PPP loans – SALT Speak – Joel Michael's Blog

Fraught Federalism

The American Rescue Plan Act or ARPA, Biden’s $1.9 trillion relief package, provides $350 billion in aid to state and local government. However, this money comes with “strings,” i.e., a provision that prohibits states from using the money to fund tax cuts. Here’s the language:

A State or territory shall not use the funds provided under this section or transferred pursuant to section 603(c)(4) 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.
ARPA, section 9901, sec. 602(c)(2)(A)

Since ARPA is itself a massive tax cut (see this TPC post suggesting it is one of the largest one-year federal tax cuts, depending upon the definition you prefer), that seems a little rich. Why not let states decide how they can best use the money? I suppose it’s yet another case (now by Democrats) of partisanship seeping into law making – it’s fine for the Democrats in Congress to decide on the parameters of tax cuts, but they don’t trust states (translation: “states controlled by Republicans”) to do so? Or Congress decided how much of the package is for tax cuts and designated all the state and local aid for delivery of government services? So, it is just a matter of preserving federal control over how its money is spent? Whatever the real rationale(s), it seems like a rejection of the basic principles underlying federalism. It’s probably the retaliation that could be expected after TCJA’s fairly transparent shot at blue states with its SALT deduction cap.

The provision raises the usual sorts of interesting questions as to how it will be applied and enforced, given the fungibility of money. The Legacy Amendment’s (Minnesota Constitution, art. XI § 15) prohibition on the legislature using its funds as a “substitute” for “traditional sources” of funding raises similar nettlesome, albeit narrower, questions but without issues of federalism. As legislative deliberations over the scope of the Legacy Amendment’s limits have illustrated, there is no clear and effective way to apply and enforce limits like these, at least without generating endless and unproductive legislative debates about legalisms rather than good policy.

State legislatures are, of course, considering a multitude of tax changes, many/most of which are reductions. Moreover, in states with dynamic conformity laws, ARPA itself will result in state tax cuts during the “covered period” (e.g., the exemption for UI benefits). (I assume Treasury will not apply the prohibition in that context since the state itself did not act even though the triggering congressional action changing state tax law in the “covered period” under (g)(1). The fact that literal language of the limit appears to apply demonstrates its breadth.) The limit could impact the Minnesota legislation to exempt PPP loan forgiveness and unemployment benefits from taxation. I’m sure legislative and DOR lawyers are now noodling about that – probably waiting for guidance from Treasury.

Given the expansiveness of the language (compare the narrower language that immediately follows it and prohibits depositing the money in a pension fund; it could easily be circumvented in my opinion), it is certainly susceptible to an interpretation that could prevent a lot of or all tax cuts (and not just those legislatively enacted but resulting from administrative interpretations). I would guess that Treasury will be flexible in exempting proposals that were in governors’ budgets and other formal legislative proposals outside of the “covered period” as defined in the law (starts March 3^rd). But newly introduced tax cuts may be in trouble if they go beyond previous formal proposals?

A group of Republican attorneys general predictably jumped into the fray sending a letter to Secretary of the Treasury Janet Yellen, decrying the provision as “an unprecedented and unconstitutional intrusion” intrusion on states’ sovereignty “usurping one-half of the State’s fiscal ledgers (i.e., the revenue half).” [italics in original] The letter goes on to cite numerous instances of tax cuts pending in the AGs’ legislatures and to point the ambiguity inherent in applying provisions of this type. Nobody says you have to take the money, of course (e.g., see Senator Rick Scott’s advice).

I would observe that many of these same AGs sued to have the U.S. Supreme Court (a federal government entity) throw out other states’ interpretations and application of their election laws in determining who won the presidential election in their states. In that context, they were not so concerned about federalism and protecting state autonomy. Clearly, partisanship trumps (I use that term intentionally) principles of federalism.

See here for media stories on the AG’s letter and/or the ARPA provision itself:

PPP loan tax update

A day after my most recent post on taxing PPP loan forgiveness, new data became available on who received PPP loans thanks to a federal court order in a FOIA lawsuit filed by WaPo. See these NYTimes (“P.P.P. Loan Data Shows How a Sliver of Borrowers Got Much of the Help”) and WaPo (“More than half of emergency small-business funds went to larger businesses, new data shows“) stories for details. I couldn’t resist posting the links and describing the information, since I think the data underlines why reversing the IRS position is a dumb idea.

According to the stories, a few firms got a lot of the money – 1% of recipients received 25% of the money and 5% got 50%. About 600 businesses received the maximum loan amount ($10 million each or $6 billion in total). These are obviously not small businesses by most standards. Many of them were national restaurant chains (e.g., P.F. Chang and Legal Sea Foods are listed in both stories) that the law treats as small businesses, along with hotels, under special rules the industries convinced Congress to include. The NYT story also reports that a couple of recognizable national law firms – Boies Schiller Flexner and Kasowitz Benson Torres – each got $10 million PPP loans. Marc Kasowitz, of course, was Trump’s lawyer for much of the Mueller investigation and David Boies is a big Democratic lawyer, representing Al Gore in the 2000 election dispute that went to the Supreme Court. [A Minnesota aside: Other sources report that Robins Kaplan, a big Minneapolis law firm, also got the maximum $10 million PPP loan. I’m glad that Faegre and Dorsey had the apparent good sense to pass on bellying up to the PPP trough.]

It is safe to say that both of the law firms likely have positive income for the relevant years. The pandemic is unlike to have hit them hard enough (if much at all) to cause them to lose money. Allowing them to deduct the expenses financed with the PPP loans will be the cherry on top of their PPP sundae. These firms are undoubtedly taxed as pass through entities, since almost all law firms are. Thus, any tax savings will go right into to their partners’ or shareholders’ pockets. Prestige NYC and DC law firms compensate their partners quite well with many of them making seven figure amounts. (See this Bloomberg law story for some detail: “Top partners at major law firms can earn between $3 million to $10 million, according to compensation experts[.]”) Assuming their partners’ average marginal federal income tax rate is 30% (probably a conservative estimate), reversing the IRS position would yield a cool $3 million in tax savings ($10 m loan proceeds * 30% tax rate = $3 m) for each firm.

By contrast, the pandemic has hit the restaurant and hotel industries hard, including chain restaurants. But I would guess that many of the national restaurant and hotel chains have not been able to get refunds of all the relevant prior years’ taxes with NOL carrybacks generated by their current year operating losses. Thus, deducting the expenses paid with PPP loans, while excluding loan forgiveness, will yield them a tax refund that will go into their corporate coffers.

In any case, this all goes to help explain why there is a powerful constituency for reversing the IRS decision. But I think it also reinforces why doing so is such a bad idea – giving money to P.F. Chang, David Boies, or Marc Kasowitz is not a good use of scare coronavirus relief money. I have some sympathy for the restaurant and hotel chains, but a far better use of the money would be to pay extended or higher unemployment benefits to their cooks, wait staff, cleaners, desk staff, and other employees that they have undoubtedly laid off, many of whom will be exhausting their benefits soon.

I have not seen details on what the bi-partisan bill (still opposed by McConnell, of course) includes but I hope they had the good sense not to include the PPP tax spiff, despite Grassley’s and Wyden’s support for it.