Managing Incentive Compliance

A recent North Carolina Department of Commerce press report states that over 80% of qualifying credits were not realized by taxpayers. North Carolina is not an exceptionmany states report similar percentages for unclaimed incentives and tax credits. Almost all states offer lucrative incentives to entice capital investment and to create jobs. Despite this, state authorities cannot guarantee that taxpayers will realize incentives to the fullest extent committed. Incentive legislation usually requires strict accountability from both business and the government, which can be difficult to attain. Further, administering government agencies audit the eligibility of awarded incentives and may deny benefits on minor technicalities.

Businesses usually have every intention of optimizing incentives and adhering to the rules for obtaining incentive benefits. However, even though a business may qualify for a tax credit, it may find that its tax liability is insufficient to use a credit fully, for example. Or, after receiving an incentive, it may discover that it did not follow the formal process for realizing the benefit. Once incentives are awarded, many companies lack the resources to establish and sustain a system to manage compliance requirements during the incentives life cycle. An effective, sustainable compliance program can make a significant difference in the value of the benefits actually realized. A successful program improves the rate of return on incentives and the companys bottom line, whether the program is internal or outsourced.

How Incentive Packages Work

Incentive package awards are based on the capital to be invested, the jobs to be created or the estimated wage and payroll to be increased. Packages can include anything from tax credits to cash grants or reimbursements. Businesses that seek incentives must be prepared to meet project investment and job creation goals and to complete the project timely. Firms that manage the compliance process throughout the life of the incentives package typically receive the greatest benefits.

Fully realizing an incentive packages benefits can take up to 25 years. Benefits are paid once a company meets the requirements of each individual incentive program. However, besides meeting the basic requirements, the company is responsible for reporting the status of incentive projects and performing the due diligence required to obtain the various incentives awarded. Complying with all Federal, state and local requirements is often cumbersome and time-consuming. Each authority has its own compliance and reporting criteria, which the company has to meet before it can totally realize the benefits.

Federal, state and local laws often require formal agreements between a business and a governing jurisdiction. Such development agreements are legal, binding contracts created by the governing authority to identify the minimum investment and/or job creation and wage requirements needed for an award. However, companies that fail to meet or sustain these requirements commonly trigger clawback provisions, which can include repayment of awarded incentives.

More states are including terms requiring incentive projects to remain and operate on-site for a specified period. Such operating clauses can double the number of years of incentive benefits and require restitution for any significant reduction in workforce. If a company closes a facility or significantly reduces the number of workers, it might have to repay all cash incentives received. Project management or a third-party consultant, and legal counsel, should review development agreements before execution.

The source of most unrealized incentive benefits is unused tax credits. By using tax credits, a business demonstrates that it has sufficient taxable income to apply the credit. Some states provide a refundable credit that benefits businesses with limited tax liability. Tax credit incentives typically have reporting requirements, including receipt of tax credit certifications that have to coincide with annual tax filings; states can and do automatically audit taxpayers applying incentive tax credits.

Planning

Realizing the full benefit of tax credit incentives requires appropriate tax planning, timing, knowledge of compliance procedures, documentation and interdepartmental coordination. Regular communication between a tax department or tax service provider and human resources, management and accounting, is key to receiving the maximum possible tax benefit.

Companies that benefit the most from incentive awards are those that include their incentive compliance process in their master plan. A team approach and ongoing coordination can help to ensure implementation success and full realization of incentives. It is important to involve all stakeholders in securing and using incentives. Company divisions (e.g., government affairs, human resources, tax, operations, real estate and legal), as well as outside professional and services firms (e.g., auditors, tax advisers and training providers), need to be aware of the activities that trigger incentive awards, and to communicate such information to each other. This is even more critical for firms having multistate incentive packages, to obtain maximum benefits.

Turning on incentives: Once a project is fully operational, first-year implementation of incentives compliance is critical to turning on incentives eligibility. Government authorities commonly include expiration dates for initiating the first steps toward receiving incentives. If a businesss project is behind budget or delayed for any reason, it must notify all committed government agencies. An inability to meet deadlines can result in a project becoming ineligible. Most state and local agencies have formal procedures for extending project deadlines. A company will have to provide valid reasons for delays; it may have to formally request extensions to meet investment and/or job creation and wage requirements. Such delays could result in losing or reducing the value of incentives, resulting in a reduction in the number of years of incentive availability or amount. One or more public meetings may be needed to amend agreements between the company and the governing authorities, to keep a project on track.

Post-launch maintenance: Although first-year implementation is critical to start benefits eligibility, continuing to secure incentives fully can take years of complying annually with multiple administering agencies. A post-launch assessment can efficiently establish and document the compliance procedures needed to receive annual benefits from every agency. The assessment is also a good time to develop management tools, such as critical timelines, manuals, audit trails and transaction histories, which contribute to effective compliance. Crucial to ongoing project maintenance is knowledgeable, trained staff. In assigning a lead manager or incentive negotiator, or managing group to take responsibility for incentives compliance, a company will ensure ongoing project maintenance and coordination, and regular communication with government administrators.

Incentive negotiators usually obtain current policies and procedures for complying with incentive programs, in the early stages. They should validate these annually, because Federal, state and local governments regularly update policies and procedures based on incentive legislation and related compliance requirements. Government changes to compliance programs require the incentive negotiator to notify parties responsible for compliance documentation. Failure to follow current compliance rules can result in a denial of incentive benefits or significantly reduced benefits.

Reorganization, staff turnover, lost or misplaced documentation, and lack of commitment all contribute to diluting the value of incentive packages.

Conclusion

Successful incentive award projects depend on resource availability. Companies should consider whether they have the internal resources available to both initiate and sustain an incentive package award before signing onto an incentive award program. If internal resources are limited, they should think about outsourcing to third-party consultants, who are experienced in all aspects of managing incentive projects, as a viable alternative to committing staff on a full-time basis.

From Dawn Baetsen, MSA, South Bend, IN