PPP Loans for Self-Employed Taxpayers: Eligibility, Forgiveness, & Recent Updates
The Coronavirus Aid, Relief, and Economic Security Act (CARES Act) authorized the Paycheck Protection Program (PPP) to provide relief to the workforce as a result of the COVID-19 crisis. This program was created as an incentive for businesses that were negatively affected by the pandemic to keep workers on their payroll. Businesses could apply for a PPP loan through any U.S. Small Business Administration (SBA) lender or federally insured depository institution or credit union.
In a second round of stimulus relief, Congress passed the 2021 Consolidated Appropriations Act (CAA) on December 27, 2020, which includes a provision of $284 billion to reopen the PPP through March 31, 2021.
Businesses eligible for a first draw PPP loan under the CARES Act generally included those with no more than 500 employees, sole proprietors, 1099 contractors, and other eligible self-employed taxpayers who were in business on February 15, 2020. To qualify for a second round PPP loan under the CAA, businesses must have used or be planning to use the full amount of their first draw PPP loan on qualified expenses, have fewer than 300 employees (based on 2020 full-time and part-time head count), and have incurred at least a 25 percent reduction in gross receipts in any quarter in 2020 compared to same quarter in 2019.
The maximum second draw loan an applicant can receive is the lower of $2 million or 2.5 times the average total monthly payroll costs incurred during calendar-year 2019 or 2020 or during a one-year period before the date the loan is made. For businesses with a 72 NAICS code, the multiplier is 3.5 but still with a maximum of $2 million.
Since sole proprietors and contractors don’t normally have employees, the SBA introduced the concept of owner compensation replacement. Owner compensation replacement means the amount of income the self-employed taxpayer would have earned or paid themselves. This can be determined by looking at the taxpayer’s 2019 or 2020 Schedule C net profit. The second draw PPP loan for a sole proprietor without employees is calculated by dividing the 2019 or 2020 Schedule C line 31 net profit (note, maximum net profit for this calculation is $100,000) by 12 months, then multiplying by 2.5. This results in a maximum owner compensation replacement loan of $20,833. It’s important to note that if a self-employed taxpayer has multiple businesses, they’re still capped at the maximum owner compensation replacement above. For example, if a taxpayer receives $20,000 in owner compensation from one business, they can only use an additional $833 from another business to qualify for the maximum forgiveness.
For Schedule C filers who received loans based on payroll, 60 percent of the PPP loan proceeds must be used for certain “payroll costs” including gross payroll, healthcare, employee retirement contributions, qualifying mortgage interest payments, qualifying rents, and utilities. The CAA also added four additional categories of non-payroll qualifying expenses for new PPP loans taken out or loans not yet forgiven, which include operations expenditures, property damage, supplier costs, and worker protection equipment. PPP loans that are used for these qualified expenses may be fully forgiven. Anything spent to replace a self-employed taxpayer’s owner’s compensation replacement income is fully forgivable up to the maximum loan amount listed above.
The original PPP rules allowed for either an eight-week or 24-week covered period, beginning with the date the loan is disbursed. The covered period means the business must spend the loan proceeds within this time frame to qualify for forgiveness. Under the CAA, borrowers can now select their covered period if they don’t need the full 24-week period, but no less than eight weeks. A business can apply for forgiveness at any time prior to the loan maturity date, as there’s no official due date set by the SBA. Any amount not forgiven will need to be repaid according to the loan terms. PPP loans have an interest rate of 1 percent and a maturity of five years. The business will be required to start making payments 10 months after the end of the covered period for any amount not forgiven.
On October 8, 2020, the SBA issued an interim final rule to address loan forgiveness for small business loans under $50,000. Taxpayers with loans under $50,000 can file Form 3508S, a simplified two-page application, to request forgiveness. The CAA simplified the PPP forgiveness process even further for loans of $150,000 or less. On January 19, 2021, the SBA revised Form 3508S to apply to loans of $150,000 or less, instead of only $50,000 or less. This is a simple two-page forgiveness application listing the loan amount, number of employees retained, and estimated amount spent on payroll. The use of Form 3508S doesn’t grant automatic forgiveness of the full PPP loan. For loans in excess of $50,000, the full-time equivalent (FTE) reduction rules and the salary and hourly wage reduction provisions that can reduce the loan forgiveness amount are still applicable. These provisions aren’t applicable to loans of $50,000 or less. While a borrower with a loan in excess of $50,000 is required to make the FTE reduction and the salary and hourly wage reduction calculations, no documentation is required to be submitted with the Form 3508S in connection with those calculations. However, documentation relating to employment and payroll is required to be maintained by the borrower for four years from the forgiveness application submission date and three years for all other documentation. According to SBA’s interim final rule 13 CFR Part 120, about 70 percent of first-round outstanding PPP loans were issued for $50,000 or less, which represents $62 billion of the $525 billion total PPP loans.
The CARES Act classified forgiven PPP loans as a class of exempt income, which means these loans are excluded from taxable income if forgiven. The U.S. Department of the Treasury originally released Notice 2020-32, which disallowed deductions for expenses paid with forgiven PPP loan proceeds in order to prevent taxpayers from receiving a double tax benefit. However, the CAA clarified that expenses paid with PPP loan proceeds are fully deductible. As a result, the IRS issued additional guidance under Rev. Rul. 2021-02 to confirm taxpayers’ ability to deduct these expenses.
Overall, the PPP loan program provides some much-needed assistance to many small businesses and self-employed taxpayers. However, the program continues to change as the pandemic drags on, and it’s essential that taxpayers fully understand the rules to help them qualify for full forgiveness to receive the maximum benefit from this program.
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