Guidance for Self-Employed Schedule C Needing a PPP Loan

• New interim final rule providing PPP guidance for self-employed Schedule C filers

• Outlines PPP loan eligibility requirements for self-employed Schedule C filers

• Provides precise calculation methods for the loan amount available for Schedule C filers with and without employees

• Details acceptable PPP loan uses

• Explains how PPP loan forgiveness will be determined

As we’ve previously reported, the CARES Act was enacted to provide numerous relief opportunities in response to the economic upheaval resulting from COVID-19—including provisions authorizing the SBA to guarantee forgivable Paycheck Protection Program (PPP) Loans for individuals with self-employment income. Again, subject to a recipient’s proper use of the funds for specified expenditures over an 8-week period after the funds are disbursed, the full principal amount of a PPP loan plus accrued interest may be forgiven.

On Tuesday, April 14, 2020, the U.S. Small Business Administration (SBA) issued a new interim final rule that provides further PPP guidance for self-employed individuals who report their income on the IRS Form 1040, Schedule C, Profit or Loss From Business (Schedule C).¹ The new guidance supplements the PPP first interim final rule issued on April 2 and FAQs that continue to be updated.

According to the SBA, the new rule “addresses eligibility issues for certain business concerns” and “applies to applications submitted under the [PPP] through June 30, 2020, or until funds made available for this purpose are exhausted.”² Besides eligibility, the additional rule also clarifies: (1) how to calculate the maximum loan amount for individuals with self-employment; (3) explains acceptable PPP loan uses, and (3) how loan forgiveness will be determined. It alerts Schedule C filers that the 2019 Schedule C is required to accompany their PPP loan application.

Eligibility

The new rule confirms that individuals with self-employment income filing Schedule Cs are eligible for a PPP loan if they: (1) were operating on February 15, 2020; (2) were “an individual with self-employment income (such as an independent contractor or a sole proprietor);” (3) have their principal place of residence in the U.S.; and (4) filed or will file a 2019 Schedule C.

On the other hand, the SBA is clear that partners in a partnership are ineligible for a separate PPP loan for themselves as self-employed individuals.  Rather, a general active partner’s self-employment is reported as a partnership payroll cost. The new rule indicated that partnerships are eligible for PPP loans, but that:

the Administrator has determined, in consultation with the Secretary of the Treasury (Secretary), 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.”³

How Schedule C Filer Calculates Maximum Amount of Loan

According to the new rule, the method for calculating the maximum loan amount depends upon whether or not the filer had employees.

For those Schedule C filers who had no employees, the method is:

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).⁴

However, if the Schedule C filer had employees, the method is:

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).⁵

What are Eligible Uses of the Loan Proceeds?

The SBA provides that proceeds of a PPP loan can be used for the following:

• Owner compensation replacement, which is calculated using 2019 net profit.
• Employee payroll costs – only for those employees with principal places of residence in the U.S.
• Eligible mortgage interest payments and business rent and utility payments. Note that for such expenses to qualify as a “permissible use” during the 8-week period following loan disbursement, the applicant must have claimed, or be able to claim, a deduction for them on their 2019 Schedule C.
• Interest payments on debt obligations incurred prior to February 15, 2020.
• Refinancing an SBA EIDL loan made between January 31, 2020 and April 3, 2020. Note that if an EIDL loan was used for payroll costs, then the PPP loan must be used to refinance that EIDL loan.⁶

The 75% Restriction

The guidance is clear that at least 75% of the PPP loan proceeds must be used for payroll costs. The SBA notes that for purposes of determining this percentage (but not for forgiveness purposes), any refinanced EIDL amount is included.

What Amounts Qualify for Forgiveness?

The SBA explained that the amount of loan forgiveness is partially dependent on the total amount spent during the covered period on:

1. 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);
2. 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 equivalent amount for which a credit is claimed under section 7002 of the Families First Coronavirus Response Act (FFCRA) (Public Law 116-127) or qualified family leave equivalent amount for which a credit is claimed under section 7004 of FFCRA;
3. 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);
4. 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
5. utility payments under service agreements dated before February 15, 2020, to the extent they are deductible on Form 1040 Schedule C (business utility payments).⁷

Required Documentation

Besides the borrower’s certification required in Section 1106(e)(3) of the CARES Act, a Schedule C filer with employees “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.”⁸  Additionally, whether the Schedule C filer has employees or not, they “must submit evidence of business rent, business mortgage interest payments on real or personal property, or business utility payments during the covered period” if the loan proceeds are applied toward such purposes.⁹

Conclusion

Certainly, this new guidance provides welcome clarification for self-employed individuals using Schedule Cs and seeking PPP relief. The new rule describes their eligibility rules, the appropriate calculation method they need to use to determine the loan amount, and elaborates on loan forgiveness issues.

However, there are still issues at large, and at least one of those issues is newly created within this guidance itself. For instance, does the new guidance’s distinction between “owner compensation replacement” and “payroll costs” mean that the SBA does not intend to include “ownership compensation replacement” in “payroll costs.” If that is the intention—this could be a planning problem in the context of the rule that at least 75% of the PPP loan proceeds must be used for “payroll costs.”¹⁰

We know that at least some additional guidance for a targeted audience is forthcoming since the SBA stated that it:

will issue additional guidance for those individuals with self-employment income who: (i) were not in operation in 2019 but who 6 were in operation on February 15, 2020, and (ii) will file a Form 1040 Schedule C for 2020.”¹¹

We will continue to update you on this developing area, and we encourage you to seek experienced legal advice to strategize and maximize benefits.

If you are a self-employed, Schedule C filer, and have COVID-19 relief questions or concerns, call Frost Law today at (410) 862-2890 or fill out our contact form.