IRS Rules on Federal PPP Expense Deductions; State Tax Questions Remain
Yesterday, the IRS and Treasury issued guidance to formalize the allowance of federal tax deductions related to PPP expenses. With the recent passage of the COVID-related Tax Relief Act of 2020 (part of the Consolidated Appropriations Act, 2021), PPP borrowers will now be permitted to deduct eligible loan expenses when such payments resulted in or are expected to result in the forgiveness of the loan.
While the IRS ruling only applies directly to federal tax deductions, the tax provisions within the stimulus legislation itself could have some consequences for state and local conformity.
State Taxes & PPP Expense Deductions
From a state tax perspective, perhaps the most significant aspect of the changes to the Paycheck Protection Program is confirmation that business expenses paid out of a forgiven PPP loan may be deducted for federal income tax purposes, even though the forgiven PPP loan is excluded from federal gross income. As readers are now likely keenly aware, states generally conform to the Internal Revenue Code (IRC) in one of two ways: “rolling” IRC conformity (i.e., the state conforms to the IRC automatically or “as amended”) and “fixed-date” IRC conformity (i.e., the state conforms to the IRC as of a specific date). Thus, while a rolling IRC conformity state should conform to the PPP loan expense deduction provisions in the new legislation unless the state enacts its own decoupling legislation, a fixed-date IRC conformity state may not conform without enacting its own legislation.
The issue is further complicated because one fixed-date IRC conformity state may conform to the IRC “as enacted on” a specific date, whereas another state may conform to the IRC “as in effect on” a specific date. Although the effective date of the expense deduction provision applies to taxable years ending after the date of the enactment of the CARES Act (March 2, 2020), only a handful of fixed-date IRC conformity states have updated their IRC conformity dates to on or after March 2, 2020.
Three fixed-date IRC conformity states that enacted legislation in 2020 conforming to the CARES Act exclusion from gross income for PPP loan forgiveness illustrate the uncertainties of whether PPP expense deductions, now allowed for federal tax purposes, will be allowed for state purposes:
- California: Despite the federal enactments of the TCJA in 2017 and the CARES Act in 2020, California has not updated its January 1, 2015 IRC conformity date. However, as part of A.B. 1577 enacted in 2020, California did conform to the CARES Act exclusion from gross income for PPP loan forgiveness but A.B. 1577 also provides that related expense deductions are not deductible for California tax purposes. The federal legislation has no impact on the California treatment of PPP expense deductions and such expenses may not be deducted.
- Hawaii: When Hawaii enacted S.B. 2920 to update its IRC conformity date to the IRC “as amended as of” March 27, 2020, Hawaii also conformed with and decoupled from various provisions of the CARES Act. One such provision was conformity with the exclusion from gross income for PPP loan forgiveness. However, Hawaii’s legislation was silent with respect to related PPP expense deductions. Given the bill’s effective date for PPP expense deductions, taxpayers will need to address whether S.B. 2920 supports deducting PPP expenses for Hawaii income tax purposes.
- South Carolina: South Carolina updated its IRC conformity date with 2020 legislation (S.B. 545) to the IRC “as amended through” December 31, 2019. That IRC fixed-date conformity clearly did not encompass the CARES Act nor obviously the recent federal stimulus legislation. However, S.B. 545 did separately conform to the federal exclusion of PPP loan forgiveness from gross income. In addition, while South Carolina’s general IRC conformity date update would not accommodate the federal stimulus legislation’s PPP expense deductions, S.B. 545 also separately permitted PPP expense deductions starting in tax year 2020 for South Carolina income tax purposes if allowed for federal purposes.
As always, MFA’s PPP Advisory Team is here to assist. Please reach out with any questions or if you need assistance with your existing PPP loan forgiveness application.
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