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Q&A Special: PPP LOAN UPDATES & CALIFORNIA’S TAX CONSEQUENCES

Q&A Special:

PPP LOANS & CALIFORNIA TAX

CONFORMITY CONSEQUENCES

 What’s going on with second draw PPP Loans, and has California completely conformed to Federal Tax Law?

Our new Q&A Special features Sharon Kreider and Karen Brosi explaining the consequences of California’s new conformity and PPP Loan Updates.

  • California is among the 20 states that don’t have automatic conformity with Federal law
  • Publicly traded companies aren’t allowed to take the deduction of expenses paid with loan proceeds

 

LISTEN NOW TO THE Q&A SPECIAL

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Sharon Kreider:             

Hi, I’m Sharon Kreider and I’m here with my friend and our guest with a conversation on the PPP loans and what’s happening with California tax. So Karen Brosi is my Federal California Tax Update partner. And we’ve spent lots and lots of time traveling except this last year when I’m-I’m having withdrawal symptoms from small seats in airplanes and bad food. So, I’m glad to have you here, um, because, you know, I, I read tax talk and I’m on a tax, on Twitter for the tax feed, and there’s just been so much conversation on what’s happening with California tax. And I know that not all of our listeners are located in California, but lots of them have California clients and those business clients that receive PPP loans. And I think all of those returns are on extension well, while California decided what to do about PPP loan forgiveness and the expenses. So, first of all, let me ask you this question: has California conformed to PPP loan tax provisions that the federal government enacted?

Karen Brosi:                    

Well. Okay. So thank you for having me here today Sharon on this topic. And let me frame that with just the briefest of explanations that you and I know that the problem with California versus federal law is that California is among the 20 some odd states that don’t have automatic conformity with federal law. So we have to enact conformity. We do that by enacting a specified date to conform to the IRC. But our last specified date is January 1st, 2015. So anything that’s been enacted by the federal government since that time requires separate legislation to conform. So last year in 2020, the state legislature did in its summer session, which is pretty much when it does anything in terms of tax law, did get around to enacting A.B. 1577. And A.B. 1577 was designed to conform with federal law relative to PPP loan forgiveness, and no non taxability on that forgiveness.                                         

Now, the problem is the timing, because at that time, I think the end of August, 2020, and what you know out of all of this legislation that has happened, at that time in August of 2020, where did we stand federally? What was the IRS saying federally? Well, the IRS was saying, “Okay, we see in the CARES Act that the PPP loan is forgiven and not taxable, but by the way, all you business taxpayers, that means you don’t get to deduct your expenses that you use the PPP loan proceeds for.” So in enacting A.B. 1577, although many of us in the state, I was not alone in this. [ I called every lobbyist I knew, I called several legislative assistants and said, “Please don’t do this. I could see it in the draft of the bill.”

What they did in 1577 is they went ahead and said the loan forgiveness is not taxable. But then they put into the legislation the IRS’s provision and made it California law. That the expenses would not be deductible. Why did we say don’t do that? Cause we knew that Congress was likely to do something else about that. But so that’s what 1577 did, it did it in August of 2020. It said no taxability on your forgiven loan, but you’re not allowed to deduct the expenses you paid with proceeds of the loan.

Sharon Kreider:             

Well, you know, I’m stuck back on you saying that our conformity is based on 2015. I was counting on my fingers and my toes how many things have changed since 2015?

Karen Brosi:                    

Yes ma’am.

Sharon Kreider:            

I know, I know. I do understand. All right, now we have the Consolidated Appropriations Act of 2021, where Congress made the expenses deductible, even though they were paid with forgiven loan proceeds, tax exempt income, as it turns out, the expenses were deductible. So we had CAA 2021, what happened in California then when the Fed said, “Okay, you can deduct the expenses. It’ll be just our additional present to you struggling businesses that will give you some tax, some extra tax relief.” What happened in California, where are we?

Karen Brosi:

Well, okay. So what happened in California first and foremost was CAA 2021 was passed in late December, December 27th of 2020. What was happening in California at that moment is nothing at all because our legislature goes into recess at the end of August, and doesn’t come back until the beginning of January. So nothing at all was happening at that point. Now, interestingly enough, when the legislature came back in early, in 2021, and this new legislation had been passed federally, they did decide they needed to do something about it. And they decided because it was already tax season that they needed to do something rather quickly. So they did something that is not unprecedented, but fairly unusual in the law. 

They tried to enact an emergency measure and to do that, what they do is they reach out and they grab a piece of legislation that’s already been through its readings, through the assembly and through the Senate, and they basically pick it up and they cross out everything that was in that piece of legislation and they override it with this emergency measure. And that was A.B. 80, assembly bill 80. And they did that, the assembly did that long about no, the middle week of February as an emergency measure, because it was clear that the legislature knew that they needed to do something about these expenses being deductible. And they appeared to be in agreement that they would make them deductible although there was an ongoing raging debate about limiting the amount of the deduction. And the figure that kept getting battered around was 150,000 of expenses that would be allowed to be deductible and anything above that would not be deductible. 

But in the end, when they finished debate on it, they put it all together, they took out the $150,000 limitation. Well, that was mid February, but by March 15th, an important date, because by March 15th, didn’t do either have to file or extend your pass through entities, your partnerships and your S corporations, it still hadn’t moved off the legislature and, uh, in, onto the governor’s desk, why not? Well, there was one further problem with, uh, enacting A.B. 80 and that further problem had to do with the American, The American Rescue Plan was enacted by Congress, and it contained a very small provision in it that said that if states enacted laws that would, as a result of this, that would reduce a taxpayer’s state income tax, that they could lose some federal funding that was available to them. 

So clearly enacting A.B. 80 and allowing business deductions to be taken with, as you say, tax exempt income would reduce those business owners taxation in California. And so they stalled A.B. 80 before putting it on the governor’s desk, because they were concerned that passing or enacting it would harm California’s federal funding in a significant way. So then finally what happened is that the governor’s office reached out to the treasury and said, “Is this what this really means or can we, can pass conforming legislation to federal law without being in danger of losing our federal funding? And the treasury finally in April, came up with a decision on that, that, that, yes, this could be enacted and not harm the state’s federal funding. So just after the nick of time, practically on the 29th of April, governor Newsom signed A.B. 80, and it does not have the limitation on deductions to it. So it, uh, both allows for, you know, the tax exempt income from the forgiveness of the loan, but it also allows for the deduction of the expenses paid against it, except for two categories of businesses that are not allowed.

Sharon Kreider: 

Wait a minute. So now California conforms to the federal law, tax-exempt on the forgiveness, forgiven, not taxable and the expenses are deductible in California did not impose the limit that they talked about.

Karen Brosi:

Mm-hmm (affirmative)

Sharon Kreider:

And secretary of treasury, Yellen said, “Okay, you can still have the other money we have for your state. So we are totally conformed is that right?

Karen Brosi: 

Yeah. Except I almost let the cat out of the bag on that. We’re totally conformed except where we don’t. So there were two categories that were carved out of, uh, on A.B. 80. And the first category is publicly traded companies. So publicly traded companies are not allowed to take the deduction of their expenses that were paid with loan proceeds, forgiven loan proceeds. But the second category that was carved out were something called ineligible businesses. And the definition in A.B. 80 of an ineligible business is a business that did not, or cannot show that for any single quarter in 2020, it had a reduction of 25% of gross receipts over the same quarter in 2019. Now that 25% reduction in gross receipts probably sounds familiar to you Sharon, doesn’t it?

Sharon Kreider:

Oh yeah. That’s our second draw on the PPP loan. We have to show a particular decline in receipts on the second draw, not in the first draw.

Karen Brosi:

Not on the first draw. Exactly right. But because that second draw legislation was sitting out there, I guess our legislature got confused about that. And so they applied it to the ability, your ability, or your business’s ability to deduct the expenses on a first draw PPP loan that was forgiven. Uh, and so you need to demonstrate, or you need to attest that there has been that 25% reduction on a quarterly basis for any single quarter, from 2020 in comparison to 2019 in order to be an eligible business to deduct those expenses.

Sharon Kreider:

All right. Here’s, so if I went in for a second draw, if my client has the second draw loan, then, because they had to show in the second draw that they had a 25% decline in revenue from 20 back 19 to 20-

Karen Brosi: 

Yeah.

Sharon Kreider:

They are gonna be alright on this for deducting their expenses. It is the clients that didn’t qualify for a second draw that have a problem, is that right right now in California?

Karen Brosi:

Yeah. I think that that’s right. Um, although, so here’s the situation with that. Is that what the FTB has now said is that… because they’ve been asked several times now, uh, since April 29th, how do we show that on the return? And all the FTB has said is that they’ll provide for the guidance, but it is not their intention at this point to provide a separate form or worksheet of any sort to demonstrate that on the actual return where you’re deducting the expenses. So I don’t know if it becomes a checkbox on the return; we’re still awaiting future guidance or additional guidance from the FTB in that regard. Now lucky, most of our clients, we put them on extension because we were waiting for A.B. 80 to actually be passed. So for most clients that we’d already did that with, they, we put them on extension.

They’re now sitting on extension and we can continue to wait that out a little bit, but it doesn’t look like anybody is inclined to change that restriction for making a business eligible for 2020. So I don’t see that as getting a lot of traction, I think that the legislature’s going to be married to this 25% reduction in gross receipts concept, whether you’re a 2020 or a 2021 loan. So then of course, I think that you just, you have to prove it out. Now, you’re right. As a preparer, I think I get a free pass if my client applied for and got a PPP two loan, because they couldn’t have gotten the loan without it. So that’s my free pass, they already demonstrated to small business administration or their lender or whatever that they qualify in that regard.

Anybody, it’s worse than that, it’s anybody who applied and didn’t qualify, then that’s also my free pass. I know they don’t qualify. And so they own ineligible business and they don’t get to deduct. But what about all those folks who took a PPP one and didn’t apply for a PPP two? Now who’s gonna tell me whether they had a drop in gross receipts or not. And I think that’s going to be my responsibility to seek that out and search that, and search that out. Now that then turns to, of course, as you and I know that age old question. So, I mean, this is thousands of businesses, isn’t it Sharon in California?

Sharon Kreider:

 Thousands.

Karen Brosi:

Thousands of businesses with a PPP forgiven loan, a PPP one forgiven loan. So without a worksheet or a form attached to the return and the deductions taken, there’s no possible way the IRS, I mean, the FTB, I get lost sometimes. There’s no possible way that the FTB is going to audit all of those returns that take the deductions, we know that’s not going to happen. So how does the FTB know for sure, that’s the age old question, isn’t it? You and I actually have the same answer to this. This is the rule. So how does the FTB know that the client actually is an eligible business?

Sharon Kreider:

Because I tell them, yeah.

Karen Brosi: 

Exactly. Because of their mistake they came to us and we knew the rule and we followed the rule and we told them that no, this business isn’t eligible and doesn’t qualify. Now there, you know, there are still some folks who are out there that are holding out hope in some way that the legislature will change this on the PPP one loans, but it is so late in the season that there are others who are very pessimistic about that happening.

Sharon Kreider:            

Well, I’m an optimist so I think that what I’ll do is I will clear out any extensions where I can show the 25%, because I helped a few clients with the 25% calculation, you know, give me your grocery receipts by quarter for 19 and 20 and they had that capability in their QuickBooks. These are small businesses because I helped them with that, I actually found it not as difficult as it sounded. For instance, to get net profit by quarter, that’s harder.

Karen Brosi:                    

– Mm-hmm (affirmative).

Sharon Kreider:             

Entries in everything else that went on in these small business books. But I think I can clear them all out. I think I’ll wait, when was the, when is the next time I might actually see legislation? I know it’s mostly late summer before anything happens. I-I’m just, I’m just hopeful that California has such high taxes and that somebody will take pity on these suffering businesses and, well I’m an optimist. 

Karen Brosi:                    

Yes. And, and, and I so love that about you, that you’re an optimist and maybe you can call me a pessimist, but I just don’t think so. Uh, when would we know? Well, at the latest we would know by the end of August, uh, because that’s when the legislature recesses. So they’re gonna send a bill to the governor’s office for signature. It’ll happen then. And even then, we have to wait a couple of weeks, because remember, we don’t have a pocket veto in California, it’s actually quite the opposite. Once a bill lands on the governor’s desk, if he doesn’t actively veto it or sign it within a couple of weeks, it just becomes law. So we have to wait a couple of weeks beyond that, but by the end of August, we’ll know if the legislature delivered on that. So if they have enrolled a bill, as we call it and sent it to the governor’s office, we’ll know by the end of August on that. Now that as you say, it still gives us time, even for our pass through entities. They might be cutting it a little close on some of our pa, on our partnerships and our S corporations for that September 15th deadline. But for our other businesses, it still gives us wiggle room in that regard.

Sharon Kreider:             

And I don’t think you’re a pessimist, I think you’re a realist-

Karen Brosi:                    

Okay.

Sharon Kreider:             

All these years doing tax returns, I’m an optimistic realist so that’s good. Can we do just one more thing? And this is really federal in California. Can you tell me what you think about this? You know, if I took my loan out in 2020, because these are still my extended tax returns, I have my borrowing, I received my proceeds in 20. I didn’t get my forgiveness until 2021. And now I have a complication of what’s happening in my California tax return and what to do with my federal tax return. But tell me what you’re doing. Are you leaving the liability on the books for 2020, and then showing the forgiveness in 21, or you just cleaned it all up in 20 is what I’m really asking about.

Karen Brosi:                    

Well, and like so many tax questions, The answer there is it depends now. I think we’re predominantly here again, we’re talking about my pass throughs, aren’t we?

Sharon Kreider:             

Yes, we are.

Karen Brosi:                    

We’re talking about my partnerships and my S corporations. And the reason, or the problem is particularly my S corporation. If my S corporation is carrying the loan still on the books at the end of 2020, that’s a third-party loan, that’s on the books and it hasn’t been adjusted to be paid in capital. And if that same S corporation then has a loss, my shareholder could be looking at a loss in excess of basis, even though I know the loan I by now, actually know the loan has been forgiven. They did get it forgiven already, but the forgiveness didn’t happen until 2021, not at the end of 2020. So I think that’s the scenario you’re most concerned about. “What do I do?” Well, you know, you and I, I think know what the right answer is.

The strictly correct answer is then they’ve got a loss in excess of basis, and I have to carry that loss forward for the shareholder until they have basis. And when the, in 2021, when that loan is forgiven, and I record that forgiveness on the books as paid in capital, then that recovers basis for them and would allow that loss to be deductible in this year. Problem is it just doesn’t help them that business that was struggling, that shareholder in that business that was struggling, it’s not, I don’t think it’s the intent of the law um, so that’s the conflict is that I really believe through all of this, even when we were back in the weeds on are the expenses deductible or not? I firmly believe that Congress’s overall intent with the PPP program was to help businesses, to aid them with a reduction in tax. And so when we get, you know, our, when we put our green shade, eye shade on and get all the accountants up there in it, we know what the correct answer is. I just don’t think it’s what the right answer is based upon the intent of Congress. I think once again, leave it to your conscience probably. And we can talk around it. What are you going to do, Sharon?

Sharon Kreider:             

Well, I’m gonna look at it early from the IRS. They said, when the expense when the, when the IRS was saying the expenses were not deductible. They said, even if your forgiveness isn’t until 21, you cannot deduct the expenses that you reasonably expect to be reimbursed. That’s what they said. So they were going to put the timing together-

Karen Brosi:                    

-Mm-hmm (affirmative)

Sharon Kreider:             

… whether it was, whether you received your official forgiveness in 21 or 20, they were gonna push it all into 20 when it wasn’t deductible. Why would they say something different now? Right. So I don’t think we have an answer and I don’t want that to be necessarily what I’m, what we’re telling our listeners. I want the listeners to hear the conversation and that there are no answers right now, but we did clear up Karen, what California did and didn’t do on the PPP loan forgiveness and the deduction of the expenses with A.B. 80. And I think that I will still sit and wait for some of my client’s tax returns to pass through to decide what to do, to see if there’s any relief push through as more and more people understand the problem. I don’t think the legislature understood the problem, but you, you and I often know that any tax law writer jumps occasionally at an answer when it wasn’t quite, wasn’t right. Correct, right, fair. Any of those.

Karen Brosi:                    

Right. Certainly doesn’t fulfill, as I said and I think that’s what we close in on is that what we’re trying to do is we can clearly see what Congress’s intent was. And they even had to bang against the IRS in order to get their intent codified. So we can clearly see what Congressional intent was. And yeah, they didn’t get it right the first time either, did they? And so we can reasonably expect that the state legislature in trying to match that up is also not quite getting it right yet.

Sharon Kreider:             

Thanks Karen Brosi. She’s our California expert and Ms.California tax law, and what’s happening in tax policy. So we appreciate you talking to us today. Our listeners are on YouTube seeing and hearing what we’re thinking right now. We’ll update as we know more, as we do in federal law and California law and California updates are provided by Karen Brosi and Western CPE likes to sponsor those. So thanks Karen. Talk to you soon.

Karen Brosi:                    

You bet, thank you.

BACKGROUND DATA

Sharon Kreider, CPA, has helped more than 15,000 California tax preparers annually get ready for tax season. She also presents regularly for the AICPA, the California Society of Enrolled Agents, CCH Audio, and Western CPE. You’ll benefit from the detailed, hands-on tax knowledge Sharon will share with you—knowledge she gained through her extremely busy, high-income tax practice in Silicon Valley. With her dynamic presentation style, Sharon will demystify complex individual and business tax legislation. She’s a national lecturer for business and professional groups and consistently receives outstanding evaluations. In 2014, she was awarded the prestigious AICPA 2014 Sidney Kess Award for Excellence in Continuing Education.

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Karen Brosi, CFP, EA, has an extensive California tax practice, advising clients in individual tax and family wealth planning, specializing in complex individual income tax matters and all types of securities transactions. Her background as a CFP and as a tax preparer for the wealthy makes her particularly effective in the tax and financial planning arenas. Karen teaches tax professionals how to avoid tax minefields with her extensive planning checklists and practical tips.

Besides being one of the most prominent California tax update instructors, she’s a favorite interviewee on radio, television, and in print media, such as Bloomberg Businessweek. Karen’s powerful real-life presentations pinpoint critical federal and state tax areas, teaching tax professionals what they need to know to optimally assist their clients. Karen was the recipient of the California CPA Education Foundation 2012-2013 Outstanding Webcast Instructor award.

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