Tax time is confusing and stressful under the best of circumstances. It could be even worse if you've taken out a loan from the government's Paycheck Protection Program.

The tax status of the PPP has been muddled from the beginning. While these forgivable loans were never meant to be taxed as income, the Treasury Department and the Internal Revenue Service, under the Trump administration, held that business owners could not deduct expenses that were paid for with PPP. Congress disagreed, and in December 2020 put its position into law with the Consolidated Appropriations Act, which also contained a $900 billion relief package

Unfortunately, that doesn't quite settle the issue. Right now, 19 states tax forgiven PPP loans, either by including them as taxable income or disallowing deductions for business expenses made with the loans, says Katherine Loughead, senior policy analyst for the Tax Foundation, which has published a map showing the loans' tax status by state. Those states include California, Texas, and Florida. 

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States have different methods for bringing their own tax regimes into alignment with federal law--or for refusing to do so. Many states use a process called "rolling conformity" to make sure their regulations match those of the federal government. Others use so-called static conformity, so that they match the federal rules as of a given date. States that use "static conformity" must proactively adopt more recent changes.

Legislatures in at least seven of the 19 states in question--Arizona, Arkansas, Hawaii, Maine, Minnesota, New Hampshire, and Virginia--have introduced bills to exclude PPP loans from taxation. In most cases, those bills have yet to make it through committee. "I expect to see more debates playing out," says Loughead. "States really need to make this decision as soon as possible, or a lot of people will have to file amended returns."

It's unclear how much of a tax liability businesses will face as a result of getting taxed on some aspects of their PPP loans at the state level. The Tax Foundation says that not all states have released notes detailing the revenue impact of these decisions. And it's hard to compare the impact with past years, since PPP loans are new. 

Yet even if states make changes, you may not like the outcome. In Wisconsin, the legislature debated following the Cares Act language, which didn't specifically address the issue--versus the language in the appropriations act, which waives the tax liability. Obviously, the state would lose revenue if it allows the loans to be entirely tax-free. So businesses that got PPP loans in the spring and summer of 2020 (so-called "first draw" loans) won't have to pay taxes on them, and they'll be able to deduct expenses that were paid for with PPP from their state taxes. But second-draw PPP loans in Wisconsin are expected to be taxed, says Irina Petrashkevich, senior manager for tax policy and advocacy for the American Institute of CPAs. She notes that the situation is equally weird in Massachusetts. There, PPP loans are fully tax-free for corporations, but taxable for individuals--even though the PPP targets the smallest businesses, in addition to those with up to 500 employees.

For many companies, time is running out. Agricultural businesses that didn't pay an estimated tax were supposed to file March 1. For partnerships that didn't pay estimated tax, the deadline is March 15. "We recommend the April deadlines be moved to June 15," says Petrashkevich. That should give states time to clarify matters, and also accommodate those states whose fiscal years end June 30. Says Petrashkevich: "Whatever they do, they need to decide sooner rather than later, so people have time to prepare."