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If you are self-employed and were able to get a loan under the Payroll Protection Program (PPP) or you received an Economic Injury Disaster Loan (EIDL) to offset the financial impact of COVID-19, it is important to understand how they may impact your taxes and how any potential loan forgiveness works.
Self-employed individuals can utilize both PPP loans and EIDL
Although the funds for the PPP program are largely already dispersed (the deadline for applying was June 30, 2020, but pending legislation may change this), even if you have a PPP loan, you can still apply for an EIDL (the deadline for applying for these loans is December 16, 2020). However, be aware that you cannot use the funds from both loan programs for the same purpose.
PPP loan forgiveness, self-employment income, and your taxes
Based on the new PPP guidance available to date (which is fluid and subject to change) any expenses eligible to be forgiven from your loan amount cannot also be deducted on your taxes. This means that normally tax-deductible expenses such as payroll expenses, mortgage interest, rent, and utilities are not deductible on your 2020 taxes in the amount that you receive PPP loan forgiveness on them.
In addition, per the Federal Register, you cannot apply for PPP loan forgiveness on home office deductions, self-employed health insurance or retirement contributions for a business owner. If you have a free-standing office that you pay rent on or you pay health insurance or retirement contributions for employees these can be counted as part of your PPP loan forgiveness amount.
However, there is some good news for self-employed individuals, who are taxed on business profit. The forgiven amount of the PPP loan is not subject to income tax (or technically a reduction of costs eligible to be expensed for tax purposes) as it was never claimed as a business expense.
The PPP loan forgiveness extension may help the self-employed
On June 7, The Payroll Protection Program Flexibility Act was passed into law, extending the covered period in which borrowers can use Payroll Protection Program (PPP) loan proceeds from eight weeks to 24 weeks. This extension applies to freelancers who received their disbursement prior to the enactment of the PPP Flexibility Act and may be especially helpful to those who are self-employed without business overhead.
Keep in mind that if you elect to use the 24-week covered period, the amount that can be forgiven cannot exceed 2.5 months’ worth of 2019 compensation for any self-employed individual, and the amount that can be forgiven is capped at $20,833 per individual.
If you did receive a PPP loan, then you are (hopefully) aware that originally, the Small Business Administration had permitted borrowers to use eight weeks as the covered period. The PPP Loan Extends the “covered period” for PPP loan forgiveness from eight weeks after loan origination to the earlier of 24 weeks after loan origination or December 31, 2020.
Now that the covered period for PPP has been extended, it is important to understand how this may impact you as a freelancer. Here is an example of the potential difference in the PPP loan forgiveness, using the eight-week window vs. the 24-week window), based on an individual reporting $50,000 of self-employment income on their 2019 tax return, with no overhead expenses:
As you can see, using the 24-week covered period allows you to maximize the amount of PPP loan forgiveness available to you, which is an underlying intention of The Payroll Protection Program Flexibility Act. This is an important cost-saving to take advantage of if you are eligible to do so.
PPP loan forgiveness is not automatic—be sure you apply for it
Another important caveat in the PPP loan forgiveness equation that you should be aware of is that currently, it appears that you have to specifically request loan forgiveness by submitting a request to the lender that is servicing the loan. You will need to provide documents that verify you used PPP funds to make payments on eligible mortgage, lease, and utility obligations. As stated above, you can use your 2019 Schedule C from your tax return to satisfy the self-employment income verification.
Be sure to watch for more details on how applying for PPP loan forgiveness will work in the news media, from your lender and from the IRS and/or SBA. The mechanics of this part of the PPP program have yet to be formally detailed.
Your lender is required to decide on the forgiveness of your loan within 60 days. Keep in mind, any PPP amount not forgiven is loaned at a 1% interest rate, with a two-year maturity period and the first payment is due in six months.
Given the fluid nature of the PPP program and the ambiguity that still exists around the process for applying for PPP loan forgiveness, it is essential that self-employed individuals who have participated in the program continue to monitor additional changes and keep track of PPP-related expenses in order to maximize loan forgiveness and avoid unwelcome and unexpected repayment obligations next tax season.
Self-employed individuals and Economic Injury Disaster Loans
If you are self-employed with employees and did not receive a PPP loan or if you are in need of additional financing due to COVID-19, you may want to consider applying for an EIDL through the federal Small Business Administration (SBA).
An additional $60 billion to fund Economic Injury Disaster Loans (EIDL) was part of the $484 billion additional COVID-19 relief package approved in late April. You can still apply for EIDL loans at covid19relief.sba.gov. In addition, due to the financial hardships caused by COVID-19, the SBA is offering loan advances to qualified applicants who select this option. You will need to provide a bank routing number and account number for them to deposit the loan advance.
An EIDL can be used to pay for payroll, fixed debts, accounts payable, and other expenses that you are unable to pay directly due to the impact of COVID-19. Your EIDL, minus the forgiven portion, will be payable over up to 30 years at 3.75% interest. The terms include an automatic one-year deferral on repayment with interest continuing to accrue during this period.
EIDL forgiveness is automatic—but only for advance portions of the loan
A portion of EIDL loans—the advance portion up to $10,000—can be forgiven. Unlike PPP loans, EIDL forgiveness is automatic, as long as you document and spend the money on qualified expenses as noted above.
Be aware that the forgivable loan advance is not a flat $10,000 but $1,000 per employee/freelancer with a maximum of $10,000 (10 or more employees). Your EIDL advance will not have to be repaid provided that you use the money for the following:
- Paid leave
- Increased material costs
- Mortgage, lease, or rent payments
- Covering obligations that occur due to revenue loss
The following are specific expenses that you cannot use your EIDL advance (or loan) for. If you do, you will not receive forgiveness and you may be subject to immediate payback:
- The replacement of lost sales or profits.
- Business expansion.
- Refinancing long-term debt.
- Any costs covered under PPP.
Since the EIDL loan and loan advance are considered disaster funds by the SBA, the penalty for misuse may be immediate repayment of one-and-a-half times the original loan amount and possible criminal charges.
Tax implications and the EIDL advance
An EIDL advance is essentially a small business grant of up to $10,000. Although specific guidance has not yet come from the IRS, the advance portion of the EIDL may need to be included in your taxable income. Alternatively, The EIDL advance may also need to be factored in when repaying PPP as some of the earlier drafts of refund applications indicated such.
As you can see the PPP loans and EIDLs made available during COVID-19 have brought with them short-term financial relief for many self-employed individuals. However, they also carry with them important financial and tax obligations that all participants in these programs should be aware of. If you are unsure of how these loans may impact your taxes, consider reaching out to a tax professional who can help you understand the implications and ensure that you get the full benefit of these programs without facing any unexpected financial consequences.