February 4, 2021
Compromise House Conformity Bill Takes Fiscally Responsible Approach on Business Tax Deductions
Economic hardship has sharply increased at the highest rate in over 50 years. In Virginia, families and communities across the state are struggling to keep up with rent and to put food on the table. After months of employment growth, employment in the state was essentially flat between November 2020 and December 2020. Similar to the experience of the last recession, national data show that state and local budget cuts are hurting overall economic growth and could dampen the recovery in the months ahead. To minimize these impacts, the state should preserve available resources to maintain support for K-12 public schools, higher education, the public health response, and other services, while providing additional targeted aid to families and small businesses.
Unfortunately, some businesses and special interests are pushing for a broad, unlimited state tax deduction related to already tax-exempt Paycheck Protection Program (PPP) loans, which would lead to deep cuts elsewhere in the state budget. Because it would have no dollar limit, this would provide a large “double-dipping” tax break for many big businesses in the name of helping small businesses.
The House of Delegates is seeking a more prudent balance, proposing to provide a more limited deduction that would better focus on helping struggling small businesses. Tomorrow, the House of Delegates will vote on legislation that takes this more measured approach, limiting deductions related to forgiven PPP loans to $25,000. Meanwhile, the Senate passed similar legislation that provides a larger $100,000 deduction. Because the loan amounts themselves are already tax-exempt, that means eligible businesses would be allowed additional tax deductions up to these amounts on their other income. In addition, both pieces of legislation provide equivalent deductions for businesses that received Rebuild Virginia grants from the state.
Both bills represent a compromise that departs from ordinary tax policy related to loan forgiveness, providing an extra tax break for businesses (albeit with limits, unlike what some business lobbyists have proposed). Normally, businesses receive income through normal operations and are able to deduct business expenses, such as payroll costs. For business loans that are later forgiven, the forgiven loan amounts are considered income, and businesses are able to take deductions related to expenses that were paid with the loan proceeds. Hypothetically, if a business had a $100,000 loan forgiven but used the entire loan on payroll, the business faces no income taxes on that loan amount.
Under the PPP loans that were created under the federal CARES Act, the usual tax policy was flipped. The forgiven loans were not counted as income for tax purposes, and deductions related to those loan proceeds were—pursuant to a May 2020 IRS Ruling—not allowed. Similar to the above scenario that applies to other types of loans, the business effectively faced no income tax on their forgiven loan amounts. The Northam administration proposed to follow this approach that was in place until late December: forgiven PPP loans would be tax-exempt for state tax purposes, but additional deductions related to the forgiven amounts would not be allowed at the state level.
However, under the federal Consolidated Appropriations Act that was signed into law in late December, the federal government changed course and decided to provide additional federal tax deductions on top of the existing tax exemption related to forgiven PPP loans. This creates a double tax benefit. Because the forgiven PPP amounts are already tax-exempt, the business can use those additional deductions to offset income taxes on their other income, including profits.
For Virginia, fully conforming to the new federal policy that provides these new PPP deductions would reduce state revenues by an estimated $340 million to $500 million for the two-year state budget. Unlike the federal government, the Commonwealth of Virginia must have a balanced budget. Fully allowing the double tax benefit would force the state to make cuts elsewhere in the budget, at a time when the state has to meet its commitments on school funding, health care, and other pressing needs.
Additional support for families, communities, and small businesses is critical, but fully tying that support to new across-the-board deductions related to PPP loans is likely to miss the mark. Numerous media reports last year highlighted that many large corporations that were relatively unaffected by the pandemic were able to receive millions in PPP loans, depleting the pool of available funds, while many struggling small businesses, particularly Black-owned businesses, were unable to obtain the loans at all. According to the nonpartisan Congressional Budget Office, the initial rounds of PPP loans provided less effective economic stimulus than other federal actions like enhanced unemployment benefits and fiscal relief to states and localities.
Targeted grants would be best able to reach struggling small businesses and hard-hit sectors. Lawmakers are pursuing a second-best strategy of limiting the deductions at the state level, which is aimed at providing a tax break to smaller entities and helping to prevent large, unaffected corporations from taking hundreds of thousands or more in additional business deductions. At most, the compromise would cost about $150 million in the current two-year budget, much lower than the estimated $340 million to $500 million of providing an unlimited deduction.
As these bills continue through the legislative process, state policymakers should continue to balance their desire to help small businesses with their fiscal responsibilities. New tax deductions must be weighed against the state’s other commitments in addressing the pandemic and economic downturn: to adequately deliver public services, provide economic support for families, partner with localities on costs to safely reopen school buildings, and fully invest in the ongoing public health response.
Budget & Revenue