As Congress Prepares to Pass PPP Extension, SBA Clarifies Rules for Self-Employed Borrowers


As Congress Prepares to Pass PPP Extension, SBA Clarifies Rules for Self-Employed Borrowers

By: Kevan Lee Deckelmann, and Tara Walker 


The $349 billion Paycheck Protection Program (“PPP”), which offers forgivable loans of up to $10 million to small businesses and self-employed individuals to cover payroll and certain other allowable costs, has been depleted, and the Small Business Administration (“SBA”) has stopped processing any new applications. Yet for those businesses and individuals who were unable to secure a PPP loan, hope remains: an expansion to the program is imminent, which would add another $310 billion to the available PPP funds. While we await the outcome of the new stimulus package, we wanted to update you on new guidance issued by the SBA regarding the treatment of self-employment income in PPP loan calculations, including for sole proprietors and LLC members who also have employees.

Sole Proprietors, Independent Contractors and Self-Employed

The PPP was expressly designed to filter money into the hands of employees of small businesses, by offering employers forgivable loans tied to their ability to spend the bulk of loan proceeds (at least 75%) on payroll costs during the eight weeks following loan disbursement. The program also offers forgivable loans to sole proprietors, independent contractors, and self-employed individuals, provided they were “in operation” as of February 15, 2020.

What is Included as “Payroll Costs”?

In the case of these self-employed individuals, “payroll costs” takes on a separate definition: the sum of compensation that is a “wage, commission, income, net earnings from self-employment, or similar compensation” up to $100,000 per year, as prorated for the covered period. This definition drives both the maximum loan amount (2.5 times the “average total monthly payments . . . for payroll costs” in the year preceding the loan) and the allowable uses of the loan.  For all borrowers, at least 75% of allowable loan uses (and 75% of the forgivable amount) must be for “payroll costs”—which, for self-employed individuals, takes on a definition of its own.

Given the dual definition of “payroll costs” embedded in the CARES Act, questions emerged regarding how self-employed individuals could spend their loan proceeds—and how those “expenses” would be forgiven.  Additionally, the dual treatment of “payroll costs” for sole proprietors and LLC members who also had employees on their payroll was a source of some confusion, as their compensation was neither “wages” in the traditional sense, nor self-employment income. Finally, the treatment of partnerships (the default organizational structure for most LLCs) was also left unaddressed. The SBA’s recent guidance addresses these questions, at least with respect to self-employed individuals who filed an IRS Form 1040 Schedule C in 2019, and for partnerships (the latter of whom should apply as organizations).

What About Those Who Also Have Employees on Payroll?

As an initial matter, the new guidance makes clear: self-employed individuals who also have employees on their payroll (namely, sole proprietors and LLC members) may file a single PPP application that covers both their individual earnings and the payroll expenses paid to their employees, even if members do not pay themselves a salary or other W-2 compensation. Were it otherwise, the employees of such organizations would have been left out of the program entirely. The new guidance also clears up another point left unaddressed in the various “payroll costs” definitions of the CARES Act (but which, heretofore, was fairly implied): the requirement that “payroll costs” may not be spent on employees whose principal place of residence is outside the United States, applies equally to self-employed individuals seeking a PPP loan, who must also principally reside in the United States.

How are “Payroll Costs” Calculated?

In a break from the text of the Act, the new guidance specifies that any self-employed individuals who filed an IRS Form 1040 Schedule C in 2019 must calculate both their maximum loan amount and the amount of their own “payroll costs” based on line 31 (net profit or loss). This clarification limits the statutory definition of “payroll costs” for such individuals to “net earnings from self-employment” (i.e. they can no longer point instead to gross wages, commissions, or income). The SBA’s guidance instructs such individuals to cap their net earnings at $100,000 per year, consistent with the Act’s language with respect to self-employment “payroll costs” (similar to its prior instructions to cap employee cash compensation at the equivalent of $100,000 annualized salaries). They must then divide this number by 12 to determine their average monthly “payroll costs,” and multiply that number by 2.5 to determine their maximum loan amount.  Note that this method differs from the method for calculating the payroll costs paid to employees: a prior interim final rule clarified that employers may elect to calculate those monthly average payroll costs, for purposes of determining maximum loan amount, either over the course of calendar year 2019 or over the course of the 12 months leading up to the loan. By contrast, the latest guidance instructs individuals who filed an IRS Form 1099 Schedule C to use calendar year 2019, both for themselves and for any of their employees.

Limitations on Usage and Forgiveness

Critically, the SBA’s latest guidance limits “payroll costs” for self-employed individuals to their “owner compensation replacement,” based on the above calculations, capped at eight weeks’ worth of 2019 net earnings. Thus, self-employed individuals may only access 8/52 of their total net earnings from 2019 to “pay themselves” with the loan, not the full amount of the maximum loan (based on 2.5 times their average monthly net earnings). The guidance reasons that allowing self-employed individuals to access the full loan amount as net earnings during the eight week forgivable period, resulting in 100% loan forgiveness, would constitute a “windfall,” especially for those self-employed individuals with low “overhead” costs like rent or mortgage interest, since their net earnings were calculated based on what they typically earned over the course of 2.5 months.

The guidance also limits self-employed individuals’ use of eligible non-payroll costs (rent, utilities, and mortgage interest) to items for which they were entitled to take a deduction in 2019. Payments of interest on other debt obligations incurred before February 15, 2020, regardless whether they were entitled to be deducted, are still an allowable use of the loan but, as with all borrowers, such payments are not eligible to be included in loan forgiveness.


Finally, the guidance clarifies that partners (including LLC members filing taxes as a partnership) should not apply individually for PPP loans, although they arguably share some characteristics with other types of self-employed individuals, such as LLC members not organized as a partnership. Instead, the new guidance clarifies, partnerships must apply for a single PPP loan at the organizational level, covering each of its members. The SBA explains that this decision is intended to prevent “loan proceeds use coordination and allocation issues.”

We will continue to keep you posted on additional guidance as it is released.

Bottom Line

The COVID-19 crisis is rapidly evolving and requiring businesses to adapt quickly to the legal, regulatory, economic, and community impacts. Our business law team is monitoring these developments in real time and we’re here to support and assist you as needed. Please do not hesitate to reach out if we can be helpful to you.