California announces it won’t tax forgiven PPP loans, but will other states do the same?

Small business owners in California that took pandemic-related federal loans shared a collective sigh of relief April 29 after Gov. Gavin Newsom signed a bill that will help their bottom lines. Under the new law, the majority of forgiven loans provided to businesses from the Paycheck Protection Program will not be counted as taxable income by the state.  The bill also lets California businesses deduct expenses that they paid for using the PPP loan funds.

Under the PPP initiative, businesses don’t have to pay their loans back if the funds were used on certain qualifying expenses such as rent, utilities and employee wages. Publicly traded companies are exempt from California’s measure.

The new tax breaks could be worth as much as $6.8B

The law will affect up to 85% of the over 1 million businesses registered in the state that jointly received close to $97 billion in federal PPP loans. California officials estimate the measure will cost the state from $4.4 billion to $6.8 billion over six years, much more than the $2 billion in tax breaks the governor initially promised. However, the final cost to be incurred by the state will depend on how many companies meet federal requirements.

The case for not taxing forgiven PPP loans

Leaders in the small business sector argue that Congress’ intent in creating the PPP was to retain jobs and keep businesses from permanently going under. Businesses applied for the loans with the understanding that they would be forgiven if they met certain conditions. Had they known in advance that they would be subject to state tax, they could have planned their budgeting ahead.

The program’s goal of keeping workers on the payroll has boosted state revenue already by providing state income tax withholding, many small business owners say. This also kept many people off the unemployment insurance rolls. Congress also addressed what some called “double dipping,” meaning allowing expense deductions and not taxing forgiven PPP loans, by coming up with legislation to make sure the program retained these aspects as intentional features.

Where the other states stand on taxing forgiven PPP loans

Congress deliberately exempted forgiven PPP loans from being taxed at the federal level. In late February, at least half of states planned to treat forgiven PPP loans as income, but legislators have moved fast to reverse that decision in many states since then. But a number of states still intend to treat forgiven PPP loans as taxable income and/or to prohibit deductions for expenses paid with forgiven loan funds.

Note: Wyoming and South Dakota have no state income tax.

Six states that will tax forgiven PPP loans:

Florida, Minnesota, Nevada, New Hampshire, Texas and Utah.

States that will not allow deductions for expenses paid for using forgiven loans:

Hawaii, Nevada, North Carolina, Texas, Virginia (Va. will allow partial deduction of up to the first $100,000) and Washington.

States that will tax forgiven PPP loans and disallow expense deductions paid using forgiven PPP loans:

Nevada and Texas.