The passage of tax reform in December, which changes the taxability of economic development incentives for businesses and developers, poses new challenges for state and local government entities. The Tax Cuts and Jobs Act (the Act) includes significant changes to the Internal Revenue Code (IRC), some of which affect the taxability of economic development incentives for businesses and developers. Prior to the Act, IRC section 118 allowed a corporate taxpayer to exclude contributions from non-shareholders (i.e. governmental entities) from their income with tax structuring that included the use of IRC section 118. Although the strategy did not permit “tax-free” receipt of funds, it did defer the tax liability to a later time when the asset was sold and the liability could be anticipated and managed.
Under the new IRC section 118, a corporation receiving an upfront cash incentive can no longer exclude these contributions unless the government makes the contribution as a shareholder. While this change is concerning for many working in economic development and government, there is some hope and potential relief if:
- You had a Tax Increment Financing (TIF) plan or a master plan in place prior to Dec. 22, 2017. The Act’s modification is effective for contributions received after Dec. 22, 2017, but does not apply to post-modification contributions if the contribution occurs pursuant to a “master development plan” approved by a governmental entity prior to the effective date. Because the Internal Revenue Service (IRS) has said it does not plan to further explain what is meant by this transition language, we are left to interpret the provision based on experience. Fortunately, some projects that received funding after the effective date may still qualify for the tax deferral if the surrounding circumstances are favorable.
- You are located in a state that has or will opt out of the section 118 modifications. State conformity further complicates the government incentive modifications. Although some states have adopted the federal provisions in their entirety, others have chosen to forgo some of the provisions. Georgia, for example, has specifically chosen to opt out of the IRC section 118 modifications. Consequently, while incentive funds received by a corporation may be subject to federal tax, they may escape state taxation if the previous structuring methodologies are used.
State and local governments planning to offer an upfront cash incentive to a project should first consider the two points above to determine if the use of IRC section 118 to defer federal or state income tax liability is an option for the taxpayer. However, if neither is applicable, there are alternative approaches to designing the incentive, such as:
- Utilizing public-private partnerships where the governmental entity is considered a shareholder with stock received equal to the capital contribution
- Providing tax abatements or tax credits, as these forms of assistance are not treated as a contribution to capital
- Providing a pay-as-you-go structure rather than an upfront TIF incentive
- Directing municipal investment toward publicly owned infrastructure rather than cash grant
The IRC change has been daunting to many economic development and government finance professionals as they work to understand the new rules of corporate taxation and develop creative solutions to incentive structuring. To assist our clients in this period of change, Baker Tilly’s state and local government specialists have teamed with our tax professionals and incentive advisors to assist you with understanding these changes and plan for your next incentive project.
For more information on this topic, or to learn how Baker Tilly state and local government specialists can help, contact our team.
The information provided here is of a general nature and is not intended to address the specific circumstances of any individual or entity. In specific circumstances, the services of a professional should be sought. Tax information, if any, contained in this communication was not intended or written to be used by any person for the purpose of avoiding penalties, nor should such information be construed as an opinion upon which any person may rely. The intended recipients of this communication and any attachments are not subject to any limitation on the disclosure of the tax treatment or tax structure of any transaction or matter that is the subject of this communication and any attachments.