COVID-19 Update, Federal COVID-19 Relief Legislation

CalTax Asks U.S. Treasury Secretary for Formal Guidance on New Federal Law’s Effect on State Tax Reductions

janet yellen

CalTax and 16 other state taxpayer associations sent a letter to U.S. Treasury Secretary Janet Yellen on March 17 asking for guidelines to clarify provisions of the American Rescue Plan Act – the federal COVID-relief law that includes a provision restricting tax reductions by states that accept relief funds.

The law, signed by President Joe Biden on March 11, provides approximately $350 billion to state and local governments to mitigate the economic impact of the pandemic. Section 602(c)(2)(A) restricts states from using the funds “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.”

The law does not define “indirectly offset,” but authorizes Yellen to write regulations “as may be necessary or appropriate” to implement the legislation.

While the U.S. Treasury Department this week indicated that states can cut taxes without penalty as long as they use their own funds to offset the cuts, the CalTax letter asks Yellen to issue formal guidance to provide clarity on how the law will be interpreted and enforced.

“Since there could be many reasonable interpretations of the language … further guidance is essential,” the letter states.

The tax-reduction provision would be in effect through 2024. The legislation requires states to provide the Biden administration a “detailed accounting” of the use of funds and any changes to tax revenue sources during the relevant time period.

California is not considering any broad-based tax reductions, but the federal law raised uncertainty as to whether certain conformity items pending before the Legislature, or efforts to restore the net operating loss deduction and tax credits suspended in the 2020-21 budget, would be considered a revenue reduction.

California lawmakers are considering a number of bills that could meet an expansive definition of a “tax reduction,” including Paycheck Protection Program loan conformity (AB 80, Burke), restoration of certain business tax credits suspended in 2020 (AB 593, Petrie-Norris), health savings account conformity (AB 727, Choi), and others.

Ohio Attorney General Dave Yost on March 17 asked a federal judge to block the tax-cut provision. Attorneys general from 21 other states wrote to Yellen seeking clarification, noting that the provision in question could be construed “to deny states the ability to cut taxes in any manner whatsoever.” Yost said he sued because “the federal government should be encouraging states to innovate and grow business, not holding vital relief funding hostage to its preferred pro-tax policies.”

A Treasury Department spokesperson said the provision isn’t meant as a blanket prohibition on tax cuts, The Associated Press reported March 17.

“States are free to make policy decisions to cut taxes – they just cannot use the pandemic relief funds to pay for those tax cuts,” the Treasury Department spokesperson said.