The Paycheck Protection Program loan can be completely forgiven if you spend it on the right things, and if you prove those expenses.
However, PPP forgiveness works differently for sole proprietors and independent contractors, the biggest difference being the concept of “owner compensation replacement” which greatly simplifies the loan forgiveness process. Here’s everything you need to know.
How sole proprietor PPP loans are calculated
Generally, the PPP loan amount that businesses qualify for is based on their average payroll expenses. However, since sole props and contractors usually don’t have payroll, their loan is based on 2019 net profit divided by 12, to get a monthly “average” net profit. This number times 2.5 equals your PPP loan amount. Which means your PPP loan is roughly ten weeks worth of net profit.
Now, how do you get that amount forgiven, since you don’t have payroll to spend it on?
Owner Compensation Replacement
Instead of spending your funds on payroll, you can automatically get eight week’s worth of net profit forgiven, without having to spend it on anything. This is called “owner compensation replacement”—it makes things nice and simple. The remaining PPP funds will need to be spent on utilities, rent, and mortgage interest expenses in order to be forgiven.
The amount of “owner compensation replacement” you’re eligible to claim for forgiveness is calculated by multiplying your reported net income in 2019 on your Schedule C by 8/52 (or 0.154).
A simple example
You filed your Form 1040 and Schedule C for 2019, where you reported $27,300 in net income.
Your monthly “payroll cost” would be $2,275, so you qualified for $5687.50 in PPP funding.
To calculate your maximum owner compensation replacement, you would multiply $27,300 by 8/52.
$27,300 * 8 / 52 = $4,200
The $4,200 would be fully eligible for forgiveness. The remaining amount of your PPP loan ($1487.50) would need to be spent on eligible expenses such as utilities, rent, and mortgage interest.