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Neal Plans PPP Fix to Provide Expenses Deduction

Posted on May 4, 2020

The top House taxwriter intends to take legislative action to make expenses funded with coronavirus relief small business loans deductible, a move that would countervail recent IRS guidance.

“We are planning to fix this in the next response legislation,” Erin Hatch, spokesperson for House Ways and Means Committee Chair Richard E. Neal, D-Mass., said May 1.

Senate Finance Committee Chair Chuck Grassley, R-Iowa, while not committing to make changes to the Paycheck Protection Program (PPP) in legislation now being negotiated in Congress, was also quick to share his disappointment with IRS guidance (Notice 2020-32, 2020-21 IRB 1) released April 30 that forgivable loans under the program are not tax deductible.

“The intent was to maximize small businesses’ ability to maintain liquidity, retain their employees and recover from this health crisis as quickly as possible,” Grassley said in a statement. “This notice is contrary to that intent.”

The PPP was created as part of the Coronavirus Aid, Relief, and Economic Security (CARES) Act (P.L. 116-136), in which Grassley played a key role.

The IRS guidance comes after weeks of debate in the tax community about whether the loan proceeds used to fund ordinary business expenses that could typically be deducted under sections 162 and 163 could still be written off, because the loans can be forgiven tax free.

Notice 2020-32 said that to the extent the income resulting from loan forgiveness under the PPP is excluded from income, it’s considered a “class of exempt income” under regulations promulgated under section 265.

“Consistent with the purpose of section 265, this treatment prevents a double tax benefit,” the IRS said.

Up to Congress

Some practitioners said the guidance clearly went against the intent of Congress, which meant all along for expenses funded with PPP loans to be deductible.

“It is very disturbing the Treasury has chosen to override Congress’s clear intention to make the forgiveness of these loans a nontaxable item,” Anthony S. Bakale of Cohen & Co. told Tax Notes. “No matter how you parse the language of the notice, the end result is the proceeds are no longer excluded from income.”

John J. Eagan of White and Williams LLP said it’s now up to Congress to fix the provision, but that many taxpayers who were deciding which CARES Act benefit to take advantage of thought the expenses funded with PPP loans could be deducted. “If you’re an employer and you took a loan and you were assuming this was deductible and you did your modeling, you’re really not happy right now,” Eagan said.

L. Stephen Bowers, also of White and Williams, said that when taxpayers were forced to run through quick scenarios to figure out which option made the most economic sense for their business, that loan was often considered deductible.

Another option under the CARES Act is an employee retention credit that provides a fully refundable credit against the employer’s portion of payroll taxes. However, only $10,000 in wages per employee can be counted for all calendar quarters, and the credit is capped at $5,000 per employee.

An employer must forgo that credit if it wants to apply for a PPP loan, and jump through several other hoops to qualify for the loan. But if an employer does qualify and a specific portion of the proceeds is used to fund payroll costs over the eight-week period after receiving the loan, it will be forgiven tax free.

Monte A. Jackel of Jackel Tax Law said the ball was always in Congress’s court and it’s up to it to fix the law if it intended the expenses to be deductible. Jackel said Congress could amend section 265 or add a new provision altogether.

Regardless of what route Congress takes to fix the issue legislatively, lawmakers need to include language that doesn’t allow other doctrines to apply to bar the deductions, such as the reimbursement doctrine or the tax benefit rule, Jackel added.

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