PPP borrowers stand to gain tax deductions

WASHINGTON -- Congress may be poised to deliver a tax benefit worth hundreds of billions of dollars to business owners who took Paycheck Protection Program loans.

The provision, part of the discussions over the year-end coronavirus relief bill, would ensure that PPP recipients can deduct the payroll costs and other expenses covered by forgiven loans, even though the loans themselves are tax-free income. The move would reverse a Treasury Department ruling that denied the deductions.

Lawmakers say they just want to clarify what Congress intended to do when it created the PPP and prevent unexpected tax bills from hitting business owners. Still, a full deduction could reduce federal revenue by about $200 billion, with a majority going to very high-income households, according to Adam Looney of the Brookings Institution, who is a former Obama administration official.

There is bipartisan agreement in Congress to overturn the Treasury decision that denied deductions and frustrated business owners. Some progressive groups and Treasury Secretary Steven Mnuchin argued that the combination of tax-free income and deductible expenses amounted to double dipping, but the lobbying clout of business groups and senior lawmakers in both parties is countering that view.

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"We're all hoping that Congress just cleans this up and takes all of this off the table so that our clients can relax," said Christopher Hesse of accounting firm CliftonLarsenAllen LLP, who is chairman of the tax executive committee at the American Institute of Certified Public Accountants.

The issue has simmered since Congress created the PPP in late March. The program offered low-interest loans with the promise of forgiveness if businesses continued paying their workers.

The law's authors attempted to address the potential tax consequences by declaring that these forgiven loans -- unlike typical forgiven loans -- wouldn't be counted as taxable income. But the law was silent on whether companies could still take deductions for salaries and other expenses funded by the loans.

In April, Mr. Mnuchin and the Internal Revenue Service said no, denying the deductions.

Lawmakers argued that they intended to allow the deductions and that the denial contradicted the purpose of making the income tax-free in the first place. But Mr. Mnuchin wouldn't budge. Without congressional action, some business owners would likely attempt to challenge the IRS in court over whether the agency's rule complied with the tax code, Mr. Hesse said.

Under the Treasury decision, a business receiving a $100,000 loan wouldn't count that as income but would have to forgo $100,000 in deductions. In many cases, the loss of those deductions is mathematically equivalent to taxing the PPP loan.

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Instead, under the proposal pushed by lawmakers now, the $100,000 loan wouldn't be income and the business could deduct $100,000 in related expenses. For a business owner in the top tax bracket, that is a $37,000 difference and would make the PPP loan more like a tax-free government benefit.

"That's huge money. You could do a lot better stuff with it," said Frank Clemente, executive director of Americans for Tax Fairness, a progressive group that opposes deductibility.

But many Democratic lawmakers support the deductions.

Trade associations mounted a campaign to get Congress to overturn Mr. Mnuchin's decision. Business owners say the whole point of the PPP program was to cover these expenses, not to provide cash for any use. They note that they had to incur these deductible expenses in order to get the loan forgiveness.

"The government gave us these PPP loans to pay our team. That's what we did," said Janice Jucker, co-owner of Three Brothers Bakery in Houston. She said she is facing a $100,000 tax bill that would soak up money she would rather use to open a new location.

"Everybody was so concerned with just surviving that that wasn't really on anybody's radar. Now it's high on everybody's radar and they're worried about it, said Tracy Vaught, owner of H-Town Restaurant Group, which owns four restaurants in Houston. "The whole idea of having to pay taxes after all this is just -- it's like Congress has to be tone-deaf not to correct this."

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Ms. Vaught said her downtown location is still struggling in an area that no longer has office workers or convention-goers.

"We will have the money to pay them, but I think a lot of people won't," she said. "It was almost a bait-and-switch."

Oddly, the large benefit for business owners doesn't actually count as part of the cost of the bill. That is because the Joint Committee on Taxation, which creates revenue estimates for tax bills, assumed that lawmakers had meant to allow the deductions in March and are just clarifying that intent now.

But the tax costs of the PPP weren't listed as part of the cost of the March bill either, as the scorekeepers assumed that the deductions existed even without PPP and that the tax-free loan forgiveness didn't change anything.

That quirk means that allowing the deductions doesn't cost the government anything for scoring purposes, even though it is allowing billions of dollars in deductions that otherwise couldn't be taken under the Treasury ruling. So Congress can use this provision to pump more money into the economy and offer tax cuts to businesses without displacing other programs inside the overall relief bill, where Republicans have insisted on limits on the total size.

"Both an income exclusion and a deduction are provided," said Richard Reinhold, who teaches tax law at Cornell University. "The result is a likely loss of tax revenues of hundreds of billions of dollars that was never scored or disclosed."