The SALTshank Redemption—How the 50 States Deal With CARES

In Stephen King’s masterpiece, The Shawshank Redemption, Andy Dufresne is convicted of a crime he did not commit. Andy was an investment banker sentenced to 40 years in prison. Andy was tarring the roof of a building one day, when he overheard Captain Byron Hadley (one of the hardest guards to walk the prison) discussing a $35,000 gift left to him by his recently deceased brother. Instead of being grateful for the gift, Captain Hadley expresses his frustration that “the federal government would be taking a big bite out of his ass” with all the taxes he would have to pay. Andy, a former investment banker, told Captain Hadley that if certain forms were filled out, the IRS could not tax the gift. This piece of advise earned Andy, and his “co-workers”, two bottles of bohemian style beer! Shawshank Prison was located in the state of Maine. It is prudent to note that Andy did not mention to Captain Hadley the possibility that state taxes would have to be paid on the gift unless Maine conformed to the federal rules. In another scene, Andy begins to prepare the tax returns for all of the guards at Shawshank Prison, as well as all the guards in various Maine prison facilities. Once again, Andy informs one of the guards that he may deduct the price of his weapon when filing his federal income tax return. Nothing is mentioned about the guard’s state income tax return!

Indeed, a lot of taxpayers do not take into consideration state taxation when analyzing the tax effects of a particular transaction.


When the government passed the Coronavirus Aid, Relief, and Economic Security Act (“CARES”) on March 27, 2020, it was made clear that the amount of any loan would be forgiven and would not trigger cancelation of debt income (“CODI”) if the funds were used for qualified expenses. Section 1106(i) of the CARES Act provides that any amount that would be includible on the forgiveness of a PPP loan “shall be excluded from gross income”. This was a taxpayer friendly decision.

Alternatively, CARES was silent regarding the deductibility of expenses paid with any loan proceeds. The CARES Act did not address the expense side of the equation, but the IRS did in Notice 2020-32, disallowing any deduction for expenses paid with loan proceeds. This was a taxpayer unfriendly decision. The inability to deduct expenses attributable to the loan proceeds would trigger higher taxable income. This burdensome tax effect seemed to go against the underlying theme of keeping small businesses afloat during the Covid-19 crisis. On January 6, 2021, the IRS redeemed itself through the issuance of Revenue Ruling 2021-2. This ruling redeemed the IRS’s position on the deductibility of expenses attributed to the loan proceeds. It expressly allowed these deductions to reduce taxable income.

SALT Conformity

No state conforms to every provision of the Internal Revenue Code (“IRC”). However, states do conform to the IRC to varying extents. Generally, state approaches to IRC conformity can be divided into three classes: rolling, static, and selective. States with rolling conformity automatically implement federal tax changes as they are enacted, unless the state specifically decouples from a provision. Static (or “fixed date”) conformity incorporates updates to the federal tax code, but only the version of the IRC as it existed up to a specific point in time (rather than adopting all changes on a rolling basis). Some such states conform legislatively every year, while others are inconsistent and may even conform to an outdated version of the IRC. Selective conformity incorporates certain federal provisions or definitions by specific reference, but may otherwise omit large portions of the federal tax code.

Regarding CARES, there are two important federal rules that must be analyzed for each state in terms of conformity. First, the fact that CODI is not triggered by forgiveness of the SBA loan proceeds. In other words, forgiveness of the SBA loan does not trigger state taxable income. Second, the fact that the qualified expenses paid with the SBA loan proceeds can be deductible from state taxable income.

As with Captain Hadley and his gift, any analysis of the tax consequences of the SBA loan proceeds must include state taxes as well. The IRS redeemed itself by passing Revenue Ruling 2021-2 allowing the expenses to be deductible. Whether the states redeem themselves by conforming to the federal rule needs to be analyzed on a state by state basis.


Andy may have saved Captain Hadley federal income tax on the gift but he forgot to inform him of any state income tax due on his gift. Did Andy truly deserve the 2 bottles of Bohemian style beer for all of his co-workers? Was Captain Hadley presented with a tax bill from the state of Maine? Both issues are moot as Andy escaped from Shawshank Prison while Captain Hadley was arrested for being a very bad prison guard!

It is prudent to note that many states have not clearly addressed one or both of the above issues. Additionally, many of the states that have addressed the issues have done so by passing complicated legislation that is not easily determinable. Unfortunately, there is no easy way to present this information as each state is nuanced and any accurate interpretation requires an analysis by an expert tax practitioner. Withum is currently analyzing all 50 states as legislation is passed to clarify each states’ position.

Author:Jeffrey A. Clayman, CPA, JD, LLM-Tax | [email protected]

To avoid being Captain Hadley, please do not consult with a prisoner, even if he is an investment banker. Instead, please reach out to a
Withum tax adviser.

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