Tax incentives for businesses in distressed communities: businesses in designated distressed areas are entitled to various tax incentives. This article provides an overview of the incentives available in designated empowerment zones and enterprise and renewal communities.

• Author: Garrison, Larry R.

EXECUTIVE SUMMARY

* Businesses in designated EZs and RCs may be eligible for an employment credit, increased Sec. 179 expensing, tax-exempt bond financing and other tax incentives.

* A capital gain deferral applies to purchased EZ assets; a 60% exclusion applies to small business EZ stock.

* Enterprise zone facility bonds may be available to finance property acquisitions.

Since 1993, Congress has enacted a number of tax provisions that offer tax incentives for businesses operating in distressed communities. The various incentives provide for credits and enhanced deductions and exclusions, depending on an area's particular designation. The Community Renewal Tax Relief Act of 2000 (CRTRA 2000) highlighted the continued importance that Congress places on investment in low-income and economically disadvantaged areas.

The Department of Housing and Urban Development (HUD) has a well-constructed website with detailed information and links to various incentives for economic development; see Exhibit 1 on p. 278. The HUD website (1) states that there are $5.3 billion in "empowerment zone" (EZ) tax incentives and $5.6 billion available in "renewal community" (RC) incentives (these terms are discussed below). However, many of these dollars may be unclaimed due to the nature of the deductions and credits. Tax incentives for distressed communities apply only to certain geographic areas. For example, employees must also reside in the designated geographic area to qualify for the Sec. 1396 employment credit. The definitions for qualified businesses, assets or employees are detailed and specific. Unclaimed credits can result from tax practitioners and business owners being unaware of these less-publicized tax incentives.

Exhibit 1: Important HUD websites The HUD website is an excellent source of information on EZs, ECs and RCs. An 80-page manual is available on how to encourage businesses to participate in the various tax incentives: www.hud.gov/offices/cpd/economicdevelopment/news/taxincentives2003.pdf The HUD address for information by state is: www.hud.gov/offices/cpd/economicdevelopment/programs/rc/tour/index.cfm The HUD address for information by round (i.e., Round I, Round II, etc.) is: www.hud.gov/offices/cpd/economicdevelopment/programs/rc/tour/ roundnumber.cfm Information on rural EZs and ECs can be found at: www.ezec.gov/ezec/mainmap.html This article highlights the tax incentives available for businesses and, in some cases, individual investors, in EZs and RCs. Businesses looking to set up new operations, or to expand or relocate existing ones, may benefit from locating their business in an economically distressed community for which tax incentives are available. Tax practitioners need to be aware of these incentives as they consult with clients on tax-saving opportunities. See Exhibit 2 on p. 279 for a summary of the incentives; many are available through 2009.

EZs

Certain economically distressed communities were designated as EZs in the Revenue Reconciliation Act of 1993 (RRA '93). (2) Businesses in the designated EZs are entitled to various tax incentives, including a wage-based employment credit for hiring employees living in the EZ, increased Sec. 179 expensing and expanded tax-exempt bond financing. (3) In addition to EZs, certain economically distressed communities were designated as enterprise communities, entitled to fewer tax incentives than are EZs.

Designated Zones

EZs are nominated by state and local governments. Under Sec. 1392(a), distressed communities submitting an application for EZ designation must have a strategic plan and meet eligibility criteria, including population, general economic distress and poverty rate.

Various tax acts since the RRA '93 have expanded the number of EZs. However, each "round" of designation has required different eligibility criteria, along with different tax incentives over different dates of coverage. Round I under the RRA '93 allowed the HUD Secretary to designate six urban EZs and the Secretary of Agriculture to designate three rural EZs, effective as of Dec. 21, 1994. The RRA '93 also authorized the designation of 65 urban enterprise communities (ECs) and 30 rural ones. The Taxpayer Relief Act of 1997 (TRA '97) authorized two additional EZs as Round I EZs, with a Jan. 1, 2000 effective date. (4)

The TRA '97 also authorized the HUD Secretary to designate 15 additional urban EZs and the Secretary of Agriculture to designate five additional rural EZs. These Round II EZs have different eligibility criteria from their Round I counterparts. Also, Round II EZs are not eligible for the Sec. 1391 credit for EZ wages paid or incurred on or before Dec. 31, 2001, under Sec. 1391(g).

The CRTRA 2000 authorized the HUD Secretary and the Secretary of Agriculture to designate nine additional EZs, with not more than seven in urban areas and not more than two in rural areas, in Sec. 1391(h)(1). These EZs are generally designated as Round III EZs.

Because Round I and II EZs were authorized by different tax legislation, they had different beginning and ending dates. Originally, they expired at the end of the tenth calendar year beginning on or after the date of designation. The CRTRA 2000 extended the expiration date for Rounds I and II to match the expiration date of Round III (Dec. 31, 2009).

Sec. 1391(d)(1) allows for an earlier expiration date if so designated by the local or state government or if the Secretary of HUD or Agriculture revokes the designation. Also, the modification of the designated area's boundary or nonadherence to a submitted strategic plan can result in revocation of the designation and an earlier expiration date.

Tax Incentives

EZ businesses may take a 20% credit on the first $15,000 of wages paid or incurred to an EZ employee, under Sec...