UPDATED JUNE 4, 2020 – PPP Loan Guidance for Self-Employed Small-Business Owners, Independent Contractors by Andrew Leonard, CPA
On April 13, the Small Business Administration (SBA) issued interim final guidance to help self-employed small-business owners impacted by the COVID-19 pandemic begin applying for immediate economic relief through the Paycheck Protection Program (PPP) introduced by the CARES Act. If you are you of these taxpayers, which includes independent contractors and sole proprietors, you should take the time to understand the myriad of requirements you must meet to qualify for loan approval, calculate maximum loan amounts and receive potential forgiveness for 100 percent of the principal amount you borrow.
PPP Eligibility Requirements for Self-Employed Taxpayers
Self-employed taxpayers, including independent contractors and sole proprietors, are often referred to as Schedule C filers, named after the tax form used to report annual business profit or loss on their federal income tax returns. As one of these taxpayers, you may be eligible for a PPP loan if you meet the following criteria:
- Your business has been in operation since Feb. 15, 2020;
- You have self-employment income and file IRS Form 1040, Schedule C; and
- The U.S. is your principal place of residence.
If your business is structured as a partnership or an LLCs, you are eligible for a PPP loan, but, you may only submit one loan application for the partnership entity; you may not apply for yourself also as a self-employed individual. More details on the partnership rules are discussed below.
Maximum Loan Amount Calculations for Sole Proprietors
In general, the CARES Act limits a small business’s maximum PPP loan amount to 2.5 times its average monthly payroll costs for the prior 12-month period. The calculation is different for independent contractors and sole proprietors, whose maximum loan amounts depend on whether or not they employ other workers.
If you are self-employed and do not have any other employees, you must first look at your average monthly net profit, up to a maximum of $8,333. Multiply that amount by 2.5 and then account for any Economic Injury Disaster Loan (EIDL) advances and outstanding balances on loans originated between Jan. 31, 2020, and April 3, 2020.
If you have employees, you must compute the maximum loan amount based on your 2019 payroll, which includes net profit, gross wages and tips paid to employees in the U.S., and employer contributions to employee health insurance and retirement plans. The limitations on payroll costs are rather complex and should be calculated under the guidance of professional advisors.
Allowable Use of Loan Proceeds
Because the PPP is intended to help businesses maintain existing operations and payroll through the COVID-19 crisis period, the SBA limits how self-employed taxpayers may use loan proceeds. Borrowed amounts may be used solely for the following expenses during the 24-week crisis period that begins on the day the borrow receives the loan proceeds and ends no later than Dec. 31, 2020:
- Replacement of owner compensation based on 2019 net profit reported on Form 1040 Schedule C;
- Payroll costs for U.S. employees;
- Mortgage interest payments;
- Interest payments on other debt instruments originated before February 2020;
- Refinancing of an SBA Economic Injury Disaster Loan (EIDL) made between Jan. 31, 2020, and April 3, 2020;
According to the language of law, 60 percent of loan proceeds must be spent of payroll costs, which include salary, wages tips; paid vacation time and family, medical and sick leave; group health insurance; contributions to employee retirement accounts; and state and local taxes on employee compensation.
Determination of Loan Forgiveness
Eligible small businesses, including the self-employed, may receive 100 percent forgiveness of loan principal when they meet certain criteria, which include the requirement that 60 percent of loan proceeds be used for payroll costs during the 24-week crisis period.
However, the actual amount that the SBA may forgive depends on the total amount borrowers spend during the 24 weeks following their receipt of funds. For example, loan forgiveness for individuals with self-employment income is limited to a proportionate 24-week share of their 2019 net profits, as reported on IRS Form 1040 Schedule C, excluding employer credits for the equivalent of qualified sick leave and family medical leave under the Families First Coronavirus Act (FFCA). In addition, payroll costs are limited to $100,000 on an annualized basis per employee (not to exceed $15,385 per individual for the 8-week period or approximately $45,000 per individual for the 24-week period).
Special Eligibility Rule for Partnerships
SBA guidance makes it clear that general partners in partnerships and LLCs may not submit separate PPP loan applications for both the entities and for themselves as self-employed individuals. Instead, because loan proceeds may be used for expenses incurred at the partnership level, the partnership itself must apply for the PPP and report on the PPP loan applications the general partner’s self-employment income as a payroll cost of up to $100,000 annualized. The specifics of how the U.S. Treasury and IRS will apply the interim PPP rules for partnerships is expected in the coming weeks.
Other Loan Requirements
The nearly $350 billion in funds set aside for PPP loans is available on a first-come-first-served basis. After completing an initial application on a bank or other approved lender’s website, self-employed business owners will be asked to substantiate loan calculations and requests for loan forgiveness by providing tax documents, including tax year 2019 Form 1040, Schedule C, payroll reports and employers’ quarterly federal tax returns on Form 941, as well as other evidence of compliance with the law.
About the Author: Andrew Leonard, CPA, is a director with Berkowitz Pollack Brant’s International Tax Services practice, where he provides tax structuring, pre-immigration planning and a wide array of international tax and consulting services to international companies, entrepreneurs, families and foreign trusts. He can be reached at the CPA firm’s Boca Raton, Fla., office at (561) 361-2000 or firstname.lastname@example.org.