President Trump signed the Paycheck Protection Program Flexibility Act into law. The legislation gives small business owners more flexibility in how they can use PPP funds and may make it easier to qualify for forgiveness. This article will be updated to include the new requirements soon. In the meantime, you can read about the changes HERE.
One of the more confusing aspects of the Paycheck Protection Program (PPP) is how to apply for a PPP loan if you are self-employed, including if you are a 1099 contractor. In earlier guidance, the SBA indicated that those individuals could apply for PPP loans beginning April 10, 2020 but did not provide specific instructions for how to do so.
At Nav, we’ve received numerous questions from those who want to apply but aren’t sure how to calculate the loan amount for which they are eligible or the amount they may be able to have forgiven. They’ve asked us questions like:
- How do I calculate my payroll or salary if I am self-employed?
- Can I include health insurance premiums I pay myself?
- What expenses may be included in the forgiven amount?
- What if I have not filed my 2019 tax return?
- If I had a loss in my business do I qualify?
On April 14, 2020 the SBA issued new guidance for those who are self-employed and file a Form 1040, Schedule C, in the form of an update to the Interim Final Rule. We have excerpted the main points below to help you understand how to apply for PPP if you are self-employed. However, this article does not include the full text of this guidance.
We strongly encourage you to review the SBA interim final rule for self-employed applicants carefully and discuss it with your tax professional, attorney, or financial advisor before you apply to clarify how it applies to your business.
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How To Calculate PPP Loan Amount If You Are Self Employed
The information in this article applies to those who are self-employed and who file a Form 1040, Schedule C. As a reminder the SBA states you are eligible for a PPP loan if:
- You were in operation on February 15, 2020;
- You are an individual with self-employment income (such as an independent contractor or a sole proprietor);
- Your principal place of residence is in the United States; and
- You filed or will file a Form 1040 Schedule C for 2019
For these applicants, the SBA provides separate calculations based on whether or not you have employees. (Also keep in mind the SBA has already issued guidance that if your business uses 1099-contractors in your business you do not include them in your PPP salary calculations.)
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If You Have No Employees
If you are self-employed and have no employees, the SBA provides the following instructions:
Step 1: Find your 2019 IRS Form 1040 Schedule C line 31 net profit amount. 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 your average net monthly profit. To do this, take the amount from your 2019 Form 1040 Schedule C line 31 (net profit) and divide it by 12. That gives you your average monthly net profit.
Step 3: Multiply the average monthly net profit amount from Step 2 by 2.5.
This is the amount most self employed borrowers with no employees will use to qualify for PPP.
However, if your business received an Economic Injury Disaster Loan made between January 31, 2020 and April 3, 2020 that you want to refinance with PPP, add the outstanding amount of that loan, minus any advance under an EIDL COVID-19 loan (because it does not have to be repaid). If you have applied for EIDL but it was not made during the time period listed, you can skip this step.
How to Substantiate Your Income
The SBA says that if you have not yet filed a 2019 return, you should fill it out and compute the net profit for your business. It also says that 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.
To substantiate your income (no employees) you must provide a “2019 IRS Form 1099-MISC detailing non-employee compensation received (box 7), invoice, bank statement, or book of record that establishes you are self-employed.” In addition, “you must provide a 2020 invoice, bank statement, or book of record to establish you were in operation on or around February 15, 2020.”
If You Have Employees
If you have employees, the SBA provides the following instructions:
Step 1: Compute 2019 payroll by adding the following:
- Your 2019 Form 1040 Schedule C line 31 net profit amount 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 by dividing the amount from Step 1 by 12.
Step 3: Multiply the average monthly amount from Step 2 by 2.5.
However, if your business received an EIDL made between January 31, 2020 and April 3, 2020 that you want to refinance with PPP, add the outstanding amount, minus any advance under an EIDL COVID-19 loan because it does not have to be repaid. If you have applied for EIDL but it was not made during the time period listed, you can skip this step.
How to Substantiate Your Income
For businesses with employees that file using Form 1040 Schedule C, the SBA explains, “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.”
Since you must establish your business was in operation by February 15, 2020 you must include, “a payroll statement or similar documentation from the pay period that covered February 15, 2020.”
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If You are a Partner In a Partnership
The SBA clarifies that while partnerships are eligible for PPP loans, a partner in a partnership may not submit a separate PPP loan application for themselves 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.” This includes an LLC filing taxes as a partnership.
What If I Have Not Filed my 2019 Tax Return for My Business?
The SBA does not state that you must file your 2019 tax return before you apply. However it does state you must fill it out as you will be relying on that information to apply for the loan. You should make sure it is accurate and complete.
What If My Business Showed a Loss?
If the amount on your 2019 Form 1040 Schedule C shows a loss, your business will not qualify for PPP.
What Expenses Can I Use My PPP Loan For?
The SBA has established some very specific guidance regarding the use of PPP loan proceeds for those with income from self-employment who file a 2019 Form 1040, Schedule C.
These loan proceeds may be used for the following purposes.
- Owner compensation replacement, calculated based on 2019 net profit.
- 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 you have 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 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), and
- Business utility payments* (e.g., the cost of electricity in the warehouse you rent or gas you use driving your business vehicle).
- 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.
*Note that the SBA specifically says: “You must have claimed or be entitled to claim a deduction for such 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. (Editor’s note: The 8 weeks immediately after disbursement of the loan is the “covered period.”) 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 covered period.”
Also note that the SBA requires that 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 Shall Be Eligible for Forgiveness?
By way of background, you can apply for forgiveness with your lender after the eight-week period after the loan was made. The lender then has sixty days to process your request. Since no payments are due on these loans for six months, you should have plenty of time to make your request and get some or all of the balance forgiven (if you qualify) before payments are due. Any balance remaining after forgiveness becomes a loan with a 1% interest rate and two year repayment period.
Also keep in mind the main purpose of the Paycheck Protection Program is to help employers maintain payroll. (That may include your income as the owner of the business.) Therefore, if you want the loan forgiven, the bulk of the loan must be used toward payroll.
If you qualify, you may be eligible to have the entire loan amount plus accrued interest forgiven.
But how much is forgiven will depend on the total amount spent over the covered period— the eight weeks after the loan is disbursed— on the following, according to the SBA:
- 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),
- 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 divided by 52) of 2019 net profit, 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.
- 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).
How to Document Forgiveness
When it comes time to apply for forgiveness of the PPP loan as a self-employed individual, the SBA says you can use the following information as documentation:
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.
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 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 the covered period if you used loan proceeds for those purposes.
The Bottom Line on Applying for PPP When Self-Employed
It will be a lot easier to apply for PPP as someone who is self employed if you are current on your bookkeeping and have kept good records of the income and expenses of your business. If you have operated your business with cash payments that you did not report to the IRS, co-mingled personal and business funds, or if you have maximized expenses to the point where your business only shows a loss, you are likely not going to be able to qualify for the PPP loan your business may have been entitled to otherwise. Your accounting professional can prove invaluable in this process so make sure you enlist their help in determining which COVID relief programs are best for your business.