Virginia Gov. Ralph Northam recently signed an emergency bill (House Bill 1935/Senate Bill 1146) that updates the state’s conformity date to the Internal Revenue Code (IRC) to Dec. 31, 2020, while decoupling from certain provisions that were included in the federal Coronavirus Aid, Relief, and Economic Security (CARES) Act and Consolidated Appropriations Act (CAA).
The law as passed decouples from CARES Act provisions involving suspending limitations for the net operating loss deduction and excess business losses availed to noncorporate taxpayers. It also decouples from federal provisions increasing the business interest expense deduction, reducing the medical expense deduction threshold for individuals, and allowing 100% deductibility of forgiven Paycheck Protection Program (PPP) loan expenses.
As noted in the Virginia Department of Taxation’s Tax Bulletin 21-4, Virginia continues to decouple from the following federal tax law provisions:
- IRC Section 168(k) bonus depreciation allowed for certain assets
- Five-year carryback of certain net operating losses generated in taxable years 2008 and 2009
- Tax exclusions related to cancellation of debt income
- Tax deductions related to the application of the applicable high-yield debt obligation rules
- The suspension of the federal overall limitation on itemized deductions
What does this mean?
Virginia has decoupled from the following CARES Act provisions:
- Suspension of certain net operating loss limitations (80% limitation on carryforwards still applies for Virginia income tax purposes) for taxable years 2018, 2019, and 2020
- Suspension of the IRC Section 461(l) excess business loss limitation for taxable years 2018, 2019, and 2020 (suspension not allowed for Virginia income tax purposes)
- Increase in the IRC Section 163(j) business interest expense deduction limitation for taxable years 2019 and 2020 from 30% to 50% of adjusted taxable income (increased limitation not allowed for Virginia income tax purposes)
These changes are retroactive and will require impacted taxpayers to make adjustments to previous-year returns, and file amended Virginia returns.
Virginia also decouples from the IRC provision changing the threshold for calculating the itemized deduction allowed for medical expenses. For taxable years beginning on or after Jan. 1, 2017, but before Jan. 1, 2018, and taxable years beginning on or after Jan. 1, 2019, the IRC decreased the threshold to 7.5% of federal adjusted gross income for calculating the deduction. The emergency bill continues utilizing the higher threshold of 10% of federal adjusted gross income to calculate this deduction for Virginia purposes.
Although Virginia conforms to the CARES Act provision that provides forgiveness of PPP loans as being exempt from federal taxation, the emergency bill limits the deduction amount for expenses paid with PPP loan forgiveness proceeds. For federal purposes, taxpayers are allowed to claim an exemption for the PPP loan forgiveness and also take deductions for expenses paid using loaned funds. For Virginia income tax purposes, the deduction is limited to $100,000 for business expenses funded by forgiven PPP loan proceeds. This limited deduction is only available for the 2020 tax year.
The legislation does not address instances where PPP loan proceeds were utilized for payroll and other allowable expenses during the tax year but PPP loan forgiveness was not granted until a subsequent tax year. However, the Virginia Department provided the following informal policy guidance regarding the state’s position in the deductibility of such expenses based on IRS Revenue Ruling 20-27 (issued Nov. 28, 2020), which was issued prior to Congress’s passage of the CAA.
According to the Department’s policy under these circumstances, any PPP expenses incurred will not be deductible in the 2020 tax year, notwithstanding the limited $100,000 deduction allowed under the emergency bill, if the taxpayer “reasonably expects” to receive forgiveness of the PPP loan in a subsequent tax year, defined as follows:
- The PPP loan forgiveness was applied for as of the end of the tax year preceding the year in which such forgiveness was granted.
- Even if the forgiveness was not applied for as of the end of the tax year, the taxpayer would be subject to the addback in that tax year if 1) the taxpayer made payment of all PPP-eligible expenses during the covered period and could quantify such amount and 2) the taxpayer satisfied all other requirements allowing them to apply for PPP loan forgiveness.
If the taxpayer does not meet this “reasonably expects” threshold of attaining PPP loan forgiveness as of the end of the 2020 tax year as provided in the IRS Revenue Ruling, the taxpayer would be allowed to deduct the full amount of such expenses in the 2020 tax year.
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