Op-EdAppeared in RealClear Policy on March 9, 2021By Alfredo Ortiz & Jonathan Williams

States Should Not Treat PPP Funds as Taxable Income

March means tax season for America’s 30 million small business owners. Tax time this year is especially burdensome for employers due to the unprecedented pandemic-induced operations disruptions in 2020.

Making matters worse, roughly 20 states are blindsiding small businesses with an unexpected expense by taxing funds received from the federal Paycheck Protection Program (PPP), which last year provided over five million small businesses with $525 billion in forgivable loans.

State legislators can ease employers’ tax burdens and accelerate their states’ small business-led economic recoveries by clarifying that PPP funds are fully tax-free. President Biden, who recently rolled out a slate of PPP modifications, can use his bully pulpit to encourage states to follow Washington’s lead and side with small businesses on this issue.

Some states are treating PPP funds as taxable income. Others aren’t directly taxing PPP funds but forbidding employers from deducting PPP-funded expenses from their tax returns.

For small businesses, this tax treatment amounts to a distinction without a difference. As a joint letter to Congress last year from 170 trade associations explained: “If a business has $100,000 of PPP loans forgiven and excluded from its income, but then is required to add back $100,000 of denied business expenses, the result is the same as if the loan forgiveness was fully taxable.”

Taxing PPP loans, either directly or indirectly, conflicts with federal guidance, and more importantly, the spirit of the PPP as passed by Congress in the CARES Act last March. The PPP was intended to provide a lifeline to businesses shuttered by government lockdowns during the pandemic, not enrich state governments.

In December, Congress clarified that businesses could deduct PPP-funded expenses on their federal returns, allowing beleaguered small business owners to breathe a sigh of relief. Numerous states, including New York, Illinois, and Missouri, which automatically conform their tax codes to the federal standard, followed suit. Yet others have left their small businesses on the hook for a significant tax burden.

The consequences of this unexpected tax bill come at the worst possible time for many entrepreneurs who have barely kept their doors open over the last year. For example, John Motta, a Dunkin Donuts franchisee, received more than $1 million in PPP loans for his 23 locations in Virginia. He spent all these funds keeping his 400 employees on the job. Yet now he is on the hook for tens of thousands of dollars in state tax liabilities, which could limit his ability to hire once business conditions pick up again.

Extrapolate similar unexpected tax burdens throughout the states that don’t follow federal tax guidelines to get a sense of the size of this small business hurdle. In Virginia, 115,000 PPP loans are now subject to taxation that will saddle small businesses with millions of dollars in state taxes. And in California, where more than 600,000 PPP loans were taken out, the inability to deduct PPP-funded expenses is just the latest blow to employers in this business-hostile state where the economic outlook already ranks a dismal 46th according to the Rich States, Poor States: ALEC-Laffer State Economic Competitiveness Index.

Some states are working to protect their small businesses from this tax bill. In Arizona, Arkansas, Georgia, Hawaii, Maine, Minnesota, New Hampshire, and Virginia, state legislatures have introduced legislation to make PPP loans nontaxable. And Wisconsin recently passed a bill to this effect. In New Jersey, Gov. Phil Murphy and State Treasurer Elizabeth Maher Muoio recently bypassed the state legislature and clarified that PPP loans are fully nontaxable, suggesting this move can be made in some states without legislation.

With Tax Day just six weeks away, policymakers have the opportunity to ensure small businesses are the true beneficiaries of the PPP loan program, not state bureaucracies. Doing so will make the March madness of tax season more bearable for America’s job creators and help springboard the economic recovery.

Alfredo Ortiz is the president and CEO of the Job Creators Network. Jonathan Williams is the Chief Economist and Executive Vice President of Policy at the American Legislative Exchange Council.