By now we have all at least heard about the Economic Injury Disaster Loan and the Paycheck Protection Program enough to know what the acronyms EIDL and the PPP stand for.  Even the infamous Pandemic Unemployment Program aka the PUA has become part of our daily vocabulary. But what are these programs and how do they work? More importantly, how do they work for us, for our clients, and are they enough to get us through this crisis?

Like me, you have no doubt been hunkered down at your desk watching recorded webinars, participating in live webinars, reading from the Treasury and Small Business Administration websites, posting in Facebook groups, and scouring any trustworthy media source with the insatiable anxiety of a Fortnite-deprived teenager searching for useful information and guidance that may answer those questions and help us serve a desperate small business clientele.

Even with this research and learning, many are still unsure as to who or what qualifies and how to apply if certain criteria are met. In particular, the area which seems to offer the maximum amount of insecurity and least amount of clarification are in relation to the truly self-employed individual filing on 1040 using Schedule C. The small business operating with the least amount of formality; a sole individual with no employees, they may not have a business bank account, and oft-times work from home most likely using their personal vehicle for any business travel.

This is particularly true of the Paycheck Protection Program or PPP. In what feels like an overdue response to industry pleas for additional policy guidance concerning the self-employed the Treasury, on April 14, 2020 issued some new information in the form of Interim Final Rule – Additional Eligibility Criteria and Requirements for Certain Pledges of Loans. While this new guidance removes some of the mystery it does not fully get the job done. I would imagine additional guidance will be forthcoming.

What Does this New Guidance Tell Us?

To put it plainly, if individuals who have income from self-employment (such as an independent contractor or a sole proprietor) and file a Form 1040, Schedule C; have fewer than 500 employees; were in operation on February 15, 2020 and before, their principal place of residence is in the United States; and they have filed or will file a Form 1040 Schedule C for 2019 they are eligible. That’s it.

What Else Do We Need to Know?

We need to know in short order how to calculate the maximum loan amount these small businesses can apply for, what documents are required to support the application, and what part of that loan, if any, may be forgivable in order to help our clients manage an already brutal economic environment.

To answer this will depend on whether or not there are payrolled employees. If there are no employees this is the method used to calculate the maximum loan amount:

It is important to note that if the 2019 1040 has not yet been completed the business will need to create a Schedule C with actual 2019 amounts in order to calculate the maximum loan amount. This should preferably be done with the help of a tax preparer. 

Sole Proprietor or Subcontractor With No Employees

  1. Use the 2019 Net Profit amount from IRS Form 1040 Schedule C, line 31. If this amount is over $100,000, reduce it to $100,000. If the Net Income amount is zero or less, the business is not eligible for a PPP loan – unless the business has payroll, use the calculation method for Sole Proprietor/Subcontractor – With Employees
  2. Calculate the average monthly net profit by dividing the amount in Step 1 by 12.
  3. Multiply the amount in Step 2 by 2.5
  4. If the business applied for the EIDL and any part of that amount must be refinanced into the PPP, add that amount to the amount in Step 3. Any of the amount of EIDL used for Payroll Expense or any other expenses covered by the PPP must be refinanced into the PPP and repaid at the PPP rate.

Using an example Schedule C:

  • If a business has Net Income from Schedule C of 41124.00 (Step 1) divide that by 12 (Step 2). This amount is $3,427.00.
  • Multiply this amount by 2.5 (Step 3). This amount is $8,567.50.
  • Add in the amount of EIDL received, which will more than likely be 1000.00, the limit per employee which in this case is the self-employed individual (Step 4). This amount, $9,567.50 is the maximum amount of the PPP loan.

These amounts will need to be documented in order to substantiate the claim made. Whether or not a 2019 tax return has been filed, a 2019 Form 1040 Schedule C must be submitted with the PPP application. Many lenders are allowing this documentation to be submitted separately from the application giving the business some time to generate the Schedule C.

Other required documents:

  • Any 1099-MISC
  • Invoices
  • Bank statements
  • Bookkeeping records such as Quickbooks or a running spreadsheet with income and expenses calculated for the year.

The business must also be able to prove they were in business prior to February 15, 2020.  Use the same documentation for this time period.

Sole Proprietor or Subcontractor With Employees

This loan amount calculation for Sole Proprietors/Subcontractors with employees is more complicated but essentially similar. First, calculate the 2019 payroll.

  1. Add the following:
    • The 2019 Net Profit amount from Schedule C line 31. This amount cannot exceed 100,000.00 or be less than zero, however, a loss here does not disqualify the business because there are still wages to compute.
    • The 2019 gross wages and tips paid to employees. Only employees whose principal place of residence is in the United States can be counted. Use the 941 Taxable Medicare wages & tips (line 5c- column 1) or W3 (box 5) from each quarter plus any pre-tax employee contributions for health insurance or other fringe benefits excluded from Taxable Medicare wages & tips. Be sure to subtract any amounts paid to any one employee in over $100,000 during the 2019 calendar year.

For small businesses using a Virtual Assistance in the Philippines or other countries, this compensation should be backed out of the calculations.

    • The 2019 employer health insurance contributions from Schedule C, line 14, retirement contributions from Schedule C, line 19, and state and local taxes assessed on employee compensation generally referred to as state unemployment tax.
  1. Calculate the average monthly amount by dividing the total amount from Step 1 by 12.
  2. Multiply the amount from Step 2 by Net Profit by dividing the amount in Step 1 by 2.5.
  3. If the business applied for the EIDL and any part of that amount must be refinanced into the PPP, add that amount to the amount in Step 3. Any of the amount of EIDL used for Payroll Expense or any other expenses covered by the PPP must be refinanced into the PPP and repaid at the PPP rate.

The required documents are:

  • 2019 Form 1040 Schedule C
  • Any 1099-MISC, Invoices, and bank statements which prove the businesses income
  • 2019 941 or W3
  • Evidence of health insurance payments for the employees only
  • Bookkeeping records such as Quickbooks or a running spreadsheet with income and expenses calculated for the year.
  • Payroll statements or other documentation which proves the business was in operation prior to February 15, 2020 and had employees.

Okay, the criteria for qualification to apply have been met, the maximum loan amount has been calculated, the required documents have been supplied to the lender, and the loan has been approved and funded. The proceeds of this loan can only be used for the following:

  1. The self-employed or subcontractor compensation replacement, calculated based on 2019 Net Profit.
  2. Employee payroll costs (as defined in the First PPP Interim Final Rule) for employees whose principal place of residence is in the United States.
  3. 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 a mortgage for the warehouse the business purchased to store business equipment or the interest on an auto loan for a vehicle used 100% for the business such as the truck of an electrician or a plumber), business rent payments (e.g., the office or storefront of the business that is not the home office), and business utility payments such as the cost of electricity in the office or storefront and the gas used in the 100% business vehicle. You must have claimed or be entitled to claim a deduction for such expenses on the 2019 Schedule C for expenses to qualify as permissible use during the eight-week period following the first disbursement of the loan also known as the “covered period”.

Note: No part of the home office expense can be paid or forgiven from the PPP Loan amount. If the loan is used for this purpose it must be repaid.

  1. Interest payments on any other debt obligations that were incurred before February 15, 2020 (Note: NOT eligible for PPP loan forgiveness).
  2. Refinancing an SBA EIDL loan made between January 31, 2020 and April 3, 2020.

**If the business received an SBA EIDL loan from January 31, 2020 through April 3, 2020, the business can apply for a PPP loan.

**If the EIDL loan was not used for payroll costs, it does not affect your eligibility for a PPP loan. **If the 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.

Certain Restrictions

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.

Loan Forgiveness

It is possible the entire amount of the PPP Loan including interest will be forgiven.

This will depend, in part, on the total amount spent over the covered period on qualifying costs such as:

The amounts are calculated using the 8 week period which begins on the date the lender makes the first payment of the loan to the self-employed/sole proprietor.

  • Payroll costs including salary, wages, and tips, up to $100,000 of annualized pay per employee (for eight weeks following the funding of the PPP, a maximum of $15,385 per individual) including covered benefits for employees (but not owners), including health care expenses, retirement contributions, and state taxes imposed on employee payroll paid by the employer.
  • Sole Proprietor/subcontractor compensation replacement. The amount of forgiveness of this compensation is limited to eight weeks’ worth of 2019 Net Profit. This is figured by dividing the Net Profit of Schedule C by 52 (weeks) and multiplying by 8 (weeks).

*It is still not clear if the 2020 amount exceeds the 2019 amount whether or not it can be forgiven. More guidance is needed.

  • 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. THIS IS MISLEADING. THIS AMOUNT DOES NOT INCLUDE ANY HOME OFFICE OR PERSONALVEHICLE EXPENSES.
  • Rent payments on lease agreements in force before February 15, 2020 provided they are deductible on Schedule C Line 18 or Line 20b
  • And any associated utility payments for business mortgage property or lease agreements

Using the Net Profit of the Schedule C from the earlier example: the Net Profit is 41124.00. Divide this by 52 (weeks) for a total of 790.54 and multiply by 8 (weeks) for a total amount of Sole Proprietor compensation of 6326.72 that could be forgiven. Add in the qualified portion of the Office Rent on Schedule C, Line 18 of 1846.08 and the qualified portion of the Utilities on Schedule C, Line 25 of 184.56 for a total forgivable amount of 8357.36. *In the earlier example of how we calculate the maximum loan amount it was determined the maximum loan amount for this Schedule C would be 9567.50. If these numbers hold true, the business would be left with 1210.14 to repay at 1% over two years.

*Remember, any qualified sick leave or qualified family leave amount for which a credit is claimed must be excluded. There is still some question as to whether or not the PPP can be claimed at all if any of the credits are taken. More guidance is still needed.

Pitfalls to be Aware of

The PPP is meant to keep small businesses alive and the people they employ working and out of the UI system, if the small business with employees has laid their workforce off or reduced hours the loan forgiveness amount will need to be adjusted to reflect this. If the small business has made no changes to workforce or pay there should be 100% forgiveness, otherwise the forgivable amount will be adjusted by the decrease percentage.

For example: In 2019 the small business has 10 employees, after February 15, 2020 the small business has 9 employees. The forgivable amount is adjusted by 10%, the amount of the decrease.

If the small business has retained their workforce but reduced their individual employee’s pay by more than 25% the loan forgiveness will need to be adjusted by the excess over 25%.

The Positives: If the small business has furloughed its workers or reduced employee wages they have until June 30, 2020 to restore their workforce and maintain eligibility for 100% loan forgiveness.

Loan Forgiveness and the EIDL

Small businesses are encouraged to apply for both the EIDL and the PPP. As long as the EIDL loan is NOT used for payroll costs, it will not impact PPP loan eligibility. If the EIDL is used to cover payroll expenses, the EIDL must be refinanced into the PPP. Proceeds from any EODL must be deducted from the forgivable amount of the PPP.

Partner or Partnership Eligibility

If you are a partner in a partnership, you may not submit a separate PPP loan application for yourself as a self-employed individual. Instead, the Partnership’s Net Income 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.

Small Businesses Not in Operation in 2019

The SBA will issue additional guidance for those individuals with self-employment income who: a) were not in operation in 2019 but were in operation on February 15, 2020, and b) will file a Form 1040 Schedule C for 2020.

Businesses Closed or Reduced Operations

A common question these days is “Do I get the money if I am forced to close or shut down for good?”. Most small businesses are under the impression this money is to compensate them while being closed rather than the true intention which is to keep the workforce paid and out of the unemployment rolls.

A Final Thought

The treasury handed the controlling reigns of the Paycheck Protection Program over to banks and the banks are not allowing the self-employed to apply unless before Feb 15, 2020 they held a business bank account. However, nowhere in the PPP does it specify a business bank account is a requirement for application or approval.

If your clients have been declined or cannot find a path to application, reach out to your Congressperson immediately. They need to know that this population is not being served. In the meantime, other vendors not classified as banks have begun to process applications for this group. Some of these vendors are Kabbage, Quickbooks, Fountainhead Capital, Cross River, Pay Pal, and Square. To be clear, this is not an endorsement but rather an encouragement to expand your search outside of the traditional banking system.

One of my clients, having been rejected by their own bank of more than twenty years, got creative and reached out to a small bank in a small town nearby.  The small bank processed their application. It was approved yesterday and expected to fund in the next five days.

*As of April 15, 2020 there is no guarantee that more funding will be forthcoming, many of you are encountering dead ends as the money is deployed. Encourage your clients to reach out to their representatives and encourage continued funding and continue to look for other sources still accepting applications.

Additional Resources

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