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Today’s Agend a

Financial Managers Society Income Tax Credits November 18, 2014 Presented by Jana B. Bacon, CPA Director, Bank Tax Services Wolf & Company, P.C. Today’s Agend a. Federal tax credits General rules Major types of credits Ordering rules What about expired / expiring credits?

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Today’s Agend a

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  1. Financial Managers SocietyIncome Tax CreditsNovember 18, 2014Presented byJana B. Bacon, CPADirector, Bank Tax ServicesWolf & Company, P.C.

  2. Today’s Agenda • Federal tax credits • General rules • Major types of credits • Ordering rules • What about expired / expiring credits? • Massachusetts tax credits • Questions?

  3. Federal Credits • General rules • Most governed by IRC§38 • Offset tax dollar for dollar • Not refundable (i.e., limited to tax) • Carryback one year and forward 20 years • Only specific credits may be used against AMT

  4. Major Types of Credits • Low-income housing tax credits (LIHTC) • Historic and other rehabilitation credits • New markets tax credits • Renewable energy tax credits • Research credits • Employment based credits

  5. Low Income Housing Tax Credits • IRC §42 - first started in 1986 to encourage investment in low-income housing • Component of the general business credit • Credit may be used against AMT if building placed in service after 2007 • Amount of credit • Applicable credit percentage times qualified basis • Both vary by type of project • Credit taken over 10 years with 15 year compliance period (pro-rate in first year) • Generally flow through limited partnership investment

  6. Low Income Housing Tax Credits (cont’d) • Recapture occurs if during 15-year compliance period: • Project fails to meet rent and income tests • Sale of building • Sale of p/s interest in p/s that owns the building • Recapture never more than 1/3 of total credit • Interest must be paid on increased tax liability due to recapture • If credit had not been used to offset liability – reduce carryover / carryback amounts

  7. Low Income Housing Tax Credits (cont’d) • New method of accounting • ASU 2014-01, Accounting for Qualified Affordable Housing Projects • Does not apply to other types of tax credit partnerships • Proportional method - amortize cost of investment in proportion to tax credits and other benefits – presented as component of tax expense • Replaces effective yield method • Cost or equity method used if you do not qualify for proportional method

  8. Low Income Housing Tax Credits (cont’d) • Conditions to use proportional method • Probable tax credits to investor will be available • Investor has no ability to exercise significant influence over the entity • Substantially all projected benefits are from tax credits and other tax benefits • Projected yield is positive (based solely on cash flows from credits and losses) • Investor is a limited liability investor for legal and tax purposes; liability limited to capital investment • Also must test for impairment when changes in circumstances indicate more likely than not that carrying value will not be realized • Disclosures required

  9. Low Income Housing Tax Credits (cont’d) • Due diligence • Pricing / rate of return • Experienced project manager? • Cash flow of project • CRA benefit? • Does schedule of tax benefits/costs consider tax capital gain/loss on termination of partnership?

  10. Certified Historic and Other Rehabilitation Credits • Established in 1976 to encourage preservation of historic property • Administered by National Park Service, IRS and state officials • HRTC involves rigorous 2 part approval process • Property must be located in an historic district • Property must be designated as a certified historic property • If certified historic and expenditures do not qualify for CHTC, cannot qualify for “regular” 10% rehab credit

  11. Certified Historic and Other Rehabilitation Credits (cont’d) • IRC §47 • 20% tax credit for certified rehabilitation of certified historic structures • 10% tax credit for rehabilitation of non-historic, non-residential buildings placed in service before 1936 • Credits generally claimed during the first year by owner of the property as dollar for dollar reduction in tax liability • Five year holding period or subject to recapture – 20% vesting per year • Credit may be used against AMT for rehabs after 2007

  12. Certified Historic and Other Rehabilitation Credits (cont’d) • Qualified rehabilitation: • Building must be placed in service before beginning of rehabilitation • Rehabilitation must be substantial • Materially extend the useful life of the building • Rehab expenditures must exceed the greater of $5,000 or the adjusted basis of the property, excluding land • Example: Adjusted basis = $100,000; must spend at least $100,001 to qualify • For non-historic rehab - • Retention of 50% or more of external walls as external walls • 75% or more of external walls retained as internal or external walls • 75% or more of internal structure framework retained • Other requirements related to measurement period

  13. Certified Historic and Other Rehabilitation Credits (cont’d) • Generally, not available with tax-exempt use property • Basis in the rehab property is reduced by the amount of the credit • Example: • Qualified rehab expenditures $100,000 • HRTC claimed 20,000 • Depreciable basis $ 80,000 • Credit is not transferable

  14. Certified Historic and Other Rehabilitation Credits (cont’d) • Generally flow through LP or LLC investment • Credit allocated to partners based on their share as per agreement • Credit recapture can occur if partner sells share and remaining partners’ interest reduced to less than 2/3 of what it was when rehab placed in service • Recapture if property sold before 5 year holding period is up • Likely pass through of other p/s income/expenses • Partner’s tax basis in p/s is reduced by the amount of the credit • Adjustment to cumulative temporary difference – effects tax expense as if permanent difference • Exception if election to amortize the credit into taxable income through K-1 pass-through - rare

  15. Certified Historic and Other Rehabilitation Credits (cont’d) • Historic Boardwalk Hall case • Historic Boardwalk Hall, LLC, N0. 11-1832 (3d Cir. 8/27/12), cert. denied, Sup. Ct. Dkt. No. 12-901 (U.S. 5/28/13) • Must be bona fide partner to claim credits • Must have “meaningful stake in the success or failure of the partnership” • IRS Safe Harbor – Rev. Proc. 2014-12 • Due diligence • Pricing / rate of return • Experience project manager? • Projections include basis reduction and gain/loss on termination? • Does agmt meet safe harbors of Rev. Proc. 2014-12?

  16. Certified Historic and Other Rehabilitation Credits (cont’d) • Accounting – no guidance specifically for CHTC p/s • Cost or equity method • Evaluate for impairment

  17. Certified Historic and Other Rehabilitation Credits (cont’d) Example - activity

  18. Certified Historic and Other Rehabilitation Credits (cont’d) Example – book basis

  19. Certified Historic and Other Rehabilitation Credits (cont’d) Example – tax basis

  20. Certified Historic and Other Rehabilitation Credits (cont’d) Example – accounting entries

  21. New Markets Tax Credits (NMTC) • Created in 2000 to encourage investment in low-income communities • Currently expired but may be extended by Congress • Administered by Community Development Financial Institutions Fund (CDFI Fund), a branch of the U.S. Dept. of Treasury • Awarded to Community Development Entities (CDE) by CDFI Fund, then allocated to qualifying projects

  22. NMTC (cont’d) • Credit equal to 39% of investment • Claimed over 7 year period • 5% claimed in each of first three years • 4% claimed in each of next four years • NMTC funds must be invested for 7 years • 100% recapture of credits occurs if: • CDE no longer meets qualifications • Equity investment is redeemed; or • CDE does not invest in qualified projects • Tax basis must be reduced by credit amount

  23. NMTC (cont’d) • Risks? • Credit recapture – generally low • Often there are indemnity provisions in agreement in even of recapture

  24. Renewable Energy Tax Credits • IRC §45 – for production and sale of electricity from renewable resources • Production tax credit – per-kilowatt-hour credit – expired at end of 2013 – awaiting renewal • Investment tax credit (IRC§48) • 30% of cost of qualified property • Solar energy property – credit available through 2016 • Small wind energy property • Credit taken when property placed in service • Five-year holding period or subject to recapture • May flow through partnership or outright purchase of panels • Tax basis adjustment

  25. Research and Development Credit • IRC§41 – 20% credit for expenditures incurred to increase research activities • Computer software development costs • Internally developed accounting, management, or customer accessible systems • Must meet expensing provisions of IRC§174 • AMT tax preference item • Expired 12/31/2013 • Heavy lobbying to make it permanent

  26. Employment Based Credits • Work opportunity tax credit • 40% of qualified first year wages • Paid to member of targeted group • Wages limited to $6k for non-veterans • Wages limited for veterans to $12k to $24k • Complex rules with minimal credit • Empowerment zone employment credit • 20% of first $15,000 of qualified wages paid • Employees must be residents of certain empowerment zones • Employees must perform substantially all employment services within the zone • Both credits expired on 12/31/2013 – may be retroactively reinstated

  27. Ordering Rules • Investment credit (IRC§46) • Rehabilitation credit (including certified historic) (IRC§47) • Energy credit (IRC§48) • Work opportunity credit (IRC§51(a)) • Low-income housing credit (IRC§42(a)) • Renewable electricity credit (IRC§45) • Empowerment zone credit (IRC§1396) • New Markets Tax Credit (IRC§45D(a))

  28. Federal Tax Reform? • Camp discussion draft proposes repeal of 27 tax credits including: • Alternative energy generation credit • Alternative energy investment credit • Rehabilitation credit • Work opportunity tax credit • Is tax reform dead?

  29. Massachusetts tax credits • Community investment tax credit • New for 2014 • Allocated $3 million for 2014 and $6 million for 2015 and thereafter • 50% credit for contribution to CDC which has received an allocation of credits • Charitable contribution deduction for federal and MA purposes, subject to 10% of taxable income limitation • Brownfields tax credit • Historic rehabilitation • Low-income housing • State tax credit certificates • Taxable gain if purchased for less than face value • Employer wellness program credit

  30. Questions? Jana B. Bacon, CPA Member of the Firm Director of Tax Services, Financial Institutions Wolf & Company 413-726-6854 jbacon@wolfandco.com

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