Additional Guidance for Sole Proprietors Regarding the Paycheck Protection Program

by | Apr 24, 2020 | Cracking the Tax Code with Christy | 0 comments

Last week additional guidance about the Paycheck Protection Program came out for sole proprietors and independent contractors.  Pay close attention to these requirements as they are different from those for small companies or partnerships.  Although sole proprietors and independent contractors are allowed to apply for Paycheck Protection Program funds, and some have received them, these types of businesses are not favored under the act.  Accordingly, to maximize forgiveness, sole proprietors need to pay extra attention to their bookkeeping and the way funds are spent.

Many sole proprietors did not get approved for funding either because they bank with a bank that was not already approved as an SBA lender or because so many businesses were in line ahead of them prior to the date they could apply, they are too far behind in the queue.  If you have not yet applied, have these documents ready so that your application is ready if the program receives more funds, which we believe is going to happen.

What documents should I submit with my application? 

  1. Your Schedule C for the 2019 IRS Form 1040.  Even if you have not filed a 2019 IRS Form 1040, the 2019 Form 1040 Schedule C must be submitted with the loan application. 
  2. 2019 IRS Form 1099-MISC detailing nonemployee compensation received, invoice, bank statement, or book of records. 
  3. A 2020 invoice, bank statement, or book of records to show you were in business on or around February 15, 2020. 

How can sole proprietors use their Paycheck Protection Program Funds? 

  1. Owner compensation replacement.  This amount is calculated based on 2019 net profit.  Your forgiveness related to owner compensation is limited to 8/52nds of your Schedule C income on the IRS Form 1040 for 2019.  If you are one of the “lucky” ones who applied and received funds before the new guidance came out without the Schedule C , get your Schedule C prepared soon so you are ready to substantiate forgiveness.     
  2. Employee payroll costs.   This is gross wages and tips paid to employees during the 8-week covered period up to $100,000 annualized and includes their health insurance contributions, employer retirement contributions, and state and local taxes assessed on employee compensation. These employees must live in the United States. 
  3. Mortgage interest payments on business obligation on real or personal property.  Note this is only for interest, not principal.  What does this mean? For example, it includes the interest on a mortgage of a warehouse that stores business equipment counts.  It also includes the interest on an auto loan for the vehicle that you use for business purposes.  The mortgage interest on your personal residence does not count.  This is unfortunate for many sole proprietors as they often use garages and other parts of their personal property for their business.  Early on there was speculation that the funds could be used for a pro rata portion of the mortgage interest depending on how much of the property was used for the business.  Unfortunately from the most recent regulations, it appears this is not allowable as a forgivable expense. It is not entirely clear, but pro rata portion for a home office may be a covered cost, just not forgivable.
  4. Business rent and utility payments. The business had to have entered into the agreement before February 15, 2020, and you must have been entitled or claimed the deduction for this type of expense in 2019.
  5. Interest payments on other debt obligations.  The debt obligations must be entered into before February 15, 2020.  These amounts are not forgivable.
  6. Refinancing an SBA Economic Injury Disaster Loan (“EIDL”) made between January 31, 2020 and April 3, 2020.  Some businesses applied for both EIDL loans and Paycheck Protection Program loans.  If you received an SBA EIDL loan between January 31, 2020 and April 3, 2020, you can still apply for a PPP loan.  If you did not use the EIDL loan for payroll costs, it does not affect your PPP eligibility.  If you did use it for payroll costs, you must use the Paycheck Protection Program loan 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 Paycheck Protection Program loan. 

What else do I need to know? 

  1. The business expenses have to be claimed on the 2019 Form 1040 Schedule C to be permissible during the eight-week period following the disbursement of the loan.  The funds are to be used for ongoing operations, not business expansion.  That means you need to have documented what you did in 2019. If you did not claim or were not entitled to these expenses in 2019, you can’t use the funds on them.  So if you did not deduct utilities in 2019 for your business, you can’t claim them as a covered expense during the 8-week period.  If you have not filed your 2019 return yet, get it filed and work with an accountant or CPA to make sure you deduct as many expenses as possible for 2019
  2. No allowance is made for health insurance or pension or 401(k) contributions for the business owner of a sole proprietorship.  This is a difference from other types of businesses like S-Corporations. 
  3. At least 75% of the loan proceeds have to go to payroll costs to be forgivable– this includes both employee costs and owner compensation. 

I was not in operation in 2019 but was in operation on February 15, 2020.  What should I do? Await further guidance from the Small Business Administration.  The SBA has said it will address these sole proprietors in regulations to come. 

Although this process may seem daunting, we are here to help our clients.  This is an excellent time to implement proactive tax strategies and bookkeeping processes to get you through to the other side of this global crisis.  The bookkeeping procedures you implement now to ensure your Schedule C is set up for the Paycheck Protection Program Loan application and forgiveness will benefit you long-term in maximizing business deductions and prepare you for any audits to come. Law Offices of Christy Lee, PC, is here to help!