If you are a small business owner who took advantage of the Paycheck Protection Program loan program, you likely felt relief when the second COVID-19 bill passed in December and you learned you could deduct expenses you’d used forgiven loans to cover. But as 2020 tax preparation begins, it’s becoming clear that there are still plenty of issues to be resolved. One of the biggest outstanding questions is how states are going to approach those deductions too, or whether they will force struggling business owners to pay taxes for loans meant to help their businesses survive.
The original Paycheck Protection Program offered loans that would be forgivable if a minimum of 60% of the proceeds were used for payroll or other allowed expenses, and that there would be partial forgiveness for those who used a stated portion of their loans for that purpose. But the federal program did not address how states would address the loans. The most recent relief bill gave qualifying businesses good news: Not only did they get the ability to get a second forgivable loan, it also cleared up the question of whether they could claim tax deductions for expenses they paid for with the loans. Though some objected to the notion of allowing deductions for expenses using forgiven loans, in the end it is being allowed, and that’s a real gift for struggling businesses, as is the low 1% interest rate being assessed for loans that aren’t forgiven.
But there’s a difference between how taxes are handled on the federal level and how they’re handled by the state, and deductions business owners take on their federal return may not be applicable for their state returns. Significant uncertainty remains, and many states have yet to clarify what their position is.
Though it might seem like common sense for states to adopt the same tax laws as the federal government, that is not the case. Some states choose not to adopt changes to the federal Internal Revenue Code, opting instead to devise their own rules. For those that do, the declining state sales and income tax revenues following the pandemic’s economic hit provide ample motivation to avoid providing any extra tax cuts to their residents or businesses. This is the case with the state of New Jersey. Some accept federal income tax changes on a rolling basis as they occur, while others apply changes to the federal code on what is known as a static conformity basis, on a separately established date.
Even if you are familiar with and comfortable with your own state’s stance on federal tax law changes, it can make tax planning hard, and this is clearly reflected in the challenge of interpreting how the COVID relief plans will apply to small business taxes and deductions related to the PPP program.
There are a couple of states that have already made decisions on PPP loan-related tax deductions. California state law does not permit deductions for expenses paid with forgiven PPP loans, and North Carolina has announced that though deductions will not be permitted, the loans will be excluded from taxable income. As for other states, no decisions have yet been made at the time of writing, and this makes it difficult for busines owners to move forward with tax planning, with paying estimated taxes, and even with preparing their state returns. If you are a small business owner who has taken advantage of the PPP loan program and you need guidance, contact your tax professional.
About Frank Jenkins Jr
Frank Jenkins Jr. CPA is the managing partner of Adams, Jenkins & Cheatham, a CPA practice based in Midlothian, VA. Frank specializes in Consulting services, tax planning, audit & assurances. "I genuinely care about our clients because I have a personal connection with them." He is active in the community and belongs to the AICPA and the VSCPA.
