Treatment of Independent Contractors Under the Paycheck Protection Program
Under the Paycheck Protection Program ("PPP"), for eligibility, loan amount, and forgiveness calculations, how should employers treat "independent contractors"?
The Coronavirus Aid, Relief, and Economic Security Act ("CARES") empowered the Small Business Administration ("SBA") to guarantee some $349 billion low-interest, forgivable PPP loans. On the evening hours of April 2, 2020, the SBA issued its Interim Final Rules ("Interim Rules") to administer the PPP. Although the Interim Rules provide the first round of promised guidance from the SBA, they also note that the SBA intends to provide further guidance concerning several aspects of PPP loan administration.
The Interim Rules provided a few surprises. For example, the PPP loans are paid out to eligible businesses on a first-come-first served basis, and a PPP borrower could only receive one loan. This surprise resulted in scramble for PPP borrowers and lenders to get their applications in to the SBA portal. Additionally, the interest rate will be 1% and will have a maturity date of two (2) years. These are surprises because the CARES Act provided that the interest rate could be up to 4% and could have a maximum maturity date of up to ten (10) years. And while the CARES Act did limit small business' avenues of relief, the Interim Rules definitively limit PPP loans to a single first-come-first served loan such that they expressly state that "if you apply for a PPP loan you should consider applying for the maximum amount." 13 CFR Part 120, Interim Final Rule, Section III, (2)(k), pg. 12 of 31. Further, while CARES enumerates multiple “allowable uses” of PPP loans, the Interim Rules clarify that at least 75% of PPP loan proceeds must be used exclusively for the category of “payroll costs.”
The Interim Rules also provide borrowers with needed guidance concerning eligibility, how to calculate the maximum loan amount, and the maximum amount of PPP loan forgiveness. And while the Interim Rules contemplate numerous scenarios, there are some aspects of small business that may cause applicants consternation when navigating these rules. To survive, some small businesses have a mixture of full-time employees, part time employees and independent contractors. Some even hire independent contractors to perform a large portion, if not all, of their necessary work. Small businesses that have a mixture of employees and independent contractors may see some aspects of the Interim Rules as confusing or even contradictory. In this article, we examine how the Interim Rules treat independent contractors.
Eligibility: Are businesses required to include independent contractors whose principal place of residence is the United States in their employee count?
Short answer: No, the Interim Rules separate employers from independent contractors and sole proprietors.
Businesses with 500 or fewer employees whose principal place of residence is the United States are among the PPP loan eligible entities. Those businesses had to be in operation on February 15, 2020 and "either had employees for whom you paid salaries and payroll taxes or paid independent contractors, as reported on a Form 1099-MISC." 13 CFR Part 120, Interim Final Rule, Section III, (2)(a)(ii), pg. 6 of 31 (emphasis added). The Internal Revenue Service ("IRS") provides that a person is to file a Form 1099-MISC for each person to whom you have paid at least $600.00 in, among other things, "services performed by someone who is not your employee." Individuals that operate under a sole proprietorship or as an independent contractor or eligible self-employed individual that were in operation on February 15, 2020 are also eligible for a PPP loan.
When applying for the PPP loan with lenders, the borrower must provide documentation necessary to establish eligibility. The Interim Rules describe such documentation as "payroll processor records, payroll tax filings, or Form 1099-MISC, or income and expenses from a sole proprietorship." 13 CFR Part 120, Interim Final Rule, Section III, (2)(a)(ii), pg. 6 of 31 (emphasis added). Borrowers that do not have that information must provide other supporting information such as bank records, sufficient to demonstrate a qualifying payroll amount.
For purposes of determining eligibility, the Interim Rules appear to separate small businesses with employees from independent contractors and sole proprietorships. Initially, the eligibility standard of having (1) 500 or less U.S. resident employees; (2) being in operation on February 15, 2020; and (3) "either had employees for whom you paid salaries and payroll taxes or paid independent contractors, as reported on a Form 1099-MISC" appeared to mean that employers would include independent contractors among the employee head count. However, in the same eligibility section, the Interim Rules specifically provide that independent contractors and sole proprietors in operation on February 15, 2020 are also eligible and recognize the different types of documentation that employers, independent contractors and sole proprietors will have to provide to lenders to establish eligibility. Unless the SBA provides further guidance otherwise, for eligibility purposes, small businesses should not include independent contractors in their employee counts.
Maximum Loan Calculation: Can an employer include payments to independent contractors when calculating their maximum loan amount?
Short Answer: No, the Interim Rules expressly state that employers are not to include independent contractors in their loan calculations.
The maximum loan amount under the PPP is the lesser of $10 million or the amount employers calculate when using the payroll-based formula specified in CARES. The Interim Rules provide guidance in the form of, among other things, a step-by-step explanation of the payroll-based formula as well as giving four examples of how to apply it. The formula is (1) the aggregate payroll costs from the last 12 months for U.S. based employees; (2) minus any compensation paid to an employee in excess of an annual salary of $100,000; (3) after completing step 2, average the monthly payroll costs; (4) multiply the average monthly payroll costs by 2.5; and (5) if applicable, add any outstanding amount of an Economic Injury Disaster Loan ("EIDL") made between January 31, 2020 and April 3, 2020, less any amount already advanced under that loan.
The question of how to treat independent contractors shows up in the initial calculation of aggregate payroll costs. The Interim Rules broadly define "payroll costs" to include compensation for U.S. resident employees in the form of salary, wages, tips, vacation, family, medical or sick leave, allowance for separation or dismissal, payment of employee benefits such as health insurance premiums and retirement, and state and local taxes assessed on employee compensation. That same definition also provides that independent contractors or sole proprietors can include their wages, commissions, income, net earnings or "similar compensation."
The Interim Rules go further than simply separating employers from independent contractors and sole proprietors in the definition of payroll costs. The Interim Rules expressly raise and answer the question:
"Do independent contractors count as employees for purposes of PPP loan calculations?
No, independent contractors have the ability to apply for a PPP loan on their own so they do not count for purposes of a borrower's PPP loan calculation."
13 CFR Part 120, Interim Final Rule, Section III, (2)(h), pg. 11 of 31. Unless the SBA provides further guidance otherwise, for PPP loan calculation purposes, small businesses should not include independent contractors in their payroll costs.
PPP Loan Forgiveness: Can an employer pay an independent contractor with PPP Loan funds and receive forgiveness for making those payments?
Short Answer: No, the Interim Rules expressly state that independent contractors do not count as employees for purposes of PPP loan forgiveness.
According to the Interim Rules, PPP loans can be forgiven up to the full principal amount of the loan and any accrued interest. 13 CFR Part 120, Interim Final Rule, Section III, (2)(h), pg. 13 of 31.To be eligible for forgiveness, however, a borrower will have to use the loan proceeds for forgivable purposes and it must maintain employee and compensation levels. The Interim Rules provide that forgivable purposes include payroll costs, payments of interest on mortgage obligations incurred before February 15, 2020, or rent on leases dated before February 15, 2020, utility payments dated before February 15, 2020 and proceeds from an EIDL loan used for payroll costs. With the exception of a borrower's ability to pay interest on any other (non-mortgage) debt obligation incurred before February 15, 2020, the forgivable purposes align with the permitted uses of PPP loans. And while the Interim Rules state that the SBA will issue further guidance on loan forgiveness, it currently states that no more than twenty-five percent (25%) of the loan funds may be used for non-payroll costs.
Notably absent from the permitted uses for PPP loans and from its list of forgivable purposes is reference to any payments made to independent contractors. Because they are excluded from payroll costs in calculating the maximum loan amount, it is intuitive that employers should exclude independent contractors from forgiveness calculations as well. To avoid confusion, however, the Interim Rules expressly raise and answer the question:
"Do independent contractors count as employees for purposes of PPP loan forgiveness?
No, independent contractors have the ability to apply for a PPP loan on their own so they do not count for purposes of a borrower's PPP loan forgiveness."
13 CFR Part 120, Interim Final Rule, Section III, (2)(p), pg. 15 of 31. Unless the SBA provides further guidance otherwise, for PPP loan forgiveness purposes, payments to independent contractors are not included when considering loan forgiveness and are not included in the list of permitted uses of PPP loan proceeds.
Conclusion: Because independent contractors may also seek PPP loans, employers are not to include independent contractors when applying for PPP loans. However, you can still provide vital assistance to your independent contractors who are seeking their own loans.
To avoid double counting independent contractors or leaving them dependent on the potentially numerous entities with whom they work to receive payment, it makes sense that Congress has chosen to make independent contractors and sole proprietors eligible for their own PPP loans and exclude them from the PPP calculations of employers. That does not mean that your small business cannot help your independent contractors. If individual contractors request documentation information for the invoices or services they provided to your small business that would help them document their earnings, please provide them with documentation as quickly as possible. While you cannot use the proceeds received from a PPP loan to pay individual contractors or sole proprietors, you can assist them with documentation and even introductions to your banker. We are all in this together. Doing your small part to help independent contractors document their information for PPP loans is a small burden on you but a large blessing on them.