The answer to this question is heavily influenced by your home state and how strictly the state follows the federal tax statutes. Taxpayers should take into account the state tax consequences of applying for PPP loans, as well as the effects of having those debts forgiven.
Before making a decision on repayment, it is critical to study the regulatory guidelines relating to debt forgiveness, the state’s backlash and conformity to the CARES Act, and the state’s response and conformance to the CAA for expenditures.
Under ordinary circumstances, forgiven loan amounts are taxed for federal income tax purposes; although, the CARES Act excludes the forgiveness of PPP lines of credit. Determining whether debt forgiveness is subject to taxation in a state is not in any way complex.
The forgiven loans are usually not taxed in almost 20 states and the District of Columbia which already have holding compliance with the Internal Revenue Code (IRC). Taxpayers who receive loan forgiveness may face significant state tax obligations in states that have static or fixed-date adherence.
The state’s conformance policies establish the extent to which a borrower’s loan forgiveness is subject to taxation at the state level. According to Section 1106(i) of the CARES Act, forgiven loans really aren’t deemed gross income for Internal Revenue Code purposes.
The forgiveness clause has no effect on the IRC. As a possible consequence, even in states that comply with the IRC, federal loan forgiveness provisions may well not adapt to state taxable income calculations, resulting in the forgiveness getting adjusted into state income taxes.
How to Report PPP forgiveness for Income Taxes
Outlined below are the three permitted cycles for admitting exempt forgiveness income:
- The First Period
The first period for admitting and disclosing exempt income commences when PPP funds are utilized for qualified spending. Note that once they are spent, the aforementioned period begins. A large percentage of PPP loan recipients would have received their first draw in 2020, followed by a second draw in 2021.
If you received your first draw in 2020 or 2021, or if your enterprise is a fiscal or non-calendar year reporter, this time span may include 2 different tax reporting cycles.
- Second Period
Have it in mind that the period during which the tax-exempt forgiveness request was submitted would mark the next period the tax-exempt forgiveness income can be reported. For example, if you leveraged this tactic and requested forgiveness in November 2020, the business would be expected to disclose the tax-exempt income on the tax return of that month.
- Third Period
The period during which the tax-free forgiveness income was granted would be the last time it can be disclosed. If you disclosed the whole amount of the PPP loan as exempt income yet it was only partially forgiven, the IRS will require an updated return to be filed to correct the error.
If the enterprise updating the return is a flow-through entity, for example, a partnership or S corporation, the company may file amended forms K-1, and the beneficiaries’ returns will also be updated.
Information to Include in Your Taxpayer Statement
The statement for each PPP loan should include the following items:
- The taxpayer’s name, address, and EIN or SSN
- Proc. 2021-48 section(s) (section(s) 3.01(1), (2), or (3))
- The total amount of tax-free income from PPP loan forgiveness that a taxpayer considers earned or accumulated during the fiscal year.
- Whether or not the PPP loan has been forgiven as of the return to which the statement is attached.
A taxpayer who took out a Paycheck Protection Program (PPP) loan and then had it forgiven in 2021 has tax-free income.
But even though the payer is not required by law to report the forgiven loan as income on their 2021 individual tax return, they must divulge specific loan details, and the Form 1040 instructions illustrate how to report data related to the PPP loan on their income tax return.
However, you should seek advice from your tax consultant to see how the loan forgiveness will actually impact your enterprise and personal income tax returns.