Article by: Jeffrey Skolnick, CPA, M.S. Taxation

On Tuesday, April 14^th, the SBA issued its 2^nd Interim Final Report. The first Interim Final Report was published on April 2^nd, the day before the PPP loan application process opened. On Monday, April 6^th, the SBA, together with the Treasury, issued an 18-point FAQ on the program. If you’ve been following me, you know I have been indicating more guidance was to come (and by the way, the guidance issued yesterday will not be the final guidance issued, so stay tuned). With that said, let’s dive into what was issued yesterday.

The guidance issued on April 14^th, very similar to the two previous clarifications referenced in the preceding paragraph, relates to the Payroll Protection Program eligibility, maximum loan calculation, and forgiveness of loan provisions of the CARES Act.

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

The latest clarification states that if you were in operation on February 15, 2020, you are an individual with self-employment income (such as an independent contractor or a sole proprietor), your principal residence is in the United States, and you filed or will file Form 1040 Schedule C for 2019, then you are eligible for the Payroll Protection Program (PPP).

This is not new, however, what is new is that it states, “if you are a partner in a partnership, you may not submit a separate PPP loan application for yourself as a self-employed individual. Instead, the self-employed 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.”

I have been advising partnerships to do this since the law was passed. Initially, it was unclear but appeared that the SBA wanted only employee payroll reported by partnerships and to have the partners apply separately on their returns, similar to individuals that are self-employed (such as independent contractors receiving From 1099). Remember multi-member LLCs are also counted as partnerships for tax purposes unless they have elected to file as S corporations. As you know, the law does not allow companies to include Independent contractors they pay through the use of Forms 1099 in their PPP loan application because these individuals have the ability to file their own PPP loan applications. The SBA wanted to avoid a company receiving money, paying these independent contractors, and having these same contractors double-dip by filing their own PPP loan applications. I have felt all along that partners in a partnership are different. First, their income comes from the partnership. If they were to apply on their own, they couldn’t list the partnership name or Federal Employer Identification Number (FEIN) because the partnership would have already filed for it’s employees and no entity can file more than 1 application. Partners would have to file individually using their own name and social security number and I assume provide a K-1 as backup. The second issue was that banks were only lending to their commercial customers. If you are the recipient of a partnership K-1 you most likely would not have a commercial account with your bank and would be standing in line waiting for clarification on how to file your PPP loan application.

It makes sense for independent contractors to file on their own because they may have expenses which reduce the income reported to them on Form 1099 while partners most likely (it is actually possible, but not usual) would not have any expenses to reduce the income reported on their Form K-1. Also, if partners filed separately, they wouldn’t have rent, utilities, or mortgage interest, which would be incurred at the partnership level. Lastly, it makes the process much easier for everyone.

Let’s say you have a partnership with 5 partners and 10 employees. By allowing each of the partners to be included in the partnership PPP, there is 1 application filed instead of 6. When you multiply that by all of the eligible partnerships filing under this program, that is a ton of applications.

You may not file for PPP and unemployment. You must chose one or the other.

Additional guidance is still to come on individuals with self-employment income that were not in operation in 2019 but who were in operation on February 15, 2020, and will file Schedule C for 2020.

How Schedule C Filers determine their maximum loan amount

Below I am listing the exact wording contained in yesterday’s clarification:

If you have no employees:

1. Step 1: Find your 2019 IRS Form 1040 Schedule C line 31 net profit amount (if you have not yet filed a 2019 return, fill it out, and compute the value). If this amount is over $100,000, reduce it to $100,000. If this amount is zero or less, you are not eligible for a PPP loan.

1. Step 2: Calculate the average monthly net profit amount (divide the amount from Step 1 by 12).

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

1. 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, less the amount of any advance under an EIDL COVID-19 loan (because it does not have to be repaid).

 You must also provide a 2019 Form Schedule C (whether or not you have filed your 2019 income tax return), so if you are intending to file for a PPP loan, then please gather your information as soon as possible (you certainly have time to do that now while sitting home during the quarantine). The Rule also states you will need to supply Form 1099-MISC detailing nonemployee compensation received (box 7), invoice, bank statement, or book of record that establishes you are self-employed. 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 you have employees:

You would follow each of the steps outlined above for Schedule C filers with no employees, but would also include the following:

2019 gross wages and tips paid to your employees whose principal place of residence is in the United States 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 United States; 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 (primarily under state laws commonly referred to as the State Unemployment Tax Act or SUTA from state quarterly wage reporting forms).

In addition to the documentation required of Schedule C filers with no employees, you will also be required to provide payroll tax forms (either Forms 941 or a report from a payroll processing company), state unemployment forms, and proof of health and retirement benefits. Additionally, 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.

The above clarification of Schedule C reporting makes clear that neither the health benefits nor the retirement benefits of a self-employed individual can be counted. The SBA specifically addresses these items above and is only allowing those items for employees, not owners, of a Schedule C filer. I don’t agree with this because employees with earnings over $100,000 can have not only $100,000 of salary annualized but also may have their health and retirement benefits included as well. This is true for shareholders in S and C corporations but does not appear to be available for partners in partnerships or Schedule C filers. My opinion is this is not equal treatment, but unfortunately, nobody asked me, and we have to follow the law as it is written.

What can the money be used for?

Per the rule, funds can be used for owner compensation (based on 2019 Schedule C profit), Employee payroll costs, mortgage interest (no principal) payments, rent and utilities allowed to be deducted on your Form Schedule C. This would not include your personal rent, mortgage or utilities, only business expenses.

The funds may also be used for interest payments on any other debt incurred before February 15, 2020, although amounts paid on these types of debts would not qualify for PPP loan forgiveness. Fund used for items in the preceding paragraph would be eligible for PPP forgiveness.

Funds can also be used to refinance an EIDL loan. If your EIDL loan was not used for payroll costs, it does not affect your eligibility for a PPP loan. If your loan was used for payroll costs, your PPP loan must be used to refinance the EIDL and will not be allowed in the forgiveness calculation. While worded slightly differently, this just means that the advance you received will reduce the maximum allowed under PPP.

For example, you received a $10,000 advance under the EIDL provisions, which is a tax free grant. You now calculate your monthly payroll cost to be $10,000, and your maximum loan amount to be $25,000 (2.5 times your monthly payroll cost). The $25,000 received must be used first to refinance the $10,000 EIDL loan, and that portion is not subject to forgiveness, only the $15,000 is. Previously I was stating, and I believe it is a little clearer to say the $25,000 is reduced by the $10,000 you already received.

Incidentally, new rules have been issued on the EIDL advance, and it is now $1,000 per employee, up to $10,000. That is not the way it was originally written, but it has been changed.

Other provisions on how proceeds may be used

At least 75% of the proceeds must be used for payroll costs (including health and retirement benefits of the employees, not the owner, of a Schedule C filer). Amounts used to refinance EIDL will be used to calculate the 75%, but again amounts paid to refinance an EIDL will not be eligible for forgiveness. This is because this money was already received as a tax-free grant that does not have to be repaid.

What amounts are eligible for forgiveness?

Per the rule the following items are allowable for the forgiveness calculation:

1. 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), as well as 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);

1. owner compensation replacement, calculated based on 2019 net profit as described in Paragraph 1.b. above, with forgiveness of such amounts 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;

1. payments of interest on mortgage obligations on real or personal property incurred before February 15, 2020, to the extent they are deductible on Form 1040 Schedule C (business mortgage payments);

1. rent payments on lease agreements in force before February 15, 2020, to the extent they are deductible on Form 1040 Schedule C (business rent payments); and 12

• utility payments under service agreements dated before February 15, 2020, to the extent they are deductible on Form 1040 Schedule C (business utility payments).

Again, it is clear that SBA is not allowing health or retirement benefits of the owners, and only rent, utilities, and mortgage interest of this business (not personal) may be counted.

What documentation will I be required to submit to my lender with my request for loan forgiveness?

This is our first communication from the SBA requiring documentation for the forgiveness portion of this loan program (expect more to come).

This document, similar to the first Interim Final Rule issued on April 2^nd, is written in a question and answer format. The answer provided indicates that Forms 941 and state quarterly wage unemployment insurance tax forms or equivalent payroll processor reports along with evidence of health and retirement benefits will be required. For Schedule C filers, the 2019 Form Schedule C will be multiplied by 8 weeks and then divided by 52 weeks to determine the amount reimbursed to the Schedule C filer. Here, I again want to encourage individuals to get on board with a payroll processing service (such as ADP or Paychex) because they will not only be able to provide the quarterly reports required but will also, I’m sure, be able to provide a report specifically showing payroll paid during an 8 week period. Keep in mind, quarterly payroll reports cannot do that.

Clarification regarding Eligible Businesses

The Rule states that businesses owned by directors or shareholders owning less than 30 percent equity in a PPP Lender are permitted to apply for a PPP Loan through the Lender with which they are associated. There is a stipulation that these individuals must follow the same process as everyone else. No favoritism is allowed.

The Rule also states businesses receiving revenue from legal gambling are also eligible for a PPP Loan as long as the business’s gaming revenue (net of payouts but no other expenses) did not exceed $1million in 2019 and legal gaming revenue (net of payouts but not other expenses) comprised less than 50 percent of the business’s total revenue in 2019.

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