The Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”) authorizes the Treasury Department to provide payments to passenger air carriers, cargo air carriers, and certain contractors that must be exclusively used for the continuation of payment of employee wages, salaries, and benefits. The Payroll Support to Air Carriers and Contractors Program provides a total of up to $32 billion in payroll support to avoid layoffs and furloughs in the airline industry, which has been hard hit by the COVID-19 pandemic. The CARES Act authorizes up to $25 billion in payroll support for passenger air carriers; other air carriers and certain contractors may receive up to $4 billion and $3 billion in payroll support, respectively. Section 4117 of the CARES Act provides that the Treasury Department may receive warrants, options, preferred stock, debt securities, notes, or other financial instruments issued by a company receiving payroll support payments to provide appropriate compensation to the Federal Government for the provision of the financial assistance. Treasury has released a form to memorialize the terms and conditions of the Payroll Support Program Agreement.
On April 2, 2020, the Treasury Department released a series of Q&As directed at air carriers and contractors hoping to learn more about the requirements of the payroll support program. The Q&As discuss the basic requirements of the program including the logistics of applying for the program as well as the forms of warrants, options, preferred stock, debt securities, notes, and other instruments that are acceptable. On April 20, 2020, the Treasury Department released an additional series of Q&As about the Program. The Treasury Department Q&As also noted that the IRS would post FAQs on the federal income tax consequences of the payroll support payments.
On April 21, 2020, the IRS released FAQs entitled “Payroll Support for Air Carriers and Contractors under the CARES Act Frequently Asked Questions.” Some key points from the IRS FAQs are as follows:
- If a Recipient does not provide warrants, options, notes or other instruments to the Treasury Department as compensation for the payroll support, the payroll support is included in the recipient’s gross income and is therefore taxable;
- Payroll support received in excess of the fair market value of any warrants, options, preferred stock, debt securities, or notes that the recipient issues to the Treasury Department in exchange for the payroll support is taxable under the Code; and
- When a recipient uses the payroll support amounts to pay wages, salaries, and other benefits to its employees as required by the program, the recipient may deduct those expenses under the Code as ordinary and necessary business expenses regardless of whether the recipient issued warrants, options, preferred stock or other instruments to the Treasury in exchange for the payroll support received.
The IRS FAQs highlight a potential disparity in the federal tax treatment of the payroll support for air carriers and contractors under the CARES Act as compared to the treatment of taxpayers receiving loans through the Paycheck Protection Program (“PPP”) that are ultimately forgiven. In particular, practitioners have disagreed over whether businesses that pay eligible expenses with funds received through the PPP are able to deduct those expenses even when the corresponding loan is later forgiven and excluded from income under section 1106 of the CARES Act. Some practitioners have pointed to section 265, which denies a deduction for expenses allocable to most tax-exempt income, and common law tax principles as denying the deduction of expenses paid with PPP loan proceeds that are forgiven. Others have pointed to the IRS’s failed efforts to deny deductions for losses tied to assets purchased during the savings and loan crisis, when the buyers of distressed assets received tax-exempt make-whole payments from the government, as evidence that those expenses are deductible.
In contrast to the PPP loan program, payroll support payments issued under the air carrier and contractor payroll support program are taxable to the extent they represent income under general tax principles. In this respect, the air carrier and contractor support program reflects more of a market-based approach to providing financial support with the support payments treated as either gross income if the business does not issue equity or debt to the U.S. Treasury, or alternatively proceeds arising from the issuance of equity or debt securities by the business to the U.S. Treasury that the business must ultimately redeem or repay to extinguish.