MEMBER OF PKF NORTH AMERICA, AN ASSOCIATION OF LEGALLY INDEPENDENT FIRMS © 2013 Wolf & Company, P.C. Financial Managers Society Income Tax Credits November 18, 2014 Presented by Jana B. Bacon, CPA Director, Bank Tax Services Wolf & Company, P.C.

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

4 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

5 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

6 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

7 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

8 Low Income Housing Tax Credits (cont’d) New method of accounting –ASU , 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

9 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

10 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?

11 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

12 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

13 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

14 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

15 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

16 Certified Historic and Other Rehabilitation Credits (cont’d) Historic Boardwalk Hall case –Historic Boardwalk Hall, LLC, N (3d Cir. 8/27/12), cert. denied, Sup. Ct. Dkt. No (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 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 ?

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

18 Certified Historic and Other Rehabilitation Credits (cont’d) Example - activity Capital contribution Taxable income (loss) Tax 35%CreditsDistributions Annual benefits ,000, ,200, (115,000) 40, ,000 50, (115,000) 40, ,000 50, (115,000) 40, ,000 50, (115,000) 40, ,000 50, ,000 (252,000) - 20,000 (232,000) 1,000, ,000 (91,000) 1,200,000 60,000 1,169,000

19 Certified Historic and Other Rehabilitation Credits (cont’d) Example – book basis Book Basis Beginning Book BasisContributionsDistributions Other activity flowthrough Ending Book Basis ,000,000 - (940,000) 60, ,000 - (10,000) - 50, ,000 - (10,000) - 40, ,000 - (10,000) - 30, ,000 - (10,000) - 20, ,000 - (20,000) - - 1,000,000 (60,000) (940,000)

20 Certified Historic and Other Rehabilitation Credits (cont’d) Example – tax basis Tax Basis Beg Tax BasisContributionsDistributions Operating Activity FlowthroughBasis Adj. Ending Tax Basis Cumulative Temporary Difference ,000,000 (1,200,000) (200,000) 260, (200,000) (10,000) (115,000) (325,000) 375, (325,000) (10,000) (115,000) (450,000) 490, (450,000) (10,000) (115,000) (575,000) 605, (575,000) (10,000) (115,000) (700,000) 720, (700,000) (20,000) 720, ,000,000 (60,000) 260,000 (1,200,000)

21 Certified Historic and Other Rehabilitation Credits (cont’d) Example – accounting entries YEAR 1 DRINV IN P/S 1,000,000 CRCASH 1,000,000 TO RECORD P/S INVESTMENT DRP/S WRITEDOWN 940,000 CRINV IN P/S 940,000 TO RECORD WRITEDOWN ON P/S INVESTMENT DRCURRENT TAX LIABILITY 1,200,000 CRFEDERAL TAX EXPENSE 1,200,000 TO RECORD TAX CREDIT FROM P/S INVESTMENT DRDEF TAX ASSET/LIABILITY 329,000 CRFEDERAL TAX EXPENSE 329,000 TO RECORD DEFERRED ASSET/LIABILITY ON P/S WRITEDOWN DRFEDERAL TAX EXPENSE 420,000 CRDEF TAX ASSET/LIABILITY 420,000 TO RECORD DEFERRED ASSET/LIABILITY ON P/S BASIS ADJUSTMENT NET TAX BENEFIT 1,109,000

22 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

23 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

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

25 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

26 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

27 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

28 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))

29 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?

30 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

Questions? Jana B. Bacon, CPA Member of the Firm Director of Tax Services, Financial Institutions Wolf & Company