Whether incentives that require companies to provide jobs should be treated as nonshareholder capital contributions.

Author:Sonnenberg, Erik K.

Corporations often negotiate various incentives from state and local governmental units or civic groups, for example, when seeking to relocate or enter a community. In exchange for meeting certain requirements--e.g., building a factory or expanding existing infrastructure, operating in the community for a period of time, and employing a specified number of employees--a corporation may receive cash, land, or other property.

At first glance, it is not immediately apparent how these transfers should be treated for tax purposes. On the one hand, such incentives may be viewed as not intending to benefit the government or civic group in such a direct way as to be considered a payment for future services or goods. This view seems consistent with treating the transfers as nontaxable gifts. On the other hand, the incentives may be viewed as extended with the expectation of some benefit to the government or civic group, namely, the indirect benefit to the public good or community at large. This view suggests treatment of the transfers as taxable receipts for the payment of goods or services.

The conclusion reached in court decisions and ultimately confirmed by Congress in enacting Sec. 118 is that transfers made to corporations in which the only benefit received is some indirect public good generally should be treated as nonshareholder capital contributions excludable from gross income. While this is the general rule, the terms under which a particular transfer is made can and do affect the tax treatment of the transfer.

Judicial precedent provides insight into what conditions must be met to classify transfers as nonshareholder capital contributions. One consideration courts have raised is the question of a jobs requirement--that is, requiring the corporation to employ a specified number of employees for a specified period of time. Given the ruling (discussed below) in Brown Shoe Co., 339 U.S. 583 (1950), imposition of a jobs requirement should not by itself prevent a subsidy from qualifying as a nonshareholder contribution.

History of Sec. 118

Sec. 118 provides that "[i]n the case of a corporation, gross income does not include any contribution to the capital of the taxpayer." The regulations provide guidance regarding nonshareholder contributions, stating (by way of example) that "the exclusion applies to the value of land or other property contributed to a corporation by a governmental unit or by a civic group for the purpose of inducing the corporation to...

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