Learn more about the federal income tax implications of receiving a Paycheck Protection Program (PPP) loan below.

After some period of confusion between Congress and the IRS, it was determined the loan forgiveness is excluded from federal taxable income, and the COVID-Related Tax Relief Act of 2020, enacted as part of the Consolidated Appropriations Act, 2021, P.L. 116-260, confirms that otherwise deductible business expenses paid out of PPP loans may be deducted for federal income tax purposes.

California partial conformity to the federal treatment of PPP loan forgiveness has come in two parts:

(1) Governor Newsom signed Assembly Bill 80 (AB 80) into law on April 29, 2021. With AB 80’s passage, California allowed taxpayers to deduct otherwise nondeductible business expenses, such as wages, even if those expenses were paid with forgiven funds from PPP, BUT with certain exceptions as explained below.

(2) AB 194, signed into law June 30, 2022, brought California into conformity with federal with regard to the time period for covered loans – see Timing of Loans, below.

Exceptions Under AB 80 - AB 80 excludes forgiven PPP loans from gross income for state purposes, in conformity with federal law. It also allows deductions for expenses paid using forgiven PPP loan funds, but it excludes two types of entities from deducting expenses paid with forgiven PPP loans:

Retroactive Application - AB 80 states that the benefits of PPP loan forgiveness exclusion and expense deductibility can be applied to tax years beginning on or after January 1, 2019. This retroactive legislation is intended to ensure that all fiscal-year filers will be subject to the legislative changes.

Loan Forgiven in a Subsequent Year – Where a taxpayer is not qualified to deduct the expenses if a PPP loan is forgiven, but has deducted the expenses and the loan is forgiven in a subsequent year, we look to the FTB Q&A on the subject.

Q - What if I already filed and claimed a deduction that I do not qualify for?

A - If you already filed and claimed a deduction that you do not qualify for, you must file an amended return using our normal amended return procedures.

Thus, if the expenses were deducted in one year and the loan forgiven in a subsequent year, making the expenses non-deductible, one would need to amend the return for the year in which the expenses were claimed.

Timing of Loans - AB 80 provided gross income exclusion for covered loan amounts forgiven pursuant to the CARES Act, the Paycheck Protection Program and Health Care Enhancement Act, the Paycheck Protection Program Flexibility Act of 2020, and CCA and EIDL grants under the CARES Act or targeted EIDL advances under the CCA. This meant that loans (both 1st and 2nd draws) made after March 31, 2021 through June 30, 2021, weren’t covered loans for exclusion from California income because forgiveness of these loans was included in the PPP Extension Act of 2021, and that legislation was not named in the AB 80 provisions.

This bit of nonconformity was addressed in AB 194, which excludes from California gross income any covered loan amounts forgiven pursuant to the PPP Extension Act of 2021. Thus, loans made after March 31, 2021 and through June 30, 2021, are eligible for nontaxable loan forgiveness provided the business meets the 25% reduction of gross income requirement described above. If eligible forgiven loans made during this time frame were reported as taxable cancellation of debt income on an already filed 2021 return, an amended return would be in order.\

Form FTB 4197 – Taxpayers who had a PPP loan forgiven or received an EIDL grant for 2021, will need to file form FTB 4197, Information on Tax Expenditure Items, with their tax return. This is a new use for this form, which for tax year 2020 was required only in relation to operating a commercial cannabis activity.