If you’re steeped in high-impact tax issues, you know how important tax credits and incentives can be when developing and implementing a business plan. They’re not only important—they also can be complex, especially in today’s economic climate. That’s why we thought a one-on-one interview with an expert would be valuable for this column. Senior editor Michael Levin-Epstein sat down with a recognized professional in this space, Matt Kelley, vice president of tax consulting services in Experian’s Employee Services group, to get his perspective.
Michael Levin-Epstein: Why are tax credits and incentives relevant to business plans?
Matt Kelley: This is an important question always, but especially right now, as we look at a difficult economic environment, where businesses are going to be very focused on margins, costs, and protecting their base. Tax credits and incentives, historically, have been meant, and are meant, to help businesses achieve those goals. Tax credits and incentives aren’t crazy loopholes that no one else knows about that we discover and exploit. They are intentional acts of Congress, and they are meant to help businesses. So, as businesses look at how they can reduce costs, how they can supplement cost to achieve strategic growth, to build head count, to hire, to train, [and] to expand their footprint, tax credits and incentives at the federal, state, and local levels can provide economic support to do that. Whether this is through an income tax credit; whether through a payroll tax credit, like the very popular employee retention credit; or whether through grants to supplement training costs or grants to supplement capital investment; or [through] sales tax exemptions or property tax abatements—all of these tax incentives are provided to encourage business growth and development. This fits squarely within the goals of executives at businesses to help grow their business. In most people’s minds, tax credits and incentives are only a piece, but a very pivotal piece, of that business expansion and business plan.
Levin-Epstein: I want to go back a little bit to get some additional historical context. When the IRS first came on the scene, were tax credits and incentives part of the overall tax structure?
Kelley: Tax credits and incentives, in a way, have really been around for hundreds, if not thousands, of years, obviously outside of the US as well. Initially, when taxes were imposed, there were exemptions to certain classes of businesses or classes of society, so there’s always been a way to use taxes to influence the economy. That’s always been a lever that governments—including the United States government—have historically wanted to have at their disposal for economic development. I would say recently, in more modern history, in the last twenty to thirty years, tax credits have become more front and center publicly. Tax incentives have become more available, because politicians—state, local, federal politicians—understand they have a role that resonates sometimes with their constituents. If you look at, for example, the Amazon HQ story, tax incentives were on the front page of almost every major newspaper for quite a while as people understood that Amazon HQ was shopping for the most economically viable location. I would say in modern times it gets more press coverage, but they’ve always been around.
Levin-Epstein: Talk some more about the relevant stakeholders when it comes to incentives.
Kelley: Sure. “Stakeholders” is a shifting environment, but generally the tax department is going to be interested in income tax incentives. They have to understand them; they have to be able to report them. They have to be able to budget them into their tax planning. But sometimes those income tax credits, the work opportunity tax credit for example, are based on hiring and payroll data. So, in some organizations I’ve personally worked with, income tax still was the owner of that work opportunity tax credit, because it’s a federal income tax credit, working with payroll, working with HR to make sure they’re capturing and reporting it correctly. In other organizations I’ve worked with on the work opportunity tax credit, income tax was the beneficiary of the credit but really had very little to do with it. Payroll or HR owned it, owned the process, owned the credit, owned the relationship with their tax consultant, and they handed that form over to the income tax team when they needed it at the end of the year. So you can see multiple stakeholders that have that ownership depending on how the culture of the organization is built. What we hope to see is, ideally, those stakeholders will work together. That doesn’t always happen, but ideally, on a credit such as the work opportunity tax credit, the payroll and HR teams and income tax would work together. They’d all know each other, they would be co-stakeholders, co-teammates on this effort, working with the consultant if they use one. Typically, you’ll see that one person wants to own it and everybody else kind of supports that person, which is fine, too. Contrast that with a sales tax exemption, or a property tax abatement, and then maybe the real estate team wants to own the tax abatement process. The type of credit, or category of tax incentive, may determine who the primary stakeholder is. Ultimately, though, the finance team, going all the way up to the CFO, that’s who wants to know what the benefit is, because it’s going to be a big part of their budget and their revenue plan for that year and years going forward. So, I think everything eventually ends up at the ultimate stakeholder, which is the CFO on most tax incentives.
Levin-Epstein: That’s an excellent explanation. Along those lines, would you say that tax incentives and credits have gotten more complicated over time?
Kelley: That’s a really good question. I think that, similar to the tax code and the tax environment, everything has gotten a little more complicated as the years go on. As taxpayers find different ways to use provisions of the tax code, the IRS or the legislature may feel like that was not the way it was intended, so they pass a regulation or they amend the tax code to try to stop that behavior, to influence that behavior, and that creates complications. Tax incentives are getting more complex, because governments are getting better at learning how to use them to influence behavior and taxpayers are getting better at using them as needed. There’s a lot of trial and error there, right? You think, “If we give this property tax abatement to a company that comes in and creates 500 jobs, then that should result in a net gain” for the county or state or city that they’re operating in. The local government is going to give up some property tax revenue, but they’re going to gain the spend that comes from people buying food and shopping and buying homes, and all the stuff that comes with that business. What they are beginning to find as they model out the real data from that investment and from that property tax abatement, maybe it didn’t achieve what they wanted it to. So, next time, maybe they don’t do a property tax abatement, they do a TIF [tax increment financing] plan, or they do a combination of a property tax abatement and a sales tax exemption to try to get the same behavior without giving up as much tax revenue. I think as we get more knowledgeable about how tax credits and incentives influence not only the behavior of the investor but also how they influence the tax revenue of the government, then it by necessity becomes a little bit more complex as people try to work through what the right answer is.
Levin-Epstein: Are there any times that local and/or state tax incentives or credits are in conflict with federal tax incentives or credits?
Kelley: Typically, when you’re looking at the tension between the federal tax regime and a state or local tax regime, it isn’t necessarily in conflicting incentives. But what it may be is a conflict in how federal and state tax authorities treat those incentives. For example, the very publicized and very popular employee retention credit passed as part of the CARES Act stimulus. When you claim the employee retention credit as a refundable payroll tax credit, similar to other payroll tax–based credits like WOTC [the Work Opportunity Tax Credit], the IRS requires that you make an adjustment on your wage expense on your income tax return. So, claiming that credit will essentially increase your income tax liability, because it will decrease your wage expense on your 1120. Many states do not require a similar income tax adjustment on the state tax calculation so it doesn’t necessarily conflict, but it’s different. Taxpayers will sometimes get a more or less favorable treatment at the state or local level, depending on what the state or local policy is and what their interest is. You saw a similar thing with opportunity zones years ago, with the federal Qualified Opportunity Zone program, where states either added on to or restricted that federal benefit at the state level. So, when a taxpayer is looking at incentives, they don’t necessarily look for, Are they going to get in trouble with the IRS if they claim this state credit? or, Are they going to get in trouble with the state if they claim this federal credit? What they look for is, What is the state and local impact of a federal credit versus what is the federal impact of a state or local credit? Is this cash grant I received from a state governor’s office taxable on my federal income tax return? That just helps them to understand, Do I need to net the benefit to make sure I’m fully reporting to the finance team what the actual benefit is?
The IRS and Tax Incentives
Levin-Epstein: How does the IRS view tax incentives?
Kelley: The IRS is fairly agnostic, I think, on tax incentives. Their job isn’t to judge whether any tax incentive should exist; they leave that to the legislature. The IRS’ responsibility is to ensure that the tax incentive is applied within the rules provided by the legislature and to avoid any abuse. The IRS is more knowledgeable, generally, about the history of how taxpayers look at these incentives, how they use them, whether there’s any potential for abuse, so they can leverage other rules that already exist for other tax credits. For example, tax credits like the research and development credit at the federal level have been around for a while. The IRS has had a lot of experience with this credit, so when a new, different income tax credit is passed, they may say, “Well, look—this is somewhat similar to the R&D credit, so let’s make sure we pull in those rules as well,” but they’re not going to come out and say, “We don’t like this credit; we hope nobody claims it.” They’re not going to pass a judgment like that. What was interesting recently—I’ve only been practicing for fifteen years, and I haven’t seen this happen on tax credits in the past—with the employee retention credit, we saw the IRS, as expected, release guidance on the credit in the form of FAQs so that taxpayers had some level of confidence in how they claim and report the credit. They published several FAQs on the employee retention credit. Very quickly, on at least one of the FAQs, the legislature came out and said, “That’s not what we meant,” and the IRS had to update their FAQs. That’s pretty unique, but that’s an example where there was public tension between the IRS and the legislature on a tax credit. Not that the IRS was viewing that tax credit in a negative light—they were just providing guidance that the legislature found was not within the intent, or the language, so they corrected it publicly. But the IRS usually isn’t going to pass judgment. They really are there to just facilitate the reporting and the claiming of the credit.
Levin-Epstein: Are there risks when you claim incentives, and, if so, what are those risks?
Kelley: There certainly are risks. I caveat by saying I don’t think these risks should, and I don’t think they do necessarily, prevent taxpayers from taking advantage of a tax credit that they have the right to use. For example, some tax incentives—maybe not even tax credits—such as a job creation credit, whether that’s in Georgia or Massachusetts, require a minimum number of jobs that need to be created in order to earn the credit. You, as a taxpayer, have to make sure you can create those jobs, and you have to make sure that you’re within the definition of “job.” Does the tax credit require net new jobs? Does the definition of “new jobs” count any new hires that year, or is it only net new hires? Part of the risk is just making sure you understand the requirements of the credit. Other times you may be looking at a discretionary incentive. For example, you get a property tax abatement because you created ten jobs this year and over the next five years you committed to create 150 jobs. The risk is, over the next five years, a lot can happen economically, whether it’s your business that doesn’t do as well as you expected, or the economy in general—again, given today’s environment—doesn’t perform as expected. Maybe you don’t create 150 jobs over that five-year period. Do you have to give back that property tax abatement? Are there clawbacks to that credit? You do have to consider the risk of potentially experiencing a clawback to a benefit that you’ve already claimed. My experience has been that the states, the economic development teams that work on those credits, that partner with the taxpayer on incentivizing that job creation, don’t want to claw back the credit. They’re not looking for the nearest, the soonest example to claw back that benefit. They really want a great story at the end of the day. They want to show that the economic development team is positively creating jobs in an area where it was difficult to create jobs, and they did so by using the tools that were given to them by the legislature. They want a positive outcome, so they will work with taxpayers. They may need to renegotiate some of the terms of that benefit, they may need to add some additional time to get those jobs created, they may need to make some amendments, but they do want to work with you. So, in my experience it hasn’t been a “gotcha” moment with that type of a risk, but it certainly is a risk that if you don’t create those jobs, in our example, there may be clawbacks. There’s risk outside of just not being compliant with the rules around the tax credit. I’ve met employers who were qualified to claim certain credits but felt uncomfortable claiming them, because they were concerned with what the public image may be if it became known that they had participated in this program. There’s a lot of tension, there’s a lot of discomfort with some employers, some big companies—and some small companies as well—around taking what others may define as “corporate welfare,” when that’s really not a fair name for it. Usually these tax credits have a net gain—they can result in a net benefit to the tax authority, to the government, to the taxpayers, by providing the incentive that they’re providing, but tax credits are still viewed negatively sometimes. Or the employer may say, “Look, I’m not in a position now where I want to be seen as participating in this. We just had this payroll protection program come out, and I don’t like all the negative publicity some people received with that program. So, even though I’m perfectly eligible for this incentive, I’m not going to do it; I just don’t want the publicity risk.” So, there’s certainly a lot of managing that risk as well, the PR risk. But when we work with taxpayers, we discuss all of these risks. It’s usually front and center in our conversations to make sure the taxpayer is comfortable. We can even manage the communications with their PR team when participating in these programs. These are examples of the two sides to the risk coin when participating in tax credits and incentives that all employers, all companies, consider as they’re looking at these for their benefit.