Improperly Forgiven PPP Loans Can't Be Excluded from Income

(Parker Tax Publishing September 2022)

The Office of Chief Counsel advised that a taxpayer whose Paycheck Protection Program (PPP) loan was forgiven, even though the taxpayer did not qualify for the forgiveness, had to include the PPP loan proceeds in gross income under Code Sec. 61. The Chief Counsel's Office determined that (1) due to the taxpayer's misrepresentations, her loan did not fall within the scope of PPP loans that were eligible for forgiveness, and therefore there was no statutory basis for the exclusion of the loan proceeds from her income, and (2) because the taxpayer received the loan proceeds under a claim of right, the taxpayer was required to include the proceeds in income in the year of receipt. CCM 202237010.

Background

As a result of the Coronavirus (COVID-19) outbreak, Congress enacted the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) (Pub. L. 116-136), which included a loan program titled the "Paycheck Protection Program" (PPP). The PPP program provided that certain loans could be forgiven and not included in the taxpayer's gross income. The Office of Chief Counsel was asked to advise whether a taxpayer, who had her PPP loan forgiven as a result of representations she made that she satisfied the conditions for forgiveness of her PPP loan when she did not, could excluded the amount of the loan forgiven from gross income.

Paycheck Protection Program

There were two rounds, or draws, of PPP loans. The first was provided under Section 1102 of the CARES Act, to assist small businesses adversely affected by the COVID-19 pandemic in paying payroll costs and other eligible expenses. The second was provided under the Economic Aid to Hard-Hit Small Businesses, Nonprofits, and Venues Act (Economic Aid Act), enacted as a part of the Consolidated Appropriations Act, 2021 (Pub. L. 116-260), which amended and extended the PPP provisions. The PPP was administered by the Small Business Administration (SBA) under Section 7(a) of the Small Business Act.

For both rounds of PPP loans (collectively, "covered loans"), the lender could forgive the full principal amount if the recipient met the criteria set forth in 15 U.S.C. Section 636(a)(36) and (37) and Section 636m. To receive qualifying forgiveness on a PPP loan, at least 60 percent of the PPP loan amount had to be used for payroll costs, while up to 40 percent of the PPP loan amount could be used for other specified costs. In addition, the qualifying forgiveness amount could not exceed the sum of specified costs that were incurred and paid during a covered period. The specified costs consisted of payroll costs, interest on covered mortgage obligations, covered rent obligations, covered utility payments, covered operations expenditures, covered property damage costs, covered supplier costs, and covered worker protection expenditures.

Once the lender granted qualifying forgiveness to a PPP loan recipient, the lender could treat the amount forgiven as canceled indebtedness. If the SBA later determined that a given forgiveness was not a qualifying forgiveness, the SBA could seek repayment of the loan. Under 15 U.S.C. Section 636m(i)(1), no amount is included in the gross income of the eligible recipient by reason of forgiveness of a covered loan. Similarly, Section 276(b)(1) of the COVID-related Tax Relief Act of 2020 provides that no amount will be included in the gross income of an eligible entity by reason of forgiveness of a covered loan.

Facts

In 2020, a taxpayer applied for and received a first draw PPP loan. The taxpayer did not use the loan proceeds for eligible expenses and applied for forgiveness of the PPP loan in 2020 as if she were entitled to a qualifying forgiveness. In the loan forgiveness application submitted to the PPP lender, the taxpayer failed to include all relevant facts that would indicate that she was not eligible for qualifying forgiveness of the PPP loan. Based on the omissions and misrepresentations on that application, the taxpayer received forgiveness of her PPP loan from the lender. It was subsequently determined that the taxpayer was not eligible for loan forgiveness.

Analysis

The Office of Chief Counsel advised that if a taxpayer who does not factually satisfy the conditions for a qualifying forgiveness causes a lender to forgive the PPP loan by inaccurately representing that the taxpayer satisfied the conditions for forgiveness, the taxpayer may not exclude the amount of the forgiven loan from gross income under 15 U.S.C. Section 636m(i) or Section 276(b)(1) of the CTRA 2020.

The Office of Chief Counsel began by explaining that there is no accession to wealth under Code Sec. 61(a) upon the receipt of PPP loan proceeds, as the PPP loan is issued by a bank, includes an interest rate and maturity date, and includes an obligation for the eligible recipient to repay. However, the Chief Counsel's Office said that once a lender forgives a PPP loan, the recipient of the loan proceeds enjoys an accession to wealth in the amount of the loan that is forgiven, and under general principles of federal income taxation, the amount forgiven generally must be included in the loan recipient's gross income. The Chief Counsel's Office noted, however, that there are express exceptions to the rule that forgiveness of a PPP loan constitutes gross income.

The Chief Counsel's Office stated that a taxpayer who received a PPP loan that is forgiven may exclude the forgiven amount of the PPP loan from gross income only if the forgiveness is described in Section 636m(i) and Section 276(b)(1) of the COVID-related Tax Relief Act of 2020. The Chief Counsel's Office found that these exclusions apply only to a qualifying forgiveness of a PPP loan, and forgiveness of a PPP loan is a qualifying forgiveness only if the use of the loan proceeds satisfies the conditions relating to specified costs (as described in 15 U.S.C. Section 636m(b) and (d)). Failure to meet these conditions, the Chief Counsel's Office determined, means that there was no qualifying forgiveness in the instant situation, and thus the exclusions would not apply to the forgiven PPP loan.

The Chief Counsel's Office therefore advised that, because the forgiveness of the taxpayer's PPP loan was based on omissions and misrepresentations, the loan that the taxpayer received did not fall within the scope of loans that could be forgiven under 15 U.S.C. Section 636m. The forgiveness of the loan accordingly did not constitute a qualifying forgiveness and could not be excluded from the taxpayer's gross income under 15 U.S.C. Section 636m(i). The Office of Chief Counsel advised that, because Section 636m(i) did not apply, the taxpayer was required to include the forgiven amount in her gross income. This result followed, according to the Chief Counsel's Office, from the application of the general principles of federal income taxation to the amount forgiven in determining the proper tax treatment.

Code Sec. 61(a) generally provides that "gross income means all income from whatever source derived." The Chief Counsel's Office noted that under Comm'r v. Glenshaw Glass Co., 348 U.S. 426 (1955), this result applies to all payments that are "undeniable accessions to wealth, clearly realized, and over which the taxpayers have complete dominion." The Chief Counsel's Office advised that in 2020, the year of forgiveness and release from the obligation to repay, the taxpayer had undeniable accessions to wealth, clearly realized, and over which she had complete dominion under the principles of Glenshaw Glass. Furthermore, notwithstanding the ability of the SBA to pursue repayment in the case of misuse of funds, the Chief Counsel's Office found that the taxpayer retained the PPP loan proceeds in 2020 under a claim of right. Under the claim of right doctrine, if a taxpayer receives earnings under a claim of right and without restriction on its disposition, the taxpayer has received income, even if he or she may later have to repay it, and regardless of whether the taxpayer acquired the proceeds lawfully. Thus, the Chief Counsel's Office said that the ability of the SBA to pursue repayment of the improperly forgiven PPP loan did not preclude the application of the claim of right doctrine to the taxpayer in 2020.

For a discussion of forgiveness of PPP loans, see Parker Tax ¶72,340.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

Parker Tax Pro Library - An Affordable Professional Tax Research Solution. www.parkertaxpublishing.com

We hope you find our professional tax research articles comprehensive and informative. Parker Tax Pro Library gives you unlimited online access all of our past Biweekly Tax Bulletins, 22 volumes of expert analysis, 250 Client Letters, Bob Jennings Practice Aids, time saving election statements and our comprehensive, fully updated primary source library.

Try Our Easy, Powerful Search Engine

A Professional Tax Research Solution that gives you instant access to 22 volumes of expert analysis and 185,000 authoritative source documents. But having access won’t help if you can’t quickly and easily find the materials that answer your questions. That’s where Parker’s search engine – and it’s uncanny knack for finding the right documents – comes into play

Things that take half a dozen steps in other products take two steps in ours. Search results come up instantly and browsing them is a cinch. So is linking from Parker’s analysis to practice aids and cited primary source documents. Parker’s powerful, user-friendly search engine ensures that you quickly find what you need every time you visit Our Tax Research Library.

Dear Tax Professional,

My name is James Levey, and a few years back I founded a company named Kleinrock Publishing. I started Kleinrock out of frustration with the prohibitively high prices and difficult search engines of BNA, CCH, and RIA tax research products ... kind of reminiscent of the situation practitioners face today.

Now that Kleinrock has disappeared into CCH, prices are soaring again and ease-of-use has fallen by the wayside. The needs of smaller firms and sole practitioners are simply not being met.

To address the problem, I’ve partnered with a group of highly talented tax writers to create Parker Tax Publishing ... a company dedicated to the idea that comprehensive, authoritative tax information service can be both easy-to-use and highly affordable.

Our product, the Parker Tax Pro Library, is breathtaking in its scope. Check out the contents listing to the left to get a sense of all the valuable material you'll have access to when you subscribe.

Or better yet, take a minute to sign yourself up for a free trial, so you can experience first-hand just how easy it is to get results with the Pro Library!

Sincerely,

James Levey

Parker Tax Pro Library - An Affordable Professional Tax Research Solution. www.parkertaxpublishing.com