The general welfare exclusion or GWE, a little known administrative exception, exempts from a recipient’s taxable income most payments from government agencies under legislatively-provided social programs that promote general welfare, like the recently issued Economic Impact Payments of 2020 that were issued under the Coronavirus Aid, Relief and Economic Security (CARES) Act1..
To qualify under this exception, an exempt payment must (1) be made from a government fund, (2) be made for the promotion of general welfare (ie. generally based upon individual or family needs), and (3) not represent compensation for any services rendered.
Regarding similar payments made to businesses, like grants or the payments provided under the Cares Act’s (SBA) Paycheck Protection Program, it has been stated that these payments generally do not qualify for the general welfare exclusion, because they are not based upon individual or family needs. Payments issued under the SBA's PPP program, for example, have been earmarked as loans, giving the recipient the ability to request loan forgiveness under SBA and IRS strict procedures.
In April, 2020, the IRS issued Notice 2020-32 and ruled that forgiven PPP loans may be excluded from gross income by an eligible recipient by the Coronavirus Aid, Relief, and Economic Security (CARES) Act. However, it stated that any expenses associated with this tax-free income (eg. the forgiven loans) would not be deductible. In May, to assist in clarifying its position, the IRS issued Notice 2020-32, providing 2 examples stating that a taxpayer that receives a loan through the PPP is not permitted to deduct expenses that are normally deductible under the Code to the extent the payment of those expenses results in loan forgiveness under the CARES Act. This expense treatment is consistent with historic guidance regarding non-taxable income and any related expenses. In essence, it has the net effect of essentially reversing the tax-free benefit of the exclusion on any loan forgiveness.
And based upon the SBA's loan forgiveness application process, it could be well into 2021 until a borrower knows how much of their loan is forgiven. The question then becomes whether the forgiveness of the loan increases taxable income in 2020 when the proceeds are received and expenses are incurred or in 2021, when the borrower receives confirmation their loan is forgiven. There’s was also the question of whether the ultimate tax treatment of these income and expense items will match a business's financial statements prepared under generally accepted accounting principles (GAAP). All of the answers to these questions appear to have been clarified in Notice 2020-32.
It is not clear whether or not the SBA loans will be taxable for state tax purposes. And to further complicate matters, "state-sponsored" program grants issued during the pandemic that are generally taxable for federal income tax purposes may or may not be taxable for state tax purposes. You will need to check with your state revenue agencies to get an answer to that question.
Note 1 - Because the individual is getting what amounts to a refundable tax credit in advance in the form of a stimulus payment, rather than waiting to get the money from the credit provided in 2021 (for 2020) when he or she actually files a 2020 tax return, he or she, in effect, is getting an advanced refundable tax credit. If, for some reason, that individual doesn’t get any stimulus payment this year, but he or she is owed one, he or she can request it when filing a 2020 tax return. If they don't get the full amount that they were entitled to this year — say, they weren't able to get the $500 payment for an eligible child under 17 — they should be able to request it once they file a 2020 tax return in early 2021. What if it turns out that the stimulus payment was more than that allowed? For example, suppose the IRS based a stimulus payment on a 2018 or 2019 tax return, when the income reported was lower, but the actual income is much higher for 2020? “If someone has income in 2020 that is higher than the tax return to calculate the advance rebate, they will not have to pay the credit back,” says Garrett Watson, senior tax policy analyst for the Tax Foundation, an independent, nonprofit tax policy organization. “In other words, any adjustments to a taxpayer's rebate on 2020 tax returns will be in the taxpayer's favor."