The Hidden Burdens of Economic Incentive Compliance
by Kelley Rendziperis, on Nov 27, 2017 4:41:15 PM
Site selection consultants know that economic incentives should never be the primary factor in making a site decision, but rather to bridge the gap between two or more competing locations when all other factors are similar. While economic incentives are typically not the main driver of a site decision, they are heavily relied upon to achieve a targeted return on investment in the selected location. However, many consultants, businesses and economic developers underestimate the complexity of the compliance required to realize economic incentives.
A client recently told me that the complexities of economic incentives compliance should be weighed in determining the overall competitiveness of a particular jurisdiction.
Since economic incentives are not supposed to be the tail that wags the dog, the backend compliance of such programs is usually not a scored item in a comprehensive community comparison or in deciding if the value of the incentive is worth the effort to pursue or claim the benefit. However, our client’s point is certainly valid. To be sure, compliance requirements are something we describe in detail at the time a site decision is being made, but until a company is performing the necessary compliance, or fails to do so, it will always be underestimated. This is especially true as economic incentive compliance continues to increase.
In this article, we describe various compliance measures which we confront daily. Of course, not all jurisdictions and economic incentive programs are the same, but the purpose of this article is to educate a company regarding the magnitude of and variances in compliance.
Economic incentive cost-benefit analysis
A company may expect to pay a filing fee associated with an application, but what about other direct and indirect costs, such as:
- Coordination and assistance from:
- Internal resources: corporate executives, real estate, tax, finance, operations, human resources, legal, governmental affairs
- External resources: construction contractors, developers, landlords, suppliers, third-party payroll providers, law firms, accounting firms, colleges and universities
- Time to inform and train all applicable personnel (and re-train if there is internal turnover) to establish or modify internal systems to track and gather required information, generate reports, review reports.
- State registration requirements, special tax accounts and any requirements to be set up as a vendor in state systems
- Requirement to title assets in the name of a governmental entity to capture economic incentives and the effect on company financial statements, lenders, lessees, etc.; coordination of such efforts with a developer or landlord
- Annual filing fees
- Payments in lieu of tax, supplemental payments
- Consultant and/or attorney fees
- In certain circumstances, a company may have to pay the costs of the city/county attorney related to the project, in addition to any internal counsel.
Drafting of the economic incentive agreement
At the outset of a project, all the parties involved usually have a mutual understanding of the terms of an economic incentive agreement. However, it is imperative to carefully review and understand the literal meanings in an economic development agreement.
- Dates: effective date, expiration date, reporting deadlines, project deadlines, commitment of long-term operations after incentive period
- Employees: part-time versus full-time, number of hours worked, residency; qualification of remote or contract employees; do the job requirements apply to each position or can requirements be applied as an average?
- Wages: taxable wages, gross wages, benefits or overtime includable; use of actual wages or annualized wages; eligibility of wages during month of hire or separation; does the wage requirement need to be met in the year of job creation or annually as the requirement adjusts?
- Capital investment: real, personal and/or intangible, existing or incremental, owned or leased, capitalized or expensed; how is it valued for purposes of meeting minimum commitments?
- Legal entities:
- Which entity is the operating entity, employer of record, real estate owner, personal property owner? How will benefits flow to parent entities or partners in tax filings?
- Transferability based on mergers, acquisitions or internal restructurings
- Need to understand exactly what information will be made public upon acceptance, approval and an ongoing basis. Many states are requiring transparency and public posting of performance with commitments and occasionally financial statements.
- Miscellaneous commitments:
- Commitment to use women or minority suppliers, make purchases from local vendors, participate in local chambers, charities or fundraisers, use of designated community or technical colleges
- Post new positions on state and local workforce websites
- Press announcements
- Ensure there is language that allows for amending agreements due to changes in project commitments, weather catastrophes, labor shortages, business reorganizations, etc.
Gathering information to stay in compliance
There is a plethora of information gathering when it comes to economic incentive compliance. Unfortunately, this is usually not a streamlined process and multiple entities (Department of Revenue, Department of Commerce, state economic development agency, appraisal districts, city council, county commissioners or workforce development board) will require different data, in different formats and at different times.
- New and existing headcount:
- Headcount data can be required only at the project site, within the entire state or across the company’s portfolio; part-time or full-time employment; monthly, quarterly or annually reporting; proof of employee residency
- Wage data:
- Wages can be based on IRS Form W-2 Box 1 wages, state taxable wages or it can include the value of benefits, etc.; note that oftentimes this data is compared to other mandatory state and local employment tax filings such as state unemployment and/or quarterly withholding returns which can cause discrepancy and audit risk.
- Capital investment:
- Cost versus fair market value versus appraised value; sales tax invoices, proof of payment, sales tax applications and exemption certificates, self-reporting of use tax
- Many incentive programs require more than 50% of a company’s revenues to be derived from customers out-of-state, thus a company might have to provide apportionment schedules
- Estimated income tax liabilities will have to be considered in light of potential credits to properly track tax provisions or perhaps to claim an intent to transfer income tax credits to another tax type, etc.
- Internal instructor wages, trainee wages, vendor invoices, cost of training materials, sign-in sheets, course descriptions
These are only some of the very important items that must be considered and dealt with in complying with economic incentives. It is important to know that the various state and local entities involved when negotiating and complying with economic incentives are usually different governmental bodies. When negotiating incentives, the primary entities conducting the negotiations may be the state and local economic development organizations whose mission is to attract and retain businesses to the state; whereas, the primary governmental bodies overseeing compliance of such programs are taxing authorities, whose mission is to collect and grow tax revenue. Although most economic development organizations are aware of program compliance requirements, they may not be experienced with the finer points or issues that companies face in meeting the requirements or the details of a company’s particular tax complexities. Also, while the taxing authorities are supportive of the effort of economic development organizations, their requirements and procedures are generally driven by strict rules, regulations and tax policy.
One can easily understand why more than 50% of companies never realize the economic incentives they negotiate. Thus, it is equally as important to consider the costs and time necessary to perform economic incentive compliance, as it is maximizing and negotiating an incentive package to its full potential.
For additional information about your compliance burdens or for assistance, please contact me at email@example.com.