Overview
Virginia’s Internal Revenue Code conformity date means that the state does not conform to either the federal gross income exclusion for Paycheck Protection Program (PPP) loan forgiveness income, or the federal allowance of deductions for expenses funded with forgiven PPP loan proceeds. However, to the extent PPP loan forgiveness income is treated as taxable in Virginia, otherwise deductible expenses funded with loan proceeds would presumably be deductible.
Treatment of PPP Loan Forgiveness Income in Virginia
While the cancellation of debt ordinarily gives rise to income for federal income tax purposes, discharge of indebtedness income generated by the forgiveness of a PPP loan is excluded from federal gross income.For federal income tax purposes, the exclusion from gross income is accomplished “off code” through Section 1106(i) of the CARES Act and Section 276 of the Consolidated Appropriations Act (CAA). Each of these provisions requires the forgiven amount to be excluded from gross income “for purposes of” the Internal Revenue Code, but neither provision actually amends the language of the Internal Revenue Code itself. This distinction has the potential to create ambiguity with respect to state conformity.
Virginia has not issued guidance on the state’s position with respect to income generated by the forgiveness of PPP loans. However, for tax years beginning on or after January 1, 2018, the starting point for computing Virginia taxable income is federal taxable income determined under the Internal Revenue Code as amended and in effect on December 31, 2019 (prior to enactment of the CARES Act and the CAA). While the federal exclusion for PPP forgiveness income does not actually amend the Internal Revenue Code, to the extent it might be considered to be incorporated in a state’s federal starting point, Virginia’s pre-CARES Act and pre-CAA conformity date for computing federal taxable income likely would not incorporate the federal exclusion. Therefore, federally excluded PPP forgiveness income may be taxable income for Virginia purposes.
On February 27, 2021, both the House and Senate of the Virginia legislature agreed on legislation that would advance Virginia’s Internal Revenue Code conformity date from December 31, 2019, to December 31, 2020, but would decouple from specific provisions of the CARES Act and the CAA. The bill does conform to the federal tax exemption for PPP loan forgiveness, but would de-conform from the provisions of the CAA allowing deductions for business expenses funded by forgiven PPP loans. However, the bill provides a Virginia individual and corporate income tax deduction of up to $100,000 for business expenses funded by forgiven PPP loan proceeds that are paid or incurred during the 2020 tax year. The bill also provides an individual and corporate income tax subtraction for up to $100,000 of all grant funds received by the taxpayer for the 2020 tax year under the Rebuild Virginia program. The bill is awaiting action by the Governor. If enacted in its present form, the bill will be passed as an emergency measure and will be in force from its passage.
Impact of PPP Loan Forgiveness Income Exclusion on Tax Attributes and Basis Increases
Subsequent taxpayer-friendly clarifications to the PPP loan program under the CAA provide that the exclusion of PPP loan forgiveness income from federal gross income does not result in the reduction of any tax attributes or the denial of any basis increases.Based on its Internal Revenue Code conformity date, Virginia may treat PPP loan forgiveness income as taxable income.The Virginia Department of Taxation has not issued guidance on the impact of PPP loan forgiveness income on tax attributes or basis increases.
On February 27, 2021, both the House and Senate of the Virginia legislature agreed on legislation that would advance Virginia’s Internal Revenue Code conformity date from December 31, 2019, to December 31, 2020, but would decouple from specific provisions of the CARES Act and the CAA. The bill does conform to the federal tax exemption for PPP loan forgiveness, but would deconform from the provisions of the CAA allowing deductions for business expenses funded by forgiven PPP loans. However, the bill provides a Virginia individual and corporate income tax deduction of up to $100,000 for business expenses funded by forgiven PPP loan proceeds that are paid or incurred during the 2020 tax year. The bill also provides an individual and corporate income tax subtraction for up to $100,000 of all grant funds received by the taxpayer for the 2020 tax year under the Rebuild Virginia program. The bill is awaiting action by the Governor. If enacted in its present form, the bill will be passed as an emergency measure and will be in force from its passage.
Treatment of Expenses Paid with Forgiven PPP Proceeds in Virginia
For federal income tax purposes, the CAA clarifies that otherwise deductible expenses paid with proceeds from a forgiven PPP loan are deductible.Because the deductibility of expenses paid with proceeds of a forgiven PPP loan is not codified in the Internal Revenue Code, this creates the same potential for ambiguity with respect to state conformity as the exclusion of the PPP loan proceeds themselves.
The CARES Act was silent on the deductibility of expenses funded with proceeds from a forgiven PPP loan. Initial guidance (later obsoleted) from the IRS indicated that otherwise deductible expenses paid with proceeds from forgiven PPP loans would not be deductible due to prohibitions against deductions related to tax-exempt income under IRC § 265. The CAA clarified that otherwise deductible expenses remain deductible, even though funded with proceeds from a forgiven PPP loan.
To the extent the loan forgiveness income is taxable in Virginia, otherwise deductible expenses funded with loan proceeds would presumably be deductible for Virginia purposes to the extent permitted by state law.