California Enterprise Zones—Improved, Expanded and Additional Compliance

Over the past two years, the California Enterprise Zone Tax Credit Program has witnessed significant changes, including major expansions, new regulations and additional tax compliance measures that will certainly affect CPAs across California. Some of the major changes include:

• Jan. 1, 2006: A significant court case was decided by Board of Equalization: Appeal of Deluxe Corporation, giving the FTB the authority to audit the vouchers previously issued by local administrative agencies.
• Nov. 3, 2006: Twenty-three EZs were either renewed or expanded significantly.
• Jan. 1, 2007: Housing and Community Development Department (HCD) issued new vouchering regulations that standardized documentation requirements.
• Nov. 15, 2007: Franchise Tax Board (FTB) issued Notice 2007-4 requiring new compliance requirements for tax credits secured under contingency fee arrangements.
• Jan. 1, 2008: HCD implemented new state vouchering forms.
• Jan. 31, 2008: Gov. Schwarzenegger announced eight new enterprise zones to boost California’s economy.

With the substantial geographic expansions of existing EZs, new 15-year designations for both expiring and entirely new EZs, plus improvements to the Hiring Credit vouchering process, we believe that the California EZ program has been markedly improved. However, what do these changes mean to you?

Enterprise Zones—Significant Expansions the Past Two Years

Check your client list on an annual basis to determine if they reside in a new or expanded California Enterprise Zone.

Between October 2006 and September 2008, 31 of California’s 42 enterprise zones were scheduled to expire. At the conclusion of a competitive bid process, HCD has awarded five brand new enterprise zone designations and re-designated 26 previous zones for an additional 15 years. Most of the communities that received a re-designation were able to significantly expand the enterprise zone boundaries of their original designation. For example, Sacramento’s enterprise zone doubled in size to 3,500 acres. The cities of Los Angeles and San Francisco substantially expanded their zones to include major portions of their downtown financial districts. And Stanislaus County, one of the newest enterprise zones, has expanded three times to approximately 67,000 acres.

CPAs will need to diligently review their client rosters to verify whether any businesses have offices in a new or expanded zone. HCD maintains the state’s official website of EZ street addresses, at www.hcd.ca.gov/fa/cdbg/ez/enterprise/#maps. Unfortunately this site has not posted the addresses of many of the new, conditionally designated zones, but, in most cases, the local communities have posted the addresses on their websites.

New Vouchering Regulations and Forms

Make sure you adhere to new documentation standards for requesting an enterprise zone hiring credit voucher. “Cross-jurisdictional vouchers” should be re-requested for the EZ in which the business is located.

On Jan. 1, 2007, the new vouchering regulations, Sections 8460-8467 of the California Code of Regulations (CCR), Title 25, became effective. Among other things, these regulations impose new documentation standards for requesting and obtaining the EZ Hiring Credit voucher for qualified employees. Previous to the enactment of these regulations, each of the local zone administrators essentially were empowered to establish their own documentation criteria, which led to problematic inconsistencies: Individuals might qualify based on one zone’s standards, but wouldn’t qualify in another. Inevitably, this led some businesses to submit their voucher requests to zones with more lenient standards, even though the business was not located within that particular zone. This practice, dubbed “cross-jurisdictional vouchering,” is now prohibited under the new regulations.

In addition to the new regulations, all new voucher requests submitted after Jan. 1, 2008, must use the state’s new voucher application and certificate. Again, this was a move to create consistency and standardization among the various Zest that previously had required their own forms and eligibility checklists. The new voucher forms are also available on HUD’s website referenced above.

New Franchise Tax Board Compliance For Contingency Fee Arrangements

Make sure you file the Form 8886 for any clients securing tax credits under a contingent fee arrangement. There is a $15,000 penalty per year if you do not.

The FTB recently published Notice 2007-4 defining reporting requirements that may impact some of your EZ clients. As you may know, many EZ businesses engage consulting firms to secure these tax credits under a contingency fee arrangement. When a taxpayer pays consulting fees that are contingent upon the taxpayer’s realization of tax benefits from certain types of transactions, these transactions are reportable to the FTB on IRS Form 8886, Reportable Transaction Disclosure Statement. Not only does the taxpayer need to file this form with the original tax return, but also a duplicate copy must be mailed to FRB’s Abusive Tax Shelter Unit for the initial year of participation.

Technically, this rule became effective for tax years beginning Jan. 1, 2003. However, the FTB provided an amnesty period through Nov. 15, 2007, to perfect all prior-year disclosures according to their notice. The penalty for failing to disclose this transaction is steep. The FTB will impose a penalty in the amount of $15,000 for each transaction and for each year .

The good news is that the FTB is considering whether to exempt the California Enterprise Zone tax credits from this reporting requirement in the future. Doing so would seem to conform to the federal government’s exemptions for taxpayers who participate in federal hiring credit programs, such as Empowerment Zones, Renewal Communities, and the Work Opportunity Tax Credit. However, at this time, the FTB has not made a determination to exempt the California Enterprise Zone, and so we are advising taxpayers to adhere to these reporting requirements.

FTB Enterprise Zone Litigation

Keep all supporting documentation used to secure an EZ hiring credit voucher. The FTB is re-evaluating the request, even though it has been approved by the local enterprise zone official.

On Jan. 31, 2006, in a case of first impression, the California State Board of Equalization held that the Franchise Tax Board has the authority to request substantiation supporting enterprise zone hiring credit vouchers submitted by a taxpayer claiming the EZ hiring credit.

The taxpayer argued that the FTB did not have the authority to determine the validity of the hiring credit voucher, because the statutes governing the enterprise zone program granted sole authority to review the voucher to the HCD and the local enterprise zone administrative agencies. However, the FTB successfully argued that, given its overall responsibility to determine a taxpayer’s correct tax liability, it may request substantiation to verify the validity of the vouchers in order to determine whether the taxpayer qualified for the credit.

Upon audit of the EZ Hiring Credit, the FTB will ask the taxpayer for the supporting documents used to secure the voucher, in addition to requesting copies of the vouchers themselves. If the supporting documentation is unavailable, the FTB may ultimately disallow the voucher and the credits claimed for that employee. We are aware of several anecdotal cases where the FTB auditor has been provided with the supporting documentation used to obtain the voucher, but nonetheless determines that the documentation is insufficient. In such cases, the FTB may require additional supporting documentation or ultimately disallow the voucher if none can be provided. In many cases where the vouchers were obtained seven, eight, or more years ago, it could prove difficult to obtain supplemental supporting documentation, particularly if the employee no longer works for the taxpayer.

Conclusion

The California Enterprise Zone program has undergone tremendous changes in the past couple of years. Geographic expansions and new zone designations will mean that more businesses than ever before can now reap the program’s benefits. Standardization of the program’s vouchering process will be a welcome improvement over the uncertainties and inequities of the past. Yet the FRB’s level of scrutiny of EZ credits is on the rise, so taxpayers and their advisers must be ever-more vigilant in determining the appropriateness of each employee’s eligibility, consistent in their record keeping and accurate in applying the credits to their tax returns.

Author

Joseph Abdallah, CPA, of Professional Solutions Group LLC, specializes in both multistate taxation and California’s audit, protest, and settlement procedures. Abdallah can be reached at (916) 791-3120 or joseph@prosolutionsllc.com.

This entry was posted on Monday, June 9th, 2008 at 1:46 pm and is filed under Chapter News. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.