Which States Are Taxing Forgiven PPP Loans?

February 22, 2021

The U.S. Small Business Administration’s Paycheck Protection Program (PPP) is providing an important lifeline to help keep millions of small businesses open and their workers employed during the COVID-19 pandemic. Many borrowers will have these loans forgiven; eligibility for forgiveness requires using the loan for qualifying purposes (like payroll costs, mortgage interest payments, rent, and utilities) within a specified amount of time. Ordinarily, a forgiven loan qualifies as income. However, Congress chose to exempt forgiven PPP loans from federal income taxation. Many states, however, remain on track to tax them by either treating forgiven loans as taxable income, denying the deduction for expenses paid for using forgiven loans, or both. The map and table below show states’ tax treatment of forgiven PPP loans.

PPP state tax PPP loan forgiveness. State tax treatment of PPP loans. States tax forgiven PPP loans May 5 2021

State Tax Treatment of Forgiven First Draw PPP Loans (as of May 5, 2021)
State Excludes from Taxable Income Allows Expense Deduction
Alabama
Alaska
Arizona
Arkansas
California**  Deductible for Some Businesses
Colorado
Connecticut
Delaware
Florida  
Georgia
Hawaii  
Idaho
Illinois
Indiana
Iowa
Kansas
Kentucky
Louisiana
Maine
Maryland
Massachusetts
Michigan
Minnesota  
Mississippi
Missouri
Montana
Nebraska
Nevada*    
New Hampshire  
New Jersey
New Mexico
New York
North Carolina  
North Dakota
Ohio*  Deduction Allowed Under PIT (not CAT)
Oklahoma
Oregon
Pennsylvania
Rhode Island
South Carolina
South Dakota No Individual or Corporate Income Tax
Tennessee
Texas*    
Utah  
Vermont
Virginia** Allows Partial Deduction
Washington*  
West Virginia
Wisconsin
Wyoming No Individual or Corporate Income Tax
District of Columbia

Notes:

*Nevada, Texas, and Washington do not levy an individual income tax or a corporate income tax but do levy a GRT. Ohio imposes an individual income tax and a GRT. Texas and Nevada treat forgiven PPP loans as taxable gross revenue, while Ohio and Washington do not. In each of these states, there is no deduction for business expenses, consistent with gross receipts taxation. Under Ohio’s individual income tax, forgiven PPP loans are excluded from taxable income and the expense deduction is allowed. Under Ohio’s Commercial Activity Tax (CAT), the loans are excluded from taxable gross revenue but, consistent with gross receipts taxation, the CAT does not allow a deduction for business expenses.

** Virginia excludes forgiven PPP loans from taxable income but allows only the first $100,000 in expenses paid for using forgiven PPP loans to be deducted. California conforms to the federal tax treatment of forgiven PPP loans for some but not all businesses; the state excludes forgiven PPP loans from taxation, but the expense deduction is disallowed for publicly traded companies and businesses that did not experience a 25 percent year-over-year decline in gross receipts between 2019 and 2020.

Sources: Tax Foundation; state tax statutes, forms, and instructions; Bloomberg BNA.

Why do states have such different practices when it comes to the taxation of PPP loans? It all has to do with how states conform to the federal tax code.

All states use the Internal Revenue Code (IRC) as the starting point for their own tax code, but every state has the authority to make its own adjustments. States that use rolling conformity automatically adopt federal tax changes as they occur, which is the simplest approach and provides the most certainty to taxpayers. States that use static conformity link to the federal tax code as it stood on a certain date and must proactively adopt legislation to accept more recent changes.

It is common for states to conform to certain parts of the federal tax code but decouple from others. States that use rolling conformity sometimes adopt legislation to decouple from certain federal changes after they occur. Most states that use static conformity update their conformity dates routinely, but sometimes indecision about whether to accept new federal tax changes results in states remaining conformed to an outdated version of the IRC for many years. When static conformity states do update their conformity dates, they sometimes decouple from specific changes on an ad hoc basis. Even beyond the question of conformity dates, there has been a great deal of uncertainty surrounding the state tax treatment of forgiven PPP loans due to the way the federal government provided for the nontaxability of forgiven PPP loans.

When the CARES Act was enacted on March 27, 2020, Congress’ intent was that forgiven PPP loans be tax-free at the federal level, which is a departure from usual practice. Normally, when federal debt is forgiven for various reasons, the amount forgiven is considered taxable income by the federal government and by states that follow that treatment. In normal circumstances, this is a reasonable practice. However, Congress specifically designed PPP loans as a tax-free emergency lifeline for small businesses struggling to stay open amid the pandemic, so the CARES Act excluded PPP loans from taxable income (although not by amending the IRC directly). Congress also seems to have intended that expenses paid for using PPP loans be deductible—the Joint Committee on Taxation scored the original provision as such—but did not include language to do so directly in statute. In the months following the CARES Act’s enactment, the Treasury Department ruled that expenses paid for with PPP loans were not deductible under the law as it stood at the time, citing section 265 of the IRC, which generally prohibits firms from deducting expenses associated with tax-free income. This interpretation came as a surprise to many lawmakers, since excluding the forgiven loans from taxation, but then denying the deduction, essentially cancels out the benefit Congress provided. Therefore, on December 27, 2020, when the Consolidated Appropriations Act for 2021 was signed into law, the law was amended to specify that expenses paid for using forgiven PPP loans would indeed be deductible.

As a result, most states now find they are in one of three positions. States that conform to a pre-CARES Act version of the IRC generally treat forgiven federal loans as taxable income and related business expenses (like payroll, rent, and utilities) as deductible. States that conform to a post-CARES Act but pre-Consolidated Appropriations Act version of the IRC are generally on track to exclude forgiven PPP loans from taxable income but deny the deduction for related expenses. States that use rolling conformity or that have otherwise updated their conformity statutes to a post-Consolidated Appropriations Act version of the IRC both exclude forgiven PPP loans from income and allow related expenses to be deducted. In some instances, however, states have adopted specific provisions on PPP loan income that supersedes their general conformity approach.

State policymakers are now in the position to help ensure PPP recipients receive the full emergency benefit Congress intended by refraining from taxing these federal lifelines at the state level. Denying the deduction for expenses covered by forgiven PPP loans has a tax effect very similar to treating forgiven PPP loans as taxable income: both methods of taxation increase taxable income beyond what it would have been had the business not taken out a PPP loan in the first place. In many states that currently tax forgiven PPP loans, including Arizona, Arkansas, Hawaii, Maine, Minnesota, New Hampshire, and Virginia, bills have been introduced to prevent such taxation, and Wisconsin recently acted to do the same. This situation is one in which baselines matter: from a baseline of the taxation of the forgiven loans (or the denial of the deduction), conforming to federal treatment represents a revenue loss. If, however, the baseline scenario is one in which forgiven PPP loans did not exist—the status quo ex ante—then following federal guidance is revenue neutral. This was not revenue that states counted on or expected to be able to generate.

If policymakers wish to avoid imposing taxes on these small business lifelines, however, they need to act quickly, as tax deadlines are fast approaching.


 

Updates

  • May 5, 2021: On April 17, 2021, H.315 was enacted in Vermont, conforming to the federal tax treatment of PPP loans forgiven in 2020. However, the law currently stipulates that PPP loans forgiven in 2021 will be included in taxable income but will remain eligible for the expense deduction.
  • May 4, 2021: California A.B. 80, signed into law on April 29, 2021, conforms the state to the federal tax treatment of forgiven PPP loans for some but not all businesses. Forgiven PPP loans are exempt from taxable income for all businesses, but the expense deduction is disallowed for publicly traded companies and businesses that did not experience a 25 percent year-over-year decline in gross receipts between 2019 and 2020.
  • April 20, 2021: Legislation enacted in Massachusetts on April 1, 2021, newly excluded forgiven PPP loans from taxable income under the state's individual income tax. Previously, Massachusetts excluded forgiven PPP loans from taxable income under its corporate income tax, which uses rolling conformity, but not under its individual income tax, which uses static conformity.
  • April 16, 2021: Arizona S.B. 1752, signed into law on April 14, 2021, conformed the state to the federal treatment of forgiven PPP loans, thereby newly excluding the loans from taxable income. Ohio S.B. 18, signed into law on March, 31, 2021, updated Ohio’s conformity date to March 31, 2021, thereby newly allowing the expense deduction under the state’s individual income tax for expenses paid for using forgiven PPP loans.
  • March 25, 2021: Idaho House Bill 251 was signed into law on March 18, excluding forgiven PPP loans from taxable income.
  • March 19, 2021: Maine L.D. 220 was signed into law on March 17, conforming to the federal treatment of forgiven PPP loans, among other provisions.
  • March 16, 2021: In Kentucky, House Bill 278 was enacted on March 15, allowing expenses paid for using forgiven PPP loans to qualify for the expense deduction.
  • March 16, 2021: In Virginia, SB 1146 was signed into law on March 15. This law excludes forgiven PPP loans from taxable income but decouples from the federal expense deduction allowance, instead offering a state-specific deduction for up to $100,000 in expenses paid for using forgiven PPP loans.
  • March 2, 2021: In Arkansas, House Bill 1361 was signed into law on March 2, conforming the state to federal tax treatment of forgiven PPP loans.
  • February 26, 2021: In Georgia, House Bill 265 has been enacted, updating the state's IRC conformity with respect to the treatment of forgiven PPP loans, among other provisions.
  • February 25, 2021: In West Virginia, HB 2358 and HB 2359 were signed into law on February 24, 2021, updating the state’s conformity date to include federal corporate and individual income tax changes made in 2020, thereby removing forgiven PPP loans from taxable income.

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