Things To Know About Buying State and Local Tax Credits

By Lori Paci September 12, 2023

State and local tax credits can have a beneficial impact on your institution’s overall tax picture. Unlike deductions and exemptions, which reduce the amount of income subject to tax, tax credits are amounts that can reduce the final income taxes owed.

As with all transactions involving tax and finance, there are very specific steps and concepts you should understand before jumping into the credit market. In this article we will provide a high-level overview of how to start thinking about credit purchases and what kinds of information you need to make well-informed decisions.

Despite the detailed nature of credit transfers, there are a lot of good reasons to consider adding credits to your portfolio. Credits may:

• Reduce your institution’s state income tax burden;
• Reduce effective tax rates in some states, and overall;
• Help your institution achieve governance requirements and sustainability goals;
• Help your institution meet local Community Reinvestment Act requirements;
• Help support your institution’s community goals by supporting affordable housing, historic rehabilitation, renewable energy, and the arts.

Know The Field

First, you should understand the various types of credits that exist.

• Credits can be transferable or non-transferable. Transferable credits are able to be transferred or sold between unrelated parties. Some credits can be transferred more than once, some only once. Contrast these with non-transferable credits, which may only be used by the original recipient of the credit.
• Credits can also be refundable or non-refundable. When a business receives a refundable credit, it can receive a refund for any portion of the credit that goes unclaimed, usually within a given timeframe, even if it has already claimed enough of the credit to reduce its tax to zero. Refundable credits allow full benefit of 100% of the credit amount. Non-refundable credits are just that. A non-refundable credit cannot reduce a tax below zero. Any credit amount that goes unused over the specified life of the credit is forfeited. Credits can also be partially refundable. A partially refundable credit reduces a tax to zero and any remaining portion is refundable up to a certain percentage or dollar amount as allowed by state statute.
• Transferability and refund status are mix and match concepts. For example, if a credit holder has a transferable and non-refundable credit, then the holder can transfer that credit to another party and that party can only use that credit to reduce its tax to zero. If a credit holder has a transferable, refundable credit, then the holder can transfer that credit to another party and that party can use that credit to reduce its tax below zero and generate a refund.

Second, you will also want to familiarize yourself with the various players in the credit world. Businesses often turn to experts in credit and incentives to help identify potential opportunities and sometimes to oversee the engagement or purchase and claim process. In deciding which professional to use, you should consider whether you want to use a credit broker, a CPA firm, or a different third party. There are benefits and drawbacks to each, and you should weigh the options carefully for your institution’s situation.

• Credit brokers often have strong industry contacts. As they tend to solely focus on credits and incentives, they can leverage those contacts to connect you with the most potential opportunities. Many credit brokers have worked in the fields in which they now broker credits, so they have knowledge of the industry. Credit brokers (not all) also tend to be very transaction focused. They will work hard to get a deal made and guide you through the process. However, they may not look at or fully understand the full impact of a particular transaction on your overall business. Additionally, not all brokers are licensed in a particular field. They also may not be regulated in all states and some fees for services can be quite high.
• You may want to turn to a CPA firm to assist with your purchase of credits or negotiated incentives. CPA firms are a good choice if you want to understand the full tax and financial impact of a credit transaction. CPA firms are also self-regulated, so there is an expectation that your institution’s best interests will be kept at the front of any transaction. CPA firms also can assist with the entire transaction from purchase to claiming or transferring a credit. The drawback to using a CPA firm, depending on the firm, is that they may not have the same level of industry contacts as brokers, so identifying opportunities may be more difficult.
• Other kinds of professionals that you may seek guidance from include lawyers and financial advisors. Again, depending on the experience of the firm and what your main concern is regarding a potential transaction, these kinds of advisors can also be helpful.

Sometimes having a full team of advisors that can help with different aspects of a purchase is best.

Once you have decided what kind of professional assistance is best for your situation and what kind of credit you might be after, it is important to understand the overall process for entering and continuing after a credit purchase.

The Credit Process

When beginning to review whether your institution is ready to purchase or sell credits, you should consider how you want to start that review. Some find it beneficial to first review their state and local tax liabilities to determine where a credit will have the largest impact and then research what kinds of credits and incentives will be available in those states. This is a targeted approach which considers a potential tax impact or liability prior to determining a specific sector or state. Others find it is best to review and identify any current or planned actions that your business wishes to engage in, and then seek states that have these kinds of credits available. For instance, if you plan to expand your workforce in the next year, you may want to seek out states that have generous credit and incentive programs for new hires or hiring veterans.

You should also familiarize yourself with the ins and outs of the credit in question prior to purchasing to help identify any risk and whether a particular credit will help meet your institution’s specific goals. Questions you should be asking when seeking out credits include:

• Are there any time limitations or time requirements that determine or interfere with when a credit may be available?
• Has any portion of the credit already been claimed and if so, can the remainder be transferred independently?
• Could any other parties claim the same credit?
• If purchasing a transferable credit, are there limitations on claiming the credit?
• Does the credit expire?
• Will credit years prior to the transfer be available if not already claimed?
• Are carryovers and carryforwards available?
• Can the credit be transferred more than once?
• Does the state need to be made aware or approve of the transfer before it can be completed?
• Does the state or locality publicly disclose the identity of those who claim, sell, or purchase the credit?
• What are the compliance obligations associated with claiming and maintaining the credit?

Once you have determined that the credit is right for you and that your risk tolerance aligns with any potential purchase, be aware of the kinds of information that will be needed for the transfer process. Some businesses have entered into negotiations to purchase a credit only to be surprised by the requirements of the state to make the transaction valid. In some instances, these can include providing personal information from the buyer such as:

• Full legal name, as used on tax documents;
• Names of officers or certain executives of buyer;
• Address of buyer, either home or office;
• Social Security numbers of officers or federal tax ID number;
• Email address;
• Phone number.

Additionally, you may be asked to supply information regarding the amount of credit to be purchased or the tax year(s) to which you intend to apply the credit. This information is important not only for state purposes in tracking credits, but also is important for you as the purchaser to know in advance. If you have any concerns that you may not be able to use a credit once it is transferred, you should use this as an opportunity to confirm whether the credit must be used consecutively or held for later use. As noted previously, some states will require that a party to a credit transaction seek approval from the issuing authority prior to the transfer. Additionally, some states may have very specific language that is required in a purchase agreement in order to validly transfer the credit. Failing to properly get approval or use required language could lead to complications later.

Know What Comes After

If all has gone well and you have identified a credit you wish to purchase, you will also want to know what your or the seller’s obligations are after the credit has been transferred.

Many credits come with recapture provisions, also known as “claw-back” provisions. These provisions allow a state to rescind an authorized and/or claimed credit when certain conditions are not met or maintained. That also means the state will be looking for its money back.

You should determine what if any such provisions exist in relation to the credit you are looking to purchase. If required, you must maintain all necessary conditions and meet any necessary reporting requirements. If you are not the responsible party for such provisions under state law, you should speak with your CPA or attorney on how best to protect your interest and be indemnified against claw-backs. Claw-back of transferred and claimed credits is very complicated and you should never assume that it will be the seller’s sole responsibility to meet all requirements.

Conclusion

Receiving and purchasing tax credits can be very beneficial for your overall tax picture. The time invested in working with your advisors to determine the best options for your institution is time well spent. While the details of the transactions and the specific state and local requirements can be complicated and sometimes frustrating, most state tax credits are a useful investment. Arming yourself with knowledge and experienced advisors puts you in the position to make sound decisions that may pay off for years to come.

If you have any questions or if you would like to further discuss any of these items in more detail, please contact Lori Paci or your preferred BNN professional at (800) 244-7444.