Less than 24 hour ago, late Wednesday, March 3, 2021, the Small Business Administration posted the latest revision to the Paycheck Protection Program (PPP) and these revisions have MAJOR effects on how sole proprietors, independent contractors, and others who file taxes using IRS Form 1040 Schedule C.
Bottom line? New applicants can now use “Gross Income” (Line 7) as a basis for their PPP amounts. This means that if you had a negative or low amount and could not get a PPP loan, or the loan amount was not worth getting previously, you may now be eligible.
The devil is in the details, however, so let’s dive into the new rules, how this is different, and how this will affect many visual creators and the self-employed. Stay tuned to ASMP.org, @asmpnational on Instagram; and our weekly newsletter to see when I will be doing more classes and webinars on this.
Note that as before, you will apply for a PPP loan through your bank or financial company, and they will not be ready for these changes today. But if you haven’t applied, and this rule might apply to you, PLEASE WAIT UNTIL YOU CAN APPLY UNDER THESE NEW RULES! This change is NOT retroactive to previously approved and funded loans.
As always, remember that I am not a tax attorney or account, and it is critical that you seek out specific advice for your situation. This is not tax or legal advice.
The Good and the Bad
This rule is a welcome change to the previous system which left many creators and the self-employed out in the cold. Previously, you could only base the amount of your “Owners Replacement Compensation” on Line 31 (Net Income) of your Schedule C. This meant that If you made $50,000 and had $55,000 in expenses, your Line 31 would be negative, and you could not get a PPP. Now, you can base your PPP calculations on Line 7 (or, if you have employees, a slightly more complex calculation noted below).
But like all programs, this change has good and bad elements. Here is a quick rundown of some of the major points:
GOOD: By using the calculation below for self-employed, independent contractors, and sole proprietors, many more micro-businesses will be able to take part in the PPP.
BAD: This change is NOT retroactive, which means that if you have already gotten a First-Draw PPP and a Second-Draw PPP, you are out of luck. (At least for now, I have already seen members of Congress seeking to change this, but that is the rule for now).
GOOD: There are some other changes tucked in here that don’t quite take center-stage, including PPP eligibility for those who are delinquent or defaulted in federal student loans, and those who have non-financial fraud felony convictions in the past year, both of which previously were bars to eligibility.
BAD: There still seems to be a gray area regarding how this will work with the limited ability announced in January 2021 to increase First-Draw PPP loans based on current rules. Even under that rule, however, if your First-Draw Loan has been forgiven, you are out of luck on that front as well. THERE IS MUCH MORE GUIDANCE TO COME ON THESE ISSUES!
CAUTION: This isn’t either good or bad, but the SBA is saying that if you use these new calculations based on Gross Income, and the amount of Gross Income you are basing the calculation on is more than $150,000, you are not automatically given “Safe Harbor”. Here is what the SBA says specifically:
“… [I]f a Schedule C filer elects to use gross income to calculate its loan amount on a First Draw PPP Loan and the borrower reported more than $150,000 in gross income on the Schedule C that was used to calculate the borrower’s loan amount, the borrower will not automatically be deemed to have made the statutorily required certification concerning the necessity of the loan request in good faith, and the borrower may be subject to a review by SBA of its certification.”
The New Calculations
Ok, so how does this all work? Here is a brief chart with major milestone questions, and a few examples below:
Have you taken and been approved for a First-Draw AND Second-Draw PPP Loan?
You are (as of now) out of luck. Even if you were eligible for significantly more money under these new rules, if you have taken both loans, you can’t go back and increase them (subject to the big gray area above). Trust that if this changes, you can read about it here.
But assuming you have not taken your First-Draw or Second-Draw loans, and you are a Schedule C filer, you can move to the calculations.
If I am a sole proprietor, independent contractor, or am self-employed and file a Schedule C on my 1040, AND I HAVE NO EMPLOYEES (directly from Page 10 and 11 of the new rules):
Step 1: From your 2019 or 2020 IRS Form 1040, Schedule C, you may elect to use either your line 31 net profit amount or your line 7 gross income amount. (If you are using 2020 to calculate payroll costs and have not yet filed a 2020 return, fill it out and compute the value.) If this amount is over $100,000, reduce it to $100,000. If both your net profit and gross income are zero or less, you are not eligible for a PPP loan.
Step 2: Calculate the average monthly net profit or gross income amount (divide the amount from Step 1 by 12).
Step 3: Multiply the average monthly net profit or gross income amount from Step 2 by 2.5. This amount cannot exceed $20,833.
Step 4: 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. Do not include the amount of any advance under an EIDL COVID19 loan (because it does not have to be repaid).
NOTE: You will have to provide the following:
“You must provide the 2019 or 2020 (whichever you used to calculate your loan amount) IRS Form 1040, Schedule C with your PPP loan application to substantiate the applied-for PPP loan amount and a 2019 or 2020 (whichever you used to calculate your loan amount) IRS Form 1099-MISC detailing nonemployee compensation received (box 7), invoice, bank statement, or book of record that establishes you are self-employed. If using 2020 to calculate your loan amount, this is required regardless of whether you have filed a 2020 tax return with the IRS. You must provide a 2020 invoice, bank statement, or book of record to establish you were in operation on or around February 15, 2020.”
If I am a sole-proprietor, independent contractor, or am self-employed and file a Schedule C on my 1040, AND I DO HAVE EMPLOYEES (directly from Page 11-13 of the new rules):
Step 1: Compute 2019 or 2020 payroll (using the same year for all items) by adding the following:
- At your election, either (1) the net profit amount from line 31 of your 2019 or 2020 IRS Form 1040, Schedule C, or (2) your 2019 or 2020 gross income minus employee payroll costs, calculated as your gross income reported on IRS Form 1040, Schedule C, line 7, minus your employee 12 payroll costs reported on lines 14, 19, and 26 of IRS Form 1040, Schedule C (for either option, if you are using 2020 amounts and have not yet filed a 2020 return, fill it out and compute the value), up to $100,000 on an annualized basis, as prorated for the period during which the payments are made or the obligation to make the payments is incurred (if this amount is over $100,000, reduce it to $100,000, or if this amount is less than zero, set this amount at zero);
- 2019 or 2020 gross wages and tips paid to your employees whose principal place of residence is in the United States, computed using 2019 or 2020 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 on an annualized basis, as prorated for the period during which the payments are made or the obligation to make the payments is incurred, and any amounts paid to any employee whose principal place of residence is outside the United States; and,
- 2019 or 2020 employer contributions to employee group health, life, disability, vision and dental insurance (portion of IRS Form 1040, Schedule C line 14 attributable to those contributions); retirement contributions (IRS Form 1040, Schedule C, line 19); and state and local taxes assessed on employee compensation (primarily under state laws 13 commonly referred to as the State Unemployment Tax Act or SUTA from state quarterly wage reporting forms).
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 made between January 31, 2020 and April 3, 2020 that you seek to refinance. Do not include the amount of any advance under an EIDL COVID-19 loan (because it does not have to be repaid).
NOTE: You will have to provide the following:
You must supply your 2019 or 2020 (whichever you used to calculate your loan amount) IRS Form 1040, Schedule C; Form 941 (or other tax forms or equivalent payroll processor records containing similar information); and 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 February 15, 2020 must be provided to establish you were in operation on February 15, 2020.
Example for Sole-Proprietor with No Employees
Let’s say you are a Sole-Proprietor with No Employees, who made $50,000 in net income last year (2020) and you have filed your 2020 1040 tax return with your Schedule C. How do you calculate your PPP amount under the new rules?
Step 1: Look at your return and determine if you want to use Net Income (Line 31) or Gross Income (Line 7). It’s likely that to maximize the amount of your PPP, you would use Gross Income (but check with your tax professional). If this number is over $100,000 lower it to $100,000.
We will assume you chose the Net Income calculation, and your Line 7 was $50,000.
Step 2: Divide this number by 12 to get your average monthly gross income amount.
$50,000 / 12 = $4,166.67
Step 3: Multiply this number by 2.5. Note that the maximum this result can be is $20,883.
$4,166.67 x 2.5 = $10,416.68
Step 4: Add in any EIDL Loan (not EIDL Advance) that you received between January 31, 2020 and April 3, 2020 that you want to refinance. (Again, check with your tax professional.)
For our purposes, we will assume you received an EIDL Advance of $1,000, but did not take an EIDL Loan. Because the Advance does not need to be repaid, you would not add anything here.
Therefore, the amount of your PPP Loan will be $10,416.68.
This is a welcome change for sole proprietors, independent contractors, and self-employed individuals. But the fact that if you have already taken a First-Draw and Second-Draw loan you cannot retroactively change to this new calculation is a tough pill to swallow. Regardless, we hope new guidance will change that drawback, and even more people can benefit from this revision.
Stay tuned to ASMP for the latest on the PPP and how it can support you and your business in this time.