A popular provision of the CARES Act is the Paycheck Protection Program (PPP), which makes forgivable loans to small businesses and nonprofit entities. The $349 billion appropriation for the program has, according to media reports, already been exhausted and Congress is haggling over appropriating another $250 billion. Democrats are insisting that money for hospitals and state and local governments be included, but no one appears to be arguing not to allocate more money to the PPP.
So what is the paradox? These loans are intended to allow the recipient businesses and nonprofits to continue paying their employees. The law requires loan proceeds to be used for payroll, rent, utilities, and mortgage interest to qualify for forgiveness. Public Law, 116-136, sections 1102 – 1106. Hence, the name “paycheck protection” I assume. Under standard tax law principles, loan forgiveness is taxable. That follows from the fact that the loan principal was excluded from income because it was exactly offset by an obligation to repay. So when that obligation is forgiven, the proceeds become taxable. The CARES Act, however, provides that forgiveness of PPP loans is excluded from taxable income. Section 1106(i).
So, the paradox is why did Congress include this exclusion? To me it seems unnecessary and simply a complication of tax administration and compliance. That is so because the law requires the loan proceeds to be used exclusively for deductible items – payroll, rent, and so forth. So, if Congress had left matters alone, the loan forgiveness would have been exactly offset by deductible expenses. Does that mean that these businesses will be able to both exclude the income and deduct the expenses as a result, thereby getting a nice tax spiff? No, because the IRC section 265 explicitly disallows that. (Minnesota law contains a comparable provisions, Minnesota Statutes, section 290.10.)
I assume Congress thought it was making matters easier by adding the exclusion. My instinct is that the reverse is the case. True, it makes it easy for the taxpayer to exclude the loan proceeds from taxable income when the loan is forgiven. But then the business must take care to exclude the expenditures of the proceeds from its business expenses, which may have occurred in a prior tax year. It’s not clear to me why that is simpler than excluding the loan proceeds from income. (As usual, I could be wrong and there is some simplification I’m missing.)
What happens if a business cheats and takes out a forgivable loan that it does not use for a qualifying purposes and SBA does not catch the violation, but the IRS does? I assume that the IRS can compel the business to recognize the loan forgiveness as taxable income, but I would guess that could lead to wrangling, potentially in tax court, about the terms and intent of the statute and IRS authority under it.
In any case, this is a provision for which a failure by Minnesota to promptly adopt conformity legislation won’t make much difference in actual tax liability (if any), but rather will create compliance headaches for taxpayers. Conformity legislation on this should be scored a zero, as it apparently was federally (nothing appears in the JCT estimate, so they must have concluded there was no timing effect).