As the social isolation saying goes: “Another day; another clarification from the SBA regarding the Paycheck Protection Program.” Alright, maybe that saying hasn’t caught on, yet. Nevertheless, the SBA did publish additional guidance specific to sole proprietors and general partners applying to the Paycheck Protection Program (PPP).
The SBA’s new Rule clarifies that self-employed individuals who file Form 1040 with a Schedule C would be eligible for PPP loans, provided the business satisfies the eligibility requirements. As with other applicants, any self-employed business must have been in operation prior to February 15, 2020 to be eligible for a PPP loan. The individual applying for the PPP loan must also be the individual with the self-employment income and must have filed a Schedule C with their 2019 tax returns.
With respect to maximum loan amounts, the SBA has provided two possible calculation methods. The first method is for those self-employed individuals with no additional employees. Under this scenario, the maximum loan is calculated based on the net profit reported by the self-employed individual on Schedule C, Line 31. The reported net profit is then divided by 12 to arrive at a monthly average net profit. The maximum loan value is 2.5 times the calculated average monthly profit. Importantly, under the Rule, the SBA caps the reported net profit at $100,000 (as opposed to the $10 million cap for other entities).
The second calculation is used for sole proprietors that also maintain employees. The calculation process largely mirrors the self-employment example above, except gross employee wages (as reported on IRS Form 941), as well as health insurance and retirement contributions are included in calculating the monthly averages, in addition to the net profit reported on Line 31. The net profit is still capped at $100,000.
Irrespective of which calculation method used, to substantiate the claimed profit amounts, the loan applicant must provide a copy of the 2019 tax return, regardless of whether the return has been filed with the IRS. Those sole proprietors with employees must also submit IRS Form 941, as well as “payroll processor records, along with evidence of any retirement and health insurance contributions, if applicable.”
As with other applicants, there are some limitations on how funds distributed under the PPP program to self-employed individuals may be used. Owner compensation and payroll costs are both acceptable uses of the PPP loan proceeds. These expenses will also be eligible for loan forgiveness. To the extent mortgage interest payments, rent, and/or utilities were claimed as deductions on Schedule C, PPP loan proceeds can also be used to make payments on any of these items. Such payments will also be eligible for forgiveness. The PPP loan can also be used to service interest on other debt obligations that arose prior to February 15, 2020, but those amounts will not be eligible for PPP loan forgiveness.
According to the SBA “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. This is most consistent with the structure of the Act and its overarching focus on keeping workers paid, and will prevent windfalls that Congress did not intend.”
Interestingly, the SBA’s Rule update also clarified that general partners are not eligible to claim self-employment status. Instead, general partners would need to have the partnership apply for a PPP loan, then claim the income of the general partnership as payroll costs up to $100,000 on an annual basis. According to the SBA, “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.”
Interestingly, there is a big disparity between the loan amount maximums for partnerships and sole proprietors versus other types of entities–$100,000 for sole proprietors versus $10 million for other types of businesses. That seems somewhat unfair because, theoretically, a single member LLC could get a lot higher maximum loan than a sole proprietor. That said, the SBA’s updates to the PPP loan program provide much needed clarity regarding the eligibility of self-employed individuals. While many questions remain regarding the PPP, it is encouraging that the SBA is actively seeking to bring ongoing clarity to the program.