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Crazed Talk About Double Dipping

Treasury Secretary Steven Mnuchin with Vice President Mike Pence and other members of the White House Coronavirus Taskforce at a press briefing.
Treasury Secretary Steven Mnuchin (center) at a coronavirus update briefing March 9, 2020.
Photo by D. Myles Cullen, courtesy The White House.

Treasury Secretary Steven Mnuchin has the wild-eyed look of a man who just learned that all three of his teenagers need new orthodontics and intensive hitting instruction before the travel team season begins.

At such moments, many people succumb to panic. They issue unhelpful pronouncements like “We will eat cream of wheat for dinner” or “I will teach the triplets to hit” or “Congress didn’t really make loan forgiveness under the Paycheck Protection Program tax-free.”

That last one is Mnuchin’s current fixation.

It is crazed talk, but I understand where it comes from. Someone recently told Mnuchin that he needs to borrow $4.5 trillion – that’s Trillion with a capital T, even if The Associated Press Stylebook says otherwise – before the end of the current federal fiscal year. The fiscal year expires on Sept. 30. I hope Mnuchin doesn’t expire first.

Worse, with the income tax deadline and its associated receipts pushed back into summer, the treasury secretary must assemble nearly $3 trillion of that sum by June 30. Most banks cap daily ATM withdrawals at something like $800 or $1,000, which is not going to get the job done. So Mnuchin will have to go to the bond market. He is probably wondering whether he would stand a better chance of scoring 3 trillion rolls of toilet paper at Costco. Or how, with the unemployment rate soaring, he got stuck in the worst job in the cabinet, if not in America.

Congress has authorized $3.6 trillion in emergency spending since the pandemic-stricken economy shut down in mid-March. The spending spree is probably not over yet, either. It must feel, to Mnuchin, as if he took the family out for dinner, saw his obnoxious brother-in-law order a caviar-crusted Kobe porterhouse, and now sees that clown beckoning the sommelier and the maitre fromager. (These are the folks who will furnish outlandishly expensive wine and cheese with a smile. I had to look them up.)

So, like any other guy who knows he is about to get stuck with a tab that hints he’ll need to survive on canned tuna in retirement, Mnuchin is desperately trying to whittle down Congress’ largesse.

The secretary’s most prominent target has been the $660 billion Paycheck Protection Program. Congress designed the program to offer businesses with 500 employees or fewer a loan of up to 10 years. Businesses could have that loan forgiven if they used money to meet payroll, rent, utility and mortgage interest costs. Congress also specified that the loan forgiveness would be tax-free.

Mnuchin’s Treasury narrowed the program in multiple rounds of guidance. Publicly traded companies included under the law’s size limits are presumptively ineligible because they may have access to other sources of capital, the secretary announced. Forgiveness is only available if businesses spend at least 75% of the borrowed amount on payroll within eight weeks of receipt, a feat that is either difficult, impossible or financially imprudent for many enterprises under lockdown conditions. Any unforgiven balance must be repaid within two years, not 10.

On top of that, the Internal Revenue Service (an arm of the Treasury Department) announced that to the extent businesses used forgiven loan proceeds to pay normally deductible business expenses (as required to win forgiveness in the first place), those deductions would be disallowed. This negates the tax-free status of the loan forgiveness that Congress explicitly wrote into the law creating the PPP in the first place.

On Monday I explained in this space why I think the IRS position is both incorrect and open to challenge by taxpayers who are guided by qualified tax advisers. Although my analysis was brilliantly conceived and artfully presented, it has thus far either escaped the secretary’s attention or failed to persuade him. So I am going to try again, approaching the topic from another angle.

At 8:37 a.m. Eastern Daylight Time on Monday (which was roughly half an hour before my column went live) Mnuchin asserted on the Fox Business channel that allowing the loan forgiveness to be tax-free while permitting expenses paid from the loan proceeds to be deducted would permit businesses to engage in unwarranted “double dipping.” He has things backwards. By denying the deduction for ordinary business expenses, it is Mnuchin’s Treasury that is taking the double dip.

Why? Because when a business reduces its tax bill by paying a deductible expense, someone else receives taxable income. The Treasury gets paid either way. Sometimes, the Treasury even gets paid more.

Let’s walk through an example. Suppose Fred is the boss and Barney is the employee. Let’s also suppose that, in normal times, both Fred and Barney pay taxes at a 30% federal rate.

Fred borrows $100 via the PPP and, in the course of eight weeks, pays it to Barney and gets the loan forgiven. Business then miraculously returns to normal. Barney goes on to earn his regular salary, and Fred his normal profit, for the rest of the year.

If Fred had simply pocketed the $100, the loan would not be forgiven. As long as Fred eventually repaid the loan, there would be no taxable income and the government would collect nothing at all. (The lending bank backed by the Small Business Administration collects the meager 1% interest that the Treasury authorized.) Barney, out of a job due to the lockdown, would pay no income tax either – in fact, he would drain government coffers by collecting unemployment. This is the result the loan forgiveness was designed to avoid.

So Fred pays Barney the $100 and gets the loan forgiven. The forgiveness is nontaxable, per Congress. If Fred is allowed the normal deduction for paying Barney, which I believe is the correct result, he saves $30 in taxes on the rest of the year’s earnings. If he has no earnings, he applies the loss to another taxable year and still saves $30. But don’t forget about Barney – the IRS gets its $30 out of his wages. Compared to the situation where Barney gets laid off and Fred pockets the loan, the Treasury has not lost or gained any taxes. In fact, it is better off if Fred keeps Barney on the payroll, because Barney will not need to collect federally enhanced unemployment.

Under Mnuchin’s approach, the IRS still collects $30 from Barney – if Fred keeps him on the job. But since the secretary’s approach denies Fred the tax deduction for Barney’s salary, Fred gets no financial benefit, apart from the pleasure and any business advantage of keeping Barney. The Treasury, which gets nothing at all if Fred spends the PPP money on himself and later repays it, is $30 ahead.

This is Mnuchin’s double dip. He is correctly applying the usual rule, which is that expenses paid from tax-exempt income are not deductible. But in so doing, he is pocketing the tax benefit that Congress intended to act as a financial incentive for Fred to keep Barney on the job. He is making Fred financially indifferent to whether he pays Barney out of PPP funds or pays himself.

The same result occurs if Fred pays his landlord or his electric bill or some other vendor with forgiven PPP funds. Almost any tax-deductible business expense is taxable income to somebody else.

And if Fred is doing business as an ordinary corporation, the result of Mnuchin’s hard line is even more skewed in Treasury’s favor. The top federal tax rate on corporations is 21%. A single taxpayer reaches a 22% tax bracket in 2020 at only $40,126 of taxable income. Barney might pay more in tax on that $100 of income than Fred Inc. would save by deducting it. Individual tax rates get as high as 37%, although few workers getting paid out of PPP funds this year will ever be subject to that rate. Whenever it does happen, it would be a net gain for the Treasury, even if the employer can claim the deduction.

Maybe somebody will show these columns to the treasury secretary, and maybe he will see the wisdom in my words. I hope so, but I am not optimistic. As the keeper of a national purse that is being turned inside out, Mnuchin does not want my advice. The only things that can make him happy are $3 trillion and a nice hot bowl of cream of wheat.

Larry M. Elkin is the founder and president of Palisades Hudson, and is based out of Palisades Hudson’s Fort Lauderdale, Florida headquarters. He wrote several of the chapters in the firm’s book, Looking Ahead: Life, Family, Wealth and Business After 55. His contributions include Chapter 1, “Looking Ahead When Youth Is Behind Us” and Chapter 4, “The Family Business."

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