Originally published on Forbes.com.
Although there are a number of programs that are supposed to help businesses and workers cope with the COVID-19 disaster included in the CARES Act, the two that stand out are the Paycheck Protection Program and Federal Pandemic Unemployment Insurance. As I am writing this, new PPP loans applications are suspended as the more than a third of a trillion dollars is all spoken for.
The Tax Provision In PPP
It turns out that an income tax provision is buried in the PPP section of the CARES Act. That is what really distinguishes the two programs from a planning perspective. And like much in the PPP, there is uncertainty about how the law will work, which makes planning challenging.
Here is the provision (1106(i) of the Act):
(i) Taxability .—For purposes of the Internal Revenue Code of 1986, any amount which (but for this subsection) would be includible in gross income of the eligible recipient by reason of forgiveness described in subsection (b) shall be excluded from gross income.
It is hard to figure out what this means, but when the Joint Committee on Taxation scored the tax provisions of the bill, they did not score that one. I doubt very much it is because they did not notice it.
Here is what makes that provision so important.
You Could Lay Them Off
If you have nothing for your people to do, you can lay them off and until July 31, they will be getting $600 per week more than the normal unemployment benefit. (That faucet is not turned on fully as I write this, but so it goes).
If you have the resources you may be able to help your employees out with disaster relief payments that they can exclude from income under Code Section 139. I’m skipping the details on that in this piece, but it is important to keep that in mind.
And Then There Is PPP
An alternative to the layoff is using a PPP loan, which will be forgivable to a greater or lesser extent if the proper hoops are jumped through. The program has been run out at such a breakneck pace, it is difficult to say this definitively, but it seem quite likely that to achieve 100% forgiveness, you will need to go further out of pocket with payroll payments beyond the loan amount. Those payments will be taxable to your employees.
Accountants have been advising their clients to go for the PPP regardless of whether it will be forgiven, because the terms are so good ( 1%, two years). There is a fly in that ointment though. A strict reading of the Act seems to indicate that you can’t spend any of the loan proceeds after June 30. That does not appear to make any sense, but it remains an uncertainty. I checked in with my friend Jeff Kristoff of Rosen Associates and Tony Nitti on that.
At any rate, it is worth considering forgetting about PPP forgiveness to let your people collected enhanced unemployment if you have little or nothing for them to do. In both situations they are being paid with government money. It is just a question of how much and whether it runs through you. Maybe the PPP money would then be available as working capital when you start ramping back up.
But That Tax Benefit !
But there is that sweet tax benefit. Normally when you borrow money and don’t have to pay it back you end up with gross income in the amount of the discharged debt, but not when it comes to a PPP loan.
So imagine you get a $300,000 PPP loan that is fully forgiven and by some mathematical miracle that causes you to just break even for the year. Since the loan forgiveness is excluded that should give you a net operating loss of $300,000 that you can carry back to 2015, picking up maybe a $100,000 refund, which is also tax free. While in the layoff model, you may be burdened with a higher unemployment tax rate for several years in the future.
Does That Work ?
So now let’s see how Greg Bernhardt used TaxTwitter to rain on that parade.
Alright #TaxTwitter I’m going all in, w/ all credit to @nahoncpa for the notion. I believe expenses connected w/ PPP forgiveness will be non-deductible under Sec 265. Taxpayer receives tax exempt inc from gov’t to help stay afloat. Taxpayer shouldn’t ALSO get deduction.Apr 6
#TaxTwitter, by the way is where the accountants who have been drafted into service as loan brokers go to share their troubles.
Code Section 265 reads in part:
No deduction shall be allowed for …. any amount otherwise allowable as a deduction which is allocable to one or more classes of income …. wholly exempt from the taxes imposed by this subtitle,
I can see the argument. It really turns on what “allocable” means. Lucien Gauthier of the Boston Tax Institute does not think that 265 applies here, but it would be really nice to have certainty. (Full disclosure, I am on the BTI faculty)
A strong argument that 265 does not apply is that it kind of makes the exclusion in the CARES Act kind of pointless. Hopefully the IRS will rule on this soon. My money is on deductibility. My reading of the politics is that the Republicans prefer that aid to people thrown out of work filter to them through banks and employers rather than just go the them directly. Of course as political analyst, I make a pretty good tax researcher.
Other Coverage
Tax Notes has something optimistic behind its paywall Double Tax Benefits Of The Cares Act.
Tony Nitti discusses the issue here. His piece also dives deeper into the fine points of forgiveness.
The Star Trek Theme
I wanted to start off by explaining how the Ferengi fit into this, but that would have been burying the lede as we say. Here is some discussion of how the Ferengi would handle PPP.
The really exciting thing about PPP is the potential for the loan being forgivable. If you are any sort of a Star Trek fan (And who isn’t? Come on.), you are familiar with the Ferengi for whom greed is the highest virtue. They elucidate the principle in the Rules of Acquisition of which there are hundreds. Rule 284 states that “Deep down everyone is a Ferengi”.
Rule 284 is certainly being proven in the scramble for PPP money, which for the moment has run the well dry. A very, very big concern is the forgivable nature of the loan. And Rule Number One is “Once you have you have their money … you never give it back”. Incidentally Rule 255 is also getting some play “A wife is a luxury … a smart accountant a necessity”.
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