On Tuesday, April 14 the SBA and Treasury released additional guidance related to individuals with self-employment income. These would include both sole proprietors, single member LLCs & independent contractors that file form Schedule C and partnerships (including multi-member LLCs taxed as partnerships). The application for these loans was technically open on Friday, April 10th however with limited guidance many lenders were not ready to process, nor borrowers prepared to apply for, these loans as many questions remained.
Partnerships (including multi-member LLCs taxed as partnerships)
One of the biggest questions for many was is and how self-employment income (Box 14A) on a K-1 would apply for these loans, as this is generally the net income of partners in a partnership. The updated guidance indicated that for partnerships, only one application should be submitted, covering both the partnership employees PPP requests and any pass-through self-employment income for partners.
The guidance further explicitly clarifies that partnerships are eligible borrowers. The self-employment income of a partnership should be calculated on the basis of the 2019 K-1, Box 14A, up to $100,000 per year and added as a payroll cost. Further guidance indicates that the payroll cost for owners is capped at $100,000 of net self-employment, which already should not allow for a deduction of health insurance benefits or retirement benefits as these are reported separately on the partners 1040 and do not reduce net self-employment income. Further, in the guidance it specifically says “covered benefits for employees (but not owners)” when discussing forgivable uses.
The guidance did not give any specific guidelines for partner documentation, but we would anticipate based on the guidance provided that 2019 Form K-1 will be the primary source document. There exists a possibility that 2019 Form 1065 may be needed as well.
While not explicitly stated, it is reasonable to assume that the forgiveness will be based on the same formula as other self-employed individuals, below.
Sole-Proprietor/Independent Contractors/Single Member LLCs
Expanding the PPP loan coverage to self-employed individuals is a key point in one of the early PPP questions, “Can I include independent contractors on Form 1099?” The answer was determined to be no based on SBA and Treasury guidance, because they stated contractors could apply themselves. However, the terms of the PPP Loans are slightly modified for self-employed individuals as compared to organizations with payroll. In general, the 2019 Form Schedule C will be the primary source of documentation of expenses; any amounts not on this Schedule C that are new in 2020 will not be permissible.
One of the above entities (Sole-Proprietor/Independent Contractor/Single Member LLC, called a Schedule C Filer) is eligible if they were in operation as of February 15, 2020, are one of the above entities listed, had a principal place of residence is in the US, and have or will file form Schedule C for 2019.
Self-employed loan calculation
The regulations use the term “owner compensation replacement” in a few places, so that is how we will refer to this amount. The owner compensation replacement is calculated by taking your 2019 Form Schedule C (or in the case of a partner, Form K-1) and dividing your net profit amount (line 31 on Schedule C, Box 14A for K-1), limited to $100,000, by 12. This is considered the owner’s “payroll cost” and will be multiplied by 2.5. If there is $0 or a loss, the Schedule C filer or partner are not eligible for a PPP Loan on these amounts.
If there are employees, this owner replacement calculation is added to the payroll cost and otherwise treated the same as any other PPP. Note that owner health insurance and retirement benefits do not count separately toward this calculation – as noted above these are excluded from the self-employed income calculation (and deducted elsewhere on the return) so they are by default already included.
At this time there are no guidelines that would allow an individual to use their 2020 information or new 2020 businesses. Additional guidance on new 2020 businesses was promised in these guidelines.
The regulations provide more documentation guidelines for a Schedule C Filer request. These include:
1. 2019 Form Schedule C (whether or not you have filed yet).
2. A Form 1099-Misc (issued to you), invoice, bank statement, or book of record that shows you as self-employed.
3. A 2020 invoice, bank statement or book of record to establish you were in operation on or around February 15, 2020.
If there are employees, these guidelines include the following:
1. Form 941 for all 4 quarters in 2019 (or other tax forms or equivalent payroll processor records).
2. State quarterly wage unemployment tax reporting forms for each 2019 quarter (or equivalent processor records).
3. Evidence of retirement and health insurance contributions.
4. A payroll statement or similar documentation from the pay period on or around February 15, 2020.
This is an expansion of prior PPP guidance and may impact all current applicants.
The PPP Loans for self-employed are permitted to be used as follows:
1. Owner compensation replacement
2. Employee Payroll Costs
4. Business mortgage interest payments
5. Business utility payments.
In order to claim these, you must have claimed them as an expense on your 2019 filed Schedule C.
The loans still need to be used for at least 75% payroll costs and 25% non-payroll costs. Note the owner compensation replacement is considered a payroll cost.
The forgiveness was a tricky question with self-employed, given that they are not like employees who are paid wages from an entity. For self-employed individuals, the forgiveness is calculated at 8 weeks of your 2019 Schedule C profit, capped at $100,000. These individuals will use the ratio of 8/52 of their 2019 self-employed profit to determine forgiveness on the owner’s compensation replacement.
Stern Warning from the Regulations
One of the points that were covered in the regulations was that participation in the PPP may affect the expanded eligibility for state and federal unemployment insurance which was opened to many self-employed individuals.
What about S Corporations?
Given that there was no specific mention of S Corporations in this guidance, and their earnings are not subject to self-employment it is now pretty much confirmed that S Corporation owners are limited to their W-2 wages. The passthrough portion of S Corporation income does not count for PPP purposes.
Edward McWilliams, CPA