The forgivable loan program known as the Paycheck Protection Program (PPP) was established by the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) to provide financial resources to small and mid-size businesses to enable them to maintain payroll and cover certain expenses during the coronavirus pandemic. PPP loans may be forgiven upon application. Although loan forgiveness typically creates a taxable event, under the CARES Act, PPP loan proceeds are specifically excluded from taxable income. However, PPP loan recipients should be aware that forgiveness of the loan, in whole or in part, may cause 2020 qualified research expenses (QREs) to become ineligible for the research and development (R&D) tax credit. Under Internal Revenue Code Section 41(d)(1)(A), a taxpayer cannot claim an R&D tax credit on expenditures (employee wages tend to be a large component of the qualified research expenses) that are not deductible, and based on guidance issued by the IRS in March 2020 (Notice 2020-32), expenses paid using forgiven PPP loan funds will be nondeductible for tax purposes even if they would otherwise be deductible. Consequently, any wages paid to employees using forgiven PPP loan proceeds are not eligible as QREs, thus, decreasing federal and state R&D credits.

Understanding PPP Loan Forgiveness

It is important to understand how forgivable PPP loan funds must be allocated among a taxpayer’s costs so that eligible R&D expenses incurred might still qualify for the R&D tax credit. Current guidance provides that PPP forgivable loan funds must be applied to the following expenses:

PPP loan forgiveness application forms include a requirement that the borrower maintain all records relating to the borrower’s PPP loan (including documentation necessary to support the borrower’s loan forgiveness application, such as the names of individual employees and wages).[1] However, there is no requirement on how the PPP loan funds have to be allocated to individual employees, which allows the borrower to make its own determination as to which employees the PPP forgivable loan funds should be applied.

Mitigating the Effect of PPP Loan Forgiveness on the R&D Costs

By applying the PPP forgivable loan funds to nonpayroll costs (up to 40% of the PPP loan funds) and employees that do not perform qualified research activities, borrowers could preserve the wages paid to employees involved in qualified research activities as deductible, thus mitigating the impact of the forgiven PPP loan funds on their R&D credit.

Companies claiming R&D tax credits and that have filed or have yet to file for PPP loan forgiveness should consider analyzing the eligible costs and allocating the forgivable funds in the following order (up to the certain limitations):

  1. Interest on mortgage obligations
  2. Rent
  3. Utilities
  4. Interest on any other existing debt obligations
  5. Certain employee benefits relating to healthcare
  6. Payroll costs that are non-taxable
  7. Payroll costs for employees who are not performing R&D-qualified services, e.g., accounting, finance, human resources
  8. Payroll costs for employees who are performing R&D-qualified services[2]



The following example shows how PPP forgiven loan funds used for QREs can reduce the amount of R&D tax credit available to borrowers.

Alternative Simplified Credit 2020 Credit Reduction for PPP Loan Forgiveness Adjusted 2020 Credit
Qualified Wages $3,500,000 ($1,050,000) $2,450,000
Qualified Supplies $500,000 $500,000
Rental or Lease Cost of Computers
Qualified Contract Research $225,000 $225,000
Total QREs $4,225,000 ($1,050,000) $3,175,000
Base Amount (Sum of Prior 3 Years QREs Divided by 6) $1,870,333 $1,870,333
Incremental Qualified Expenses $2,354,167 ($1,050,000) $1,304,167
Total Gross Research Credit $329,583 ($147,000) $182,583



PPP loan recipients should review their PPP eligible costs to determine whether they can reduce the impact on the R&D tax credit by allocating some or all of their forgivable PPP loan funds to expenses other than research-related expenses. Key items to review include whether and to what extent the loan recipient:

Future IRS guidance may create additional requirements relating to the allocation of the PPP forgivable loan funds to costs, so it is important for taxpayers with PPP loans that want to qualify for the R&D tax credit to monitor developments carefully.

[1]  Form 3508 Schedule A Worksheet requires borrowers to list the names of individual employees to whom the requested PPP forgivable loan funds were applied.  Form 3508 Schedule A Worksheet must be maintained by the borrower but is not required to be submitted with the PPP loan forgiveness application to the lender.

[2] For each individual employee, the total amount of cash compensation eligible for PPP loan forgiveness may not exceed an annual salary of $100,000, as prorated for the covered period.

Earlier in the year, the Small Business Administration (SBA) announced in an updated FAQ on the program that it will be auditing all Paycheck Protection Program (PPP) loans of $2 million or more. Borrowers whose loans meet this threshold amount might receive a Loan Necessity Questionnaire from their lender soon after they apply for loan forgiveness.

Even though the official channels indicate the questionnaire is not yet final, we understand that SBA is already sending letters to lenders instructing them to send the questionnaire to specific borrowers within five business days. Borrowers have only 10 business days of receipt of the questionnaire to return a completed version to the lender, which the lender must then submit to SBA within five business days. Both borrowers and lenders may be surprised by the short turnaround time and the extent of detailed information requested, as well as signatures, certifications and supporting documentation. Since the requested information may not be readily available and could take considerable time and effort to compile, borrowers should begin gathering the information on the questionnaire even before they receive the request from their lender.


SBA has already sent the questionnaire to some PPP lenders for delivery to borrowers, although SBA has not officially announced the finalization of the form and the process.

For-profit employers will receive Form 3509 asking about business operations, while non-profit employers will receive Form 3510.

Unlike the PPP loan application and loan forgiveness forms, SBA has not yet posted Form 3509 or 3510 on its website. However, copies of Forms 3509 and 3510 have been widely circulated on the internet.

Despite the short turn-around time and complex data required to complete the questionnaire, it seems that extensions of time to complete the questionnaire will not be available. SBA has 90 days under the CARES Act to approve PPP loan forgiveness (regardless of the size of the loan), which may make it unlikely for SBA to grant extensions on information that might be relevant to its approval process.

The following is a summary of the purpose of new Forms 3509 and 3510 (for profit-making borrowers and non-profit borrowers, respectively), which contain the questionnaire, as well as the key items included on both forms.

What is the purpose of the new forms?

It seems that SBA will use the new Forms 3509 and 3510 to evaluate borrowers’ good-faith certifications of their economic need for the PPP loan. Some critics view the forms as SBA’s attempt to change PPP rules retroactively to penalize borrowers that (in hindsight) did not actually have the requisite financial need to qualify for a PPP loan.

Remember that the PPP was intended to provide disaster relief to small employers (generally those with 500 or fewer employees) facing economic uncertainty (for example, due to COVID-19 governmental shut-down or stay-at-home orders) and for whom the loan was necessary to support the ongoing operations of the business. In the early days of the PPP, some entities received sizable PPP loans even though they were not eligible (often because they did not face the requisite economic uncertainty for the PPP loan).

Widely circulated media reports identified several well-funded publicly traded companies, universities with significant endowment funds and affiliates of such entities that had quickly received PPP loans and may have caused the program’s original funding to run out prematurely. Many of those ineligible borrowers returned their loans during an amnesty period that expired in May 2020. To further address possible abuse, the Treasury Secretary said that SBA will closely review all PPP loans of $2 million or more, seemingly using the Loan Necessity Questionnaires to do so.


In the October 26, 2020 Federal Register, SBA estimated that 52,000 borrowers will need to complete these new forms (about 42,000 for-profit borrowers and 10,000 non-profit borrowers).

Notably, the new forms may be sent to borrowers that received a PPP loan of less than $2 million if they, together with their affiliates, received an aggregate of $2 million or more in PPP loans. Original PPP program rules generally limited the availability of PPP loans to one loan per controlled group of entities, but in reality, various members of a controlled or affiliated group may have received separate PPP loans. To address that situation, SBA included a box that borrowers must check on their PPP loan forgiveness applications (the Form 3508 series) if they, together with affiliates, received $2 million or more of PPP loans. SBA will review all loans within that controlled group.

The questions on the new forms seem to indicate that SBA will be evaluating the “economic necessity” for the borrower’s PPP loan both on the PPP loan application date and thereafter. The loan application only required borrowers to make a good faith certification of economic necessity as of the loan application date, so it is unclear why SBA is asking about what actually happened to the borrower’s operations afterwards.

What are the key items on the new forms?

Each of the forms has two sections: a “Business Activity Assessment” and a “Liquidity Assessment.”

Business Activity Assessment

This section asks for-profit borrowers for detailed information and documentation about the impact of COVID-19 on their businesses, including whether the business was subject to mandatory or voluntary closures and whether it made any changes in its operations. The borrower also must report gross revenue for Q2 2020 and Q2 2019 and indicate whether it made any capital improvements between March 13, 2020 (i.e., the date that COVID-19 was declared a national disaster) and the end of the borrower’s “covered period” (a maximum of 24 weeks from the date their PPP loan was funded). Borrowers can include additional comments on any of these questions. Non-profit borrowers must provide similar information, but the definition of gross receipts includes grants, gifts and contributions, and non-profit borrowers must submit Q2 expenses for 2019 and 2020.

Liquidity Assessment

This section asks for the following information:

As a reminder, the PPP loan eligibility and loan forgiveness process continues to evolve; hopefully, SBA or the Treasury Department will soon clarify how the answers to these questionnaires may impact borrowers’ PPP loan forgiveness.