Article: California Enterprise Zone Rule Change Would Close Loophole, Boost Accountability

bloomberg bna logoLaura Mahoney with Bloomberg BNA wrote an in-depth article about HCD’s proposed reforms to the State Enterprise Zone program. With permission from the publisher, HCD is sharing the report below.

Reproduced with permission from Daily Tax Report, 10 DTR H-1 (Jan. 15, 2013).
Copyright 2013 by The Bureau of National Affairs, Inc.
(800-372-1033)

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BNA Daily Tax Report
10 DTR H-1, 1/15/2013

California Enterprise Zone Rule Changes
Would Close Loophole, Boost Accountability

SACRAMENTO, Calif.—State regulators Jan. 11 proposed long-awaited changes to California’s Enterprise Zone Program to close a loophole and improve accountability in the program that is expected to give employers in designated zones $700 million in tax credits in the 2013-14 fiscal year.

The Department of Housing and Community Development (HCD) released the proposed regulations one day after Gov. Jerry Brown (D) announced the changes as part of his state budget plan for coming year. The reforms would reduce the amount of credits awarded to employers by $310 million over five years, according to HCD.

“These common sense reforms will eliminate waste and improve accountability for the State Enterprise Zone program,” HCD Director of External Affairs Colin Parent said in a news release.

The governor proposed in 2011 to eliminate the zones completely, but dropped the proposal after gaining little support from lawmakers. Short of elimination, HCD is now seeking to reform the program through the regulations. Brown said he will seek legislation in 2013 to make additional changes.

Enterprise Zone Managers Have Concerns

The California Association of Enterprise Zones, representing managers of the 42 designated zones around the state, responded cautiously to the regulatory reforms. The association participated in talks with HCD while the department was developing the rules in the past year, and has said it has major concerns about the proposal.

“Governor Brown proposed significant changes to our program that will likely impact job growth in some of our state’s most distressed areas,” CAEZ President Craig Johnson said in a written statement. “We’re committed to working with him to ensure any changes protect the program’s core: to help struggling Californians, many currently unemployed or receiving state aid, reenter the workforce.”

The key reform in the regulations is aimed at a practice called “retrovouchering.” Under the EZ program, employers must obtain vouchers from EZ administrators for hiring employees from specific groups, such as veterans, people on public assistance, or former felons. The vouchers allow employers to claim up to $37,000 in tax credits per employee.

Retroactive Vouchers Not Tied to Program Aims

According to HCD, the current rules give employers a loophole by allowing them to obtain vouchers years after they have hired qualified employees. The only limitation employers face is the standard four-year statute of limitations for amending tax returns, or even longer if an employer is undergoing an audit and has open years beyond the statute.

Approximately 20 percent to 30 percent of hiring credit vouchers are issued retroactively each year, and the hiring decisions for the covered workers are not tied to the purpose of the EZ program, which is to encourage employers to locate and hire workers inside the zones, HCD said.

Companies that are undergoing audits and have larger-than-reported tax liabilities may reach back into hiring records to discover past hires that may be eligible for the hiring credit, according to HCD.

“A cottage industry of tax consultants has developed to be hired on a commission basis by taxpayers to ‘mine’ old hiring records with the objective to provide an ‘after the event’ tax benefit to taxpayers,” HCD said in its explanation of the changes. “The problem with this practice is that it has escalated the generation of hiring credits beyond the ‘decision to hire’ incentive it was intended to create.”

One-Year Limit for Vouchers

To close the loophole, HCD is proposing that employers be required to obtain vouchers from EZ administrators within one year of hiring a qualified employee. The regulations would allow a one-year grace period for employers to obtain vouchers that go back more than one year for employees hired before the regulations take effect.

According to HCD, the one-year cutoff is likely to limit vouchers only for companies that make hiring decisions without regard to EZ program incentives.

HCD chose to propose a one-year cutoff for vouchers after also considering a two-year cutoff that some in the EZ industry said would be acceptable, or a shorter 30-day cutoff proposed by the California Labor Federation.

CAEZ said in comments submitted to HCD in February 2012 that the one-year cutoff would create inconsistent tax law, and would almost eliminate the voucher system.
“Current tax law allows residents and businesses a four-year look back,” CAEZ said. “If retroactive vouchering was limited to only one or two years, this would cut in half the look back period codified in existing law. That means businesses would be able to use the four-year look back for all tax purposes other than Enterprise Zone Hiring Credits.”

Voucher System Could Shut Down

CAEZ also pointed out that employers cannot claim a qualified employee’s wages for the EZ credit until the employee has worked for nine months, leaving only three months to obtain a voucher. Many employers obtain vouchers for all employees at one time, once a year.

“Any hiring done in the latter part of the year will not qualify for vouchering because of the nine-month requirement,” CAEZ said. “Limiting the hiring credit window to a mere three months each year will greatly affect a business’s hiring decisions and undermines the legislative intent of the Enterprise Zone program.”

Other provisions of the proposed regulations would:

• require third-party verification of an employee’s residence within Targeted Employment   Areas, which are subzones within larger enterprise zones;
• streamline the vouchering process for hiring veterans and recipients of public assistance; and
• create stricter zone audit procedures and audit failure procedures.

The TEA changes would tighten up voucher issuance for hiring employees who live in those areas. The TEA resident category now makes up almost 80 percent of all vouchers issued, but economic status varies widely between people who live in designated TEAs and not all TEA residents qualify as disadvantaged workers, HCD said.

HCD would no longer accept federal Forms I-9, Employment Eligibility Verification, because they may be used only for immigration purposes, or landlord statements or lease or rental agreements because they are not reliable and can be easily fabricated.

HCD would accept driver’s licenses, voter documents, utility bills, passports, mortgage statements, county tax documents, or credit card bills.

More Data Reporting Required

Increased reporting requirements for zone administrators are intended to improve the quality of data available about the program, and to help regulators and lawmakers determine whether it is effective and encouraging business development, HCD said.

“One of the most consistent complaints about the current status of the Enterprise Zone Program is the absence of reliable data and transparency for the program’s operation,” HCD said.

State tax expenditures on the EZ program have increased from $410 million in 2006 to $732 million in 2010, according to HCD. The number of voucher applications jumped from 69,000 in fiscal year 2007-08 to 133,000 in FY 2011-12.

HCD is accepting written comments on the proposal until 5 p.m. Feb. 28. Comments should be sent to Colin Parent, HCD external affairs director, at ezregcomments@hcd.ca.gov

Written comments may also be sent to Enterprise Zone Program, Department of Housing and Community Development, P.O. Box 942054, Sacramento, Calif. 94252-2054, or faxed to (916) 323-6016, Attention: Colin Parent.

HCD will hold four public hearings on the regulations: Feb. 12 in Los Angeles, Feb. 13 in San Diego, Feb. 20 in Oakland, and Feb. 28 in Sacramento.

For More Information

Additional information on the Enterprise Zone Program regulations, Title 25, California Code of Regulations Chapter 7, Subchapter 21, is at http://www.hcd.ca.gov/ezregs/

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