Tax Law Insights

Payroll Protection Program (PPP) loans under the CARES Act are available not only to small business but to self-employed individuals, too.  Banks began accepting PPP loan applications for self-employed individuals beginning April 10th.  The Small Business Administration (SBA) has now issued helpful guidance to self-employed individuals who may apply for these PPP loans.  More information about the CARES Act and PPP loans can be found at www.burr.com.

Under the new SBA guidance, an individual is eligible for a PPP loan if: (i) you were in operation on February 15, 2020; (ii) you are an individual with self-employment income (such as an independent contractor or a sole proprietor); (iii) your principal place of residence is in the United States; and (iv) you have already filed or will file an IRS Form 1040 income tax return, and containing a Schedule C, for 2019.   The SBA also announced rules for partners and partnerships in this guidance, and which will be addressed in a separate post.

I. Calculate the Amount of your PPP Loan

The SBA states in its new guidance that the amount of a PPP loan will depend upon whether or not you employ other individuals.

• If you have no employees, the following steps should be used to calculate your maximum loan amount:
  • 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.
    • Note: if you have not yet filed a 2019 federal income return, fill out Schedule C and compute the net profit amount from this schedule
  • 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).

Under Internal Revenue Service COVID-19 related announcements, the filing date for 2019 federal income tax returns for individuals has been extended to July 15, 2020.   Under its guidance, the SBA now states that regardless of whether you have yet filed a 2019 income tax return with the IRS, you must fill out and submit the 2019 Form 1040, Schedule C with your PPP loan application, provide a 2019 IRS Form 1099-MISC (detailing nonemployee compensation received- box 7), and also provide a 2020 business-related invoice, bank statement, or other record showing you are self-employed and were in operation on or around February 15, 2020. The 2019 Form 1040, Schedule C can be found at the IRS website, www.irs.gov.

• If you have employees, the following steps should be used to calculate your maximum loan amount:
  • 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;
      • Note: if you have not yet filed a 2019 income tax return, fill out Schedule C and compute the net profit from this schedule
    • 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).

The SBA states that you must supply a 2019 IRS Form 1040, Schedule C; quarterly 2019 IRS Forms 941 (or other tax forms or equivalent payroll processor records containing similar information); state quarterly wage unemployment insurance tax (SUTA) reporting forms from each quarter in 2019 or equivalent payroll processor records; and evidence of any retirement and health insurance contributions, if applicable. A payroll statement or similar documentation from the pay period that covered February 15, 2020 must also be provided to establish you were in operation on February 15, 2020.

II. What Can I use my PPP Loan for?

The SBA in its guidance now instructs that the proceeds of a PPP loan are to be used for the following.

• Owner compensation replacement, calculated based on 2019 net profit as described above.

• Payroll costs for employees (other than the owner) whose principal place of residence is in the United States, if you have employees. For these purposes, payroll costs include:
  • compensation to employees such as salary, wages, commissions, cash tips, but limited to $100,000 of annualized pay per employee;
  • payment for vacation, parental, family, medical, or sick leave;
  • allowance for separation or dismissal;
  • payment for the provision of employee benefits consisting of group health care coverage, including insurance premiums, and retirement; and
  • payment of state “SUTA” taxes assessed on compensation of employees (not including withholdings).

• Mortgage interest payments (but not mortgage prepayments or principal payments) on any business mortgage loan 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).

• You must have claimed or be entitled to claim a deduction for these expenses on your 2019 IRS Form 1040 income tax return, Schedule C, in order for these expenses to be a permissible use during the eight-week period following the first disbursement of the loan (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 PPP loan proceeds for utilities during the covered period.

• 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.

III. Restrictions on use of PPP Loans

• The use of PPP loan proceeds is limited to those types of expenses the self-employed individual had in 2019.
  • For example, if you did not claim automobile expenses for your 2019 taxes, you cannot use the PPP loan proceeds to pay interest on a new business-related car loan now in 2020.
• The SBA has also determined that self-employed individuals will need to rely on their 2019 IRS Form 1040 income tax return, Schedule C, which provides verifiable documentation on expenses between January 1, 2019 and December 31, 2019. Expenses incurred between January 1, 2020 and February 14, 2020 will not be considered.
  • Note: The SBA states it will issue additional guidance for individuals with self-employment income who: (i) were not in operation in 2019 but who were in operation on February 15, 2020, and (ii) will file a Form 1040, Schedule C for 2020.
• At least 75 percent of the PPP loan proceeds must be used for payroll costs (as defined above). 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.

IV. Loan Forgiveness

PPP loans are, in fact, loans – and which may be required to be repaid with interest.  However, if the loan is used for specific purposes, the loan can be forgiven and need not be repaid.  For purposes of determining whether all or part of a PPP loan for a self-employed individual may be forgiven, the SBA now states that the actual amount of loan forgiveness will depend, in part, on the total amount spent over the covered period on:

• 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 SUTA unemployment insurance premiums);
• owner compensation replacement, calculated based on 2019 net profit as described above, 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 the Families First Coronavirus Response Act;
• 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).

V. What Documentation must I submit to my bank for a self-employed PPP loan?

• If you have employees, you should submit IRS Form 941 and state quarterly wage unemployment insurance tax (SUTA) 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.