On Feb. 5, 2021, Pennsylvania enacted Act 1 of 2021 (Act 1), specifically excluding forgiven Paycheck Protection Program (PPP) loans and economic impact payments1 from personal income tax (PIT).2 Following the bill’s enactment, the Pennsylvania Department of Revenue (Pennsylvania Department) released guidance explaining the provisions of Act 1 and addressing the PIT treatment of various relief payments under the Coronavirus Aid, Relief and Economic Security (CARES) Act of 2020.3 The PIT law changes apply to both individuals and passthrough entities operating in Pennsylvania. In addition, on February 1, 2021, the Philadelphia Department of Revenue (Philadelphia Department) released guidance clarifying the treatment of certain provisions contained in the CARES Act and Consolidated Appropriations Act of 2021 (CAA) for purposes of the Business Income and Receipts Tax (BIRT) and Net Profits Tax (NPT).4
Pennsylvania treatment of PPP Loans and CARES Act relief payments
The CARES Act included provisions establishing the PPP, which resulted in cash in the form of potentially forgivable loans being distributed to eligible taxpayers meeting certain requirements. Under the CARES Act, any forgiven PPP loan amount is specifically excluded from federal gross income.5 The CAA, signed into law on Dec. 27, 2020, clarified that deductions are allowed for otherwise deductible expenses paid with the proceeds of a forgiven PPP loan and that the tax basis and other attributes of the borrower’s assets will not be reduced as a result of the loan forgiveness.6
The Pennsylvania PIT does not explicitly conform to the Internal Revenue Code or the federal individual income tax base, creating some uncertainty as to whether forgiven PPP loans would be considered taxable income for PIT purposes. Act 1 was enacted in part to conform the PIT to the federal treatment of PPP loan forgiveness. Specifically, PPP loans used to pay business expenses during the pandemic that are subsequently forgiven by the lender are not considered taxable income for PIT purposes.7 Similarly, the legislation clarifies that expenses claimed as deductions on the PIT return are still allowed if those expenses were reimbursed by PPP loans.8 Act 1 also codifies previous Pennsylvania Department guidance specifying that economic impact payments from the CARES Act and CAA will not be included in the PIT base because they are considered nontaxable rebates.9
The Pennsylvania Department’s guidance further explains the applicable Act 1 provisions and also clarifies the PIT treatment of other CARES Act relief payments, including pandemic-related distributions on retirement accounts, COVID-19 disaster relief payments, economic injury disaster loans (considered a nontaxable grant), grants received from Pennsylvania localities, Provider Relief Fund payments, and student loan repayments made by an employer. The guidance also confirms that PPP loan forgiveness is nontaxable for corporate net income tax (CNIT) purposes because the CNIT tax base conforms to the federal corporate income tax base.
Philadelphia treatment of certain CARES Act provisions
On Feb. 1, 2021, the Philadelphia Department issued guidance explaining its treatment of certain business tax provisions contained in the CARES Act and the CAA.
PPP loans
For purposes of the BIRT, the guidance clarifies that all filers will exclude forgiven PPP loan amounts from gross income and may report deductions for eligible expenses to the extent reimbursed by forgiven PPP loans. Similarly, the BIRT Gross Receipts tax base will also not be increased by the amount of a forgiven PPP loan.10 Finally, the guidance confirms that Philadelphia will apply similar treatment for purposes of the NPT, by excluding forgiven PPP loans from gross income and allowing business deductions of expenses reimbursed by forgiven PPP loans.
Federal Employee Retention Credit
The federal Employee Retention Credit (ERC) provides a refundable payroll tax credit to employers impacted by government restrictions on businesses, offered as an incentive to keep their employees on their payroll during the pandemic. Eligible employers include those forced to reduce or cease business operations due to government shutdowns, or those that saw a 50% reduction in quarterly receipts year-over-year as a result of the pandemic. Eligible businesses receive a refund of 50% of wages paid to employees through Dec. 31, 2020, toward a maximum of $10,000 of each employee’s wages, with the quarterly federal employment tax return.11 The CAA extended and expanded the ERC through July 1, 2021, covering 70% of an employee’s wages paid up to $10,000. The federal American Rescue Plan Act of 2021, enacted on March 11, 2021, once again extended the ERC through the last two quarters of 2021.12
According to the Philadelphia Department guidance, qualified wages refunded by the ERC are considered taxable compensation for purposes of the City Wage Tax. BIRT Method II taxpayers will follow the federal treatment of qualified wages, meaning that the employer’s tax deduction for qualified wages will be reduced by the ERC, while the refunded amount will be nontaxable to the employer.
IRC Section 163(j) business interest expense limitation
The guidance confirms that Philadelphia will conform to the CARES Act amendments to the IRC Sec. 163(j) business interest expense limitation originally enacted under the Tax Cuts and Jobs Act of 2017 (TCJA). The CARES Act further amends Sec. 163(j) for the 2019 and 2020 tax years, increasing the threshold for deducting business interest expense from 30% of adjusted taxable income (ATI) to 50%.13 Taxpayers may elect to use 2019 ATI (in lieu of a 2020 ATI calculation) for purposes of determining their Sec. 163(j) limitation for the 2020 tax year.14 The increased 50% ATI threshold applies to partnerships only for tax years beginning on or after Jan. 1, 2020. For the 2019 tax year, 50% of the excess business interest expense (i.e., exceeding 30% of ATI) allocated by a partnership to a partner is fully deductible by partners in 2020; the other 50% is deductible in future years when excess taxable or interest income may be netted.15
Along with conforming to the CARES Act amendments to Sec. 163(j), Philadelphia also conforms to the special partnership rules for purposes of the Net Income portion of the BIRT. In accordance with previously issued Philadelphia Department guidance addressing conformity to TCJA provisions, the federal business interest expense deduction should be calculated on a separate company basis for purposes of the BIRT.
Qualified Improvement Property (QIP) Treatment
Finally, the guidance confirms the city’s treatment of 100% federal bonus depreciation for eligible QIP. The CARES Act made a retroactive technical correction to TCJA that expands the definition of 15-year property to include QIP acquired after Sept. 27, 2017, and placed in service after Dec. 31, 2017, and before Jan. 1, 2023.16 This allows taxpayers to claim 100% federal bonus depreciation for eligible QIP placed in service during 2018 and 2019.17 The correction resolves the so-called “retail glitch” of the TCJA and provides new tax benefits for an industry that has been uniquely affected by the pandemic. However, the guidance confirms that Philadelphia taxpayers will be unaffected by this change as it relates to city business tax filings. Pennsylvania decoupled from the 100% federal bonus depreciation deduction enacted in the TCJA, and this treatment remains unchanged. By law, Philadelphia is required to follow Pennsylvania’s treatment of federal bonus depreciation.18
Commentary
The enactment of Act 1 marks the culmination of efforts by legislators, tax practitioners and the business community to bring the Pennsylvania PIT into alignment with the CNIT treatment of forgiven PPP loans and exclude such forgiveness from taxable income. Initially intended as a bill addressing appropriation and program requirements associated with federal stimulus funds allocated to Pennsylvania, the legislation was later amended in the House to include the PPP and economic impact payment PIT provisions. Because Pennsylvania does not explicitly conform to the federal income tax base as it relates to the PIT, statutory clarification was needed in both cases. Therefore, Act 1 resolves a potential taxability issue favorably, especially when viewed from a public policy perspective. The Pennsylvania Department’s guidance is a welcome development for taxpayers looking to clarify the income tax treatment of various CARES Act relief payments. Impacted taxpayers should consider the implications of the exclusion of forgiven PPP loans from PIT, including whether such forgiveness increases the tax basis of a borrowing S corporation.
Philadelphia’s conformity to the federal treatment of forgiven PPP loans and other CARES Act provisions is likewise a welcome development. With respect to the amended Sec. 163(j) limitation rules, the guidance specifically states that the city will conform to the special rules for partnerships, with the benefit of this rule being the allocation of the 2019 limited interest expense amount to partners to carry forward. However, the BIRT is imposed at the entity level; there are no partners to which the excess amount would be allocated. As such, Philadelphia will follow the federal treatment of the excess business interest expense allocated by a lower-tier partnership to an upper-tier partnership that is subject to the BIRT when calculating that partnership’s business interest expense deduction for purposes of the Net Income portion of the BIRT.
1 Economic impact payments refer to the federal stimulus checks distributed under the CARES Act of 2020 and the Consolidated Appropriations Act of 2021.
2 Act 1 of 2021 (S.B. 109), Laws 2021.
3 Coronavirus Aid, Relief & Economic Security (CARES) Act: Pennsylvania Taxability, Pennsylvania Department of Revenue, Feb. 2021.
4 Philadelphia’s treatment of certain business tax provisions as a result of the Coronavirus Aid, Relief, and Economic Security (CARES) Act and The Consolidated Appropriations Act, 2021, Philadelphia Department of Revenue, Feb. 1, 2021.
5 P.L. 116-136 (2020), § 1106(i).
6 P.L. 116-260 (2020), § 276.
7 Act 1, § 1.1, adding 72 PA. STAT. § 104-A(a)(1).
8 Act 1, § 1.1, adding 72 PA. STAT. § 104-A(a)(2).
9 Act 1, § 1.1, adding 72 PA. STAT. § 104-A(b).
10 Generally, Philadelphia considers loan forgiveness to be a receipt for both the Net Income and Gross Receipts portions of the BIRT.
11 P.L. 116-136, § 2301.
12 P.L. 117-2 (2021).
13 IRC § 163(j)(10)(a)(i).
14 IRC § 163(j)(10)(b).
15 IRC § 163(j)(10)(a)(ii).
16 P.L. 116-136, § 2307.
17 IRC § 168(k)(6).
18 Act 89 of 2002, § 31.1.
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