Significant Small Business Tax Relief Bills Pending in the Arkansas Legislature: Coronavirus Aid and SALT Deduction Parity

Two significant proposals for tax relief for small businesses are making their way through the Arkansas General Assembly that promise hundreds of millions of dollars of tax savings: (1) conformity to federal tax exemptions for PPP loan forgiveness and other coronavirus aid and (2) creating an elective tax regime to allow federal deductibility of Arkansas income tax for business owners. Similar proposals are being adopted in other states. Interested small business taxpayers should consult with their tax advisors about the potential benefits and may wish to contact their legislators about supporting the bills.

Tax Exemption for PPP Loan Forgiveness and Other Coronavirus Relief

HB1361, sponsored by Rep. Les Eaves and Sen. Jonathan Dismang, would conform Arkansas to the recent federal clarification of nontaxability of Paycheck Protection Program (PPP) loan forgiveness and certain other coronavirus relief under the Consolidated Appropriations Act, 2021 (CAA21), as well as exempting Coronavirus Food Assistance Program (CFAP) payments to farmers. The projected one-time tax savings for small businesses and other taxpayers is $212 million.

PPP loans are provided to businesses to help keep them afloat during the COVID-19 epidemic. The loan is forgiven if the funds are used to pay eligible expenses (payroll, utilities, rent, etc.). About $3.3 billion in loans were made made to Arkansas businesses in the first round, and about half that is expected for the second round of PPP loans.

While debt forgiveness generally is taxable income, the CARES Act said that PPP loan forgiveness was nontaxable for federal income tax. There was a debate during much of 2020 about whether expenses covered by PPP loan forgiveness were deductible. Congress settled the matter with CAA21, specifying that the loan forgiveness is nontaxable and the taxpayer gets deductions for the associated expenses.

Arkansas is a selective conformity state that does not automatically follow federal tax law. Unless HB1361 is enacted, Arkansas will allow deductions for PPP expenses but tax the PPP loan forgiveness. HB1361 will make Arkansas follow the federal treatment in not taxing the loan forgiveness while allowing the associated deductions.

In addition to PPP loan forgiveness, HB1361 follows CAA21 on the tax exemption of other kinds of federal coronavirus aid:

  • Economic Injury Disaster Loan (EIDL) advances;
  • Subsidies on existing Small Business Administration (SBA) loans;
  • Emergency financial aid grants for students;
  • Treasury Program Management Authority loan forgiveness (akin to PPP); and
  • Grants for shuttered venue operators. 

The bill also exempts Coronavirus Food Assistance Program (CFAP) aid to farmers. CFAP payments are taxable for federal tax purposes. 

All House Revenue & Tax Committee members and almost all state senators are listed as cosponsors, so the bill seems to have strong momentum. It has passed through House Revenue & Tax already and seems set to proceed though the legislative process when the General Assembly returns after the recent winter weather.

SALT Deduction Parity: Elective Entity-Level Arkansas Taxation to Maximize Federal Deductions

HB1209, sponsored by Rep. Joe Jett, would help small businesses maximize their federal tax deductions by paying Arkansas income tax at the business entity level instead of at the individual level. It is projected to save about $50 million annually of federal taxes for Arkansas pass-through business owners while raising a slight amount of revenue — probably a few million dollars — for the state.

The federal Tax Cuts and Jobs Act capped the deduction for state and local taxes — the "SALT deduction" — at $10,000, but only for individuals. Businesses can still deduct taxes at the entity level. So it is better from a federal tax perspective to pay state income tax at the business entity level than as an individual. Accordingly, states have started creating tax systems where business owners can opt to pay state income tax at the business entity level instead of at the individual level. The IRS recently recognized the validity of this approach in Notice 2020-75. (These elective passthrough entity taxes may also be helpful in other situations like federal alternative minimum tax (AMT) or if the taxpayer is taking the federal standard deduction.)

HB1209 would allow a business taxed as a partnership or an S corporation to pay Arkansas income tax at the entity level. Income taxed at the entity level then would be exempt from Arkansas individual income tax. The entity-level tax would be a flat tax at the top marginal rate of 5.9%. The tradeoff for a taxpayer is the benefit of the restored federal SALT deduction versus the loss of the progressive Arkansas individual rates and Arkansas individual deductions or credits. Since this is an elective system, taxpayers could chose whichever approach was preferable. The election would be made at the business entity level.

Several states adopted elective passthrough entity taxes in the preceding years, including Louisiana and Oklahoma. With the IRS now blessing the approach, many more states are adopting or considering the idea this year. Not adopting one could put Arkansas at a competitive disadvantage versus neighboring states by making the state's effective income tax burden higher than it needs to be.

HB1209 has not yet started moving through committee. It would not be surprising to see it begin to move in the coming weeks.

 

 

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