Guidance issued by the Treasury Department and the Small Business Administration (SBA), the federal agency that administers the Paycheck Protection Program (PPP), demonstrates that the PPP loans, as originally thought, were too good to be true.

PPP was established by section 1102 of the Coronavirus Aid, Relief, and Economic Security Act (CARES Act), Public Law 116-136, 134 Stat. 281, 286-93 (March 27, 2020). As enacted, the PPP provided for readily available low-interest loans potentially forgivable to the extent used for a broad range of expenditures, all of which were otherwise deductible. Further, the statute expressly provided that the amounts forgiven were not taxable as income to the borrower.  When the CARES Act was enacted, many thought that PPP was “too good to be true,” a belief validated by recent guidance issued by Treasury and SBA.

First, the SBA declared in an Interim Final Rule that no more than 25 percent of the amount forgiven can be attributable to non-payroll costs. See Q&A 2.o. in Part III of the interim final rule, Business Loan Program Temporary Changes; Paycheck Protection Program, Docket No. SBA-2020-0015, 85 Fed. Reg. 20811, 20813-20814 (April 15, 2020). This requirement is not in the statute and significantly limits the utility of the loan to employers in high-rent locations forced to lay off most of their staff due to government closure orders. The SBA’s subsequent Interim Final Rule stated that a borrower may not take multiple draws from a PPP loan to delay the start of the eight-week covered period. Together, these limitations have forced employers to decide to return the PPP loan proceeds, rather than make the expenditures and later fail to meet the forgiveness requirements.

Next, the SBA objected to the many large or publicly traded companies that applied for and received PPP loans during the initial round of funding. Despite the statute expressly making such entities eligible for PPP loans through a waiver of certain SBA affiliation rules that would otherwise disqualify them, the SBA issued two “frequently asked questions” (FAQS) reiterating that PPP loan applicants must certify in good faith that “current economic uncertainty makes this loan request necessary to support the ongoing operations of the Applicant.” The FAQS went on to state that in so certifying, borrowers consider “their current business activity and their ability to access other sources of liquidity sufficient to support their ongoing operations in a manner that is not significantly detrimental to the business.” The SBA takes the position that “it is unlikely that a public company with substantial market value and access to capital markets will be able to make the required certification in good faith, and such a company should be prepared to demonstrate to SBA, upon request, the basis for its certification.” The SBA then provided a safe harbor for such borrowers (which were expressly eligible for PPP loans under the CARES Act) by allowing any “borrower that applied for a PPP loan prior to the issuance of this guidance and repays the loan in full by May 7, 2020” to be “deemed by SBA to have made the required certification in good faith.” Finally, the SBA published a FAQ stating that “[t]o further ensure PPP loans are limited to eligible borrowers in need, the SBA has decided, in consultation with the Department of the Treasury, that it will review all loans in excess of $2 million, in addition to other loans as appropriate, following the lender’s submission of the borrower’s loan forgiveness application.” These FAQs and related comments by public officials have had a chilling effect on PPP borrowers; several have reportedly returned the loan proceeds and countless others are no doubt considering doing so.

On April 30, 2020, the IRS released Notice 2020-32, which “clarifies that no deduction is allowed under the Internal Revenue Code (Code) for an expense that is otherwise deductible if the payment of the expense results in forgiveness of a covered loan pursuant to section 1106(b) of the [CARES Act] and the income associated with the forgiveness is excluded from gross income for purposes of the Code pursuant to section 1106(i) of the CARES Act.” This conclusion is based on section 265(a)(1) of the Code, which disallows otherwise allowable deductions (such as the payroll, rent, and utility payments for which loan forgiveness is available under the CARES Act) because such payment is allocable to tax-exempt income and therefore “prevents a double tax benefit” that would otherwise occur. While not beloved by PPP borrowers, Notice 2020-32 provides certainty on at least one open issue regarding forgiveness.

The CARES Act was enacted during an unprecedented crisis and understandably did not address every contingency. Even as the law has developed post-enactment, the PPP loans still offer significant and potentially existential benefits to borrowers. Hopefully, the SBA will issue much-needed guidance on the myriad of issues remaining open and allow borrowers to maximize their intended impact.