IRS says improperly forgiven PPP loans are taxable

The Internal Revenue Service said Wednesday that improperly forgiven Paycheck Protection Program loans are taxable, as federal investigators uncover billions of dollars in fraud tied to pandemic relief programs like the PPP.

The IRS cited a memorandum released last week by its Office of Chief Counsel saying that when a taxpayer’s loan is forgiven based upon misrepresentations or omissions, the taxpayer isn’t eligible to exclude the forgiveness from income and needs to include in income the portion of the loan proceeds that were forgiven based upon misrepresentations or omissions. Taxpayers who inappropriately received forgiveness of their PPP loans should take steps to come into compliance, for example, by filing amended returns that include the amount of the forgiven loan proceeds within their stated income.

“This action underscores the Internal Revenue Service’s commitment to ensuring that all taxpayers are paying their fair share of taxes,” said IRS Commissioner Chuck Rettig in a statement Wednesday. “We want to make sure that those who are abusing such programs are held accountable, and we will be considering all available treatment and penalty streams to address the abuses.”

Up to $80 billion, or approximately 10%, of the $800 billion given out through the PPP, may have been fraudulently distributed, according to NBC News.

Other pandemic relief programs also seem to be rife with fraud, including the Employee Retention Credit, perhaps amounting to trillions of dollars ( see story).

The IRS acknowledged that many PPP loan recipients who received loan forgiveness were qualified and used the loan proceeds properly to pay their eligible expenses. However, the IRS said it has also discovered that some recipients who received loan forgiveness did not meet one or more of the eligibility conditions. These recipients received forgiveness of their PPP loan through misrepresentation or omission and either didn’t qualify to receive a PPP loan or misused the loan proceeds.

The PPP loan program was originally established by the CARES Act in March 2020 to help small businesses hit by the COVID-19 pandemic in paying certain expenses, and it was later extended in follow-up legislation and regulations that made it easier to apply for forgiveness on PPP loans. 

Under the terms of the PPP loan program, lenders can forgive the full amount of the loan if the loan recipient 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 Feb. 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 loan proceeds had to be used to pay eligible expenses, such as payroll costs, rent, interest on the business’ mortgage, and utilities.
3. The loan recipient had to apply for loan forgiveness. The loan forgiveness application required a loan recipient to attest to eligibility, verify certain financial information, and meet other legal qualifications.

If those three conditions are met, then under the PPP loan program the forgiven portion can be excluded from income. But if the conditions are not all met, then the amount of the loan proceeds that were forgiven but don’t meet the conditions have to be included in income and any additional income taxes need to be paid to the IRS.