The tax headaches started early for US small businesses this tax season. States can help these employers and accelerate economic recovery by making business expenses paid through Paycheck Protection Plan loans fully tax deductible, in accordance with federal tax laws.
The PPP is one of the most successful government programs in American history. It has distributed $ 525 billion in forgivable loans to more than 5 million small businesses nationwide, supporting more than 50 million jobs. Without the PPP, unemployment would have been much higher and the economic contraction much more severe. The PPP served as a bridge to enable small businesses to traverse the worst depths of the pandemic. Yet the state’s tax rules threaten to undermine its success.
Congress wanted PPP loans, created under the CARES law passed last March, to be tax-free. Yet the Treasury Department initially thought otherwise, issuing guidelines that while PPP funds themselves are not taxable, business expenses paid with those funds cannot be deducted from returns.
For employers, this amounted to an indistinguishable distinction. As a joint letter to Congress from 170 business associations last year explained: “If a business has $ 100,000 in canceled PPP loans that are excluded from its income, but then has to add $ 100,000 back in denied business expenses, the bottom line is is the same as if the loan forgiveness were fully taxable. “
In December, Congress listened to calls from small business advocates like the Job Creators Network and the Coalition of Franchisee Associations and corrected this tax problem. But some states did not receive the memo. While many states conform their tax codes to federal guidelines, some – like Virginia, Wisconsin, and California – do not. Unless state legislators take action, small businesses in those states will not be able to deduct business expenses paid with PPP funds from their tax returns.
This PPP tax liability would surprise small business owners who did not expect to have to pay taxes to comply with this government program to save jobs. This expenditure would come at a terrible time as employers continue to grapple with declining demand due to the pandemic and associated trade restrictions. This would prevent some small businesses from hiring, expanding, and raising wages. For others, it would make them unprofitable, forcing them to close their doors and lay off their employees – ironically, the very opposite outcome the PPP seeks.
Consider John’s situation. Its 23 Dunkin Donuts franchises in Virginia have received over $ 1 million in PPP loans. John spent all that money on payroll to keep his 400 employees working. He now has to pay tens of thousands of dollars in tax debt in Virginia, which seeks to raise up to $ 101 million in income through small business P3 loans. This tax bill could limit its ability to hire once business conditions resume.
Extrapolate similar unexpected tax burdens to all states that do not comply with federal tax guidelines to get a sense of the magnitude of this barrier for small businesses. In Virginia, 115,000 PPP loans are now subject to tax. In Wisconsin, nearly 90,000 small businesses are facing hundreds of millions of dollars in state taxes. In California, where more than 600,000 PPP loans have been taken out, the inability to deduct PPP-financed expenses is just the latest blow to besieged businesses. In contrast, in New Hampshire, where John has nine other locations, the state Senate introduced a bill allowing P3 recipients to fully deduct expenses – the right thing to do for small businesses.
State legislators who do not want to comply with federal tax treatment and the spirit of the CARES Act by making PPP business expenses fully deductible are playing a dangerous game. The pandemic has shown that small businesses are increasingly mobile. Even physical businesses like John’s may seek to expand beyond state borders where they are better treated.
States that choose to burden their small businesses with this PPP tax to generate a little extra revenue may find their decision to be pessimistic but foolish. The last thing small businesses should have to worry about when looking to jumpstart state economies across the country is an unexpected tax liability.
Alfredo Ortiz is the President and CEO of the Job Creators Network. John Motta is the President of the Coalition of Franchisee Associations.