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COVID-Related State and Federal Grants

Posted on Aug. 30, 2021
Kathleen K. Wright
Kathleen K. Wright

Kathleen K. Wright is the director of the state and local tax program in the School of Taxation at Golden Gate University, San Francisco. She frequently presents seminars on SALT issues for the California CPA Education Foundation.

In this installment of States of Mind, Wright outlines grant programs established in California to help small businesses and the state and federal taxation of payments received under those programs.

The pandemic has focused state and federal attention on small businesses’ plight in dealing with COVID-19. If small California businesses are active, then financial help might be available not only from the federal government, but also from the state and several cities via credits and grant programs with varying requirements. This article discusses the California grant programs for small businesses and the state and federal taxation of payments received under these (and related) programs.

Generally, government grants to businesses and individuals are included in taxable income for state and federal purposes,1 but exceptions abound — particularly for grant programs that require significant pandemic-related revenue losses.

California Grant Programs for Businesses

California’s recently enacted budget allocated significant funding to businesses affected by COVID-19. These grant programs, established in S.B. 151,2 are structured to provide assistance to businesses affected by COVID-19 through interruptions and closures. They also reward businesses that provide new jobs or result in new construction in California. Collectively, billions of dollars are being pumped back into the local economy, and time will tell how successful this effort will be.

California Small Business COVID-19 Relief Grants

This program provides competitive microgrants ranging from $5,000 to $25,000 to eligible small businesses and nonprofits affected by COVID-19 through interruptions and closures.3 Grants are available to California-based businesses operating since at least June 1, 2019. The grant amount is based on annual gross revenue as follows:

Annual Gross Revenue; Amount of Grant

$1,000 to $100,000; $5,000

$100,000 to $1 million; $15,000

Greater than $1 million to $2.5 million; $25,000

An eligible small business means:

  1. a small business includes a sole proprietor, independent contractor, or registered for-profit business entity (for example, a C corporation, S corporation, limited liability company, or partnership) that has yearly gross revenue of $2.5 million or less (but at least $1,000) based on its most recently filed tax return;

  2. a small nonprofit entity (registered 501(c)(3), 501(c)(19), or 501(c)(6)) having yearly gross revenue of $2.5 million or less (but at least $1,000) based on its most recently filed Form 990;

  3. active businesses or nonprofits operating since at least June 1, 2019;

  4. a business currently operating or having a clear plan to reopen when allowed by the state; or

  5. a business affected by COVID-19 and the health and safety restrictions — such as interruptions or closures — implemented as a result of the pandemic.

Industry sectors most affected by the pandemic are given priority in the funding decisions, including:

  1. educational services;

  2. arts, entertainment, and recreation;

  3. accommodation and food services;

  4. apparel manufacturing;

  5. clothing and clothing accessory stores;

  6. sporting goods, hobby, musical instrument, and book stores;

  7. transit and ground passenger transportation;

  8. scenic and sightseeing transportation;

  9. motion picture and sound recording industries;

  10. personal and laundry services; and

  11. newspaper, periodical, book, and directory publishers.

S.B. 874 adds Cal. Rev. & Tax. Code section 17158 and section 24312 to clarify that for tax years beginning on or after January 1, 2020, and before January 1, 2030, grants received under this program are excluded from gross income for state purposes. These grants are fully taxable under federal law.

The program was originally established under S.B. 87 with an appropriation of approximately $2.5 billion. S.B. 151 provides an additional $1.5 billion in funding for this program for a total of approximately $4 billion, which makes this the largest small business grant program of its kind in the country. Under S.B. 151, the first round of funding will be a closed round for existing eligible applicants that were waitlisted in previous funding rounds. Despite increased funding, the program is currently closed to new applicants.

California Competes Grant Program

S.B. 151 also created the California Competes grant program,5 which is administered by the Governor’s Office of Business and Economic Development (GO-Biz) and will award grants to businesses meeting one of the following requirements:

  1. creates at least 500 new jobs in California;

  2. invests at least $10 million in new construction or renovation expenditures over no more than five years; or

  3. creates jobs or makes investments in a high unemployment area in California.

The application process is similar to the related California Competes tax credit in that an application is filed with GO-Biz. Among other things, GO-Biz will consider the extent to which the grantee will create jobs in the state, the grantee’s financial solvency and ability to finance proposed expansion, and compliance with all federal or state laws.

The GO-Biz written agreement will set forth the amount of the grant (no more than 30 percent of the grants awarded in any fiscal year can be allocated to a single grantee) and provisions governing funding and recapture if the grantee fails to comply with the agreement.

Because there is no exclusion provided for these grants, they appear to be taxable for both federal and state purposes.

California Venues Grant Program

The fiscal 2021/2022 budget also provides $150 million for independent venues and promoters.6 The California venues grant program will fall under the domain of the state Office of the Small Business Advocate, which will help administer funds to eligible venues. Eligible venues must include a defined performance space, mixing equipment, public address system, and a lighting rig. A venue must have at least two employees who perform the duties of a sound engineer, booker, promoter, stage manager, box office manager, or security personnel.

To be eligible, the venue’s primary function must be to host or produce live events — including concerts, comedy shows, theatrical productions, or other events by performing artists. At least 70 percent of the earned revenue of the individual or entity must be generated through cover charges or ticket sales; production fees or production reimbursements; or the sale of event beverages, food, or merchandise.

The grants will be 20 percent of gross earned revenue for tax year 2019, not to exceed $250,000. The business must have lost at least 70 percent of its revenue in 2020 compared to the same fiscal quarter in 2019. Publicly traded corporations — or companies majority-owned by a publicly traded corporation — are not eligible. A business that owns or operates entities in more than five states or in another country is also ineligible.

There is no exclusion provided for these grants, which appear to be taxable for both state and federal purposes.

California Microbusiness COVID-19 Relief Grant Program

The fiscal 2021/2022 budget also established the California Microbusiness COVID-19 Relief Grant Program,7 which will provide up to $2,500 of grants to a microbusiness that:

  1. began operations before December 31, 2019;

  2. is active and operating, or had a clear plan to reopen when the state allowed reopening of the business;

  3. was significantly affected by the COVID-19 pandemic;

  4. had less than $50,000 in revenues in the 2019 tax year; and

  5. has less than five full-time equivalent employees and had fewer than five full-time equivalent employees in the 2019 and 2020 tax years.

There is no exclusion provided for these grants, which appear to be taxable for both state and federal purposes.

California Rebuilding Fund

The California Rebuilding Fund has been established to aggregate funding from private, philanthropic, and public sector sources to fund working capital needs of California small businesses as they reopen and recover from the COVID-19 economic crisis. The maximum loan of $100,000 is based on the business’s average monthly revenues for three months before the COVID-19 outbreak (in 2019 or early 2020, whichever is less). The interest rate on these loans is capped at 4.25 percent, and the term of the loan is 60 months or 36 months depending on several factors — including the borrower’s credit worthiness. Small businesses are only eligible if they have 50 or fewer employees and have gross revenues of less than $2.5 million in 2019.

Since this program is structured as a loan, there is no state or federal tax liability incurred upon receipt or repayment of the funds.

Federal COVID-19-Related Grants

Under IRC section 61(a), gross income means all income from whatever source derived and includes grants, unless the federal statute enacting the grant program provides otherwise. The IRS has, however, consistently carved out an exclusion for payments to individuals under legislatively provided social benefit programs for the promotion of the general welfare (known as a general welfare exclusion).

To qualify under the general welfare exclusion, payments must: (i) be made from a governmental fund, (ii) be for the promotion of general welfare (that is, generally based on individual or family needs), and (iii) not represent compensation for services.8 Payments to businesses generally do not qualify for the exclusion because they are not based on individual or family needs.

Various code sections also provide exclusions, and the one most relevant here is IRC section 139. IRC section 139(a) excludes from gross income any amount received by an individual as a qualified disaster relief payment.

On March 13, 2020, then-President Trump declared the outbreak of COVID-19 in the United States to be a national emergency under the Stafford Disaster Relief and Emergency Assistance Act.9 So the COVID-19 pandemic is a federally declared disaster eligible for multiple benefits, including inclusion under IRC section 139.

But most federal grant programs for businesses do not qualify under IRC section 139. Therefore, the tax exemption has to be included in the federal statute that enacts the program. California does not automatically conform to federal law and has a conformity date of January 1, 2015. That leaves open the question of whether the state conforms to federal exclusions. What follows is a discussion of federal grant programs and the taxability of those payments under federal and state (California) law.

Forgiveness of Paycheck Protection Program Loans

The Paycheck Protection Program provides loans to help businesses retain employees and pay other operating expenses during the COVID-19 pandemic. If the borrowed funds are used for specific expenses, then the borrower can apply to the Small Business Administration for loan forgiveness. Contrary to the general rule, forgiveness of PPP loans is excluded from taxable income.10 Notwithstanding the general prohibition on deducting expenses that are reimbursed to the taxpayer, expenses paid with funds from the loans are deductible. Moreover, taxpayers are not required to reduce their tax attributes or forgo an increase in the basis of an asset because they had the loans forgiven.11

California conforms to the federal exclusion for forgiven PPP loans, applicable to tax years beginning on or after January 1, 2019.12 And under A.B. 80, taxpayers with a decrease in gross receipts are allowed deductions for all amounts paid by qualified taxpayers with forgiven PPP debt for both first- and second-draw PPP loans, retroactive to tax years beginning on or after January 1, 2019.13 Businesses can deduct qualifying expenses if they can show a minimum 25 percent reduction in profits for 2020 for at least one calendar quarter compared to the same calendar quarter in 2019. If they were in business for all of 2019, they can also compare calendar year 2019 to calendar year 2020.

If they were not in business during all of 2019, then the business must show a 25 percent reduction in gross receipts during any quarter in 2020 from the 2019 calendar quarters it was in operation. Businesses that do not meet the 25 percent threshold must reduce expenses by the forgiven amount on the 2020 return.

Multistate businesses must count their total gross receipts — not just California receipts — in determining whether the taxpayer meets the 25 percent reduction threshold.

Economic Injury Disaster Loans and Advances

Passage of the Consolidated Appropriations Act, 2021 on December 27, 2020, extended the Economic Injury Disaster Loan (EIDL) program through December 31 and created a new targeted EIDL advance program. The original EIDL advance program expired July 11, 2020, and is no longer available. However, the new targeted EIDL advance program is only available to previous EIDL applicants in low-income areas identified by the SBA. The American Rescue Plan Act of 2021 (117-2) provides $15 billion in additional funding for the special targeted EIDL advance grants and mandates that those funds will not be included in taxable income.

The small business owner must first apply for a COVID-19 EIDL. Once the individual applies for the loan, the SBA will invite the applicant (via email) to apply for one of the advance programs if the business is in a low-income area. If they qualify, applicants for the COVID-19 EIDL may be eligible to receive up to $10,000 (or as high as $15,000 in some instances) in advances from the SBA that do not need to be repaid (similar to a grant).

To qualify for an EIDL, the business must meet the SBA definition of a small business, be located in the United States or a U.S. territory, and have suffered working capital losses because of the coronavirus pandemic. According to the SBA, a small business:

  1. is organized for profit;

  2. has a place of business in the United States;

  3. operates primarily within the United States or makes a significant contribution to the U.S. economy through payment of taxes or use of American products, materials, or labor;

  4. is independently owned and operated; and

  5. is not dominant in its field on a national basis.

This program provides up to $10,000 in forgivable funding to previous EIDL applicants who:

  1. are located in a low-income community as defined by IRC section 45D(e);

  2. can demonstrate a more than 30 percent reduction in revenue during an eight- week period beginning on March 2, 2020, or later; and

  3. previously received an EIDL advance for less than $10,000.

If the business meets those qualifications, received no advance because of a lack of available funding, and has 300 or fewer employees — then it may also be eligible for the targeted EIDL advance.

EIDL program grants and targeted EIDL advance grants are excluded from taxable income, and the expenses paid with the funds received under this program are also deductible.14

California conforms to the federal tax treatment, excludes targeted EIDL advance grants from taxable income, and allows the deductibility of expenses paid with these proceeds.15

U.S. SBA Debt Relief Assistance

The SBA has several loan programs, including:

  1. Section 7(a) loans: These loans can be used for short- and long-term working capital, refinancing current business debt, and purchasing furniture, fixtures, and supplies. The SBA has been making monthly payments on 7(a) loans for up to six months during the COVID-19 crisis.

  2. Section 504 loans: These loans are provided by certified development companies that promote economic development in their communities. The loans can be used for major fixed asset acquisition — including the purchase or construction of existing buildings or land, new facilities, or long-term machinery and equipment. The SBA has been making monthly payments on 504 loans for up to six months during the COVID-19 crisis.

  3. Microloans: These loans of up to $50,000 are provided to help small business and not-for-profit child care centers start up and expand. The SBA has been making monthly payments on microloans for businesses affected by COVID-19 for up to six months during the COVID-19 crisis.

For federal purposes, SBA payments of 7(a) loans, 504 loans, and microloans for the benefit of the taxpayer are excluded from taxable income.16 This income exclusion is an exception from rules that normally require the recognition of cancellation of indebtedness income.17

California has not conformed to the exclusion from taxable income for the six months’ worth of payments on these SBA loans. Therefore, the debt forgiveness is fully taxable on the state side; however, expenses paid with these funds are fully deductible.

Restaurant Revitalization Fund Grants

ARPA authorized the SBA to spend up to $26 billion in grants to restaurants that experienced pandemic-related revenue losses. The grants are excludable from gross income, and the expenses paid with the grant monies are fully deductible.18 The amount treated as tax exempt is also treated as exempt for purposes of IRC sections 705 (partnerships) and 1366 (S corporations). The grant amount is generally based on the 2019 gross receipts less the 2020 gross receipts — with special rules for restaurants with short years or that opened in 2020. The amount of the grants is capped at $10 million and limited to $5 million per physical location. The funds must be used for payroll, mortgage or rent payments, utilities, maintenance expenses, supplies, food and beverage expenses, and anything else that the SBA might determine is essential to operating a restaurant. The grants must be used no later than March 11, 2023.

Since its date of conformity to federal law is January 1, 2015, California has not conformed to the tax provisions related to this federal grant program. Therefore, on the state return, these payments are fully taxable, and the expenses are fully deductible.

Shuttered Venue Operators Grants

The shuttered venue operators grant program was established by the Economic Aid to Hard-Hit Small Businesses, Nonprofits, and Venues Act and amended by ARPA. The program includes over $16 billion in grants to shuttered venues, to be administered by the SBA’s Office of Disaster Assistance. This program is intended to offer much-needed financial support for theatrical producers, live venue operators and promoters, live performing arts organization operators, museum operators, zoos, aquariums, movie theater operators, and talent representatives who were in operation on February 29, 2020. Also, the venue must have had gross earned revenue during any quarter in 2020 that shows a 25 percent reduction from the gross earned revenue of these business during the corresponding quarter in 2019.

The venue must not be listed on a stock exchange or majority-owned and controlled by an entity listed on a stock exchange. It must not have — or be majority-owned and controlled by an entity with — all three of the following characteristics:

  1. owns or operates venues, relevant museums, motion picture theaters, or talent agencies or talent management companies in more than one country;

  2. owns or operates venues, relevant museums, motion picture theaters, or talent agencies or talent management companies in more than 10 states; and

  3. employs more than 500 employees as of February 29, 2020, determined on a full-time equivalent basis.

Any grant made under the program is excluded from the recipient’s gross income.19 The recipient may also fully deduct ordinary and necessary business expenses that are paid with the grant.20 Moreover, any amount excluded from gross income does not result in the reduction of any tax attributes or denial of basis increase in assets as required for some other forgiven debt.21

Since the date of conformity to federal law is January 1, 2015, California has not picked up the tax provisions related to this federal grant program. Thus, these payments are fully taxable, and the expenses are fully deductible on the state return.

Conclusion

In addition to the state and federal programs, some federal agencies received appropriations through the Coronavirus Aid, Relief, and Economic Security Act in 2020 and ARPA in 2021, with which they offered — and in some cases continue to offer — specialized grants and other types of financial assistance. For example, the National Endowment for the Arts received $75 million through the CARES Act to help it and its employees weather the economic hardships caused by forced closure because of COVID-19. There’s a catch, however: Applicants had to be recipients of a National Endowment for the Arts grant within the last four years. Other agencies that received funding include the U.S. Economic Development Administration, the U.S. Department of Agriculture, and the Community Development Fund.

And don’t forget that the CARES Act also included $150 billion for the Coronavirus Relief Fund, which was distributed to state, territorial, local, and tribal governments with populations over 500,000. Localities have been given considerable flexibility on how to spend their allocation. How a city plans to use the funds was supposed to be determined (and committed to by the city) by December 31, 2020.

For example, San Francisco (my hometown) has announced a $10 million relief fund to support small businesses affected by the pandemic. This is supposed to be administered as a combination of loans and grants, including mini-grants for independently owned businesses that serve the neighborhood and women-owned small businesses in underserved commercial neighborhoods.

Taxpayers — or their financial advisers — now have to roll up their sleeves and dig into myriad programs to find the best fit for them. One of these programs could be the lifeline that allows a business to get its operation back together and move toward recovery.

FOOTNOTES

2 California S.B. 151 (July 12, 2021, Ch. 74).

3 Cal. Gov’t Code section 12100.83.

4 California S.B. 87 (Feb. 23, 2021, Ch. 7).

5 Cal. Gov’t Code section 12096.6. The state has had a California Competes tax credit program administered by GO-Biz for several years. This program recently received expanded funding of approximately $290 million, which allows taxpayers to qualify for tax credits.

6 Cal. Gov’t Code section 12100.83.5.

7 Cal. Gov’t Code section 12100.90.

8 Rev. Rul. 75-246, 1975-1 C.B. 24.

10 Act section 7A(i)(1) of the Small Business Act (P.L. 96-354) and Act section 278(a)(1) of the Consolidated Appropriations Act, 2021 (P.L. 116-260).

11 Act section 7A(i)(2) of the Small Business Act; Act section 278(a)(2), (b)(2), (c)(2), and (d)(2) of the Consolidated Appropriations Act, 2021; and Act sections 9672(2) and 9673(2) of ARPA.

12 A.B. 80 (Ch. 21-17); Cal. Rev. & Tax. Code sections 17131.8 and 24308.6.

13 Cal. Rev. & Tax. Code sections 17138.8 and 24308.6.

14 Act section 278(b)(1)DivN of the Consolidated Appropriations Act, 2021 and in the case of Targeted EIDL Advance grants also under acts section 9672(1) of ARPA. Act section 7A(i)(2) of the Small Business Act; Act section 278(a)(2), (b)(2), (c)(2), and (d)(2) of the Consolidated Appropriations Act; and Act sections 9672(2) and 9673(2) of ARPA.

15 Cal. Rev. & Tax. Code sections 24308 and 17131.8.

16 Act section 278(c)(1)DivN of the Consolidated Appropriations Act, 2021.

18 IRC section 9673(1) and (2). Grants for shuttered venue operators are excluded from taxable income. Restaurant revitalization grants are also excluded under Act section 9673(1) of ARPA.

19 Frequently Asked Questions (July 22, 2021) question 94 and Act section 278(d)(1)DivN of the Consolidated Appropriations Act, 2021.

20 Act section 7A(i)(2) of the Small Business Act; Act section 278(a)(2), (b)(2), (c)(2), and (d)(2) of the Consolidated Appropriations Act, 2021; and Act sections 9672(2) and 9673(2) of ARPA.

21 Act section 278(d)(1)DivN of the COVID-related Tax Act.

END FOOTNOTES

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