InvestOhio — FAQs & Administrative Rules
Date: December 08, 2011
Earlier this month, the Ohio Department of Development (ODOD), in conjunction with the Ohio Department of Taxation (ODOT), issued guidance in the form of FAQs and administrative rules with respect to the new InvestOhio individual income tax credit. The InvestOhio credit is summarized in our outline dated July 8, 2011. Our firm submitted an inquiry during July to the ODOD and the ODOT on open questions that needed to be addressed regarding the eligibility of the new tax credit. The following is a brief update based on the new guidance. We continue to have discussions regarding remaining open questions.
The guidance provides a procedure for the (1) registration by both the Eligible Investors and the Small Business Enterprise (SBE) and (2) submission of an application by either an Eligible Investor or the SBE. The registration process began on November 14 and the application process began on December 5. The following link provides access to the guidance and tutorials provided by the Ohio Department of Development. http://development.ohio.gov/bs/bs_investohio.htm
The initial submission of applications during the first week absorbed about 25 percent of the tax credit dollars available. To the extent that applicants are unable to properly complete the investments or satisfy the substantive requirements, the allocated dollars would again be available for use by new applicants.
The submission of an application initiates the relevant point for receiving an InvestOhio Transaction ID that prioritizes the availability of the tax credit. The application requires specific information on the cash to be contributed to the SBE and the time that such investment will be made. The application also commences the timing that cash be invested into the SBE and that the SBE uses the cash to make qualifying purchases. Thereafter, the ODOD must receive evidence (1) from the Eligible Investor that the cash investment has been timely made into the SBE and (2) from the SBE that timely qualifying purchases have been made. The ODOD issues a certificate to the Eligible Investor once the cash investment into the SBE has been completed.
Cash investments into an SBE eligible for the tax credit cannot exceed the amount stated on the application. If the cash invested into the SBE is less than 50 percent of the amount stated on the application, zero tax credit is available. If the cash invested into the SBE is more than 50 percent but less than stated on the application, a partial tax credit is provided.
Annually and on the completion of the two-year holding period, the Eligible Investor must provide proof of the continued ownership and the SBE must provide proof of continuous ownership of the acquired property. If the Eligible Investor reduces its investment in the SBE or if the SBE ownership of the acquired property does not meet the holding period requirement, the tax credit is not available. Caution should be taken to prevent a dilution of the investor’s ownership interests in the SBE during the requisite holding period.
Substantive Structuring Points
An existing entity or a new entity can be used as the qualifying SBE. Cash would be contributed into the SBE, the SBE would purchase the qualifying property within the requisite six-month period, and then the SBE would hold such property for the requisite two-year holding period. However, as discussed below, new entities would not seem to satisfy the employee requirement immediately and might need to delay the registration/application process, which is an impairment to the use of new entities. A fix might be to proceed with the registration/application process and set a future date for the cash investment to assure that the employee requirement is met by such date.
- While the cash infusion into the SBE must create an equity interest, the actual issuance of shares or membership interests is not required. This is relevant where existing members are contributing new cash into the SBE on a basis consistent with their proportional interests. An increase in the capital account is sufficient.
- An individual can use a single-member LLC as a qualifying SBE.
- Whether an existing pass-through entity that exceeds the asset and sales threshold can form a new single member LLC as a qualifying SBE is an open question under certain circumstances but the guidance would seem to permit this.
- An existing pass-through entity that has either assets or sales that are within the permitted threshold should be able to contribute its operating cash to a newly formed single-member LLC that could qualify as a SBE or, alternatively, make distributions to its owners who would contribute the cash into a newly formed SBE.
The new guidance does not provide clear guidance on the validity of a cash distribution and reinvestment in the same entity as a qualified investment. If the existing SBE has employees who satisfy the employee requirement, consideration should be given to best understanding the possible use of existing cash in the SBE to satisfy the qualified investment requirement without the formation of a new entity. Revised guidance on this point is expected.
In real estate ventures, the following points present problems that delay and create obstacles regarding the availability of the tax credit:
- If cash is invested into an SBE over time (i.e., staggered payments as in a phased construction project), it does not seem possible to complete an application that lists each expected cash infusion date and then the six-month period for the SBE to purchase qualifying property commencing on the date that each such cash infusion occurs. Consideration needs to be given to accurately predicting the infusion of the cash payments or the use of separate applications to reflect each staggered payment.
- To maximize the credit available, investors should borrow any necessary funds directly and contribute the loan proceeds. Having the SBE use financing for the acquisition and construction of eligible property, followed by a cash infusion by the Eligible Investors that is used to satisfy part or all of the financing would not be a procedure eligible for the tax credit.
- A SBE that has gross sales of $10 million or less is always an eligible SBE regardless of the amount of its assets. The guidance does not elaborate on whether “sales” includes rent income. The definition of sales is determined under GAAP. It is very important that an accounting firm determines whether rental income is included in sales for GAAP purposes. The status of a lease arrangement as an operating or capital lease could be determinative. If rent is excluded from the term “sales,” then the SBE real estate venture would have zero sales and could be an eligible SBE. It is expected that future guidance could treat rental income as included within the term “sales.”
- The employee requirement continues to present the largest obstacle for having a qualifying SBE in a real estate venture. Based on the new guidance, a real estate SBE with only Ohio operations must meet the following prerequisites: (i) have at least one employee, (ii) the employee must be in place by the time of the cash investment into the SBE, (iii) the employee must be on pace to work 2,080 hours annually, and (iv) having one employee who has worked eight-hour days in advance of the cash investment might satisfy this requirement. The hour requirement raises questions for those employees who work less than eight-hour days and with respect to salaried employees. It might be possible to hire multiple workers who, in the aggregate, satisfy the hours requirement.
- The SBE must use the cash infusion to buy property directly. Purchasing the interest in a single-member LLC would not qualify.
- If the SBE will be immediately segregating and selling or demolishing any portion of the qualifying acquired property, the cash infusion stated on the application as eligible for the tax credit should exclude the value of the portion of the property that will be sold or demolished.
- For cash investments into a qualifying SBE made on or after July 1, 2011, the registration and application process can reference such amounts pursuant to the links and information available on the ODOD website. Even though such cash investment has already been made and the qualifying property may have been purchased by the SBE, the application date will continue to be the critical date for prioritizing the availability of the Ohio tax credit on a first-come, first-served basis.
We’ll be glad to further discuss the parameters of this Ohio tax credit that can provide up to a $2 million benefit for married couples.
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