By Richard Rubin 

WASHINGTON -- Congress left a loose end in March's economic-relief law that could end up costing small businesses $120 billion in taxes, and lawmakers are still struggling to tie it up.

Lawmakers from both parties say small businesses that get loans forgiven under the Paycheck Protection Program should be able to deduct associated expenses, such as wages, on their tax returns.

Despite that consensus, Senate Republicans' latest proposal omitted the provision. Treasury Secretary Steven Mnuchin objected to including language that would allow the deductions, according to a Republican aide familiar with the discussions.

Now, as Congress debates the next round of relief to counter the impact of the coronavirus pandemic, the issue remains unsettled, with millions of small-business tax returns hanging in the balance.

The Treasury Department has said allowing the deductions would provide an impermissible double benefit to businesses, because they would be able to claim deductions and get tax-free income. Congress could overrule that.

The issue stems from the way Congress wrote the economic-relief law in March that created the PPP, now a $670 billion program in which loans can be forgiven if businesses used the money to maintain payrolls and meet certain other requirements. The law explicitly says that forgiven loans don't count as taxable income, but it is silent on whether ordinary tax deductions for the same expenses are allowed.

In late April, the Treasury Department and Internal Revenue Service determined that businesses couldn't also take deductions, citing a section of the tax code that prevents such double benefits.

Mr. Mnuchin called it "Tax 101" in defending the Treasury decision but hasn't expressed a public view on the proposed legislation that would overturn that decision. A spokeswoman declined to comment Tuesday.

A House relief bill, passed in May, included a provision allowing the tax deductions. Key Senate Finance Committee members, including Chairman Chuck Grassley (R., Iowa), top Democrat Ron Wyden of Oregon and John Cornyn (R., Texas), also want to allow the breaks.

They are backed by business groups, such as the National Federation of Independent Business, which said Tuesday that it was disappointed to see the idea dropped from the GOP bill.

In a statement, Mr. Cornyn blamed Washington bureaucrats for a "hidden tax increase" and said his proposal would just clarify what Congress meant back in March.

"This bill creates no new tax breaks and costs nothing," he said.

Allowing the deduction would give businesses more than $120 billion, according to Steve Rosenthal of the Tax Policy Center. Much of that would go to high-income business owners such as doctors and lawyers, he said.

Consider a simple example -- a business with $100,000 in loan forgiveness and a 22% tax rate. Currently, the $100,000 wouldn't count as income, and the business couldn't take $100,000 of deductions. Under the proposal advanced by Mr. Cornyn, Rep. Lizzie Fletcher (D., Texas) and others, the $100,000 wouldn't count as income and the business could get deductions worth $22,000.

That would be helpful even for businesses that are losing money, because they can use current losses against past years' income to claim refunds.

The IRS decision came as a surprise to Mike McKenny, president of Assured Vehicle Protection Inc., a 15-employee insurance-claims business in Mission, Kan., that took a PPP loan.

"It was a little kick in the gut after you had a swift pat on the back," said Mr. McKenny.

Already, some business owners are paying more on their quarterly estimated taxes to reflect the lack of deductions, said Joe Kristan, a partner at the accounting firm Eide Bailly LLP in Des Moines, Iowa.

"It's a live issue now and will obviously be a bigger live issue as you get close to year-end," he said. "Because the stakes are too high, somebody's going to [claim deductions and] litigate it if the bill isn't passed, and others will just hope they fly under the radar."

Lawmakers say they wanted companies to get the deductions. The Joint Committee on Taxation, the nonpartisan staff that estimates tax legislation, said in a July 27 letter to Mr. Cornyn that it agreed with that understanding of congressional intent and didn't assume in March that PPP changed which expenses could be deducted.

That means that overriding the Treasury Department's decision won't officially add to federal budget deficits, because it is viewed as clarifying what Congress did in March. But compared with doing nothing, the proposal would, in fact, reduce tax collections by tens of billions of dollars or more.

"It could be an unpleasant surprise at the end of the year," said Matt Turkstra, director of tax, fiscal affairs and accounting at the Associated General Contractors of America. "This is definitely something that was a disappointment."

Write to Richard Rubin at richard.rubin@wsj.com

(END) Dow Jones Newswires

July 29, 2020 11:53 ET (15:53 GMT)

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