Legislation that would exempt federal and state unemployment benefits paid to recipients from state income taxes in 2020 and 2021 cleared the Arkansas Senate Revenue and Taxation Committee on Wednesday.
The Senate tax committee sent Senate Bill 236 by Sen. Jonathan Dismang, R-Searcy, to the Senate for further action.
"We all agree that we're in unprecedented times," he told the Senate tax committee, referring to covid-19.
"None of us expected this pandemic. Our employers didn't expect the layoffs. They didn't expect the shutdown and, in turn, those same employees never anticipated that they would have to rely on unemployment insurance," Dismang said.
Arkansas' unemployment rate had been around 3%-4% prior to the start of the pandemic. The first official covid-19 case was identified March 11. In April, the unemployment rate hit 10.2% as nearly 100,000 Arkansans lost their jobs as businesses shut down or laid off workers.
The state didn't have the ability to withhold state income taxes on unemployment benefit payments, and those payments became more sizable as the federal government added funds to the state's unemployment benefits, Dismang said.
"The result of that is you've got quite a few people that are not familiar with this process, not familiar with the program [and] had not set aside funds, had not prepared to be able to pay state income taxes," Dismang said.
He said some state lawmakers already have received phone calls from people who never claimed unemployment benefits and received a 1099 tax document in the mail.
"This will help assist with that issue. It is just one more large hurdle that would be eliminated as far as the reporting requirements on the state's version of the 1040, but also allow the taxpayers to know what to expect when that filing starts," Dismang said.
The state Department of Finance and Administration projects the bill would reduce state general revenue in fiscal 2021 "somewhere less than $51 million," said Paul Gehring, an assistant revenue commissioner for the department. Fiscal 2021 ends June 30.
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"There is a room in our current surplus to provide for this revenue impact to be built into so we could provide this benefit to all those individuals that were affected by the pandemic," he said. So far in fiscal 2021, the state has a surplus of more than $400 million over what was forecast.
The finance department also projects SB236 would reduce state general revenue by $3.1 million in fiscal 2022. Fiscal 2022 starts July 1.
Afterward, the state's chief economic forecaster, John Shelnutt, said the state's general revenue forecast "assumed the $3 million impact in FY21 and 22, which was built into the forecast prior to the surge in claims, eligibility, and fraud issues.
"The amount was not raised in a forecast context because of concerns about both the collectable amount to use for forecasting in the budget process and timing issues in that collection process divided realistically across fiscal years," he said in a written statement. "This bill only impacts state tax treatment of unemployment benefits reported on [the] 1099 tax document."
The bill would affect more than those who lost their jobs because of the pandemic.
According to the finance department, 1099 tax documents from the state Department of Workforce Services show that $2.6 billion in unemployment benefits were paid to 281,840 individuals in the 2020 tax year.
The finance department said its revenue projection assumes 65% of the recipients of unemployment benefits will file an income tax return, include income totaling $1.7 billion on the taxpayer's 2020 return, and pay a 3% effective tax rate.
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Gehring said, "What that actual number of fraudulent claims were for unemployment [benefits] actually could potentially be we don't know.
"It could be upwards of 25%," he said, "so we certainly had to account for those fraudulent claims that would never received any type of income from because it should not be reported on a return [since] it was not income to that taxpayer."
Gehring said the state began levying state income taxes on unemployment benefits as part of a law enacted in 2017 that also exempted military retirement benefits from state income taxes.
He said an average of slightly more than $100 million in unemployment benefits a year was reported by about 44,000 people on 1099 tax documents from the Department for Workforce Services in tax years 2018 and 2019.
About 65% of the people who received the benefits in tax years 2018 and 2019 reported that income on their returns, Gehring said. The people who didn't report their unemployment benefits on their tax return are subject to an assessment at a later date, he said.
The estimated state income taxes due on unemployment benefits reported on the 2018 income tax returns was $3.2 million and on the 2019 income tax returns was $3.1 million, according to the finance department.
The 2017 law that exempted military retirement benefits from state income taxes also cut the excise tax on soft-drink syrup. To offset the tax cuts, the law increased the 1.5% state sales tax on candy and soft drinks to 6.5%; levied income taxes on unemployment compensation; and imposed a sales tax on certain digital products.
"It was designed to be a general revenue neutral bill in order to fund the $13 million that was needed for a military retirement bill," Gehring said.
He said a bill has been introduced to allow the Department of Workforce Services to have a recipient of unemployment benefits to withhold income taxes on their benefits as they receive them. That bill is House Bill 1049 by Rep. Joe Jett, R-Success, finance department spokesman Scott Hardin said afterward.
Sen. Jason Rapert, R-Conway, said, "It just bothers me because here we have not ever taxed unemployment benefits in our state.
"I think we ought to debate why we would continue to tax unemployment benefits in this state when we had never done so before," he said. "To be quite honest, we never should have started in the first place."