Effective Tuesday, April 14, the Administration, through the U.S. Small Business Administration (“SBA”), issued yet another “Interim Final Rule.”  This occurred as the SBA was running out of money to fund Payroll Protection (“PPP”) loans, and as Senate Republicans and Democrats neared impasse on a proposal to infuse an additional $250 billion into the popular PPP loan program.  Using its emergency rulemaking authority, this time the SBA provided guidance for self-employed individuals seeking to apply for PPP loans.  The rule also addresses eligibility and loan forgiveness issues for certain businesses.

This article hits the highlights of this latest SBA guidance entitled, “Business Loan Program Temporary Changes; Paycheck Protection Program – Additional Eligibility Criteria and Requirements for Certain Pledges of Loans.”  However, because yesterday the PPP loan program ran out of money, the practical effect of the SBA’s guidance on how to apply for PPP loans going forward remains uncertain.

Who Qualifies as “Self Employed” for Purposes of the PPP Loan Program?

The new rules provide guidance for independent contractors and sole proprietors who earn income in the form of a net profit amount generated by the small business, rather than wages, bonus, commissions or other traditional forms of compensation.  These are people who use Schedule C on their Federal Income Tax Returns. Active partners in business partnerships (for example, members of limited liability companies taxed as partnerships) are not eligible to apply for PPP loans.  Rather, self-employment income of general active partners/members, up to $100,000 on an annualized basis, may be reported as a component of the LLC or partnership’s overall payroll costs for purposes of a PPP loan application.

How Are Self-Employed Individuals Required to Calculate Their Income?

Self-employed individuals will calculate their maximum PPP loan amount by determining their average monthly net profit amount for 2019. That amount is then divided by the sum of their net profit for the year (shown on their 2019 IRS Form 1040, Schedule C Line 31, not more than $100,000) plus eligible payroll costs of employees, if any, by 12, and multiplying that average monthly net profit amount by 2.5.  This maximum amount would then be adjusted for amounts associated with an SBA Economic Injury Disaster Loan (“EIDL”).  The SBA’s new guidance also specifically describes the documentation an applicant is required to submit to substantiate the requested PPP Loan amount.

Proceeds of PPP loans received by self-employed individuals may be used during the eight-week period following the first disbursement of the loan (the “Covered Period”) for:

  • Owner compensation replacement, based on 2019 net profit amounts
  • Employee payroll costs (the guidance indicates at least 75% of the PPP loan proceeds shall be used for payroll costs)
  • Mortgage interest payments (not principal payments on real or personal business property, business rent payments, and business utility payments (but only if deductions for these categories of expenses were claimed on the applicant’s 2019 Form 1040 Schedule C)
  • Interest payments on other debt obligations incurred before February 15, 2020 (amounts are not eligible for PPP loan forgiveness)
  • Refinancing an SBA EIDL loan made between January 31, 2020 and April 3, 2020

Up to the full principal amount, plus accrued interest on PPP loans to self-employed individuals, are eligible for forgiveness.  The actual amount of loan forgiveness depends on the total amount spent over the Covered Period on:

  • Payroll costs, including salary, wages and tips up to $100,000 of annualized pay per employee (for eight weeks, a maximum of $15,385 per employee), including health care expenses, retirement contributions, and state taxes imposed on employee payroll paid by the business, such as unemployment insurance premiums
  • Owner compensation replacement, calculated based on 2019 net profit, limited to eight weeks’ worth (8/52) of 2019 net profit (excluding qualified sick leave or family leave amounts for which a credit is claimed under the Families First Coronavirus Response Act)
  • Business mortgage interest, rent and utility payments, to the extent they are deductible on form 1040 Schedule C

It’s important to note that 75% of the proceeds of PPP loans made to self-employed individuals are required to be used for payroll costs.  For this purpose, payroll costs do not include owner compensation replacement, and PPP loan forgiveness with respect to owner compensation replacement is limited to only eight weeks’ worth of 2019 net profit.  The SBA’s guidance indicates: “This is most consistent with the structure of the [CARES] Act and its overarching focus on keeping workers paid, and will prevent windfalls that Congress did not intend.” 

Now that self-employed individuals have a path for applying for PPP loans, now all they need is another act of Congress to provide additional funding for the SBA program.

Author:  J. Michael Vaughn, Shareholder, Enterprise Counsel Group