The Arkansas Department of Finance and Administration (DFA) has updated its "Frequently Asked Questions Regarding the Impact of Coronavirus (COVID-19)" (rev. Sept. 18, 2020) to specify that receipt of an Arkansas Ready for Business grant is taxable income for Arkansas income tax purposes that generally will be offset by expense deductions for purchases under the program. This guidance seems correct given the legal framework of Arkansas income tax, although it conceivably could be changed by legislation in the upcoming legislative session. (And regardless of what the Arkansas General Assembly does, it would also seem to be required for federal income tax purposes.)
Recall that Arkansas Ready for Business grants were an innovative, quickly-deployed mechanism to provide funding for Arkansas businesses to safely reopen in a pandemic. Businesses could get $1000 per employee, up to $100,000 business, and then use the funds for personal protective equipment and other qualifying expenses associated with safe opening and operation during a pandemic.
DFA's guidance in their FAQs about the grants constituting income is unsurprising. Arkansas recently conformed, via Act 870 of 2019, to section 118 of the Internal Revenue Code as of January 1, 2019. Before section 118's amendment as part of the federal Tax Cuts and Jobs Act, sometimes state and local economic development grants could be excluded from income as contributions of capital. After the amendment (and Arkansas's conformity to it), state and local grants generally will constitute taxable income absent special circumstances. Since the grant is fully taken into income, purchases with grant monies are potentially deductible (or at least capitalized and depreciated) as would be the case with any other purchases.
The interplay of the grant clawback with timing of tax information reporting could present a wrinkle: After 2020 year-end, businesses have to report their Arkansas Ready for Business qualifying expenditures and return any unused funds or funds that were for nonqualifying expenditures. The 2020 1099-G information report for a taxable state grant would likely reflect the full amount of the grant without any reduction for any repayment that occurs in 2021, potentially leaving the taxpayer facing federal and state tax on the full amount for the 2020 tax year.