What was supposed to be a routine piece of tax code legislation has become the vehicle for a $450 million or more tax break for Wisconsin businesses that received federal loans to help them in the pandemic.
The proposed change would enable a business to take a tax deduction on expenses it incurred in the pandemic — expenses that were already covered by a tax-free federal grant.
It’s “double dipping,” says Adam Thimmesch, a Nebraska law professor who has analyzed the issue for a national tax newsletter. “You don’t have to report the income — and you deduct the expenses.”
The state’s largest business lobby, Wisconsin Manufacturers & Commerce, has been campaigning hard for the change, saying that without it, “employers could face hundreds of millions of dollars in unexpected taxes.”
On Tuesday, however, Wisconsin Department of Revenue (DOR) Secretary Peter Barca told WMC that several of its claims were “untrue.”
The issue will go before the Legislature’s Joint Finance Committee on Wednesday when the committee will vote on whether to add an amendment that creates the tax break to a routine bill to update Wisconsin’s tax laws.
The prospective tax break is tied to the Paycheck Protection Program (PPP), a loan and grant program to aid small businesses hurt by the COVID-19 pandemic. The PPP was part of the federal Coronavirus Aid, Relief and Economic Security (CARES) Act, which was enacted in late March; a new round of PPP funds was authorized in the Consolidated Appropriations Act (CAA) that Congress passed in December.
Under the PPP, administered by the U.S. Small Business Administration, employers can seek loans to keep operating in the COVID-19 pandemic. The PPP money that a business receives is to cover specific expenses.
Businesses and nonprofits that receive the loans can have them forgiven — converting the loans to grants if they meet certain criteria.
PPP money is tax-free
The CARES Act specifies that PPP grants will not be taxed as income. Wisconsin Act 185, the state law passed in April to implement the CARES Act, also treats the PPP grants as tax-free income.
That’s a departure from “normal tax treatment of forgiven debt,” which would be to treat the funds as income, according to Michael Mazerov of the Center on Budget and Policy Priorities (CBPP) in Washington, D.C., who wrote about the issue in a blog post for the think tank.
“Consistent with other provisions of federal tax law,’ Mazerov wrote, the IRS ruled that expenses that a business covered with PPP loans could not be deducted from its taxable income — just as people can’t deduct medical expenses for which their health insurance plan reimburses them.
Thimmesch, a University of Nebraska law professor, compares the reasoning to how the tax law treats employee business expenses if they’re reimbursed by the employer.
If an employer rolls the reimbursement into the employee’s W-2 income statement, the employee can take a tax deduction on the expense. “Or they exclude the reimbursement from your income, but then you don’t get to deduct the expense,” Thimmesch says. “You get one or the other. You don’t deduct expenses that you didn’t economically bear because somebody else reimbursed you.”
In December, however, Congress passed the CAA. In addition to opening a new round of PPP funds, the CAA included a provision to override the IRS ruling. The act allows businesses not to declare the PPP grant money as income on their federal tax return — but also allows them to deduct the expenses that the money covers from their income.
In states with tax codes that automatically update to follow the federal tax law, that same tax break was then extended to those states. Other states, however — including Wisconsin — don’t automatically update with the federal law.
In a January 11 analysis published in the newsletter Tax Notes, Thimmesch contrasted how a company that can deduct expenses that have already been covered with PPP funds might compare with an otherwise similar company that didn’t get PPP funding. (The paper is behind a paywall, but Thimmesch sketched out some early thoughts on his analysis for a blog post.)
The company without any PPP help “would include all of their income as taxable income,” Thimmesch explains in a telephone interview. “They could deduct their expenses, but they have to fund those out of their own money.”
He continues: “The PPP recipient would have those expenses funded by the federal government, still get to deduct them as if they paid for them, but keep all of that [PPP] cash. But those two companies would be expected to pay the same amount in state taxes.”
The potential cost to states that don’t automatically follow federal rules is significant, Thimmesch says — and made more so because states, unlike the federal government, must balance their budgets.
Business lobby campaign
Last month, WMC launched a campaign urging lawmakers to change the Wisconsin law to match the federal treatment of expenses covered by the tax-free PPP grants, accusing DOR of a “surprise $450 million tax hike.” The organization sent a letter to state legislators urging them to take action to match the federal tax break.
The letter repeatedly refers to DOR as planning to “tax these loans” and as stating that “the forgivable loans are actually taxable.” WMC also accused the agency of “reversing course.”
In his letter Tuesday to the business lobby, Barca challenged those descriptions.
In Act 185, Wisconsin adopted the CARES Act provision “ensuring that the PPP loans or grants do not result in any income tax liability,” Barca wrote.
“What we understand your request to be is not merely ‘not taxing’ PPP loans, but rather, providing the double benefit of excluding the income and also allowing the deductions for expenses related to PPP loans,” Barca added. “Rather than a net neutral result, the double benefit results in a new positive tax result for the PPP recipient and a tax liability for the state.”
He asserted that “there has been no course reversal” regarding DOR’s handling of PPP-covered expenses. “The guidance we posted follows current Wisconsin law,” the letter states. “We must wait until new laws are enacted in Wisconsin before we can administer them.”
Republican lawmakers have introduced amendments that would extend the federal tax break to the state tax code. The amendments have been proposed for two different bills: AB-2 in the Assembly and its Senate counterpart, SB-2. Both bills are going through the committee processes in their respective houses of the Legislature.
The companion bills were originally written to address a number of routine and largely technical changes needed in the state tax laws, and had the support of DOR when the Assembly version had a public hearing Jan. 21.
On Feb. 4, however, the Senate Committee on Financial Institutions and Revenue voted 3-2 on party lines to pass an amendment to SB-2 that would make expenses tax deductible that are covered by the PPP grants. In the Assembly, Republicans offered a similar amendment to AB-2 on Feb. 5, two and a half weeks after the bill had passed the Committee on Ways and Means with bipartisan support.
A DOR summary shared with state lawmakers states the amendments have been estimated to cost about $450 million. The Joint Finance Committee will take up AB-2 and that bill’s PPP grant amendment Wednesday.
Senate Minority Leader Gordon Hintz (D-Oshkosh) blasted GOP leaders Tuesday, saying that in using the amendment process they “avoided having a public hearing on it because they didn’t want to draw attention to the fact that they were, spending $450 million in the least effective, most inequitable way.”
According to Small Business Administration data, in the first PPP round, nearly 75% of Wisconsin’s $9.9 million in PPP funding went to just under 14% of the recipients, whose loans ranged from $150,000 to $10 million. Meanwhile, 25% of the PPP money in the state was for loans of less than $150,000 — representing 86% of the recipients.
In short, the bulk of PPP dollars has gone to the larger recipients, who would enjoy the biggest benefit from being able to deduct the expenses that were paid for by the PPP program.
“That is a pretty inefficient, ineffective use of tax money,” Hintz says. “I think there’d be a lot of support for targeting $450 million towards businesses in need, especially in the sectors that have been impacted.”