One hundred and twenty-seven national trade groups sent a letter today to Congressional and Administrative leaders asking them to quickly enact three key improvements to the Paycheck Protection Program (PPP):
- Eliminate the unnecessary 75/25 rule;
- Extend the eight-week period for purposes of calculating loan forgiveness; and
- Extend the June 30 safe harbor date for rehiring and restoration of pay.
The S Corporation Association eagerly signed this letter. The PPP is the single-most effective program Congress has devised to help businesses through the crisis, but it is badly in need of a tune-up. Recent SBA numbers indicate demand for the loans has all but dried up even as surveys of small businesses warn that one-third or more expect they will close for good.
Addressing the letter to both Congress and the Administration sends an important signal. This is not just a task for Congress alone, as much of the PPP’s malaise is the direct result of administrative actions. Eliminating the 75/25 rule, for example, is something the SBA could do on its own.
More importantly, the letter focuses on keeping the PPP relevant and available. For too many weeks, Treasury and SBA officials have been talking down their own program, apparently more worried about negative press than helping employers. In response, many small business employers are foregoing applying for a loan, or giving back loans they already received. This has serious implications for the economy and workers, and it needs to be corrected.
The PPP was enacted and implemented at a moment of crisis. It was designed to mitigate the long-term adverse effects of the government shutting down businesses for an indeterminate period of time by providing massive amounts of funding to employers on easy terms. It had the obvious purpose of preventing the cascading destructive force of businesses collectively deciding to lay off vast numbers of their employees. For businesses who retained their employees and kept them off unemployment, the loan’s terms were the easiest possible – you didn’t have to pay back the loan.
It worked — millions of businesses applied and received the loans, giving them the incentive and resources necessary to keep their workers employed while the economy operates at half-speed.
Then the SBA apparently lost focus. They stopped issuing clear rules intended to speed and maximize participation and focused instead on rules that conflicted with previous guidance and narrowed participation, together with lots of talk about audits and criminal referrals.
The good news is the PPP can work again. The most recent guidance from the SBA corrects past errors and, for smaller borrowers at least, clarifies that their good-faith attestations will not be held against them. The three reforms included in the business community letter would help, too, by better aligning the timing of the loans with the current COVID-19 response.
Both the Senate and House are looking at moving these reforms this week. They should act quickly to restore confidence and energy to this critical program. The Paycheck Protection Program is not perfect, but its been more effective than anything else in helping keep people employed and businesses open. We need the PPP to succeed.
House leadership released their HEROES Act yesterday with a plan to vote on it Friday. The bill includes an eye-popping $3 trillion in assistance to families, businesses, non-profits, and governments.
One item that stands alone in this tidal wave of spending is the repeal of the NOL and loss limitation relief enacted as part of the CARES Act. Where almost all the other HEROES Act provisions reduce costs on businesses, this one would hike their taxes.
Let’s be clear — the CARES Act NOL provisions are largely timing benefits – whatever tax benefit businesses receive now will have to be repaid in the form of higher taxes in coming years. The idea is to help them when times are tough and then reclaim the revenues when the economy returns to normal.
This general approach of counter-cycle taxation has a long and strongly bipartisan history. Members of both parties have introduced and voted on similar relief in past decades – it really is a standard tool in the tax writers recession toolbox.
- Disallowing any carryback if the company pays its executives more than $1 million in compensation subject to section 162(m); and
- Disallowing any carryback if the company’s cumulative distributions since 2017 exceed an amount equal to the value of any stock issued after 2017 plus 5 percent of the corporate fair market value (measured as of the last day of the year).
For S corporations and other pass-through businesses, the HEROES Act goes even further. It rolls back the loss limitation rule relief, so that business owners with more than $250,000 (single) in active business losses will be precluded from claiming those excess losses this year or in past years. They would have to be carried forward and claimed in future years.
It also effectively blocks pass-through owners from carrying back any losses by applying the distribution limitations to them as well as C corporations. Note to Taxwriters: Pass-through businesses must make distributions so their owners can pay their taxes. It’s the equivalent of a C corporation writing a check directly to the IRS. Plus, how is a private business supposed to know its “fair market value” on the last day of the year, or any other time?
Finally, the HEROES Act would make permanent the more restrictive NOL and loss limitation rules enacted under the Tax Cuts and Jobs Act (TCJA). They currently expire at the end of 2025. As a result, the tax benefits from the TCJA only last for 7 years, but the “pay-for” for those provisions lasts forever. Permanence results in a tax hike in the hundreds of billions
How did we get here? How did conventional, bipartisan policy suddenly become the tax theft of the century? Two events took place.
First, the TCJA eliminated all loss carrybacks. Under the TCJA, any losses experienced by businesses would need to be carried forward. Numerous tax experts, including Steve Rosenthal, observed at the time that this was a bad idea that would hurt companies in the next recession.
It also limited the ability of pass-through owners to offset active business losses against their wages and investment income. (This latter provision was apparently designed to prevent rate arbitrage where owners would take losses subject to a 29.6 percent rate and apply them against wages taxed at 37 percent, but we’re not sure.)
Second, the Joint Committee on Taxation has consistently estimated that the new TCJA policy and its suspension would result in massive revenues gained and lost. How a simple timing difference can score in the hundreds of billions is still beyond us, but even with a revised score the JCT issued in late March, the size of the revenue estimates on these provisions is clearly attention getting.
The net result is that the standard NOL relief of the past was now scored as a huge tax cut and attributed to business owners directly, rather than to the corporation.
Which brings us back to the beginning of this analysis – these are timing issues. When the business community asked for them as part of the response to COVID-19, the idea was to identify reasonable policies that would help at a time when large percentage of all businesses were going to experience losses.
As an example, many private companies are selling assets this year to help fund their operations. They need money to pay their workers, the rent, suppliers, etc. Their revenues are down and they need cash, so they sell stuff. Under the CARES Act, these owners can offset the gains from these sales with the losses from their businesses. Under the HEROES Act, they would be required to recognize their capital gains, but delay recognizing their business losses until next year or later. They still get the deductions, but only after the crisis has run its course.
So the HEROES Act would have these businesses pay taxes in a year in which overall, they experienced significant losses. That’s just bad tax policy, and its magnified by the prospect that the policies will be extended out beyond 2025. The Main Street Employers coalition that initially asked for the CARES Act NOL rules has responded to this new draft.
At a time when 20 million Americans are out of work and millions of businesses are closing their doors, the HEROES Act would raise their taxes. The Main Street Employers coalition strongly supports the NOL and loss limitation relief provided by the CARES Act and calls on Congress to keep this important relief intact as it considers additional responses to COVID-19.”
NOL carrybacks have been part a response to every economic downturn since we can remember. Now that the economy is sinking into something that resembles a depression, they are needed more than ever.
Allowing businesses to use losses to offset income earned in prior years is a longstanding anti-recession policy with solid bipartisan support. It was adopted after the 9/11 terrorist attacks, after Hurricane Katrina, and again following the financial crisis. It is simply a way to give businesses suffering losses the ability to recognize those losses more quickly.
Yet now some are charging that the bipartisan loss limitation relief included in the CAREs Act is a “massive” tax break for “hedge funds” and real estate moguls that was “snuck” into the bill at the last moment. None of this is true.
In fact, the bipartisan relief was in the first CAREs Act “draft” released back on March 19th, it was in every subsequent draft as negotiations ensued over the weekend, and it was in the final bill that unanimously passed both the Senate and the House a week later. It was included in our business community letter signed by 120 national trade groups. And, it was included in the alternative bill released by Speaker Pelosi on March 23rd.
Anybody claiming not to know it was part of the relief package simply wasn’t paying attention.
How does the policy work? Many companies are selling assets this year to raise capital to keep the businesses running. The Cares Act helps by allowing these businesses to offset any capital gains they realize against their active business losses, reducing the tax hit at the end of the year. Using active business losses taxed at high rates to offset capital gains taxed at low rates is extremely inefficient and not something that would happen in normal times. But these are not normal times and these businesses need the liquidity.
This benefit is limited to “trade or business” losses that have already passed through the passive, at-risk and other tests. Losses from investments in passive assets, like those made by many hedge funds, do not benefit.
Moreover, any losses claimed this year will not be available in the future. The NOL and loss limitation relief are primarily timing benefits. Lower taxes in 2020 will equal higher taxes in 2021 and beyond. As the Obama White House said during the financial crisis:
“The Economic Recovery Act included a provision that allowed small businesses to count their losses this year against the taxes they paid in previous years. Today, the President extended that benefit for an additional year and expanded it to medium and large businesses as well….This provision is a fiscally responsible economic kick-start, putting $33 billion of tax cuts in the hands of businesses this year when they need it most, while enabling Treasury to recoup the majority of that funding in the coming years as these businesses regain their strength and resume paying taxes.”
The same logic that applied when Democrats controlled the White House, the House of Representatives, and the Senate, applies now. The policy makes perfect sense during the COVID-19 response because it helps businesses now and then recaptures the revenue when the economy improves.
Another issue is the revenue estimate issued by the Joint Committee on Taxation. That estimate suggests that the revenue loss of for the corporate Net Operating Loss provision was $26 billion over ten years, while the same policy applied to pass-through businesses under the loss limitation relief was, although recently revised downward, still an eye-popping $135 billion.
How is a revenue loss that high possible? The short answer is we have no idea. Any benefit from recognizing more losses this year should equal the higher taxes the business will pay next year. It should be close to revenue neutral over a ten-year window. One potential explanation: the losses being suffered by Main Street businesses from the government-imposed shutdown are going to be simply massive, like nothing we’ve ever seen before.
So the motivation of the after-the-fact opponents remains a mystery. What’s not a mystery is where the provision came from, why its in the bill, and how much long-term, bipartisan support it has enjoyed. It’s working exactly as promised, providing temporary relief to millions of employers. Congress should leave it be and focus instead on the many other economic challenges in front of us.
More than 200 national and state-based trade groups wrote to congressional leadership today calling on Congress to increase funding for Paycheck Protection Program (PPP) loans.
That program was authorized by the CAREs Act last month and, among many other programs, provided individually and family-owned businesses with $350 billion in loans to help those businesses retain their employees during the COVID-19 crisis.
According to the latest figures from the Small Business Administration, however, applications to date number over million and nearly$300 billion of the initial authorization. The expectation is that the program will run out of authorization by the end of the week.
With both the House and Senate in recess until May, its unlikely Congress will be able to agree to – and pass by unanimous consent – specific changes to the loan program. A simple increase in the loan’s authorized amount, however, is both possible and badly needed – the demand for these loans is high and there are millions more small businesses who need them to survive the crisis intact. As the letter says:
In just a few weeks, the PPP has emerged as a central and effective response to the economic damage resulting from COVID-19. PPP loans are providing a vital source of liquidity to more than a million individually and family-owned businesses whose operations have been curtailed or shut-down by stay-home orders and other government actions taken in response to the virus. These businesses, in turn, are using the loans to keep millions of Americans employed.
According to the Small Business Administration, however, banks have already committed most of the $349 billion provided to capitalize the PPP, and it is likely the program will run out of money within the week, leaving millions of additional businesses without the funds necessary to keep their workers employed.
While the chance of increased funding appears low at the moment, we expect that will change in the coming days when millions of business owners are told by their banks that PPP loans are no longer available. The economic damage caused by stay home orders is immense and growing. The federal response needs to grow with it.
Is the loss limitation relief in the CAREs Act an unwarranted giveaway, as claimed by the Washington Post this week? That’s a big “N-O.” As others have noted, this relief prevents the “recession bombs” of the underlying NOL and loss limitation rules from inflicting damage on Main Street during the COVID-19 crisis.
Here’s the reality and why 120 Main Street business groups asked Congress to adopt this provision earlier this year:
- The benefit is timing only: Aside from some limited rate arbitrage, any tax reductions allowed by the loss limitation relief this year would have otherwise been claimed in 2021 or later. Put another way, lower taxes in 2020 equal higher taxes in the future. There’s little net tax benefit here. As the National Taxpayers Union Foundation observes, “Net Operating Losses Aren’t Handouts.”
- Its good tax policy: Good tax policy smooths the realization of income, so that taxes go up when times are good and they go down when times are bad. Times are very bad right now, so the provisions shift deductions that would otherwise be claimed in the future and allows businesses to claim them now.
- The benefit is temporary: The NOL and loss limitation relief sunset at the end of the year. Businesses can use the relief in 2020 to increase their deductions and to file amended returns in 2018 and 2019. As before, any deductions claimed in 2018-20 would mean increased taxes in the future.
- The benefit is not new: Congress has provided NOL relief in just about every US recession going back decades. This is standard tax policy when the economy sinks and business losses are widespread. The only new item is the loss limitation rule, which didn’t exist in previous recessions and would prevent pass-through business owners from claiming NOLs.
- Needed for Pass-Through Fairness: Absent loss limitation relief, pass-through business owners would be blocked from claiming the NOL relief offered to C corporations.
The NOL and loss limitation relief accelerates a business’ ability to deduct losses, so they can claim them now rather than later. Any losses claimed now are effectively used up and not available in future years, so while a business might see lower taxes (or bigger refunds) this year, they will then see higher taxes next year and beyond. This is especially important now that, with the economy shut down, millions of profitable businesses are going to be reporting losses this year.
The need for Congress to relax these rules should not be a surprise. The NOL and new loss limitation rules were controversial when they were adopted three years ago and many tax experts warned that they would threaten businesses when the economy turned. They are, as the Investment News argued, a “recession bomb” that “could prove troublesome for businesses and their owners — as well as the broader economy — in the next recession.”
By allowing businesses to deduct their current losses against past profits, the old rules provided economic help for struggling businesses via an immediate cash infusion, said Steven Rosenthal, a senior fellow at the Urban-Brookings Tax Policy Center. “That softens the blow to the direness of that [situation],” he said.
However, in a future recessionary environment when companies are suffering from widespread losses, they must wait for a year of profits to get a cash infusion, Mr. Rosenthal said, and that infusion will be smaller. It’s money you don’t have in your pocket that you can’t put back into your business,” said Robert Keebler, founder of accounting and tax advisory firm Keebler & Associates.
How does it work? Here’s Forbes on the implications of the new rules published last May:
Suppose Cindy is single and has a start-up software business with $510 thousand in losses. She also has $250 thousand in other income (note: there are some questions on what constitutes ‘other income’), $20 thousand in dividends and $150 thousand in capital gains. Under the previous rules, Cindy would have income of -$90 thousand, which she could carry back against the previous two years’ income. Under the current rules, Cindy would have income of $165 thousand ($250 + $20 + $150 – $255). The remaining losses would be carried forward and then offset against 80% of future income.
So Cindy loses $90,000 but has to pay taxes as if she made $165,000? In normal times, this policy would be a challenge to Cindy – where does the money come from to pay the tax? With the entire economy shut down, it’s everybody’s problem. There are thousands of Cindy’s losing money this year and they employ many millions more.
The business relief in the CAREs Act simply restores — for one year – tax rules that used to exist on a permanent basis prior to the TCJA. NOL and loss limitation relief puts money in the pockets of employers now, when they need it most. It will keep more businesses afloat, and it will keep more people employed. Its good tax policy. By opposing it, the Washington Post is embracing “recession bombs,” bankruptcies and joblessness. Nicely done, WP.