Empowerment zones, enterprise communities, and rural development investment areas. (State & Local Taxation)by James, Jeffrey K.
Special tax incentives will be provided for up to nine empowerment zones and 95 enterprise communities to be designated during 1994 and 1995 from qualifying areas nominated by state and local governments. These designated areas will remain in effect for 10 years or until the date designated in the nominated document.
Qualified businesses operating in these enterprise communities and empowerment zones will be eligible to finance property with a new category of exempt facility private activity bonds. This is the only incentive available to enterprise communities. Two additional incentives will be available to empowerment zones. Specifically, a qualifying business will be able to expense up to an additional $20,000 under IRC Sec. 179, and employers will be entitled to a 20% credit on the first $15,000 of wages paid to certain zone employees.
The Secretary of Housing and Urban Development will be responsible for designating six empowerment zones and 65 enterprise communities in urban areas. If six urban zones are designated, at least one will be located in an urban area in which the most populous city has a population of 500,000 or less. Additionally, at least one urban zone must be located in at least two states.
The Secretary of Agriculture will designate three empowerment zones and 30 enterprise communities in eligible rural areas. Congress intends for the IRS to promulgate regulations regarding selection.
All areas nominated for designation as an empowerment zone or enterprise community must meet eligibility criteria in population, general distress, area size, and poverty rate.
The first step in the application process is for the local and state governments in which the area is located to submit a strategic plan that demonstrates the nominated area satisfies the eligibility criteria and details how the empowerment goals will be attained. The strategic plan must describe the coordinated economic, human, community, and physical development plan and related activities proposed for the nominated area; describe how the affected community is a full partner in related activities proposed for the nominated area; and identify the amount of state, local, and private resources that will be available in the nominated area and the public/private partnerships to be used.
The plan must also identify the funding requested under any Federal program in support of the economic, human, community, and physical development and related activities and identify baselines, methods, and benchmarks for measuring the success of the plan. Finally, the plan may not include any action to assist any establishment in relocating from an area outside the nominated area to the nominated area. However, assistance for the expansion of an existing business entity through the establishment of a new branch, affiliate or subsidiary is permitted under certain conditions.
The Tax Credit
Generally, a 20% credit against income tax liability is available to all employers for the first $15,000 of qualified wages paid to full or part time qualified zone employees who are residents of the empowerment zone and who perform substantially all their employment services within the zone in the employer's trade or business for at least 90 days. The maximum credit per employee is $3,000 per year.
The credit will be phased out beginning in 2002. An employer is entitled to a 20% credit during calendar years 1994-2001, a 15% credit for wages paid during 2002, a 10% credit during 2003, and a five percent credit during 2004.
Wages include salary and wages as defined under FUTA purposes, training and educational expenses paid on behalf of the employees who would be excludable under the Code Sec. 127 educational assistance program provision, or, if the employee is under the age of 19, the expenses incurred by the employer in operating a youth training program in conjunction with local officials. Wages do not include the amount paid to family members, partners/shareholders owning more than 10% of the capital or profit interest, or, if the employer is a corporation or partnership, certain relatives of the person who owns more than 50% of the business.
Qualified wages do not include amounts taken into account in determining the targeted job tax credit under Code Section 51.
The empowerment zone employment credit will be included as part of the general business credit allowable under IRC Sec. 38. No unused portion of the credit may be carried back to any tax year ending before January 1, 1994. However, like the targeted job tax credit, an amount disallowed as a credit is allowed as a deduction for the first tax year following the last year for which the credit could, under IRC Sec. 39, have been allowed as a credit. Also, just like the targeted job tax credit, the deduction the employer would normally be allowed for wages is reduced by the amount of the credit claimed for the year.
The credit will be available with respect to a qualified employee regardless of the number of the employees who work for the employer or whether the employer meets the definition of an "enterprise zone business". The employment zone employment credit also may offset up to 25% of the alternative minimum tax liability.
Increased Sec. 179 Expense
The second available tax incentive for empowerment zones is the increased IRC Sec. 179 expense allowance. The expensing cap is increased by an amount equal to the lesser of $20,000 or the cost of the Sec. 179 property that is qualified zone property place in service by an enterprise zone business. As under present law, types of property eligible for the Sec. 179 expensing do not include buildings. The Sec. 179 allowance is reduced for taxpayers with investments above $200,000 in qualified zone property and the other qualifying section 179 property during the year. The phase out is applied by taking into account only one-half of the amount of the cost of the qualified zone property that is Sec. 179 property. In so applying the phaseout, the cost of Code sec. 179 property that is not qualified zone property is not reduced. Generally all provisions of Code Sec. 179 related to the increased expensing allowance is permitted for purposes of the alternative minimum tax. It should also be noted that the recapture rules similar to those under IRC Sec. 179(d)(10) are applicable.
Qualified zone property includes all depreciable tangible property, including buildings, used in the zone businesses, provided that the property was acquired by the taxpayer after the zone designation took effect, the original use of the property in the zone commenced with the taxpayer, and substantially all the use of the property is in the zone in the active conduct of a qualified trade or business by the taxpayer in the zone.
The increased expense allowance and the tax exempt bond financing provision are available only to "enterprise zone businesses." An enterprise zone business is a corporation, partnership, or proprietorship that meets specified criteria designed to ensure that the business at issue is an active trade or business. The criteria are that every trade or business of the entity is the active conduct of a qualified trade or business within an empowerment zone; at least 80% of the total gross income of the entity is derived from the active conduct of such trade or business; and substantially all of the use of the entity's tangible property whether owned or leased occurs within an empowerment zone. Substantially all of the entity's intangible property is used in, and exclusively related to, the active conduct by any such business; substantially all of the services performed for such entity by its employees are residents of the empowerment zone; less than five percent of the average of the aggregate unadjusted bases of the property owned by the entity is attributable to collectibles not held for sale to customers in the ordinary course of an active trade or business, and less than five percent of the average unadjusted bases of the property of such entity is attributable to nonqualified financial property.
New Tax-Exempt Bond Category
Finally, the Act creates a new category of exempt bonds called Qualified Enterprise Zone Facility Bonds. These bonds will help finance property located in an empowerment zone or enterprise community. The bonds are fully subject to the state private activity bond volume limitation and may be issued only while an empowerment zone or enterprise community designation is in effect.
Generally, to be entitled to tax-exempt treatment under this provision, 90% of the net proceeds of the bonds must be used to finance qualified zone property. This also includes property which would qualify as qualified zone property but for the fact that it is located in the enterprise community rather than an empowerment zone. The aggregate amount of outstanding qualified enterprise zone facility bonds allocable to any person cannot exceed $3 million with respect to any one empowerment zone or enterprise community, or $20 million with respect to all empowerment zones and enterprise communities.
Practitioners should consult with their state and local legislators and government agencies in charge of economic development in their respective states and municipalities for information regarding implementation of, and the progress of, their strategical plan for nomination of the designated areas in their states under new IRC Sec. 1391.
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