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Analysts Wonder Whether PPP Deductibility Was a Mistake

Posted on Dec. 7, 2020

It’s possible Congress will step in and allow businesses to take deductions with forgiven coronavirus relief loans, but some question whether lawmakers really intended that outcome when they created the program.

The Joint Committee on Taxation has said Congress always intended for expenses funded with forgiven Paycheck Protection Program loans to be deductible, so it would have no revenue impact in terms of scoring if lawmakers passed a bill allowing it.

But some experts say it’s revisionist history to claim lawmakers really considered the deductibility issue when drafting the Coronavirus Aid, Relief, and Economic Security Act (P.L 116-136), which created the PPP.

Lawmakers are considering expanding the PPP, which provided government-backed loans to businesses that can be forgiven tax free if a specified portion of the proceeds is used on items such as payroll and rent. Senate Finance Committee member John Cornyn, R-Texas, introduced a PPP deductibility bill (S. 3612), and lawmakers think similar language will make it into a final COVID-19 relief package.

However, the PPP could already cost hundreds of billions of dollars, even before a potential expansion in new legislation. Allowing expenses to be deducted with forgiven loans could mean losses generated from the deduction are carried back to years when the corporate tax rate was 35 percent, according to Richard L. Reinhold, professor of practice at Cornell University Law School.

Immediately after the CARES Act was enacted, practitioners and academics alike pointed out that although the forgiven loans are excluded from gross income under the law, it wasn’t clear that expenses funded with forgiven loans could be deducted.

The IRS quickly responded by releasing Notice 2020-32, 2020-21 IRB 837, which said allowing deductions in that instance would be a double tax benefit and would violate section 265, which denies deductions allocable to a class of exempt income.

That prompted a bipartisan letter from taxwriters saying the IRS got it wrong and it was always Congress’s intent to allow the deductions to truly have the loans forgiven tax free. But as many pointed out, the law wasn’t explicit on that, and it was correct from a policy perspective to deny the deductions until Congress stepped in to clarify.

But practitioners thought they might have a workaround: If the loans were still on the books in 2020, they could take deductions for expenses for that year and deal with the issue later in 2021 when the loans were eventually forgiven. The IRS caught on to the plan and released Rev. Rul. 2020-27, 2020-50 IRB 1, which said if borrowers reasonably expected the PPP loan to be forgiven, they couldn’t take deductions funded with them, regardless of when forgiveness occurred.

Look to Intent

As lawmakers negotiate the next round of financial relief, it’s likely the deductibility issue will be fixed legislatively once and for all — but as a technical correction with a revenue score of zero.

A former senior JCT staffer told Tax Notes that once the JCT determined it was Congress’s initial intent to allow deductibility, the score would properly be set at zero because the change was simply implementing that intent and would have been part of the original score.

“As long as the JCT is satisfied that it was Congress’s intent, that’s the ballgame,” according to the staffer, who wondered how the JCT reached that conclusion. The staffer added that contemporaneous evidence is usually required to show original intent, but that evidence wasn’t disclosed by the JCT.

Some would point to the letter from lawmakers after Notice 2020-32 as the proof, but the staffer said that isn’t evidence of congressional intent at the time of enactment. And according to some practitioners, it could be described as revisionist history.

But despite some issues pointed out by practitioners, an aide to Cornyn said no other interested parties have raised any concerns. “Our bill was drafted in consultation with the Finance Committee, the Joint Committee on Taxation, and Senate legislative counsel,” the aide said.

Similar language found in Cornyn’s bill is also in both versions of the Health and Economic Recovery Omnibus Emergency Solutions Act (H.R. 925) that was approved by the House in May and again in October.

Bad Tax Policy

James W. Wetzler, a former chief economist at the JCT, said allowing deductions attributable to PPP expenses is bad tax policy. However, there is no reason not to accept the JCT’s statement that Congress intended that there be no denial of a deduction attributable to expenses.

The JCT revenue estimate for the CARES Act properly applies static revenue-scoring conventions, Wetzler said. The key assumption in static scoring is that GDP is unchanged or, alternatively, any impact of the bill on GDP is accounted for in baseline revenues. 

“Thus, enactment of PPP by itself produces a revenue gain because it increases the income tax base by creating cancellation of indebtedness income (COD),” Wetzler said. “COD income is not part of GDP, so its creation is a net addition to the tax base.”  

Wetzler explained that the expenses that give rise to the debt forgiveness don’t create additional deductions because they are assumed to be in the baseline on account of the constant GDP assumption of static scoring. Hence, the impact of the CARES Act provision excluding COD income is to wipe out what would otherwise be revenue gain and drop the revenue impact down to zero, he added.

As the language now stands in various pieces of pending legislation, the so-called deductibility fix may need some tweaks, Monte A. Jackel of Jackel Tax Law said. The language would negate the problem posed by section 265 regarding deductions funded with tax-exempt income, but the common law principles in the notice and revenue ruling could still be a problem, he added.

To fix that, lawmakers could include language to expressly negate those provisions as well, Jackel said.

If Congress ultimately fixes the issue legislatively, states will have to decide whether they want to decouple from what is really just bad policy, Reinhold said. Wetzler agreed.

“States are well advised to consider decoupling from the CARES Act exclusion for PPP COD income unless they consider it a justifiable tax break,” Wetzler said. “From a state standpoint, it is irrelevant whether any federal revenue impact is accounted for in the CARES Act or some other bill.”

California has already acted on the PPP front. The governor signed legislation in September excluding forgiven PPP loans from being taxable under state law but disallowed the deduction of expenses with forgiven loans. (For additional coverage, see our article in Tax Notes Today State.)

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