11 00a federal tax credits


Published on

Published in: Technology, Business
  • Be the first to comment

  • Be the first to like this

No Downloads
Total views
On SlideShare
From Embeds
Number of Embeds
Embeds 0
No embeds

No notes for slide

11 00a federal tax credits

  1. 1. Session C2: Federal Tax Credits James Ahern – GE Capital Americas (Moderator) Bruce Belman, Partner – Crowe Horwath LLP Kevin Powers, Partner – Crowe Horwath LLP Jennifer Sanders, Tax Director – Stock Yards Bank & Trust Company Scott Tarney, Senior Manager – Crowe Horwath LLP
  2. 2. Disclaimers  These slides are for educational purposes only and are not intended, and should not be relied upon, as legal, tax or accounting advice.  Pursuant to Circular 230 promulgated by the Internal Revenue Service, please be advised that these slides were not intended or written to be used, and that they cannot be used, for the purpose of avoiding federal tax penalties unless otherwise expressly indicated.
  3. 3. Agenda  Historic Rehabilitation Tax Credit  New Markets Tax Credit  Tax Credit Bonds  Low-Income Housing Investments  Due Diligence & Annual Compliance  State & Local Tax Incentives
  4. 4. Historic Rehabilitation Tax Credit
  5. 5. Strawberry Fields Forever…
  6. 6. Historic Rehabilitation Tax Credit (HRTC)  HRTC – Background & How it Works  Claiming the Credit  HRTC in a Partnership  Historic Boardwalk Case – Facts & History  What's Next?
  7. 7. HRTC – Background and How it Works The Historic Rehabilitation Tax Credit (HRTC) was an attempt to encourage the preservation of historic property. Some Highlights:  Based on a percentage of certain capital expenditures  Rehabilitation must be qualified  The entire credit is taken in a single year….the year the qualified expenditures are placed in service…..or even earlier if taxpayer elects to use qualified progress expenditures
  8. 8. Two-Tier Credit  10% credit for the rehab of non-historic buildings first placed in service before 1936  20% credit to the owner of a “certified historic structure”  Building must be listed individually or in a historic district, and  The rehabilitation must be certified by the Secretary of the Interior  The credit is a dollar-for-dollar reduction in the tax liability
  9. 9. Qualified Rehabilitation Qualified rehabilitation must meet the following:  The building must be placed in service before the beginning of the rehabilitation  The rehabilitation must be substantial  Must materially extend the useful life of the building  Cosmetic improvements alone would not qualify  Rehabilitation expenditures exceed the greater of $5,000 or the adjusted basis of the property, excluding land  Therefore, if the adjusted basis of the property is $100,000, you need to spend at least $100,001 in qualified rehabilitation expenses
  10. 10. Qualified Rehabilitation (cont’d) Qualified rehabilitation must meet the following requirements on the rehabilitation process:  50% or more of the external walls of the building must be retained in place as external walls;  75% or more of the existing external walls of the building mist be retained in place as internal or external walls; and  75% or more of the existing internal structure framework must be retained in place. Note: The external wall requirement is eliminated for certified historic structures qualifying for the 20% credit
  11. 11. Measuring Period The owner choses the “Measuring Period” for which the qualified rehabilitation expenditures will be incurred  The measuring period is the 24-month period that expenses are expected to be paid  The measuring period should end in the taxable year the credit is to be claimed  Long term projects can elect to use a 60-month period  Can use if rehabilitation is expected to last longer than 2 years  Must have written plans and specifications in identified phases
  12. 12. Government Approval Process  The HRTC does not involve a competitive application process, as is the case with LIHTC and NMTC  In the case of the 20% credit, approvals are required with regard to the historic quality and character of the building and the rehabilitation of the building  Certification is effected through the appropriate state official (or regional National Park Office if there is no approved state program) and the interior Department
  13. 13. Tax-Exempt Use Property  The credit is generally not available with respect to taxexempt use property  Tax-exempt use property includes property owned by, or leased to, a tax exempt entity, governmental entity or a foreign entity under a disqualified lease
  14. 14. Tax-Exempt Use Property - Disqualified Leases  Disqualified leases generally include leases in excess of 20 years, leases with “fixed or determinable” purchase options and other designated types of leases…There are a number of exceptions to this rule For Example: Property is not considered “tax-exempt use property” if the portion of the property leased to tax-exempt entities in disqualified leases is 50% or less
  15. 15. Lease Pass-through  Under certain circumstances, the owner of an HRTC building can elect to pass through the credit to the lessee  When the lessee claims the credit, the depreciation deductions stay with the landlord
  16. 16. Basis Reduction  The basis of a project that qualifies for the HRTC is generally reduced by the amount of the credit  NOTE: This reduction does not apply if the credit is passed through to the lessee; instead, the lessee will have additional income to report…effectively “antidepreciation” income  Included in income over the recovery period of the property = 50% of the HRTC allowable to the lessee divided by the recovery period
  17. 17. Example: Basis Reduction Total qualified rehabilitation expenses placed in service..$ 100,000 20% HRTC Credit Claimed…………………………………. 20,000 Depreciable Basis on Expenditures………………………...$ 80,000 Depreciation is taken on a straight line basis  27.5 years for residential  39 years for nonresidential
  18. 18. Excluded Costs Some costs that should be excluded from the qualified rehabilitation expenditures are as follows:      Acquisition Costs Enlargement Costs Site Work Expenditures Personal Property Tax-Exempt Use Property
  19. 19. At Risk  The HRTC is subject to the “at-risk” rules  The amount of non-recourse financing with respect to a qualified rehabilitation cannot exceed 80% of the credit base of the qualified rehabilitation expenditures
  20. 20. Transferability  The credit is non-transferable…only available to the owners at the time the qualified expenditures are placed in service  If the building is transferred, no credit for the new owner and the transferor may have recapture
  21. 21. Recapture  If the property is disposed of or sold before the property is in service for five years, a portion of the credit claimed must be recaptured in the year of disposal  The amount of recapture is based on the year of disposal as follows: Before year: 1….. 100% 2….. 80% 3….. 60% 4….. 40% 5….. 20%  The amount recaptured must then be added back to the depreciable basis of the assets
  22. 22. Example: Recapture From our prior example, assume the property (27.5 year property) was disposed of before the close of year 3 Depreciable Basis…………………...........$ Accumulated Depreciation (3 years)…….$ Adjusted Basis in Property………………..$ 80,000 (2,900) 77,100 Credit recaptured at 60% (20,000*.6).........$ Adjusted Basis……………………………….$ 12,000 89,100 Note: New basis depreciated over the remaining life of the property
  23. 23. Passive Activity Rules There are passive activity limitations for owners/investors who do NOT materially participate  The credit is phased out for individuals with income between $200,000 and $250,000  Owners/Investors who materially participate are not subject to the limitations under the passive loss rule
  24. 24. Claiming the Credit The credit is claimed on Form 3468, which is filed with the tax return in the year the credit is being claimed The following must be attached on a separate statement:  Beginning and ending dates for the measuring period selected by the taxpayer;  Adjusted basis of the building as of the beginning of the measuring period; and  Amount of qualified rehabilitation expenditures incurred during the measuring period
  25. 25. Claiming the Credit (cont’d) Taxpayers must also report on the form 3468 certain information listed on the Part 2 Certification (final certification) received from the Secretary of the Interior  NPS project number  Date of final certification of completed work Often Part 2 Certification is not issued by the time a taxpayer files the tax return the credit is being claimed on…In these circumstances the taxpayer will need to attach the following to claim the credit:  1st page of the Part 2 Application  A notice from the Department of the Interior stating the application has been received Once the taxpayer receives the Part 2 Certification, the appropriate information will need to be listed on the next tax return filing
  26. 26. HRTC in a Partnership Typical investors are major corporate entities such as financial service companies and bank…In the case of a small or medium-sized project in a small to medium-sized town, a local bank may well act as the investor Partnerships are typical owners of these projects…The entities most chosen are as follows:  Limited Partnerships  Limited Liability Companies
  27. 27. HRTC in a Partnership (cont’d)  The available credit is allocated to the partners (investors) of the partnership based on their share of profits on the date the qualified rehabilitation expenditures were placed in service  The corresponding property, all related items of income, gain, loss and deduction with respect to that item are allocated in the same manner  This is done regardless of the partnership’s general profit sharing percentages
  28. 28. HRTC in a Partnership (cont’d) Credit Recapture in a Partnership  Recapture may result where the tax credit in the year taken was subject to the at-risk or non-recourse financing limitations
  29. 29. HRTC in a Partnership (cont’d) Credit Recapture in a Partnership (cont’d)  In the event that rehabilitated property is owned by a partnership and one of the partners sells or disposes of all or a portion of their partnership interest, a portion of the credit will be required to be recaptured  If the partner’s interest is reduced to less than 2/3 of what it was when the qualified rehabilitation property was placed in service, the reduction is treated as a proportional disposition of the property  The percent reduction of ownership interest is the portion of the credit, multiplied by the recapture percentage for the year in question, that is added to the taxpayer’s tax in the year in which the partnership interest changed
  30. 30. Example of Sale of Partnership Interest Facts: Calculation:  A limited partner has a 90% interest in the partnership in the year the HRTC is taken  A $20,000 HRTC was claimed  The partners interest is reduced to 55% (i.e., 35% reduction) 3.5 years after the credit was taken  55/90= 61.11%  The owner’s interest has been reduced to less than 2/3 of what is was when the HRTC was originally taken, and therefore a portion of the credit will be recaptured % property considered to be disposed: 35/90=38.89% Credit to be recaptured and added to the depreciable basis of the assets and the partners tax liability in that year: Original HRTC……………..$ 20,000 38.89% disposed of…………. 7,778 HRTC recapture of 40%........ 3,111
  31. 31. Profit Motive  Does a participant need a profit motive?  Most HRTC transactions are structured to demonstrate a profit motive by showing the possibility of a “cash on cash” return for the investor  There has been some recent guidance with regard to this issue
  32. 32. Historic Boardwalk Case The members of Historic Boardwalk Hall, LLC were Pitney Bowes and the New Jersey Sports and Exposition Authority (NJSEA). The partnership was formed for the historic rehabilitation of East Hall, a New Jersey convention center. Pitney Bowes (PB) received the following in this transaction:  99.9% of the historic rehabilitation credits   3 percent preferred return for its  investment in the partnership  Puts and calls between NJSEA and PB were  present
  33. 33. Historic Boardwalk Case (History)  The Tax Court originally held for the taxpayer  The Third Circuit reversed and held in 2012 that the LLC formed by the New Jersey Sports and Exposition Authority was not a valid partnership and Pitney Bowes was not a bona fide partner
  34. 34. Historic Boardwalk Case (Third Circuit Decision)  The court held that PB could not be treated as a partner because it did not have a meaningful stake in the success or failure of the partnership, and therefore was NOT a bona fide partner  Consequently, PB could not use the historic rehabilitation credits  Specifically, the court noted that PB lacked a meaningful risk of loss and was entitled to receive the cash equivalent of any credits lost as a result of Internal Revenue Service examination
  35. 35. Historic Boardwalk Case (Third Circuit Decision)  PB’s capital contributions were not necessary for the completion of the project  All anticipated costs were fully funded before PB came into the deal  PB was entitled to a preferred return on its investment, which was nominally at risk if the partnership did not have sufficient cash flow  This risk effectively was eliminated by offsetting puts and calls between NJSEA and PB that virtually guaranteed the 3 percent preferred return
  36. 36. Petition to the Supreme Court  On May 28, 2013, the U.S. Supreme Court declined to hear an appeal of the Third Circuit’s decision denying HRTCs for a state authority’s partnership with Pitney Bowes Inc. to redevelop the Atlantic City N.J. historic Boardwalk Hall Historic Boardwalk Hall, LLC, No. 11-1832 (3d Cir. 8/27/12), cert. denied, Sup. Ct. Dkt. No. 12-901 (U.S. 5/28/13)
  37. 37. What does this mean?  If you are in the third circuit, Historic Boardwalk is the law of the land  Probably good practice to structure valid partnerships with downside risk and upside potential that is meaningful to all partners  As a response to this case, the IRS plans to provide guidance in the form of a revenue procedure focused specifically on safe harbors for transactions that involve rehabilitation credits  The safe harbor is expected to be similar to Rev. Proc. 2007-65, 2007-45 IRB 967, which addresses section 45 wind energy credits…taking into account industry norms
  38. 38. What’s Next?  In the discussion provided in Historic Boardwalk Hall, LLC v. Commissioner, it specifically states: “The HRTC statue is not under attack here. It is the prohibited sale of tax credits, not the tax credit provision itself, that the IRS has challenged…We confront taxpayers who have taken a circuitous route to reach an end more easily accessible by a straightforward path, we look to the substance over form”
  39. 39. What’s Next? Things to consider when forming a partnership and taking advantage of the Historic Rehabilitation Credit:  Do the partners have a meaningful stake in the enterprise?  If there is no risk of loss, the answer is probably “no”  Investment terms need to show intent to share in the profits and losses  Transactions should never guarantee tax results by reimbursing for any tax benefit lost  Investors should enter the contract before all funds needed to complete the project have been secured  Be careful when using put/call options that guarantee preferred returns…Returns should be based on cash flow instead
  40. 40. New Markets Tax Credit
  41. 41. New Markets Tax Credit – Introduction  Enacted by Congress as part of the Community Renewal Tax Relief Act of 2000 (now extended through 2013) and administered by the CDFI Fund of the U.S. Treasury Department  Stimulates new private-sector investments in low-income communities  NMTC equity investors receive a federal tax credit, over a seven-year period, equal to 39 percent of capital invested in low-income communities via specialized community development entities (“CDEs”)  Some projects may also generate a state credit  Can be paired with Rehabilitation credit  Investors typically purchase an interest in a pooled fund treated as a partnership, but could also invest directly in a CDE (either may qualify for CRA “credit”)
  42. 42. New Markets Tax Credit – Introduction (cont’d)  Tax credits are awarded each year through a highly competitive application process  $3.5 billion of NMTC investment authority awarded earlier this year under the 2012 application round  Up to $8.5 billion of NMTC investment authority could be available under the 2013/2014 application round  In recent years, credit allocations awarded to banks have generally been limited to large, national banks or specialized banking organizations with a market focus on low-income communities (e.g., CDFIs)
  43. 43. New Markets Tax Credit – Introduction (cont’d)  All NMTC funds must be invested for 7 years  If funds are returned early, they must be reinvested within 12 months or risk full recapture of all tax credits claimed  Flexible program can be used for a broad range of eligible projects in lowincome communities  However, due to IRS and compliance-related issues, most credits have been used toward real-estate based projects  Focus on commercial development, not housing  Rules and Process are complicated!
  44. 44. New Markets Tax Credit – Computation of Credit  Credit rate is 5% of the qualified equity investment (“QEI”) for the first 3 years, and 6% of the QEI for the last 4 years  For partnership funds, the QEI is leveraged with non-equity sources of capital, thus providing an enhanced return to the credit investor  NMTC credit also reduces the investor’s basis in the CDE (or in the partnership fund)  This basis reduction typically results in gain at end of required 7-year investment period  Gain can be eliminated if CDE is a corporation
  45. 45. New Markets Tax Credit – Credit Recapture  Qualified equity investment is transferable     Sale to (or purchase from) 3rd party Taxable and tax-free acquisitions Dividend from subsidiary Capital contribution from parent  Credit recapture is 100% if:  CDE no longer meets qualification requirements  Equity investment is redeemed  CDE fails to invest in qualified projects
  46. 46. New Markets Tax Credit – Benefits  What can it do for a bank’s loan customers?  Provides subsidy into the project source of funds  Can help fill a financing gap in project sources and/or significantly reduce the overall financing cost  Structure designed to ensure that majority of tax credit benefit is provided to fill project financing needs
  47. 47. New Markets Tax Credit – Eligibility  How does a project qualify for NMTCs?  Commercial projects that benefit low-income communities  Job Creation, Social Services, Catalytic Investment  New Investment – Not refinancing of term debt  Geographic eligibility – qualification based on census tracts  Qualifying census tracts have < 80% of applicable median income (“AMI”) and/or poverty rate > 20%  Most NMTC recipients commit to serve areas of higher distress  Census tracts with < 60% of AMI and/or poverty rate > 30%  Rural areas currently at a slight advantage
  48. 48. New Markets Tax Credit – Risks  Primary risk to NMTC equity investors is recapture of credits  “All or nothing”  If recapture event occurs, 100% of credit is lost  Recapture risk is typically very low  Indemnification between the NMTC participants intended to make equity investors whole in event of a recapture event
  49. 49. Entity Role NMTC Equity Investor Purchases tax credits from NMTC Allocatees. Borrower receives “equity-like” financing benefits from investor’s equity. Leverage Loan Provider Provides leverage into NMTC structure. Leverage loan sources include traditional providers like a national or regional bank, capital campaign funds, or monies from state or federal grant programs. NMTC Allocatee Receives NMTC allocation authority from Treasury. Sells tax credits to the equity investor and makes loans to borrower. Project Borrower/QALICB Typically a single purpose entity (SPE) created to act as the borrower for the NMTC funding. Is a Qualified Active Low-Income Community Business, per Treasury regulation. Project Sponsor The parent entity of the QALICB. For example, a manufacturer building a new facility or expanding an existing one. Professional Service Providers Legal counsel, accountants, and consultants who help structure and/or opine on each transaction.
  50. 50. Leverage  Loan  Provider NMTC  Equity  Investor $ Loan • Provides leverage into NMTC  structure. • Leverage loan sources include  traditional providers like a  national or regional bank, capital  campaign funds, or monies from  state or federal grant programs. Investment  Fund Project  Sponsor Credit Allocation $ QLICI (e.g., Loans) Project Borrower Creates SPE • Purchases tax credits from  NMTC Allocatees. • Borrower receives “equity‐ like” financing benefits from  investor’s equity. $ QEI CDE • The parent entity of the  QALICB. • For example, a  manufacturer building a new  facility. $ Equity NMTC  Allocatee • Receives NMTC allocation  authority from Treasury. • Sells tax credits to the  equity investor and makes  loans to borrower. (Qualified Active Low‐Income  Community Business) • Typically a single purpose entity  (SPE) created to act as the  borrower for the NMTC funding.
  51. 51. Tax Credit Bonds
  52. 52. Tax Credit Bonds  Investors receive a tax credit in lieu of interest payments  Direct payment option was available for bonds issued with the 2009 and 2010 bond-allocation pools, providing for interest payments in lieu of tax credit  Credit treated as interest includible in gross income  Credits reduce partner’s/shareholder’s basis in the partnership interest/ S corporation stock (treated as a distribution)  Investor credit based on published IRS rate (for the month in which the bond issued), multiplied by the bond’s outstanding face amount on each credit allowance date
  53. 53. Tax Credit Bonds  Investors claim 25% of the annual tax credit on each of four credit allowance dates  March 15, June 15, Sept. 15 and Dec. 15 (plus the last day the bond is outstanding)  If the bond is purchased between credit allowance dates, the purchaser is allowed the full amount of the quarterly credit on the next allowance date  Tax credit can be used to offset AMT liability  Unused credit can only be carried forward, not back  Bond holders should receive a Form 1097-BTC on a quarterly/ annual basis (from the issuer), reporting the amount of the quarterly/annual credit
  54. 54. Qualified Zone Academy Bonds  Used to finance renovation, equipment purchases, and curriculum development for certain public schools in certain distressed areas  $400 million of QZAB issuing authority for 2013  Treasury Department allocates to each state based on respective populations of individuals below the poverty line  Different rules applied to QZABs issued prior to Oct. 3, 2008  Unused credits cannot be carried forward or back  Annual, versus quarterly, credit allowance dates  Only financial institutions, insurance companies, and other lenders are eligible holders entitled to the credits
  55. 55. Qualified School Construction Bonds  Used for constructing, rehabilitating, or repairing public school facilities or for acquiring land on which a public school facility will be constructed  $11 billion of QSCB issuing authority in 2009 and 2010 (none authorized after 2010)  Treasury Department allocated to each state based on designated criteria (more involved than QZAB allocations)  Unlike QZABs, these bonds were not available before 2009  The majority of QSCBs were likely issued with the direct payment option
  56. 56. Build America Bonds  “New” form of tax credit bond issued before Jan. 1, 2011  Municipalities that would issue an otherwise tax-exempt bond (including private activity bonds) could elect to treat that bond as having taxable interest  Bank investors receive a nonrefundable tax credit in the amount of 35 percent of the interest payable by the issuer  Municipality could elect to forego the credit to the investor and instead receive a cash payment from the federal government equal to the credit that would otherwise be offered to the investor (reflected in the bond yield)  Other general rules for tax credit bonds apply (e.g., can offset AMT liability, unused credit can only be carried forward, etc.)
  57. 57. Low-Income Housing Investments
  58. 58. Low-Income Housing Purpose  Generates a tax credit that can be utilized to reduce federal tax liability  General business credit  Can be used to offset AMT (i.e., the tentative minimum tax is treated as being zero), but only for LIHC projects placed in service after 12/31/2007  Investors typically purchase an interest in a limited partnership (which may qualify for CRA “credit”)
  59. 59. Low-Income Housing How the Credit Works  Credit claimed for 10 years  Project must “qualify” for 15 years  Projects that fail rent and income tests during 15-year period subject to recapture
  60. 60. Low-Income Housing Computation of Credit  Exact credit percentage depends on:  When the project is placed in service  Whether housing is new or old  Federal subsidies  Credit allocation must be received from the state
  61. 61. Low-Income Housing Recapture  Failing to meet rent and income tests  Sale of building  Sale of partner’s interest in partnership that owns the building  Recapture never more than one-third of total credit  Tax liability increased by amount of recaptured credits, plus interest  Carryback / carryover amounts adjusted if credit was not used to reduce tax liability
  62. 62. Low-Income Housing Investor Concerns  Recapture of credit if project fails to meet LIHC criteria for 15 years  Credit may not offset AMT (i.e., pre-2008)  Losses under equity method must be included in financial statements “above the line”  May not be a secondary market for partnership investments
  63. 63. Low-Income Housing Effective-Yield Method of Accounting  FASB Emerging Issues Task Force released Issue No. 13-B, Accounting for Investments in Affordable Housing Tax Credits, on April 17, 2013  Proposes new guidance regarding when such investments will qualify for use of the effective-yield method of accounting (“EYM”)  Currently, investors have to meet specific and strict requirements in order to elect use of the EYM  Status of revised standards is still pending
  64. 64. Low-Income Housing Effective-Yield Method of Accounting  Investors may currently elect EYM if the following conditions are met: 1. The availability of the tax credits allocable to the investor is guaranteed by a creditworthy entity through a letter or credit, a tax indemnity agreement, or similar arrangement; 2. The investor’s projected yield, based solely on the cash flows from the guaranteed tax credits, is positive; and 3. The investor is a limited partner in the affordable housing project for both legal and tax purposes and the investor’s liability is limited to its capital investment.
  65. 65. Low-Income Housing Effective-Yield Method of Accounting  Under the EYM, the tax credit allocated to the investor, net of the amortization of the investment in the LP, is recognized in the income statement as a component of income taxes attributable to continuing operations (i.e., “below the line”)  There are no pre-tax losses recognized in the financial statements for investments that qualify for the EYM  If elected, the EYM is an accounting policy decision that must be applied to all investments that qualify for use of the EYM (i.e., cannot pick and choose)
  66. 66. Low-Income Housing Effective-Yield Method of Accounting  Under proposed guidance, investors could elect to use the EYM if the following conditions are met: 1. It is probable that the tax credits allocable to the investor will be available; 2. The investor retains no operational influence over the investment, and substantially all of the projected benefits are from tax credits or other tax benefits (e.g., flow-thru losses); 3. The investor’s projected yield, based solely on the cash flows from the tax credits and other tax benefits, is positive; and 4. The investor is a limited partner in the affordable housing project for both legal and tax purposes, and the investor’s liability is limited to its capital investment.
  67. 67. Low-Income Housing Why the proposed changes to the EYM?  Presentation in the income statement of the investment losses separately from the tax credit benefits distorts investment performance by reporting pre-tax losses on otherwise profitable investments, and makes investment performance difficult to understand  Very small percentage of LIHTC investments currently qualify for the EYM due to requirement to have a guarantee by a creditworthy entity
  68. 68. Low-Income Housing Why the proposed changes to the EYM? (cont’d)  Reporting entities that invest in LIHTC investments generally view yield as a combination of all cash inflows from the investment, including tax credits and other tax benefits (e.g., flow-thru losses) – positive yield is not based solely on the cash flows from the guaranteed credits
  69. 69. Low-Income Housing Sample EITF calculation ** • Purchase price of investment = $100,000 (5% LP interest) • Annual tax credit = $16,000 • Received annually for 10 years • Allocable share of annual tax depreciation = $7,273 • Applicable tax rate = 40% • Computed IRR on tax credits only = 9.607% ** Based on Exhibit 94-1A from EITF Issue No. 94-1, Accounting for Tax Benefits Resulting from Investments in Affordable Housing Projects
  70. 70. Low-Income Housing Year 1 financial statement impact • Tax credit = $16,000 (A) • Book amortization of investment: Tax credit = $16,000 Less: BOY investment = $100,000 Multiply by IRR x 9.607% = ($9,607) $ 6,393 (B) • Benefit of tax dep’n expense = $7,273 x 40% = $2,909 (C) • Current tax benefit = (A) – (B) + (C) = $12,516
  71. 71. Low-Income Housing Year 1 financial statement impact (cont’d) • Current tax benefit from previous slide = $12,516 (D) • Deferred tax benefit (expense): Book amortization of investment = Less: Tax depreciation expense = Multiply by tax rate • $ 6,393 ($7,273) ($ 880) x 40% ($ 352) (E) Impact on net income = (D) + (E) = $12,164
  72. 72. Low-Income Housing Year 2 financial statement impact • Tax credit = $16,000 (A) • Book amortization of investment: Tax credit = $16,000 Less: BOY investment = $ 93,607 Multiply by IRR x 9.607% = ($8,992) $ 7,008 (B) • Benefit of tax dep’n expense = $7,273 x 40% = $2,909 (C) • Current tax benefit = (A) – (B) + (C) = $11,901
  73. 73. Low-Income Housing Year 2 financial statement impact (cont’d) • Current tax benefit from previous slide = $11,901 (D) • Deferred tax benefit (expense): Book amortization of investment = Less: Tax depreciation expense = Multiply by tax rate • $ 7,008 ($7,273) ($ 265) x 40% ($ 106) (E) Impact on net income = (D) + (E) = $11,795
  74. 74. Due Diligence & Annual Compliance
  75. 75. Due Diligence     Pricing and rate of return Relationship and knowledge of borrower/developer Loan underwriting standards Cash flow of the project, debt service coverage, loan to value, construction risk  Meeting the needs of the public (working with a non-profit)  CRA is an enhancement to a project
  76. 76. Annual Compliance  Annual on-site visits to projects  Review of annual compliance filings
  77. 77. State & Local Tax Incentives
  78. 78. Credits and Incentives Overview  Credits and incentives are often a vital part of any company’s strategic planning, especially in connection with the expansion or relocation of new facilities  Additionally, credits and incentives provide a way for jurisdictions to encourage growth in economically challenged areas and to promote increased job growth  As such, knowledge of the credits and incentives arena can be helpful to expanding businesses and practitioners
  79. 79. Credits and Incentive Drivers  Credits and incentives are offered to businesses in order to encourage economic development – The following activities can trigger an opportunity for a business to recognize credits and incentives:  Investing and expanding in new branches, back office operations or headquarters  Purchase or expansion of building and/or land  Signing a new lease on a building  Purchase of equipment and/or computers  Creating new jobs – higher paid jobs are treated with more lucrative incentives  Investing in specialized equipment and buildings  Research and development  “Green Initiatives” – environmental conservatism and renewable energy property
  80. 80. Credits and Incentive Drivers (cont’d)  Credits and incentives are offered to businesses in order to encourage economic development – The following activities can trigger an opportunity for a business to recognize credits and incentives:  Retaining a high number of existing jobs within the state or jurisdiction  Investing in employee training and increasing employee skills  Headquarters / back-office consolidations  M&A transactions
  81. 81. Statutory versus Discretionary Credits and Incentives  What are the differences between statutory and discretionary credits and incentives?
  82. 82. Statutory Credits and Incentives  Programs that are defined in state and local tax codes, statutes or ordinances to affect certain behavior of businesses  Any company that meets the requirements of the program are eligible for these incentives – Typically, approval is not required; however, in some cases, approval or applications are necessary to ensure the company meets the requirements of the program  Can be obtained retroactively in some cases  Each state offers various statutory credits and incentives, and depending on the state, may or may not apply based on their respective guidelines due to industry restrictions, minimum hiring and/or capital investment requirements
  83. 83. Statutory Credits and Incentives (cont.)  Credits       Job Tax Credits – credits for increased employment over a baseline Enterprise Zone Credits – credits based on geographic locations of the business Investment Tax Credits – varies state-to-state Research and Development Tax Credit – for businesses investing in research Training Credits – credits based on training expenditures Child and Dependent Care Credits – credits for businesses investing in child care facilities for their employees  Sales and Use Tax Exemptions – exemptions from sales and use tax for investments in building costs and equipment (usually taxable)  Property Tax Abatements – reductions in real and personal taxes (discretionary or statutory, depending on state)
  84. 84. Discretionary Credits and Incentives  Generally defined in the state’s code or statutes as funding to be distributed on the discretion of the state or local jurisdiction to encourage the economic growth in the state or jurisdiction  Awarded on a wholly discretionary basis and typically requires formal approval by a governing body  Generally applied for and negotiated prior to any commitment by the company is made  Cannot commence project by purchasing land, entering in lease agreement, press releases, etc.  “But for” requirement – without the incentive, the project would not occur  Requires competition
  85. 85. Discretionary Credits and Incentives (cont.)  Grants and Rebates  General Purpose Grants – cash grants available to companies with economic impact  Infrastructure Grants – grant to provide funding for local infrastructure (e.g., a new road)  Withholding Tax Rebates – cash rebates for withholding taxes of new employees  Training Grants – reimbursements for eligible training expenditures  Payment-in-Lieu of Taxes (PILOT/FILOT) – fixed, reduced property tax payments  Refundable Loans – loans that offer a reduction of payment for new employment
  86. 86. Discretionary Credits and Incentives (cont.)  Financing – states typically offer a broad array of financing such as TIFs, bonds and loans to incentivize businesses  Property Tax Abatements – reductions in real and personal property taxes for businesses investing in additional capital expenditures  Other – includes various other forms of incentives such as utility rate reductions, easier access to permits, training services provided by community colleges, etc.
  87. 87. Obtaining Discretionary Incentives – Process  The business should speak to a consultant, their tax provider, internal tax director or a state economic development official before any steps occur to begin the project
  88. 88. Obtaining Discretionary Incentives – Process (cont’d)  Steps 1 – 7 below (and next slide) need to be completed before lease is signed; purchase of building/equipment; hiring and/or any public announcement of the project 1. Develop project profile and the scope of the project (consider 3 – 4 year timeframe) 2. Evaluate available incentives and usability of each 3. Contact economic development (“ED”) organization 4. Present project to ED officials and obtain proposals from the state
  89. 89. Obtaining Discretionary Incentives – Process (cont’d)  Steps 5 – 9 (cont’d) 5. Structure and negotiate incentives  Effective negotiations must consider the ability to use tax credits in the future to incentivize a project; consider other taxes or opportunities such as cost segregation, income/franchise, property tax, and sales and use tax; no tax liability, no tax credits 6. Submit required applications for each incentive program 7. Execute legal agreement to secure incentives 8. Document compliance required of each incentive 9. Claim benefit/file required compliance and monitor hiring/capital investment commitments
  90. 90. Considerations – Maintaining Credits and Incentives  Carefully read the incentive agreement and document all outlined requirements and don’t be afraid to negotiate language favorable for the business  Recognizing credits and incentives, although obvious, can be easily missed once they have been secured  It is important to maintain a schedule of the incentives and the compliance due dates associated with the incentives  Most incentive programs require quarterly and/or annual compliance reports; the business should keep accurate documentation so all compliance requirements can be met by the deadlines
  91. 91. Considerations – Maintaining Credits and Incentives (cont’d)  Businesses should be conscious of the various claw-back provisions that can be embedded in an executed agreement  State and local jurisdictions are putting language in the agreements to ensure businesses are meeting their commitments  Recapture/claw-back provisions require a business to repay the amount of the credit or incentive if the business fails to meet the agreed upon criteria and requirements  Incentives need to be considered for M&A transactions  Pre-M&A – Review any existing incentive agreements for transferability and potential claw-back of the incentives; it is not guaranteed that an acquirer can claim incentives of the acquired business  Post-M&A – Does the transaction create opportunities for new incentives?
  92. 92. Case Study – Finance Outsourcing Company  Finance Outsourcing Company (FOC) was considering expanding operations in North Carolina  The company offered a full range of back-office, voice and onsite support solutions such as credit card servicing, consumer lending servicing, accounts receivable management, and mortgage origination services  The company would invest $17M in capital expenditures and would hire an additional 1,000 employees at their North Carolina headquarters facility
  93. 93. Case Study – Finance Outsourcing Company (cont’d)  After negotiations, the business was able to secure the following discretionary incentives:  Employment and Recruitment Screening $110,200  Training Program Assistance $1,102,200  NC Job Development Investment Grant (JDIG) $8,611,500*  Total Incentives $9,823,900 *A grant which provides a refund of North Carolina withholding taxes from new NC employees
  94. 94. Conclusion  When considering expanding business operations, it is important to take into account cost reductions available from credits and incentives  Be sure to reach out regarding obtaining incentives prior to any type of project commitment  Fully document the requirements of compliance and claiming the incentive  Credits and incentives can be a powerful tool to incentivize a business, so be sure that all options are being considered
  95. 95. Questions??
  96. 96. Crowe Horwath LLP is an independent member of Crowe Horwath International, a Swiss verein. Each member firm of Crowe Horwath International is a separate and independent legal entity. Crowe Horwath LLP and its affiliates are not responsible or liable for any acts or omissions of Crowe Horwath International or any other member of Crowe Horwath International and specifically disclaim any and all responsibility or liability for acts or omissions of Crowe Horwath International or any other Crowe Horwath International member. Accountancy services in Kansas and North Carolina are rendered by Crowe Chizek LLP, which is not a member of Crowe Horwath International. This material is for informational purposes only and should not be construed as financial or legal advice. Please seek guidance specific to your organization from qualified advisers in your jurisdiction. © 2013 Crowe Horwath LLP
  97. 97. For more information, contact: Bruce Belman, Partner Crowe Horwath LLP Direct 502.420.4525 bruce.belman@crowehorwath.com Jennifer Sanders, Tax Director Stock Yards Bank & Trust Company Direct 502.625.9953 jennifer.sanders@syb.com Kevin Powers, Partner Crowe Horwath LLP Direct 630.586.5140 kevin.powers@crowehorwath.com Scott Tarney, Senior Manager Crowe Horwath LLP Direct 614.469.4001 scott.tarney@crowehorwath.com