Editor: Mark G. Cook, CPA, MBA
State & Local Taxes
The California Enterprise Zone (EZ) tax credit program was established in 1984 in an effort to stimulate business and industrial growth in economically depressed areas of the state. Through the EZ program, the state legislature declared that it was in the “economic interest of the state to have one strong, combined and business-friendly incentive program to help attract business and industry to the state, to help retain and expand existing state business and industry, and to create increased job opportunities for all Californians” (CA Gov’t Code §7071(b)). By law, California is limited to 42 enterprise zone designations, with each designation lasting for a period of 15 years. The program has undergone many revisions since its inception, primarily aimed at expanding the scope of its reach to businesses operating within EZs, such as the creation of additional categories under which employees may be qualified.
However, with California’s financial crisis, opponents of the EZ program have recently attacked its effectiveness, arguing that certain provisions in California’s tax code are not living up to their expectations. At the forefront of this movement is California state senator and Senate president pro tem Darrel Steinberg (D-Sacramento), the principal author of Senate Bill (S.B.) 974, which seeks to eliminate the use of targeted employment areas (TEA) and retroactive vouchering, along with other modifications that would phase out the EZ in favor of a tax incentive program that focuses on improvement of California’s workforce development for future jobs. This item highlights the proposed changes to the EZ program and the potential impact on taxpayers.
Qualified Employees: TEA Residents
The term “qualified employee” is defined under CA Rev. & Tax. Code Sections 17053.74(b)(4) and 23622.7(b)(4), for purposes of both the personal and corporation income tax, respectively. EZ businesses may qualify their employees under one of the 11 general enumerated target groups, including individuals on public assistance programs, veterans, dislocated workers, ex-offenders, and residents of TEAs. However, S.B. 974 makes a significant change by eliminating the TEA classification.
The current statutes provide that a qualified employee is an individual who, “[i]mmediately preceding the qualified employee’s commencement of employment with the taxpayer, was a resident of a targeted employment area” (CA Rev. & Tax. Code §§17053.74(b)(4)(A)(iv)(IX) and 23622.7(b)(4)(A)(iv)(IX)). The bill seeks to completely remove the TEA as a qualifying criterion. The TEA classification was originally established to promote the hiring of individuals from economically depressed areas. TEAs typically overlap or are contiguous with EZ boundaries. Businesses would be motivated to hire employees from the local EZ or TEA instead of importing individuals from other areas, which would not promote the development of the zone.
Proponents of the bill argue that the TEA designation is ineffective in promoting continual business and industrial development in the targeted areas. The absence of a procedure that would require periodic reevaluations of whether economic growth has occurred within the TEA, making the area no longer economically distressed, would divert limited resources from areas that could otherwise stand to benefit from business investment. The authors of the bill state, “TEA residency allows employers to claim tax credits based solely on where a worker lives and not on any objective measure of whether that individual faces a barrier to employment” (CA Assembly Committee on Jobs, Economic Development, and the Economy, Bill Analysis: S.B. 974, Comments: Author’s Purpose (6/30/10)).
Eliminating the TEA classification would severely restrict the applicability of the EZ program. In practice, the majority of employees who qualify their employers for the tax credit are from TEAs. While S.B. 974 maintains the other target groups intact, the rate at which employees qualify under the other classifications is significantly lower. Moreover, the administrative burden of gathering the data necessary to claim an individual as a qualified employee under the other criteria, as well as the cost of recordkeeping, may discourage employers from pursuing the incentives of the EZ program.
Under the current law, businesses located within an EZ may go back to tax periods still open under the applicable statute of limitation and claim any tax credits under the EZ program to which they were entitled but never claimed. As part of the revisions to the EZ program, S.B. 974 would implement strict deadlines in which to claim any credits. The proposed legislation provides that businesses claiming benefits under the EZ program must file an application for certification with the administering agency within 28 days of the qualified employee’s commencement of employment. Proposed CA Rev. & Tax. Code Section 17053.74(c)(1)(B) explicitly states that “[t]he certifying agency shall not provide a certification for any employee whose employment commenced more than 28 days before the taxpayer requests a certification.” In addition, the business must actually obtain employee certification (i.e., the credit voucher) from the Employment Development Department or other certifying agency within 42 days of the qualified employee’s commencement of employment. This time frame resembles that implemented under the federal Work Opportunity Tax Credit.
The authors of S.B. 974 believe that retroactive credits “simply provide bonuses for past actions, but do not encourage businesses to increase employment in future years and thus do not promote job creation” (CA Assembly Committee on Jobs, Economic Development, and the Economy, Bill Analysis: S.B. 974, Comments: Author’s Purpose (6/30/10)). The new legislation would not only prevent businesses from going back and claiming credits from prior tax years still open under the statute of limitation, but in some cases would also penalize businesses that do not certify an employee within the 28-day period, even if the qualified employee was hired in the current tax year.
S.B. 974 was scheduled to go before the Assembly’s Committee on Jobs, Economic Development, and the Economy on June 30, 2010. However, Senator Steinberg pulled the bill one day before the hearing, and it was not reintroduced for hearing before the California Senate’s final recess on August 31, 2010. As such, the bill has died, and the California Enterprise Zone Program remains intact. However, the state budget crisis that was the impetus for the bill has not gone away, and it remains to be seen whether S.B. 974 will be reintroduced in 2011. The bill poses a significant threat to the EZ program and would undoubtedly restrict businesses from benefiting from the generous tax credits, which in turn may limit businesses’ ability to hire those individuals targeted by the EZ credit.
Mark Cook is a partner at Singer Lewak LLP in Irvine, CA.
For additional information about these items, contact Mr. Cook at (949) 261-8600, ext. 2143, or firstname.lastname@example.org.
Unless otherwise noted, contributors are members of or associated with Singer Lewak LLP.