When applying for Paycheck Protection Program (PPP) loans, businesses are limited to the lesser of two amounts: 1) A defined maximum loan size ($10 million for first-draw loans, $2 million for second-draw) or 2) a calculated amount based on payroll costs.

SBA and the Treasury recently released an Interim Final Rule (IFR) with special guidance for filers of Form 1040, Schedule C – sole proprietors, independent contractors, and self-employed individuals – on how to calculate that second amount.

Read our overview of how this change impacts the loan amount calculation, documentation, a safe harbor, and more.

Summary

PPP rules had previously defined payroll costs for Schedule C filers as net profits – or net earnings from self-employment – plus any employee payroll costs, for those with employees.

Recognizing that Schedule C filers may have negative net profits and therefore may not receive “meaningful” PPP loan amounts, SBA will now allow such filers to choose to calculate the “owner compensation” share of their payroll costs based on either net profit or gross income. There are additional calculation components for Schedule C filers with employees to avoid any double-counting of employee payroll costs. (The IFR uses the term “proprietor expenses” for the owner compensation share of a Schedule C filer’s loan amount, encompassing an owner’s business expenses and own compensation but not employee payroll costs.)

Note that this change applies only to PPP loans approved after March 4, 2021; those whose loans had already been approved cannot increase their loan amounts based on the new calculation.

Updated calculations for the maximum loan amount

There is a new borrower application form available for first-draw borrowers that choose to use the gross income calculation: Form 2483-C. Applicants will need to calculate their loan amount as follows, based on whether they have employees:

Proprietors with no employees

1. From your 2019 or 2020 Schedule C, use the lesser of:

a. Your choice of your net profit (line 31) or gross income (line 7) (Note: If both are zero or less, you are not eligible for a PPP loan.)

b. $100,000

2. Divide that Step 1 amount by 12 to get your average monthly net profit/gross income.

3. Multiply the Step 2 amount by 2.5. (Corresponding with the Step 1 limitation of $100,000, the maximum amount for Step 3 is $20,833.)

4. If you received an Economic Injury Disaster Loan (EIDL) between Jan. 31, 2020, and April 3, 2020, add any outstanding amount that you seek to refinance; do not include amounts of any COVID-19-related EIDL Advances.

Proprietors with employees

1. Compute your 2019 or 2020 payroll costs by adding up the following (using the same year for all items):

a. Your choice of:

i. 2020 or 2019 net profit (Schedule C, line 31)

ii. 2019 or 2020 gross income (line 7), minus employee payroll costs (up to $100,000 on an annualized basis, prorated for your relevant time period):

1. Employer contributions to employee group health, life, disability, vision, and dental insurance (attributable portion of line 14); retirement contributions (line 19); and state and local taxes assessed on employee compensation (line 26)

iii. If this amount is over $100,000, use $100,000

iv. If this amount is less than zero, use zero

b. 2019 or 2020 gross wages and tips paid to employees whose principal place of residence is in the U.S., calculated as:

i. 2019 or 2020 Form 941 Taxable Medicare wages and tips (line 5c, column 1) from each quarter

ii. PLUS any pre-tax employee contributions for health insurance or other fringe benefits

iii. MINUS any amounts paid to any individual employee in excess of $100,000 on an annualized basis, prorated

iv. MINUS any amounts paid to employees principally residing outside the U.S.

c. 2019 or 2020 employer contributions to employee group health, life, disability, vision, and dental insurance (line 14); retirement contributions (line 19); and state and local taxes assessed on employee compensation (line 26)

2. Divide the Step 1 amount by 12 to get your average monthly amount.

3. Multiply the Step 2 amount by 2.5.

4. If you received an Economic Injury Disaster Loan (EIDL) between Jan. 31, 2020, and April 3, 2020, add any outstanding amount that you seek to refinance; do not include amounts of any COVID-19-related EIDL Advances.

Second-draw loans

The calculations are the same for the second-draw loan application – Form 2483-SD-C – except that there are two differences for borrowers with a NAICS code beginning with 72:

1. In Step 3, multiply by 3.5 instead of 2.5.

2. This Step 3 amount is limited to $29,167 instead of $20,833.

Recall also that the maximum loan amount for second-draw loans is $2 million, instead of the $10 for first-draw loans.

Documentation

Due to this change, applicants should plan to provide the following:

Proprietors with no employees

• Your 2019 or 2020 Schedule C (whichever was used to calculate your loan amount)
• Documentation that you are self-employed: An invoice, bank statement, book of record, or 2019 or 2020 Form 1099-MISC detailing nonemployee compensation received (box 7)
• If you use 2020 to calculate your loan amount, this is all required even if you have not yet filed your 2020 tax return; you must provide a 2020 invoice, bank statement, or book of record showing that you were in operation “on or around” Feb. 15, 2020.

Proprietors with employees

• Your 2019 or 2020 Schedule C (whichever was used to calculate your loan amount)
• Form 941, or other tax forms or payroll processor records containing similar information
• “State quarterly wage unemployment insurance tax reporting forms from each quarter in 2019 or 2020 (whichever you used to calculate your loan amount) or equivalent payroll processor records, along with evidence of any retirement and health insurance contributions, if applicable”
• A payroll statement or similar documentation from the pay period that covered Feb. 15, 2020

Good-faith certification

PPP applicants have long been required to make a good-faith certification “that the uncertainty of current economic conditions makes necessary the loan request to support the ongoing obligations.” SBA created a safe harbor that automatically deemed this certification to have been made in good faith for borrowers that received an original principal amount of less than $2 million. 

This latest guidance eliminates that safe harbor for certain Schedule C filers. Knowing that this change will increase the maximum loan amount for relevant applications, and may make it so that their gross income may not reflect their need for a PPP loan, SBA has stated that Schedule C filers that calculate their first-draw loan amount based on gross income, using a gross income of more than $150,000, will not automatically be deemed to have made the required certification in good faith, and may be subject to SBA review. (This safe harbor elimination does not apply to second-draw applicants, who are required to certify a 25% reduction in gross receipts.) “SBA is eliminating the loan necessity safe harbor for these borrowers as they may be more likely to have other available sources of liquidity to support their business’s operations than Schedule C filers with lower levels of gross income,” the IFR states.

Impact on forgiveness amounts for owner compensation

The IFR also applies this new allowance for the use of net profits or gross income to the PPP forgiveness process, for the calculation of payroll amounts for owner-employees or self-employed individuals, or “owner compensation.” This amount is capped for each individual, in total across all businesses, at the lesser of:

• 2.5 months’ worth of the individual’s 2019 or 2020 net profit or gross income, excluding any qualified sick or family leave equivalent amounts for which credits are claimed under the Families First Coronavirus Response Act (FFCRA) 
• The 2.5-month equivalent of $100,000 on an annualized basis ($20,833 per individual in total across all businesses)

Either amount must be prorated according to the chosen covered period; for example, for a borrower with an eight-week covered period, owner compensation would be capped at the lesser of eight weeks’ worth (8/52) of 2019 or 2020 compensation or $15,385 per individual, in total across all businesses.

To determine the amount of net profit or gross income allocated for the covered period, borrowers must use the same 2019 or 2020 Schedule C that was provided with their loan application.

Contact

Stephanie O'Rourk, CPA, Partner, Tax and Advisory

404.250.4079

Jeff Bobrosky, CPA, Partner, Assurance and Advisory

818.205.2640

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