Avoiding a $100 Billion Tax Hike on Main Street
As the Administration negotiates with Congress over the next round of COVID-19 relief, here’s a simple way they can help Main Street businesses to the tune of $100 billion plus… just do what Congress intended.
That’s the message more than 170 business trades are sending to congressional leadership today. The letter, signed by the Farm Bureau, NFIB, AICPA, the National Restaurant Association, the National Retail Federation among others, makes clear that loan forgiveness under the Paycheck Protection Program should be tax-free as intended in the CARES Act. Here’s the text of the letter:
As Congress negotiates another round of relief in response to the on-going COVID-19 pandemic, we strongly encourage you to include a technical correction addressing the tax treatment of loan forgiveness under the Paycheck Protection Program (PPP).
When the PPP was adopted as part of the Coronavirus Aid, Relief, and Economic Security (“CARES”) Act, Congress made clear that any loan forgiveness under the program would be excluded from the borrower’s taxable income. Specifically, a recipient of a PPP loan was eligible for forgiveness of indebtedness for amounts equal to certain payroll, mortgage interest, rent, and utility payments made during a prescribed period, with any resulting cancelled indebtedness excluded from the borrower’s taxable income. As Section 1106(i) makes clear:
(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.
The publication of IRS Notice 2020-32 effectively overturned this policy by denying these borrowers the ability to deduct the same expenses that qualified them for the loan forgiveness. The Notice argues “…section 265(a)(1) of the Code disallows any otherwise allowable deduction… for the amount of any payment of an eligible section 1106 expense to the extent of the resulting covered loan forgiveness….”
Defenders of the IRS’ position argue that allowing businesses to deduct these expenses would result in business owners receiving a “double” benefit. This is simply untrue. Congress intended for the loan forgiveness under PPP to be tax-free. The IRS Notice reverses that position and eliminates any benefit, let alone a double benefit. If a business has $100,000 of PPP loans forgiven and excluded from its income, but then is required to add back $100,000 of denied business expenses, the result is the same as if the loan forgiveness was fully taxable. Section 1106(i) becomes moot if the IRS Notice is allowed to stand.
On the other hand, denying the correct tax treatment of these loans will result in hardship for many struggling businesses. More than five million businesses have participated in the PPP. More than $520 billion has been lent. In nearly all cases, these businesses have already spent the loan proceeds keeping employees on payroll and meeting other necessary costs. In addition to the approximate $100 billion tax hike the IRS position represents, denying businesses the ability to deduct these expenses could result in numerous other complications – how would the denial of deductible wages affect the 199A deduction or the Work Opportunity Tax Credit? How do you offset expenses incurred in 2020 with loan forgiveness realized in 2021? Does disallowed interest expense avoid the excess business interest expense limitation under section 163(j)?
The correctness of the IRS’s reasoning underpinning Notice 2020-32 is a debatable point and if left intact it will certainly result in extensive legal challenges. What is not debatable, however, is congressional intent regarding the tax treatment of these forgiven loan amounts. As part of the next round of COVID-19 relief, we request that Congress reaffirm its intent and restore the tax benefits it intended to give distressed Main Street businesses as part of the CARES Act.
The signatory trade groups are not alone in supporting restoring congressional intent. Key tax-writers in Congress also recognize this as a technical correction restoring what Congress intended, as does the Joint Committee on Taxation. Meanwhile, other trade groups have previously written Congress requesting this fix (here, here and here).
The Paycheck Protection Program has been a successful response to the COVID-19 shut down. Congressional action to avoid a surprise $100 billion tax hike on millions of Main Street business would help ensure it continues to be a success.
Senate Amendment Targets Private Businesses
The Senate this week will debate an amendment to require private companies to annually report the personal information of their owners to the Financial Crimes Enforcement Network (FinCEN) at the Department of Treasury, or face large fines and multi-year jail sentences.
The amendment — sponsored by Senate Banking Committee leaders Mike Crapo (R-ID) and Sherrod Brown (D-OH) – mirrors the Corporate Transparency Act of 2019 that passed the House last fall. If it passes the Senate as part of this year’s Defense Authorization Act, it is very likely to become law.
The stated goal of the amendment is to crack down on criminals who use shell companies to launder money, but nobody believes terrorists and other criminals will volunteer accurate, detailed information of their criminal enterprises to the Department of Treasury. Can you imagine Tony Soprano sitting in his kitchen filling out forms identifying the senior members of his crime family and which enterprises they benefit from?
No, real criminals will take a pass, so the burden will fall on legitimate businesses with law-abiding owners instead. They are the ones who will have to comply with the new annual reporting requirements or face stiff penalties and jail terms. As the Due Process Institute argued last year:
Creating criminal penalties for paperwork errors will not prevent money laundering or terrorism, which are already crimes. To support the criminalization of this reporting requirement, you would have to accept the premise that those engaging in such crimes—and who have the intention of engaging in such crimes while “hiding behind” a legal entity to go unnoticed—would comply with any legal requirement to disclose themselves. Meanwhile, those attempting to comply in good faith would be providing personal identifiable information to government entities that may then share them with other government entities with little meaningful assurance that their privacy will be properly protected. The draft would impose criminal penalties, including jail time, on small businesses that fail to meet compliance requirements with no real indication that such requirements would curtail international money laundering cartels.
The scale of the reporting alone defies effective law enforcement. The National Federation of Independent Business estimates these new rules will apply to over five million businesses, while the Congressional Budget Office estimated last year’s House-passed bill would have resulted in 25-30 million new filings to Treasury every year. There is simply no means for FinCEN or any other government agency to effectively manage and monitor a database that large.
A good measure of the amendment’s lack of seriousness is the long list of industries and entities that are exempt from the reporting requirements, including banks, credit unions, accounting firms, money transfer firms, registered brokers and dealers, investment companies, investment advisors, insurance companies, dealers in commodities, swaps, foreign exchanges and futures, public utilities, pooled investment vehicles, non-profits, political organizations, trusts, and larger corporations, LLCs, and partnerships. Sarcasm Alert: Oh no, those types of businesses are never involved in money laundering.
What’s left are all newly formed corporations and LLCs and those existing corporations and LLCs with $5 million or less in revenues, 20 or fewer employees, and a physical presence in the United States. As noted above, the NFIB estimates that encompasses more than 5 million businesses for starters, but you should expect that number to grow over time. There’s simply no rationale for exempting partnerships and trusts, for example, and no reason the amendment’s proponents won’t immediately begin advocating for their inclusion once this amendment has passed.
Opposition to beneficial ownership efforts is broad and diverse. Last fall, nearly fifty national trade groups wrote to Senators Crapo and Brown in opposition to the beneficial ownership provisions included in their Illicit Cash Act (S. 2563). Signatories included the Farm Bureau, the Restaurant Association, and the National Retail Association. Other groups opposing the effort include the American Bar Association and the ACLU.
Concerns with the rules include the failure of proponents to demonstrate they will be effective, their redundancy to existing “know your customer” and other reporting requirements, their lack of privacy protections for legitimate business owners, their use of vague key legal terms, and their complexity of compliance for multi-tiered businesses.
If your business or organization would like to join that opposition, please let us know or, better yet, reach out to your Senators immediately. A vote on this amendment could happen as early as this week.
Talking Taxes In a Truck Episode 6 – Doug Badger on the Coronavirus, Health Savings Accounts, Florida, and the Phillies
Doug Badger, former Deputy Assistant to the President and misguided Phillies fan, talks COVID-19, what needs to happen for the economy to reopen, and the prospects for baseball to return in our latest “Talking Taxes in a Truck” podcast. Recorded on June 26, 2020 — 23 minutes.
You can access the podcast on Libsyn by clicking here.
NOL-Loss Limitation Relief Support Building
Advocates defending the CARES Act NOL-Loss Limitation relief had a busy week. First, more than 75 national and local trade groups signed a letter in favor of keeping the relief intact. The broad number of signatories on the letter, drafted by our friends at the National Mining Association, makes clear arguments that the provision was “snuck” into the CARES Act or would only benefit a “narrow” sliver of industries are wholly meritless. As the letter states:
The ability to carryback NOLs is a critical component of a well-operating income tax system. Indeed, NOL carryback provisions have long been bipartisan tools utilized by lawmakers to provide liquidity and are routinely expanded during times of economic dislocation. As the non-partisan Joint Committee on Taxation has noted (see JCX-12R-20), the “provision allows taxpayers to use NOLs to a greater extent to offset taxable income in prior or future years in order to provide taxpayers with liquidity in the form of tax refunds and reduced current and future tax liability.” The provision suspending limitations on excess business losses for non-corporate taxpayers offers similar relief. As Chairman Grassley recently noted, the “key was for businesses to keep cash on hand, if they hadn’t already filed, or get refunds to give them liquidity to keep the doors open, machinery running, and most importantly, employees paid, to the greatest extent possible.”
Next, former CBO Director Doug Holtz-Eakin weighed in support of keeping the relief in a piece entitled “No U-turns on Pandemic Tax Policy.” As Doug argues:
Loss carrybacks and carryforwards are not gimmicks invented in this crisis; they are longstanding features of the tax system. When businesses have losses in some years and profits in other years, they would be overtaxed if they were not permitted to reduce their income with those losses. This was recognized by the Supreme Court in 1957: “Those provisions were enacted to ameliorate the unduly drastic consequences of taxing income strictly on an annual basis. They were designed to permit a taxpayer to set off its lean years against its lush years, and to strike something like an average taxable income computed over a period longer than one year.”
And finally, Tax Notes included a great letter to the editor from Harry Gutman, the former chief of staff of the Joint Committee on Taxation, making a number of key points, including the fact that the JCT doesn’t even consider NOLs to be a tax expenditure because of their unique role in ensuring businesses pay no more tax than their long-term income would necessitate:
The Joint Committee staff assumes that normal income tax law would provide for the carryback and carryforward of net operating losses. The staff also assumes that the general limits on the number of years that such losses may be carried back or forward were chosen for reasons of administrative convenience and compliance concerns, and may be assumed to represent normal income tax law (Joint Committee on Taxation, “Estimates of Federal Tax Expenditures for Fiscal Years 2019-2013,” JCX-55-19, at 8 (Dec. 18, 2019)).
When Congress eliminated NOLs in 2017, many tax experts on both sides of the aisle worried that this was a mistake that we would regret the next time the economy stopped growing. Well, the economy has stopped growing, we immediately regretted preventing businesses from carrying back the losses they are experiencing, and we did something about it. It was the right thing to do, and it should be retained.
Treasury Addresses 4960 Shortcomings – More Work Needed
When Treasury released its initial Section 4960 guidance last year (Notice 2019-09), S-Corp warned the rules would force many family businesses to dissolve their related charities and/or private foundations to avoid the new tax. Those concerns remain under the proposed rules published last week, but they are dramatically reduced, so that’s progress. Here’s the good and the bad on Section 4960.
To recap, tax reform created a new excise tax on million-plus salaries earned by executives at non-profits, or applicable tax-exempt entities (ATEOs). The targets were the high salaries earned by CEOs at charity hospitals and football coaches at large universities. Congress wanted to make certain tax-free dollars intended for non-profit purposes weren’t used for personal enrichment instead. As House Report 115-409 stated:
The Committee believes that tax-exempt organizations enjoy a tax subsidy from the Federal government because contributions to such organizations generally are deductible and such organizations generally are not subject to tax (except on unrelated business income). As a result, such organizations are subject to the requirement that they use their resources for specific purposes, and the Committee believes that excessive compensation (including excessive severance packages) paid to senior executives of such organizations diverts resources from those particular purposes.
The guidance issued by Treasury turned that goal on its head, however. Through a broad interpretation of the “related” entity and “covered employee” provisions in the statute, Treasury applied the tax to private operating companies who share directors, officers, and staff with an ATEO. Under the Treasury guidance, for example, the salary of a CEO at a large family-owned business would be subject to the tax if he or she also volunteered as the director of the family’s private foundation.
Worse, the statute would prevent avoiding the tax by having the CEO resign as the director of the foundation. Under Section 4960, once an individual is listed as a “covered employee,” they are always listed, even if they stop working or volunteering at the ATEO. The only way to avoid the tax is to dissolve the ATEO.
That’s the background. Under the old Treasury guidance, thousands of companies were forced to pay the excise tax last fall simply because their leadership volunteered at the company’s non-profit. The good news is the new rules out of Treasury provide relief to many of these companies. For workers at private companies considered covered employees under the prior guidance, the proposed rules provide the following exceptions:
- Director’s Exemption: Excludes employees who also serve as directors and officers of an ATEO, but perform only minor or no services for the ATEO and receiving no renumeration from the ATEO;
- Limited Hours Exception: Excludes an employee who receives no remuneration from an ATEO and works at the ATEO for no more than 10 percent of their total working hours at all the related entities. A safe harbor excludes all employees who perform fewer than 100 hours of service as an employee of an ATEO or related ATEOs; and
- Nonexempt Funds Exception: In cases where employees of business donate their time at a related ATEO, they are excluded from being a covered employee if 1) neither the ATEO, nor any related ATEO, nor any taxable related organization controlled by the ATEO pays the employee remuneration, 2) the ATEO does not reimburse the business, 3) the business does not provide services to the ATEO for a fee, and 4) the employee primarily (more than 50 percent of their total hours worked) provides services to the business, not the ATEO.
Here’s an example from the proposed rules:
Consider, for example, a corporate employee making $2 million per year who spends 5 percent of her time (roughly one day each month) working for the corporation’s foundation, a related ATEO, without receiving compensation from the ATEO and who would be a covered employee of the ATEO absent the exceptions. The value of the employee’s services provided to the ATEO is roughly five percent of her salary, or $100,000. Without the exceptions, her compensation in excess of $1 million from the corporation, which is a related party of the foundation, is subject to a 21 percent excise tax, or $210,000 in excise tax liability. The exceptions remove that liability and the incentive it provides to stop providing such services or to dissolve the relationship between the ATEO and the related organization.
That’s the good news. The bad news is the rules don’t appear to address the broader “control” issue raised by S-Corp in our earlier comments. As we noted last year:
Merely because a for-profit business is a primary financial sponsor of an ATEO, has overlapping directors and officers with an ATEO, or whose employees provide limited personal services to the ATEO, such factors alone should not be determinative of “control” by a for-profit business and relatedness to an ATEO for purposes of applying the excise tax. Rather, “control” and relatedness should be evaluated and determined in the context of circumstances and criteria which demonstrate a joint-operational relationship between the for-profit business and the ATEO facilitating direct or indirect compensation of relevant key employees attributable to services provided to or on-behalf of the ATEO – thereby diverting resources that would otherwise be available to the ATEO for charitable purposes.
Finally, the once listed, always listed mandate remains. This rule is in the statute, but it is unclear whether Congress fully understood its implications when it was adopted. It forces ATEOs to endlessly track current and past employees, regardless of whether they provide ongoing services, and will prove to be a trap for the unwary. Congress needs to fix this by repealing the mandate. Treasury should support this effort.
These are proposed rules and there is a 60-day comment period, so S-Corp intends to work with other stakeholders to identify areas where Treasury can make improvements. The rules released last week are a good start and would provide meaningful relief to many private companies blindsided by the new tax. Hopefully, we can make them better.