Tax & AccountingDecember 30, 2020

State Action Uncertainty on Covid-Relief Act PPP Loan Forgiveness & Expense Deductibility Creates Risk

State Action Uncertainty on Covid-Relief Act PPP Loan Forgiveness & Expense Deductibility Creates Risk

I reported last week that the Covid-relief bill contained a provision that allowed business owners to deduct expenses paid for with PPP loans proceeds, which can be forgiven by the government without incurring a tax. The president has now signed the bill into law.

As I wrote, this was done over objections from Treasury Secretary Mnuchin and others. The law clarifies that business owners can deduct expenses paid for with PPP loans, which can be forgiven by the government without incurring a tax. This overrides IRS official guidance in Revenue Ruling 2020-27, in which the IRS stated that a taxpayer who received a covered loan guaranteed under the PPP and paid or incurred certain otherwise deductible expenses listed in section 1106(b) of the CARES Act (“eligible expenses”) may not deduct those expenses in 2020 if, at the end of 2020, the taxpayer reasonably expects to receive forgiveness of the covered loan, even if the taxpayer has not submitted an application for forgiveness of the covered loan by the end of 2020. This ruling applies if: (i) the taxpayer has applied for PPP loan forgiveness but the lender has not responded by the end of 2020, or (ii) the taxpayer has incurred eligible expenses, has a reasonable expectation of reimbursement in the form of forgiveness, and expects to apply for forgiveness in 2021 but has yet to apply for PPP loan forgiveness by 2020 year end. Therefore, no deductions for the eligible expenses are allowed on the 2020 income tax return. The IRS used the rationale that the tax code prohibits that sort of doubling up of tax benefits.

So, businesses should be celebrating, right? Not so fast. The potential gotcha here is that states may not go along with allowing these deductions together with tax-free loan forgiveness with the result that these businesses may be faced with unexpected state tax bills.

States have yet to indicate what they will do

States deal differently with how they follow federal tax law. Some follow their own rules. Others conform their rules to federal law on either a static or rolling basis.

States that follow a static model conform their rules to the federal code on a specific date. Those that conform on a rolling basis adopt the changes as they occur.

Eighteen states and the District Columbia have rolling conformity with the Internal Revenue Code, meaning that they will conform to relevant provisions of the new federal law automatically, while nineteen must update their fixed-date conformity statutes to adopt the new provisions. The remaining states only conform selectively.

The result is that there may be differences in how income is reported form federal and state purposes. Thus, states may decide to simply not allow tax-free loan forgiveness and/or business deductions paid for by loan proceeds.

What to do?

Businesses and their advisors face tax planning challenges as a result of the uncertainty in what individual states will do. Many businesses could decide to choose to extend their tax filing, however they will still be responsible to pay estimated taxes. The hope is that states will decide soon on what they will do in terms of conforming their tax codes to the changes made by the Covid-relief legislative changes for the PPP and other tax-related provisions.

By Mark Friedlich, Esq., CPA.

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Mark Friedlich
Author at Tax & Accounting
Mark Friedlich, a CPA & tax lawyer, is the principal international & corporate indirect taxation analyst for Wolters Kluwer Tax & Accounting. He is a member of the U.S. Senate Finance Committee’s Chief Tax Counsel’s Advisory Board, advisor to 14 state taxing authorities, and a member of the American Bar Association’s Tax Section and AICPA’s Tax Section leadership teams. Prior to joining Wolters Kluwer he was a Managing Tax Partner at PricewaterhouseCoopers.