On December 21, 2020, Congress finally passed a new COVID-19 relief bill (Consolidated Appropriations Act, 2021) which President Trump signed into law on December 27, 2020. The bill includes clarification of the deductibility of certain eligible expenses paid with forgiven Paycheck Protection Program (PPP) loans.
The bill now permits taxpayers who receive PPP loan forgiveness to deduct the eligible expenses that were paid with the forgiven PPP loans. In addition, taxpayers are not required to adjust tax basis or make other reductions in tax attributes related to any expenditures paid with the forgiven PPP loans.
Confusion on Deductibility of Expenses
Under the original Coronavirus Aid, Relief, and Economic Security (CARES) Act, a PPP loan would be forgiven and not be treated as taxable income on forgiveness if the loan funds were used to pay for certain eligible expenses. The CARES Act did not specifically provide guidance on the deductibility of eligible expenses, which led to confusion on whether the intent of Congress was to allow deduction of eligible expenses paid with the forgiven PPP loan funds. IRS subsequently announced their position on the question by issuing Notice 2020-32 in April 2020, stating that taxpayers were not permitted to deduct eligible expenses that were paid with forgiven PPP loan funds. IRS later issued Rev. Rul. 2020-27 in November 2020, clarifying that if taxpayers had a reasonable expectation that their PPP loan would be forgiven, the eligible expenses paid with the loan funds in the 2020 tax year were notdeductible even though the forgiveness had not yet been granted or the forgiveness application had not yet been submitted by the end of the 2020 tax year. Both the notice and revenue ruling announcements are now superseded by the new relief bill.
California Law is No Longer in Conformity
At this time, California does not conform to the new federal treatment of allowing a deduction of eligible expenses paid with the loan funds. In September 2020, the California legislature passed Assembly Bill (AB) 1577 and the California governor signed it into law. Under AB 1577, the amount of PPP loans forgiven is to be excluded from gross income and eligible expenses paid with forgiven PPP loan funds are not allowed as deductible expenses. The treatment under AB 1577 was in conformity with Federal law at that time; however, with the current change in the Federal law with respect to deduction of eligible expenses paid with forgiven PPP loan funds, California law is no longer in conformity. Under the current California law, taxpayers are required, for California reporting purposes, to reduce their deductions if paid with forgiven PPP loan funds. There is a possibility that California may legislate conformity to the new federal tax treatment at a later date and we will continue to monitor the situation.
If you have any questions about the new relief bill, please contact us at firstname.lastname@example.org or your engagement lead member directly.