profit amount. If this amount is over $100,000, it should be reduced to $100,000. If this amount is zero or less – the business had no profit, or it suffered a loss – the individual is not eligible for a PPP loan.
Step 2: Divide the amount from Step 1 by 12 (the average monthly net profit amount).
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 the individual seeks to refinance, less the amount of any advance under an EIDL COVID-19 loan (because it does not have to be repaid).
Regardless of whether the individual applicant has filed a 2019 tax return with the IRS, they must complete and provide the 2019 Form 1040 Schedule C with their 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 they are self-employed. The individual applicant must provide a 2020 invoice, bank statement, or book of record to establish their business was in operation on or around February 15, 2020.
Note also that if a self-employed individual broke even or had a Schedule C loss in 2019, they are not eligible for a PPP loan.
If the individual business owner has employees, the following methodology should be used to calculate their maximum PPP loan amount:
Step 1: Compute 2019 payroll by adding the following:
- The individual’s 2019 Form 1040 Schedule C, line 31, net profit amount, up to $100,000 annualized; if this amount is over $100,000, it must be reduced to $100,000; if the individual had a loss last year, this amount should be set at zero;
- 2019 gross wages and tips paid to the 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; then 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 the individual business owner seeks to refinance, less the amount of any advance under an EIDL COVID-19 loan (because it does not have to be repaid).
The individual must supply their 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 the individual’s business was in operation on February 15, 2020.
As in the case of all PPP loans, the proceeds are to be used for the following purposes:
- Owner compensation replacement, calculated based on 2019 net profit as described above.
- Employee payroll costs (as defined in the First PPP Interim Final Rule) for employees whose principal place of residence is in the United States, if the business has employees.
- 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 a mortgage for the warehouse the individual purchased to store business equipment or the interest on an auto loan for a vehicle used in the business), business rent payments (e.g., the warehouse where business equipment or vehicles are stored), and business utility payments. These expenses must have been claimed or are allowed to be claimed as deductions for such expenses on the business owner’s 2019 Form 1040 Schedule C for them to be a permissible use during the eight-week period following the first disbursement of the loan (the “covered period”). *At least 75 percent of the PPP loan proceeds must be used for payroll costs.*
- 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 the individual received an SBA EIDL loan from January 31, 2020 through April 3, 2020, they may apply for a PPP loan. If the EIDL loan was not used for payroll costs, it does not affect the individual’s eligibility for a PPP loan. If the EIDL loan was used for payroll costs, the PPP loan must be used to refinance the 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.
It is important to note that a self-employed individual (one who files a Form 1040 Schedule C) may use their PPP loan proceeds only for uses for which the individual made expenditures in 2019. This limitation is required in order to ensure that the individual will be able to provide verifiable documentation.
The SBA plans to 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.
As in the case of all PPP loans, the amount of loan forgiveness can be up to the full principal amount of the loan plus accrued interest. However, the actual amount of loan forgiveness will depend, in part, on the total amount spent over the covered period 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 (NB: 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 as described above, with forgiveness of such amounts limited to eight weeks’ worth of 2019 net profit, but excluding any qualified sick leave equivalent amount for which a credit is claimed under certain provisions of 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;
- Rent payments on lease agreements in force before February 15, 2020, to the extent they are deductible on Form 1040 Schedule C; and
- Utility payments under service agreements dated before February 15, 2020 to the extent they are deductible on Form 1040 Schedule C.
Again, note that the SBA is limiting 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.
Finally, in order for the individual to substantiate their request for loan forgiveness, if the business has employees, they should submit Form 941 and state quarterly wage unemployment insurance tax reporting forms, or equivalent payroll processor records, that best correspond to the covered period (with evidence of any retirement and health insurance contributions). Whether or not the business has employees, the individual must submit evidence of business rent, business mortgage interest payments on real or personal property, or business utility payments during the covered period if they 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.