Self-Employed Taxpayer Cash Flow and Tax Planning Opportunities
In light of all the recent legislation surrounding the COVID-19 pandemic, there are several tax provisions aimed at assisting self-employed individuals who report their income as a sole proprietor on Form 1040 Schedule C or receive their self-employment income via a partnership or LLC interest. We’ve outlined a few programs of interest below.
CARES Act Provisions
If you need cash flow assistance, apply for the CARES Act Paycheck Protection Program (PPP) loan. The PPP loan program’s primary focus is to help companies impacted negatively from COVID-19 continue to keep their workforce employed and supply cash flow for essential expenses. However, the PPP loan program is also available to self-employed individuals and partners/members of Partnerships or LLC’s who may or may not have employees with W-2 type payroll costs. The Treasury Department issued additional interim final rules on April 14, 2020, which provided additional guidance for self-employed taxpayers.
A self-employed person receiving income from a partnership (or an LLC filing as a partnership) may not submit a separate PPP loan application as a self-employed individual; instead, the self-employment income of general active partner (or LLC member) may be reported as a payroll cost, up to $100,000 annualized per partner, on a PPP loan application filed by or on behalf of the partnership entity. For example, an LLC with five active members and no employees would submit their PPP loan application for all of the LLC members for a maximum of $500,000 earnings annualized for 2.5 months (equal to a maximum of $104,167).
An eligible self-employed person filing a tax return on Form 1040, Schedule C should apply based on 2019 net self-employment income, even if the 2019 tax return has not yet been filed. Individuals who expect to file Form 1040, Schedule C to report 2020 self-employment income who were not in operation in 2019 but were in operation on February 15, 2020, should watch for additional guidance from SBA on eligibility and computation of borrowing.
The calculation for the maximum amount to borrow is simple if there are no employees of the business, as described in the interim final rules. Further, if you had a net loss in 2019, you are not eligible for the PPP loan unless SBA issues additional guidance as the formula will result in zero loan proceeds under the current rules.
Formula: (2019 IRS Form 1040 Schedule C line 31 filed or expected to be filed (not to exceed $100k and not less than zero) / 12) * 2.5 + (EIDL Loan refi – EIDL loan grant) = Max PPP Loan
If you have employees, even if you reported a net loss for your 2019 Schedule C, you may still be eligible. A sole proprietor with employees should use the following formula to calculate the maximum loan amount.
Schedule C Filer with Employees
First, compute 2019 Payroll Cost:
- Start with 2019 IRS Form 1040 Schedule C line 31 filed or expected to be filed (not to exceed $100k and not less than zero)
- Add 2019 IRS Form 941 line 5c – column 1 from each quarter
- Add 2019 pre-tax employee contributions for health insurance or other fringe benefits excluded from line 5c above
- Less Excess for any individual employee in excess of $100,000
- Less Costs for employees whose principal place of residence is outside the United States
- Add 2019 IRS Form 1040 Schedule C line 14 employer health insurance contributions
- Add 2019 IRS Form 1040 Schedule C line 19 employer retirement contributions
- Add 2019 state and local employment taxes assessed from state quarterly wage reporting forms
- = 2019 Total Payroll Cost
Apply Formula: (2019 Total Payroll Cost / 12) * 2.5 + (EIDL Loan refi – EIDL loan grant) = Max PPP Loan
Allowable Expenses and Loan Forgiveness
How can the loan proceeds be used for a self-employed person filing Form 1040, Schedule C?Similar to the rules outlined in the First PPP Interim Final Rules, loan proceeds can be spent on employee payroll costs, mortgage interest payments, rents, utilities, interest on other debt obligations incurred before February 15, 2020, and refinancing an SBA EIDL Loan made between January 31, 2020, and April 3, 2020. However, there are some essential differences in the definition of allowable expenses and amounts eligible for loan forgiveness:
- Mortgage interest, rent, and utilities are specified to be for business mortgage interest, business rent and utility payments (for example on a warehouse purchased/rented to store business equipment or a vehicle used to perform business). Though not spelled out in this rule, it seems it was not intended to cover indirect home office expenses.
- Further, if you did not claim (or could not have claimed) similar costs in 2019, you cannot use the proceeds for these costs during the eight-week period. Since the intention was to limit the self-employed individual’s use of loan proceeds to similar allowable uses they incurred in 2019, taxpayers should be careful in restricting the use of these funds accordingly. For example, if in 2019 there was zero interest deducted for a vehicle loan, the taxpayer could not use loan proceeds to pay for interest on a new vehicle purchased in 2020.
- Mortgages, lease agreements, and utility service agreements must be dated before February 15, 2020. Therefore, if you had a vehicle loan in 2019 and incurred interest expense, you could use the loan proceeds to pay for interest on a new vehicle loan purchased in 2020 as long as the agreement was entered before February 15, 2020.
- If loan proceeds were used to pay for interest on other debt obligations, this is allowable expenditure, but such amounts are not eligible for PPP forgiveness.
- The portion of loan obtained for owner compensation replacement (in a case with a sole-proprietor with no employees) is based on 2.5 months of 2019 net self-employment income, yet the amount forgivable is based on 8/52 of 2019 net profit as adjusted for qualified sick leave and payroll tax credits taken under Sec 7002 and 7004 of FFCRA. This means for the loan proceeds to be fully forgiven, the difference must be spent on eligible costs. Example: $100,000 of net self-employment income equals loan proceeds of $20,833 (($100,000/12)*2.5). Loan forgiveness for the owners compensation replacement portion is ($100,000/52)*8 = $15,385. This leaves a difference of $5,448 (1/2 of a month) to be spent on other costs. Though note, some banks are limiting loan proceeds to the amount expected to be forgiven.
Other incentives outlined in the CARES Act designed to help self-employed individuals (and partners/members earning self-employment income from a partnership or LLC filing as a partnership) includes the ability to defer 50% of the social security tax on net earnings from self-employment income for the period March 27, 2020 – December 2020. See IRS FAQ #9-11 of the CARES Act.
Though not specifically addressed in these FAQs, as with deferral of the employer share of social security tax on employees, once a self-employed individual receives notification PPP loan forgiveness, it is expected the 50% of self-employment taxes incurred after that date would no longer be eligible for deferral. The taxes deferred before the date notified for loan forgiveness would continue to be due on the “applicable dates” outlined in the FAQs to mean 50% due December 31, 2021, and the remaining amount due December 31, 2022.
If your sole proprietorship results in a net self-employment loss for the 2020 tax year and results in an overall net operating loss on your 2020 individual income tax return, you may be eligible to carry back the net operating loss to 2019 to obtain a refund of income tax.
The Family First Coronavirus Response Act (FFRCRA) also created tax credits for a Self-employed person to take against their Self-Employment Tax for Sick Leave and Family Leave, similar to credits allowed for small businesses related to employees. So if the individual would have qualified as an employee for such a credit, they will also qualify as self-employed.
As with all of the recent COVID-19 legislation, as more information is released or clarified, please check back regularly for updates.
This article was last updated on April 28, 2020, with the available guidance from Treasury Department FAQs and SBA Interim Final Rules. As ambiguity remains in some of the rules, please consult your advisor for additional advice on this topic.
Meet the Author
Partner + Director of Private Wealth Tax
Marcy Lantz, CPA, CSEP®
Aldrich CPAs + Advisors LLP
Marcy joined Aldrich CPAs + Advisors in 1995 and has worked with a wide range of clients, including closely-held businesses, private equity, and high-net-worth individuals. As the Director of Tax and Director of Estate Planning, Marcy has a special interest and expertise in wealth transfer planning and strives to deepen the relationship with her clients... Read more Marcy Lantz, CPA, CSEP®
- High-net worth individuals
- Closely-held businesses
- Certified Public Accountant
- Strategic tax planning and compliance
- Certified Specialist in Estate Planning (CSEP)
- Private-equity and financial lenders