As Michelman & Robinson has reported in several prior alerts, the Paycheck Protection Program authorized under the CARES Act is designed to provide eligible small businesses with the resources they need to maintain payroll, hire back employees who may have been laid off, and cover applicable overhead.
What is particularly attractive about a PPP loan (which can be up to $10M) is that it is forgivable when the proceeds are used to cover payroll and most mortgage interest, rent, and utility costs over the eight-week period after the loan is made. In fact, when used pursuant to the terms of the CARES Act (and employee and compensation levels are maintained), a PPP loan acts much like a grant—free money to qualifying small businesses. Better yet, the extent of loan forgiveness will be exempt from U.S. federal income taxation.
It is the latter point that seems to have triggered Internal Revenue Service Notice 2020-32, which was issued yesterday (April 30, 2020). Pursuant to the notice, even if otherwise ordinarily deductible, payment of an expense (read: payroll, mortgage interest, rent, and utility costs) that results in forgiveness of a PPP loan is not allowed as a deduction under the Internal Revenue Code (IRC). On the plus side (and as indicated above), the CARES Act makes clear that income associated with PPP loan forgiveness is excluded from gross income for purposes of the IRC.
The rationale behind the IRS’s position as set forth in the notice is that it “prevents a double tax benefit.” This is no big surprise, and the net effect is that the PPP, which was thought to be a tax-free program, does indeed have tax implications.
In terms of state income tax, conformity with the IRS’s treatment of a given transaction or item is the norm. That being said, rules regarding the PPP are new and developing, and states could decide to take an approach to taxation that is different from the federal government’s. Bottom line: should a state not follow suit with the IRS and tax loan amounts forgiven as income, the actual benefit of a forgiven PPP loan would be significantly reduced.
This blog post is not offered, and should not be relied on, as legal advice. You should consult an attorney for advice in specific situations.