Maine businesses would have to pay state income taxes on forgivable federal Paycheck Protection Program loans that are not taxed by the federal government under a budget proposal from Gov. Janet Mills.

The administration told the Legislature on Monday that state government could be facing a more than $100 million revenue shortfall if the state were to fully conform with changes to the federal tax code passed by Congress in December. Those changes exempted PPP loans from federal income taxes while allowing businesses to also claim the expenses the loans helped pay for.

“Now, the federal government allows a double benefit, both the exclusion of the forgiven loans from income and the allowance of related expense deductions – deductions that will now offset other income,” said Administration and Financial Services Commissioner Kirsten Figueroa. “Effectively, the federal government is using the tax code to provide additional fiscal stimulus to PPP loan recipients. But, without additional funding to the states to pay for this effort, this is a conformity provision that is challenging state governments across the nation.”

Figueroa noted the change in federal policy came just days before the end of the 2020, enacted on Dec. 27. The Legislature’s Appropriations and Financial Affairs Committee discussed the issue during a public hearing on a supplemental state budget proposal from the Mills administration.

Additional public hearings on Mills’ budget proposal have been scheduled for Tuesday, Wednesday and Thursday this week. Once the committees have finished gathering testimony on the proposal they will a hold work session on the measure to vote on a recommendation for the bill, which the full Legislature will have to vote on. As an emergency measure it will require two-thirds support in both the House and the Senate in order to become law. Those votes will likely take place at the Augusta Civic Center some time in mid to late February.

Representatives for the Maine State Chamber of Commerce, the National Federation of Independent Business and Hospitality Maine, which includes over 1,000 of the state’s restaurant and lodging businesses, all urged lawmakers to match the latest federal law that not only exempts the forgiven amount of PPP loans from taxation but also allows businesses to deduct the costs paid by PPP loans from their overall bottom line.

The forgivable loan program, passed by Congress last spring to help businesses weather the COVID-19 pandemic and keep workers on the payroll, has infused $2.3 billion into Maine’s economy during the pandemic.

Maine businesses took out more than 28,000 loans under the program and local banks have been gearing up for a second round of PPP loans after the U.S. Treasury approved another $284 million for the program this month.

If the business community prevails, PPP loan recipients would not only face no negative tax consequences but would actually experience a net tax benefit from being able to deduct expenses paid for with PPP funds.

Mills’ supplemental budget proposal also takes several other key actions, including a provision that would allow a state income tax credit for any Mainer now working from home who may already be paying taxes in the state the business they work for is located. Other provisions protect the state’s earned income tax credit for low-wage workers by fixing the credit to their 2019 income instead of their 2020 income.

Mills’ proposal mirrors federal law by exempting the $1,200 and $600 direct federal stimulus payments from state income tax and it counts unemployment payments, including increased federal unemployment benefits, as income.

Figueroa said Mills would have preferred to mirror the federal policy on PPP loans, but the state doesn’t have the luxury to deficit spend, as Maine’s constitution requires a balanced state budget. But the possibility of additional aid to states from the federal government could spur another budget change before lawmakers enact the administration’s proposal, which is meant to put the state’s current budget, which ends on June 30, in order.

“Right now, Maine people are focused on what’s most important: trying to keep themselves healthy, trying to provide for themselves and their families, and trying to get through this pandemic,” Mills said in a prepared statement. “In this package, my administration is maximizing tax relief wherever and whenever possible, providing as much stability and predictability to Maine businesses as we can, and providing whatever help we can to get Maine people through these trying times.”

Mills’ proposal was met with support from some, including those who advocate for economic policies that help Maine’s poorest, but Republican lawmakers see the move as damaging to the state’s already struggling small businesses.

“These small businesses are barely hanging on as it is. Taking away the savings that they have set aside to get through this winter and spring would be devastating,” said Senate Minority Leader Jeff Timberlake, R-Turner. “This is money they intended to use to pay their heating bills, pay their employees, and survive – all of the things the program was designed for.”

Testimony to lawmakers Monday was lopsided in favor of the state fully matching the federal government in exempting PPP funds from taxation.

Greg Dugal, with Hospitality Maine, said income losses caused by pandemic-related restrictions on the hospitality industry have been five times what they were from the losses experienced in 2009 during the Great Recession.

“If not for PPP and the Maine Economic Recovery grants, half our industry would no longer exist in 2021,” Dugal said. “In this devastating economic time the one thing we all know for sure is small businesses should not be receiving unexpected income tax bills of $1,000 or more based on a rescue loan forgiven by the federal government.”

Dugal said that bill would be coming at the worst time for restaurants and lodging businesses – at the height of the winter – when outdoor dining has become dramatically limited and most businesses have burned through any cash reserves they had.

“It will also be a time when they need to have money on hand to purchase supplies for reopening or ramping up for the upcoming summer and fall seasons and perhaps the end of the pandemic,” Dugal said.

Dugal pointed out that Maine Economic Recovery grants offered by the Mills administration with funds that came from the federal CARES Act would also be taxable. Dugal said the industry was very appreciative of both state and federal funds that have been directed toward saving the hospitality industry, but an extra tax bill “could be the final straw for some businesses.”

And the clock is ticking on the 2020 tax filing season, said Patricia Brigham, the chief executive director of the Maine Society of Certified Public Accountants.

“As the de facto tax adviser for so many of the state’s small businesses we urge you to consider conformity,” Brigham told the Legislature’s Appropriations and Financial Affairs and Taxation committees. Brigham said accountants understand that doing so would become a new state expense, but she said not doing so would create new financial uncertainty and cut into cash flow for many Maine businesses that are still working to recovery from a pandemic-restricted economy.

“As a general matter, conformity provides predictability for businesses and accountants and it significantly streamlines the tax return process allowing businesses to focus on their business and not necessarily their tax returns,”  Brigham said.

A rapidly changing federal tax code that’s been propped up by the federal government’s ability to deficit spend has left Maine and other states, most of which have state constitutional requirements for balanced budgets, in the lurch.

While Congress has funneled billions of dollars to the states to help them respond to the COVID-19 pandemic, it has not provided resources that allow states to backfill tax revenues that have been lost in a pandemic-crippled economy.

Fred Brewer, a CPA from Bath, said he and many of his clients recognized the situation state government was facing and while he urged  lawmakers to adopt new budget and tax bills that conformed with the federal code it, was also important they get the work done quickly.

Brewer said about 40 percent of his client base received PPP funds across the spectrum. He said businesses he worked with had a range of responses to the possibility the state would not exempt expenses paid for with PPP funds.

“I would like to impress upon you the importance of making this decision quickly,” Brewer told the committees. “Because even if you make this decision today for us to start processing tax returns you’re at least two to three weeks out before the tax prep software can update for whatever changes you have in place.”

Not all who testified favored full conformity with the federal tax code.

Sarah Austin with the Maine Center for Economic Policy, a left-leaning organization that advocates for economic policies that help low-income Mainers, said many of the federal tax breaks were going to business entities that had weathered the pandemic well, including real estate brokers and hedge fund managers.

“Maine is better served focusing resources that all Mainers need to pull through this pandemic,” Austin said. “That’s safe schools, access to health care, child care, good infrastructure and protecting jobs.”

Austin also noted that while PPP loans would be tax exempt, the unemployment benefits paid to workers who lost their jobs during the pandemic would not be.

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