April 14, 2020

COVID-19   Paycheck Protection Program

Interim Final Rule:  Self-Employment Income (1040 Schedule C)

We’ve been waiting on guidance regarding what is considered income for the loan calculation as well as how you qualify for loan forgiveness since there is no “owner” payroll as a Self-Employed (SE) business.  This Interim Rule answers most of the questions we’ve been held-up by.  I am not covering PPP items that were generic in nature – only commenting on items directly related to self-employed that were not clear in previous Rulings or guidance.

Below summarizes several items directly associated with the Paycheck Protection Program of the CARES Act – Phase III legislation – specifically the Interim Final Rule regarding Self-Employment Income.  This is a recap of the Rule itself and all items listed are subject to final SBA interpretations.

Individuals with SE Income who File Form 1040, Schedule C

• Partnerships – If you are a partner in a partnership (including LLCs filing as partnership), you may NOT submit a separate PPP loan application for yourself as a self-employed individual. The self-employment income of general active partners may be reported as payroll cost (up to the $100,000 annualized limit) on a PPP loan application filed by or on behalf of the partnership.
• Maximum Loan Amount
  • If no employees
    • Net Profit, limited to $100,000 (2019 Form 1040 Schedule C line 31)
      • If you have not filed a 2019 return, you must fill it out and compute the net profit value. Regardless if you’ve filed taxes yet for 2019, the 2019 Form 1040 Schedule C must be provided to lender.
      • If this amount is zero or less, you are not eligible for a PPP loan
    • Calculate average monthly net profit (div by 12).
    • Multiply average monthly net profit by 2.5.
    • 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 forgivable advance under an EIDL.
    • Items that must accompany application form:
      • 2019 Schedule C
      • One of: form 1099-Misc detailing nonemployee compensation received (box 7), invoice, bank statement or book of record that establishes you are self-employed
      • A 2020 invoice, bank statement or book of record that establishes you were in operation on or around February 15, 2020.
    • If you have employees
      • Net Profit, limited to $100,000 (2019 Form 1040 Schedule C line 31)
        • If you have not filed a 2019 return, you must fill it out and compute the net profit value. Regardless if you’ve filed taxes yet for 2019, the 2019 Form 1040 Schedule C must be provided to lender.
        • If this amount is zero or less, this part of the calculation is zero.
        • Add: 2019 gross wages and tips paid to your employees computed using 2019 IRS Form 941 (line 5c – column 1).
        • Add any pre-tax employee contributions for health insurance or other fringe benefits that were excluded from Taxable Medicare wages & tips.
        • Less any amounts paid to any individual employee in excess of $100,000 annualized and less all amount to any individual included above if principal residence is outside the US.
        • Add 2019 employer health insurance contribution (health insurance component of Form 1040 Schedule C – line 14).
        • Add retirement contributions (Form 1040 Schedule C line 19).
        • Add state and local taxes assessed on employee compensation (primarily SUTA).
      • Calculate average monthly net profit after above adjustments (div by 12).
      • Multiply average monthly net profit by 2.5.
      • 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 forgivable advance under an EIDL.
      • Items that must accompany application form:
        • 2019 Schedule C
        • Form 941 (or other equivalent payroll processor records to support numbers)
        • Evidence of any retirement and health insurance contributions
        • Payroll Statement or similar documentation from the pay period that covered February 15, 2020 – establishes you were in operation on February 15, 2020.
      • Use of PPP proceeds (during the 8 week forgiveness “covered period”)
        • Covered Period begins the day proceeds are received and is for the following 8-week period.
        • Owner compensation replacement, calculated based on 8/52 of 2019 net profits. (the ruling has made this very simple as is just a calculation from the 2019 tax return)
        • Employee payroll costs (US residents only) and associated taxes as calculated in loan proceeds calculation above.
        • Mortgage interest (on real or personal business property) – contractual obligation must have incurred before 2/15/20.
        • Rent and Utilities – contractual obligation must have incurred before 2/15/20.
          • The Rule also indicates that gas used in your business vehicle qualifies as utilities allowed as PPP expenses:  “business utility payments (e.g., … gas you use driving your business vehicle)”.  We will expect additional guidance on this (the SBA had UBER drivers in mind with this one ).
        • NOTE – for any of the above to be qualified expenses, taxpayer must have claimed or been entitled to claim a deduction for such expenses on the 2019 Form 1040 Sch-C
        • If you also received a SBA EIDL loan, you can still apply for PPP.
          • If your EIDL loan was used for payroll costs, your PPP must be used to refinance your EIDL loan (maturity will be reset to PPP’s two year limit)
          • Any EIDL advanced proceeds (since forgiven) will be deducted from the loan forgiveness amount on the PPP loan.
        • At least 75% of PPP loan proceeds shall be used for payroll costs.
        • NOTE – although possible, it is highly unlikely and actually not intended by Congress that the Self-Employed PPP borrower end up with a 100% forgiven PPP loan. Congress recognizes that small business have fewer of the overhead expenses that qualify for forgiveness under the Act.  Thus when given proceeds based upon 2.5/12 months of payroll (approx. 10.83 weeks) but forgiveness “covered period” of only 8 weeks, it may be difficult to spend the remaining proceeds on the other “qualifying” expenditures if they do not exist or are minimal.  Quote “Allowing such a self-employed individual to treat the full amount of a PPP loan as net income would result in a windfall”.  Congress designed this program to limit forgiveness to certain expenses incurred in an eight-week covered period so these guidelines are construed to follow that intent.
      • If not in operation during 2019 (thus no 2019 Sch-C) but who were in operations on February 15, 2020, SBA will issue additional guidance.
        • There was no mention of any additional guidance coming for a SE that started business during 2019 thus only has a partial year 1040 Sch-C but possibly they will address this situation in future guidelines also.
      • Documentation required for forgiveness
        • Form 941 and state quarterly unemployment insurance forms (or equivalent payroll records that correspond to the covered period)
        • Evidence of any retirement and health insurance contributions
        • Evidence of Rent, mortgage interest and utility payments during the covered period
        • 2019 Form 1040 Schedule C (same that was provide during the loan application process) for calculation of owner allocation (2.5/12 of net income – $100,000 limit)

As with all the PPP programs, there is a lot of room for individual lending bank interpretations.  Thus, please make certain you fully understand your individual bank’s requirements and expectations required for the application process and especially for forgiveness qualifications.

FARMERS (Schedule F filers)

• This specific Interim Ruling did not address farmers specifically (actually directly did not as specifically refers several items toward Schedule C).
• Assumption at this time is that any Schedule F filing will follow this same Ruling above very closely and substitute Schedule F where they are using Schedule C in the current Ruling.
• One item that needs addressed specifically for the farmer is that gains on equipment on Form 4797 is part of the farming operation but outside the Schedule F.  Hopefully the SBA will rule on this sometime soon or possibly some USDA guidance will be issued as using the above calculation, a farmer isn’t getting the full income benefit of the farm operations since Form 4797 gains are separated from the Schedule-F

Hopefully the above information has been useful.  Please contact your tax advisor at LattaHarris if you have financial questions while completing any of the above processes.

We will also keep the most updated information and applicable links on our website www.lattaharris.com and social media postings.  Please monitor these for any further updates or developments affecting these or other COVID-19 issues.

Thank you for giving us the privilege to be your trusted tax preparer and consultant.