Client Alert- The Government Giveth And The Government Taketh AwayMay 06, 2020
- FisherBroyles News
Late last week, the Internal Revenue Service issued a notice providing Triple P borrowers important guidance on the tax effect of forgiveness for Triple P borrowers.
If you recall, the Triple P program permits qualified small business borrowers adversely impacted by the COVID-19 pandemic to borrow up to 2.5 times the borrower’s monthly payroll. (Thus, a borrower with a $1.2 million monthly payroll could borrow up to $3 million under the program.) You can read more about the Triple P program in the article we published just after Congress passed the CARES Act, which is the enabling statute for the program. (You can find the CARES Act here.) The Small Business Administration (“SBA”) is administering the Triple P program under the CARES Act.
Perhaps the single most attractive benefit of the Triple P program is that borrowers using loan proceeds for payroll and certain other specifically designated expenses (like rent, utilities and interest on mortgage payments) can ask the SBA to forgive the portion of the loan used to pay such expenses. Of course, the practical effect of forgiveness is to convert the government loan into a government grant. In the days following the enactment of the program, businesses flooded approved SBA lenders with loan applications. After all, who doesn’t want a government give-away? As we’ve seen, in light of the pandemic, the volume of loan applications and the fact that Congress passed the CARES Act to put the program in place, there are a number of on-going issues that borrowers – approved and yet to be approved – need to factor into their decision to participate in the program.
One very important issue was the tax impact of loan forgiveness. What was clear in the CARES Act was that the proceeds of forgiven loans would not be taxable to borrowers for purposes of federal income tax. (Ordinarily, the forgiveness of debt results in the forgiven borrower receiving taxable income under Section 83 of the tax code [and that’s the only section I recall from Fed Tax in law school over 30 years ago].)
That’s the government giveth part. Here comes the government taketh away part –
Last week’s IRS notice made it clear that borrowers who receive loan forgiveness because they used loan proceeds to pay approved expenses will not be able to write off those approved expenses from the borrower’s gross income for federal income tax purposes as they otherwise ordinarily would. Thus, for the hypothetical $3 million borrower cited above, this means the company’s taxable income for the year in question – assuming no other changes – would increase by $2.5 million (because of the absence of deductions) and – assuming a 30% tax rate – the borrower would end up paying an additional $750,000 in federal income taxes. The rationale advanced by the IRS was that under the Internal Revenue Code taxpayers can’t take deductions for expenses paid for by tax-exempt income. Admittedly, it seems to make sense.
Given this development, borrowers should consider the tax ramifications of the loan and forgiveness. Simple math dictates that the borrower in our hypothetical is still up $2.25 million (i.e., the $3 million proceeds forgiven less the $750,000 federal income tax). There still may be, however, tax planning, cash flow or other financial issues to consider, especially if a borrower assumed it would be able to deduct the forgiven expenses from its federal income taxes.
There is some possibility Congress could pass an amendment to the CARES Act addressing this issue and providing borrowers additional tax relief. There certainly continue to be a number of different issues that have come to light in the roll-out of the Triple P program and we certainly could use some direction on what Congress intended. That said, given the gridlock in Washington, the second round of funding for the Triple P program may be all we get. Stay tuned for further developments.
For additional information, please contact the following: Eric Pritchard at firstname.lastname@example.org
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© 2020 FisherBroyles LLP
About FisherBroyles, LLP
Founded in 2002, FisherBroyles, LLP is the first and world’s largest distributed law firm partnership. It has grown to over 240 people in 22 offices nationwide. The FisherBroyles’ efficient and cost-effective Law Firm 2.0® model leverages talent and technology instead of unnecessary overhead that does not add value to our clients, all without sacrificing BigLaw quality. Visit our website at www.fisherbroyles.com to learn more about our firm’s unique approach and how we can best meet your legal needs.
© 2020 FisherBroyles LLP