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Reinhold Defends Nondeductibility of PPP Loan-Funded Expenses

Posted on May 11, 2020

To the Editor:

I write to applaud Treasury Secretary Steven Mnuchin’s defense of Notice 2020-32, 2020-21 IRB 1, disallowing deductions for expenses funded with nontaxable Paycheck Protection Plan (PPP) loan proceeds. The point can’t be made more simply or succinctly than when Mnuchin said: “This is basically Tax 101. . . . The money coming in the PPP is not taxable. So if the money that’s coming is not taxable, you can’t double dip.” (Related coverage: p. 1048.)

Reacting to Notice 2020-32, Senate Finance Committee Chair Chuck Grassley, R-Iowa, and House Ways and Means Committee Chair Richard E. Neal, D-Mass., have stated that they wish to overturn this result and provide a full deduction for the expenses. But the IRS’s prompt explanation of the impact of the tax-free treatment of the PPP loan forgiveness, coupled with Mnuchin’s ringing support for the underlying principle, suggests stepping back to consider the right tax policy.

Other COVID-19 response provisions providing comparable value transfers to taxpayers have afforded symmetrical and neutral tax treatment, thus:

In each case, the result is neutral tax treatment of the recipient of governmental benefits — taxable income associated with the grant and an offsetting deduction for the wage expenses or, in the case of the retention credits, a nontaxable grant coupled with nondeductibility of the related expense. This treatment is fully consistent with the IRC’s general tax policy to treat governmental transfers to private companies as income (see section 118(b)(2), as adopted by the Tax Cuts and Jobs Act; see also section 597(b)(3), relating to federal assistance to banks: “No regulations . . . shall permit the utilization of any deduction (or other tax benefit) if such amount was in effect reimbursed by nontaxable Federal financial assistance.”).

If full deductibility of PPP-funded expenses is permitted, it’s not unreasonable to expect a revenue cost of at least $125 billion (obviously, beyond the up to $600 billion in unrepaid loan amounts). That is, the tax subsidy could equal the product of the $600 billion forgiven loan amounts and the 21 percent corporate tax rate. That is, the $600 billion cash paid to taxpayers is not only tax-free to taxpayers, but it also allows $600 billion of other income of taxpayers to be in effect exempt from tax. Some borrowers may be tax-exempt, but most aren’t, and businesses that operate as passthroughs will be subject to tax at personal tax rates up to 37 percent. Also, borrowers in some circumstances might fail to qualify for loan forgiveness, yet an overall cost of not less than $125 billion would seem reasonable — a figure that approaches one-half the cost of the $1,200/$2,400 rebates for individual taxpayers, as estimated by the Joint Committee on Taxation (JCX-12R-20).

So the question for Congress is whether a PPP loan was intended to provide small business and other borrowers not only an immediate cash transfer to facilitate payroll and other expenses but also a tax subsidy equal to 21 percent or 37 percent of each dollar borrowed (but not repaid). Thus, PPP participants would pay over to employees and creditors each dollar received under the program — at no cost to the “borrower” — and then pocket $0.21 or $0.37 of subsidy due to nontaxable forgiveness coupled with a tax deduction in the same amount that shelters other income. A $125 billion tax subsidy to small business and other borrowers under the PPP may have been intended, but it’s not obvious why PPP borrowers should be so favored when airline carriers and contractors as well as employers receiving sick leave and retention credit benefits under the CARES Act didn’t obtain a similar subsidy.

Very truly yours,

Richard L. Reinhold
Cornell Law School
May 5, 2020

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