Self-Employed Folks, Here’s Your Complete Guide to the Paycheck Protection Program

You’ve probably heard of the Paycheck Protection Program (PPP). The $660 billion forgivable loan program was created to help small businesses impacted by COVID-19 keep their lights on and their teams paid. But what if you don’t have employees?

This piece will break down how the PPP loan application and forgiveness processes differ for self-employed folks, sole proprietors, and independent contractors.

How the PPP is different for self-employed individuals

While many small businesses were able to start applying for PPP loans on April 3, applications from the self-employed weren’t accepted until April 10.

Who exactly does this apply to?

The separate guidance mainly applies to unincorporated businesses, aka sole proprietorships and Limited Liability Companies (LLCs), and 1099 contractors. 

Why are things different for this group?

The short answer is that PPP loan amounts are typically calculated based on businesses’ average payroll expenses. For businesses without employees or payroll, the loan amounts then have to be calculated based on profit. 

For a little extra context, sole props and LLCs don’t have a separate tax liability like corporations do. Their business concerns are taxed on a personal basis, and this would preclude them from paying wages and taxes as an employer would to an employee.

Self-employed: Applying for PPP loans

Corporations use their W-2 employee payroll costs to calculate their PPP loan amounts.

When self-employed individuals apply for PPP loans, their “average monthly payroll cost” figures are substituted by owner compensation. This is calculated by averaging their monthly owner draws.

Here’s how you’d do that: Aggregate your 2019 monthly draws in a simple spreadsheet, divide the sum by 12, and you’ll get your monthly average net profit. (If you were only in business for part of 2019, divide by the total number of months you were operating.) Multiply the result by 2.5, and you get your PPP loan amount.

(Total 2019 monthly draws / 12) x 2.5 = PPP loan amount

As these aren’t technically payroll costs, they don’t include payroll taxes; so unlike corporations, you’ll leave those costs out. Note that your “payroll cost” amount must exceed $2,400 in order for you to apply.

To substantiate the application amount, sole props should provide the following tax documentation:

• 1040 with a Schedule C and/or
• 1099 statements

Self-employed: Applying for PPP loan forgiveness

PPP loan forgiveness is pretty easy for self-employed borrowers with no employees.

Owner compensation replacement

Rather than spending on payroll, self-employed individuals get their compensation reimbursed and forgiven without having to spend it on anything. This is called “owner compensation replacement.”

Your owner compensation replacement value is two and a half months of your net income as reported on your 2019 Schedule C, with an annualized cap of $100,000. That means the maximum possible loan amount is $20,833, with $15,385 automatically eligible for forgiveness as owner compensation replacement. The remaining $5,448 can be forgiven if spent on approved expenses (more on those below) over the 24-week covered period.

What else can you spend the loan on?

Generally, PPP funds must be used during the allotted 24-week period for payroll. For self-employed folks without employees, all the payroll funds can only be used to pay the owners.

What else can self-employed folks use the funds for and still qualify for forgiveness? There are very narrow categories, and all must have been in place prior to February 15, 2020:

• Rent, including business housing and equipment like computer software or hardware
• Business utilities, including gas, water, transportation, cable, and software
• Mortgage interest for pre-existing business property mortgages
• Required business services that support the production of the businesses product or services

Pro tip: COVID-19 supplies are considered business-related expenses—or better yet, migration of your website, or software acquisition to help you transition to remote work.

Many of you may be wondering if you can use the remaining funds to pay contract workers. Unfortunately, PPP funds can only be used to pay W-2 employees as contractors themselves are self-employed and are therefore considered separate tax entities by the IRS.

My suggestion to sole props in this situation is to follow the rules—but note that the rules don’t dictate how you “distribute” your personal funds, including using them to pay contract workers.

Here are a couple tips to improve your likelihood of qualifying for full forgiveness:

• Make regular and even payments (e.g. bi-weekly).
• Track all withdrawals, including dates and amounts, throughout the 24-week forgiveness period.
• Keep records in Excel or your favorite accounting software.

Form 3508EZ

Earlier this week, a new EZ application for PPP loan forgiveness (Form 3508EZ) was introduced. It’s only one page and much simpler than the previous application. You can apply for forgiveness with the EZ application if:

• You are a self-employed individual, independent contractor, or sole proprietor;
• If you had no employees at the time of the PPP loan application; and
• If you did not include any employee payroll expense in the “average monthly payroll cost” calculation on your loan application. 

When you’re ready, you can apply for PPP loan forgiveness here.