Getting the Most Out of State and Local Tax Incentives

Corporate executives today should consider all of the state and local tax incentives that are available to them before entering a capital project. ...
Michael R. PressAugust 22, 2013

As CFOs and other senior executives prepare to implement their 2014 capital budget, they should be aware that there is an excellent opportunity to maximize their return on investment (ROI) by using state and local tax incentives. Depending on a corporation’s project parameters, these incentives can offset most, or all, of the up-front costs of the investments to which they relate.  The three-step process outlined here will ensure that corporations aren’t leaving money on the table.

Step 1: Gather Relevant Data Before the Capital Plan is Set
This is the step that trips up most companies, especially the big ones.  Typically, the problem is that the tax department or other incentives-responsible staff below the CFO level doesn’t own enough of the capital budgeting process to be brought into the loop while all of the capital requests are still on the table.  So it’s important to keep them informed.

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The input of human resources is also essential since very few discretionary incentives are awarded without regard to the investment’s impact on headcount. It’s best to create a simple table of capital requests and corresponding headcounts across territories that can be compiled. This way it’s easy to spot significant potential incentives opportunities.

Step 2: Re-Define Projects To Satisfy the Governments’ Definitions 
It’s important to know that the way a company’s business units define projects for capital budgeting purposes is not the same as the way the government defines economic development “projects” supported by incentives. This is a critical distinction.

For example, when a capital project (as the business defines it) is first initiated, it is generally intended to boost productivity in a particular manufacturing process that will enable a reduction in headcount. Six months later, say, a production line is likely to be moved in that would add headcount without any significant capital spent on new equipment. When taken separately, both actions may fail to qualify for investment tax credits or other discretionary incentives, but together, under the umbrella definition of a “production increase and plant modernization project,” as the government defines a “project,” these same programs clear the thresholds for significant discretionary incentives. So to maximize the return to be obtained from tax incentives, the story given to government authorities can be quite different than the one heard by the company’s board of directors in justifying the capital expenditures individually.

Another approach to defining a project to suit government program definitions is to aggregate routine capital maintenance costs over time with other capital costs in the same location. Most state and local discretionary programs allow a two- or three-year window to achieve investment goals. But a company might prepare a location for a piece of machinery in, say, Q1 2014, install the equipment in Q2 and be operational by June. Then, it will go on to spend another amount in Q3 2015 and Q3 2016 to replace parts and perform maintenance. The installation costs as well as the expenditures in 2015 and 2016 can usually be counted along with the equipment costs in qualifying for incentives. Absolutely key to this part of the process is knowledge of the government incentive programs in the investment locations and what constitutes a “project” under each program.

How a project is presented is also important. A rigorous economic and fiscal impact study that demonstrates how the community will benefit from the project is needed.  Quantifying the project’s downstream impacts including indirect job creation, direct and indirect household income, and state and local tax receipts can help since they assist the government in justifying the incentives awarded.

Step 3: Create and Maintain a Competitive Environment
Obviously, state and local governments are only motivated to offer discretionary financial incentives when they believe they are competing with other jurisdictions for the company’s projects.

Similar to a public auction where time works for the seller, the more time bidders are given to think it over or to find creative ways to finance their purchases, the higher the bids will go. It’s no different with discretionary incentives. So commencing the dialogue with government authorities should occur as soon as possible after the capital project requests are assembled, even if it means discussing projects that may never materialize.

Once the internal decision is made on the specific capital investment, there is usually a window of several months before construction or hiring occurs or new equipment is placed in service. It is crucial that during this period, the “last-best” offers of incentives from each competing governmental unit are received, analyzed and fully negotiated.

An important challenge, however, during this period is controlling the company’s internal and external communications.

by Michael R. Press, executive director, M. R. Press Consulting, LLC, a tax advisory.