California: Update to Paycheck Protection Program Loan Conformity

May 2021

BY

Scott Smith, State & Local Tax, National Technical Practice Leader

California Governor Gavin Newsom on April 29 signed into law legislation that generally conforms the state’s tax treatment of Covid-19 aid in the form of loans and grants with the federal individual and corporate income tax treatment of such aid, including the CARES Act and the Consolidated Appropriations Act, 2021 (CAA).
 
Assembly Bill 80 (AB 80) allows qualifying taxpayers to exclude from California gross income Paycheck Protection Program (PPP) loans that have been forgiven, and advance grants provided under the Economic Injury Disaster Loan (EIDL) program.
 

PPP Loan Expense Deduction Conformity  

In September 2020, California enacted AB 1577, which conformed to the CARES Act exclusion from gross income for PPP loan forgiveness. However, AB 1577 did not allow taxpayers to deduct PPP covered expenses. Further, AB 1577 applied only to tax years beginning on or after January 1, 2020. As a result, it provided no California tax relief for fiscal year taxpayers whose tax year began before January 1, 2020, but who obtained a PPP loan after January 1, 2020. 
 
Retroactively effective for tax years beginning on or after January 1, 2019, AB 80 allows individuals and businesses to deduct covered expenses paid for with forgiven PPP loans or EIDL advances and targeted grants received under the CARES Act and the CAA. The new legislation supersedes AB 1577. For tax years beginning in 2019, qualifying taxpayers can now exclude PPP loan forgiveness or EIDL grants from California gross income and deduct allowable covered expenses paid with PPP loan or EIDL grant proceeds.   
 
However, AB 80 does not permit an individual owner or corporation that is an “ineligible entity” to deduct PPP covered expenses. Ineligible entities are either publicly traded companies or entities that do not meet the requirements of 15 U.S.C. Section 636(a)(37)(A)(iv)(bb), which requires the entity to have experienced at least a 25% drop in gross receipts in the first, second or third quarter of 2020, or the fourth quarter if a PPP loan application was submitted on or after January 1, 2021, compared to the same quarter in 2019.   
 
Only a gross receipts reduction in one quarter in 2020 must meet this 25% threshold to qualify for the PPP loan expense deduction, assuming the entity is not publicly traded. A taxpayer cannot combine two or more 2020 quarterly losses to arrive at this threshold. California taxpayers can also fully deduct expenses paid with EIDL funds since this threshold does not apply to EIDL grants. Other special rules in the federal statute apply to entities that were not in business for the entirety of 2019.