Many states follow the federal tax treatment of Paycheck Protection Program (PPP) loan forgiveness. Under the federal Coronavirus Aid, Relief, and Economic Security Act (CARES Act), borrowers may have their loans forgiven without incurring tax liability that would normally result from discharge of debt income. States that do impose a tax on PPP loan forgiveness usually allow expenses paid with the loan proceeds to be deducted.
What Is the Paycheck Protection Program?
The PPP was designed to encourage businesses to maintain their workforce. If employment requirements are met, as well as certain other conditions, the borrower may have its loan forgiven while at the same time not have to pay tax on the discharge of debt income. It is also possible for a borrower to have only a portion of its loan forgiven if it reduced the number of its full-time equivalent (FTE) employees.
What Expenses may be Forgiven?
To qualify for loan forgiveness, a borrower must use at least 60% of the PPP loan amount for payroll costs. Up to 40% of the PPP loan may be used for mortgage interest, rent, and certain utilities.
Are Expenses Paid with Forgiven Loan Proceeds Deductible?
At first it was unclear if expenses paid with PPP loan proceeds could be deducted for federal income tax purposes if the loan was later forgiven. The IRS issued a notice clarifying that no deduction is allowed if the payment of the expense results in forgiveness of the PPP loan and the income associated with the forgiveness is excluded from gross income.
What is the State Tax Treatment of PPP Loan Forgiveness?
How states treat PPP loan proceeds that are forgiven depends on several factors. For example, whether the state conforms to the federal CARES Act and the PPP provisions, as amended. Even if a state generally conforms to the CARES Act, it may choose to decouple from provisions that do not include loan amounts as income if the loan is forgiven or otherwise discharged.
Does State Conform to Federal Tax Treatment?
Some states have conformed to the federal CARES Act PPP provisions. States that have provided guidance on their conformity include the following:
- California conforms to federal law excluding any covered loan amount from income and will not tax forgiven PPP loan amounts, beginning with tax year 2020;
- Connecticut conforms to the PPP provisions because of its starting point for computing state tax, so taxpayers are not required to add back the federal exclusion of income from the forgiveness of PPP loans when computing corporation business or personal income tax liability;
- Iowa allows a taxpayer’s PPP loan that is forgiven and excluded from federal gross income to be excluded from income for Iowa tax purposes after 2018;
- Kentucky allows taxpayers to exclude income from loans forgiven under the PPP;
- New Hampshire does not conform to the CARES Act, so federal PPP loans that are forgiven and not taxable federally are included as income for New Hampshire BPT purposes; and
- Tennessee begins with federal taxable income for its excise tax, so it conforms to the exclusion from gross income of PPP loan forgiveness.
Does State Allow a Credit or Deduction for Expenses Paid Using PPP Funds?
- California does not allow a credit or deduction for any expenses paid using forgiven PPP funds. Taxpayer borrowers must reduce any credit or deduction otherwise allowed for those expenses by the amount of the forgiven loan excluded from income;
- Kentucky does not allow business expenses from PPP loans to be deducted as the expenses relate to tax-exempt income under Kentucky law;
- New Hampshire BPT taxpayers may deduct business expenses paid with PPP funds that are generally not deductible on the federal return because the PPP funds were excluded from income for federal purposes; and
- North Carolina requires taxpayers computing state corporate and personal income tax liability to add back any expense deducted on the taxpayer’s federal return if the payment of the expense results in PPP loan forgiveness and the taxpayer excludes that income from federal gross income.
Several states have not yet issued definitive guidance on whether they will follow federal tax treatment of PPP loan forgiveness.
By Tralawney Trueblood, J.D., M.B.A.
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