Programs...

Gulf Opportunity Zone Act of 2005

EXECUTIVE SUMMARY

The Gulf Opportunity Zone Act of 2005, signed into law by President Bush on December 21, 2005, contains significant economic incentives to rebuild the Gulf Coast, as well as to attract new investments to the affected areas.

These economic incentives are so significant that any business considering an investment in any new, replacement or expanded operations, buildings or equipment within the GO Zone should consider how to employ these incentives to the fullest extent possible.

The most significant incentives in the GO Zone Act include:

• 50% Bonus Depreciation

• 5-Year NOL Carryback

• Tax-exempt Financing

• 100% First-Year Equipment Expense Deduction for Small Business

• Special Incentives for Employers

• Expensing of Demolition and Cleanup Charges

The process of successfully developing a plan to optimize use of the incentives for a particular taxpayer or a specific project includes identifying and understanding:

   (1)  what is available from all sources (federal, state and local);

   (2)  The existing status of the taxpayer and the nature of the potential project; and

   (3)  the short term and long term business objectives of the taxpayer.

Because of the time sensitive nature of the major federal incentives, it is critical that taxpayers begin the planning process as soon as possible.

50% BONUS DEPRECIATION

The GO Zone Act allows for a significant acceleration of the normal depreciation deduction by allowing a bonus depreciation deduction in the first year Qualified GO Zone Property is placed in service equal to 50% of its cost, in addition to the normal depreciation deduction for the balance of such costs.

This bonus depreciation is available to businesses of all sizes for their investments in equipment, non-residential real property or residential rental property substantially all of which is used both in the active conduct of the business’ trade or business and in the GO Zone.  This tax benefit applies to rehabilitation costs and costs incurred on new projects.  The original use of the property in the GO Zone must commence on or after August 28 2005 (the day before Hurricane Katrina made landfall).  To qualify, eligible personal property must be placed in service on or before December 31, 2007, and eligible real property must be placed in service on or before December 31, 2008.

A business may opt out of the bonus depreciation allowance on its property on an asset-by-asset basis.  For example, a business could elect bonus depreciation only on its real property and not on its computer software.

Continuing the limitation under existing law, if any portion of property is financed with tax-exempt bonds, that entire property is ineligible for bonus depreciation.  Costs incurred for replacement, renovation or rehabilitation of existing property are treated as separate property for purposes of the GO Zone Act.

Gaming property is excluded, but ancillary facilities and related equipment may qualify.  Also excluded is property used in connection with any private or commercial golf course, country club, massage parlor, hot tub facility, suntan facility, or liquor store.

The business is subject to recapture provisions if the property ceases to be GO Zone Property.  Also, use of the deductions afforded by bonus depreciation remains subject to the “at-risk” and “passive activity” rules just like normal depreciation.

5-YEAR NOL CARRYBACK

Recognizing that the deductions generated by the 50% bonus depreciation may exceed current year income, Congress expanded the opportunity for businesses in the GO Zone to carry back their net operating losses from 2 years to 5 years.  These businesses also will retain the right to carry forward their net operating losses for up to 15 years.

Qualifying losses, which include certain (i) in-Zone casualty losses; (ii) moving expenses; (iii) temporary housing expenses; (iv) depreciation deductions with respect to qualified Zone property; and (v) repair expenses resulting from Katrina, may be used to offset up to 100% of income subject to the Alternative Minimum Tax.  The NOL provisions may enable a client to convert operating losses into refunds for taxes previously paid.

BONUS DEPRECIATION EXAMPLE:

   Non-residential Real Property (Recovery Period:  39 Years)

Hotels and Office Buildings

   Assumptions:  Basis of $10,000,000; Placed in Service in June 2006

   Assumptions:  Basis of $10,000,000; Placed in service in June 2006;

   and segregation study results in 30% of basis qualifying for treatment

   as other than real property at an average depreciation allowance

   equal to an 8-year straight-line calculation[1]

TAX EXEMPT BONDS

Tax-exempt, private activity bonds have now been authorized to finance development of a wide array of commercial projects in the Zone on or after August 28, 2005.  Mississippi may issue in excess of $4.8 Billion in tax-exempt “GO Bonds,” while Louisiana may issue nearly $7.9 Billion, and Alabama may issue in excess of $2.1 Billion.

• Bonds are available to most business sectors (gaming and certain other activities are excluded)

• Bond proceeds may be used to fund construction and renovation of nonresidential real property and certain residential rental property (movable fixtures and equipment are excluded).

• For new acquisitions of existing property to qualify, improvements must be made to the property in an amount not less than 50% of the purchase price.

• A project must choose between bonus depreciation and tax-exempt bonds on project costs that otherwise would qualify for both incentives.

• Bonds must be issued on or before December 31, 2010.

Note: Under current federal tax law, borrowers may use bond proceeds to reimburse for costs previously incurred by the borrower for only 60 days prior to initial approval by the governmental authority issuing the bonds. Therefore, it is critical that the borrower request this initial approval from the governmental authority and that the project be induced as soon as possible, especially since the approving agency meets only every four weeks.

v  CONSIDERATIONS FOR TAX-EXEMPT GO BOND FINANCING:

• Estimated savings of 150 – 200 basis points in lower cost of funds per annum.
• Tax-exempt bonds are typically amortized over 10-20 years.
• Interest on tax-exempt private activity bonds is typically priced at a weekly floating rate.
• The tax-exempt bonds are backed by a letter of credit issued by a “rated” financial institution.
• $3 Million is the minimum project size to justify the increased costs of stand-alone, tax-exempt financing.

Mississippi Small Enterprise Development FinanceProgram (SED):

Under the Small Enterprise Development (SED Program), eligible companies may borrow up to $4 million of tax-exempt, fixed interest rates from the Mississippi Business Finance Corporation (MBFC) to finance capital projects.

• An eligible company includes most commercial businesses located within the GO Zone.
• Proceeds may be used for land, buildings, new machinery and equipment.
• Tax-exempt bonds generally are amortized over 10-15 years.
• Interest on tax-exempt private activity bonds is priced at a fixed rate.
• Estimated annual interest savings of 150 to 200 basis points are available due to tax-exempt financing.
• Bonds are backed by an irrevocable, direct-pay letter of credit with minimum maturity of 5 years issued by an approved bank and other collateral required by MBFC.
• $300,000 is the minimum project size to justify the increased costs of tax-exempt pool financing (usually an initial cost of 2-3% of the amount of the bond issue, plus annual fees of approximately 1.5% for bank letter of credit fees, MBFC servicing fees and trustee fees).
• $4 Million is the maximum loan amount available under the SED tax-exempt pool-financing program.
• Companies utilizing tax-exempt bonds issued by the MBFC may also be eligible for RED Program state income tax credits.
• If properly structured, projects financed with tax-exempt bonds issued by MBFC can be exempt from the sales and use tax (generally 7%) and, with proper planning, a portion of the contractor’s tax (3 ½% on component materials and on design services).
• Projects financed through the SED program are also eligible to obtain ad valorem tax exemptions, subject to the discretion of the local governing body where the project is located.

v  OTHER BENEFITS OFFERED BY THE GO ZONE ACT

100% Deduction for Qualifying Tangible Personal property for Small Businesses

Under current law, small businesses are permitted to expense, rather than depreciate, up to $100,000 of investments in equipment and computer software. The GO Zone Act increases to $200,000 the amount that eligible small businesses can expense under Section 179 for qualifying tangible personal property and computer software placed in service in the Zone. The deduction is phased out to the extent the amount of qualifying property placed in service in a year exceeds the applicable threshold. The placement in service dates are the same as those that apply to bonus depreciation.

Demolition and Cleanup Expenses May Be Expensed

Under existing law, the cost of demolition generally is added to the business owner’s basis in the underlying land and cannot be recovered until the property is sold. The GO Zone Act allows businesses to expense 50% of their demolition and cleanup expenses incurred through 2007.

Special Incentives for Employers

• Employee Retention Tax Credit.  The Employee Retention Tax Credit was expanded to apply to all employers in the Zone, regardless of the number of employees.  The credit is equal to 40% of qualifying wages up to a subject to a maximum of $6,000 (for a maximum credit of $2,400 per qualifying employee) and applies to qualifying amounts expended prior to December 31, 2005.

Qualified employees may exclude from gross income up to $600 per month for employer-provided lodging located in the Zone.  In addition, employers receive a credit for 30% of the tax-free lodging benefit.  This provision applies to lodging benefits provided during the 6-month period from and after enactment.

• WOTC.  Employers may claim the work opportunity tax credit (WOTC) if they hire a “Hurricane Katrina employee.”  This is an individual who, on August 28, 2005, had a principal place of abode in the “core disaster area” and (1) who is hired after August 27, 2005, and before August 28, 2007, for a job located in the core disaster area; or (2) who was displaced by Hurricane Katrina and is hired after August 27, 2005, and on or before December 31, 2005 for a job located outside the core disaster area.

For employers outside the GO Zone, the employee must have been hired after August 27, 2005, and before January 1, 2006.  For employers within the GO Zone, the WOTC is extended for employees hired through August 27, 2007.

Eligible employers are allowed a credit of 40% of the first $6,000 of qualified first-year wages paid to each eligible employee.

Other Important Provisions of the GO Zone Act.

The GO Zone Act contains a number of additional incentives and relief provisions that are important to businesses considering an investment in the GO Zone, including:

• Increase in Qualified Rehabilitation Credit:  The credit for qualified expenditures for a historic structure was raised to 26% and for other qualified structures to 13%.
• New Market Tax Credit Authority Increased:  The allowable credit is equal to 39% of qualifying investments in low-income communities.  To qualify, the investment must be made by an authorized community development entity.  An additional $1 Billion in authority was granted for the years 2005-2007.
• Reforestation Incentives for Small Timber Owners:  The cap on the deductibility of reforestation costs was doubled to $20,000 per year through 2008, and a special 5-year NOL carryback for small timber operations was authorized.  To qualify, the timber owner must own less than 500 acres of timber.
• Low Income Housing: The Act authorizes almost $40 Million in additional low-income tax credits for Mississippi.  Additional provisions will increase the credits available to investors for new construction and rehabilitation expenditures.
• Expensing of Qualified Environmental Clean-up Costs:  The deductibility of environmental clean up costs incurred on qualifying sites was extended for 2 years and applies to the clean up of petroleum products.  To qualify, costs must be incurred from August 27, 2005 through December 31, 2007.

v MISSISSIPPI NON-GO-ZONE TAX INCENTIVES AND SAVINGS

There are many other state law incentives or other incentives that could apply in certain circumstances depending on the nature of the project and whether the business obtains tax-exempt financing either through a GO Zone Bond or through the MBFC. These include RED debt service income tax credits, income tax job credits, and local property tax exemptions.

RED Debt Service Income Tax Credits

Projects financed with bonds may also be granted credits against the State income tax under the Rural Economic Development (RED) Program. However, “RED” is a misnomer, since it is available throughout the State – not just rural areas, although it is not available to all enterprises that qualify for bond financing. Projects must be approved by MBFC for participation in the RED Program.

The annual RED Credit is the amount of the debt service payments (principal and interest) made for that year under the bonds for the project.  It is available for both new facilities and expansions.  Unused RED Credits can be carried over for 3 years; are available for the term of the bonds (but not to exceed 25 years for a total of 28 years with carryover); are limited annually to 80% of Mississippi income tax from the project; and can be combined with other credits.

Income Tax Job Credits

The requirements for qualification and amount of the credit for new jobs vary with the State Tax Commission’s annual county designation.  All of the State’s 82 counties are divided into three equal categories or tiers based on economic criteria.  The minimum number of net new fill-time jobs required in a single year in order to qualify for a new job credits varies by category.  Qualification of each project must be pre-certified as “qualified” by the State Tax Commission.

Once the minimum number of new jobs is created, the enterprise will be eligible for an annual new jobs credit for each net new full-time employee of 2.5% or 10% of the payroll for the net new jobs depending on the county.  The credit can offset 50% of the business’ annual State tax liability, and unused credits may be carried forward for 5 years.

Other Jobs Incentives

The “Mississippi Advantage Jobs Act” provides quarterly incentive payments from the State to a qualified business or industry for a period generally not to exceed 10 years. The amount of the incentive is directly related to jobs created as a result of an establishment locating in the State.

Exemptions from Property Taxes

All are discretionary with local taxing authorities (city and/or county governing authorities).  The new enterprise/additions exemption exempts all real and tangible personal property (including raw material and work-in-process inventories but excluding finished goods inventories and automobiles and trucks) from ad valorem real and personal property taxation, except taxes for school district purposes.  It covers new enterprises, additions to or expansion of an enterprise, replacements of equipment used in connection with or necessary to the operation of the enterprise, and renovations of an existing facility (at least in conjunction with otherwise qualifying expansion of such enterprise).  It is available for a maximum of 10 years and is nonrenewable but is available annually.

All real and personal property purchased with bond proceeds (whether taxable or tax-exempt) is also exempt from property taxes.  However, there are no property tax advantages over the new enterprise/additions exemption.  As a general rule, even if bonds are issued, new enterprise/additions exemption should still be obtained.

There is also a free port exemption which is applicable to the portion of finished goods shipped out of Mississippi. Unlike any other type of property tax exemptions, the free port exemption can be granted A finished goods exemption is also available for all finished goods, whether shipped out of Mississippi or not, but school taxes are not subject to exemption, and the exemption cannot exceed a maximum of 10 years and is non-renewable.  The free port and finished goods exemptions can be combined.to include an exemption from school taxes and for longer than a 10-year term.

CIRCULAR 230 DISCLOSURE:  pursuant to Treasury guidelines, any federal tax advice contained in this communication, or any attachment, does not constitute a formal tax opinion.  Accordingly, any federal tax advice contained in this communication, or any attachment, is not intended or written to be used, and cannot be used, by you or any other recipient for the purpose of avoiding penalties that may be asserted by the Internal Revenue Service.  This advice was not written to support the promotion or marketing of the matter addressed by the written advice, and any reader of this advice should seek advice from his or her independent tax advisor.

[1] The 8-year estimate is used to simplify the illustration.  It reflects an assumed average of the annual deductions allowed under 5-year MACRS property, 7-year MACRS property and 15-year MACRS property, etc.  The actual mix of property in a project could differ substantially from this illustration.For more information contact:

Bill Barry, Mississippi Business Finance Corporation
601.355.6232 or bbarry@mbfc.cc