Small business relief loans could face some state tax hurdles

Businesses receiving debt forgiveness under the emergency loan program created by Congress could face an unpleasant surprise without more clarity from their state legislatures: tax bills on these canceled loans.

Debt forgiveness generally counts as a taxable benefit, but Congress has made the $349 billion Paycheck Protection Program loans forgivable as long as certain conditions are met, and said the federal government will not tax the debt discharged. But unless some states update their own tax codes to allow for a similar discount, they could end up taxing debt relief intended as economic aid.

Some states, such as New York and Tennessee, have what is called “ongoing compliance” with federal tax laws. This means that their tax codes are automatically updated based on federal tax code changes. But others update their tax codes to federal changes statically, and sometimes it takes them several years to do so.

This year, legislatures have truncated their sessions due to the health emergency. Some part-time legislatures may need to call an emergency session if they want to fix the problem.

“States with what is called rolling compliance are defined; they will not tax the forgiveness of federal PPP loans unless those state legislators pass a law expressly doing so,” said Jared Walczak, director of state tax policy for the Policy at Washington-based nonprofit, the Tax Foundation, in a recent To analyse. “But with static compliance states, it all depends if and when they update their compliance.”

Unless their own laws are updated, more than half of the states, including some of the biggest economies like California, can tax the emergency benefit. According to the Tax Foundation, up to 30 states may need to update their tax laws to comply with Congress’ third emergency relief package (Public law 116-136).

The National Conference of State Legislatures did not respond to a request for comment.

A Democratic congressional tax policy aide, who requested anonymity to speak freely, said he was not immediately aware of the companies facing higher taxes due to federal debt cancellation . The aide said the payments businesses had to spend federal money on to qualify for the rebate — utilities, wages, rent and mortgage — could get enough state deductions to offset an increase in levies. of the State due if the loan is cancelled. But the staffer warned that the deductions may not be enough to offset the tax burden in all states or for all businesses.

Tax experts’ opinions vary on whether the canceled loans could incur state taxes or whether the expenses would be eligible for tax deductions, reflecting the uniqueness of the situation.

Deduction Question

Normally, expenses such as salaries and utilities are deductible for corporate taxpayers and non-deductible for tax-exempt organizations. When Congress exempted canceled loans in this unprecedented relief package, it said nothing about deductibility.

Since employer-borrowers who receive loans under the Paycheck Protection Program do not bear the economic cost of salaries, utilities and other expenses, they would not be able to deduct them to offset any increases. taxes due to federal debt cancellation, Harvey Bezozi, a Boca Raton-based certified public accountant, said.

“The intention is to provide tax-free income by canceling loan debt,” he said in an email. If the expenses were not deductible, “all the interest in encouraging the maintenance of full employment would be lost. We are therefore awaiting clarification from the Treasury to allow not only non-taxable income, but also the deductibility of expenses. This further incentivizes employers to maintain a full workforce. »

Michael Daze, a Bloomberg Tax analyst, said state legislatures could review the intent of the law and allow deductibility, or Congress could as well.

“Deductions are a matter of legislative grace,” Daze said. “Congress or a state legislature could always decide to limit deductions, but that would be surprising in the current situation.”

Some tax attorneys warn states to anticipate the possibility of increased taxes on small businesses that receive federal assistance.

seek certainty

Bruce Ely, a partner at Bradley Arant Boult Cummings LLP in Alabama, said he was working with an Alabama senator to determine whether the state should pass a bill that specifically exempts the PPP loan exemption from the version state debt cancellation rules. .

As written, the Coronavirus Relief Act “does not constitute an amendment to the IRC,” Ely said.

For states with ongoing or automatic IRC compliance, such as Alabama on the corporate tax side, federal relief law language may be sufficient to protect taxpayers from the negative tax consequences of state, Ely said.

“However, I would like an announcement or a ruling from the state DOR to confirm this,” he said.

“States that do not adopt the Internal Revenue Code on an ongoing basis should pass legislation providing for the forgiveness of PPP loans,” said Marc Finer, president of the tax practice group at Murtha Cullina, a law firm based in Connecticut.

Since a state like Massachusetts generally adopts the federal code for personal income tax purposes, the PPP loan forgiveness would likely be included in the state’s personal taxable income, Ely said.
But lawmakers could specifically pass a provision exempting the loan amount from state personal income if they wanted to provide certainty, he added.

Ely raised a caveat. For states complying with the IRC “as amended from time to time” or “effective from time to time” – as stated in Alabama’s compliance law – a beneficiary of income tax revenue Revenue from that state could challenge the favorable interpretation of the state’s DOR, according to Ely. Since the decision was not made by statute and would reduce income tax revenue into state coffers, they could challenge it as lacking legal authority,

“Perhaps a governor or a state DOR could wave their magic wand and announce that the income will be exempt from state income tax, but that could be challenged later by, say, a beneficiary or recipient of such income”, Ely mentioned.

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