The IRS Chief Counsel’s Office issued an Advice Memorandum confirming that improperly forgiven paycheck protection loans are taxable income. The IRS urges PPP borrowers whose loans were improperly forgiven to file original (or amended) returns that include any improperly forgiven loan amounts in income.
Paycheck protection program (PPP) loans.
PPP loans were established to help small U.S. businesses adversely affected by the COVID-19 pandemic cover certain expenses. Under the program, lenders can forgive the loan if the borrower meets three conditions:
1. The loan recipient was eligible to receive the PPP loan. An eligible loan recipient
- is a small business concern, independent contractor, eligible self-employed individual, sole proprietor, business concern, or a certain type of tax-exempt entity;
- was in business on or before February 15, 2020; and
- had employees or independent contractors who were paid for their services, or was a self-employed individual, sole proprietor or independent contractor.
2. The borrower used the loan proceeds to pay eligible expenses, such as payroll costs, rent, interest on the business’ mortgage, and utilities.
3. The borrower applied for loan forgiveness and attested on the application that they were eligible for a PPP loan, they used the loan proceeds for eligible expenses, certain financial information was correct, and they met other legal qualifications.
When all three requirements are met, the loan (or a portion of it) is forgiven. However, unlike other forgiven debts, the borrower doesn’t need to include the forgiven portion of the loan in income.
Improperly forgiven PPP loans.
The Advice Memorandum confirms that when these conditions aren’t met, the portion of the forgiven loan that doesn’t meet the requirements for forgiveness must be included in income and any additional income tax must be paid.
According to the Advice, the taxpayer applied for a PPP loan in 2020. The taxpayer didn’t use the loan proceeds for eligible expenses, but she applied for loan forgiveness attesting that she had. The Advice noted that the taxpayer’s PPP loan was forgiven based on the misrepresentations or omissions she made in her forgiveness application.
Because the taxpayer’s PPP loan forgiveness was based on omissions and misrepresentations, the loan wasn’t eligible for forgiveness. Accordingly, the loan proceeds couldn’t be excluded from the taxpayer’s income because the taxpayer had “an accession to wealth, clearly realized, and over which they had complete dominion.”
Moreover, even though the Small Business Administration could pursue repayment of the loan for misuse of the loan proceeds, the taxpayer retained the proceeds under a claim of right during the tax year at issue. Therefore, the forgiven loan proceeds were income.
For more information about debt cancellation income, see Checkpoint’s Federal Tax Service ¶ J-7200.