Self-employed individuals receive guidance for Paycheck Protection Program participation

On April 14, 2020, the Small Business Administration released much-anticipated guidance on how self-employed individuals as well as partners in partnerships can participate in the Paycheck Protection Program enacted under the Coronavirus Aid, Relief, and Economic Security (CARES) Act.

Background                                                                                              

Paycheck Protection Program (PPP) loans are small business loans issued by private lenders and fully guaranteed by the federal government. The principal purpose of these loans is to help employers retain their employees. The loans are intended to cover eight weeks of payroll expenses, applied for any date between Feb. 15, 2020, and June 30, 2020.

Under the PPP, an eligible recipient includes:

• Small business concerns (as defined under the Small Business Act), plus
• Other business concerns as long as such business concern employs not more than the greater of:
  – 500 employees; or
  – If applicable, the size standard in number of employees established by the SBA for the industry in which business concern operates

Others eligible to receive a covered loan include: (a) individuals who operate as sole proprietors, independent contractors or as self-employed persons; and (b) any business concern that employs not more than 500 employees per business location and that is assigned a North American Industry Classification System (NAICS) code beginning with 72 (Accommodation and Food Services).

Key takeaways

• Partners in a partnership, solely in their capacity as partners, cannot qualify for the PPP loan program. Qualification for the program is determined solely at the partnership level. Up to $100,000 (annualized) in self-employment income of a “general active partner” can be included in payroll costs in the partnership’s loan application.
• Individual self-employed Schedule C filers are eligible for PPP loans if they were in business on Feb. 15, 2020, their principal place of business is in the U.S., and they filed or will file a Form 1040 Schedule C for 2019.
• Additional guidance will be issued for those individuals with self-employment income who: (i) were not in operation in 2019 but who were in operation on Feb. 15, 2020; and (ii) will file a Form 1040 Schedule C for 2020.
• Individuals will need to have a completed 2019 Schedule C (whether they have filed their Form 1040 or not) to comply with the loan requirements, determine eligible uses of the loan and determine the owner’s eligible compensation.

Application to partners

Partners in a partnership may not submit a separate application for themselves as self-employed individuals. The self-employment income of general active partners may be reported as a payroll cost (subject to a $100,000 limitation) on the partnership’s PPP loan application. A variety of reasons for prohibiting partners from individually applying for loans on their partnership income is given in the guidance, including: (1) allowing as many applicants as possible to apply by the June 30, 2020, deadline; (2) faster processing of applications; (3) many of the expenses for which the loan is provided are incurred at the partnership level; and (4) avoiding confusion regarding which entity, the partner or the partnership, applies for allocating partner and LLC member income.

The guidance does not provide a definition of a “general active partner” – presumably, it is a partner whose income is subject to self-employment taxes. The guidance also does not mention whether partners that receive guaranteed payments for services qualify as self-employment income for purposes of computing the partnership’s payroll. Unless clarified otherwise in additional guidance, we interpret guaranteed payments for services as being self-employment income that would qualify when determining the partnership’s payroll costs. We also believe that Line 1 of Schedule K-1 (ordinary business income (loss)) can be included as payroll costs (limited to a total of $100,000 per partner) as long as that income is subject to self-employment taxes.

Eligibility rules for individuals filing Schedule C, Form 1040

Taxpayers are eligible if they meet the following requirements:

• In operation on Feb. 15, 2020
• An individual with self-employment income (such as an independent contractor or a sole proprietor)
• With a principal place of residence is in the United States
• Have filed or will file a Form 1040 Schedule C for 2019

Additional guidance will be issued for those individuals with self-employment income who; (i) were not in operation in 2019 but who were in operation on Feb. 15, 2020; and (ii) will file a Form 1040 Schedule C for 2020.

The guidance points out that participation in the PPP loan program may affect eligibility to receive state unemployment compensation and to participate in other CARES Act programs, such as the CARES Act employee retention credits.

Calculation of maximum amounts that can be borrowed

The maximum amount that can be borrowed depends on whether the borrower has employees.

Use of PPP loans

Proceeds of PPP loans can be used for:

• Owner compensation replacement, calculated based on 2019 net profit
• Employee payroll costs (only U.S. resident employees)
• Certain mortgage interest, rent and utility payments. For these expenditures to qualify, they must have been a deductible expense on the 2019 Schedule C
• Interest payments on any other debt obligations that were incurred before Feb. 15, 2020 (such amounts are not eligible for PPP loan forgiveness)
• Refinancing certain Economic Injury Disaster Loan (EIDL) program loans

It is worth noting that the use of the loan proceeds is limited in some instances to expenditures for which the borrower claimed or could have claimed a deductible expense in 2019. For example, 2020 rent and utility payments on leased property that was not leased in 2019 and for which the borrower had no expenditures in 2019 is not an eligible use of the loan proceeds. The reason is that this is consistent with the intent of the Act, which is “to support the ongoing operations” of the borrower and not business expansion. Although the Act makes businesses eligible if they were in operation on Feb. 15, 2020, individuals will need to rely on their 2019 Form 1040 Schedule C, which provides verifiable documentation on expenses between Jan. 1, 2019, and Dec. 31, 2019.

At least 75% of the loan proceeds must be used for payroll costs.

Forgiveness of PPP loans

The amount forgiven can be up to the full amount of the principal plus accrued interest. Additional guidance explaining the mechanics of the loan forgiveness component is expected. There are many unanswered questions as to the computation, such as what happens if 75% of the loan proceeds do not end up being spent to cover payroll costs. Does that mean the entire amount of the loan cannot be forgiven? The SBA and the Treasury Department are expected to issue further guidance concerning the loan forgiveness program.

The information provided here is of a general nature and is not intended to address the specific circumstances of any individual or entity. In specific circumstances, the services of a professional should be sought. Tax information, if any, contained in this communication was not intended or written to be used by any person for the purpose of avoiding penalties, nor should such information be construed as an opinion upon which any person may rely. The intended recipients of this communication and any attachments are not subject to any limitation on the disclosure of the tax treatment or tax structure of any transaction or matter that is the subject of this communication and any attachments.