CARES Act: SBA Clarifies Eligibility for Self-Employed Individuals under Paycheck Protection Program and Pledges of PPP Loans

Practical Law Legal Update w-025-0765 (Approx. 8 pages)

CARES Act: SBA Clarifies Eligibility for Self-Employed Individuals under Paycheck Protection Program and Pledges of PPP Loans

by Practical Law Finance

Eligibility Rules for Self-Employed Individuals

Individuals with Self-Employment Income who File a Form 1040, Schedule C

Section III of the IFR clarifies that self-employed individuals that file an IRS Form 1040, Schedule C, are eligible to apply for a PPP loan if they:

Were in operation on February 15, 2020.
Are an individual with self-employment income (such as an independent contractor or a sole proprietor).
Have their principal place of residence in the United States.
Filed or will file a Form 1040 Schedule C for 2019.

Partners in a partnership may not submit a separate PPP loan application for themselves as a self-employed individual. However, the self-employment income of general active partners may be reported as a payroll cost, up to $100,000 annualized, on a PPP loan application filed by or on behalf of the partnership.

The IFR points out that participation in the PPP may affect an individual's eligibility for state administered unemployment compensation or unemployment assistance programs, including the programs authorized by Title II, Subtitle A of the CARES Act, or CARES Act Employee Retention Credits. (See Legal Update, IRS Procedures Address Employee Retention Tax Credit Under CARES Act.)

The SBA will issue 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.

Calculation of Maximum Borrowing Amount and Required Documentation

The calculation for the maximum loan amount depends on whether the self-employed individual (you) employs other individuals.

With No Employees

If you have no employees, complete your Form 1040 if you have not yet filed your 2019 return, and follow this methodology to calculate your maximum loan amount:

Step 1: Take the net profit amount in line 31 from your 2019 IRS Form 1040 Schedule C. Reduce that amount to $100,000, if it exceeds $100,000. If that amount is zero or less, you are not eligible for a PPP loan.
Step 2: Divide the amount in Step 1 by 12 to calculate the average monthly net profit amount.
Step 3: Multiply the average monthly net profit amount from Step 2 by 2.5.
Step 4: Add the outstanding amount of any EIDL made between January 31, 2020 and April 3, 2020 that you seek to refinance. Subtract the amount of any advance under an EIDL COVID-19 loan since it does not have to be repaid.

Whether or not a 2019 tax return has been filed with the IRS, the following information must be provided with the PPP loan application to substantiate the requested loan amount, self-employment status and dates of operation:

2019 Form 1040 Schedule C.
2019 IRS Form 1099-MISC detailing nonemployee compensation received (box 7).
An invoice, bank statement, or book of record that establishes you are self-employed.
A 2020 invoice, bank statement, or book of record to establish you were in operation on or around February 15, 2020.

With Employees

If you have employees, complete your Form 1040 if you have not yet filed your 2019 return, and follow this methodology to calculate your maximum loan amount:

Step 1: Compute 2019 payroll by adding the following:
- Net profit amount in line 31 from your 2019 IRS Form 1040 Schedule C, up to $100,000 annualized, if this amount is over $100,000, reduce it to $100,000, if this amount is less than zero, set this amount at zero;
- 2019 gross wages and tips paid to your employees residing in the US computed using 2019 IRS Form 941 Taxable Medicare wages & tips (line 5c- column 1) from each quarter plus any pre-tax employee contributions for health insurance or other fringe benefits excluded from Taxable Medicare wages & tips. Subtract any amounts paid to any individual employee in excess of $100,000 annualized and any amounts paid to any employee whose principal place of residence is outside the US; and
- 2019 employer health insurance contributions (health insurance component of Form 1040 Schedule C line 14), retirement contributions (Form 1040 Schedule C line 19), and state and local taxes assessed on employee compensation (such as the State Unemployment Tax Act or SUTA from state quarterly wage reporting forms).
Step 2: Divide the amount in Step 1 by 12 to calculate the average monthly amount.

Step 3: Multiply the average monthly amount from Step 2 by 2.5.

Step 4: Add the outstanding amount of any EIDL made between January 31, 2020 and April 3, 2020 that you seek to refinance. Subtract the amount of any advance under an EIDL COVID-19 loan since it does not have to be repaid.

You must provide the following information to substantiate the requested loan amount, self-employment status and dates of operation:

2019 Form 1040 Schedule C, Form 941 (or other tax forms or equivalent payroll processor records containing similar information).
State quarterly wage unemployment insurance tax reporting forms from each quarter in 2019 or equivalent payroll processor records, and evidence of any retirement and health insurance contributions, if applicable.
A payroll statement or similar documentation from the pay period that covered February 15, 2020 to establish you were in operation on February 15, 2020.

Eligible Uses of PPP Loan Proceeds by Self-Employed Individuals
The proceeds of a PPP loan must be used for:

Owner compensation replacement, calculated based on 2019 net profit methodology described in With No Employees and With Employees.
Employee payroll costs (as defined in the Initial Rule) for employees whose principal place of residence is in the US, if you have employees.
Payments for:
- mortgage interest payments (but not mortgage prepayments or principal payments) on any business mortgage obligation on real or personal property (such as the interest on your mortgage for the warehouse you purchased to store business equipment or the interest on an auto loan for a vehicle you use to perform your business);
- business rent payments (such as the warehouse where you store business equipment or the vehicle you use to perform your business); and
- business utility payments (such as the cost of electricity in the warehouse you rent or gas you use driving your business vehicle).
A deduction for these expenses must be able to be claimed on your 2019 Form 1040 Schedule C for them to be a permissible use during the eight-week period following the first disbursement of the loan (covered period).
Interest payments on any other debt obligations that were incurred before February 15, 2020. Be aware that such amounts are not eligible for PPP loan forgiveness.
Refinancing an SBA EIDL loan made between January 31, 2020 and April 3, 2020. The maturity of the refinanced EIDL will be reset to PPP’s maturity of two years. If you received an SBA EIDL loan from January 31, 2020 through April 3, 2020, you can apply for a PPP loan. If your EIDL loan was not used for payroll costs, it does not affect your eligibility for a PPP loan. If your EIDL loan was used for payroll costs, your PPP loan must be used to refinance your EIDL loan. Proceeds from any advance up to $10,000 on the EIDL loan will be deducted from the loan forgiveness amount on the PPP loan.

At least 75 percent of the PPP loan proceeds must be used for payroll costs. The amount of any refinanced EIDL will be included in this calculation (but not for PPP loan forgiveness purposes).

Amounts Eligible for PPP Loan Forgiveness and Required Documentation

PPP loans will be forgiven to the extent they were spent over the eight-week 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 individual), and covered benefits for employees (but not owners), including health care expenses, retirement contributions, and state taxes imposed on employee payroll paid by the employer (such as unemployment insurance premiums).
Owner compensation replacement, calculated based on 2019 net profit as described in With No Employees and With Employees. Forgiveness of such amounts is limited to eight weeks’ worth (8/52) of 2019 net profit, but excluding any qualified sick leave equivalent amount for which a credit is claimed under section 7002 of the Families First Coronavirus Response Act (FFCRA) (Public Law 116-127) or qualified family leave equivalent amount for which a credit is claimed under section 7004 of FFCRA. (See Legal Update, Families First Coronavirus Response Act Mandates Paid Sick and Expanded FMLA Leave for Many Employees.)
To the extent they are deductible on Form 1040 Schedule C:
- payments of interest on mortgage obligations on real or personal property incurred before February 15, 2020;
- rent payments on lease agreements in force before February 15, 2020; and
- utility payments under service agreements dated before February 15, 2020.

At least 75 percent of the amount forgiven must be for payroll costs. Up to the full principal amount of the loan plus accrued interest may be forgiven if loan proceeds are used for payments of forgivable amounts described in this section.

To request forgiveness, you must provide:

The borrower certification required by Section 1106(e)(3) of the CARES Act.
If you have employees, a Form 941 and state quarterly wage unemployment insurance tax reporting forms or equivalent payroll processor records that best correspond to the covered period and evidence of any retirement and health insurance contributions.
Evidence of business rent, business mortgage interest payments on real or personal property, or business utility payments during the covered period if loan proceeds are used for those purposes.

The 2019 Form 1040 Schedule C that was provided at the time of the PPP loan application must be used to determine the amount of net profit allocated to the owner for the eight-week covered period.

Clarification regarding Eligible Businesses

Directors and Shareholders of PPP Lenders

Eligible businesses owned (in whole or part) by outside directors or a holder of a less than 30 percent equity interest in a PPP lender may apply for a PPP loan through the lender with which they are associated, provided there is no favoritism and the eligible business owned by the director or equity holder follows the same process as for other similarly situated customers of the lender with which they are associated. However, a director or owner who is also an officer or key employee of the PPP lender may obtain a PPP loan from a different lender, but not from the PPP lender with which they are associated.

Legal Gaming Businesses

Businesses that receive revenue from legal (but not illegal) gaming are eligible for a PPP loan if the existing standard in 13 CFR 120.110(g) is met or the business's legal gaming revenues (net of payouts but no other expenses) were both:

Not over $1 million in 2019.
Less than 50 percent of the business’s total revenue in 2019.

Requirements for Certain Pledges of PPP Loans

The requirements for loan pledges under 13 CFR 120.434 do not apply to PPP loans pledged for borrowings from a FRB or advances by a FHLB.

Under SBA regulation 13 CFR 120.435(d) and (e), a pledge of SBA 7(a) loans to a FRB or FHLB does not require notice to or prior written consent from the SBA. Therefore, the SBA does not have to approve loan documents or require a multi-party agreement among the SBA, the lender, and others.

More Information

For summaries of the SBA PPP, see:

Checklist, CARES Act: Stimulus for Small Businesses Under the SBA.

Checklist, CARES Act: Small Business Administration Payroll Protection Program: Lender Guidance.

For additional guidance from the Treasury Department, see:

CARES Act: SBA Clarifies Eligibility for Self-Employed Individuals under Paycheck Protection Program and Pledges of PPP Loans | Practical Law