Tax cut clawback looms as new federal wildcard

BOSTON (SHNS) – The spending law signed this week by President Joe Biden will deliver over $4.5 billion in budgetary relief for Massachusetts, but some experts say it could also wind up doubling the cost of a pair of tax breaks lawmakers want to extend to small businesses and low-income workers unemployed over the past year.

A part of the new federal law intended to discourage states from using billions in relief funding to finance tax cuts prohibits states from using federal relief funding to offset a reduction in state tax collections resulting from a change in state tax law, including new rebates, deductions or credits.

States that do use federal relief funds to offset a tax cut “either directly or indirectly” will be forced to pay back the amount they used, which in this case could be as much as $225 million.

House and Senate Democratic leaders say they’re not worried about being penalized under the rule if an advancing state tax relief bill becomes law, but some tax law experts said the clawback  provision puts Massachusetts at risk of seeing the cost of the new tax breaks climb to $450 million.

“There’s certainly a fair amount of uncertainty about the precise scope of the federal  clawback provision, although its intent appears to be to prevent states from treating the federal  assistance as creating an opportunity to reduce state taxes in any manner,” said Peter Enrich, a law professor at Northeastern University and a member of the Massachusetts Budget and Policy Center board of directors.

Enrich, who worked as counsel in Gov. Michael Dukakis’s budget office, said a definitive answer will likely have to wait until there is clear guidance from U.S. Treasury Secretary Janet Yellen, but he said “it certainly would appear to apply to the provision in the state legislation providing a new tax credit for low-income unemployment beneficiaries.”

On the same day that Biden signed the historic $1.9 trillion law on Thursday, House lawmakers on Beacon Hill voted unanimously for a tax and unemployment insurance rate relief package that would reduce the tax burden on some small businesses and low-income workers by more than $200 million.

That relief would come, in part, from an exemption from state income taxes on loans made to small businesses through the federal Personal Paycheck Protection program that were forgiven by the government.

While corporations in Massachusetts that received PPP grants are already exempt from paying taxes on those funds by state and federal law, the new bill would also allow smaller “pass-through” entities whose profits are taxed as the owner’s personal income to continue to deduct payroll and other expenses paid for with federal aid.

Critics have described this as a “double-dip” because businesses are taking a tax deduction for something they used the federal government’s money to pay for, but proponents say employers, especially small business, can use the help.

Democratic leaders coupled the PPP tax exemption and unemployment insurance rate relief for employers with a new tax credit for workers earning less than 200 percent of the federal poverty level. Eligible workers would be entitled to a tax credit of up to 5 percent of their unemployment benefit earnings in 2020.

Estimates of how much tax revenue the state would be leaving on the table by exempting PPP grants range from the administration’s projection of $150 million to the Massachusetts Budget and Policy Center’s $175 million.

The unemployment tax credit would be capped at $30 million in 2020 and $20 million in 2021.

House Ways and Means Chairman Aaron Michlewitz said the conversation on Beacon Hill about exempting PPP grants and creating a new tax credit for low-income workers began before Democrats in the U.S. Senate slipped the clawback provision into the stimulus bill.

“There are guidelines that are supposed to be set by the Treasury and we will monitor those, but we feel this is not going to put us in jeopardy,” Michlewitz said.

Both Michlewitz and Senate Ways and Means Chairman Michael Rodrigues pointed out that potential revenue from taxes on forgiven PPP loans was not included in the tax estimate developed by lawmakers and the Baker administration in January, and were not counted on to balance the governor’s fiscal 2022 budget proposal.

“We are still reviewing the impacts of the American Rescue Plan that President Biden signed into law today and what it will mean for the Commonwealth. However, because tax revenue collections for this fiscal year have been trending positively and performing better than benchmarks, the relief package currently moving through the Legislature, which was in development prior to the federal legislation being finalized, does not rely on expected federal funds to pay for the provisions relative to PPP and the unemployment tax credit,” Rodrigues said in a statement.

The tax law change as it relates to forgiven PPP loans would also bring Massachusetts into full conformity with federal tax law, giving state lawmakers more confidence that the Biden administration won’t seek to penalize the state.

“I’m confident the moves we are making, A, we can afford and, B, are the right ones for the commonwealth in terms of the COVID relief discussion,” Michlewitz said.

Doug Howgate, executive vice president of the Massachusetts Taxpayers Foundation, said how the Treasury chooses to enforce the clawback provision is a big question mark.

“The conditions on receipt of these funds is something everyone needs to pay close attention to, and I think we’re going to waiting a little bit on the federal government,” Howgate said.

An official with the House Committee on Oversight and Reform said it was their office’s belief that the provision developed by Senate Democrats was intended to “prevent the relief dollars from being used on tax cuts that disproportionately benefit higher wage earners.” That committee is chaired by New York Democrat Rep. Carolyn Maloney.

The Tax Foundation has also said that it envisions multiple scenarios under which states could change tax laws over the next two years and find themselves either in compliance with or running afoul of the new law.

Paul Craney, of the Massachusetts Fiscal Alliance, said he opposes the restriction on tax cuts, which he said could be used to stimulate private sector growth in some states, and he does not believe that the federal government will try to penalize Massachusetts for exempting PPP grants from state income taxes.

“It’s hard to get your head around it because it all happened so quick, but when Congress and the previous president were designing the PPP loan it wasn’t designed to be a taxable source of revenue for states,” Craney said. “I think the state should follow a path that these are forgiven for all businesses, including pass-throughs, and I don’t think the federal government is going to penalize them for doing so.”