This blog was written by PCV Advisor Scott Nelson, Managing Principal at Tax Incentives Group
The State of California is proposing regulatory changes to its State Enterprise Zone (EZ) program. The program was established in the mid-1980s as an economic development strategy for the State: the overall goal is to incent capital investment, promote the creation of new jobs and retain existing jobs in California. California legislation created 42 different Enterprise Zones throughout the State. By law, any company or individual operating within the boundaries of an EZ is afforded the opportunity to utilize the program. There are two primary ways that taxpayers benefit: 1) hiring qualified employees (Hiring Credit); and 2) purchasing qualified property (Sales or Use Tax Credit). Both of these benefits provide tax credits against California income tax liability – though the Hiring Credit generates significantly more value. The Hiring Credit is managed through a process called “vouchering”, which is in essence documenting qualified employees and receiving confirmation of their qualification by receiving a voucher from a local government agency.
Under State law, taxpayers are allowed to amend their California income tax returns up to four years, retroactively, from the date the original return was filed. As a result, taxpayers can go back in time and recapture tax credits under the EZ program that were not taken on original returns. The process of recapturing tax credits generates cash payments from the State for previous tax paid. Obviously, there must be tax liability in the prior years for this scenario to make sense. That being said, there can be considerable value for some taxpayers who take advantage of this law. The proposed regulatory changes will be broad, but one in particular will significantly limit taxpayers who have not previously utilized the program. It will only allow taxpayers to take the Hiring Credit for employees hired within one year. Previously, taxpayers were allowed to look back four or more years and capture those employees.
The State department currently in charge of the program is the Housing & Community Development Department (HCD). HCD issued a public notice on January 21st regarding its intent to adopt and change the regulations related to the EZ program. There will be four different public hearings around the state in order to receive public comment. For Bay Area companies, the hearing will be held in Oakland on February 20th. Written comments can also be submitted to HCD through February 28th. The proposed changes can be categorized as follows:
• Eliminate retroactive vouchering
• Technical updates
• Update voucher application fees
• Streamline vouchering rules for hard-to-hire categories
• Eliminate self-certification
• Collect data for the program
• Create audit procedures
The bigger picture has to do with the State of the State, California’s budget and financial stability…or lack thereof. The proposed changes are estimated to save California $55 million per year. Governor Brown attempted to eliminate this program during his first budget process last year, along with eliminating the State Redevelopment Agency Program. He was successful in dismantling Redevelopment, but was not able to do the same with the EZ Program. The program has withstood attacks from multiple governors and legislators throughout the years. However, it has been resilient as a result of receiving support from both sides of the aisle. There have been numerous studies both for and against the EZ Program all citing various statistics. Statistics, as we all know, can sometimes be manipulated to weave a particular story. You can be the judge of that. Since Governor Brown has been unsuccessful in eliminating the program via legislation, he has instructed HCD to reduce the program’s benefits to taxpayers via regulatory change. That being said, there are reports hinting that some Republicans may mount a counter to HCD by positioning the proposed regulatory changes as a “tax increase”. Under a recently new law, all tax increases have to pass the legislature by a two-thirds vote; whereas before only a majority was required. Though with a super-majority of Democrates in the legislature, it’s anyone’s guess as to how that would play out.
My career began with the California Trade & Commerce Agency, which no longer exists, and where the EZ Program used to reside. I used to pitch this program to both in-state and out-of-state companies as a reason they should either stay and expand in California or bring their new facilities and expansions to the State. So my exposure and connection to the program spans a time of over 20 years. At that time, there were a few other tax credits for manufacturing & technology companies. Those tax incentives have gone away. This program is one of the only economic development tools the State has left to sell. And with California’s reputation as one of the most expensive states in which to conduct business – from labor to taxation to regulation – it doesn’t help that we’re cutting programs that spur economic development. There’s no easy answer when we have to continue to cut areas like education and healthcare. But that’s another topic all together.
I have been on the consulting side of the tax incentives business since 1996. I have personally witnessed how these tax credits can positively impact small businesses, their owners, their employees and the communities they operate within. These companies are able to not just stay afloat, but expand, hire new employees and invest in their communities. I obviously have a personal interest in the program remaining in place, but I do recognize that there are some regulatory changes that need to be made to the program. Generally speaking, I do support changes to the program – though perhaps not to the degree of change currently proposed.
HCD is projecting to adopt the new regulations by May 1st. All companies who have not participated in the program and wish to do so are well-advised to act quickly. As long as a voucher is issued prior to the May 1st target date, those companies will be grandfathered into the program and able to utilize the four-year amendment law. All others will fall under the new regulations and be limited to just one year.
If you wish to learn more about the proposed regulatory changes, please visit the HCD website at www.hcd.ca.gov/ezregs.
About the Author
As the founder and Managing Principal of Tax Incentives Group, Scott Nelson has spent his entire career dealing with tax and financial incentives for business. Mr. Nelson began his career with the State of California, Trade & Commerce Agency in the Sacramento Regional office. He was responsible for attracting new business and retaining existing business in California through site selection assistance and the promotion of business incentives.
After obtaining his MBA, Scott was hired as the Pacific Northwest practice leader for KPMG Peat Marwick’s Business Incentives Group, part of the State & Local Tax practice in San Francisco. He was then recruited by Ernst & Young to build and lead their Business Incentives practice on the West Coast. His former clients include Bank of America, Mercedes-Benz USA, American Airlines, Home Shopping Network, and Amazon.com.
Scott has saved his clients in excess of $150 million over the course of his career. His clients range in size from small business to the Fortune 50 and cut across various industries including manufacturing, distribution and service company environments. Scott has also been a frequent speaker at the Tax Executives Institute and authored numerous articles in Site Selection and Area Development magazines.