Last year as the seriousness of the Coronavirus began to sink in, when governors issued stay at home orders and only allowed “essential” businesses to open, fear and panic ensued. We worried about our safety, security, and health and how long this could possibly go on until we flattened the curve. Many businesses worried how they would stay afloat, save their investments and pay their employees. How long would this go on and how deep would the damage be? The federal government was worrying about the same things.
The Paycheck Protection Program was part of the third COVID-19 federal relief package, enacted in 2020 as the Coronavirus Aid Relief and Economic Security Act. (CARES Act). The small business loans were designed to help businesses keep their employees on the payroll through closures and the economic uncertainty of the global pandemic. The maximum loan is $10 million for a first time PPP loan and $2 million limit for a second loan by the same company. There are no fees or processing charges and there is no personal guarantee or collateral required for the loan.
As of March 7, 2021, 7,555,249 loans have been approved totaling $687,374,564,619, using 5,747 lenders. Some loans are forgivable if the borrower maintains the pre-covid number of employees and compensation and uses the money for payroll costs. Over 1 million PPP loans have been forgiven totaling over $1 billion in loans. PPP loans are available until March 31, 2021. However, the $1.9 trillion federal relief, American Rescue Plan Act of 2021 (ARPA) provides an additional $7 billion for PPP loans and extends the eligibility to include more digital media companies and non-profits.
In NC, about 130,000 companies with 1.27 million employees have received PPP loans, totaling over $12 billion. Large and small companies, non-profits, public, and private entities took the loans. They were all eligible and the loans saved many companies and kept thousands of people employed.
When Congress authorized PPP loans, they allowed two tax treatments; 1) The loans are exempt from the federal income tax and 2) a deduction is allowed for expenses paid using the loan money. Congress intended for the loans to be entirely tax-free; not counting the forgiven loan as income and leaving the expenses deductible as an ordinary business expense. The U.S. Treasury Department sought to remove the deduction for expenses paid, keeping in line with the typical treatment of expenses when paid with tax-exempt income. Congress’s intent was clarified when the Consolidated Appropriations Act for 2021 was signed into law. At the federal level, the PPP loans are tax exempt and expenses are deductible.
States have chosen to conform to the federal taxation of PPP loans in three different ways; 30 states conform with the federal treatment by exempting the income tax and allowing the deduction, a few states tax the PPP loan income and do not allow deductions and about 12 states allow one or the other—an exemption or a deduction. North Carolina is one of four states that exempts the income from tax but does not allow for a deduction of expenses, along with California, Hawaii, and Kentucky. We have de-coupled with the federal Internal Revenue Code on this particular expense deduction tax treatment. So when our businesses who have taken a PPP loan pay their taxes this year, they will get an exemption and a deduction on their federal taxes and an exemption but not a deduction on their state taxes. NC regularly de-couples from federal tax treatments – mortgage insurance, tuition, net operating loss, limitation on charitable contributions, are just a few recent examples.
If North Carolina were to change its tax code and allow for the deduction of expenses from the PPP loans, the resulting loss in revenue would be about $600 million over three years; $350 million for the remainder of the current fiscal year, about $200 million less in FY 2022 and $50 million in FY 23. Lawmakers could also make expenses deductible for loans up to a certain amount, like the first $100,000 or $1 million, reducing the price tag and providing more relief targeted to smaller companies.
North Carolina could provide an expense deduction in addition to excluding income from state taxation, but it would require legislation. Lawmakers face tough questions. Is it better tax policy to help businesses who have qualified for PPP loans, keeping their workers employed or would it be better to enact widespread tax relief to all taxpayers? That’s the $600 Million question.
*The John Locke Foundation has not applied and does not intend to apply for a PPP loan.