PPP Loans: What Is Owner Compensation Replacement & How Does It Work?
-
Expert Analyst & Reviewer
- 20 comments
- Updated on:
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
Expert Analyst & Reviewer at Merchant Maverick
An expert in personal and business loans and financial health, Chris Motola has been writing about small business finance and payments for over 5 years. He has been cited in various industry publications, including Forbes Advisor, GoBankingRates, and Medium. Chris is a graduate of the University of Central Florida.
View Chris Motola's professional experience on LinkedIn.
Latest posts by Chris Motola (see all)
- The Complete Stripe Nonprofit Guide For Fundraising & Donations - November 18, 2021
- The 5 Most Popular Crypto Payment Gateway & Processors - October 22, 2021
- Setting Up Shopify Payments: Everything You Need To Know - October 8, 2021
- What Is A Payment Link & How Do You Use One? 6 Best Pay-By-Link Options For Small Business - September 30, 2021
- PayKings Review - September 3, 2021
IWhat form do I fill out for loan forgiveness if I am claiming owners compensation replacement? I received a total less than 20000 for 2021. How do I do the math for forgiveness? What paper word do I also show I dont want to send a lot i have so many receipts and statements but I only want to send what necessary.
Hi NAT,
You can find all that right here in this post! 🙂 We’ve included links to the forgiveness form 3508EZ in the article as well as instructions on how to calculate & claim your owner compensation, and a list of needed documents can be found in the FAQ section toward the bottom. I hope that helps, and please let me know if you have any follow-up questions. Thanks!
Thanks for your extremely helpful article. You refer to SBA Form 3508EZ but that form appears to apply to PPP loans of more than $150,000. Moreover, that form caps the forgivable amount at 60% of the amount entered on line 1 of the form. (SBA Form 3508S does not mention such a cap.) That would mean that a sole proprietor with a loan of less than $20,833 with no payroll expense cannot claim 100% of the loan to the extent it does not exceed net (or gross?) income divided by 12 and multiplied by 2.5. So I assume that what you are saying is that the 60% cap does not apply to a sole proprietor with no employees who is claiming loan forgiveness for owner compensation replacement.
Hi Chet,
Thank you for posting! Form 3508ez instructs borrowers to divide line 1 by 0.60, not multiply it by 0.60. So it’s not 60% of line 1. For example, if you claim the maximum $20,833 owner compensation, your maximum forgiveness amount is $34,721, not $12,499 (assuming you claim no other expenses). So no special exemption is needed for ownership compensation on Form 3508ez. I hope that helps!
i have a question. I am on unemployment compensation while i got approved for PPP loan. can i only apply my expenses for forgiveness since i am on unemployment.
or I have to return all the money.
Hi Mirna!
If you have received PPP funds, this will need to be reported as income to your state unemployment office. Doing so may make you ineligible to receive benefits through your PPP covered period. However, you may be eligible to apply and receive benefits again once your PPP loan funds have been exhausted. I would encourage you to reach out to your state unemployment office to learn more. Good luck!
Regarding the 20,833 limit, does that apply to each draw or both draws combined? I just received my second draw today, I’m an independent contractor and used 100% of the first draw for owner compensation (which was less than 20k), but if I do the same with the second draw that would exceed 20,833, but not sure if that rule applies to each draw separately or both combined? Thanks
Hi Mandy!
That amount applies to each draw. Since your second draw will cover a time period that is different than your first draw, you will be able to pay yourself owner’s compensation up to the maximum amount with your new PPP loan.
I had 1099 NEc for 100K for 2020 and I received $20800 PPP 1 Loan in April 2021. I did not file my tax return for year 2020 yet as I have extension.
Do I have to show profit of minimum of $20800 on line 31 of Schedule C of tax year 2020.
Hi Chris,
Thanks for posting here! Our understanding is that if the loan is forgiven you don’t have to report it as income–I hope that answers your question!
I’m self employed with no employees. in your response to Sheree, you stated that the Owner Compensation Replacement rule allows you to allocate 2.5 months’ worth of net profit (using 2019 net profit for calculation) to personal compensation and that this amount is considered forgivable. My 2nd draw PPP loan was approved using 2020 gross income. How does Owner Compensation Replacement work with that?
Hi Sheri!
If gross income was used to calculate your PPP loan, you will also use gross income to calculate Owner Compensation Replacement. As someone that is self-employed with no employees, you can simply calculate 2.5 months’ worth of your 2020 gross income that was reported on line 7 of your Schedule C. The maximum amount of $20,833 still applies when you calculate your OCR this way. Good luck!
I used my 2020 Schedule C to determine my PPE amount as a self-employed contractor. As I understand it, 11 weeks after my loan process, I can apply for forgiveness using the entire amount (less than $10k) as compensation. Do I just put this on the Payroll line of the EZ form?
Also, are any travel expenses a qualified expense trying to get Covid reduced business back?
Hi PLM!
Yes, if you used your PPP loan for Owner Compensation Replacement, this will be forgiven. This amount will be written on the “Payroll Costs” line of Form 3508EZ.
Unfortunately, travel expenses are not forgivable under the rules of the PPP. Good luck!
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!