The Paycheck Protection Program (PPP) has been a lifeline for many small businesses during the COVID-19 pandemic However, the rules surrounding forgiveness can be confusing, especially for sole proprietors. This article will answer the question: can sole proprietors use 100% of their PPP loan for payroll? We’ll also explore the concept of owner compensation replacement (OCR) and how it can help self-employed individuals maximize their forgiveness amount
Key Takeaways:
- Sole proprietors can use 100% of their PPP loan for payroll under the owner compensation replacement (OCR) provision.
- The OCR allows self-employed individuals to claim their average monthly net profit as payroll costs, even if they don’t have employees.
- To qualify for full forgiveness, sole proprietors must use at least 60% of their PPP loan on payroll costs and the remaining 40% on eligible non-payroll expenses.
- The OCR is not taxable income, but it may be subject to self-employment taxes.
Understanding the PPP and Forgiveness Rules
The PPP was established to assist small companies in keeping their staff members paid throughout the pandemic. The program provided eligible businesses with forgivable loans, the amount of which was determined by the borrower’s payroll expenses.
Forgiveness Rules for Sole Proprietors
Initially, the PPP forgiveness rules were based on the assumption that all borrowers had employees. However, this posed a challenge for sole proprietors, who typically don’t have employees and therefore don’t have traditional payroll expenses.
The Small Business Administration (SBA) developed the idea of owner compensation replacement (OCR) in order to address this problem. Even without employees, sole proprietors may deduct their average monthly net profit from payroll expenses under the OCR provision. This makes it possible for them to be eligible for complete PPP loan forgiveness, even in the event that none of the money is used for customary payroll costs.
How to Calculate OCR
To calculate your OCR, you’ll need to use your net profit from your 2019 Schedule C tax form. Divide your net profit by 12 to get your average monthly net profit. This amount is your OCR.
Example:
Let’s say your net profit on your 2019 Schedule C was $60,000. Your average monthly net profit would be $5,000 ($60,000 / 12). This means your OCR would be $5,000.
Using OCR for Forgiveness
To use your OCR for forgiveness, you’ll need to submit a PPP forgiveness application to your lender. The application will ask you to provide documentation of your net profit, such as your 2019 Schedule C tax form.
Once you’ve submitted your application, your lender will review it and make a decision on forgiveness. If your application is approved, your PPP loan will be forgiven and you won’t have to repay it.
Important Considerations
- The OCR is not taxable income. However, it may be subject to self-employment taxes.
- You must use at least 60% of your PPP loan on payroll costs (including OCR) to qualify for full forgiveness. The remaining 40% can be used on eligible non-payroll expenses, such as rent, utilities, and mortgage interest.
- The OCR provision is only available for PPP loans made after June 5, 2020.
During the pandemic, the PPP has proven to be an invaluable resource for numerous sole proprietors. Self-employed people can maximize their forgiveness amount and maintain the viability of their businesses by being aware of the OCR provision. For any inquiries regarding the PPP or OCR, please speak with a licensed financial advisor.
The Three MOST IMPORTANT Thing to Keep in Mind When Calculating Payroll Amounts
I want you to consider the following three factors when filling out that box on the PPP application:
- What matters is what you paid (which may have been subject to payroll or self-employment tax). Not what you made. This means that there are differences in the accounting and tax regulations for various business forms. However, you must consider the reason behind the PPP, which is to provide companies with the funding necessary to keep their workforces in place for a period of two months. That means your “payroll costs” are the primary figures you should consider. I’ll explain what that entails for each business form below. Your average payroll costs, as an S- or C-Corporation, are calculated by dividing your total payroll expenses by 12 if you made $1,000,000 last year and have one salaried W-2 employee making $24,000 annually. Similarly, your figures would be the same if you earned $25,000 last year and paid your staff the same $24,000. Recall that the loan amount is intended to enable you to maintain employee employment. It’s not what your business produced; rather, it’s what it paid in approved payroll costs and taxable payroll.
- Your main thought should be “TAXABLE PAYROLL” salary and payments. This is all about factoring in the amounts that employees were required to pay in payroll taxes. If you work for yourself as a W-2 employee or if you employ W-2s, this is easy. You get your W-2 and grab the numbers. Even better, have a third-party payroll provider run a report for you. However, if you are an IC, sole proprietor, partnership, S- or C-Corp, continue reading but don’t stop to consider whether payroll is taxable. ”.
- One size does not fit all people! I will say it once more: Speak with an advisor if you are alone or if you are unclear of what to do. Don’t have one? Now’s a good time to get one. Since a large portion of these loans and stimulus packages are tax-related, you should speak with a bookkeeper, tax preparer, or CPA. s. There are some excellent internet businesses that offer a lot for very little money. Although I am not a tax attorney, things change daily, so trust me but double-check me.
Paycheck Protection Program Basics
Let’s get into it. First, some basics. As part of the CARES Act passed on March 27, 2020, a large amount of money is allocated towards a program known as the Paycheck Protection Program (PPP). In a nutshell, this program allows for a loan of 2.5x average monthly payroll which, if you use it for a few specified purposes (payroll, rent, utilities, etc.) will be FORGIVEN! Meaning you don’t have to pay the money back. Read that again.
Alright, so what makes this program so special? Well, for starters, it’s available to all small businesses, 501(c)(3) organizations, sole proprietors, and independent contractors. That’s right, you too are included in this program as a freelancer, IC, or sole proprietor. Although there is a ton of excellent information about the PPP available, I want to concentrate on the essentials and how you can prepare for what you need to be doing.
Click here to view our frequently updated post on the PPP if you want to learn all the essential details about it.
PPP for Sole Proprietors – EVERYTHING you need to know (independent contractors, 1099, Schedule C)
FAQ
Can you use 100% of PPP for payroll?
Can sole proprietors pay themselves with PPP?
What is the maximum PPP loan for a sole proprietor?
What percentage of PPP must be spent on payroll?