The IRS recently issued a chief counsel advice memorandum (CCA 202237010 (Aug. 19, 2022)) addressing the proper treatment of improperly forgiven PPP loans. The IRS ruled that the PPP loan forgiveness amount is not tax-free, even if the SBA and lender granted the borrower full loan forgiveness, if the taxpayer did not satisfy the factual requirements for loan forgiveness.
The paycheck protection program (PPP) is administered by the Small Business Administration (SBA) along with participating lenders. PPP loans provided small businesses with loans that could be used to maintain their payroll and certain eligible expenses like rent, utilities, mortgage interest, etc. PPP loans bore a very low rate of interest, 1%, but the most important aspect of them was that they would be forgiven in full if the proceeds were spent on payroll and certain eligible expenses within a prescribed period of time – the covered period.
Businesses applied for PPP loans through participating lenders, and the lenders processed the applications with the SBA. There were two PPP loan programs: (i) First Draw PPP Loans that were issued beginning in April 2020, and (ii) Second Draw PPP Loans that were issued beginning in January 2021. The PPP loan forgiveness rules evolved rapidly over time, and some have compared the design and execution of the PPP to flying a plane while trying to build it.
Taxation of PPP Loans
The receipt of a PPP loan, like the receipt of any loan, is not a taxable event because it includes an obligation to repay. Although a taxable event occurs when a loan is forgiven, the CARES Act (enacted March 27, 2020) excluded from gross income PPP loan forgiveness amounts. There was much back and forth about whether expense disallowance applied, which would have rendered the PPP loan forgiveness amount taxable. The IRS staked out its position in Notice 2020-32 and Rev. Rul. 2020-27 that expense disallowance applies, but Congress stepped in to reverse that position in the Consolidated Appropriations Act, 2021 (CAA), which was enacted on December 27, 2020. Section 276 of the CAA guarantees that the loan forgiveness amount will not be included in taxable income by virtue of expense disallowance.
The taxpayer in the CCA received a First Draw PPP Loan and did not use the loan proceeds on eligible expenses within the covered period. The taxpayer nevertheless applied for loan forgiveness from her lender and the SBA even though she failed to include on the loan forgiveness application the relevant facts which would have shown she was not entitled to loan forgiveness. Based on her omissions and misrepresentations, the taxpayer received forgiveness on her PPP loan and presumably she excluded from gross income the loan forgiveness amount, which is why the IRS was addressing this issue in the CCA.
The IRS examined the rules governing the PPP and noted that in order to receive loan forgiveness, a taxpayer had to be an eligible recipient and the PPP loan proceeds had to be spent on eligible expenses within the covered period. In addition, the exclusion from gross income for PPP loan forgiveness applies only to borrowers and loans within the program’s scope.
In the case of the taxpayer under consideration, the taxpayer did not spend the PPP loan proceeds on eligible expenses, and her loan forgiveness “did not constitute a qualifying forgiveness” as described in the CARES Act. Because there was no qualifying forgiveness, the exclusion from gross income did not apply. The rest of the analysis in the CCA is a relatively straightforward application of the tax law. Gross income includes all income from whatever source derived, including loan forgiveness, unless an exclusion applies. The PPP loan forgiveness exclusion applies only if the PPP requirements are met; if they are not met, the exclusion does not apply. Also, even though the SBA retains the ability to audit and pursue repayment of a PPP loan for six years after forgiveness is granted, the taxpayer in the CCA retained the PPP loan proceeds in 2020 under a claim of right, which means that 2020 is the proper year of inclusion even though repayment may have to be made in a later year.