Do I Report PPP Loan Forgiveness in California for Taxes?
Understand how PPP loan forgiveness impacts your California taxes, key reporting differences, and the documentation needed to stay compliant.
Forgiven Paycheck Protection Program (PPP) loans provided relief to businesses, but tax treatment varies by state. In California, reporting rules differ from federal guidelines, creating confusion for business owners and taxpayers.
Understanding California’s approach to PPP loan forgiveness is crucial to avoid tax filing errors.
California Tax Treatment
California does not fully align with federal tax rules on forgiven PPP loans. While the federal government excludes forgiven amounts from taxable income and allows deductions for expenses paid with PPP funds, California initially took a stricter stance. Assembly Bill 80 (AB 80), signed in April 2021, brought state tax rules closer to federal provisions but with key differences.
Forgiven PPP loans are not considered taxable income in California, so businesses do not report them as revenue on state tax returns. However, AB 80 limits expense deductions to businesses that experienced at least a 25% reduction in gross receipts in any quarter of 2020 compared to the same quarter in 2019. Businesses that do not meet this threshold cannot deduct expenses paid with forgiven PPP funds, increasing their state tax liability.
For example, a business that received $150,000 in PPP funds and used it entirely for payroll and rent could deduct those expenses on federal returns. In California, if the business did not meet the 25% revenue decline requirement, it would lose those deductions, leading to a higher taxable income at the state level.
Federal Reporting Differences
The IRS treats forgiven PPP loans as nontaxable income, meaning businesses do not report them as revenue on federal tax returns. The Consolidated Appropriations Act of 2021 confirmed that businesses could also deduct expenses paid with forgiven PPP funds, ensuring the relief program did not create additional tax burdens.
While the IRS does not require forgiven PPP loans to be reported as income, businesses must maintain records to support their deductions. Payroll reports, rent or mortgage statements, and utility bills should document how funds were used. The IRS also requires that expenses meet the standard deductibility criteria under Section 162 of the Internal Revenue Code, meaning they must be ordinary and necessary for business operations.
For businesses that received second-draw PPP loans, federal tax treatment remains the same. These loans required businesses to demonstrate a 25% revenue decline to qualify, but this threshold does not affect tax deductions. Businesses that met the eligibility requirement can deduct all qualifying expenses, regardless of further revenue changes.
Required Documentation
Businesses with forgiven PPP loans must keep detailed records to comply with tax regulations and potential audits. Documentation should confirm how funds were used and verify eligibility for deductions.
A key document is the official forgiveness determination from the Small Business Administration (SBA) or the lender, which confirms that the borrower met program requirements. Without this, a business may struggle to prove loan forgiveness under the CARES Act and later amendments.
Payroll records, including pay stubs, tax filings, and benefits statements, are essential for businesses that used PPP funds for wages. Those that allocated funds to rent, mortgage interest, or utilities should keep lease agreements, lender statements, and utility bills to verify eligible expenses.
Potential Penalties for Noncompliance
Failing to properly account for PPP loan forgiveness on tax filings can lead to financial penalties, interest assessments, and audits. The California Franchise Tax Board (FTB) and the IRS compare tax returns with loan forgiveness data to detect discrepancies. Businesses that incorrectly exclude taxable income, claim unauthorized deductions, or fail to substantiate reported amounts may face reassessments that increase tax liability.
The FTB can impose accuracy-related penalties under California Revenue and Taxation Code Section 19164, which generally mirrors federal penalties under Internal Revenue Code Section 6662. These penalties can reach 20% of any underpaid tax due to negligence, substantial understatement, or disregard of tax laws. In cases of intentional misreporting, fraud penalties under Section 19164(b) can add a 75% penalty on underreported amounts.