A second round of guidance on the new loan program aimed at keeping people working during the economic downturn shows how self-employed individuals can take advantage of the program but introduces new limits on partners and leaves many questions unanswered.
An interim rule released April 14 by the Small Business Administration clarifies that a partner in a partnership can’t submit a separate application for a Paycheck Protection Program (PPP) loan as a self-employed individual.
“Instead, the self-employment 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,” according to the guidance. Partnerships are eligible for PPP loans, and the SBA and Treasury decided to limit a partnership and its partners to one PPP loan to help ensure as many borrowers as possible get loans before the deadline expires June 30.
“This limitation will allow lenders to more quickly process applications and lower the burdens of applying for partnerships/partners,” the rule says.
Adam Sweet of Eide Bailly LLP said he was surprised that the self-employment income of partners is considered the payroll of the partnership for PPP loan purposes.
“This goes against long-standing IRS precedent holding that partners are self-employed individuals and not common law employees of a partnership,” Sweet said. The guidance also raises questions about what constitutes a general active partner — the new rule references the eligibility of a limited liability company taxed as a partnership, so it appears “general active partner” is a term of art, he added.
The Coronavirus Aid, Relief, and Economic Security (CARES) Act (P.L. 116-136), signed into law March 27, gave employers options for how to keep paying workers while the nation is on lockdown trying to halt the spread of COVID-19. Those options include an employee retention credit that provides a fully refundable credit against the employer’s portion of payroll taxes, but only $10,000 in wages per employee can be counted for all calendar quarters and the credit is capped at $5,000 per employee.
Employers can forgo that credit and instead apply for a new loan under the CARES Act to help with payroll costs. The CARES Act modified section 7(a) of the Small Business Act to create the PPP, for which Congress authorized nearly $350 billion to provide guaranteed loans for businesses.
2019 Role
The first round of guidance, released April 2, answered some of the general questions employers had on the new loan program, but other questions immediately began to pop up in the partnership context. For one thing, it’s not clear whether guaranteed payments count as payroll costs under the program. Also unclear was how self-employed individuals would take advantage of the program.
Sweet pointed out that the second round of guidance didn’t state whether guaranteed payments for services are included in the definition of self-employment income, although those payments are self-employment income for purposes of section 1402.
Martin A. Sullivan, Tax Analysts’ chief economist, interprets the new guidance to mean guaranteed payments and all payments to partners subject to self-employment tax would count as payroll costs of the partnership.
But the second round of guidance generally answers the question of how self-employed individuals can use the loan program, and it turns out that 2019 really matters. A self-employed individual must have been in business on February 15, 2020, and have filed or will file a Form 1040, “Individual Income Tax Return,” Schedule C for 2019.
The rule provides detailed steps for determining how much a self-employed worker can borrow and lays out the documentation needed. It also describes how the PPP loan proceeds can be used by self-employed individuals.
‘Automatic Money’
Sullivan said the big news in the guidance is the new concept of "owner compensation replacement."
Sullivan said that for the purpose of determining loan forgiveness related to an individual’s self-employment income, the amount is equal to 8/52 of self-employment income in 2019. That is, forgiveness is based not on performance during the eight-week period following loan origination, but on past performance — that is, average self-employment income in 2019, he said.
“This is automatic money,” Sullivan said. “It does not matter if business during the eight-week 2020 forgiveness period is booming or lousy; 8/52 of 2019 self-employment income is forgiven.”
Glen Birnbaum of Heinold Banwart Ltd. said the guidance is useful in helping self-employed individuals make sense of the loan program, but added that more guidance is needed on forgiveness for both employers and self-employed taxpayers.
“We are getting so many questions now on the forgiveness part. There is so much nuance, even just basic cash-basis-versus-accrual-basis questions for the eight-week period,” Birnbaum said. “No one knows these answers.”