Improperly forgiven PPP loans are taxable

by Cain Ellsworth & Company, LLP Posted August 31, 2022

On August 19, 2022, The IRS Office of Chief Counsel released a memorandum saying that when a taxpayer’s loan is forgiven based upon misrepresentations or omissions, the taxpayer is ineligible to exclude the forgiveness from income. This means the taxpayer will need to include the portion of the loan proceeds that were forgiven based on misrepresentations or omissions as taxable income. 

The information in the memorandum isn’t exactly new. Still, it could have staggering implications for the millions of taxpayers who received forgiveness of the Paycheck Protection Program (PPP) loans over the past several years. 

While the full scale of PPP loan fraud is unknown (and likely will be for years), the Office of the Inspector General (OIG) reports investigating an unprecedented number of fraud complaints. Based on an analysis of SBA loan data as of August 2020, more than 70,000 loans totaling over $4.6 billion were identified as potentially fraudulent. However, some news sources estimate that up to $80 billion received via the PPP may have been fraudulently obtained. 

The OIG and other law enforcement agencies also report systemic patterns of potential fraud, such as false attestations on loan documents, payroll inflation, falsified tax documentation, identity theft, and misuse of proceeds. Each of these forms of fraud will likely be considered a misrepresentation or omission – triggering the IRS’s rule that the forgiven amount will be taxable. 

The Paycheck Protection Program

In March 2020, President Trump signed the CARES Act into law. One of the major provisions of the CARES Act was the Paycheck Protection Program, a loan program designed to help small businesses affected by the COVID-19 pandemic. While the PPP was originally scheduled to expire on June 30, 2020, it was extended by follow-up legislation through June 30, 2021. 

To obtain a PPP loan, eligible small businesses, individuals, and nonprofits had to submit an application to an approved lender. These applications included good faith attestations that the information contained in the application was correct. If the lender approved the application, they submitted it to the SBA to be assigned an SBA loan number before funds could be disbursed. 

After receiving the funds, borrowers could complete and submit a PPP loan forgiveness application to the lender. The lenders had 60 days to review the forgiveness applications and submit their decision regarding whether the applicant was qualified for forgiveness to the SBA. The SBA was then required to remit the appropriate forgiveness amount to the lender within 90 days. 

Who qualified for a PPP loan? 

Many organizations and individuals potentially qualified for the PPP; however, eligibility requirements were rather complex. 

More specifically, PPP loans were available to all small businesses, including nonprofits, veterans organizations, tribal business concerns, sole proprietorships, self-employed individuals, and independent contractors whose principal place of business was in the United States.

The applicant must have been in operation on February 15, 2020, and either had employees who were paid salaries and payroll taxes or independent contractors, as reported on Form 1099. 

The applicant must have had 500 or fewer employees or met the SBA employee-based size and revenue standards for their specific industry. Also, a business could qualify if it met both tests in the SBA’s “alternative size standard.” To meet the standard, the business must not have had a net worth greater than $15 million, and the average net income after federal income taxes, excluding any carry-over losses, for the two full fiscal years before the date of the application could not be more than $5 million. 

SBA’s affiliation standards, which were used to calculate total employees, were waived for the following types of businesses: 

• Businesses in the accommodations and food services industries
• Businesses that are franchises in the SBA’s franchise directory
• Businesses that receive financial assistance from small business investment companies licensed by the SBA

Who qualified for the PPP loan forgiveness? 

The PPP loan program allowed for 100% forgiveness of the loan amount as long as the recipient met three conditions: 

1. The loan recipient was eligible to receive the PPP loan. 
2. The loan proceeds were used to pay eligible expenses, such as payroll costs, rent, interest on the business’ mortgage, and utilities. 
3. The loan recipient applied for loan forgiveness. The application required a loan recipient to attest to eligibility and verify certain financial information, among other legal requirements. 

As long as each condition was met, recipients qualified for total forgiveness of the loan, and the forgiven amount did not qualify as income for tax purposes. 

However, if those conditions were not met, or there was any fraud, misrepresentation, or omission in the course of obtaining or using the loan, the amount should not have been forgiven. If the loan was forgiven despite not meeting the legal requirements, the recipient must include the forgiven amount as taxable income. 

As such, any PPP loan recipients who received more forgiveness than they were eligible for should take steps to come into compliance with the IRS by filing an amended return. The return should include the amount of the forgiven loan proceeds within their stated income. This may help to avoid any penalties or interest assessed by the IRS. Additionally, it is important to keep good records of all documentation related to the PPP loan, as this may be necessary to prove eligibility for forgiveness. 

This article is intended to provide a brief overview of the PPP loan forgiveness program and a recent statement issued by the IRS. It is not a substitute for speaking with one of our expert advisors. If you are a PPP loan recipient and would like more information about this news, please contact our office.