Guidance on Self-Employment Income from Form 1040 Schedule C Businesses, Partners and PartnershipsApril 14, 2020
On April 14, the Small Business Administration (SBA) released an interim rule on additional aspects of the Paycheck Protection Program (PPP) loan program. The guidance provides important clarifications regarding self-employment income from Form 1040 Schedule C businesses, partners and partnerships. Below are relevant questions and answers that are contained in the guidance.
Q: Can individuals with self-employment income (Form 1040 Schedule C filers) apply for PPP loans?
A: Yes. Form 1040 Schedule C filers are eligible to apply for PPP loans if (1) their business was in existence on February 15, 2020; (2) the owner had 2019 Schedule C income (such as an independent contractor or a sole proprietor); (3) the owner’s principal place of business is in the United States and (4) a Form 1040 Schedule C has been or will be filed for 2019. The SBA will be issuing additional guidance for those individuals with self-employment income who were not in operation in 2019 but who were in operation on February 15, 2020, and will file a Form 1040 Schedule C for 2020.
Q: Can partners in partnerships apply for PPP loans?
A: No. A partner may not apply for a loan individually as a self-employed individual. However, partnerships may apply for loans. For purposes of calculating the borrowing base, “payroll costs” will include up to $100,000 in net earnings from self-employment income of each “general active” individual partner plus the payroll costs of any employees of the partnership.
Q: How do you calculate the maximum loan amount for Form 1040 Schedule C filers?
A: The guidance provides precise steps for calculating a Form 1040 Schedule C filer’s maximum loan amount for borrowers with and without employees.
For Form 1040 Schedule C filers with no employees, the steps include the following:
Step 1: Identify the 2019 IRS Form 1040 Schedule C line 31 net profit amount (but not below zero or more than $100,000). For borrowers who have not yet filed a 2019 return, the guidance requires a return to be completed for purposes of the application.
Step 2: Calculate the average monthly net profit amount (divide the amount from Step 1 by 12).
Step 3: Multiply the average monthly net profit amount from Step 2 by 2.5.
Step 4: Add the outstanding amount of any Economic Injury Disaster Loan (EIDL) made between January 31, 2020, and April 3, 2020, that will be refinanced into a PPP, less the amount of any advance under an EIDL COVID-19 loan.
For Form 1040 Schedule C filers with employees, the steps are as follows.
Step 1: Compute payroll by adding the following:
- 2019 IRS Form 1040 Schedule C line 31 net profit amount (but not below zero or more than $100,000).
- 2019 Medicare wages and tips reported (line 5c - column 1) on all 2019 IRS Form 941s and employee pre-tax health insurance contributions and other fringe benefits not in the Medicare base less any amounts paid to an employee in excess of $100,000 and any amounts paid to an employee who lives outside of the USA.
- Amounts from 2019 Schedule C line 14 (health insurance benefits) and line 19 (retirement benefits) and 2019 state and local taxes on employee wages (commonly referred to as the State Unemployment Tax Act or SUTA).
Step 2: Calculate the average monthly amount (divide the amount from Step 1 by 12).
Step 3: Multiply the average monthly amount from Step 2 by 2.5.
Step 4: Add the outstanding amount of any EIDL (if applicable) made between January 31, 2020, and April 3, 2020, that will be refinanced, less the amount of any advance under an EIDL COVID-19 loan.
Observation: Since the new guidance provides that net Schedule C earnings up to $100k constitute at least part of the borrowing base, it is evident that a Form 1040 Schedule C filer who experienced a loss in 2019 and who did not have any employees will not qualify for a PPP loan under the new guidance.
Q: What information will Form 1040 Schedule C filers need to provide?
A: For Form 1040 Schedule C filers with no employees, the borrower must provide the 2019 Form 1040 Schedule C and a 2019 IRS Form 1099-MISC detailing nonemployee compensation received (box 7), invoice, bank statement, or book of record that establishes self-employment. The borrower also must provide a 2020 invoice, bank statement, or book of record to establish that the business was in operation on or around February 15, 2020. Form 1040 Schedule C borrowers with employees must provide additional documentation including their 2019 quarterly 941 filings, 2019 quarterly SUTA filings and any other state payroll tax returns (other than withholding), and evidence of 2019 health insurance and retirement plan contributions.
Q: How can the loan proceeds be used by Form 1040 Schedule C filers?
A: Subject to certain limitations, PPP loan proceeds are to be used for the following expenses:
- Owner compensation replacement calculated based on 2019 net profit
- Employee payroll costs for employees who live in the United States
- Mortgage interest payments on any business mortgage obligation
- Business rent payments
- Business utility payments
- Interest on any business debt obligations that existed before February 15, 2020, even though these payments do not count toward forgiveness.
Q: Are there any limits on how much qualifying expenses can be paid with loan proceeds?
A: Yes. The amount that can be expended on non-payroll costs cannot exceed 25% of the loan proceeds. For direct compensation of employees (not including health insurance and retirement benefits), the most that can be paid to any individual employee is capped at $15,385, which represents approximately eight weeks of pay. Owner “draws” constitute payroll costs and the guidance “limits the forgiveness of owner compensation replacement for individuals with self-employment income who file a Schedule C to eight weeks’ worth (8/52) of 2019 net profit.”
Q: What information will Form 1040 Schedule C filers need to provide to apply for forgiveness?
A: Form 1040 Schedule C filers will need to provide Form 941 filings and other payroll records that cover or straddle the eight-week period along with evidence of health insurance premiums paid for employees and any retirement plan contributions made. Form 1040 Schedule C filers will also need to provide records which show the amount of rent, mortgage interest and utilities paid.
The interim guidance also provided clarifications regarding revenues from legal gaming operations, eligibility for individuals who are directors or shareholders of PPP lenders and loan pledges.
Marks Paneth recognizes that there are many questions concerning SBA loans that remain unanswered. We will keep you updated on all activities relating to SBA loans including further much-needed guidance on the PPP loan forgiveness regime. If you have any questions, please feel free to contact your Marks Paneth advisor or email our Response Team. You may also visit our Pandemic Resource Center for additional updates and guidance on the coronavirus (COVID-19).