Practice Notes is a new column by Cara Griffith, who was a legal editor for State Tax Notes before taking a position as a manager with PricewaterhouseCoopers LLP. She is now a freelance writer focusing on how practitioners are addressing state tax issues facing clients.
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In the first installment of this column, which will provide practitioner insight into issues facing taxpayers, the focus is on state and local tax credits and incentives. The article will address what credits and incentives are available, how taxpayers can benefit, pitfalls to be avoided when negotiating packages, and how to address compliance issues. The discussion of whether credits and incentives are beneficial or detrimental to state and local governments will be left for another day. What is important for the current discussion is that tax credits and incentives can benefit businesses, and that despite budget crises in many states, credits and incentives are being used by state and local governments to encourage businesses to relocate within their borders and create jobs. However, while businesses can benefit from lucrative packages, some states are showing a greater propensity to enforce clawback provisions if businesses fail to comply with the terms of the agreement.
There are thousands of state and local tax credit and incentive programs available to taxpayers, in addition to certain federal credits. There are 3,000 to 4,000 state and local credits and incentives available, worth some $60 billion for businesses. There are two basic types of credits and incentives: statutory and negotiated. Statutory credits and incentives, like the name implies, have their basis in a statute or regulation. If a taxpayer meets the qualifications as set forth in law, the taxpayer is eligible to receive the credit. Nicholas A. Nesi, partner and national director of BDO Seidman LLP's State and Local Income Tax Practice, said that because the qualifications are relatively cut and dried, during 2009, "state legislatures had to tighten up the administration of statutory credits and incentives and that trend will likely continue in 2010 and 2011."
One example of a statutory credit is an enterprise zone program. Enterprise zones, known generically as zone-based initiatives, are used in at least 40 states under various names, including Empire Zones, opportunity zones, and economic target areas. The programs are designed to encourage economic development in distressed areas. Enterprise zones have been widely publicized recently because the overriding goal of many states' zone programs is job creation. For example, some states provide tax credits for increased payroll expenditures to firms located in the enterprise zone. States may also focus on increasing local employment by providing incentives to manufacturing facilities or other facilities requiring a large labor pool that relocate to an enterprise zone. Other common incentives provided in some enterprise zone states include income tax credits, job creation tax credits, sales and use tax exclusions, property tax relief, investment tax credits, and tax increment financing.
Although enterprise zone programs are widely used and have been seen as important to economic development in distressed areas, they are being scrutinized by state and local officials. New York's Empire State Development Agency has undertaken a review of all companies that now qualify for benefits under the New York Empire Zone program, Nesi said. If the agency finds that some companies are not in compliance, they will be decertified and will have to appeal to retain benefits.
An additional challenge for taxpayers, said Ali Master, a partner and national director of business incentives and credits, state and local tax, at Ernst & Young LLP, is what he calls the "dual agency problem." In essence, when a taxpayer applies for a credit or incentive, it will typically go to a commerce or economic development department, but the revenue department is often in charge of auditing the tax benefit. So while the commerce or economic development agency may grant a credit or incentive based on one standard, the revenue department may enforce the credit or incentive based on another, often higher, standard.
Negotiated credits are granted on an ad hoc basis. Nesi said that negotiated credits are provided to companies with the right credentials -- that is, they are in the type of industry the state or locality is seeking to attract, and they have the ability to create measurable jobs and investment. "To a certain degree," he said, "the availability of negotiated credits is increasing, not necessarily in terms of the total number of credits and incentives available, but in terms of the potential magnitude of dollars available to targeted taxpayers."
For example, NCR Corp. recently received $60 million from Georgia, under the state's new mega job tax credit. NCR manufactures ATMs, cash registers, and retail self-checkout machines. In return for Georgia's generosity, NCR is moving its headquarters to the state and is building a new manufacturing facility there. NCR is expected to invest $30 million in the project and create a significant number of jobs. Annual payroll for new jobs in the state is expected to reach $150 million.
It's easier to address noncompliance with negotiated credits than with statutory credits. For statutory credits, there is little room to maneuver (the law is the law, and the revenue department is generally not authorized to change it). For negotiated credits, "if a company discusses candidly a change in circumstances, it is possible to get a change in terms and conditions," said Nesi. For example, in the economic downturn, many companies found that they were unable to create jobs and were fortunate to retain the jobs they had. If approached early, some states were willing to extend deadlines or modify the negotiated credit and incentive agreements, Nesi said.
The idea of going green has taken the nation by storm. Both governments and businesses have jumped on the bandwagon. For the federal and state governments, the lure of being green is based on the alleged environmental impact of energy use as well as a desire for less dependence on foreign oil. For businesses that are trying to exhibit solid corporate citizenship, being green can be a visible measuring stick for energy-conscious consumers. During 2009 the federal government, largely through the American Recovery and Reinvestment Act of 2009, became much more involved in driving the green agenda, said Master. To foster a green corporate culture, the federal and state governments have implemented a number of tax credits and incentives that reward green behavior such as the production and use of energy from renewable sources.
Many state governments offer incentives to promote renewable energy. Those incentives include corporate income tax deductions, exemptions, and credits, as well as property tax abatements and exemptions and sales tax exemptions and refunds. Also, some states are offering grant and rebate programs to businesses using and providing renewable energy. States are also encouraging energy efficiency, often through credits and incentives that reward a business for constructing energy-efficient buildings or renovating existing buildings to be more energy efficient. For example, if a building project is Leadership in Energy and Environmental Design (LEED) certified, meaning it meets the highest green building and performance standards, it may be entitled to significant tax benefits at the federal, state, and local levels.
Although energy and green credits seem to be the rage, it is questionable how valuable they are to companies outside the energy industry. Hartley Powell, a principal with KPMG LLP, said that most taxpayers will not qualify for energy credits and even if they might, they may not be in a locality that offers an applicable credit. For example, even if a company has obtained LEED certification for a building project, it will receive some benefits, such as a property tax abatement, only if the project is in a locality that offers the benefit. As a result, taxpayers must not only have undertaken the right project, but must also be in the right locality. In many cases, "the stars have to align," Powell said.
Nonetheless, that shouldn't deter companies from trying to obtain benefits when they are available. In particular, for businesses in the construction, manufacturing and distributing, retail, health, and hospitality industries, for which an expansion could include the construction of a new building or the renovation of an existing building, energy credits are a possibility and can mean significant dollar savings.
Effects of Budgets and Legislative Calendars on Incentive Negotiations
As noted above, although there are still a substantial number of credits and incentives available to taxpayers, state and local governments will face difficulties balancing their budgets this year. That will present a conflict for officials because every dollar of revenue is important, but job creation and investment are equally important. The result, said Master, is that there will be greater scrutiny on state and local credits and incentives, and companies should expect more jurisdictions to exercise the clawback provision in their incentive agreement.
States want to be sure they are getting results for sacrificed tax revenue, and they do not want to be accused of providing corporate welfare. For example, Ohio is looking at each of its tax credits to determine how much each credit and incentive costs versus how much it is bringing the state in jobs and investment.
For discretionary credits, Master said, "timing matters." For some credits and incentives that require preapproval, it can be difficult for local officials to award a package if the project has already been announced publicly. "It is wise for companies that are looking to expand to approach the appropriate economic development, commerce, or energy department and begin the process as early as possible," said Master. Companies also need to be realistic in what they negotiate and should refrain from overselling. "It is better to exceed goals," said Powell, as state and local governments have a lot riding on credits and incentives.
Powell said the push for cash is another trend in state and local tax credits and incentives. When companies are expanding or relocating their operations, "cash is king," said Powell. Approximately 29 states offer some type of cash incentive -- for example, an assignment of credits to subsidiaries, the ability to offset employment tax rather than corporate income tax, or a refund. That is beneficial for companies that received tax credits but were unable to use them. In some instances, because of the economic downturn or other business issues, companies showed losses and hence owed no corporate income tax. If they received a corporate income tax credit, that credit would go unused.
In other instances, as a result of a state's adoption of single-sales-factor apportionment, companies owe significantly less corporate income tax. Again, if they received a sizable corporate income tax credit, much of the credit would go unused. States to some extent have addressed that issue -- whether through a payroll or withholding tax refund or a reward for creating a specific number or type of jobs, states are attempting to ensure that companies are able to use the credits and incentives they have been granted. A cautionary note, however, for cash-type incentives: Elections must be made early.
In response to public concern over the length of the recession and the handling of public funds, many states have reportedly become aggressive in including and enforcing clawback provisions in tax credit and incentive packages. In essence, a clawback provision permits state officials to rescind the benefits of the deal if the business doesn't uphold its end of the bargain. Although enforcement of clawbacks depends largely on the state, with some states more aggressive than others, businesses should not assume that if they will be unable to meet the terms of the agreement, they will lose all the benefits.
Master said that if a company negotiates a credit or incentive on the basis that it will create a specific number of jobs and then finds that circumstances have changed and it will be unable to meet that goal, it might walk away. But while renegotiation of the benefit will be harder in the current environment than in the past, it is possible. "States don't want the deal to look like a failure any more than the company does," Master said, particularly if the state made a prominent announcement of the deal and the jobs that were expected to be created in the state.
Powell likewise said, "The pushback from states is a bit of form over substance. States will watch their dollars, but they want to work with companies to get jobs and investment inside their borders. And as a result, states will work with businesses on compliance with and the terms of the package, provided companies approach them early."
Although tax credits and incentives should not be the first consideration when a business decides to expand, they can be a valuable consideration at the end of the process to determine which of several viable sites is the most cost effective. Businesses should not assume that in difficult economic times, credits and incentives are off the table. "While there is a lot of hype surrounding budgets, states are willing to put good deals on the table for companies that can provide good jobs and good investments in the state," Powell said. Thus, there may be no better time than now to engage in "onshoring."
That is, companies should look first in the United States before moving jobs offshore. States, desperate in many cases to put people to work, might be willing to put a package together that can make it economically viable for a company to create or retain jobs in the United States.
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