This post was updated on May 1, 2020 with additional guidance from the IRS regarding the deductibility of expenses that would be covered by PPP loan forgiveness.
Are forgiven PPP loans taxable? The short answer may be, “No,” but the complete answer could be, “Maybe.” It depends on whether we’re talking about federal taxes or state taxes.
I’m not an accountant and you should not take my comments here to be either tax advice or legal advice, but merely an effort to help inform the questions I advise you to speak with your accountant, CPA, or tax attorney about.
According to the text of the CARES Act 1106(i):
“Taxability.—For purposes of the Internal Revenue Code of 1986, any amount which (but for this subsection) would be includible in gross income of the eligible recipient by reason of forgiveness described in subsection (b) shall be excluded from gross income.”
In other words, it appears that forgiven PPP loans, at least as far as the IRS and your federal taxes are concerned, will not be taxed because they won’t be considered gross income. That being said, I’m not a tax expert and this is merely my understanding from reading the CARES Act and looking a little deeper. I suggest you consult with a tax expert to make a decision about how this will apply to your business.
Although you won’t need to include the forgiveness amount in your gross income for federal income tax purposes, the current guidance is unclear as to whether or not you will need to include the forgiveness amount in your business’ gross income for state and local tax purposes.
You should be aware though, that those expenses covered with PPP financing that would normally be tax deductible, like wages and the forgiven debt, will not be tax deductible.
The Hill recently reported: “The IRS said in its guidance Thursday that expenses that result in forgiveness of a PPP loan are not tax deductible in order to prevent a “double tax benefit,” and continued, “The agency cited Section 256 of the tax code, which states that deductions can’t be taken if they are tied to a certain class of tax-exempt income. If desired, Congress could override the IRS’s stance by passing a law that explicitly allows the deductions.”
In other words you won’t be able to get forgiveness of your PPP loan and take the tax deductions associated with the covered expenses. This is another areas where we encourage you to seek the advice of your accountant, CPA, or tax attorney.
More Guidance is Needed
Without much guidance from the SBA and Treasury regarding the state and local tax consequences of a forgiven PPP loan—it appears we will need to wait for further guidance from the SBA, the IRS, and state tax authorities depending upon the state you’re in. Depending on how quickly they respond to this situation, you may or may not have a state tax bill for the forgiven portion of a PPP loan.
According to CLA, an auditing, tax, and consulting firm with offices all across the country:
“It appears that Congress intended the PPP to be fully non-taxable with no effect on the deductibility of the expenses paid during the eight-week period. Guidance from the IRS and the Department of the Treasury is needed to confirm full deductibility of expenses. The American Institute of CPAs (AICPA) is requesting guidance from the IRS regarding the deductibility of the expenses.”
The Tax Foundation, the nation’s leading independent tax policy 501(c)(3) non-profit, has been around since 1937, and suggests, “The sooner businesses know what to expect, the better, but ultimately businesses won’t owe state taxes on forgiven PPP loans if their states conform before final calendar year 2020 tax returns are due next year. If, however, states fail to conform by then, small businesses might be left with an unexpected tax burden.”
What is Conformity and Why Does it Matter?
This gets a little complicated and you should ask your tax advisor about this because it’s important to understand when contemplating whether or not a forgiven PPP loan will be taxable in your state. Under federal law, loan forgiveness is typically counted as taxable income and the individual states usually incorporate this provision into their own codes. The CARES Act excluded the forgiven portion of a PPP loan from this provision.
Individual states will often follow what the federal government does in a situation like this, but only if they “conform” to the most recent version of the Internal Revenue Code (IRC), which includes this exception.
Some states have what’s called rolling conformity and will likely not tax the forgiven portion of a PPP loan unless state lawmakers adopt a law expressly doing so. Other states have what’s called static conformity, which means lawmakers vote to update their conformity date each year, but sometimes they don’t.
Because of the scope of this federal tax change, it’s more important than usual for state legislatures to vote on the date of their conformity. If your state adjourned their legislative session early because of the coronavirus this year without voting on the date of conformity, the normal practice of taxing the loan forgiveness of the PPP is likely.
This may be problematic for a number of states according to The Tax Foundation:
“Unfortunately, a few states are notorious about not updating their conformity dates. California’s conformity date is still stuck in 2015. Wisconsin uses a 2017 conformity date. New Hampshire just brought its conformity date into the present after several years of neglect. And Massachusetts’ individual (but not corporate) income tax still uses the IRC as it existed in 2005. It’s not uncommon for states to fall a year or two behind—but this year it matters, for PPP loans and other provisions related to the CARES Act.”
In other words, you may not know whether or not your forgiven loan will be taxable by the state where you live until it’s time to file your business tax return. States with rolling tax conformity are:
- New York
- North Dakota
- New Mexico
Unless your state legislators expressly vote not to conform to this exception within the federal tax code, your forgiven PPP loan will likely not be taxable.
Some states don’t assess a state tax, so you will most likely not see the forgiven PPP loan taxed there either. The following states have not state income tax:
- South Dakota
- Washington State
The remaining states may or may not elect to conform and may or may not act quickly. Regardless of the state where you do business, I advise you to consult with your tax advisor to determine the tax planning that best suits your business.
Please keep in mind this information is changing rapidly and is based on our current understanding of the programs. It can and likely will change. Although we will be monitoring and updating this as new information becomes available, please do not rely solely on this for your financial decisions. We encourage you to consult with your lawyers, CPAs and Financial Advisors. To review your real-time funding options with one of Nav’s lending experts, please contact us.
This article was originally written on April 29, 2020 and updated on May 1, 2020.