Federal and California treatment of the PPP loan forgiven and related expenses.
Under the CARES Act, the amount of Paycheck Protection Program (PPP) loan forgiven is excluded from gross income. On May 2, 2020 the Department of the Treasury and the IRS released notice 2020-32, which clarified that no deduction is allowed for expenses paid from the forgiven loan. However, the notice did not provide any clarity as to the timing of when the expenses become nondeductible – at the time the expenses are incurred or when the loan is forgiven, which could span different tax years. In addition, many tax professionals were hopeful that Congress or the IRS would reverse course and issue guidance allowing for the deduction of the expenses in alignment with the original intent of the PPP loan.
On November 18, 2020 the IRS released Rev. Rul. 2020-27, which confirms that a taxpayer may not deduct the expenses in the tax year such expenses were paid or incurred, to the extent that as of the end of the tax year, the taxpayer reasonably expects to receive forgiveness for the PPP loan. This rule applies whether or not the PPP loan forgiveness application has been submitted by the end of the tax year.
E.g. A taxpayer received PPP loan funds of $1 million in 2020 and plans to submit an application for forgiveness in January 2021 expecting to get $800,000 forgiven. The $800,000 forgiven amount would be nontaxable in tax year 2021, but the $800,000 related expenses that were paid or incurred in 2020 will be non-deductible in tax year 2020 since this is the amount the taxpayer reasonably expects to have forgiven.
Based on this, borrowers who have been delaying submitting their applications in the hopes they could delay when related expenses would be treated as non-deductible, may want to proceed with submitting their applications. At a minimum it is advisable to start gathering the required information as soon as possible because estimating the loan forgiveness amount will directly impact year-end tax planning. However, there is no need to rush into submitting the application, especially because more guidance is still expected and further bills are still being introduced into Congress.
The Paycheck Protection Program Flexibility Act of 2020, enacted on June 5, 2020 retroactively extended the covered period from 8 weeks to 24 weeks from the date the loan was received. Taking advantage of the full 24 weeks may give borrowers more time to qualify for full loan forgiveness. Borrowers have 10 months from the last day of their covered period to submit their loan forgiveness application. -. As of December 2, 2020, there are now three types of loan forgiveness application forms: Form 3508, Form 3508EZ, neither of which have been updated since June 16, 2020. Newly posted on October 8, 2020 is Form 3508S, which can only be used by borrowers with PPP loans of $50,000 or less.
Even if a borrower is ready to submit their application, some lenders are not yet ready to receive these applications. Please contact your lender to determine if they are accepting applications and to determine what process they are requiring for submitting the application and supporting documentation. If you need assistance with gathering the required documentation and running the calculations, please contact your GPW advisor for assistance.
At the time the CARES Act was first enacted the forgiveness of PPP loans would have generated taxable income for California purposes because California did not automatically conform to the CARES Act and subsequent related federal legislation. However, on September 9, 2020, California has since passed Assembly Bill No. 1577, which conforms to the Federal rules for PPP loan forgiveness. This allows an exclusion from gross income for the amount of PPP loans that are forgiven as part of the CARES Act, while disallowing the deductions for amounts paid or incurred using the forgiven loan funds.
One additional hurdle California taxpayers may need to navigate is that as it currently stands Assembly Bill No. 1577 applies only to taxable years beginning on or after January 2020. While this has no impact on calendar year taxpayers, this presents a difference from the Federal rule for fiscal year taxpayers who’s tax years begin in 2019.
The FTB has stated that fiscal year taxpayers should deduct all expenses paid with PPP loan funds on their 2019 fiscal year returns even if they expect forgiveness. If their debt forgiveness occurs in the 2019 taxable fiscal year, the PPP loan amount forgiven will be treated as taxable income, which will be offset by the deductions paid with those funds. I.e. The income will be taxable, and the related deductions will be deductible. If the debt forgiveness occurs in the 2020 taxable fiscal year, the taxpayer would have to include in gross income the amount of expenses that had been deducted on their 2019 fiscal year tax return which were used to qualify for forgiveness in the 2020 taxable fiscal year.