2013-Issue 43—As the end of 2013 tiptoes closer, many California taxpayers may soon be impacted by new replacement incentives enacted in July (AB 93 and SB 90). The old California enterprise zone program ceases to exist at the end of 2013, and effective January 1, 2014, a new employment credit and a partial sales tax exemption on manufacturing or research and development equipment become available.
Taxpayers may have to change procedures after January 1, 2014, because the new hiring credit requires contemporaneous action. No longer can the calculation of the credit be put off until the filing of the original income tax return, much less be claimed as a refund on an amended return. Also, taxpayers should be allowed to obtain vouchers under the old enterprise zone program for 2013 hires until December 31, 2014, but it may be prudent to obtain 2013 vouchers before year-end (2013), if possible, to avoid any transitional problems that concern some local zone coordinators.
The significant partial sales tax exemption from the state-level portion of the tax (4.1875 percent) becomes effective July 1, 2014. The incentive applies to purchases of qualified property used in certain manufacturing and research and development activities, including the life sciences industry.
There is also a new investment incentive called the California Competes credit. Businesses will be able to compete for available tax credits based on the number of jobs to be created or retained, the extent of poverty in a business development area, a minimum compensation limitation and a set job retention period. Unlike the old program, the location of the business can be anywhere in California.
New Incentive Details
I. New Employment Credit
The new employment credit is potentially larger than the old enterprise zone hiring credit, as the new maximum credit per employee is $56,000 over five years versus $36,000 over five years. It will be available from January 1, 2014 to January 1, 2021 to a “qualified taxpayer” that hires a “qualified full-time employee” and pays or incurs “qualified wages” for work performed in a designated geographic area (or DGA).
The designated geographic areas are designated census areas that have the highest unemployment in California. They will be determined by the Department of Finance. All prior enterprise zones (in existence on December 31, 2011) and LAMBRAs — local agency military base recovery areas — (in existence on July 11, 2013) are part of the designated geographic areas, except in census tracts within those zones with low unemployment and low poverty levels. The catch is that the Department of Finance has just announced some exceptions and some shrinkage of the existing enterprise zones. The Department recently released a . Certain zones have changed slightly — like the San Francisco financial district, which lost a few pockets of the old enterprise zone but maintained most of its territory. Presumably, wholesale changes were avoided because the Department of Finance chose to continue with the old formula that determined which areas were economically depressed by focusing on the area’s residents. The neighborhoods around the financial district, for example, are impoverished and distressed, which is why the zone was initially created and has now been shaved in some areas and expanded in others.
How the Credit Is Calculated
The new employment credit is equal to 35 percent of wages paid in the first five years of employment (up to $56,000), but only wages in excess of 150 percent of California minimum wage (currently $12 per hour or $10 per hour in designated pilot areas) and not greater than 350 percent of California minimum wage (currently $28 per hour) qualify. This new credit is not available for retailers, food service, temporary employment agencies, casinos, bars or sexually oriented businesses.
Qualified employees include the long-term unemployed, unemployed veterans, ex-felons and recipients of the federal earned income tax credit, CalWORKs or general assistance. Note that under the old enterprise zone program, new hires who were residents of a targeted employment area (or TEA) would also qualify. Targeted employment area residents were easy to identify by address. However, the new employment credit does not have a targeted employment area category.
The tentative credit reservation (or TCR) will replace the voucher and is needed to qualify an employee for purposes of computing the credit. Applications will be submitted online and must be requested within 30 days after reporting the new hire to the Employment Development Department’s New Employee Registry, which must be done within 20 days of their start date (thus no more than 50 days).
The new credit has the additional administrative burden of annually re-certifying continued employment for any qualified employee who received a tentative credit reservation (this must be done within 2.5 months after the close of the taxable year). The old credit required the voucher and an internal schedule tracking the qualified employee’s hours and wages. The new credit can apply to all income, not just income generated from activity within the designated geographic area. The old credit apportioned income from enterprise zone apportionment factors. The new hiring credit can only be carried over for five years, as compared with the old credit’s indefinite carryforward period. The new credit’s recapture period for "termination" is 36 months after beginning employment. The old credit’s recapture period was approximately 270 days of employment. Finally, employers must have an annual net increase in full-time employees statewide, and the credit may be taken only on an originally filed income tax return.
II. The New (Partial) Sales and Use Tax Exemption
The new rules provide a statewide sales tax exemption for a portion (4.1875 percent) of the state sales and use tax on up to $200 million of certain manufacturing and research and development equipment (and certain related equipment). The exemption can create savings of over $8 million per taxpayer or combined group. Qualified persons will be determined by the North American Industry Classification System (NAICS). The exemption is available to manufacturers (NAICS codes 3111 to 3399) and also certain biotechnology, physical, engineering, and life sciences companies conducting research and development (NAICS codes 541711 and 521712). It is not available to certain financial institutions, agricultural and extractive taxpayers. The exemption applies to purchases made on or after July 1, 2014, and sunsets on July 1, 2022.
Qualified tangible personal property includes machinery and equipment and certain other items purchased by a qualified person for use “primarily” (meaning 50 percent or more of the time) in any stage of manufacturing or research and development, or used primarily to maintain, repair, measure or test property used in manufacturing or research and development. Qualified tangible personal property also includes special-purpose buildings and foundations used as an integral part of the manufacturing process, and purchases made on behalf of a qualified person by a construction contractor. The exemption also applies to leases of qualified property if the leases are considered “continuing sales” and “continuing purchases” under existing sales tax law.
III. New ‘California Competes’ Incentive Credit Program
A new fund will be created to allow negotiated agreements to provide tax credits related to certain investments and employment expansion in California. The program will be administered by the Governor’s Office of Business and Economic Development, “GO-Biz.” GO-Biz negotiates the amount of credit based on factors including the number of jobs, location and new capital investment. The business location can be anywhere in California.
The following funds will be available: (1) $30 million for 2013-14; (2) $150 million for 2014-15; and (3) $200 million for each additional year through 2017-18, with adjustments based on the performance of the hiring credit and sales/use tax exemption. The program is available January 1, 2014, and sunsets on January 1, 2025.
Taxpayers will be allowed to continue using any existing enterprise zone carryover credits (earned before 2014) for 10 years. Previously, these credits had an unlimited carryforward period.
Other Related 2014 California Tax Changes:
In 2014, the San Francisco payroll expense tax begins to transition into a gross receipts tax. A San Francisco enterprise zone tax credit has been available to offset the previous city payroll expense tax. The city has indicated that this credit will be eligible to be credited against the sum of the gross receipts tax and the payroll expense tax liability to the extent that it would have been creditable if the payroll expense tax had been in full force at the 1.5 percent rate. However, the credit cannot be used by related members of the combined group. Because the city treats the San Francisco credit as independent from and a supplement to the state enterprise zone credit program, the current view is that the new program should not impact how the city credit will operate. Presumably, this means that the new tentative credit reservations will replace the old vouchers for the city credit as well.
Alvarez & Marsal Taxand Says:
The new programs provide potentially significant changes for many taxpayers. Some may find reductions or eliminations of the credits they had qualified for, but others may find significant new benefits and incentives. The state is hoping to incentivize certain behaviors. Taxpayers that have significant credit carryforwards should consider the impact, including financial statement impact, of the new 10-year limitation on the carryforward period that previously had been an unlimited carryforward period.
While the state’s goals for the new employment credit include better incentivizing expanded new hiring and simplifying its administration, the removal of the targeted employment area category of qualified employees is one example of a change that will impose a greater burden, by requiring many taxpayers to more rigorously document qualifying new hires.
The new employment credit, sales tax exemption and California Competes credit have the potential to be significantly larger per taxpayer than the credits available under the old enterprise zone program, although there are also some stricter limitations. The new credits also have the potential to be generated in new locations throughout California. Taking maximum advantage of these benefits will likely require more upfront planning and action than before.
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