California shouldn’t penalize businesses for taking PPP loans

Only a handful of states are planning to hit businesses with taxes as a result of accepting loans from the Paycheck Protection Program, and it is an outrage that California is one of them.

A generous share of federal COVID-19 relief funds is on the way to California, a state that imposed some of the nation’s strictest limitations on business operations during the pandemic and saw its unemployment rate rise from 4.7% in January 2020 to 9% in January 2021.

The point of the PPP loans was to help businesses keep employees on the payroll. This need is ongoing in California, as evidenced by the governor’s personal appearances around the state to highlight small business assistance programs.

Under most circumstances, a forgiven loan is taxed as income. However, the Paycheck Protection Program loans were specifically designed to be forgiven. The money was advanced to qualifying businesses to help them keep their employees on the payroll. If they met the terms, the loans converted into grants.

When the CARES Act was passed in March 2020, Congress apparently intended that the PPP loans should not be considered taxable income and that expenses paid with the funds would continue to be deductible. The Joint Committee on Taxation scored the bill in accordance with those assumptions. When the Treasury Department later ruled that expenses paid with PPP loans were not deductible, Congress added a provision to the Consolidated Appropriations Act for 2021, signed into law on December 27, specifying that these expenses were, in fact, deductible on federal tax returns.

That still left the question unresolved for state tax returns. Some state Legislatures passed new laws to conform with federal rules.

This certainly makes sense. When taxpayers are handing out emergency aid, it’s not the time to claw back the money back in higher taxes by eliminating tax deductions.

California has not acted to conform to the federal tax guidance. The Legislature is taking its sweet time to pass Assembly Bill 80, which would allow businesses to deduct expenses, such as payroll, that were paid with the proceeds of PPP loans.

The delay is a problem for small business owners who are currently preparing their tax returns and facing state tax bills that are higher than they should be. If the Legislature eventually passes the tax conformity bill, these business owners will have the additional expense of preparing and filing amended returns.