PROVIDENCE — Rhode Island could be one of only a handful of states to tax both forgiven Paycheck Protection Program loans as well as full unemployment benefits.
Taken together, the two items represent $100 million in revenue for the state, Governor Dan McKee has said. And if lawmakers wanted to make changes, they’d have to figure out some other way to make the numbers work in the budget, McKee said.
But the vast majority of states are making do without one or both of the taxes.
Asked by the Globe for a nationwide analysis, tax preparer H&R Block and the D.C.-based think tank Tax Foundation identified only three other states that are pursuing taxes on both forgiven PPP loans and full unemployment benefits: Hawaii, North Carolina, and Minnesota.
If McKee’s budget passes without further General Assembly action, Rhode Island would join them. Plans are in flux in all those states, with legislative proposals changing the picture day by day. But the review shows most states are giving tax breaks on PPP loans and unemployment.
The tax situation in Rhode Island has riled advocates for businesses and working people alike, who are facing what they call surprise tax bills after a difficult year. The General Assembly is considering bills to exempt the full amount of PPP grants from taxation, and also to allow recipients of unemployment to keep the first $10,200 tax-free.
Supporters note that the state is getting a massive influx of federal aid, more than a billion dollars, but McKee said as recently as Tuesday that it’s still unclear how Rhode Island will be able to use it. If the federal funds can’t be used to replace the revenue from PPP and unemployment taxes, officials would have to look at cuts elsewhere, McKee said.
“If you’re talking about a billion dollars, or a little more than a billion dollars, it sounds like a lot of money,” McKee said at a news conference Tuesday. “But if you take 10 percent of that money and you take it to the two programs you just asked about, now you’ve got $900 million. ... I think those dollars should be used on long-term investments that bring long-term economic opportunity to the state.”
Here’s how it breaks down in Rhode Island: PPP loans, a critical lifeline for small businesses across the country last year, can be forgiven if they’re spent the right way. The federal government has long said they are not taxable. And Congress in December passed a law saying businesses could also count the expenses they paid for with PPP loans as deductions, essentially lowering their other tax obligations with the money they got from the government.
McKee’s administration says this would mean a $133 million revenue shortfall from what it expected when it was planning things out in November. To make up some of the gap, McKee proposed making anything above $150,000 in forgiven PPP loans taxable.
That would raise about $67 million in revenue from businesses, his proposal says. Most of that would hit in the 2021 tax year, because that’s when most of the loans are actually going to be forgiven, experts say. That means businesses would have to pay just as they’re trying to return to profitability, according to opponents.
Most states, including Massachusetts, are following the federal rules: The forgiven PP loans aren’t taxable as income, and businesses can take deductions on expenses paid with that money. Only 12 states would subject the forgiven loans to more tax than the federal government, either by including them as taxable income or by disallowing the expense deduction, according to Katherine E. Loughead of the Tax Foundation. (Hawaii and North Carolina are disallowing the expense deduction, while Minnesota would include them in taxable income, according to both H&R Block and the Tax Foundation.)
Rhode Island automatically follows federal rules, but McKee’s budget would explicitly “decouple” Rhode Island from the federal law and make PPP amounts over $150,000 taxable.
McKee had originally distanced himself from the proposal, saying it could change depending on how much federal stimulus money the state got and how it could use it. He has recently shifted to defending it as fair. Because the first $150,000 wouldn’t be taxable, the state estimates that fewer than 1 percent of for-profit businesses with forgiven PPP loans would be taxed under the proposal in the 2020 tax year, and about 15 percent in the 2021 tax year.
For individuals who received unemployment benefits during the pandemic, Congress in March as part of the American Rescue Plan passed a law excluding the first $10,200 in unemployment from people’s federal taxes for 2020 if they make under a certain amount. Rhode Island, though, isn’t following suit, even though a raft of other states have done so. A proposal in the General Assembly to exclude the first $10,200 is set for a hearing in the House next week. In the meantime, people who were laid off or furloughed last year face the possibility of higher state tax bills than they would in many other states.
Only 11 states are taxing the full amount, according to Alison Flores, principal tax research analyst at the Tax Institute at H&R Block.
McKee said he supports legislation that would exempt the first $10,200, but asks: Where is the General Assembly going to make up the $30 million in revenue that represents? If the federal stimulus money doesn’t allow the state to offset that, what “adjustments” will the state make to the budget? McKee noted he was only sworn in a few days before the budget was due.
“We don’t print money,” McKee said Tuesday.
Tax day this year is May 17.