IRS Taxing Fraudulent PPP Loan Forgiveness

On September 16, 2022, The Office of Chief Counsel of the IRS issued a memorandum regarding fraudulently forgiven PPP Loans. It seems that fraudulent PPP loan issues will never die. The short story: If you received PPP loan forgiveness under false pretenses,  you must claim that amount as taxable income. 

PPP Loan History

When the Coronavirus (Covid-19) pandemic struck in the United States, everyone was sent to a collective timeout. Businesses had to shut down. Citizens were warned to stay away from populated places. Covid-19 devastated many businesses. The government responded with the Paycheck Protection Program (PPP) Loans to assist small businesses with paying payroll and other eligible expenses. These loans were processed by lenders and guaranteed by the Small Business Administration (SBA).

There were two rounds of PPP Loans. The first was issued under the Coronavirus Aid, Relief, and Economic Security Act (CARES Act). The second was issued under the Economic Aid Act, which amended previous PPP Loan provisions. For both rounds, lenders made these loans to “eligible recipients under specified terms, conditions and processes of the program”.  The lenders could forgive the loans based on certain criteria and be reimbursed from the SBA.

Who was eligible to receive a PPP Loan?

According to the internet, EVERYBODY was eligible to receive a PPP Loan. [Insert the biggest eyeroll possible].
The actual requirements to be eligible to receive a PPP Loan were:

  1. Be a small business (as determined by the SBA), independent contractor, eligible self-employed individual, sole proprietor, business concern, or a certain type of tax-exempt organization. 
  2. In business on February 15, 2020
  3. Either had employees or was an eligible self-employed individual, sole proprietor or independent contractor.

What were eligible PPP Loan expenses?

Paycheck Protection Program loans were issued to cover specific, eligible expenses. These expenses include payroll costs, rent, interest on the business’s mortgage, utilities, and other operational expenses; SUBJECT TO REPAYMENT and additional liability if the funds were misused. You were not eligible to take PPP loan funds and start a business. 

PPP Loan forgiveness qualifications

Loan forgiveness was truly the selling point of PPP Loans. To receive PPP Loan forgiveness one had to meet the following:

  1. At least 60% of the loan must be used for payroll
  2. Up to 40% of the PPP loan could be used for other operational expenses. 

If a recipient used 100% of their PPP Loan to cover payroll costs, then the loan qualified for loan forgiveness. Forgiven PPP loan funds were excluded from taxable income. This was truly free money from the government!

Fraudulent PPP Loan Forgiveness

If you receive PPP loan forgiveness based on false statements, your loan does not actually qualify for forgiveness and must be included in taxable income. For example, let’s assume you were an eligible recipient and received a $20,000 PPP loan. Your documentation said that you used 100% of the PPP loan proceeds to pay payroll expenses (eligible expense), and the loan was forgiven. In reality, you actually used the funds to buy a car (ineligible expense). You must include the $20,000 as taxable income. 

Fraudulent PPP Loan Recipients

If you received a PPP Loan, and you were not an eligible recipient, your loan does not qualify for forgiveness. If you submitted your loan and received forgiveness, you must include the forgiven amount as taxable income. 

Let’s assume you received a $50,000 PPP loan based on false representation that you had a business with employees and received the loan disbursement. Later on, you submitted false documentation representing that you spent the loan funds on payroll for non-existent employees. You must claim the $50,000 on your tax return as taxable income. 

Forgiven PPP Loans - Income or Nah?

Internal Revenue Code Section 61(a) states that “gross income means ALL income from whatever source [legal or illegal] derived.” This applies to all payments that are “undeniable accessions to wealth, clearly realized, over which the taxpayers have complete dominion” constitute taxable income - Commissioner v. Glenshaw Glass Co. (1955). Internal Revenue Code section 636m(i) of the Covid Tenant Relief Act provides the exclusion of forgiven PPP Loan funds from gross income.

Once PPP Loans are forgiven, the funds provide for an “undeniable ascension to wealth”, especially when you flex for the ‘gram and post your ill-gotten gains. However, if your loan was forgiven based on lies - spent on ineligible expenses or you were an ineligible recipient - your loan was not forgiven based on the specific terms of the program and you must claim it as income.

Forgiven loan funds are not taxable income unless the forgiveness was based on fraud.  Let's assume that you obtained a PPP Loan fraudulently, and received forgiveness, but don't claim it on the return. Should you get caught in your illegal dealings, you should look for a charge of tax evasion to be added to the fraud charges you'll get.

How PPP Loan Fraud Gets Caught

Let me start by saying that I’m neither a detective, nor an attorney. I’m a tax professional. However, you don’t really need to be anything special to know how government systems work, especially when it comes to money. As it pertains to the Paycheck Protection Program, the Department of Justice immediately established a fraud detection unit when the CARES Act was passed in March 2020. The Inflation Reduction Act of 2022 increased the time to prosecute PPP Loan Fraud to 10 years. That has some people shaking in their boots. With this post, I’m going to share how PPP Loan Fraud is getting caught. 

Loan amount over $2 million

When the Payroll Protection Program (PPP) was created, then Secretary of the Treasury Steve Mnuchin announced that ALL PPP loans $2 million or more WILL be audited. There was no flexibility in that statement. That’s where they started, not where they stayed. People and companies that received loans in the millions were audited. If they received loans based on fraudulent information or misused funds… #Busted!

Mismatch Schedule C

In my opinion, this is the most common way PPP scammers will get caught. PPP Loans required Sole Proprietors, Independent Contractors and Single Member LLC owners to submit the Schedule C in the loan application. In the initial round of PPP disbursements, your loan amount was based on the amount of profit you earned. The rules changed once President Biden was elected. The loan was based on the amount of gross revenue shown on the Schedule C. In either case, the max amount of the loan was based on $100,000, so that the max loan amount one could receive is $20,833. 

People were submitting Schedule Cs to the bank that had not actually been filed. Because the banks were under pressure to get the money out quickly, there just wasn’t time to verify the information at the time of the loan application. An applicant could submit a Schedule C even if they had not filed their taxes yet. PPP scammers received loans of approximately $20,000 because they claimed they earned $100,000 in income. 

One of the forms you signed to get the PPP loan was a 4506-T. This form allows certain entities to pull your transcripts from the IRS. If your Schedule C doesn't match your application, or you don’t file a Schedule C at all… #Busted. 

Mismatch Employment Tax Returns (Form 941)

The purpose of the PPP Loan was to assist small businesses in continuing to pay their employees during the Covid Emergency. The loan was based on the amount of your payroll. People claimed fraudulent employees and created fraudulent employment tax returns (Form 941) showing employees and payroll amounts that didn’t exist. I had a caller tell me that someone on Clubhouse was advertising that they would create the fraudulent 941s for you to use to support your loan. 

Employment Tax Returns (form 941 filed quarterly) detail: wages you paid, income taxes, social security tax, and Medicare tax withheld. This report determines how much money your business should have paid to the government (Federal and State). The government compares what you claim on your 941s to what they have in their records. They look to see if they have records of 941s AND the money you claim to have paid to the government. Once the government determines that you have neither filed the returns, nor paid the withheld taxes… #Busted!

how ppp loan fraud gets caught
Social Media 

Social Media has to be my favorite method of the government catching thieves. These days, people can’t keep ANYTHING to themselves. They gotta flex for the ‘Gram. Oy! The government will use your Social Media posts to convict you. People were using their fraudulent PPP loan money to buy ridiculous things - expensive cars and jewelry, homes, and clothes, then posting about it on social media. There was even a guy who posted about how he was committing fraud on YouTube. What?!?! … #Busted!

Bank Secrecy Act

One of the things that PPP Loan Ballers did was take out large sums of money. The Bank Secrecy Act requires U.S. financial institutions to assist U.S. government agencies to detect and prevent money laundering. Specifically, the act requires financial institutions to keep records of cash purchases of negotiable instruments, file reports of cash transactions exceeding $10,000 (daily aggregate amount), and to report suspicious activity that might signify money laundering, tax evasion, or other criminal activities.” 

PPP Loan fraudsters were quick to withdraw money. Any time you withdraw $10,000 or more in cash, the bank reports it to the IRS. Banks were looking at accounts getting PPP loan money and then watching the activity afterward. Guess what… #Busted!

Look, lying on loan forms or any federal form is a felony. If you have to lie on a loan form, then you really don't qualify for the loan. You can go to prison. Many people thought that the government wouldn't prosecute loan scammers. They also thought that if they got caught, they would just have to pay the loan back under favorable terms. Yeah... No. Just don't lie. It's that simple.