Jan 31, 2021 Despite PPP Loan Forgiveness, State Tax Conformity Rules May Reduce R&D Tax Credits
Many businesses made a collective sigh of relief when the Consolidated Appropriations Act, 2021 (“CAA”) clarified that expenditures paid with forgiven Paycheck Protection Program (PPP) loan proceeds were made deductible for federal income tax. For state income tax purposes, the relief may be short-lived depending on which state the business is operated. States vary in their approach to conforming to the Internal Revenue Code (IRC) and generally follow one of the three categories; rolling, static or selective.
States that have rolling conformity continuously adopt IRC changes each year (e.g., Illinois, Louisiana, Maryland). States with rolling conformity will likely follow the CAA and exclude the forgiven PPP loan proceeds from income and allow deductibility. However, none of the COVID relief acts, CARES or CAA specifically update the IRC, forgiven PPP loan deductions are not a guarantee.
Static states are those that a law must be passed in order to change the state’s date of conformity to the IRC (e.g., Minnesota, Arizona, Georgia). Conformity dates vary by state. Most states have not adopted the CARES relief provisions, thereby are not exempting forgiven PPP loans from gross income.
States that are selective adopt specific federal provisions, such as bonus depreciation or Net Operating Loss treatment (e.g., California, Pennsylvania). States with this approach must specifically adopt the recently enacted CAA provisions in order for expenditures paid with forgiven PPP loans to be deductible.
How Does this Effect the R&D Tax Credit?
States have not clarified whether they will conform to the deductibility of expenditures paid with forgiven PPP loan proceeds. Thus, unless a state has updated its tax codes, a taxpayer may be back to square on, and not be able to deduct the expenses covered by the forgiven PPP loan proceeds for state income tax purposes.
For example, California does not allow deductions covered by a forgiven PPP loan. Thus, qualified R&D wage expenditures could be reduced, effectively lowering the R&D tax credit. However, California is one of few states that does have draft legislation to potentially change the negative tax impacts.
California clearly illustrates the uncertainty of state tax deductibility of PPP loans. Unfortunately, not every state will be trying to adopt more taxpayer friendly laws. Thus, it is important that you consult with your tax provider prior to filing for your R&D credits and income taxes.
About the Author: Lacey Robb is the R&D Tax Credit Practice Leader for ICS Tax, LLC. She is an attorney and has an LLM in Taxation and has helped numerous taxpayers in a variety of industries take the R&D tax credit. She can be reached by phone at 310-968-0970 or by email at firstname.lastname@example.org.
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ICS Tax, LLC (ICS) is a consulting firm providing innovative tax planning strategies. ICS collaborates with taxpayers and their tax professionals to identify credits and incentives that reduce tax liabilities and increase profitability. ICS provides nationwide service through its offices located throughout the country.