Taxpayers whose Paycheck Protection Program (PPP) loans are forgiven under the program but who are ineligible for that forgiveness may not exclude the forgiven loan amount from gross income for federal tax purposes, the IRS Office of Chief Counsel stated.
The Chief Counsel Office’s position and reasoning were outlined in Chief Counsel Advice (CCA) 202237010 released Sept. 16. In an accompanying news release, the IRS said it was aware that some taxpayers’ PPP loans have been inappropriately forgiven. These taxpayers should take steps to come into tax compliance, such as by filing amended returns that include the forgiven loan proceeds in income, the IRS advised.
In arriving at its conclusion, the CCA relied on both the terms and conditions of the PPP and general federal tax principles.
PPP loans are administered and guaranteed by the U.S. Small Business Administration (SBA), first provided under the Coronavirus Aid, Relief, and Economic Security Act, P.L. 116-136, and subsequently extended in a “second draw” under the Consolidated Appropriations Act, 2021, P.L. 116-260. Both rounds of covered loans may be forgiven by lenders if recipients meet criteria specified in 15 U.S.C. Sections 636(a)(36), 636(a)(37), and 636m. Among the criteria are that at least 60% of the loan amount must be used for payroll costs and up to 40% for other specified costs, including payroll, interest on covered mortgages, covered rent, and covered utility payments. To have their loans forgiven, borrowers are required to properly submit applications to the SBA in accordance with specified procedures, making certain representations and providing documentation. Resulting “qualifying forgiveness,” as the CCA termed it, was excluded from gross income of an “eligible recipient” or “eligible entity” under 15 U.S.C. Section 636m(i)(1).
In an example, the CCA described a taxpayer (Taxpayer X) who received a first-draw PPP loan in 2020 and did not use the loan proceeds for eligible expenses. Taxpayer X nonetheless applied for forgiveness as if she were eligible for it, omitting relevant facts that would have indicated she was ineligible.
The CCA noted that the statutory income exclusion provisions apply only to qualifying forgiveness of a PPP loan. “Failure to meet these conditions means that there is no qualifying forgiveness, and thus the exclusions would not apply to the forgiven PPP loan,” the CCA stated. The CCA cited Springfield Hospital Inc., 28 F.4th 403 (2d Cir. 2022), in which the Second Circuit stated that “forgiveness [of a PPP loan] is neither automatic nor guaranteed. A borrower must apply for forgiveness, which will only be granted if specified criteria are met.”
The CCA stated that its conclusion is also supported by the claim-of-right tax doctrine, under which a taxpayer must include in income an amount the taxpayer receives under a claim of right without substantial restriction, even where the taxpayer may be liable to return or relinquish the amount. “[N]otwithstanding the ability of the SBA to pursue repayment in the case of misuse of funds, Taxpayer X retained the PPP loan proceeds in 2020 under a claim of right,” the CCA said. The doctrine applies even where a taxpayer obtains the amount illegally, the CCA stated, citing James, 366 U.S. 213 (1961).
To comment on this column, contact Paul Bonner, the JofA’s tax editor.