Life is in a constant state of flux right now with the COVID-19 virus. It has affected daily life and the economy. Congress has worked to provide economic stimulus programs such as loans and credits. The intent of Congress was to stimulate the economy and help employers maintain business and retain employees to alleviate the economic hardship caused by COVID-19. However, as is typical when trying to quickly stop the negative impact of a disaster, details get omitted from the legislation and key areas need clarification as we have seen recently with the Paycheck Protection Program (PPP) and the Employee Retention Credit. More specifically, with the PPP concerning the deductibility of expenses when payments were made with debt forgiven funds and with the Employee Retention Credit in determining whether employers could claim the Employee Retention Credit when the only payments made to furloughed employees was for their health care benefits.
Paycheck Protection Program
Section 1102 of the CARES Act taken in conjunction with Section 7 of the Small Business Act, regarding business loans, enacted the Paycheck Protection Program. The PPP allows for loans to cover Payroll and other “covered expenses” such as rent. In addition, the loan can be forgiven upon application by the business and proof that the loan was used to pay “covered expenses” per Section 1106(b) of the CARES Act. Furthermore, 1106(i) of the CARES Act excludes the debt forgiven costs from Gross Income.
The CARES Act did not address whether the “covered expenses” could also be deducted in addition to the allowance for debt forgiveness. This led to the Department of Treasury and the Internal Revenue Service (IRS) releasing new guidelines and provisions under NOTICE 2020-23. The IRS’s position per the notice is that the “covered expenses” are not deductible pursuant to IRC Section 265. IRC Section 265 does not allow a deduction for expenses that are “wholly exempt” from federal income taxes. Therefore, since the loan is forgiven debt and not included in gross income i.e. “wholly exempt” it is not deductible per IRC Section 265.
This position is contrary to the intent of the law and is evident by the fact that Senate Finance Committee Chairman Chuck Grassley and ranking member Senator Ron Wyden have introduced bipartisan legislation to permit businesses to deduct the “covered expenses” as well as have the debt forgiven. The Small Business Expense Protection Act, S.3612 is a Bill to clarify that the deductibility of ordinary business expenses is not prevented due to coronavirus asstiance that is excluded from gross income. In his comments, Grassley stated that the interpretation of the Treasury and IRS is “opposite” of the intent to deduct “covered expenses”. Prior to introducing legislation, Grassley, Wyden and House Ways and Means Committee Chairman Richard Neal, sent a joint letter to Treasury Secretary Steven Mnuchin dated May 5, 2020, stating that disallowing the business deductions for the “covered expenses” reverses the benefit intended by exempting the loan forgiveness from income. This Bill will correct the misinterpretation by the Treasury Secretary and IRS and allow for the full intent of the law to be carried out.
Employee Retention Credit
In addition to the Bill filed to update the intent and function of the PPP, the Treasury released a letter updating the position of the Treasury and the IRS on the Employee Retention Credit. Generally, Section 2301 of the CARES Act allows for a credit that is equal to 50 percent of the “qualified wages” of each employee for an “eligible employer” for which the employee is not providing services due to a government order. “Qualified Wages” are defined by Section 2301(c)(3) and under 2301(c)(3)(C)(i) include the “eligible employer’s qualified health plan expenses”.
The issue with this particular credit incentive arose when an employer furloughed the employees and did not pay the furloughed employees a wage but did continue to pay for their health care benefits. The Treasury and the IRS took the position that for an “eligible employer” with an average number of full-time employees that was greater than 100 and had furloughed employees that were not paid a wage but the employer still paid the qualified health plan expenses for those employees the employer could not take those employees into account for the credit. This, however, was against the intent of Congress when enacting the CARES Act. One of the goals of the CARES Act is to incentivize employers to maintain the health care benefits of its furloughed employees during the shutdown and by taking the above position there is a limiting effect that minimizes the potential benefit and has a further negative impact on the economy.
After, receiving the letter mentioned above sent to Mnuchin, the Treasury Principal Deputy Assistant Secretary provided a letter, dated May 7, 2020, to Grassley reversing this position on the “qualified health plan expenses” and as of May 7th the COVID-19-Related Employee Retention Credits Frequently Asked Questions section on the IRS website have been updated to account for this change. “Eligible employers” can now take the “qualified health plan expenses” as part of the “qualified wages” towards calculation of the credit for furloughed employees not receiving a wage but for which the employer is paying for the health care benefits of those employees.
These will probably not be the only times that additional clarification will be needed to address the Treasury Secretary’s and IRS’s interpretations of various relief programs provided by the CARES Act. This is evident since it is clear that the Treasury Secretary and IRS read the black and white letters of the CARES Act and do not take into account the legislative intent. Stay Tuned.
Consult a tax specialist if you have additional questions or need clarification with the coronavirus incentive packages.