Gov. Janet Mills is proposing to extend a tax break on Paycheck Protection Program loan proceeds that would benefit smaller borrowers but exclude full relief for the largest loans.

Under the plan, borrowers could receive a double benefit on the first $1 million received under the federal program because it would not be taxed as revenue and could be deducted as business expenses. It would cover nearly all PPP loan recipients in the state, including the vast majority of small employers.

In a news release, Mills said the compromise struck a middle ground between opponents of conforming to the federal tax code to provide full tax exemption for the loans and those who support a tax benefit for all employers that received loans. It also would direct the biggest benefit to small companies and nonprofits struck hard by the coronavirus pandemic last year and still struggling in a tough economy.

“We recognize the incredible hardships these businesses have endured and, as we have throughout this pandemic, we want to ease their burdens and allow them to stay open and keep people employed,” Mills said in a statement. “With this proposal, we are matching the measure enacted by the Congress in late December to deliver full tax relief to 99 percent of Maine businesses that received PPP in order to do the most good for the most businesses and the most employees.”

Under current state rules, the proceeds from forgiven Paycheck Protection Program loans are taxable, but businesses can deduct expenses paid with that revenue. But a change to federal law in December extended a double tax benefit to loan recipients, wherein PPP revenue is not considered taxable income and expenses paid with loan proceeds can be deducted, effectively treating the income as a net loss on employers’ balance sheets.

Loan revenue over $1 million would still be subject to Maine state tax, but if a business deducts its expenses from the revenue, it will be tax neutral.

If the double benefit were extended to all borrowers, it would have cost at least $100 million in state tax revenue, the Mills administration said last month. The updated proposal would cost the state about $82 million. The Mills administration plans to cover part of that loss with $61 million in savings from pandemic cutbacks the state proposed to add to its rainy day fund, said Kelsey Goldsmith, director of communications for the state Department of Administrative and Financial Services.

“It is all money that was set aside as a result of frugality measures at the onset of the pandemic,” Goldsmith said. “Instead of being used for other purposes, it is being used for this purpose.”

Another $20 million is available in cost savings from higher federal Medicaid reimbursement rates, she said. The governor’s compromise would be included in a supplemental budget lawmakers need to pass.

At least one pro-business group that earlier pushed for Maine to mirror the federal double benefit for all loan recipients applauded Mill’s compromise.

“We commend Gov. Mills and her administration for their work to find a solution to this problem,” David Clough, state director for the National Federation of Independent Business, said in remarks included in the news release from the governor’s office. “Her revised Paycheck Protection Program tax conformity proposal would be a tremendous relief to the thousands of small businesses that utilized this vital federal lifeline to keep their doors open, employees working and customers able to get their needs met locally.”

Maine employers received more than 28,000 PPP loans worth almost $2.3 billion in 2020. The parent company of the Portland Press Herald received a loan of more than $3.8 million to pay almost 300 workers.

The program provided employers with up to 500 workers loans that would be forgiven – converted into grants – if they followed lending rules such as spending most of the money to pay workers and avoid layoffs.

Loan amounts were pegged to employers’ payroll, not their demonstrated financial need, so big companies with well-paid employees received larger loans than small companies with fewer, lower-paid employees. Many law firms, medical offices, construction companies and others that received huge PPP loans stabilized and recovered from the pandemic-triggered economic shock last spring, while many small employers – particularly hospitality, retail and entertainment businesses – received smaller loans and experienced huge revenue losses and layoffs.

According to the state, the tax proposal would give a double tax benefit to almost 27,700 businesses, the vast majority of paycheck loan recipients. Just 251 employers would not receive the exemption on the full amount of their forgiven PPP loan.

Garret Martin, executive director of the Maine Center for Economic Policy, said the governor’s proposal creates a tax loophole and costs state revenue that could be better spent on public health, schools or struggling Maine families. Businesses can already write off grant revenue on payroll and other legitimate expenses for a tax break, he said.

“Allowing businesses to claim another tax cut on the same funds would set a horrible precedent for tax policy in Maine,” Martin said. “Given the challenges that lie ahead and continued underinvestment in Maine’s schools, people and communities, Maine can ill-afford the PPP double tax cut.”

The Maine Society of Certified Public Accounts, in a statement, supported full federal conformity because it makes tax filing easier, but recognized the federal PPP treatment raised unique challenges, and that the governor’s proposal would give nearly all recipients the full tax benefit.

“We appreciate the governor and her team’s ability to find a compromise that helps the majority of taxpayers,” the statement reads.

Many states already have passed laws that conform their taxes to the federal standard, including 21 that do so automatically, according to the Tax Foundation. California, Indiana and Ohio are among states that voted to give PPP loans a double tax benefit, while Wisconsin will not tax the loans but also will not allow businesses to deduct expenses paid with loan proceeds, said Janelle Cammenga, a Tax Foundation policy analyst. So far, Maine is the only state that has set an income threshold for receiving the double benefit, Cammenga said.

“Maine’s approach to partially exclude those benefits is unique among states,” she said.

But creating a $1 million cutoff for the tax exemption “has no real connection to ability to pay,” Cammenga added.

“(The program) is about keeping businesses open and keeping people employed,” she said. “Larger loans went to businesses with more employees, expenses and needs. It doesn’t make sense to arbitrarily cut things off at $1 million.”

Lawmakers on the state Legislature’s Taxation Committee on Tuesday sent a tax conformity report to the Appropriations Committee that was mostly split along party lines, with Democrats advocating for Mills’ proposal and Republicans urging full conformity with federal rules.