California law does not currently conform to the Consolidated Appropriations Act (CAA) provision that allows taxpayers to claim deductions for expenses paid with forgiven PPP loan amounts. This has led to numerous questions from tax professionals regarding what adjustments, if any, are required on the California return.
The following is a summary of the responses we received to questions we posed to the FTB:
- Taxpayers must reduce deductions claimed for specific expenditures on their returns rather than making a general “other deduction” adjustment for the full amount of the loan forgiveness.
- Taxpayers should base the amount of the deduction reduction on available records indicating which expenses related to the forgiven amounts. The “information submitted to lenders to obtain loan forgiveness would be sufficient to document the amount of deduction reduced.”
- Schedule C PPP loan borrowers with no employees are not required to reduce their expense deductions “to the extent the borrower applied all funds to payroll.” Schedule C borrowers with no employees who use borrowed funds to pay interest, rent, or utilities would be required to reduce these deductions in an amount equal to the expenses paid with such funds.
- California does not conform to the CAA provision prohibiting the disallowance of a basis increase as a result of the PPP loan forgiveness. This means there will continue to be a decrease in the adjusted basis of a partner’s interest equal to the partner’s distributive share of expenditures of the partnership not deductible in computing its taxable income and not properly chargeable to the capital account under IRC §705(a)(2). Similar treatment applies to basis adjustments for S corporation shareholders.
We realize that it is still unclear exactly how this will all translate onto the return.
As we previously reported, AB 281 has been introduced, which states a legislative intent to adopt conformity to the CAA provision allowing PPP borrowers to claim full deductions for expenses paid with forgiven PPP amounts. Enactment of a PPP expense deduction conformity bill would eliminate the confusion and complexity arising from the adjustments discussed above. Tax professionals should consider putting these returns on extension until we know whether this legislation will be enacted.
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