Guidance issued April 14 for self-employed individuals applying for the Small Business Administration’s Paycheck Protection Program (PPP) is mostly good news for the self-employed and bad news for partners. Self-employed individuals are guaranteed loan forgiveness equal to about 15 percent of their 2019 self-employment income. Partners in partnerships (even if they are S corporations), however, aren’t eligible for PPP loans, although a partnership can include partners’ income subject to payroll tax in determining its loan amount and loan forgiveness.
Forgiveness Guaranteed
Under the SBA’s new guidance, an individual eligible for a PPP loan is anyone who was “in operation” on February 15, 2020; has self-employment income; is a resident of the United States; and has or will file a Schedule C for 2019. Presumably, self-employment income means self-employment income subject to self-employment tax (section 1402(b) of the code). (See technical notes below.)
For a self-employed individual with no employees, the guidance says payroll cost for determining loan forgiveness doesn’t depend on any activity after the loan is disbursed (contrary to statutory language in the Coronavirus Aid, Relief, and Economic Security (CARES) Act (P.L. 116-136)), but on 8/52 (= 0.1538) of self-employment income, not in excess of $100,000, reported on line 31 of the 2019 Form 1040 Schedule C. This amount is called the “owner compensation replacement.” Because the maximum loan amount is equal to 2.5/12 (= 0.2083) of that same Schedule C amount, this means 73.8 percent (= 0.1538/0.2083) of the loan amount is automatically forgiven. The remaining amount of forgiveness can be generated with interest, rent, and utility expenses incurred during the eight-week post-origination period as long as those amounts don’t exceed 25 percent of the total loan forgiveness amount.
For self-employed individuals with employees, loan forgiveness is the sum of owner compensation replacement; eligible rent, interest, and utilities over the eight-week post-origination period; and payroll costs of employees over the same eight-week period. As has been discussed extensively, payroll costs for employees are wages and salary (capped at $100,000 per employee annualized) plus benefits — most notably employer-provided health insurance and employer contributions to retirement plans.
So self-employed individuals with no employees are guaranteed loan forgiveness equal to 15.38 percent of their 2019 self-employment income not exceeding $100,000. That means the maximum forgivable payroll cost for each self-employed individual is $15,385. That amount doesn’t depend on business activity after loan origination (as do all the other components of loan forgiveness). Whether business is terrible or booming, loan forgiveness is fixed. It is automatic money.
In 2017 26.4 million individual tax returns filed had a Schedule C attached. Of this, 19.4 million filers reported Schedule C income amounting to $415.8 billion, and 6.4 million filers reported losses totaling $69.5 billion. Under the new guidance, Schedule C filers with no employees and with losses in 2019 aren’t eligible borrowers.
The additional guidance doesn’t mention farm sole proprietorships or Schedule F. In 2017 1.79 million individual tax returns included a Schedule F. Of this, 481,000 filers reported Schedule F income amounting to $11.2 billion and 1.3 million filers reported losses totaling $30.4 billion.
Glitch
Just as we were preparing to thank the SBA and Treasury for some clarification, the text of the guidance threw us another curveball. Immediately after carefully explaining that interest, rents, and utility expense can be added to the loan forgiveness amount, the guidance states: “For individuals with self-employment income . . . it is appropriate to limit loan forgiveness to a proportionate eight-week share of net profit.” Combined with the preceding text in the guidance, this statement is certainly ambiguous, and probably a drafting error.
For self-employed individuals with no employees, this sentence implies that no rent, interest, or utility expense can enter the loan forgiveness calculation, and so loan forgiveness is 73.8 percent of the loan amount (equal to 2.5/12 of 2019 self-employment income). That would be less generous that some might hope, but it would sure simplify matters.
For the self-employed with employees — and note that the troubling sentence applies to all Schedule C filers, with and without employees — it would imply the ridiculous result that, for example, a Schedule C employer with 10 employees could only include the employer’s own self-employment income.
So perhaps we are misinterpreting after too much coffee, but we can’t be sure what loan forgiveness will be for Schedule C filers. This ambiguous language has got to be more than a little disconcerting to Schedule C businesses and their advisers.
Partners Shut Out
Under the new guidance, a partner in a partnership may not submit a separate loan application as a self-employed individual. Some commentators had speculated that partners could apply for PPP loans on their own.
The partnership may include as payroll costs on a PPP loan application costs that are “the self-employment income of general active partners,” up to $100,000 annualized. This phrase seems to imply that all partnership income to partners subject to self-employment tax can be included in payroll costs. That would include all partnership income to general partners and all guaranteed payments to limited partners. This corresponds to box 14 on the Schedule K-1. (See technical notes below.)
Technical Notes
Section 1102(a) of the CARES Act, amending section 7(a) of the Small Business Act, defines the term “eligible self-employed individual” by cross-reference to section 7002(b) of the Families First Coronavirus Response Act (P.L. 116-227). Section 7002(b) in its entirety defines the term “eligible self-employed individual” to mean “an individual who (1) regularly carries on any trade or business within the meaning of section 1402 of such Code, and (2) would be entitled to receive paid leave during the taxable year pursuant to the Emergency Paid Sick Leave Act if the individual were an employee of an employer (other than himself or herself).” The two-prong test suggested here must be a drafting error because the second prong would require a self-employed individual to be under the same duress that would trigger sick leave under the Families First Coronavirus Response Act for that individual to apply for a PPP loan.
Section 1402(a) of the code defines the term “net earnings from self-employment.” The term includes distributive share (whether or not distributed) of income or loss from any trade or business carried on by a partnership. Section 1402(a)(13) excludes the distributive share of any item of income or loss of a limited partner, as such, other than guaranteed payments described to that partner for services actually rendered to or on behalf of the partnership to the extent that those payments are established to be in the nature of remuneration for those services. Section 1402(a)(1) excludes from net earnings from self-employment “rentals from real estate and from personal property leased with the real estate” (with some exceptions for material participation). Section 1402(b) defines the term “self-employment income” as net earnings from self-employment less any excess of the Social Security contribution cap, and excludes any amount below $400 annually. Section 1402(c) defines the term “trade or business” when used with reference to self-employment income or net earnings from self-employment.