PPP Loans: What Is Owner Compensation Replacement & How Does It Work?
Advertiser Disclosure: Our unbiased reviews and content are supported in part by affiliate partnerships, and we adhere to strict guidelines to preserve editorial integrity.
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.
Table of Contents
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.
Chris Motola
Finance Writer at Merchant Maverick
Chris Motola is a writer, programmer, game designer, and product of NY. These days he's mostly writing about financial products, but in a past life he wrote about health care and business. He's a graduate of the University of Central Florida.
Latest posts by Chris Motola (see all)
- 10 Ways To Improve Your Working Capital Ratio & Liquidity - May 4, 2021
- What Is Working Capital & Why Is It Important For My Small Business? - April 30, 2021
- Best Working Capital Loans For Small Businesses In 2021 - April 23, 2021
- What Is The SBA Community Navigator Program & Will It Help My Small Business? - March 25, 2021
- SBA Restaurant Revitalization Fund Grants For Food Service Businesses: 2021 Guide - March 22, 2021
If I am self employed with no employees do I pay myself or not
Hi Sheree,
Yep! The short answer is:
“…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.”
But please refer back to the article for more specifics and calculations.
Do I have to pay income tax on the Owner compensation Replacement?
Hi Christine!
PPP loans that are used for eligible purposes and are forgiven are not taxable. This includes Owner Compensation Replacement.
So, if you are the owner and you have employees that work for you and they get W2s, that means you are not a sole propieter. So, therefore, you cant use ppp loan to compensate. CORRECT????
Hi Diana,
The term sole proprietor really just refers to the business structure, meaning that there is one sole owner who is the responsible party. A sole proprietorship can have employees, and the owner can receive compensation as well. We breakdown the payroll calculation in this post on PPP Loans For Sole Proprietors. Does that help? I hope so!