May 26, 2020
Forgiven PPP Loans and the Deductibility of Expenses Paid
Posted by Stephanie Shorkley
- While most states have yet to comment on whether taxpayers can deduct ordinary business expenses paid with Paycheck Protection Program (PPP) loan proceeds that are forgiven by the IRS, taxpayers should monitor state conformity to the CARES Act (P.L. 116-136) and the Internal Revenue Code.
- Rolling conformity states that conform to the CARES Act will not tax or include as gross income any forgiveness amount associated with the PPP. As such, it is likely that these states will also follow the federal treatment that disallows expense deductions associated with any forgiven PPP loan amount.
- Taxpayers should also be aware of the introduction of measure S.3612, which seeks to establish that coronavirus assistance, whether forgiven or repayable, will not affect the treatment of ordinary business expenses.
PPP Expense Deductions
As a part of the CARES Act (Sec. 1102), the Small Business Administration (SBA) made available PPP loans, for the purpose of helping businesses keep their workforce employed during the COVID-19 pandemic. The SBA would not require repayment of the loan if a business kept employees on its payroll for eight weeks and used the loan money for payroll, rent, mortgage interest, or utilities, with 75% of the loan amount forgiven being used for payroll. While loans that are forgiven would normally be considered cancellation of debt income, the CARES Act specifically states in Sec. 1106(i) that any forgiven loan amount will be excluded from gross income.
The IRS has issued Notice 2020-32 to provide guidance regarding the deductibility for federal income tax purposes of certain otherwise deductible expenses incurred in a taxpayer’s business when the taxpayer receives a PPP loan. Notice 2020-32 states that “no deduction is allowed under the Internal Revenue Code (Code) for an expense that is otherwise deductible if the payment of the expense results in forgiveness of a covered loan pursuant to section 1106(b) of the Coronavirus Aid, Relief, and Economic Security Act (CARES Act), Public Law 116-136, 134 Stat. 281, 286-93 (March 27, 2020) and the income associated with the forgiveness is excluded from gross income for purposes of the Code pursuant to section 1106(i) of the CARES Act.”
Therefore, currently to the extent that any PPP loan is forgiven and excluded from a taxpayer’s gross income, the taxpayer will not be entitled to deduct ordinary and business expenses that were paid by the forgiven loan proceeds.
Most states have been silent in regards to whether they conform to the CARES Act and follow the federal treatment of excluding forgiven loan proceeds as gross income and disallowing expense deductions associated with PPP loan proceeds. However, it is likely that rolling conformity states that automatically conform to the IRC, such as Massachusetts or New Jersey, will conform to the CARES Act and will also follow the federal treatment of excluding forgiven PPP loans from gross income and disallowing expense deductions associated with any forgiven PPP loan amount.
However, states that have static conformity provisions that do not conform to the CARES Act, such as California (conforms to the IRC as of January 1, 2015), will likely not follow the federal treatment regarding forgiven PPP loan proceeds and related expenses. In these non-conforming states, any forgiven loan proceeds will likely be included as income for state purposes. States that do include forgiven PPP loan proceeds as income will likely allow expense deductions for ordinary expenses funded by the PPP loans.
Small Business Expense Protection Act of 2020 (S. 3612)
On May 5, 2020, the Small Business Expense Protection Act of 2020 (S. 3612) was introduced to the Senate. This bipartisan legislation clarifies that ordinary expenses that are backed by PPP loan proceeds will be deductible as normal ordinary expenses. This bill, if passed, will reverse the federal treatment of disallowing ordinary expense deductions that are funded by PPP amounts as stated in Notice 2020-32.
The lawmakers that introduced S.3612 believe its passage is necessary to achieve the PPP’s true goal of providing relief to small businesses affected by the COVID-19 pandemic. Specifically, the lawmakers stated that, “Providing assistance to small businesses, only to disallow their business deductions as provided in Notice 2020-32, reverses the benefit that Congress specifically granted by exempting PPP loan forgiveness from income.”
If S.3612 is to become law, a rolling conformity analysis will likely not need to be conducted in order to determine if states will allow expense deductions funded by PPP loan proceeds, as federal preemption will require states to allow for the deduction. Currently S.3612 has been introduced to the Senate and assigned to the Senate Committee on Finance. The next step is for the Committee to send the bill to the Senate floor for debate or a subcommittee for further research. If it does go to the Senate floor and receives a majority vote, the bill will move to the House of Representatives for a similar process of committees, debate and voting. Once both houses approve the final bill, it will go to the President for signature or veto.
For specific guidance regarding state specific treatment pertaining to the PPP and related expenses see Armanino’s COVID-19 Relief Matrix.
Taxpayers who have received PPP loans and satisfied the conditions necessary to result in partial or full forgiveness of the loan amount, must determine whether they are able to deduct the ordinary business expenses that they paid with their PPP loan proceeds. Absent any specific comment from the states regarding these expense deductions, a conformity analysis should be done to determine whether a state conforms to the CARES Act and the IRC generally.
If a state conforms to the CARES Act, the states will follow the current federal treatment to exclude any forgiven PPP amount from gross income and disallow any deduction for any associated expenses. While the federal treatment currently disallows PPP expense deductions associated with forgiven loan amounts, new measures and proposals will likely result in expense deductions associated with PPP being allowed at a later time.
Also keep an eye on S. 3612 to see whether it becomes law and thereby allows taxpayers to take the ordinary expense deductions paid for by PPP loans. This bill is just in the first stage of the legislative process – so stay tuned!
Stephanie is a Senior Manager within the State and Local Tax division, where she focuses on multi-state income tax planning and compliance. While her expertise is in income and franchise taxes, she also has experience in sales and use tax, state credits and incentives, mergers and acquisitions due diligence and state income tax refund return reviews. Her clients cover a range of industries, including technology, cryptocurrency, manufacturing, distribution, retail, healthcare and service providers.
Co Authors :
Kaylyn is a Senior Manager in Armanino’s State and Local Tax practice and leads the firm’s state TCJA practice group. She has been with Armanino for over ten years and has primarily focused on the high technology industry for both private and public corporations in such areas as multi-state corporate income tax, ASC 740, FIN48, business activity tax (BAT) nexus analysis, local taxes such as San Francisco Gross Receipts Tax (SFGRT) and Los Angeles City Business Tax (LACBT), unitary and consolidated filings, and revenue sourcing analysis for apportionment purposes.
Kaylyn has been a key leader for internal state and local tax trainings and, previously, she has been a speaker at Armanino’s EVOLUTION Conference addressing state tax compliance during changing times.
Kaylyn received a Certificate of Advanced Accounting Proficiency (CAAP) from Santa Clara University’s Leavey School of Business and a bachelor’s degree in economics and business from Westmont College.
Kaylyn is a Registered Lobbyist with Los Angeles and an active member of Armanino’s Women’s Advancement Network.