Brewing Tax Battle: Deductibility of Business Expenses Financed by Paycheck Protection Program Loans

Brewing Tax Battle: Deductibility of Business Expenses Financed by Paycheck Protection Program Loans

An ongoing tax controversy has left unanswered questions in the minds of U.S. business owners. The stakes are incredibly high. As of June 30, 2020, the federal government’s Paycheck Protection Program (PPP) has allowed over 521 billion dollars of PPP loans to be issued to over 4.8 million businesses. The federal government expects the vast majority of these loans will be forgiven.

May a business deduct the expenses that were financed via their forgivable PPP loans?  If this deduction is allowed, the private sector will likely have an additional 100 billion dollars of liquidity, which business owners may use to stay in business. However, the government will lose over 100 billion dollars of tax revenue.

In one corner of the ring is the Internal Revenue Service (“IRS”). To quote Treasury Secretary Mnuchin, “[t]he money coming in the PPP is not taxable. So, if the money that’s coming is not taxable, you can’t double dip. You can’t say you are going to get deductions for workers that you didn’t pay for.” This position was formally clarified when the IRS issued Notice 2020-32. In this Notice, the IRS outlines its position that it does not believe expenses paid by the forgivable portion of a PPP loan also will be tax deductible.

In the other corner of the ring is a team of influential politicians including Chuck Grassley – Chairman of the Senate Finance Committee, Richard Neal – Chairman of the House Ways and Means Committee, and Ron Wyden – Ranking Member on the Senate Finance Committee. Recently, they signed a joint letter condemning the IRS’ position as against Congressional intent. “We believe that 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.”

There appears to be bipartisan support in Congress for allowing businesses to deduct all their valid business expenses regardless of whether these expenses were financed via PPP loans that were forgiven by the federal government. However, it is an open question whether this bipartisan support is strong enough to bypass the gridlock in Washington, D.C. If a political agreement is not achieved, the dispute will ultimately be decided by the U.S. federal court system. Both sides have strong legal arguments, so it is difficult to predict which side will prevail.

There is even more ambiguity surrounding how Wisconsin will tax PPP loans and the expenses financed by these loans. Wisconsin is a fixed date conformity state meaning that Wisconsin conforms to the Internal Revenue Code as stated on December 31, 2017. Any changes after this date are not adopted into Wisconsin law unless the state legislature explicitly decides to include specific provisions from the Internal Revenue Code.

In this case, on April 15, 2020, the Wisconsin legislature passed, and Governor Evers signed into law, Act 185, which adopts the federal tax law with regards to PPP loans. However, the federal rules relating to PPP loans changed after April 15, 2020. Therefore, there is ambiguity regarding whether Wisconsin has adopted the changes that occurred after April 15, 2020. At this stage, it is too early to opine on how Wisconsin will tax forgiven PPP loans or whether Wisconsin will allow taxpayers to deduct the expenses financed with the forgivable portion of their PPP loans. We plan to write an additional article on this topic in the coming weeks if the law becomes more clear.

WARNING:  Unless either the IRS reverses its position or Congress passes a bill that reverses the IRS’ position, deducting expenses that were paid for from the proceeds a PPP loan that is forgiven could cause significant penalties. A final court decision regarding the deductibility of the expenses could be more than a decade away, but there may be actions a taxpayer could take in the meantime to preserve the right to take the deductions should they ultimately be allowed.

If you have questions about what your business must do to comply with this new mandate or how to prepare or respond to the unique challenges presented by this pandemic, we are here to help.

The guidance provided above is general in nature and readers are encouraged to reach out to Neider & Boucher, S.C., or to their own legal counsel to determine the applicability of these issues to their own personal and/or business needs.