PPP Loans: What Is Owner Compensation Replacement & How Does It Work?

Though the Paycheck Protection Program (PPP) is primarily meant to help small businesses retain their workforces and help with expenses, sole proprietors are also covered by the program.

While many of the same qualifications apply to sole proprietors and self-employed as larger businesses, there are specific provisions for individuals who are the entirety of their company and do not compensate themselves through payroll.

These individuals will want to be aware of the owner compensation replacement provision and how to use it.

What Is Owner Compensation Replacement?

The Owner Compensation Replacement rule allows the self-employed to claim a portion of their PPP funds as personal compensation while still receiving forgiveness for the loan.

The PPP typically uses your average monthly payroll expenses (with salaries capped at $100,000) to establish how much money you can borrow. That number is typically multiplied by 2.5–there are exceptions–to get your total maximum loan amount, which is capped at $10 million for your first draw, and up to $2 million for your second.

This isn’t very useful for sole proprietors as they don’t have any employees, nor do they compensate themselves through payroll. Instead, your 2019 net profit is used to determine your monthly average net profit. The Owner Compensation Replacement rule allows you to allocate 2.5 months’ worth of net profit to personal compensation.

This amount is considered forgivable, meaning you won’t be expected to pay it back. Better yet, there are no restrictions on how you can spend that portion of your funds.

How To Calculate & Claim Your Owner Compensation

To claim your Owner Compensation Replacement, you’ll follow most of the same steps that generally apply to sole proprietorships that are seeking PPP funds.

First, you’ll need your 2019 net profits (line 31 of Schedule C). If that amount is over $100,000, reduce it to $100,00. Divide that amount by 12 to get your average monthly net profit. Once you have that number, multiply it by 2.5. This number represents both the maximum PPP loan amount you can get and the maximum amount you can claim as Owner Compensation Replacement. Yes, you can claim your entire PPP loan as Owner Compensation Replacement. The maximum amount of money that can be claimed this way, assuming you’ve hit the $100,000 cap, is $20,833.

So let’s say you made $62,000 in net profit in 2019. Your maximum Owner Compensation Replacement would be $12,916: ($62,000/12) x 2.5.

If you don’t have a Schedule C for 2019, you can also use your net profits from January and February of 2020. Just be aware that this effectively lowers the maximum amount you can qualify for to $16,667. Businesses that formed after that time aren’t currently eligible for PPP.

There’s one more wrinkle that applies only to sole proprietors who received a PPP loan before June 5, 2020. If you choose an eight-week rather than a 24-week coverage period, your maximum loan amount is $15,385. All PPP loans made after June 5, 2020 automatically have a 24-week coverage period.

Claiming your Owner Compensation Replacement doesn’t require any special actions. When you file your Form 3508EZ, you’ll enter the amount you are claiming on Line 1, Payroll Costs. That’s it.

PPP Loan Owner Compensation FAQs

More About PPP Loans

The PPP is an extremely popular and, it seems, constantly evolving program. We’ve made it our mission to bring you the most up-to-date information on the PPP and other COVID-related relief programs. If you’re just looking into PPP for the first time, check out our Round 2 PPP Loans Explained: Rules Requirements, & Where To Apply feature to get started.