Sweet Rewards: State and Local Incentives Arrangements

By Marcus Panasewicz, Los Angeles, CA

Editor: Nick Gruidl, CPA, MBT

As economists forecast a recession, businesses continue to look for ways to increase their profits and lower their effective tax rates. States are also looking for innovative ways to keep businesses thriving.

Many state governments and local communities help businesses grow and expand by offering various credits or incentives for routine investments, for workforce training, or for more targeted behaviors, such as locating in an enterprise zone. Forty-five states offer tax incentives for job creation and/or industrial investments, and 47 states offer some type of training assistance for employees.

Credits and incentives come in a variety of flavors. Some credits or incentives are “plain vanilla”—they do not require much interaction between the government and the business. Statutory credits are examples of this type. Other credits and incentives require some distinct involvement from business and/or government. Training grants and incentives are good examples of such distinct involvement. Other incentives require more substantive involvement by many parties. Negotiated incentives require significant effort from both government and businesses.

How Good Is “Plain Vanilla”?

Often the “plain vanilla” credits or incentives are best because they require only moderate interaction between business and government to claim the credits. For example, the California Enterprise Zone (CAEZ) benefits are among some of the most lucrative statutory benefits in the country and are offered to all businesses operating a trade or business within an enterprise zone. If a business is located in one of the state’s 42 enterprise zones, it can receive a tax credit of over $37,400 (over a five-year period, assuming employees work 2,080 hours and make $12 per hour) for each qualified employee it hires, certifies, and retains (Cal. Rev. & Tax. Code §23622.7). Unlike some state credit programs, it is not necessary for the employee to remain employed for the entire five years in order for the company to generate some of the credits. The credit is a function of the number of hours worked and the wage rate paid to the qualified employees for the time they are employed, not exceeding 60 months. In addition, a corporation operating in a CAEZ can generate a tax credit equal to the sales/use tax paid (generally between 7.25% and 8.75%) of the equipment cost to purchase up to $20 million of qualified property. For individuals, estates, trusts, and partnerships, the limitation on qualified purchases is decreased to $1 million of qualified property (Cal. Rev. & Tax. Code §§23612.2 and 17053.70).

With its CAEZ program, California is among many states taking an active approach to helping businesses in distressed areas. In late 2006, California’s Housing and Community Development Department (HCD) designated 23 new enterprise zones (EZs) through-out the state at a time when the program was under heavy scrutiny by the legislature and taxing authorities. HCD plans to designate another eight EZs in early 2008 to head off a gap that otherwise would be created by eight EZs set to expire in the near future. This will keep the number of California EZs at 42—the maximum number authorized by the state.

Incentives That Require Involvement

For years, states have helped companies improve their workforces by funding training incentive programs for their employees. These programs continue to grow in popularity as economic tools for state and local government officials to attract and retain businesses. While training programs differ from state to state, they have several common elements: Training is from the employer’s perspective, its focus is on the well-being of the employees, and its goal is to improve the skills of the workers. Successful training programs improve worker productivity, increase product or service quality, reduce the company’s operating expenses, and enhance the attraction and retention of valued employees.

For companies to benefit from these programs they have to provide training for their employees. Most states require the company to complete a formal application requesting approval of the training being conducted and requesting the state’s financial assistance. Most training incentive programs are for prospective training, meaning that applications have to be completed, submitted, and approved before the training takes place. It is imperative that before a company training initiative is started, an analysis is performed to see if the training qualifies for any benefits under the state’s rules. Financial incentives vary by state, with some imposing caps on the amount of funding per trainee. For example, Colorado’s FIRST and Existing Industry and Customized Training programs limit funding to $800 for any trainee (Colorado Office of Economic Development and International Trade, www.state.co.us/oed/business-development/job-training.cfm). Other states may determine the funding awards on a case-by-case basis.

Negotiated Incentives Offer Best Results

Negotiated incentives require the most work from businesses and state or local government officials; however, the reward can be substantial. Negotiated incentives are becoming more popular as states vie to attract or retain businesses for their communities. Consequently, as businesses have become aware of the value they bring to a community, they have become more incentive savvy. All this interaction makes negotiated incentives lucrative for many companies while providing growth to the states and communities. For example, it is estimated that Alabama’s win over Louisiana to attract the $3.7 billion dollar Thyssen-Krupp Steel manufacturing facility will bring 2,700 new full-time jobs to Alabama once the plant is operating at capacity. In exchange, Alabama granted ThyssenKrupp an incentives package estimated to be valued at more than $400 million dollars, which includes, but is not limited to, tax breaks, utility payment caps, and cash incentives (Alabama Economic Incentive Enhancement Act of 2007 (HB 664)).

In addition to megadeals like Thyssen-Krupp, several states offer a plethora of incentives, including property tax abatements, investment tax credits, sales/use tax exemptions, training grants, and utility tax exemptions or reductions. These incentives often require a great deal of interaction among city council members, top economic development directors, and company officers to assess the value of the business expansion or retention to the community and the business. Incentive negotiations usually take several months to close, so it is imperative to start the negotiation process early and before any final decisions are made or press releases are sent out.

Current Trends

In today’s credit and incentive environment, some trends seem to be emerging that could threaten some types of incentives. First, states are becoming more aggressive in measuring business performance against the incentives awarded. Many states use “clawback” provisions in their incentive agreements, which require the business to pay back all or a portion of the incentives if the business fails to meet the specified employment or investment goals. Second, states such as California have stepped up auditing activities around statutory credits to ensure that the credits are meeting the requirements of the law. Finally, demanding new accounting rules such as FIN 48, Sarbanes-Oxley, and FAS 109 interpretations may eat away at the valuation of those credits and incentives.

Positive trends have also started to emerge. Some states are looking at ways for businesses to capitalize on credits that they generate but otherwise cannot use. Louisiana and New Jersey are among a few states that allow taxpayers to sell unused tax credits to businesses that can use them (La. Rev. Stat. §47:6019(A)(3)(b)(i)(aa); N.J. Rev. Stat. §34:1B-7.42a).

In addition, Indiana, Kansas, Iowa, and Missouri are among several states that offer various refundable credits. Even though Kansas already offers refundable credits, in the January 2008 legislative session its lawmakers plan to discuss the credit issue whereby Kansas corporations have built up more than $400 million in unused high-performance incentive program income tax credits. While the outcome of that session was still unclear at the time this item was written, it is clear those legislators have already started thinking of ways to allow Kansas businesses to utilize these unused credits (Voorhis, “Focuses, Concerns for the Legislative Session,” Wichita Eagle, January 10, 2008).

State credits and incentives are effective ways for companies to combat the increasing costs and changing times ahead. Fortunately, they come in many flavors so businesses can evaluate which type works best for them. Credits are direct offsets to tax liabilities, and incentives can go straight to the bottom line instead of melting away.


EditorNotes

Nick Gruidl, CPA, MBT, Managing Director, National Tax Department, RSM McGladrey, Inc., Minneapolis, MN

Unless otherwise indicated, contributors are members of RSM McGladrey, Inc.

If you would like additional information about these items, contact Mr. Gruidl at (952) 893-7018 or nick.gruidl@rsmi.com.

Newsletter Articles

TAX ACCOUNTING

Should Small Businesses File Form 3115?

Small business taxpayers should be aware of the implications of adopting the tangible property regulations through the small business exception and, especially, that any change to this treatment must be made very soon.

PRACTICE MANAGEMENT

2015 Tax Software Survey

See how nearly 5,000 paid CPA tax preparers rated the strengths and weakness of major tax preparation software products they used in 2015.