States have been very active in updating their conformity to federal Paycheck Protection Program (PPP) guidance. Currently, almost all states conform to the federal treatment, however, there are a few states who don’t intend to conform to the recent regulatory updates. These states either don’t allow the deduction of expenses paid with PPP loan proceeds or limit the deduction for specific taxpayers, to specific amounts, or both.
A good example of these limits is California, which doesn’t include forgiven PPP loan proceeds in taxable income. On February 17, Governor Newsom and state legislative leaders announced their agreement on a package that will provide pandemic-related relief to California taxpayers. This is the first time California has commented on its treatment of expenses paid with PPP loan forgiveness proceeds.
Although it is not a 100% deduction, the agreement will allow up to $150,000 of expenses paid with PPP loan forgiveness proceeds to be deductible for any size company. However, this was never passed into law. Assembly Bill 80, which is expected to be passed in the next few weeks, has now been amended to only allow conformity with expenses paid with PPP loan proceeds for entities that meet certain qualifications.
The PPP loans were created to provide an important service to help keep millions of small businesses open and their workers employed during the COVID-19 pandemic. For a borrower to have their loan forgiven, they must comply with certain requirements. Forgiveness eligibility requires using the loan for qualifying purposes (e.g., payroll costs, mortgage interest payments, rent and utilities) within a specified amount of time.
Generally, a forgiven loan qualifies as income. However, Congress chose to exempt forgiven PPP loans from federal income taxation. Most states conform to this treatment, however, Florida, Minnesota, New Hampshire and Texas all view the forgiveness as income. Other states deny the deduction for expenses paid for using forgiven loans or have specific guidance limiting the deduction, like California, Hawaii, North Carolina, Utah and Virginia. For up-to-date details related to individual states’ treatment of PPP see our PPP Loan Tax Implications page.
As noted above, California has recent legislation in the works to conform to the federal treatment of expenses paid with PPP loan proceeds. Assembly Bill 80 (AB 80) has passed both the assembly and senate. It’s now awaiting the signature of Governor Newsom. Once passed, this bill will allow eligible taxpayers to deduct business expenses paid by a forgiven PPP debt.
For a taxpayer to be eligible for these deductions, it can’t be a public company and it must demonstrate at least a 25% reduction in gross receipts in the first, second or third quarter of 2020 relative to the same 2019 quarter. The fourth quarter of 2020 may also be used if the PPP application was submitted on or after January 1, 2021. AB 80 will also include deductibility for all forgivable Emergency Injury Disaster Loan (EIDL) loans.
For more details related to the revenue reduction calculation, see the SBA guidance on how to calculate revenue reduction for second draw PPP loans.
Although it is not a full deduction, this is the first step the state has made to address the issue. It is possible that with time California will allow a full deduction, but for estimate and provision purposes, the $150,000 cap should be used to maintain regulatory compliance. For California R&D credit purposes, wage expenses paid with forgiven PPP loan proceeds are eligible as qualified research expenses (QREs) only up to the $150,000 limit.
