CA 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 Equalizations: 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.
  • November 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, what do these changes mean to you?

Enterprise Zones- Significant Expansions the Past Two Years

Review your client list annually to determine if they reside in a new or expanded EZ.

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 awarded five 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. 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.

HCD maintains the state’s official webite of EZ street addresses, at www.hcd.ca.gov/fa/cdbg/ez/enterprise/#maps. While this site has not posted the addresses of many of the new, conditionally designated zones, 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, Secs. 8460-8467 of the California Code of Regulations, 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 were empowered to establish their own documentation criteria, which created inconsistencies and, inevitably, led some businesses to submit their voucher requests to zones with more lenient standards, even thought he business was not located within that particular zone. This practice, dubbed “cross-jurisdictional vouchering,” is now prohibited.

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 zones that preciously had required their own forms and eligibility checklists. The new voucher forms are also available on the HCD website.

New Franchise Tax Board Compliance for Contingency Fee Arrangements

Make sure you file the Form 8886 for any clients who secure 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: $15,000 for each transaction and for each year, according to RTC Sec. 19772.

However, 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.

FTB Enterprise Zone Litigation

Keep all supporting documentation used to secure an EZ hiring credit voucher. The FTB is re-evaluating requests, even though they have been approved by local enterprise zone officials.

The FTB has the authority to request substantiation supporting enterprise zone hiring credit vouchers submitted by a taxpayer claiming the EZ hiring 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 disallow the voucher and the credits claimed for that employee.

I am aware of several anecdotal cases in which 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 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 can reap the program’s benefits. Standardization of the program’s vouchering process will be a welcome improvement over the uncertainties of the past.

Yet the FTB’s level of scrutiny of EZ credits is on the rise, so taxpayers and their advisers must be evermore vigilant in determining the appropriateness of each employee’s eligibility, consistent in their record keeping and accurate in applying the credits to their tax return.

Joseph Abdallah, CPA, of Professional Solutions Group LLC, specializes in the California Enterprise Zone Tax Credit Program. He can be reached at joseph@prosolutionsllc.com.

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