Lots of folks have talked about why small businesses should not get this tax break. But I want to highlight four reasons they should.
No Taxes on PPP Funds Original Deal
A first—and maybe critical—point. Congress wrote the PPP statute to say that borrowers would not be taxed on the funds. The explicit language says this:
(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.
I think that matters.
People borrowed with explicit assurance from Congress that the PPP money would not be taxed. They then spent the money paying employees payroll, paying states their payroll taxes, paying landlords their rent—and other expenses as well. Again, all based on an explicit statue the money wouldn’t be taxed.
What later happened, as discussed in blog posts here? The IRS invoked an old statute to say “Yes, but…” and then struck that part of the law.
To put this into simple terms, the current situation resembles this. You go out and buy a home or condo partly based on tax laws that say you get a mortgage interest deduction. Then, after you’ve bought the house, the IRS changes the rule and says, “We don’t care what Congress passed as law. No mortgage interest deduction.”
That seems like dirty pool. Sorry.
Small Borrowers Get the Tax Break Anyway
Something else to understand here: The smallest borrowers don’t lose tax deductions even under the IRS’s current rules.
If you’re a sole proprietorship operating as a one person show, for example? The PPP rules say “just take the money.” And that’s it. You don’t have to spend the PPP funds on employee payroll, rent or utilities. You therefore don’t even have deductions the IRS can disallow.
Small partnerships that employ only “owners” work the same way.
The accounting works differently for other PPP borrowers, however.
This is slightly extreme, but consider these two examples which are possible under the IRS’s current rulings.
Example #1: A one person sole proprietor might borrow up to $20,833 of PPP money, draw those funds for personal spending, and get full forgiveness. This borrower neither receives nor loses a tax deduction. But he or she gets free money!
Example #2: Another small business owner, taking no wages, might borrow $20,833 of PPP, use those funds to pay workers’ wages, and get full forgiveness. This borrower may personally receive no benefit from the PPP funds. She or he acts as a conduit, passing along the money to the employees and vendors. But Congress gave this PPP borrower a benefit: A tax deduction that might be worth a few thousand dollars. At a 20 percent tax rate, the savings from a $20,833 deduction equal about $4,000.
So the business owner in example #1 receives $20,833 of tax free financial support. But the IRS wants to prevent the business owner in example #2 from getting $4,000 of tax savings.
That seems a little off-kilter to me. You?
State and Local Government Closures of Small Business
A third comment about the PPP program. For small businesses beat up by the Covid-19 pandemic, the PPP program is really the only big impact way that we, as a country, currently help small business owners.
Other programs like the Employee Retention Credit that subsidizes business owners who continue to employ folks? Nickel and dime grant programs from states and cities? Come on. That stuff doesn’t move the needle.
And to be objective, the Paycheck Protection Program doesn’t work very efficiently either. (See this research.)
All the while, state and local restrictions and then dampened consumer demand have closed millions of small businesses. And then beat up on many of the those that have remained open.
One example of this shown below… According to tracktherecovery.org website, the Covid-19 pandemic pushed small business revenues down by 32 percent and forced more than 25 percent of small business to close.
That’s roughly 7 million small businesses. Firms that employ maybe 14 million of our neighbors, friends and family. And the carnage for many small employers continues.
Smallest Borrowers Often Underfunded
One final point about the PPP program—which I think is relevant to this discussion.
I don’t have much other than anecdotal evidence on this. But we saw lots of PPP borrowers get shortchanged. Partnerships, for example, often got shortchanged because banks misunderstood the rules and provided no payroll money for business owners (see here).
So, for example, some small business should have been able to borrow $100,000. Maybe $20,000 of that money should have went to the owners for compensation replacement. The remaining $80,000 went to keep employees on the payroll. Or the doors open. Or the lights on.
But what often happened? The bank only provided $80,000 of funding. So no money for the business owners.
In a case like this, the lost tax deduction might be viewed as a way to mitigate damages.
Don’t get me wrong. I would not call the PPP program an example of well-crafted legislation. The PPP bills show real sloppiness.
But the real answer here in my opinion? Federal, state and local policy makers need to understand their actions have destroyed millions of small businesses and small business jobs. And these folks need to do what they can to stop the destruction.
If you’re a small business owner or a professional serving small businesses, you want to be ready to respond to the new PPP legislation when it passes. Probably very soon.
Here are a handful of earlier blog posts we did about proposed PPP enhancements:
Rubio’s new PPP bill details: The Two Minute Summary.
How the PPP second draw loans will work. These allow some small businesses to take a second bite of the Apple.
Finally, if you didn’t (or a client didn’t) get the full PPP loan amount to which they were entitled, you want to know about PPP loan amount increases.