Empowerment Zone Tax Incentives

Tax Credits (download this pdf document)
• Reduces federal tax liability of business – if a business owes $50,000 in federal taxes and has 17 employees that qualify for the full $3,000 EZ employment credit, the business would owe no taxes and would have $1,000 credit to carry forward or back.
• Credits are “nonrefundable” – if a business does not owe any federal taxes in the year the credit is earned, the business does not get a refund of the credit amount.
• Unused credits (credits exceeding tax liability) can be carried forward 20 years (and back 1 year, generally).

Expensing
• General tax rule that expense of asset with economic life greater than 1 year is spread out over life of asset.
• Taxpayer would rather reduce income in the year the asset was purchased.
• Expensing or accelerated depreciation reduces taxable income, which ultimately reduces federal tax liability.
• If expenses greater than income in a taxable year, various ways of carrying over losses depending on activity and status of taxpayer.
• Benefit of expensing depends on marginal tax rate and other specific tax attributes of taxpayer.

Bond Financing
• Tax benefit is taken by the holder of the tax-exempt bond who does not pay income tax on interest income it receives.
• Financial benefit to business borrower of lower interest cost.
• Public/private partnership in that bonds must be issued by state or local government.

Capital Gains
• Income and losses related to the sale of capital assets.
• Capital losses netted against capital gains, so timing of gain and loss can be important.
• Incentives relate to tax on appreciation in property only so if not expected to be worth more, incentive not important.
• Minimum holding periods to take advantage of incentive may tie up investments.

EMPOWERMENT ZONE EMPLOYMENT TAX CREDIT
Eligible Business
• Any business with qualified employee who performs services in the EZ.
• Credit available for portion of time the employee performs services in the EZ.
• Example: Construction worker performs services in EZ for part of year – take credit based on pay period or portion of year.

Qualified Employees
• Any employee who resides in the EZ.
• Credit for new-hires and existing employees.
• Credit for full-time or part-time after employed minimum of 90 days.
• Does not include: 5% owner, relatives of employer, employees of certain businesses (gambling establishments, golf course, country club, liquor store, massage parlor, suntan facility, certain farms).

Credit Calculation
• Percentage of wages paid or incurred for any calendar year = 20%.
• Qualifying wages limit per calendar year = $15,000.
• Use FUTA definition of wages.
• Credit available through December 31, 2009.

WORK OPPORTUNITY TAX CREDIT
WELFARE TO WORK TAX CREDIT
Qualifying Employees
• EZ youth category. Youth at least 18 years old and not older than 24 years (on the hiring date) who resides in a EZ.
• EZ youth category. Youth at least 16 years old but not 18 on the hiring date who resides in EZ and who performs services for the employer in the summer (between May 1 and September 15).
• Must be new hire.
• Expires for employees who begin work after December 31, 2003.

Credit Amount
• The chart shows the credit amount, which is based on the number of hours the new hire works for the employer.

• Enhanced credit for long-term welfare recipient (regardless of where employee resides)

Credit Procedures
- The employer must get a certification from the state employment security agency (SESA) that the new hire is a member of a “targeted group.” To receive certification, the employer must either:
- Receive the certification by the day the individual begins work, or

• Do both of the following:

- Complete IRS Form 8850 by the day individual is offered a job, and
- Submit the form to the SES

• Youth may be “pre-certified” to shorten process

ENTERPRISE ZONE BUSINESS DEFINITION
Business Operational Requirements

Any corporation, partnership or sole proprietorship that meets the following requirements for the taxable year
• every trade or business is the active conduct of a qualified business within the EZ.
• at least 50% of business income is derived from the active conduct of a trade or business within the EZ.
• a substantial portion of the use of the tangible property (owned or leased) of the business is within the EZ.
• a substantial portion of the intangible property of the business is used in the active conduct of business in the EZ.
• a substantial portion of services performed for the business by its employees is performed in the EZ.
• at least 35% of the employees are residents of the EZ.
• less than 5% of the average of aggregate adjusted bases of the property of the business is attributable to collectibles (art work, wine, antiques) other than collectibles held primarily for sale to customers in the ordinary course of business.
• less than 5% of the average of the aggregate adjusted bases of the property of the business is attributable to “nonqualified financial property” (debt, stock, partnership interests, options, futures contracts) other than reasonable amounts of working capital held in cash, cash equivalents or debt instruments with a term of no more than 18 months).

Definition of “Qualified Business”
Any trade or business other than:
• business predominately involved in the development or holding of intangibles for sale or license (such as software).
• rental of commercial real estate unless at least 50% of gross rental income is from EZ businesses.
• the rental of residential real estate.
• the rental of tangible personal property unless at least 50% of rentals are to EZ businesses or EZ residents.
• country clubs
• massage parlors
• hot tubs
• racetracks
• health clubs
• stores the principal business of which is the sale of alcoholic beverages for consumption off premises.
• Farming unless the aggregate unadjusted bases of the assets owned or leased by the taxpayer which are used in the trade or business of farming are less than $500,000 as of the close of the taxable year.

TAX INCENTIVES REQUIRING
EZ BUSINESS
• Increased Section 179 Expensing
• Tax–exempt Bonds
• Nonrecognition of Gain on Sale of Empowerment Zone Assets
• Partial Exclusion of Gain on Sale of Empowerment Zone Stock

EXPENSING
• Section 179 of Internal Revenue Code allows election to deduct cost of personal property in the year the property is placed in service, up to specified limit.
• Expensing limit is increased by up to $35,000 for Qualified Zone Property (QZP) after December 31, 2001.
• Expensing Allowance/QZP Allowance

• Investment Limit - each dollar over $200,000 reduces expensing by $1
Each dollar over $200,000 for QZP/QRP reduces expensing by $0.50
• Recapture- If a business fails to meet the EZ business definition or if the property is no longer used in the Zone.

EXAMPLE
Two businesses, A meets the definition of EZ, Business B does not.
Year 1 - Both buy $60,000 in equipment
Year 2 - Both buy $300,000 in equipment

QUALIFIED ZONE PROPERTY
Tangible personal property of a taxpayer where all of the following are true:
1). The taxpayer acquired the property after the EZ designation is in effect.
2.) The taxpayer was the first person to use the property in the EZ or property is substantially renovated (100% of basis or $5,000 if greater) with 24-month period.
3.) At least 85% of the property’s use is in the EZ and in the active conduct of a qualified trade or business of an EZ business.
4.) The taxpayer did not acquire the property from a related person or member of a controlled group of which the taxpayer is a member.

ENVIRONMENTAL CLEANUP COST DEDUCTION
Deduction preferable to depreciation. The business can elect to deduct “qualified environmental cleanup costs” that are contaminated with hazardous substances in the tax year the business pays or incurs the cost. The business does not have to be an EZ business to qualify for this deduction.
• Time limitation. This special tax treatment is generally available for qualified environmental cleanup costs paid or incurred after August 5, 1997, and before January 1, 2004.

Recapture. The deduction may have to be recaptured as ordinary income under §1254 of the Code when it is sold or otherwise disposed of.
• Qualified environmental cleanup costs. Qualified environmental cleanup costs are generally costs paid or incurred to abate or control a hazardous substance (as defined by Internal Revenue Code section 198(d)) at a “qualified contaminated site.”

• Qualified contaminated site. A qualified contaminated site must meet all of the following requirements.
- The business holds it for use in a trade or business, for the production of income, or as inventory.
- There has been a release or threat of release of a hazardous substance at or on the site.

The business must get a statement from the designated state environmental agency that the site meets requirements.

A TAX-EXEMPT BOND TRANSACTION

Investors in the Public Market		Sells	State/Local Government Issuer	Lends	Enterprise Zone Business
		Bonds (Debt) Through Underwriter		Bond Proceeds

		Purchase		Makes
		Price to Issuer		Loan Payments

	Issuer Passes Through
	Loan Payments to Trustee

Technical Steps, Documents, Players
• Private business meeting definition of Enterprise Zone Business makes application to State or Local Government Issuer.
• Issuer reviews and approves financing after a published notice and public hearing.
• Issuer enters into bond purchase agreement with underwriter or placement agent (investment banking firm).
• Underwriter, EZ business and issuer prepare securities offering document for the bonds, describing the terms of the bonds, the project to be financed, the security for repayment of the bonds.
• Legal counsel specializing in federal tax laws related to municipal bonds review transaction and deliver opinion to purchasers of bonds that interest income the bond purchaser receives will be exempt from federal income tax (and usually also from state and local income taxes of the Issuer’s state).
• Investor is willing to charge a lower interest rate for the Issuer’s debt because the interest income is exempt (investor gets higher return).
• Underwriter sells the Issuer’s bonds in the public debt market based on the credit of the EZ business (or a letter of credit bank).
• Issuer enters into a loan agreement with the EZ business to lend the money from the sale of the bonds to the EZ business.
• Issuer passes on lower rate to EZ business on the Issuer’s loan, but Issuer may charge the EZ business an up-front or continuing fee for its debt program.
• Loan Agreement will have financial and tax covenants the EZ company must comply with throughout the term of the bonds. Financial covenants will be based on what the Underwriter believes are necessary to sell the Issuer’s bonds to the public.
• Issuer enters into Trust Indenture with a trustee bank to carry out the Issuer’s obligations to the investors.
• EZ business requisitions money from Trustee to pay costs of the project
• EZ business makes loan payments to the Trustee, who passes the payments on to bondholders.

TIME PERIOD FOR MEETING
ENTERPRISE ZONE BUSINESS DEFINITION
Start-Up Period
• Borrowers are allowed up to 2 years after the later of the date the bonds are issued or the date the financed property is placed in service to come into compliance with enterprise zone business requirements.
• To qualify for the start-up period, the borrower must expect to meet the tests by the end of the start-up period.

Test Period
• The requirements for being an enterprise zone business (other than the resident employee requirement) must be met only for the first three taxable years beginning after the start-up period.
• In addition, throughout the zone designation period or average term of the bonds, if less, the following requirements must be met:
• The business must be a “qualified business”
• At least 35% of the employees of the business are residents of the Zone.

For tax-exempt financing purposes only, a business may meet the business definition by treating its business operations in the EZ as separately incorporated (for example, the EZ store of a national chain could apply the tests to the EZ operations only).

What Can Be Financed
• acquiring land (limited to an amount related to the needs of the business)
• constructing a new facility
• acquiring an existing building if the building is renovated in an amount equal to 15% of building purchase price
• rehabilitating an existing facility
• expanding an existing facility
• acquiring new equipment
• acquiring used equipment that has not previously been used in the EZ
• acquiring a building abandoned prior to EZ designation

Limit on the Principal Amount of Bonds Issued During Zone Designation Period
Rural Zones                         $60 million
Urban Zones (Zone            $130 million
population 100,000
or less)
Urban Zone (Zone             $230 million
population greater
than 100,000)

• No limit per borrower in EZ: $3 million per borrower limit in EC and subject to state private activity bond volume cap.

NONRECOGNITION OF GAIN ON SALE
OF EMPOWERMENT ZONE ASSETS
Postpone gain on selling empowerment Zone assets (EZA by rolling over gain to replacement EZA

Eligible Assets
• Stock in EZ business corporation acquired by taxpayer at original issuance from the corporation solely in exchange for cash after December 21, 2000 and before January 1, 2010.
• Capital or profits interest in EZ business partnership acquired by taxpayer at original issuance from partnership solely in exchange for cash after December 21, 2000 and before January 1, 2010.
• Tangible property used by EZ business purchased after December 21, 2000 and before January 1, 2010.
• If real property or intangible asset, must be integral part of EZ business.

Holding Period
• Asset must be held for at least 1 year.
• Business must remain EZ business for holding period.

Amount Rolled Over
• Amount realized from sale to the extent it does not exceed the cost of a replacement Empowerment Zone Asset.
• Replacement asset must be purchased within 60 days.
• Example: Taxpayer buys stock in EZ business for $100 and sells stock 2 years later for $150 for a gain of $50. Taxpayer buys new stock in another EZ business for $60 within 60 days. Taxpayer does not have to pay capital gain on $50 of gain.
• Gain on replacement asset can also be rolled over if otherwise meets requirement and is held for at least one year.

PARTIAL EXCLUSION OF GAIN ON
SALE OF EMPOWERMENT ZONE STOCK
Qualified Stock
• Must be stock in a small business corporation with gross assets of $50 million or less (gross assets = cash and property over indebtedness).
• Stock must be purchased upon original issuance by corporation after December 21, 2000.
• Corporation must meet requirements of EZ business when stock purchased or be formed for purpose of meeting requirements.

Holding Period
• Must hold stock for at least 5 years.
• Corporation must be EZ business for substantially all of the holding period.

Amount of Gain Excluded
• Exclude 60% of gain on sale or exchange of stock.
• Overall limit on excluded gain of 10 times the basis in the stock or $10 million gain from stock in that corporation.
• Gain after December 31, 2014 not eligible for partial exclusion.

NEW MARKETS TAX CREDIT
Investor Benefits
• Credit against federal taxes equal to 5% of the cash used to purchase stock or partnership interest in a Qualified Community Development Entity that has received a credit allocation from U.S. Treasury (Credit “QCDE”).
• Credit equal to 5% on 1st and 2nd anniversary date, 6% credit for 3rd through 6th anniversary dates.
• Example for $1,000,000 investment made 1/2/03 and held for full 7 credit dates.

• In addition to credit, investor would get return on stock or partnership interest in QCDE.
• If investor sells the investment, new investor can receive remaining benefit of credit.

Credit QCDE
• Must be a for-profit entity which is selling stock or partnership interest to investor for cash.
• Must receive an allocation of NMTC from U.S. Treasury Department and must allocate credit to investors within 5 years of receiving allocation from Treasury.
• Must have a primary mission of serving low income communities (20% poverty level / 80% of statewide median family income) and be accountable to low income community.
• Once receives cash from investor, Credit QCDE must use 85% of invested funds for
Qualified Investments.

Qualified Investments
Investors funds must be used by the Credit QCDE for the following purposes:

• Make loans to qualified active low income community businesses (“Qualified Businesses”)
• Make equity investments in Qualified Businesses
• Purchase loans made by a QCDE (nonprofit or for profit) to Qualified Businesses
•Make equity investment in a QCDE that in turn makes Qualified Investments
• Make a loan to a QCDE that in turn makes Qualified Investments
• Provide financial counseling to businesses and residents of low income communities

Qualified Businesses
• Same definition as EZ or RC Business, except eliminate the requirement that 35% of employees be residents and no restrictions on tenants of commercial buildings
• Assistance to business can be for working capital or capital expenses and can be in form of equity or loan
• Qualified Business can get loan from Credit QCDE or QCDE that has received loan or equity investment from Credit QCDE

Other Tax Implications
• Recapture of credit if Credit QCDE does not maintain Qualified Investments.
• Credit reduces basis of stock or partnership interest for purposes of calculating gain on sale.
• Credit cannot be taken against alternative minimum tax (AMT).