Taxation of Forgiven PPP Loans
The Paycheck Protection Program (PPP) enacted as part of the CARES Act has provided hundreds of billions in loans to businesses across the country. Currently, the Small Business Administration (SBA) has forgiven a substantial number of PPP loans with more forgiveness applications under review or not yet received by the SBA. Despite the relatively simple mechanics of the distribution and forgiveness of PPP loans, the taxation of both expenses paid for with PPP loan proceeds and forgiveness of the PPP loans has continued to evolve, leaving complicated rules for taxpayers to navigate.
Federal law generally includes forgiven loans in a taxpayer’s gross income. However, section 1106(i) of the CARES Act excludes forgiven PPP loans from gross income at the federal level. Unfortunately, the CARES Act was silent on the deductibility of expenses paid for with proceeds from PPP loans. The IRS initially said that such expenses were not deductible until Congress expressly made such expenses deductible via Section 276 of the COVID-related Tax Relief Act of 2020 contained in the 2021 Consolidated Appropriations Act (the 2021 Appropriations Act), passed on December 27, 2020.
On January 6, 2021, the IRS officially reversed its position on deductions to conform with this change in law via Rev. Rul. 2021-2. Section 276 also provides that forgiven PPP loan amounts are treated as tax exempt income for purposes of Sections 705 and 1366 of the Internal Revenue Code (the Code). However, a partner’s increase in basis under Section 705 of the Code for forgiven amounts is statutorily equal to the partner’s distributive share of the deductions related to the forgiven amounts. While the general deduction changes and rules for partnership and S corporations are retroactive to the initial PPP loans authorized under the CARES Act, the delay complicated amendments to previously-filed federal returns and state-level taxation of PPP loans and expenses funded with PPP loans.
Whether a state excludes PPP loan forgiveness from taxable income, or allows deductions for expenses paid with PPP loan proceeds, or both, depends on how each state conforms with the Code. Some states automatically adopt changes to the Code as they occur (rolling conformity states), while other states conform to the Code as of a certain date (static conformity states). However, states in both categories frequently choose to follow some parts of the Code while rejecting other parts.
Currently, 37 States and the District of Columbia both exclude PPP loan forgiveness from taxable income and allow a deduction for expenses paid for with PPP loan proceeds for all businesses. In the remaining states, the rules differ based on the type of tax each state imposes on businesses, and specific policy decisions. For simplicity, this post will focus on states that conform with federal law and use Minnesota as one such example, but taxpayers should carefully monitor the rules for their state.
Minnesota is a static conformity state that until July 2021 conformed to the Code prior to the CARES Act. Under House File 9, enacted July 1, 2021, Minnesota now excludes PPP loan forgiveness from taxable income and allows deductibility of PPP expenses by adopting section 1106(i) of the CARES Act and Section 276 of the COVID-related Tax Relief Act of 2020 contained in the 2021 Appropriations Act. Although, as of this writing, the Minnesota Department of Revenue has yet to update its website to reflect these changes – despite reporting that they updated the relevant webpage on July 26, 2021. Minnesota’s adoption of all of Section 276 means that state-level taxation of forgiven PPP loans and related expenses for partnerships and S corporations follows the federal rules outlined above. Whether other states that conform with federal law generally on the taxation of PPP loans follow this approach depends on how each state chose to conform with federal law. Given that state level responses to PPP loans are still evolving and state agencies may be slow to update their guidance, taxpayers should continue to watch how their state treats the taxation of PPP loans, the forgiveness of those loans, and business expenses paid for with PPP loan proceeds.