Federal Tax Law Could Be Stumbling Block for State Incentives

Daily Tax Report: State provides authoritative coverage of state and local tax developments across the 50 U.S. states and the District of Columbia, tracking legislative and regulatory updates,...

By John Herzfeld

A provision of the new federal tax law will create hurdles for state and local governments negotiating economic development incentive packages with corporations, practitioners said.

The new law includes an amendment to tax code Section 118, taking away the ability of a corporation to exclude from its gross income “contributions to capital” from a governmental entity—thus increasing corporate tax liability for certain state and local incentives.

By taxing contributions of money or property in incentive deals, the 2017 federal tax act ( Pub. L. No. 115-97) is expected to generate $6.5 billion in new revenue between 2018 and 2027, according to Joint Committee on Taxation estimates.

That estimate may not hold up, however, because state and local governments can restructure their economic development packages to try to avoid the resulting federal tax owed by the benefiting company, said Joshua E. Gewolb, a partner at Harter Secrest & Emery LLP in Rochester, N.Y.

That can be accomplished by switching the emphasis in an economic development offer from grant payments to tax breaks, Gewolb said during a Jan. 23 panel discussion at the annual meeting of the New York State Bar Association’s Tax Section.

State and local tax incentives, such as as credits, deductions, abatements, rate reductions, and exemptions, generally aren’t considered taxable income for federal tax purposes.

Long-Term Impact

States will look at ways to restructure future incentive deals in the long term, said Helen Hecht, general counsel at the Multistate Tax Commission in Washington. But she expressed doubts that the change would have a “chilling effect” on state incentives in the short term.

“This is not an urgent question for states,” but in the future their incentive negotiations will have to cover how to handle the additional tax costs, she said.

Local governments typically can’t react quickly to developments like the federal tax law changes and often have to go to their state legislatures for approval of any workaround arrangements, Hecht told Bloomberg Tax on the sidelines of the meeting.

Also, confusion can be expected over which incentives are covered. With industrial revenue bonds, for instance, the government is the issuer, but the money really goes to the corporation, Hecht said. “Does that count as a contribution to capital or not?”

Rates v. Base

The new law, in general, reduces tax rates while making changes to the tax base, but the states now face changes in the base without the corresponding change to rates, Gewolb said.

The federal changes, taken together with state law, suggest “the increased importance of state tax planning,” Gewolb said. State legislatures and tax departments, he added, face “a lot of decision points” about how to respond.

The federal law, at only a month old, “raises more issues than we have the answers to,” said panel moderator Irwin M. Slomka, senior of counsel at Morrison & Foerster LLP in New York.

He credited the New York Department of Taxation and Finance for issuing an “extremely comprehensive” preliminary report on the impact of the federal law Jan. 17 as it tries “to figure out the implications of this sweeping legislation.”

New York Gov. Andrew M. Cuomo (D), in a Jan. 23 statement, said that the department’s report “detailed the many devastating impacts that this new federal tax code will have on New Yorkers, including the negative consequences of having a tax code closely coupled with the federal tax system.”

“We are reviewing the federal changes and we will propose legislation to address the impacts arising from our coupled tax system and offer new protections from this federal assault,” Cuomo added. “This is what was passed in Washington, and we are going to fix it in New York. We look forward to working with the legislature to get it done.”

To contact the reporter on this story: John Herzfeld in New York at jherzfeld@bloomberglaw.com

To contact the editor responsible for this story: Ryan C. Tuck at rtuck@bloombergtax.com

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