While most states generally conform to the federal Opportunity Zone (OZ) rules, a handful of states have elected either to decouple from these rules or to impose additional limitations on OZ benefits. Other states have decided to expand existing OZ benefits, creating additional incentives for taxpayers who invest in the defined OZs of those states. In either case, it is important to consider the state tax impact when investing in an OZ.

STATE NONCONFORMITY IN GENERAL

Because most states begin the calculation of income tax with the taxpayer’s federal taxable income, generally states “conform” to the federal OZ regime unless they include a modification on their income tax return that disallows, or adds back, the federal deferral and deduction.

Currently, there are seven states with either corporate or individual income taxes that do not fully conform to the OZ incentive program: Arkansas, California, Hawaii, Massachusetts, Mississippi, North Carolina and Rhode Island. While California, Mississippi, and North Carolina do not conform to federal OZ rules for either corporate or individual income tax purposes, Massachusetts is nonconforming for individual income tax purposes only. This means that corporations can still take advantage of federal OZ incentives in Massachusetts.

Arkansas, Hawaii and Rhode Island conform to the federal OZ treatment for individuals and corporations only if the OZ is located within the state. If it isn’t, those states will disallow the related federal deduction and deferral through the use of an addition modification to the taxpayer’s federal taxable income. Minnesota will conform to federal OZ rules for tax year 2019 and forward for taxpayers other than C corporations, but has issued guidance stating that it will retroactively conform to the federal OZ deferral for tax year 2018 for corporations. New Hampshire conforms for corporations beginning Jan. 1, 2020, but doesn’t impose tax on capital gains for individual income tax purposes.

CALIFORNIA NONCONFORMITY

As previously mentioned, California does not conform to the federal tax law for OZ incentive purposes. In 2019, the state legislature faced many disagreements concerning limitations and budgetary issues regarding OZ conformity, which raised questions and concerns throughout the state.

As the most populous state in the country, California has 879 OZs, 274 of which are in Los Angeles County alone. [1] The state estimates that some 3 million Californians are living in OZs. [2] While the state proposed legislation to conform to the federal OZ guidelines for low and moderate income housing projects and green energy projects, the proposed legislation did not provide benefits for market-rate housing, or office, industrial, and retail developments, which proved to be problematic in getting the bill passed. [3][4]

The disagreement over whether and how much California should conform to federal guidelines will likely have long-term impacts in the state, because investors are instead investing in states that are currently conforming to the federal OZ provisions. A 2019 study by Capital Matrix Consulting found that OZ conformity in California would lead to between $745 million and $1.2 billion in new economic activity as a direct result of 2019 investments. [5] In subsequent years, the study said economic activity would range from more than $700 million to just under $500 million. [6] While conforming to federal provisions would cause the state to lose out on tax dollars it would have otherwise acquired, each dollar of state revenue reduction would specifically generate between $10 and $66 of private investments in low-income communities in California. [7]

STATES WITH SPECIAL CONFORMITY RULES

Some states have enacted special rules governing whether individuals and businesses can receive state-level conformity to OZ benefits. For example, Arkansas, Hawaii and Rhode Island require the OZ to be located within the state for the state to recognize OZ incentives; otherwise, the federal deferral for those incentives must be added back to the federal taxable income starting point used on the taxpayer’s state tax return.

Although Arkansas enacted OZ conformity legislation in February 2019, it does not conform to OZ deferral treatment for investments into OZs outside of the state. Instead, for both individual and corporate income tax purposes, the census tract benefitting from the investment must be located in Arkansas in order for conformity to apply.[8]

Hawaii enacted similar legislation in June 2019, providing incentives to investors in Hawaii, limiting the scope to “opportunity zones designated by the chief executive officer of Hawaii (which is usually the state’s governor),” meaning that investments into OZs outside of the state do not qualify for state-level conformity. [9]

While Rhode Island conforms to federal OZ guidelines for individual income tax purposes, H.5151A (signed into law on July 5, 2019) states, “for purposes of a taxpayer’s state tax liability, in the case of any investment in a Rhode Island opportunity zone by the taxpayer for at least seven years, a modification to income shall be allowed,” which essentially limits the state-level conformity benefit to opportunity zones located within Rhode Island. [10]

STATES PROVIDING ADDITIONAL BENEFITS

While states like California have yet to conform to federal OZ provisions, other states are providing additional state-level incentives and allowing more credits to taxpayers investing in OZs within their state. States that offer specific incentives include Alabama, Connecticut, Indiana, New Jersey, Ohio, and West Virginia.

In July 2019, Ohio passed legislation that provides taxpayers with a state tax credit of up to $1 million for investments made in any number of the state’s OZs. The 10% income tax credit applies against the taxpayer’s income tax liability, equal to 10% of the taxpayer’s investment. The taxpayer may claim the credit in the year the investment was made and will receive a tax credit certificate 60 days after submitting a completed application to the director of development services. There is no minimum holding period and the carryforward period is five years. [11]

In October 2019, Ohio Governor Mike DeWine said he hopes the additional state incentives will help “move investment into businesses inside of the zones.” He also said he is “open to adjusting state policy to encourage that sort of investment over real property deals.”[12]

Over the summer of 2019, New Jersey passed a law to increase the Angel Investor Tax Credit (AITC) percentage for qualified investments made by technology businesses into OZs, low-income communities, and certified minority- or women-owned businesses. The AITC program, which was initially approved by state legislators in 2013, provides investors with a 10% tax credit against New Jersey Corporate Business or Gross Income Tax. There is a maximum credit of $500,000 for each qualified investment per tax year. [13]

Changes to the AITC made in 2019 increased the credit from 10% to 25% of the investment for qualified technology investments made in OZs, low-income communities, or state-certified minority- or women-owned businesses for tax years that started Jan. 1 this year. Corporate taxpayers may carry over tax credits up to 15 tax years following the tax year for which a credit was allowed. However, individuals cannot carry forward tax credits. [14] By providing additional incentives, the state hopes it will be able to increase investment in some of its most economically depressed communities.

The OZ incentives set forth by the Tax Cuts and Jobs Act have sparked much debate regarding state conformity. While many believe the OZ incentives will spark growth in deteriorating communities, some legislatures wonder whether the new incentives will have the desired effect in the low income communities they are meant to serve. In states like Arkansas, some legal experts have questioned whether special conformity rules that provide benefits only to investments made within the state raise constitutional concerns, as this may be in conflict with the Dormant Commerce Clause. Arkansas’s law could be deemed discriminatory against interstate commerce by restricting the tax incentive to only state investment.

Going forward, we can expect to see more state discussion regarding the TCJA Opportunity Zone conformity in the near future.

Notes:

[1] Pimentel, Joseph, (2019, August 15). “Opportunity Zones Could Flop in California, Officials Warn.” Retrieved from https://www.bisnow.com/los-angeles/news/opportunity-zones/strong-unlikelihood-california-will-conform-to-opportunity-zone-tax-advantages-100351

[2] California Opportunity Zones (State of California). About Opportunity Zones. (2019). Retrieved from https://opzones.ca.gov/

[3] Barth, Ian. (2019, June 04). “Newsom’s Opportunity Zone Restrictions Will Chase Money out of California.” Retrieved from https://www.sacbee.com/opinion/article231561803.html

[4] Lovett, Jennifer. (2019, September 06). “Making California Opportunity Zone Ready Will Boost Critical Housing and Clean Energy Projects.” Retrieved from https://cafwd.org/reporting/entry-new/making-california-opportunity-zone-ready-will-boost-critical-housing-and-cl

[5] Williams, Brad. (2019, April 19). “California Needs to Conform With Federal Opportunity Zone Provisions.” Retrieved from https://caeconomy.org/reporting/entry/california-needs-to-conform-with-federal-opportunity-zone-provisions

[6] Capital matrix Consulting. “Economic and Fiscal Impacts of California Conformity to Federal Opportunity Zone Tax Provisions.” Retrieved from https://ee.caeconomy.org/resources/entry/study-california-conformity-to-federal-opportunity-zone-tax-provisions

[7] Williams, supra note 5.

[8] Arkansas Code Annotated, Section 26-51-460.

[9] Hawaii Revised Statutes, Section 235-2.3

[10] H.5151A. General Assembly. 2019 January Session. (R.I. 2019).

[11] H.B. 166. 133rd Regular Session. (Ohio 2019).

[12] Ebert, Alex. (2019, October 10). “Ohio Looks to Expand Opportunity Zones and Reporting.” Retrieved from https://news.bloombergtax.com/daily-tax-report-state/ohio-governor-looks-to-expand-opportunity-zones-and-reporting

[13] Tapinto Edison Staff. (2019, July 1). “New Law Raises Tax Credit Amount Under “New Jersey Angel Investor Tax Credit Act.” Retrieved from https://www.tapinto.net/towns/edison/articles/new-law-raises-tax-credit-amount-under-new-jersey-angel-investor-tax-credit-act

[14] State of New Jersey- Department of the Treasury (Division of Taxation). Corporation Business Tax and Gross Income Tax. (2019). Retrieved from https://www.state.nj.us/treasury/taxation/noticeangelinvestortaxcreditincrease-cbt.shtml

The information contained herein is general in nature and is not intended, and should not be construed, as legal, accounting, investment, or tax advice or opinion provided by CliftonLarsonAllen LLP (CliftonLarsonAllen) to the reader.

 

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