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Tax Credit Investments: Benefits and Planning Considerations

By   Jason Oelrich

August 30, 2017

Tax credit investments can be extremely impactful tools for reducing federal and state taxes, although there are numerous accounting, tax and regulatory implications of making a tax credit investment. Here are some highlights of potential benefits and planning issues that require evaluation when considering different tax credit investments.

Types of Credits

The most common federal credits in which banks invest are Low Income Housing Tax Credits, New Markets Tax Credits, Historic Rehabilitation Tax Credits, and Renewable Solar Energy Credits. Many states also offer complimentary state credits that mirror the federal credits. Additionally, sometimes federal tax investments pair more than one of the federal credits together.

Both Low Income and New Market tax credits qualify as CRA investments, with an average 6-9 percent ROI, based on seven-year and 10-year credit periods, respectively. Historic Rehabilitation credits may also qualify for CRA and average 9-10 percent ROI, while Renewable Solar credits do not qualify for CRA but offer a higher 10-35 percent ROI.  Both Historic Rehabilitation and Renewable Solar credits have a one-year credit period.

For federal taxes, the ability to claim credits can vary, although generally the maximum amount of credits that can be used to offset taxes is limited to approximately 75 percent of total taxes, with other possible limitations depending on whether the bank is an S corporation or a C corporation. For C corporations there are more restrictive rules when the corporation is classified as closely-held by the IRS. Most federal credits can also offset alternative minimum tax.

State taxes that can be offset using state credits fluctuate amongst states. Some state credits may only allow for the offset of state income tax, but not bank franchise tax, for example.

Federal credits generally allow for a one-year carryback or a 20-year carryforward, but treatment amongst states differs, with some types of credits having a much shorter carryforward and/or no available carryback.

Various Structures

Many state credits are transferable, allowing for an outright purchase of credits that can be claimed on a state return or possibly re-sold. Federal credits and non-transferable state credits require investment into a partnership so that the credits can be allocated to investors.

For federal credits, there is generally a recapture period of between five to 15 years depending upon the credit. This obliges banks to remain a partner for several years even though for some credit types the benefit was only in year one.   Many states have similar recapture periods.

The accounting treatment varies depending on credit type, generally resulting in the investment being amortized over 10 years or accounted for under the equity method with an adjustment to reflect a reduced net realizable value for one-time credits.

Potential Tax Reform

Because potential sweeping tax reform is possible, 2017 may be the last opportunity to initiate federal tax credit investments. Furthermore, investment in tax credits generally cannot be put off until year-end due to the timing requirements of tax credit projects.