(CNN) — Forgivable loans from the Paycheck Protection Program have been a lifeline to small businesses trying to stay afloat during the pandemic.
And Congress made that lifeline even stronger with two big tax breaks: Forgiven PPP loans will not be subject to federal income tax and small business owners may deduct business expenses paid for with their PPP money. (Normally forgiven debt is taxable and only business expenses paid for with company income are deductible.)
But small business owners might not get those same tax benefits when it comes to their state taxes.
That’s because many state legislatures have not yet decided whether to adopt or reject the tax changes made at the federal level. Many likely will make a decision over the next several months and probably make the changes retroactive to 2020. But where each state comes down on the issue remains to be seen.
“Many states have not provided guidance directly, and those that have provided guidance have not followed a uniform approach,” said Brian Kirkell, a principal at the tax, audit and consulting firm RSM.
Nor will a state necessarily make an all-or-nothing decision.
“Even if some states conform to the exclusion from income for forgiven PPP loans, they still may elect to remain decoupled from the federal provision and rules allowing taxpayers to deduct qualifying business expenses from income if paid for with PPP loan funds,” said Julie Sforza-Smith, program manager at the Tax Institute of H&R Block.
For instance, Alabama and South Carolina have indicated they will provide the same two tax benefits regarding PPP loans as the IRS. But North Carolina and California will only adopt one of them — treating the forgiven loan as tax free.
Or, in some states such as Massachusetts and Pennsylvania, whether a small business can enjoy either of the PPP-related tax breaks will depend on whether its state taxes are filed under the corporate tax code or the individual tax code.
With so much uncertainty and complexity surrounding states’ tax treatment of PPP loans, “practitioners and software providers have been making educated guesses,” Kirkell said.
His advice to small business owners: Before filing, talk with a tax adviser familiar with your state’s tax laws.
And, if you can afford to wait for a state and local tax refund you may be owed, file for an extension on your state taxes. In several months you’re likely to have a clearer picture on how your state intends to treat your forgiven PPP loan and the deductibility of your business expenses not just for tax year 2020 but also tax year 2021. That will be relevant since neither the pandemic nor the PPP program are over.
If you can’t afford to wait, “take a filing position based on the limited guidance we have, and with the understanding that the guidance may be subject to change and filing an amended return may be necessary,” Kirkell said.
In some states, though, you may get clarity before April 15 so it pays to hold on to your return a few weeks longer.
In West Virginia, for instance, there’s a bill likely to be signed in the coming days that will follow the IRS in its treatment of both PPP-related tax breaks, Sforza-Smith said. “We recommend West Virginia filers reporting forgiven PPP loans wait just a little longer to file so they do not have to amend their state return.”
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