State Incentives Deemed Tax-Free Nonshareholder Capital Contributions
Over the years, the IRS and taxpayers have battled the issue of whether state tax incentives and grants are taxable gross income under Reg. Section 1.61-1(a) or nontaxable contributions to capital under Section 118.
Recently, the U.S. Tax Court took up the issue in Brokertec Holdings, Inc. v. Commissioner, T.C. Memo 2019-32 (April 9, 2019). In Brokertec, the taxpayer and its affiliates relocated its offices from New York to New Jersey and received cash grants from the New Jersey Economic Development Authority. The Tax Court found that the cash grants received from New Jersey’s Business Employment Incentive Program constituted nontaxable contributions to the taxpayer’s capital under Section 118.
This decision may present an opportunity for corporations with similar circumstances. Corporations should review their treatment of any discretionary and statutory incentives they received in recent years, and consider filing protective refund claims for any amounts treated as taxable income. Note also that the tax law commonly known as the Tax Cuts and Jobs Act (TCJA) altered Section 118 rules. Under the TCJA changes, a “contribution to capital” does not include “any contribution by any governmental entity or civic group (other than a contribution made by a shareholder as such).”
Nevertheless, contributions made by a governmental entity pursuant to a master development plan that was approved prior to the TCJA’s enactment date (Dec. 22, 2017) are not affected by the law change.
The IRS position in Brokertec essentially was described in a 2011 IRS publication, Appeals Settlement Guidelines on State and Local Tax Incentives. The IRS has yet to publicly declare the next step it will take with respect to the recent developments in Brokertec. Taxpayers should assess their previous taxable treatment of incentives in open tax years, and consider the applicability of Brokertec to determine if they should file protective refund claims.
Section 118 has a long history of IRS scrutiny, and the time to file an appeal of the Brokertec opinion has not expired, so we anticipate that protective refund claims will be denied. Nevertheless, it will protect your right to file a refund suit should the decision be sustained. And remember, it has long been the position of the IRS that the benefits of Section 118 do not apply to entities other than corporations (outlined in LMSB-04-1008-051). This sentiment was also echoed in the legislative history to the TCJA (outlined in the conference report to the TCJA, H.R. Rep. 115-466, at 241).
For more information, please contact us.
Copyright © 2019, CBIZ, Inc. All rights reserved. Contents of this publication may not be reproduced without the express written consent of CBIZ. This publication is distributed with the understanding that CBIZ is not rendering legal, accounting or other professional advice. The reader is advised to contact a tax professional prior to taking any action based upon this information. CBIZ assumes no liability whatsoever in connection with the use of this information and assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect the information contained herein.
CBIZ MHM is the brand name for CBIZ MHM, LLC, a national professional services company providing tax, financial advisory and consulting services to individuals, tax-exempt organizations and a wide range of publicly-traded and privately-held companies. CBIZ MHM, LLC is a fully owned subsidiary of CBIZ, Inc. (NYSE: CBZ).