Menu
Tax Notes logo

Treasury Issues Much-Awaited Guidance on Tax Offset Provision 

Posted on May 11, 2021

States and territories are permitted to cut taxes but must show that the reductions were financed by sources other than federal COVID-19 relief funds, according to much-awaited guidance from the U.S. Treasury Department

Treasury on May 10 announced the launch of COVID-19 relief emergency funding for state, local, territorial, and tribal governments as included in the American Rescue Plan Act of 2021 (ARPA, P.L. 117-2). The announcement coincided with the release of an interim final rule on how the $350 billion in funding can be used, which is effective as of May 10.

“It is a top priority for the Department of Treasury to make sure that we do everything we can to help those who have been adversely impacted by COVID-19 and promote a strong and equitable recovery,” Deputy Treasury Secretary Wally Adeyemo said during a news briefing. “In the coming days and weeks, Treasury’s Office of Recovery Programs will work hand in hand with governors, mayors, members of Congress, and other local officials to answer any questions and ensure funds are making it to communities as soon as possible.”

The funds will be released to local governments in two tranches, with 50 percent beginning this month and the remainder disbursed 12 months later, according to an information sheet from Treasury.

States that have seen “a net increase in the unemployment rate of more than 2 percentage points from February 2020 to the latest available data as of the date of certification” will get the funds in a single payment, while other states will receive funds in two equal tranches, according to the information sheet.

The guidance lays out eligible uses for the funds such as covering revenue shortfalls, funding COVID-19 mitigation efforts, medical expenses, rehiring public sector workers, providing assistance to small businesses, and expanding access to broadband internet.

Concerns have been raised over a provision in section 9901 of the ARPA that restricts aid from being used to “either directly or indirectly offset a reduction in the net tax revenue of such state or territory resulting from a change in law, regulation, or administrative interpretation during the covered period that reduces any tax (by providing for a reduction in a rate, a rebate, a deduction, a credit, or otherwise) or delays the imposition of any tax or tax increase.”

Critics of the provision say it is ambiguous, and several states have sued to block Treasury from enforcing it.

Treasury said in the information sheet that states and territories can’t use the funds “to directly or indirectly offset a reduction in net tax revenue due to a change in law from March 3, 2021 through the last day of the fiscal year in which the funds provided have been spent.”

States or territories that choose to cut taxes will be required to show how they paid for the tax cuts from other sources, such as enacting policies to raise other sources of revenue, by cutting spending, or through higher revenue from economic growth. If funds are used to offset tax cuts, the state or territory will be required to repay the funds, Treasury said.

Arizona Attorney General Mark Brnovich (R), who filed a lawsuit over the provision, said in a statement to Tax Notes: “Unfortunately, what Congress passed in the American Rescue Plan was ambiguous, and Secretary Yellen still has not provided clear guidelines. Americans cannot put their faith in whatever the latest interpretation is from the Biden administration. Arizona should not be put in a position of losing billions of dollars because the federal government wants to commandeer states’ tax policies.”

Jared Walczak of the Tax Foundation told Tax Notes the good news in the interim final rule is that states can pay for tax cuts with economic growth, but he was surprised at how limited the spending cut authorization is.

“It was expected, of course, that Treasury would impose some limits on the use of offsetting spending cuts because you couldn’t simply swap in federal aid to offset those spending cuts,” Walczak said. “But the interpretation is incredibly broad. . . . There is ultimately very little, it sounds like, that states would be allowed to cut to offset a tax reduction.”

Walczak also said that the guidance adds more confusion to whether income tax changes that conform a state or territory’s tax law with changes in federal income tax law are subject to the offset provision.

Treasury announced April 7 that a state or territory may adopt or reject income tax changes under the $1.9 trillion ARPA without being subject to the offset provision. 

“It is unclear, given this new language, whether a state is only in the clear if it conforms without change or if it can conform selectively to some of the provisions in the most recent version of the [IRC] without creating a violation,” Walczak said.

Under the guidance, states will be allowed to use the funds to restore their unemployment trust funds to their pre-pandemic balances. The funds can’t be used to offset reductions in net tax revenue resulting from new business tax incentives, a Treasury spokesperson told Tax Notes.

The interim final rule includes a process for determining whether, and the extent to which, the funds have been used to offset a reduction in net tax revenue.

For states and localities that are unsure whether their proposals will pass muster, Treasury is setting up a recovery office that will have a process to determine whether a government's policy falls within or outside the guidance, senior administration officials told reporters May 10.

Copy RID