“Painful social lockdowns in Europe and some American states helped blunt the coronavirus. Now, amid a fitful reopening, the pandemic is once again surging.”
So begins an article on the front page of last weekend’s Wall Street Journal.[i] The article describes how governments – in response to the “economic strain” being experienced by many businesses, the social “isolation” that has proven to be an ordeal for large segments of the population, and the general public’s “fatigue” with anti-virus measures[ii] – have allowed the re-opening of various kinds of institutions and business establishments.
Unfortunately, and almost immediately following the liberalization of “stay-at-home” orders, and the relaxation of restrictions on the operation of many businesses, we have started to witness a significant increase[iii] in the number of coronavirus cases throughout the country; consequently, some state and local governments have moved to reinstate social-distancing measures in various “hotspots” within their jurisdictions.[iv]
These developments do not bode well for businesses and their employees, or for the economy, generally. Indeed, even before the recent outbreaks, there was ample evidence that the beginning of the “economic recovery” we observed this summer was running out of steam.
According to the Federal Reserve – which has already reduced interest rates to near-zero – this situation calls for major fiscal stimulus; generally speaking, this means increased public spending, tax cuts, and incentives for spending by business.[v] This can only come from Congress.
Ah Congress. Do you recall how quickly the CARES Act[vi] was enacted? It passed the Senate on March 25, 2020,[vii] with an amendment, by a vote of 96 to 0; on March 27, 2020, the House agreed to the Senate amendment by voice vote, and the President signed the legislation that same day.
At $2.2 trillion, the CARES Act represented the largest economic stimulus package in U.S. history. Considering its breadth and how quickly it was drafted, negotiated, and enacted, it would have been a remarkable piece of legislation under almost any circumstances. What’s more, it worked pretty well.[viii] The Paycheck Protection Program (“PPP”) loans probably rescued thousands of businesses and preserved millions of jobs.[ix] The Federal Pandemic Unemployment Compensation Program enabled millions of Americans to sustain their families.
Fast forward . . . to May 2020. The House introduced a second economic stimulus package (the “HEROES Act”), worth $3.5 trillion,[x] which passed by a vote of 208 to 199, by-and-large along party lines.[xi]
In July, the Senate introduced the HEALS Act, with a price tag of approximately $1 trillion;[xii] it was never brought to the Senate floor for a vote.
Almost five months after the House’s passage of the HEROES Act, the two parties – principally, the Administration and the Democratic leadership of the House and Senate – are still “negotiating” the terms of a stimulus package.[xiii] During this process, the Democrats pared down the HEROES Act to $2.2 trillion, while a “skinny” version of the HEALS Act[xiv] was introduced in the Senate.
In displays of election year politics, the HEALs Act was brought to the Senate floor, but failed to garner the necessary 60 votes to stop debate (which was a forgone conclusion),[xv] while the revised HEROES Act passed the House (with no prospect of being considered by the Senate).[xvi]
Then, this past Thursday, the Administration indicated that it would be willing to move closer to the spending levels proposed by the House by proffering a $1.8 trillion alternative. Many Senate Republicans, however, were quick to criticize the Administration’s offer.[xvii]
Status of Legislative “Efforts”
With only three weeks to go before the general election,[xviii] the likelihood of Congress enacting another comprehensive economic stimulus package seems remote.
The question then is whether the immediate post-election political environment will be conducive to the passage of some badly needed economic relief by the lame duck Congress, or whether political partisanship will continue to blind our legislators, thereby deferring any action into the next Congress.[xix]
That is not to say that the two political parties cannot agree on anything. In fact, they actually agree on many items and, with respect to many others they are separated only by what may be characterized as a question of degree.
Then there are some genuine substantive disagreements on what to spend money on, the significance of which cannot be understated. These are the issues that stand in the way of a comprehensive deal[xx] that covers a broad range of relief measures, the issues on which the House leadership has shortsightedly based its reluctance to pass legislation on what it describes as a piecemeal basis.[xxi]
There is one item, however, that can easily stand on its own, and that is not readily paired with the other provisions being contemplated; an item on which the two parties have been in agreement since the enactment of the CARES Act, and the effective date of which would be retroactive to the enactment of that earlier legislation. What’s more, this one item would actually unite the two parties against the Treasury Department. Finally, this item provides an immediate infusion of liquidity into the hands of many businesses.
The item in question: Ensure that otherwise deductible business expenses that were paid using loans forgiven under the PPP may still be deducted for purposes of determining the income tax liability of the borrower-business and its owners.
The IRS’s Misguided Interpretation
As you may recall, current IRS guidance bars the deduction of business expenses paid using a forgiven PPP loan. Last week, the Congressional Research Service[xxii] issued a brief report that examined the deduction issue and its history.
The report reminds us that the CARES Act has no language regarding the deductibility of expenses paid with PPP loan proceeds. The Code, it states, permits taxpayers to deduct any ordinary or necessary trade or business expenses, which would include PPP-eligible expenses. However, the Code also provides that an expense cannot be deducted if it is allocable to a class of income which is exempt from taxation.[xxiii]
The CRS then describes IRS Notice 2020-32,[xxiv] issued on April 30, 2020, which disallows deductions for business expenses paid for with forgiven PPP loans. According to the IRS, no deduction is allowed to a taxpayer for any otherwise deductible expense that is allocable to a class of income that is excluded from the taxpayer’s gross income or that is exempt from income taxes. In this way, the Code seeks to deny the taxpayer a double tax benefit.
Thus, the Notice concludes, to the extent the CARES Act[xxv] operates to exclude from a taxpayer’s gross income the amount of a PPP loan made to the taxpayer that is forgiven under the terms of the Act, the Code disallows any otherwise allowable deduction for expenses paid by the taxpayer with the loan.[xxvi]
The CRS report indicates that some policymakers have expressed concerns with the IRS’s guidance, including the Democratic and Republican chairs, respectively, of the House Ways and Means and Senate Finance Committees. In a letter to the Secretary of the Treasury, these committee chairs explained that:[xxvii]
“[W]e are writing to express our concern with the position taken by Treasury and the IRS in Notice 2020-32, which is contrary to congressional intent. Notice 2020-32 provides that otherwise deductible business expenses are not deductible if the taxpayer is the recipient of a Paycheck Protection Program (PPP) loan that is subsequently forgiven. We believe the position taken in the Notice ignores the overarching intent of the PPP, as well as the specific intent of Congress to allow deductions in the case of PPP loan recipients. . . .
“Providing assistance to small businesses, only to disallow their business deductions as provided in Notice 2020-32, reverses the benefit that Congress specifically granted by exempting PPP loan forgiveness from income. This interpretation means that whatever income a small business is able to produce will be taxed on a gross basis to the extent of the loan forgiveness, leaving substantially less after-tax capital for the swift economic recovery we hope is on the horizon.”
The chairs went on to explain that the exclusion of PPP loan forgiveness from income was specifically included in the CARES Act to provide a tax benefit to small businesses that received the PPP loan. “Had we intended to provide neutral tax treatment for loan forgiveness,” the chairs continued, the Act’s forgiveness provision “would not have been necessary. In that case, loan forgiveness generally would have been added to the borrower’s taxable income, and the expenses covered by the PPP loan would be deductible, reducing taxable income by an offsetting amount and resulting in no additional net income. Notice 2020-32 effectively renders” the income exclusion provision meaningless, and “is contrary to the intent of . . . the CARES Act.”[xxviii]
Nothing in the CARES Act denies the borrower-business the ability to claim a tax deduction for legitimate and eligible expenses paid with the loan proceeds. Thus, the payment of the salaries, rent, etc. for which the PPP loans were intended should be deductible, thereby reducing the borrower’s tax liability. These deductions, which were to be generated by using the PPP loan proceeds for their intended purpose – not to mention the resulting tax savings and liquidity – were taken for granted by most loan applicants and their advisers, and were clearly intended by Congress.[xxix]
In the absence of an about-face by the Treasury, several bipartisan-backed proposals have been introduced separately by the Republican-controlled Senate and by the Democrat-controlled House – the first within a week of the release of the IRS’s interpretation – to allow taxpayers to receive PPP loan forgiveness without affecting their ability to claim business expense deductions.[xxx]
Unfortunately, these proposals have been held hostage to the “piecemeal” vs “all-or-nothing” stimulus package debate referenced above.
Why Wait for Congress?
The IRS’s position – that no deductions should be allowed for expenses paid using the proceeds from a PPP loan that is ultimately forgiven – converts that loan forgiveness into a meaningless gesture, and is contrary to the intent of the CARES Act.
Given the uncertain economic future faced by so many businesses, and given the continuing deadlock in Congress over any stimulus legislation, the IRS should reconsider its interpretation of this CARES Act provision and immediately withdraw its above-referenced “guidance.”
This one act would provide those businesses that participated in the PPP with additional liquidity – just as though they had received an infusion of cash – in the form of immediate tax savings. It would also deliver a positive message in the midst of what has been a frustrating and over-politicized post-CARES Act “legislative process” that has yet to yield a tangible result.
[i] “New Virus Cases Surge Across U.S., Europe,” Ted Mann, WSJ, Sat./Sun. Oct. 10-11, 2020.
[ii] Physical distancing, wearing masks, etc.
[iv] For example, last week N.Y.’s Governor Cuomo imposed limits on certain public gatherings in specified areas of the state. In some communities, this action was met with outright hostility, and even physical abuse of law enforcement.
[v] We’re talking Keynesian economics here.
[vi] P.L. 116-136, Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”). Enacted March 27, 2020.
[vii] Yes, that’s right, it did not actually originate in the House, notwithstanding that Article I, Section 7, Clause One of the Constitution requires that “all bills raising revenues shall originate in the House of Representatives.”
The CARES Act originated in the Senate. In order to comply with the Constitutional mandate, the Senate adapted an earlier, unrelated bill passed by the House (in 2019), replaced it with what would become the CARES Act – see the reference to the “amendment” above – and returned it to the House where it passed by voice vote.
This sleight of hand was probably not what the Founders intended, but they also did not provide for the popular election of Senators; until 1913 (and the 17th Amendment), that responsibility belonged to the state legislatures.
[viii] That’s not to say there weren’t gaps or misjudgments. These are inevitable, especially given the urgency of the circumstances, the size of the effort, the complexity of the issues, and the speed with which it necessarily had to be implemented. Add to that the presence of bad actors, whose activities rose to the level of treason, at least in my book.
[ix] There are wildly differing estimates.
[x] The Health and Economic Recovery Omnibus Emergency Solutions Act (the “HEROES Act”). Suffice to say it was not limited to economic stimulus.
[xi] It was never brought to the Senate floor for debate and a vote.
[xii] Health, Economic Assistance, Liability Protection and Schools Act (the “HEALS Act”).
[xiii] With each side accusing the other of acting in bad faith.
They suspended their animus long enough for the Senate and the House to agree – on June 30 and July 1, respectively – to extend the PPP loan program until August 8, 2020.
[xiv] Hardly in the spirit of compromise.
[xv] The Senate’s cloture rule.
[xvi] Thus, each party won the right to blame the other.
A couple of days later, on Rush Limbaugh’s radio show, the president stated that he wants a stimulus package that is larger than that proposed buy the Democrats.
[xviii] And with members of Congress eager to hit the campaign trail themselves.
[xix] The 117th Congress begins on January 3, 2021.
[xx] Some might describe it as an all-or-nothing proposition.
[xxi] See, e.g., https://www.reuters.com/article/us-health-coronavirus-usa-democrats/democrats-reject-piecemeal-approach-to-u-s-coronavirus-relief-idUSKCN24O2AP . What ever happened to the old English adage “you can’t always get what you want, but if you try sometimes, you just might find you get what you need”?
[xxii] Congressional Research Service (“CRS”) serves as nonpartisan shared staff to congressional committees and Members of Congress. It operates solely at the behest of and under the direction of Congress.
[xxiii] IRC Section 265(a)(1).
[xxv] Section 1106(i) of the CARES Act.
[xxvi] IRC Sec. 265(a)(1).
[xxvii] https://www.finance.senate.gov/imo/media/doc/2020-05-05%20CEG,%20RW,%20RN%20to%20Treasury%20(PPP%20Business%20Deductions).pdf and the Treasury’s defense of its position at https://thehill.com/policy/finance/495996-mnuchin-defends-irs-guidance-on-ppp-loans
[xxviii] I borrow $100; I pay expenses of $100; I deduct the $100 of expenses; the loan is forgiven; I have $100 of CODI; tax neutral result; no benefit to borrower. Ice in winter, right?
Compare: I borrow $100; I pay expenses of $100; I deduct the $100 of expenses; the loan is forgiven; no CODI; unlike the result described immediately above, I have a benefit equal to the tax savings attributable to the $100 of deductions.
[xxx] The Safeguarding Small Business Act (S. 3596), the Heroes Act (H.R. 6800), the Small Business Emergency Protection Act (H.R. 6821; S. 3612), and the Safeguarding Small Business Act (S. 3596).
An updated version of the Heroes Act (H.R. 925), which allows deductibility, passed the House on October 1:
SEC. 203. CLARIFICATION OF TREATMENT OF EXPENSES PAID OR INCURRED WITH PROCEEDS FROM CERTAIN GRANTS AND LOANS.
(a) IN GENERAL.—For purposes of the Internal Revenue Code of 1986 and notwithstanding any other provision of law, any deduction and the basis of any property shall be determined without regard to whether any amount is excluded from gross income under section 202 of this Act or section 1106(i) of the CARES Act. [this is the exclusion from gross income for any PPP loan]
(c) EFFECTIVE DATE.—Subsection (a) and the amendment made by subsection (b) shall apply to taxable years ending after the date of enactment of the CARES Act.