Can I Include 1099 Employees for PPP Loan?

The Paycheck Protection Program (PPP) was a federal initiative designed to provide financial relief to small businesses and other eligible organizations affected by economic disruptions. This program aimed to help businesses retain their employees and cover certain operating expenses. Many business owners sought to understand how independent contractors, often called 1099 employees, fit into PPP loan applications and how their income should be considered.

PPP Eligibility for Businesses with Independent Contractors

Business owners who engaged independent contractors frequently inquired whether payments to these contractors could be included in their own PPP loan calculations. Generally, businesses were not permitted to include payments to independent contractors as part of their payroll costs for their PPP loan applications.

The rationale behind this rule was that independent contractors were eligible to apply for their own PPP loans. Therefore, counting them on a business’s application would have resulted in a duplication of benefits. The program distinguished between W-2 employees, whose wages and related costs were eligible for inclusion in an employer’s PPP calculation, and 1099 independent contractors, who were treated as separate entities for PPP purposes.

This meant that if a business paid an independent contractor, that expense could not be used by the business to determine its maximum PPP loan amount or for loan forgiveness. Businesses focused on their W-2 payroll expenses, while independent contractors considered their own self-employment income.

PPP Loan Eligibility for Independent Contractors

Independent contractors, self-employed individuals, and sole proprietors were specifically eligible to apply for their own PPP loans. To qualify, an individual generally needed to have been in operation by February 15, 2020, and have self-employment income.

A primary requirement involved having net self-employment income, which was typically reported on IRS Form 1040, Schedule C. This tax form served as the foundational document for verifying income for PPP purposes. Individuals also needed to have their principal place of residence in the United States. The program recognized various forms of self-employment, including freelancers, gig workers, and sole proprietors who file a Schedule C. This often involved providing tax filings for a relevant prior year.

Calculating the PPP Loan Amount for Independent Contractors

Calculating the maximum PPP loan amount for an independent contractor was primarily based on their self-employment income. Initially, this calculation used 2.5 times their average monthly net self-employment income. This net income figure was found on Line 31 of IRS Form 1040, Schedule C.

A significant change introduced on March 3, 2021, allowed independent contractors to elect to use their gross income from Schedule C instead of net profit. This gross income figure is reported on Line 7 of IRS Form 1040, Schedule C. This update often resulted in a higher eligible loan amount for many independent contractors, as gross income is typically larger than net profit.

To perform the calculation, an independent contractor would locate either their 2019 or 2020 Schedule C, depending on which year’s income they chose to use. They would then identify the amount from either Line 7 (gross income) or Line 31 (net profit). This amount was capped at $100,000 annually for the loan calculation.

Next, this capped annual income amount was divided by 12 to determine the average monthly income. Finally, this average monthly income was multiplied by 2.5 to arrive at the maximum eligible PPP loan amount. For example, if an independent contractor had $60,000 in gross income from Schedule C, their average monthly income would be $5,000 ($60,000 / 12), leading to a maximum loan of $12,500 ($5,000 x 2.5).

If an independent contractor had no employees, the calculation remained straightforward, focusing solely on their owner compensation replacement. In cases where an independent contractor also had W-2 employees, the calculation became more involved, combining their owner compensation with their employee payroll costs.

Submitting Documentation and Applying for Independent Contractors

After calculating their eligible loan amount, independent contractors proceeded to gather the necessary documentation and apply through an approved lender. The primary document required was a completed IRS Form 1040, Schedule C, for the tax year used in the loan calculation (either 2019 or 2020).

To further substantiate their self-employment and business operations, applicants might also need to provide supporting documents. These could include IRS Form 1099-MISC detailing non-employee compensation received, bank statements demonstrating business income and expenses, or other business records like invoices. Lenders often requested proof of operation as of February 15, 2020, such as a 2020 invoice or bank statement.

The application process typically involved submitting these documents along with a completed PPP application form to a participating financial institution. Many banks and online lenders were approved to accept PPP applications. After submission, the lender would review the application and supporting documentation to verify eligibility and the calculated loan amount. Upon approval, the loan proceeds would be disbursed to the applicant’s business account. Independent contractors were generally advised to work closely with their chosen lender.