Letizia Le Fur | ONOKY | Getty Images
While the federal Covid bill addresses a key concern for small businesses with unsuccessful credit, those businesses could still face a tax hit – this time on their government returns.
In addition to promising stimulus checks for American households and increasing unemployment benefits by $ 300, the new Covid bill offers help for sick small businesses in the form of a second loan from the Paycheck Protection Program.
In general, borrowers may be eligible for PPP lending if at least 60% of the proceeds are used for wages and salaries. Partial lending may be available to those who fall below the threshold.
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Any amounts not wiped off must be repaid and are subject to an interest rate of 1%.
Legislature has also addressed a long-standing problem in the relief bill: it allows PPP borrowers to apply for tax deductions for the expenses they covered with loan proceeds – a move the Finance Department and IRS previously referred to as a “double dip” because forgiveness is tax free.
Small businesses shouldn’t be celebrating just yet.
Unresolved year-end tax planning issues emerge – including the fact that states can prevent PPP borrowers from claiming deductions from state tax returns or from clearing balances tax-free.
“There is still significant uncertainty,” said Jared Walczak, vice president of government projects at the tax foundation. “Many states still have to clarify their position.”
Roles vs. static conformity
When it comes to tax planning, the federal code is only part of the story.
States will differ in how they approach the Internal Revenue Code, including whether or not they make changes to federal law.
Some states, like New Jersey, have their own rules for determining income. Others correspond to the federal code on a so-called static or rolling basis.
With static conformity, the states adhere to the code from a certain date. With rolling compliance, they adopt changes to the tax code as soon as they occur.
These differences can create a discrepancy between the definition of your income on your income tax return and your state tax return.
It also means that states may take a different path in interpreting Covid relief efforts, including potentially not allowing tax-free PPP forgiveness or blocking deductions associated with PPP.
There remains considerable uncertainty. Many states have not yet clarified their position.
Vice President for State Projects at the Tax Foundation
Another motivating factor for states that decide against the bill: their battered coffers due to the pandemic. Government sales and income tax revenues have declined due to layoffs and companies closing their doors.
“When a state is really pushed for money, it’s a place to go,” said Ed Zollars, CPA and partner at Thomas, Zollars & Lynch in Phoenix and an instructor at Kaplan Financial Education.
“When you need to raise money, you find something at the federal level that you can’t agree with,” he said.
A waiting game
Currently, California does not allow any deductions for expenses paid on issued PPP loans under state law. The companies there have to reduce their deductions to their government returns.
North Carolina excludes issued PPP loans from taxable income, but entrepreneurs are unable to deduct these covered expenses.
It remains to be seen how other states will act, which will add a wrench to year-end tax planning for small businesses.
This complicates the situation for entrepreneurs who still have to pay estimated taxes even if they renew and wait for more clarity from their state.
“We need states to tell us what to do,” said Dan Herron, CPA and director of Elemental Wealth Advisors in San Luis Obispo, California.
“A lot of people would rather hold onto the money and pay it later when they have an idea of how much they owe – that money is cash for their business,” he said.