Many taxpayers have been affected by the COVID-19 pandemic. In the business sector, many small business taxpayers were forced to seek loans under the Paycheck Protection Program (“PPP”) in an effort to navigate the crisis’ effect on their businesses and employees. Moreover, taxpayers can literally trip over the amount of guidance, legislation, and information circulating (and changing) in the ether with respect to the use and forgiveness of their PPP loans. The largely unanswered question has been this—how will the various tax agencies treat PPP loans that are forgiven and/or the expenses paid or incurred as a result of the PPP loans? While taxpayers may have more clarity from the federal government, it is still unclear how Texas will answer that question.
PPP Tax Consequences at the Federal Level
The U.S. Congress recently clarified the tax treatment (for federal purposes) of PPP loan forgiveness and the deductibility of related business expenses. This past year has seen a relative evolution in the tax treatment of these unique items. Recently, the Internal Revenue Service issued Revenue Ruling 2020-27. That revenue ruling attempted to address the issue of whether a taxpayer that received a PPP loan could then deduct expenses that it paid during the year if it “reasonably expected” to receive forgiveness of the PPP loan. Simply put, taxpayers would not receive a tax deduction for such expenses. For more information on Revenue Ruling 2020-27, see the following Insight Blog: Treasury Warns Against Taking Deductions Related to PPP Funds.[1]
At the eleventh hour of 2020, the federal government enacted the Consolidated Appropriations Act—both the U.S. House of Representatives and the U.S. Senate passed the bill on December 21, 2020, and former President Trump signed the bill on December 27, 2020.[2] Among its provisions, the relief bill provided clarity with respect to the federal tax treatment of PPP loans:
SEC. 278. CLARIFICATION OF TAX TREATMENT OF CERTAIN LOAN FORGIVENESS AND OTHER BUSINESS FINANCIAL ASSISTANCE.
(a) United States Treasury Program Management Authority.—For purposes of the Internal Revenue Code of 1986—
(1) no amount shall be included in the gross income of a borrower by reason of forgiveness of indebtedness described in section 1109(d)(2)(D) of the CARES Act,
(2) no deduction shall be denied, no tax attribute shall be reduced, and no basis increase shall be denied, by reason of the exclusion from gross income provided by paragraph (1) . . . .[3]
Consequently, the U.S. Congress’ recent reform highlights that, for federal tax purposes: (1) forgiven PPP loans will not be included in a taxpayer’s gross income, and (2) deductions incurred and paid by a taxpayer as a result of the PPP loans will not be denied if those PPP loans are forgiven.
PPP Tax Consequences at the State Level (Texas)
Across the country states have been grappling with the state tax consequences of PPP loans and related business activities. Put simply, there has been much uncertainty. Currently, in Texas, the franchise tax may be looming over taxpayers for the 2021 filing season. Texas still needs to act (and act quickly) with respect to the same questions recently addressed by the federal government.
In a recent Tax Policy Update, the Texas Comptroller’s office suggested that PPP loans that were ultimately forgiven would be included in revenue for franchise tax purposes. This is an obvious break from how the federal government is treating forgiven PPP loans for federal tax purposes. Section 171.1011 of the Texas Tax Code states how “total revenue” is determined for franchise tax purposes. Total revenue, in large part, is based on the amounts reported on a business taxpayer’s federal income tax return.[4] Further, cost of goods sold deductions (determined under Tex. Tax Code Ann. § 171.1012) and compensation deductions (determined under Tex. Tax Code Ann. § 171.1013) would also likely be affected. In effect, Texas taxpayers could be left with a higher taxable margin for franchise tax purposes.
H.B. 1195 & S.B. 372
Likely in response to the recent news from the Texas Comptroller’s office, Texas Representative Charlie Geren (R-District 99) introduced HB 1195 on January 19, 2021. Two days later, on January 21, 2021, Texas Senator Kelly Hancock (R-District 9) introduced SB 372, which mirrors HB 1195’s language.
The pertinent language of the bills states, in part:
SECTION 1. Section 171.1011, Tax Code is amended by adding subsection (y) to read as follows:
(y) Total revenue does not include any amount of loan forgiven under the Paycheck Protection Program, as provided for under section 1106 of the Coronavirus Aid, Relief, and Economic Security Act, as amended by the Paycheck Protection Program Flexibility Act. Qualifying expenses paid with such loan proceeds may be included in the determination of cost of goods sold under Section 171.1012 or in the determination of compensation under Section 171.1013.[5]
Further, the bills make clear that while the amendment generally takes effect September 1, 2021, the amendment to Section 171.1011 only applies to Texas franchise tax reports originally due on or after January 1, 2021.[6]
Conclusion
Notably, the recently introduced bills by Representative Geren and Senator Hancock create relative parity between the federal government and the Texas government—at least with respect to their treatment of forgiven PPP loans and related business deductions. Those bills, if passed, will prevent a potential whipsaw to Texas taxpayers—particularly small business owners. Those mom-and-pop shops may breathe a sigh of relief with federal tax deadlines quickly approaching. However, those same businesses should keep an eye out on the Texas Comptroller until May 15th. Uncle Sam may not be the problem on this issue, but the Texas Comptroller might be!
[1] It should be noted that the Internal Revenue Service later issued Rev. Rul. 2021-2, which now makes Rev. Rul. 2020-27 obsolete.
[2] The Consolidated Appropriations Act, 2021, H.R. 133 (enacted Dec. 27, 2020).
[3] Id. at Section 278.
[4] Granted, there are notable exceptions and adjustments to the figures reported on the federal tax return (e.g., bad debt expense).
[5] Texas H.B. No. 1195, 87th Leg., R.S. (2021); Texas S.B. 372, 87th Leg., R.S. (2021).
[6] Id.
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