June 29, 2020

Can a Sole Proprietor Seek PPP Forgiveness Without Payroll Expenses?

When the Paycheck Protection Program (“PPP”) first was launched, the SBA portal was available to small businesses that could evidence loan application amounts based upon documented payrolls. Later, the PPP was opened to sole proprietors who report income on Schedule C filings instead of via payroll. Now, many of those sole proprietors are asking how to obtain full forgiveness of PPP loans in the absence of payroll documentation. Because most self-employed individuals do not pay themselves through payroll, the PPP has introduced a concept known as Owner Compensation Replacement (“OCR”) which allows sole proprietors to claim forgiveness amounts to make up for lost income without reliance upon documented evidence of payroll.

Generally, the PPP loan amount that businesses qualify for is based on 2.5 months of average payroll expenses. However, since sole proprietors usually don’t have payroll, their PPP loan is instead based on 2019 net profit as reported on the 2019 Schedule C tax return divided by 12. This monthly “average” net profit is then multiplied 2.5 times to equal the PPP loan amount. In essence, the PPP loan should be roughly ten weeks’ worth of 2019 net profit.

Using the OCR, sole proprietors can claim forgiveness based upon 2019 net profit. It is not necessary to document any payroll. Borrowers who received loans prior to June 5, 2020, may elect to use the 8-week forgiveness covered period and can claim eight weeks’ worth of OCR. In those circumstances, because PPP income is capped at $100,000, the maximum amount allowed as OCR over the eight weeks is $15,385. On the other hand, if a borrower utilizes the 24 week covered period authorized by the Flexibility Act, 2.5 months of 2019 net profit as reported on Schedule C can be claimed for forgiveness. In those circumstances, because PPP income is capped at $100,000, the maximum amount allowed as OCR over the 2.5 months is $20,833.

Borrowers who fall short of 100% forgiveness using solely the OCR will have to document spending any remaining PPP loan funds on allowable non-payroll expenses such as utilities, rent, and mortgage interest expenses in order for the PPP loan to be 100% forgiven.

Self-employed individuals can use the newly released EZ application form so long as there are no employees on the payroll.

ONE LAST WORD OF CAUTION – It has not been clearly resolved for sole proprietors whether using OCR becomes a taxable event. While the CARES Act indicates that forgiven PPP amounts will not be taxed, this doesn’t clearly account for the OCR’s expressed purpose as a substitute for actual income. Absent clear resolution and a favorable determination, borrowers may need to report the amount of the OCR as taxable personal income.


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