We know you have questions regarding PPP adjustments on your clients’ California returns; so do we. We have been in contact with the FTB regarding those questions, and they have assured us they are working on guidance. There are a number of complex issues that must be addressed before they can release any answers.
Spidell and the FTB agree that California does not conform to the federal provision allowing deductions for the expenses paid with forgiven PPP debt because AB 1577 specifically disallows those deductions. California does conform to the previous guidance in Revenue Ruling 2020-27, where the IRS stated borrowers who had a reasonable expectation of forgiveness in the future must reduce deductions in the year the expenses were paid, even if the forgiveness happens in a later year. However, there are still questions surrounding how those adjustments will be made. For example, among other questions, we have asked the following regarding the California returns:
- Do we simply make a general “other deduction” adjustment for the full amount of the loan forgiveness?
- Do we reduce specific categories of deductions?
- If we reduce specific categories of deductions, will we be required to base those amounts on what is included on the forgiveness application, or can we make a reasonable estimate?
- The PPP loans for Schedule C borrowers with no employees are based solely on net 2019 self-employment earnings, and so is their forgiveness. Because their forgiveness is not tied to any specific expenses paid, does this mean we are not required to reduce deductions for these borrowers on the 2020 return?
- How will we address California basis for partners and shareholders in flow-through entities where we have forgiven debt and disallowed deductions?
The FTB has assured us they will have guidance in the near future. So we suggest that you wait for guidance before filing for forgiveness. We expect to see something soon.
Because taxpayers may have paid estimated taxes assuming they would get these deductions, there are a number of questions regarding fourth quarter estimates. We believe that taxpayers should make a reasonable estimate of their liabilities, but there should not be an underpayment penalty because the penalty is based on legislation enacted in 2020. R&TC §19136(g) generally waives underpayment penalties in situations where tax legislation was enacted mid-year.
You can count on Spidell’s 2020/2021 Federal and California Tax Update webinar. The course material has been completely updated to reflect the passage of the Consolidated Appropriations Act. Click here and register today.