In response to lingering questions, the Small Business Administration (SBA) issued supplemental rules providing guidance for individuals (such as independent contractors or sole proprietors) and partnerships with self-employment income. The supplemental Interim Final Rule was issued on April 14, 2020 and took effect April 20, 2020.
Independent Contractors & Sole Proprietors
Independent contractors and sole proprietors residing in the United States who reported self-employment income on Form 1040 Schedule C for the year ending December 31, 2019, and were operating on February 15, 2020, are eligible to apply for a loan.
For independent contractors and sole proprietors who do not have employees, the maximum loan amount is determined as follows:
Step 1: Determine the “owner compensation replacement” based on the net profit reported on line 31 of Schedule C, Profit or Loss from Business, filed, or to be filed, with Form 1040 for 2019. Amount may not exceed $100,000.
Step 2: Calculate the average monthly net profit by dividing the amount from Step 1 by 12.
Step 3: Multiply the average monthly net profit 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 less the amount of any advance under any COVID-19 related EIDL loan.
For independent contractors and sole proprietors who have employees, the maximum loan amount is determined as follows:
Step 1: Compute payroll costs based on the sum of:
- “Owner compensation replacement” based on the net profit reported on line 31 of Schedule C, Profit or Loss from Business, filed, or to be filed, with Form 1040 for 2019. Amount may not exceed $100,000.
- Taxable Medicare wages and tips as reported on 2019 Form 941, 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 and tips. Amount paid to any individual employee may not exceed $100,000.
- Employer health insurance contributions reported on Schedule C line 14, retirement plan contributions reported on Schedule C line 19, and state and local unemployment tax.
Step 2: Calculate the average monthly amount by dividing the amount from Step 1 by 12.
Step 3: Multiply the average monthly 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 less the amount of any advance under any COVID-19 related EIDL loan.
To substantiate the requested loan amount, independent contractors and sole proprietors are required to provide a copy of 2019 Form 1040 Schedule C (regardless of whether Form 1040 has been filed) and, if applicable, copies of Form 941 and state unemployment tax filings for each quarter of 2019. In addition to the income and payroll tax filings, a 2019 Form 1099-MISC reporting nonemployee compensation, invoice, bank statement, or other books and records must be provided to confirm self-employment status during 2019. Lastly, as verification that the business was operating on February 15, 2020, an invoice, bank statement, or other books and records must be provided along with a payroll report including amounts paid to employees during the payroll period including February 15, 2020.
Additional guidance will be issued for independent contractors and sole proprietors who were in operation on February 15, 2020, but were not in operation during the calendar year ending December 31, 2019.
Loan proceeds received by an independent contractor or sole proprietor may generally be used for:
- “Owner compensation replacement”
- Employee payroll costs
- Mortgage interest payments (excluding prepayments)
- Interest on an auto loan for a vehicle used to perform the business
- Rent payments
- Utilities
- Interest payments on any other debt obligation incurred before February 15, 2020
- Refinancing of an EIDL loan made between January 31, 2020 and April 3, 2020
However, since the PPP was intended to provide funding to maintain existing operations and payroll and was not issued for business expansion, an independent contractor or sole proprietor must have claimed, or been entitled to claim, a deduction for such expenses on Form 1040 Schedule C for 2019 in order for the expenditure to be treated as a qualifying disbursement. For example, if a deduction for a rent expense was not claimed on Schedule C for 2019, then loan proceeds can’t be used for payment of rent.
Principal and accrued interest on loans obtained under the PPP can be forgiven to the extent funds are spent on the following items during the eight weeks following the initial disbursement of loan proceeds:
- Employee payroll costs (including health insurance premiums and retirement contributions)
- “Owner compensation replacement” amount (limited to 8/52 of net profit reported on 2019 Form 1040 Schedule C) less any qualified sick leave equivalent amount or qualified family leave equivalent amount, for which a credit is claimed under the Families First Coronavirus Response Act
- Since net profit used to calculate the “owner compensation replacement” amount is capped at $100,000, the maximum amount eligible for loan forgiveness is $15,385 ($100,000 x 8/52)
- Interest on mortgages and real property loans incurred before February 15, 2020 to the extent deductible on Form 1040 Schedule C
- Rent payments on leases in force before February 15, 2020 to the extent deductible on Form 1040 Schedule C
- Utility payments under service agreements entered before February 15, 2020 to the deductible on Form 1040 Schedule C
Consistent with the program’s intent of keeping workers paid and employed, no more than 25% of the loan proceeds can be used to pay non-payroll costs. Furthermore, employee headcount and compensation levels must be maintained at consistent levels in order to qualify for loan forgiveness.
In support of a request for loan forgiveness, an independent contractor or sole proprietor will be required to submit payroll tax filings or equivalent records prepared by a payroll administrator verifying employee headcount and payroll costs during the eight-week period, along with evidence of qualifying interest, rent, and utility payments. No additional recordkeeping or reporting is required for purposes of verifying the “owner compensation replacement” amount since the amount is determined based on the 2019 Form 1040 Schedule C provided at the time of the loan application.
Amounts not forgiven will bear interest at a rate of 1% and must be repaid over a term of two years, with principal and interest payments deferred for the first six months.
Partnerships
Under the supplemental rule, partners in a partnership are not considered self-employed for purposes of the PPP. Accordingly, partners in a partnership may not submit loan applications individually. Instead, in an effort to lower the administrative burden for partners and allow lenders to process applications more quickly, partnerships are allowed to file a single application on behalf of partners. Self-employment income of active partners, including guaranteed payments, should be included in payroll costs (maximum of $100,000 per partner) reported on the PPP loan application filed by the partnership.
Note: Subsequent to the issuance of the supplemental Interim Final Rule, the SBA announced on April 16, 2020 that applications for PPP loans were no longer being accepted because funding for the program was no longer available. Legislation providing additional funding for the program is currently being deliberated in Congress and expected to be enacted in the coming days.
