NIL Collectives: Is there cause for panic?

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Last summer, the issue of college athletes and the three elements of their rights of publicity, those being name, image, and likeness (NIL), came to the attention of those deep thinkers at 1111 Constitution Avenue. After the Supreme Court ruled that the National Collegiate Athletic Association had violated antitrust law in restricting compensation for student-athletes, NCAA v. Alston, 594 U.S. 2147 (2021), an interim policy was adopted allowing student-athletes, under certain conditions, to profit from their publicity rights without otherwise affecting their amateur eligibility.

Cue the land-rush business by exuberant boosters to pool donations and thereby lend a helping hand to the student-athletes in exploiting their hard-won NIL opportunities. And so were created what are commonly called “NIL collectives” (an intriguing name choice in view of the likely ideology of many of the boosters). These collectives typically use their funds to compensate student-athletes for charity appearances, speaking engagements, autograph signings, social-media marketing, product endorsements, and more. According to some reports, over 200 such collectives exist, a quarter of which claim nonprofit status.

In response to this development, on June 9, 2023, the IRS released a general legal advice memorandum (GLAM), AM 2023-004, https://www.irs.gov/pub/lanoa/am-2023-004-508v.pdf, that generally surveys the current state of play in this area and concludes that “in most cases,” such NIL collectives are operating for a substantial nonexempt purpose that is more than incidental, both qualitatively and quantitatively, to any exempt purpose that may be pursued by these entities.

The GLAM reaches an eminently sensible result as most NIL collectives do inherently appear (and were initially designed) as blatant devices to simply transfer funds to those big people on campus whom everyone looks up to. It is the nature of the beast that most NIL collectives will serve the private interests of those favored student-athletes possessing appreciable NIL attributes. The GLAM is forthright in affirming that student-athletes are not themselves a recognized charitable class. Further hammering in the nail, the act of NIL collectives paying student-athletes for the use of a valuable property right “does not further educational purposes under I.R.C. § 501(c)(3).”

The initial reporting on the GLAM was pretty bleak from the perspective of the NIL collectives, but we must keep in mind that the document addresses a broad subject. For example, the GLAM notes that some collectives promise to pay out 80 to 100 percent of all contributions to student-athletes, which may not always be the case. So, all may not be lost for NIL collectives, but a drastic restructuring may be called for. The focus must be upon plainly tax-exempt purposes. A worthy cause must receive the lion’s share of munificence flowing through from those amazing boosters. And the student-athletes may have to settle for more of that warm, fuzzy feeling for helping out charities and less of that cash.

And indeed, according to the website businessofcollegesports.com, thirty-one of the listed collectives purport to serve charitable purposes, including All Good Dawgs at Butler University, Hoosiers for Good at Indiana University, and Horns with Heart at the University of Texas-Austin. It may be possible to salvage some collectives with enhanced guidelines. The GLAM does concede that if the student-athletes are selected based on need, the purpose may be considered for the relief of the poor or distressed.

But for other collectives, ones more brazen in their aims, it may even be necessary to dissolve and start anew with starkly different articles of incorporation and bylaws and with new Form 1023 applications. And this is a matter to take seriously as the GLAM indicates the IRS may reconsider the exempt status of collectives that have already received determination letters, although relief may also be granted under I.R.C. § 7805(b) to limit the retroactive effect of any revocations of tax-exempt status. And of course, donors to NIL collectives must be concerned over potential challenges to any claimed deductions under I.R.C. § 170.

The IRS’s PR Gamble on AI and Partnership Audits

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On September 8, 2023, the IRS announced that it is leveraging artificial intelligence (AI) to target large partnerships. https://www.irs.gov/newsroom/irs-announces-sweeping-effort-to-restore-fairness-to-tax-system-with-inflation-reduction-act-funding-new-compliance-efforts. Large partnerships (those with more than $100 million in assets and 100 or more partners) have been an enforcement black hole for the IRS. On average, more than 80% of large partnership audits have resulted in “no change”-– meaning that the audit resulted in no tax adjustment. This is more than double the no-change rate of large C corporation audits. While these no-change rates are disappointing from the perspective of IRS enforcement, the audits that resulted in changes fared even worse. When field audits of large partnerships resulted in changes to the return, from tax year 2010 to 2018, the average audit income adjustment was negative $264,000.

And not only has the IRS been unsuccessful in generating revenue from these audits, but large partnership audits are time consuming. IRS revenue agents spend on average 345 hours on each large partnership audit, and the audits last on average 1.7 years. The average audit closed 2.99 years after the original return was filed. This was just inside of the three-year statute of limitations on assessment. And less than one percent of these audits had a statute extension signed – surely due to the seasoned practitioners representing the taxpayers in these audits. This indicates that many of these audits may be closed because the IRS revenue agents assigned were unable to identify issues within the three-year statute of limitations, and the taxpayers wisely decided not to provide the agents with additional time.

Because of its poor selection of large partnership returns for audit, and the lack of revenue generated by such audits, by 2019 the IRS had largely abandoned large partnership audits. The IRS audited 54 large partnerships out of more than 20,000 that filed tax returns in 2019 (an audit rate of 0.3 percent). But despite these difficulties, the Government was unwilling to give up on enforcement of large partnerships. Congress granted the IRS more expansive powers when auditing large partnerships and the IRS reworked its audit selection tools.

With the enactment of the Bipartisan Budget Act, Congress centralized the partnership audit regime, effective beginning in the 2018 tax year. That regime made it easier for the IRS to audit large partnerships by (1) allowing tax adjustments and assessments to be made at the partnership level and (2) establishing a partnership representative with sole authority to act for the partnership in the audit. These changes to the previous (TEFRA) partnership audit regime made it easier for the IRS to resolve audits, assess adjustments, and collect the tax due.

Even with this increased statutory authority, the IRS still needed to figure out how to better select large partnerships for audit. The IRS has various methods for selecting returns for audit. But the most prevalent is statistical modelling. Generally, the IRS will run filed returns through its statistical models to identify returns that have a higher risk of noncompliance. Partnership returns will be run through these models twice a year. And additional runs are made whenever the IRS needs to increase its audit inventory. Classifiers then manually review returns identified as higher risk. Those classifiers will identify specific issues to audit on a return and then forward the case to an audit manager to assign to a revenue agent.

The IRS uses two statistical models to review partnership returns – the Partnership Model and the Large Partnership Compliance Model (LPCM). The Partnership Model has been used since 2018. It reviews all partnership returns for which the IRS’s Large Business & International (LB&I) Division is responsible (those being all partnership returns filed showing $10 million or more of assets). For the 2020 tax year, the Partnership Model reviewed 249,464 partnership returns with $10 million or more in assets. As of April 2023, 400 of those returns had been selected for audit.

The LPCM is the IRS’s newest statistical model aimed at partnerships, and is currently, as its name implies, being used exclusively to identify audit potential for large, complex partnerships. The new model uses multiple indicators of risk for noncompliance that are based on accounting rules, tax law, and a machine learning algorithm. IRS subject matter experts assign importance to different metrics, which the LPCM then uses to classify the risk of noncompliance for each return as very low, low, medium, high, or very high. The IRS is quite impressed by this statistical model, and has classified it as an AI system. Federal agencies are required to publish lists of AI use cases, see Executive Order 13960, Promoting the Use of Trustworthy Artificial Intelligence in the Federal Government, and the IRS includes the LPCM on its list. (Interestingly, the Treasury Department has included a redesign of the National Research Program on its latest list of AI use cases.)

But putting a name to something does not make it so. The Government Accountability Office (GAO) found deficiencies in the development and testing of the LPCM. See GAO-23-106020, IRS Audit Processes Can Be Strengthened to Address a Growing Number of Large, Complex Partnerships.

First, IRS subject matter experts tested returns that the LPCM flagged as high risk to determine whether it was correctly identifying issues with audit potential. But checks were not done of returns identified as lower risk to determine if the LPCM was failing to identify issues with audit potential. Therefore, the LPCM was developed with the use of unrepresentative data. The IRS conceded that this was due to budget and time constraints. Second, the GAO also found that the LPCM used untested assumptions to select assign audit risk to returns. As one example, assumptions used to develop the business risk indicators on partnership returns and the weighting factors used to develop aggregate risk scores were drawn from interviews with IRS subject matter experts. These individuals’ views were not tested against outcomes from audited returns or validated research. The GAO notes that these shortcomings violate best practices of statistical modeling and AI development.

Ultimately, the issues identified by the GAO can be fixed. And the GAO provides guidance to the IRS on the steps that it can take to improve the LPCM. But the IRS used the LPCM in April 2023 to identify 150 large, complex partnership returns from the 2021 tax year as having high audit potential. The IRS has assigned 75 of those returns for audit. The September 8, 2023 public announcement of those audits touts the LPCM, and specifically ties its development and deployment to the Inflation Reduction Act funding.

Based on the GAO’s findings, the IRS’s public relations efforts seem like a gamble. There may be deficiencies in the LPCM that tarnish its audit selection. And the realities of these large partnership audits, including the relative resource and information disparities between these wealthy partnerships and IRS field agents, make it difficult for the IRS to sustain successful audit adjustments. If the IRS’s large partnership enforcement shortcomings continue with these 75 large partnership audits, it may diminish support the IRS’s needed technological development and additional funding. But the IRS has apparently taken a calculated gamble that either (1) its efforts will be successful or (2) the announcement will garner positive press, and the potential negative results of these audits will not garner any press.

Yet Another Form to File with FinCEN: the Beneficial Ownership Information Report

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Unfortunately, you and/or your clients will have yet another filing requirement with the Financial Crimes Enforcement Network (FinCEN) that you’ll have to check off your “to do” list beginning as early as January 1, 2024, unless you fit within one of 23 exempt categories. Like the dreaded FBAR (Report of Foreign Bank & Financial Account, Form 114) that is required to be filed for certain foreign financial accounts held by a U.S. person, this new beneficial ownership information (BOI) report carries heavy civil and criminal penalties for either the failure to timely file or incomplete filings. Here are some bullet points to get you up-to-speed on this new FinCEN filing requirement:

  • What is the new filing requirement with FinCEN?

The Corporate Transparency Act added a new section, 31 U.S.C. § 5336, to the Bank Secrecy Act to address the broader objectives of beneficial ownership transparency. The section requires certain types of domestic and foreign entities, called “reporting companies,” to submit specified BOI reports to FinCEN. (And FinCEN already is the repository for filing various other forms such as Report 112, Currency Transaction Report; Report 110, Designation of Exempt Person; Report 111, Suspicious Activity Report; Report 114, Report of Foreign Bank and Financial Accounts; and Form 8300, Report of Cash Payments Over $10,000 Received in a Trade or Business.) In certain circumstances, FinCEN is authorized to share this BOI with government agencies, financial institutions, and financial regulators, subject to appropriate protocols.

  • Why is this BOI report required by the government?

Congress recognized that most or all states do not require information about the beneficial owners of corporations, limited liability companies, or other similar entities formed under the laws of various states. With this absence of ownership information, Congress believed that bad actors leveraged this gap of information to engage in illicit activity, including money laundering, tax fraud, financial fraud, and foreign corruption. (Congress enacted new section 5336 to subchapter II of chapter 53 of Title 31 of the United States Code.)

  • What are the penalties for failing to comply with the BOI reporting requirement?

Any person that violates the BOI reporting requirement “shall be liable to the United States for a civil penalty of not more than $500 for each day that the violation continues or has not been remedied; and may be fined not more than $10,000, imprisoned for not more than 2 years, or both.” 31 U.S.C. § 5336(h)(3)(A). A violation includes not only the failure to timely file but also the failure to submit correct BOI reports.

  • Who is required to file BOI report and when is it due with FinCEN?
    • A “reporting company” created or registered to do business before January 1, 2024 – will have until January 1, 2025 to file its initial “beneficial ownership information” report.
    • A “reporting company” created or registered on or after January 1, 2024, will have 30 days to file its initial “beneficial ownership information report.” This 30-day deadline runs from the time the company receives actual notice that its creation or registration is effective, or after a secretary of state or similar office first provides public notice of its creation or registration, whichever is earlier.
  • You mentioned “initial report.” Is this a recurring report that must be filed? 

No. The BOI report is required to be filed just once. However, If there is any change to the required information about your company or its beneficial owners in a BOI report that your company filed, your company must file an updated report no later than 30 days after the date of the change.

  • What is a “reporting company”?
    • Domestic reporting companies are corporations, limited liability companies, and any other entities created by the filing of a document with a secretary of state or any similar office in the United States.
    • Foreign reporting companies are entities (including corporations and limited liability companies) formed under the law of a foreign country that have registered to do business in the United States by the filing of a document with a secretary of state or any similar office.
  • Who is a “beneficial owner” of a “reporting company”?

A “beneficial owner” is an individual who either directly or indirectly: (1) exercises “substantial control” over the reporting company, or (2) owns or controls at least 25% of the reporting company’s ownership interests. An individual can exercise “substantial control” over a reporting company in different ways such as being a “senior officer” (the company’s president, chief financial officer, general counsel, chief executive office, chief operating officer, or any other officer who performs a similar function), possessing the authority to appoint or remove certain officers or a majority of directors (or similar body) of the reporting company, or being an “important decision-maker” for the reporting company. What would fit within the category of “important decisions” to fall within the “substantial control” net to be considered a beneficial owner? An individual that directs, determines, or has substantial influence over important decisions concerning a reporting company’s business, finances, and structure exercises substantial control over a reporting company. Examples include where a person directs the selection or termination of a business line or geographic focus, deciding whether to enter or terminate a contract, deciding where to make major expenditures or a company’s compensation scheme.

  • Are there any exceptions to the “beneficial owner” definition?

Yes. There are five exceptions to the definition of beneficial owner: (1) minor child; (2) nominee, intermediary, custodian or agent (someone who performs ordinary advisory or other contractual services such as tax professionals); (3) employees who are not senior officers with control that is derived solely from their employment status; (4) inheritor (individual’s only interest in the reporting company is a future interest through a right of inheritance); and (5) creditor.

  • What is “beneficial ownership information”?

Beneficial ownership information refers to identifying information about the individuals who directly or indirectly own or control a company. Two categories of information will be required in the BOI report: (1) information about the “reporting company”; and (2) information about the “beneficial owners” of the reporting company.

  • How much information will be required to be submitted in the BOI report?
    • Information regarding the “reporting company” – not that much information is required to be submitted to FinCEN for reporting companies. The BOI report must include the legal name of the company, and DBAs, current address, the jurisdiction of formation or registration.
    • Information regarding “beneficial owners” – not that much information is required to be submitted to FinCEN for beneficial owners. However, the problem may come from determining whether a person exercises “substantial control” over the reporting company to qualify as a “beneficial owner.” Once “beneficial owners” are determined, most of the BOI report will include basic data such as the full legal name of the beneficial owner, DOB, and their current residential or business address. The troublesome part for “beneficial owners” is that the BOI report must include a unique identifying number from an image sourced from one of four types of acceptable identification documents: (1) a nonexpired U.S. passport; (2) a nonexpired state, local, or Tribal identification document; (3) a nonexpired state-issued driver’s license; or, (4) if an individual lacks one of those other documents, a nonexpired foreign passport. So, this central BOI database will include not only beneficial owner information but a picture of each beneficial owner. In response to concerns that the government would possess a public database of photos of these beneficial owners, FinCEN responded, “images of identification documents will assist law enforcement in accurately identifying individuals in the course of an investigation because those scans will contain a picture of the person associated with the identifying number.” https://www.federalregister.gov/documents/2022/09/30/2022-21020/beneficial-ownership-information-reporting-requirements#footnote-308-p59567
  • Are there any entities that are exempt from the BOI reporting requirement?

Yes. Congress exempted 23 specific types of entities from the BOI reporting requirement:

One exempt category is for “large operating companies,” applicable if all six criteria below apply:

  • Are reporting companies required to report their “company applicants” (individuals who assisted in directly filing the document that created a domestic reporting company with the secretary of state or similar office) to FinCEN as part of this process?

The answer depends on when the reporting company was created. If the reporting company was created before January 1, 2024, then the reporting company is not required to report its company applicants. However, if the reporting company was created on or after January 1, 2024, then the reporting company is required to report its company applicants.

  • Can accounting firms assist me in filing this new BOI report with FinCEN?

TBD. We’ve heard from a few accounting firms that their insurance carriers believe the preparation and filing of these new BOI reports with FinCEN would involve the unlawful practice of law. As such, a few accounting firms have advised us that they would not engage in this work. However, our law firm will be taking on the work of preparing and filing BOI reports.

Inflation Reduction Act of 2022 – Update to EV Tax Credits

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The Inflation Reduction Act (“IRA”) enacted August 16, 2022 includes a number of provisions addressing the tax credit for new and used electric vehicles.  The IRA provides significant changes to the existing tax credit under section 30D and two new “clean” vehicle credits – section 25E (for used vehicles) and section 45W (commercial vehicles).  For an easy introduction to these provisions, let’s start with an overview via the following diagram:

Changes to New Vehicle Purchases Provided Under Section 30D

  • Before IRA of 2022: Section 30D provides a credit for qualified plug-in electric drive motor vehicles including passenger and light trucks for vehicles purchased after December 31, 2009.
    • Tax credit structure: base credit of $2,500 and $417 for each kilowatt hour of battery above 5 kilowatt hours allowing an additional max credit of $5,000.  No critical component or battery sourcing requirement.
    • 200,000 limit for vehicles. The credit begins to phase out for a manufacturer’s vehicles when at least 200,000 qualifying vehicles have been sold for use in the United States (determined on a cumulative basis for sales after December 31, 2009).
    • No income threshold for EV tax credit eligibility. Even if your taxable income is $1,000,000, you are eligible for a EV tax credit.
    • No price cap for vehicles that qualified for EV tax credit upon purchase.
  • Changes under the IRA to Section 30D:
    • New tax credit structure for “clean” vehicles: two-part credit up to max of $7,500 (Part 1 = new critical minerals requirement; Part 2 = new battery component requirement).  40-50% of the critical minerals and battery components cannot be sourced from a foreign covered nation, such as China and Russia.[1]
    • Eliminates the 200,000 qualifying vehicle limit
    • New income threshold for eligibility to obtain the clean vehicle tax credit. Based on filing status, any taxpayer with MAGI exceeding a threshold amount cannot qualify for an EV tax credit under section 30D:
      • MFJ filers – MAGI >$300,000,
      • HH filers – MAGI > $225,00, or
      • Single filers – MAGI >$150,000.
    • New car price cap – If a manufacturer’s suggested retail price exceeds a threshold amount, then the vehicle is not eligible for tax credit under section 30D.
      • Vans, SUVs and pick-up trucks – retail price cannot exceed $80,000
      • Any other vehicle – retail price cannot exceed $55,000.
    • New “final assembly” requirement must occur in North America. This provision applies after August 16, 2022.  The U.S. Department of Energy provided a list of 2022 and early 2023 models that meet the “final assembly” requirement here:  https://afdc.energy.gov/laws/inflation-reduction-act.  And, you can go to the following U.S. Department of Transportation link to search by VIN to determine the final assembly status for a new car:  https://vpic.nhtsa.dot.gov/decoder/
    • New transferability of tax credit to dealers who are registered with the Treasury Department so taxpayers who otherwise would not have enough tax liability to fully utilize the credit can take advantage of the credit. The credit is transferred to the dealer, and the dealer lowers the selling price to the buyer.  But, check the effective date in the diagram above for this new transferability of the tax credit.
    • Effective Date: applies to vehicles acquired 2023 thru 2032.  However, the “final assembly” requirement for application of section 30D applies after August 16, 2022

Let’s try a scenario to test our understanding of these new rules:

Scenario:  On August 1, 2022, you visited a Tesla showroom in Walnut Creek, CA and put a $250 nonrefundable deposit for a new Tesla Model Y with a suggested retail price of $67,000.  Tesla tells you that the car may be delivered to you anytime from October 2022 thru February 2023.  Your MAGI is $350,000 and your filing status is “married filing joint.”  Since you put the deposit down before IRA 2022 was enacted and effective, can you still qualify for the credit?

Answer:  No.  First, the 200,000 vehicle limit for the Model Y Tesla was exceeded before Aug. 1, 2022 under the old version of Sec. 30D.  Second, what if the vehicle limit wasn’t exceeded for the Model Y?  Here is the transition rule that addresses this situation per the IRS:  “If you entered into a written binding contract to purchase a new qualifying electric vehicle before August 16, 2022, but do not take possession of the vehicle until on or after August 16, 2022 (for example, because the vehicle has not been delivered), you may claim the EV credit based on the rules that were in effect before August 16, 2022.”  Because your $250 deposit was likely not a “written binding contract,” you probably don’t qualify for the EV credit under the old rule.  OK, what’s with the hedging language on “written binding contract”?   The IRS stated in its website (nonbinding source) that “a written contract is binding if it is enforceable under State law and does not limit damages to a specified amount (for example, by use of a liquidated damages provision or the forfeiture of a deposit)….if a customer has made a non-refundable deposit or down payment of 5 percent of the total contract price, it is an indication of a binding contract.”  With this explanation, it’s uncertain whether a $250 non-refundable deposit qualifies as a “written binding contract.”  So, if you put down a non-refundable deposit for an EV in effect before August 16, 2022 that did not exceed the vehicle limit, look for IRS guidance with more precision on what constitutes a “written binding contract.”

New Section 45W Creates Business Tax Credit for Commercial Clean Vehicles

  • Effective 2023 thru 2032.
  • Limited to commercial use, placed in service 2023 thru 2032, purchase or lease
  • No “final assembly” in North America required as in amended section 30D(d)(1)(g) for new, non-commercial vehicles.
  • (*) No income limits as in 30D and 25E
  • Limit of tax credit:
    • Lesser of:  (1) 15% of cost basis; 30% if 100% EV, not hybrid; or (2) incremental cost of the vehicle – increased cost between the “qualified commercial clean vehicle” and a “comparable vehicle” (gas/diesel only vehicle that is similar in size and use).  Gray area:  Since this is a “lesser of” test for the tax credit, you have to determine the “comparable vehicle”.  Section 45W(f) provides that the Treasury “shall” issue regulations relating to determination of the incremental cost of any qualified commercial clean vehicle. But who knows when such regulations will be issued.
    • Limit for tax credit:
      • $7,500 if GVW < 14,000 lbs, or
      • $40,000, if GVW 14,000 lbs or greater.
  • Commercial EV credit can apply to new and used cars.
  • Sec. 45W cannot apply if the car already received the EV credit earlier.  E.g., the original buyer claimed the credit, now the new commercial buyer buys the car.

New Section 25E creates a tax credit for previously-owned clean vehicles

  • Effective starting in 2023 – 2032.
  • Limited to individuals (no entities) to qualify for credit.
  • MAGI limits to eligibility for this vehicle tax credit ($75,000 for single; $150,000 for joint filers).
  • Sale price cannot exceed $25,000.
  • Limited to the first transfer since enactment date of 25E (no resellers).
  • Credit is lesser of: $4,000 or 30% of vehicle sale price.
  • Model year is at least 2 years earlier than the purchase year.
  • GVW < 14,000 lbs.
  • Limit of using this credit 1 time within a 3-year period for each buyer.
  • A sale to a spouse or dependent does not qualify for this vehicle tax credit.
  • Purchased from a dealer (a person licensed to engage in the sale of vehicles) – so sales of used vehicles owner to owner doesn’t count.
  • Qualified buyer can transfer the credit to the selling car dealer, but only starting in 2024, not 2023.
    • Question: is this credit available if the original buyer received an EV tax credit?  There is no double benefit prohibition as in section 45W.

[1] GM stated that this new requirement for sourcing included in the IRA will be “challenging.”  However, on Aug. 29, 2022, CNN Business reported that Honda struck a deal with Korean battery giant LG Energy Solution to build a $4.4 billion U.S. factory to supply its electric vehicles.  In May 2022, Hyundai announced that it was building a battery plant in Georgia.  Earlier in 2022, Mercedes-Benz opened a battery plant in Alabama, as reported by CNN Business.

 

Some Recipients of PPP Loan Forgiveness Face Tax Jeopardy

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In this article, Anthony Kim explores the implications for taxpayers who had their Paycheck Protection Program loans forgiven, including potential legal jeopardy stemming from improperly issued loans and forgiveness.

The COVID-19 pandemic presented unprecedented challenges for Americans from all walks of life. Not surprisingly, the federal government reacted to this crisis by offering substantial financial aid to businesses and consumers. As part of the Coronavirus Aid, Relief, and Economic Security Act, the government made hundreds of billions of dollars in forgivable loans available to American businesses through the Paycheck Protection Program. These loans were offered to businesses so they would have funds available to keep paying their workers and thus avoid catastrophic job losses during a time of national emergency. The PPP was intended to provide a much-needed lifeline to American businesses and workers who were suffering during the national emergency. Better still, once the PPP loans were properly forgiven (see below), the loan amounts aren’t treated as taxable income.

By the time the program ended on May 31, 2021, more than 11 million PPP loans had been extended, with a total value of about $786 billion.[1] Borrowers under the program could qualify for loan forgiveness by submitting Small Business Administration Form 3508S, “PPP Loan Forgiveness Application,” a one-page form seeking basic information and, most importantly, written confirmation that the borrower complied with all PPP forgiveness requirements — for example, rules regarding eligible uses of loan proceeds and a declaration that the proceeds had been used for eligible payroll and non-payroll costs.[2]

Notably, the PPP loan forgiveness process listed documents that each borrower “must maintain but is not required to submit.” With a basic one-page form and no supporting documentation to submit, how many applicants received PPP loan forgiveness? Ninety-two percent of loan recipients sought forgiveness of loans totaling about $753 billion,[3] and almost everyone that requested PPP loan forgiveness received it: 10,482,553 PPP loan forgiveness applications were received, with 10,436,367 fully or partially forgiven, for a total of $742,833,627,955.[4] Of the applicants that submitted Form 3508S, 99.6 percent received PPP loan forgiveness.[5] While under normal circumstances a forgiven loan means the amount becomes taxable income, PPP loan recipients escaped this liability as long as they qualified under the PPP criteria for loan forgiveness.[6]

With the disbursement of so much easy money, criminal opportunists naturally were drawn to the program. Enforcement statistics released by the Department of Justice taken against various bad actors that tried to exploit the PPP are alarming. In 2020 the Justice Department announced that it had charged 57 defendants with PPP-related fraud for their attempts to steal over $175 million from the program.[7] Just two years later, the Justice Department announced that it had seized more than $1.2 billion in fraudulently obtained COVID-19 relief funds and had charged more than 1,500 defendants with crimes in federal districts across the country.[8] And the Justice Department continues to ramp up its focus on PPP-related fraud. In September the department announced the establishment of three strike force teams to further enhance efforts to combat and prevent COVID-19-related fraud.[9]

Along with the Justice Department’s criminal enforcement measures, what can we expect from the IRS regarding the PPP? First, anyone that obtained a PPP loan through an illegal scheme or by other fraudulent means must include income derived from those illegal or criminal activities in the same manner as income from other sources.[10] A loan doesn’t constitute income to the borrower because of the corresponding obligation to repay the sum borrowed.[11] However, if the facts establish that the recipient recognizes no obligation to repay the loan, the transaction can become a wrongful appropriation and fall within the broad definition of gross income.[12] Thus, taxpayers caught in the wide net of the Justice Department’s PPP-related criminal fraud investigations will be determined to have illegal gross income.

Second, even if a recipient of a fraudulent PPP loan managed to avoid the Justice Department’s criminal sweep, the next potential snare is whether the loan was properly forgiven. A seemingly anodyne IRS chief counsel advice released September 16 (ILM 202237010) concluded that if a taxpayer fails to satisfy the conditions for PPP loan forgiveness, they have reportable gross income equal to the amount of the loan.[13]

The amount of a PPP loan that is properly forgiven as provided under the PPP isn’t included as gross income for federal income tax purposes.[14] Qualifying forgiveness occurs if the PPP loan recipient satisfies the forgiveness criteria set forth in 15 U.S.C. sections 636m and 636(a)(37)(J), the participating lender forgives the loan in whole or in part, and the forgiven amount doesn’t exceed the full principal amount of the loan. To request forgiveness of a PPP loan, the loan recipient (or an authorized representative) must attest to eligibility for forgiveness, including verifying that the loan proceeds were properly used for eligible expenses, that the amount applied for forgiveness satisfies all the limitations relating to specified costs, and that other legal requirements were met. To receive qualifying forgiveness on a PPP loan, at least 60 percent of the loan amount must be used for payroll costs, and up to 40 percent of the loan amount may be used for other specified costs.

What does the PPP loan forgiveness process mean for federal tax purposes? Taxpayers that had their PPP loans forgiven but rushed through the process and maintained poor supporting documents have reason to worry. Discovering whether a PPP loan recipient failed to report gross income for the loan amount that didn’t (or can’t) qualify for loan forgiveness is low-hanging fruit for a revenue agent conducting an audit. The name of every recipient of a PPP loan is publicly available; a revenue agent can easily search publicly available sources to find the name of any given recipient.[15]

During an audit, the revenue agent could ask the taxpayer for basic information to determine if the taxpayer failed to report the forgiven amount of their PPP loan on their federal income tax return. In an information document request, the IRS could simply ask a taxpayer for information that Form 3508S required applicants to maintain to qualify for loan forgiveness. As a former IRS attorney who advised revenue agents conducting audits, I would recommend that the government seek basic information on the PPP loan forgiveness issue as follows:

  • You, Mr. John Doe, received a PPP loan in the amount of $XXX,XXX in tax year 202X. If this is incorrect, please explain.
  • To request forgiveness of a PPP loan, the loan recipient must attest to eligibility for forgiveness, including by verifying that the loan proceeds were properly expended on eligible expenses and that the amount applied for forgiveness satisfies all the limitations relating to specified costs, and meet other legal requirements. Did you file (by paper or electronically) Form 3508S to request forgiveness of your PPP loan received in tax year 202X?
    1. If yes, provide the following:
      1. a copy of your filed application (Form 3508S), including the signed attestation requesting forgiveness of your PPP loan;
      2. contact information, title, and authority of the individual who signed the attestation requesting forgiveness of your PPP loan;
  • name(s) and contact information of any third party that assisted you with the PPP loan forgiveness application;
  1. name(s) and contact information of any person(s) or entity(ies) that possess, or could possess, documents supporting your application for PPP loan forgiveness (the specific list of required supporting documents for PPP loan forgiveness is set out on pages 4 and 5 of Form 3508S);
  2. any and all documents and representations required by 15 U.S.C. section 636m(e) and by the SBA that support your application for PPP loan forgiveness (the specific list of required supporting documents for PPP loan forgiveness is set out on pages 4 and 5 of Form 3508S); and
  3. any and all documents, including correspondence with third parties and authorized representative(s), related to your application requesting forgiveness of your PPP loan.
  1. If you assert that any of the requested information in request 2.a.i through 2.a.v above is subject to either attorney-client privilege, federal tax practitioner privilege under 26 U.S.C. 7525, or work-product privilege prepared in anticipation of litigation, provide a log specifically asserting each applicable privilege along with: (1) the name(s) of the author(s), recipient(s), and individual(s) copied on the communication; (2) the subject matter of the communication/document; and (3) the date of the document/correspondence.

The taxpayer’s responses to those questions will help determine whether the PPP loan recipient properly qualified for loan forgiveness. As concluded in ILM 202237010, if a taxpayer does not factually satisfy the conditions for PPP loan forgiveness because they inaccurately represented that they satisfied them, the taxpayer has reportable gross income.[16] And if a taxpayer’s responses to IRS questions during a civil tax audit present evidence of deception, the situation becomes far more complicated.

Who is likely to be selected for audit and receive these IRS information document requests? The potential population to be audited is large: More than 10 million applicants received full or partial loan forgiveness of PPP loans.[17] It will be interesting to see how the IRS decides to pursue this PPP loan forgiveness issue. It may begin by sending out to the entire population of forgiven loan recipients a soft letter noting a potential noncompliance issue and requesting a response from the taxpayer.

What is an IRS “soft letter?” As part of its compliance campaign program, and sometimes before an examination has begun, the IRS may send a taxpayer a letter inquiring about a tax position the taxpayer has taken or asking the taxpayer to take some action, such as providing specific information. For example, the IRS issued a soft letter to some taxpayers addressing virtual currency transactions.[18] In this letter, the IRS instructed that the taxpayers take specific actions by a fixed date. Taxpayers aren’t required to respond to a soft letter, but disregarding the IRS’s friendly tap on the shoulder for information could trigger an audit.[19]

Beyond the scary possibility of being selected for an audit or receiving a soft letter regarding PPP loan forgiveness, there are other issues for forgiven PPP loan recipients to worry about:

  • Potential application of the civil fraud penalty under section 6663, a 75 percent addition to any tax due.
  • Possible referral for criminal investigation. Internal Revenue Manual section 25.1.3.1.1(1) instructs IRS agents to refer a taxpayer for criminal investigation when affirmative acts of fraud are found. If an agent discovers that a taxpayer inaccurately represented that they satisfied loan forgiveness conditions in attested documents and determines the presence of affirmative acts of fraud/deception, the revenue agent must suspend the civil examination and refer the matter for criminal investigation. IRM section 25.1.3.3(3).

If the points discussed above cause a PPP loan recipient whose loan was forgiven some anxiety, he may think that filing an amended return reporting gross income of the amount of improperly forgiven PPP loan will correct the problem and at least start the statute of limitations period. Not so. In Badaracco,[20] the U.S. Supreme Court held that “a taxpayer who submits a fraudulent return does not purge the fraud by subsequent voluntary disclosure; the fraud was committed, the offense completed, when the original return was prepared and filed.” So filing an amended return won’t provide relief from a civil fraud penalty or start the statute of limitations for assessment. If the IRS determines that a taxpayer committed fraud by requesting and receiving PPP loan forgiveness, it has no time limit to contact the taxpayer about their failure to report forgiveness of PPP loan income. The issue could hang over the taxpayer forever.[21] That’s a significant COVID-19 hangover.

If a taxpayer knows that they didn’t factually satisfy the conditions for PPP loan forgiveness and inaccurately represented that they satisfied them, can they mitigate criminal liability somehow? Would the filing of an amended tax return help avert a criminal prosecution?

Don Davidson was an assistant U.S. attorney with the Justice Department, a deputy general counsel, a senior vice president at UBS Financial Services, and a partner with a trio of multinational law firms in New York and San Francisco. Given his experience with criminal matters in both the public and private sectors, I asked Don for his views on a basic fact pattern regarding this PPP loan forgiveness issue: A taxpayer received a PPP loan, received forgiveness of the loan, and knows that he didn’t meet the criteria for loan forgiveness even though he attested to meeting requirements when he filed Form 3508S with the SBA. The taxpayer is concerned about possible criminal liability from this situation. Does the taxpayer have any potential criminal exposure? And if so, is there anything the taxpayer can do now to reduce his potential criminal exposure?

Davidson confirmed that under the facts presented the taxpayer is subject to potential prosecution for both the underlying fraud against the PPP and the false return, with a tax evasion offense arising from their failure to properly report the income associated with the improperly forgiven PPP loan. Also, he noted that filing an amended return, or “self-reporting” after the crime is complete, isn’t a Get Out of Jail Free card, though it may help to reduce the potential punishment. Legally, the fraud crime is complete when the false attestation has been submitted, and the tax crime is complete when the false return has been filed.

As a former federal prosecutor, Davidson offered this view for those who may be concerned about criminal liability from PPP-related offenses:

There are pros and cons to tacking a criminal tax charge on to a case involving some illicit monetary gain (e.g., fraud, bribery, extortion, money laundering, etc.). On the plus side, a tax charge provides both additional plea-bargaining leverage and significant investigative resources from the IRS’s Criminal Investigation division (“CID”). CID agents are often invaluable in white-collar cases because they bring demonstrated skill and expertise in following complicated monetary transactions and deciphering mounds of financial documents, account statements, and the like. The downside of bringing the IRS into a criminal case is that the agency is going to rightfully expect that a “tax count” (i.e., some violation of Title 26 of the United States Code) will be included in the charges that eventually will be brought. Charging a tax offense, in turn, requires the United States Attorney’s Office to consult and receive written approval from their counterparts at “Tax Justice,” the tax crime subject matter experts at Justice Department headquarters in Washington, D.C. Since the 94 U.S. Attorneys Offices largely work independently and normally do not need sign off from “Main Justice” to prosecute most cases, the requirement to consult and seek approval from the tax specialists in Washington, D.C., is generally something they would prefer to avoid if possible. Nevertheless, despite the extra administrative and logistical burden of prosecuting a criminal tax charge, I usually found it a worthwhile trade-off in order to get the benefit of the CID investigators. Adding a CID agent or two to an investigative team is a true “force multiplier” for federal prosecutors, and the unhappy target who finds himself or herself on the business end of such an investigation is in a very precarious position.[22]

In sum, if you submitted Form 3508S, received PPP loan forgiveness, and maintained the proper paperwork required to qualify for loan forgiveness under the program, there is little to worry about. You may need to respond to an IRS soft letter, but I suspect that of the more than 10 million applicants who received full or partial forgiveness of PPP loans totaling more than $742 billion, there are many who will be dealing with far more than a soft letter.

[1]Small Business Administration, “Forgiveness Platform Lender Submission Metrics” (Sept. 11, 2022).

[2]SBA, Form 3508S, “PPP Loan Forgiveness Application” (revised July 30, 2021).

[3]SBA, supra note 1.

[4]Id.

[5]Id.

[6]IRC section 61(a)(11); section 1106(i) of the CARES Act.

[7]Justice Department, “Acting Assistant Attorney General Brian Rabbitt Delivers Remarks at the PPP Criminal Fraud Enforcement Action Press Conference” (Sept. 10, 2020).

[8]Justice Department, “Justice Department Announces COVID-19 Fraud Strike Force Teams” (Sept. 14, 2022).

[9]Id.

[10]Reg. section 1.61-14.

[11]James v. United States, 366 U.S. 213, 219 (1961).

[12]United States v. Rochelle, 384 F.2d 748, 751 (5th Cir. 1967) (holding that fraudulently obtained funds were taxable to the recipient, even though he had received them in the form of loans, since he had no intention of fulfilling his representation or repaying the moneys he received).

[13]Chief counsel advice is a term used to describe a subset of legal advice that is required to be released to the public under section 6110. Not all legal advice is subject to this public disclosure requirement. Chief Counsel Directives Manual section 33.1.2.2.3.2(4).

[14]Section 1106(i) of the CARES Act provides that for purposes of the code, any amount that would be includible in gross income of the recipient by reason of forgiveness described in section 1106(b) “shall be excluded from gross income.” Thus, section 1106(i) operates to exclude from the gross income of a recipient any category of income that may arise from covered loan forgiveness, regardless of whether that income would be (1) properly characterized as income from the discharge of indebtedness under IRC section 61(a)(11), or (2) otherwise includible in gross income under IRC section 61. However, it’s important to note that many states may address forgiven PPP loans by either treating forgiven loans as taxable income, denying the deduction for expenses paid for using forgiven loans, or both. For a summary of how various states are addressing the forgiven PPP loans, see Katherine Loughead, “Which States Are Taxing Forgiven PPP Loans?” Tax Foundation (last updated Aug. 23, 2021).

[15]Moiz Syed and Derek Willis, “Tracking PPP,” ProPublica, July 7, 2022.

[16]Section 61(a) generally provides that “gross income means all income from whatever source derived.” That applies to all payments that are “undeniable accessions to wealth, clearly realized, and over which the taxpayers have complete dominion.” Commissioner v. Glenshaw Glass Co., 348 U.S. 426, 431 (1955). Even if the SBA can pursue repayment in the case of the misuse of PPP funds, a recipient that retained the PPP loan proceeds under a claim of right has gross income under section 61(a).

[17]Id.

[18]IRS, “Reporting Virtual Currency Transactions.”

[19]There have been grumblings about the use of soft letters by the IRS. National Taxpayer Advocate, “Objectives Report to Congress: Fiscal Year 2021,” at 79 (June 29, 2020).

[20]Badaracco v. Commissioner, 464 U.S. 386 (1984).

[21]If a taxpayer received PPP loan forgiveness, knew the application was false, and bragged to others about this deception, the taxpayer is at risk that the information will make its way to the IRS through a whistleblower submission. The tax code provides a financial award for whistleblowers who provide information to the IRS that assists in the detection of underpayments of tax. Section 7623.

[22]Email to author from Donald S. Davidson.

Amobi Okugo: Financial Tips for Athletes (and everyone!)

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By Annie Tyler and Anthony Kim, Esq.

Amobi Okugo recently retired after 13 years as a professional soccer player. In 2010, Amobi was drafted in the first round (6th overall) in the Major League Soccer (“MLS”) SuperDraft by the Philadelphia Union. Over the course of his stellar soccer career, he played on six different MLS teams. Recognized as Forbes 30 under 30 for achievements on and off the field, Amobi Okugo is a first generation Nigerian American professional soccer player, founder of Frugal Athlete (https://www.afrugalathlete.com/) which helps empower athletes through financial education, a philanthropist launching the OK U GO Foundation (https://okugofoundation.org/) to help black and brown youth by creating the foundation for future financial stability, and a content creator on Instagram, YouTube, Twitter, TikTok, LinkedIn, and Apple Podcasts. MLS star Amobi Okugo has taken his experiences as a professional athlete and applied them to his next adventure in life, which is being a
financial advocate, planner, and advisor.

Given Amobi’s focus on financial literacy and the importance of proper planning for athletes and underserved kids, the attorneys at Norton Basu LLP (https://www.nortonbasu.com/) and Kim & Rosado LLP (https://www.kimrosado.com/) invited him to share his thoughts. Here is what we learned in our interview with Amobi on November 21, 2022:

Q: Tell us about your soccer career before you turned pro?

Amobi: I was fortunate enough to play soccer at a very young age, at a very high level, so I always joke around that I was a pro before going pro. My parents got me in soccer because it was a way to stay active first and foremost, and to stay busy with extracurricular activities. I built skills that can only be learned through sports.

Q: What was your experience as a Major League Soccer Player?

Amobi: It was amazing, but it went by quickly. There are so many things that you take for granted until you’re done playing. Soccer is truly a global game. I played with people from various countries and cultures such as Africa, South America, and Europe. I was able to compete at a high level and get paid for it. Athletes were naturally competitive, we’re naturally greedy, so we don’t really come to appreciate those moments. At the end of the day what are you really complaining about? You’re playing soccer for a living!

Q: What did you know about how to manage your financial situation when you first became a Major League soccer player?

Amobi: When I first became a professional soccer player, I didn’t know much about managing finances. I thought: You make money, and you save money. But when it comes to investing, taxes, and estate planning there are different factors to consider when you’re making substantial money. And it goes deeper than that, depending on how you live, where you live, and what you want for your life. All those factors play a big role in your overall financial performance and there’s a lot of lessons that I had to learn either through trial and error or just by asking questions.

Q: What do you know now that you wish you would have known when you entered the world of professional sports, in terms of finance?

Amobi: I wish I knew different tax strategies and estate planning. As athletes, we want to build a legacy.

Q: When did you finish your career as a professional athlete?

Amobi: I’m done playing, I retired last year.

Q: How has your experience as a professional athlete impacted your career path?

Amobi: I think it’s impacted everything, especially me right now, as a pseudo-entrepreneur. I’ve applied what I learned to the work that I’m doing now, which is financial literacy, a little bit of sports business, a little bit of marketing.

Q: What are a few key financial lessons that you think are important for people to know?

Amobi: I think the biggest one for me is the legal and tax ramifications to various types of investments. I think another one is understanding your budget. Sometimes the hardest thing to do is the simplest thing. And then, lastly, investing, because there are many ways to get to the top of the mountain. Some people like to invest in real estate. Some people like to invest in alternative assets. Some people like to invest in the stock market, so it’s finding what works for you and staying diversified within that. Everyone has their main asset-grower or asset-builder.

Q: Now that you’re rich and famous, and knowing that there is a legacy of many very famous, wealthy, and accomplished people passing away without an estate plan such Whitney Houston, Aretha Franklin, and Prince – and so many others – what do you know about estate planning?

Amobi: This is a great point that you bring up. I think, as athletes, we think we’re going to play forever and we’re going to live forever. We never want to have a GoFundMe page to take care of our family if we’re gone. That’s why we work so hard, to make sure that our family and our loved ones are supported long after we’re gone. And we don’t want our family fighting over, “Who gets what?”

Q: Do you plan to have total assets over 12 million dollars during your lifetime?

Amobi: Ideally, yes.

Q: Then we’re going to talk about what’s called the Basic Exclusion Amount. The acronym is BEA. It’s about 12 million dollars. It goes up every year, but based on projected tax law, it may go down dramatically. If your estate is valued at less than 12 million dollars, you pay zero estate tax. The estate tax rate can vary between 18 to 40 percent, which is separate from income tax.

But what if your estate is above the estate tax limit? Knowledge is power, and you must plan for it.

Should tax and estate planning be part of personal financial planning?

Amobi: Most definitely, I think it’s part of the holistic financial portfolio. That would be like working out and only working your upper body and missing out on your legs, your core, and your cardio.