April 13, 2021

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Which States Are Taxing Forgiven PPP Loans?

The US Small Business Administration Paycheck Protection Program (PPP) provides a vital lifeline to keep millions of small businesses open and their employees throughout the world Covid-19 pandemic. Many borrowers are given these loans; Eligibility for forgiveness requires the loan to be used for qualified purposes (such as wages and salaries, mortgage interest payments, rent, and utilities) within a specified time period. Usually, a loan made is considered income. However, Congress chose to exempt PPP loans issued from federal income tax. However, many states remain on track to tax them by treating either issued loans as taxable incomeDenial of deduction for expenses paid for the use of loans granted, or both. The map and table below show the states’ tax treatment of PPP loans granted.

PPP State Tax PPP Loan Grant.  State tax treatment of PPP loans.  Government PPP Loan Grant March 16, 2021-01

State tax treatment of granted PPP loans (as of March 19, 2021)
Status Excluded from taxable income Allows cost deduction
New Hampshire
New Jersey
New Mexico
new York
North Carolina
North Dakota
Rhode Island
South carolina
South Dakota No individual or corporate tax
Virginia Allows partial deduction
West Virginia
Wyoming No individual or corporate tax
District of Columbia

Notes: * Nevada, Texas, and Washington do not have individual income tax or corporation tax, but rather a GRT. Ohio charges an individual income tax and a BRT. Texas and Nevada treat PPP loan issued as gross taxable income, while Ohio and Washington do not. There is no business expense allowance in any of these states, which coincides with Gross income taxation.

** Massachusetts excludes issued PPP loans from taxable income as part of its corporate income tax that uses rolling compliance, but not as part of its individual income taxwho used static compliance before the CARES Act.

Sources: Tax Foundation; state tax laws, forms and instructions; Bloomberg BNA.

Why do states have such different taxation practices on PPP loans? It all has to do with how states adhere to federal tax laws.

All states use the Internal Revenue Code (IRC) as a starting point for their own tax code, but each state has the power to make its own adjustments. States that apply ongoing compliance automatically adopt federal tax changes as they occur. This is the simplest approach and offers taxpayers the greatest security. States using static compliance tie federal tax laws at a point in time and must proactively pass laws to accept recent changes.

It is common for states to adhere to certain pieces of federal tax law but decouple themselves from others. States that apply rolling compliance sometimes pass laws to decouple certain federal changes after they occur. Most states using static compliance routinely update their compliance data, but sometimes indecision about whether to accept new federal tax changes results in states following an outdated version of the IRC for many years. When there are static conformance states do Update your compliance data, sometimes you become uncoupled from certain changes to one to Base. Beyond the question of compliance dates, there was a great deal of uncertainty about the state tax treatment of PPP loans granted due to the way in which the federal government provided for the non-taxation of PPP loans granted.

If the CARES Act was adopted on March 27, 2020. Congress intended that PPP loans issued be tax-exempt at the federal level, a departure from normal practice. When federal debt is waived for various reasons, the waived amount is usually considered taxable income by the federal government and states that follow that treatment. This is reasonable practice under normal circumstances. However, Congress designed PPP lending specifically as a tax-free lifeline for small businesses struggling to stay open during the pandemic. Therefore, the CARES Act excluded PPP loans from taxable income (but not by directly changing the IRC). Congress also appears to have intended that expenses paid for the use of PPP loans be deductible – the Joint Tax Committee assessed the original provision as such – but did not directly incorporate the language for it into the law. In the months after the CARES law came into effect, the finance department decided that the costs paid with PPP loans were due Not Deductible under the law of the time, citing Section 265 of the IRC, which generally prohibits companies from deducting expenses related to tax-free income. This interpretation came as a surprise to many lawmakers because excluding the loans granted from taxation and then refusing to deduct them essentially nullifies the benefit granted by Congress. Therefore on December 27, 2020, when the Consolidated Funds Act for 2021 When the law was signed, the law was amended so that the costs paid for the use of PPP loans made are actually deductible.

As a result, most states are now finding that they are in one of three positions. States compliant with a Pre-CARES Act version of the IRC generally treat federal loans made as taxable income and related business expenses (such as payroll, rent, and utilities) as deductible. States that comply with a Post-CARES Act but a version of the IRC of the Pre-Consolidated Appropriations Act are generally on track to exclude issued PPP loans from taxable income but refuse to deduct related expenses. States that use ongoing compliance, or have otherwise updated their compliance statutes to a version of the IRC under the Consolidated Appropriations Act, exclude PPP loans made from income as well as the deduction of related expenses. In some cases, however, states have specific regulations on PPP loan income that replace their general compliance approach.

State policymakers are now in a position to help ensure that PPP recipients receive the full Emergency Congress, which is intended not to tax these federal lifelines at the state level. Refusing to deduct expenses covered by issued PPP loans has a tax effect very similar to treating issued PPP loans as taxable income: both tax methods increase taxable income beyond what it would have been if the company hadn’t taken out a PPP loan in the first case. Many states that currently have PPP loans for tax purposes, including Arizona, Arkansas, Hawaii, Maine, Minnesota, New Hampshire, and Virginia, have bills in place to prevent such taxation Wisconsin recently acted to do the same. In this situation, baselines play a role: based on the baseline of taxation on loans granted (or denial of deduction), compliance with federal treatment means a loss of revenue. However, if it’s a baseline scenario where there were no PPP loans issued – this From the status quo ante– If you follow federal guidelines, this is revenue neutral. This was not income that the states were expecting or that they could probably generate.

However, if policymakers want to avoid levying taxes on these small business lifelines, they need to act quickly as tax deadlines are rapidly approaching.

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