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COVID-19 Legislative Actions

Posted on May 25, 2020
Samantha K. Trencs
Samantha K. Trencs
Jonathan A. Feldman
Jonathan A. Feldman
Todd A. Lard
Todd A. Lard
Chris Lee
Chris Lee

Todd A. Lard and Jonathan A. Feldman are partners and Samantha K. Trencs and Chris Lee are associates with Eversheds Sutherland (US) LLP in Atlanta and Washington.

In this article, the authors discuss COVID-19 impacts and what the states are doing in terms of financial assistance and tax relief for businesses and individuals.

COVID-19 continues to affect the economy at extraordinary levels and has resulted in significant state and local revenue declines and expected shortfalls. The federal government enacted multiple rounds of substantial relief to address the impacts of the crisis. The third phase of COVID-19 relief, the Coronavirus Aid, Relief, and Economic Security Act (CARES Act), was signed into law March 27. The CARES Act is the largest stimulus package in U.S. history and provides financial assistance and tax relief for businesses and individuals in response to the impacts caused by the COVID-19 crisis. States are already considering and will almost certainly pass legislation to address the impacts of COVID-19 and to address the impacts of this federal legislation.

State legislators face the task of filling budget gaps while complying with balanced budget requirements. For example, the Georgia governor’s office recently reported that April tax revenue fell by 36 percent or $1.03 billion compared with April 2019.1 Unlike the federal government, state governments are generally required to balance their budgets, with many states constitutionally prohibited from carrying a deficit forward into the next fiscal year. Currently, 20 states have not passed a 2021 budget.2 Legislators must also decide whether to conform to federal COVID-19 relief legislation that may further affect state tax revenue. Rhode Island estimates that conformity with the CARES Act could cost the state $17.5 million over two years.3

States facing budget shortfalls are looking for more federal assistance. The CARES Act established the coronavirus relief fund to make payments for specified uses to state and some local governments. Federal legislators are working to enact further legislation to provide additional financial relief to the states.4 Beyond federal assistance, states may cut spending programs, draw down reserves, increase rates, broaden tax bases, or seek additional revenue sources, like new taxes. The following addresses potential legislation we may see states consider and enact in the following months.

State Conformity to the IRC and CARES Act

The CARES Act imposes multiple provisions that affect and change provisions of the Internal Revenue Code. A state’s conformity with the IRC will affect whether specific provisions of the CARES Act apply for state income tax purposes. About half the states are rolling conformity states and thus will automatically conform to the latest version of the IRC unless their legislatures pass legislation to decouple from the specific CARES Act provisions of the IRC. However, other states are selective or fixed conformity states and will conform to the latest version of the IRC containing the CARES Act only if the state takes legislative action.

While already facing significant analysis regarding conformity to the CARES Act, COVID-19 and the limitation on the length of legislative sessions are affecting the ability of legislatures to address IRC conformity during their regular sessions. Sixteen states have already adjourned their legislative sessions.5 Fifteen other state legislative sessions have been suspended because of COVID-19.6 Many of these states did not update their IRC conformity before adjourning. When the legislative bodies of these states reconvene, they will focus on immediate and foreboding health, safety, and budgetary spending measures related to the impacts of COVID-19.

It seems possible that many fixed and selective conformity states will not take action to update their IRC conformity or will not have time during the remainder of their regular session to address the intricacies of conformity to the CARES Act, although special sessions could be called later in the year. However, not quickly addressing federal conformity is not uncommon. After federal passage of the Tax Cuts and Jobs Act in December 2017, it took some states more than a year to update their IRC conformity, and states continue to issue additional guidance concerning TCJA provisions. For example, Minnesota did not update its conformity until May 31, 2019, California did not update its conformity until July 2019, and New Jersey was still in the process of issuing regulations addressing global intangible low-taxed income in April 2020.

Even if these selective and fixed conformity states pass conformity legislation before the end of current legislative sessions, they must decide which provisions of the IRC they wish to conform to or decide the effective date of the IRC to which they conform. For example, the Arizona governor signed a bill March 24, 2020, updating Arizona’s fixed date conformity to the IRC in effect on January 1, 2020, and specifically excluding changes to the code enacted after January 1, 2020. Thus, because the CARES Act was enacted after January 1, Arizona does not currently adopt the tax provisions of the CARES Act. Georgia H.B. 949 as now proposed would update Georgia’s fixed date conformity to the IRC as of January 1, 2020. In these states, the tax provisions enacted by the CARES Act will not apply without further legislative action.

A specific example of how states might struggle with conformity is section 2303 of the CARES Act, which temporarily repeals the 80 percent net operating loss use limitation imposed by IRC section 172 for tax years beginning before January 1, 2021. Section 2030 of the CARES Act also permits a five-year carryback period for NOLs arising in 2018, 2019, and 2020. These provisions temporarily reverse, in part, the NOL provisions of the TCJA, which imposed the 80 percent limitation on NOL use and eliminated NOL carryback. After the TCJA, many states conformed to these NOL changes. The impact of the NOL provisions within the CARES Act will depend on a state’s prior IRC conformity to the TCJA, whether states update their IRC conformity, and whether states decouple from the CARES Act’s provisions concerning NOLs.

We expect that most states will choose to not conform to the temporary repeal of the 80 percent NOL use limitation or the allowance of a five-year carryback. Given the economic downturn, impact on state tax revenue, increased costs relating to COVID-19 health and safety measures, and the requirement to keep a balanced budget, states are likely to decouple from a provision that allows the reduction of prior year tax liabilities and requires the issuance of cash refunds, even though this would provide much needed cash flow to businesses that are negatively affected by the pandemic. For example, North Carolina has introduced legislation (S.B. 727) proposing to decouple from the CARES Act NOL provisions. New York has already passed its 2021 budget bill that decouples from the CARES Act’s NOL carryback provisions and the temporary suspension of the NOL limitation, and we expect many other states will pass similar bills. Further, in economic downturns, states are known to move in the opposite direction regarding the use of NOLs. Similar legislation occurred around 2008 when California suspended NOL deductions for several years, Pennsylvania capped the amount of NOL use, and other states took similar action to suspend or limit NOL use.

However, some states may move in a different direction. Louisiana has proposed House Concurrent Resolution No. 76, which urges and requests that any proclamation convening an extraordinary session of the Louisiana Legislature include conforming to the NOL deductions adopted in the CARES Act to assist businesses in overcoming cash flow issues they will face in light of the pandemic. Such legislation cannot be introduced or enacted in 2020 without an extraordinary session as the Louisiana Legislature is limited by its State Constitution in even-numbered years from levying any new taxes or tax increases or legislating with regard to tax exemptions, exclusions, deductions, or credits.7

State Taxation of CARES Act Loans and Debt Forgiveness Income

Section 1102 of the CARES Act allows small businesses to obtain Paycheck Protection Program (PPP) loans of up to $10 million or 2.5 times average monthly payroll. These loans have an interest rate of 1 percent and a two-year repayment term. Section 1106 provides that the business may obtain forgiveness of the loan equal to the amount the business spends on payroll, mortgage interest, rent, and utilities over an eight-week period following disbursement of the loan. Qualifying payroll expense does not include amounts paid to an employee that exceed $100,000 on an annualized basis and other types of compensation specified in the act. Section 1106(c)(1) of the CARES Act provides that “amounts which have been forgiven under this section shall be considered canceled indebtedness by a lender authorized under section 7(a) of the Small Business Act (15 U.S.C. 636(a)).”

States face numerous issues with considering how the PPP loans may affect state taxes. First, in the absence of further authority within the federal legislation, the PPP loan forgiveness could produce cancellation of indebtedness income subject to federal and state income tax. However, section 1106(i) provides that “for purposes of the Internal Revenue Code of 1986, any amount which (but for this subsection) would be includible in gross income of the eligible recipient by reason of the forgiveness described in subsection (b) shall be excluded from gross income.” Therefore, the CARES Act provides specific provisions to exclude PPP debt forgiveness income from federal taxable income.

However, this raises questions concerning treatment of the loan forgiveness for state income tax purposes. As described above, some states have fixed or selective conformity to the IRC. In the absence of state legislation to adopt this current version of the IRC or the provisions of the CARES Act, arguably the provisions of section 1106(i) providing an exclusion from federal taxable income would not apply for state income tax purposes. Thus, there would be no mechanism to exclude the debt forgiveness income from federal taxation income or the starting point for calculating state tax. Other provisions of the IRC previously adopted by fixed and selective conformity states would operate to treat the PPP debt forgiveness as taxable income.

Some states have taken action to introduce or enact legislation to exclude the PPP loan forgiveness from the state taxable base. For example, the District of Columbia introduced B23-0734, which would exclude the PPP loans awarded and subsequently forgiven under section 1106 from the District’s franchise tax. Similarly, Minnesota introduced H.F. 4596 and S.F. 3843, which would exclude the PPP forgiven loans from income for purposes of calculating the state corporate franchise tax and individual income tax. Conversely, North Carolina introduced S.B. 727, which would require corporate taxpayers to add back any loan forgiveness amount allowed under the CARES Act to its income for purposes of determining the Corporate Income Tax. In the absence of further state legislation, PPP debt forgiveness income would be subject to state income tax in the selective and fixed conformity states.

Second, although the CARES Act addresses exclusion of debt forgiveness income from federal taxable income, it does not address whether IRC section 265 applies. Section 265 provides that no deduction is allowed for expenses allocable to income that is wholly exempt from tax. Arguably the payroll, rent, utilities, and mortgage interest expense incurred over the eight-week period that generates the PPP debt forgiveness income is an expense allocable to exempt income. Recently, the IRS released Notice 2020-32, 2020-21 IRB 1, providing that no deduction is allowed under the IRC for an expense that is otherwise deductible if the payment of the expense results in forgiveness of a covered loan under section 1106(b) of the CARES Act. However, some congressional tax law writers have argued that this conclusion conflicts with the legislative intent of the CARES Act,8 and on May 5 the Small Business Expense Protection Act of 2020, S. 3612, was introduced in the Senate. This bill would overrule the notice and permit deduction of the expenses paid with forgiven PPP loans.

Ultimately, states may vary in their treatment of the IRC section 265 deduction disallowance. Also, some states impose their own statutes requiring an addback of expenses deducted on the federal return to the extent the related income is not taxed by the state. States could use these provisions to require an addback of payroll, rent, interest, and utility expense incurred in the eight-week period that produced the PPP debt forgiveness income.9

Third, some states, including Washington, Oregon, and Ohio, impose gross receipts taxes. Even if federal and state rules exclude the PPP debt forgiveness income for income tax purposes, taxpayers should consider whether this income is included in the gross receipts tax base. For example, Ohio R.C. section 5751.01(F) includes in the definition of gross receipts the value of any debt forgiven as consideration. Although Ohio relies on IRC sections for its definitions in R.C. section 5751.01, it does not conform to the IRC as a whole. Regardless of whether a state conforms to the latest version of the IRC or the CARES Act, additional legislation may be needed to address whether PPP loan forgiveness is subject to gross receipts taxes in some states. However, Oregon recently announced that PPP loan forgiveness income will not be subject to its corporate activity tax.10

Finally, although we believe it would be poor policy, states that address conformity could choose to decouple from section 1106(i) and thus treat the loan forgiveness income as taxable income. If states took this action, the corresponding expenses would be deductible. Given the significant amount of PPP loans and debt forgiveness income taxpayers are likely to receive, we expect states will introduce legislation addressing conformity with the CARES Act and treatment of PPP loan forgiveness.

State Incentives for Payroll Retention Similar to the Federal Employee Retention and Other State Incentives

Among the provisions within the CARES Act is an employee retention credit, which is designed to encourage eligible employers to keep employees on their payroll despite experiencing economic hardship related to COVID-19. The credit can be claimed against payroll taxes equal to 50 percent of qualified wages paid to eligible employees after March 12, 2020, and before January 1, 2021. The maximum qualified wages per employee is $10,000 during this period, which results in a maximum federal credit of $5,000 per employee. The credit is limited to businesses affected by COVID-19, as it applies only to qualified wages paid by a business whose operations have either been fully or partially suspended because of a government order related to COVID-19, or have a significant decline (that is, 50 percent) in gross revenue during the period from March 13, 2020, through December 31, 2020. Because this is implemented as a federal tax credit rather than an adjustment to federal taxable income, it will not affect the calculation of state taxable income. This is similar to how the employer credit for paid family and medical leave implemented by the TCJA did not affect the calculation of state taxable income.

Piggybacking off this provision in the CARES Act, the New Jersey Legislature has proposed its own employee retention tax credit in addition to the federal credit, which would apply against the New Jersey corporate business tax and gross income tax. S.B. 2348 would permit those eligible for the federal tax credit to be allowed a New Jersey tax credit in an amount equal to the sum of 20 percent of the federal tax credit allowed for each qualified New Jersey-based employee (that is, a maximum state credit of $1,000 per employee). However, unlike the federal tax credit, New Jersey’s credit, if enacted, would apply only to those taxpayers with 10 or fewer full-time employees. In addition to allowing the credit to apply against income tax liability, states should strongly consider allowing any available credit to apply against payroll withholding to provide more immediate relief to businesses that are likely to show taxable losses for 2020. North Carolina has provided such temporary relief for employers in its recently enacted COVID-19 response bill, S.B. 704, which provides employers with a tax credit for contributions to the state’s unemployment insurance fund for the current calendar year.

New Jersey has taken other measures to ensure employees are paid during this crisis. Last month New Jersey enacted A.B. 3845, which authorizes the New Jersey Economic Development Authority to offer grants during the period of emergency declared by the governor for employers to meet payroll requirements. We are likely to see states take additional similar actions to help struggling employers and employees. For example, the Kansas Chamber of Commerce policy agenda contains a provision urging the creation of an employee pay tax credit for businesses that continue paying employees.11 Rather than tax credits, Mississippi is proposing direct payments to businesses to provide economic support while minimizing administrative costs and delay. Specifically, S.B. 2772, which was presented to the governor for signature, establishes the Mississippi COVID-19 Relief Payment Fund, which would provide direct payments of $2,000, plus additional grant funds if warranted, to certain eligible businesses with no more than 50 full-time employees.

To Predict the Future, We Should Look to the Past — Anticipated Changes to Tax Rates and Tax Base, and Adoption of Gross Receipts Taxes

In response to recessions and projected revenue shortfalls, state legislatures have historically opened up their menu of options to recoup lost revenue: increasing tax rates, broadening the tax base, eliminating tax exemptions, or enacting new taxes or fees. According to the Center on Budget and Policy Priorities, states took in $87 billion less in tax revenue — or 11 percent less — from October 2008 through September 2009 than they collected in the previous 12 months.12

To recoup revenue lost because of the Great Recession, 33 states raised new revenue, relative to what would have been collected during 2008 and 2009, by enacting tax changes, many of them temporary.13 Personal income tax and sales tax changes are generally states’ largest source of revenue and were the largest sources of increased state tax revenue. Several states looked to high-income earners to gain additional revenue by creating new high-income tax brackets, increasing the tax rate of the existing top tax brackets, or restricting deductions for individual income taxes. For example, nine states — Connecticut, Delaware, Hawaii, Maryland, New Jersey, New York, North Carolina, Oregon, and Wisconsin — created a new high-income bracket or increased the rate of an existing top bracket.14 Other states looked to increase the sales tax rate or expand the sales tax base to include additional products like sales of digital products or computer software.15 As history has a way of repeating itself, states may again look to recoup lost revenue by raising taxes on high-income earners and increasing income tax rates or limiting deductions or exemptions.

Some states took similar actions following the economic impact of the events on September 11, 2001. For example, in 2002 New Jersey enacted an alternative minimum assessment on apportioned gross receipts or gross profits and required taxpayers to pay the greater of the alternative minimum assessment or corporate business tax. Also, California imposed a limitation on using NOLs for 2000-2003. In response to the economic impact of COVID-19, states could enact alternative minimum taxes or somehow limit the use of NOLs. California is again looking to impose NOL limitations. Gov. Gavin Newsom (D) recently released his May budget revision, which proposes a three-year suspension of NOL provisions.16 However, current pending legislation in California (A.B. 2166) proposes conforming to the CARES Act five-year carryback of NOLs.

The impacts to state tax revenue caused by COVID-19 and the economic downturn will almost certainly encourage states to seek new sources of tax revenue, including gross receipts taxes. For example, in May 2019 Oregon passed its corporate activity tax, which went into effect for years beginning on or after January 1, 2020. The Oregon Department of Revenue recently issued a notice of proposed rulemaking, which began the permanent regulation notice and comment process. Other states may enact a gross receipts levy similar to this tax, the Washington business and occupation tax, or the Ohio commercial activity tax. States may also look to novel taxes on some alternative base. For example, A.B. 10357 was recently introduced in New York to tax excess profits. If a taxpayer realized profits during the period after the COVID-19 emergency declaration was issued that are 20 percent higher than profits during a similar period in 2019, the taxpayer must pay a 5 percent tax on those excess profits.

We are also likely to see changes to the sales tax once states resume their legislative sessions or as states convene for new sessions next year. Minnesota proposed a constitutional amendment to temporarily increase the sales and use tax rate by 0.375 percent beginning July 1, 2021, and ending June 30, 2036, in S.F. 4510 and H.F. 4534. If passed, the amendment would have to be approved by the voters during the 2020 general election. However, as written, the additional revenue collected from the sales tax rate increase would go toward a deficient roads and bridges fund and a clean water fund, rather than to the general fund.

In Florida, several democratic lawmakers are calling on Gov. Ron DeSantis (R) to stop an estimated $543 million in corporate tax refunds that are expected to be issued in May. After the enactment of the TCJA, Florida enacted legislation providing refunds to corporate taxpayers if the state’s fiscal year receipts exceed the state’s adjusted forecast collections by more than 7 percent.17 This refund policy was the result of Florida’s automatic conformity to the new expanded definition of income in the TCJA, which expanded the tax base that Florida could tax with the tax rate remaining the same. However, because of increased costs caused by COVID-19, several lawmakers wrote a letter to the governor urging him to cancel or refrain from issuing the refunds because they “will not go to small or even medium-sized businesses” as “only 1 percent of all businesses in the state of Florida pay any corporate income tax.”18

Those states that have not yet enacted remote seller or marketplace legislation will likely look to enact remote seller and marketplace collection laws to capture additional revenue. While Georgia and Tennessee were able to enact marketplace collection before the COVID-19 pandemic, the remaining states without remote seller or marketplace collections laws — Florida, Kansas, Louisiana, Mississippi, and Missouri — will likely make enacting these laws a priority upon reconvening or convening the 2021 legislative session.

Also, before the disruptions from the pandemic, several state legislatures proposed taxes on digital advertising by either expanding the sales tax base to include digital advertising or proposing entirely new taxes on advertising and data. While only Maryland has managed to pass its gross receipts tax on digital advertising, which Gov. Larry Hogan (R) vetoed on May 7, 2020, other state legislatures may look to adopt a similar tax once their legislative sessions resume.

Although several states adopted tax increases following the Great Recession, there was a countertrend among a handful of states to cut taxes to stimulate the economy. We’re currently seeing some state legislatures propose or enact tax cutting measures. Before Georgia’s legislature suspended the legislative session indefinitely, H.B. 949, Georgia’s annual income tax conformity bill, was pending in the state Senate. This bill would reduce individual tax rate for many taxpayers by eliminating marginal rates and setting a single flat rate of 5.375 percent (down from 5.75 percent).19 H.B. 949 would fulfill part of the legislative promise for future rate reductions. However, given the economic upheaval surrounding COVID-19 (including deferred 2019 collections and reduced 2020 withholdings and estimated payments) and assuming that IRS conformity legislation is even addressed during the remaining 11 days of the legislative session, it will be interesting to see if the rate reduction remains in the conformity bill (perhaps unlikely) or if additional tax relief is proposed in 2020 in Georgia or in any other state.

Pennsylvania is another state proposing and enacting potential tax cutting and saving measures. The Pennsylvania legislature passed S.B. 841, a tax savings measure for property taxes in which taxing districts have the ability to collect the property tax at a discounted rate. Other tax savings measures include Pennsylvania H.B. 2377, which proposes suspending the imposition and collection of sales tax and excluding from taxable income any compensation received by an employee during the governor’s declaration of an emergency for purposes of the state’s personal property tax.

Finally, we anticipate that in response to the impacts of COVID-19, states will offer tax amnesty programs allowing taxpayers to report delinquent tax liabilities in exchange for an abatement or reduction to penalties. In the wake of the Great Recession, in 2009 many states, including Arizona, Connecticut, Massachusetts, and New Jersey, enacted tax amnesty programs, and now these programs could also include amnesty for remote and marketplace sales tax collection.

Conclusion

The CARES Act and COVID-19 will continue to affect the economy and state and federal tax collection for months or years. We should expect to see additional federal and state legislation to address these impacts. In addition to addressing IRC conformity and conformity with the CARES Act and other federal legislation, states will consider whether to implement their own tax incentives, to modify state tax rates or tax base calculations, and to adopt new taxes to address the impact on state revenue.

FOOTNOTES

1 Gov. Brian Kemp (R), press release, “April Tax Revenues Fall -35.9%” (May 6, 2020).

2 National Conference of State Legislatures, “FY 2021 State Budget Status” (May 13, 2020).

3 James Nani, “RI Estimated to Lose $17.5M With CARES Act Tax Conformity,” Law360, May 4, 2020.

4 Erik Wasson, Billy House, and Laura Litvan, “Pelosi Says States and Cities Seek $1 Trillion in Next Stimulus,” Bloomberg, Apr. 30, 2020.

6 Id. And many of these regular sessions are limited to a specific number of days.

7 La. Const. Art. III, section 2(A)(3).

8 Letter from Senate Finance Committee Chair Chuck Grassley, R-Iowa, House Ways and Means Committee Chair Richard Neal, D-Mass., and Finance Committee ranking minority member Ron Wyden, D-Ore., to Treasury Secretary Steven Mnuchin (May 5, 2020).

9 State intercompany interest addback rules could also apply to add back intercompany interest deducted during the eight-week period.

10 Oregon Department of Revenue, “PPP Loans, EIDL Advances, SBA Loan Subsidies Not Subject to CAT” (May 6, 2020).

11 Kansas Chamber of Commerce, Relief & Recovery Agenda (Apr. 2020).

12 Nicholas Johnson, Catherine Collins, and Ashali Singham, “State Tax Changes in Response to the Recession,” Center on Budget and Policy Priorities (Mar. 8, 2010).

13 Id.

14 Id. The CBPP also reported that nine states restricted deductions or broadened the tax base. For example, Colorado, Rhode Island, Vermont, and Wisconsin limited the capital gains exclusion while Delaware and New Jersey included lottery winnings in the tax base. Further, California, New Jersey, New York, Oregon, and Vermont limited itemized deductions, exemptions, or credits.

15 Id. In 2008 and 2009, California, Indiana, Massachusetts, and North Carolina each raised the general sales tax rate by 1 percent or more. The sales tax increases in California and North Carolina were scheduled to expire in 2011, while the rate increases in Indiana and Massachusetts were permanent.

16 State of California, 2020-21 Revised Budget Summary, Revenue Estimates.

17 H.B. 7093 (2018) and H.B. 7127 (2019).

18 Letter to DeSantis from Sens. José Javier Rodriguez and Victor M. Torres Jr. and Reps. Anna V. Eskamani, Javier E. Fernandez, Margaret Good, Cindy Polo, and Carlos Guillermo Smith (Apr. 7, 2020).

19 The bill does not change the corporate income tax rate.

END FOOTNOTES

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