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Take the Money and Run - A Primer on the Income Tax Consequences of Tax Increment Financing
Debate continues over the role of infrastructure projects, including government incentives in job creation. It is important to look at some developments related to existing incentives for infrastructure spending. One notable example of discretionary government incentives has been the use of Tax Increment Financing (TIF) bonds. Taxand US summarises the potential outcome for the recipients of TIF proceeds in the US.
What is a TIF?
TIF is a financing tool used to pay for land, improvements, capital projects and infrastructure projects in specified geographic areas. Proceeds from the sale of TIF bonds through the municipal securities market are made available to fund large-scale capital projects.
Proceeds from a Loan That Must Be Repaid
If there is a fixed obligation of the recipient to repay the amount received from the TIF, then it may be classified as debt for US federal income tax purposes. For this purpose, a repayment using solely taxes that qualify as "generally applicable taxes" is not considered a fixed obligation to repay.
Contribution to Capital vs. Taxable Grant
If there is no fixed obligation for repayment, then the federal income tax consequences vary depending on the tax characterisation of the recipient (ie corporation versus partnership), the use of the proceeds and the ultimate ownership of the asset towards which the proceeds are applied.
Contribution to Capital in Aid of Construction
Deferred taxation generally results when there is a permanent private benefit and the recipient is classified as a corporation for federal income tax purposes.
Current taxation generally results when there is a permanent private benefit and the recipient is classified as a partnership for federal income tax purposes. This results because there are no statutory provisions applicable to partnerships that produce similar results as IRC Sections 118 and 362(c) in the corporate context.
Tax-Exempt Development Cost Reimbursements
No current or deferred income taxation may result when there is no obligation to repay TIF proceeds that are expended to benefit the general public. In these cases, the TIF district generally owns the applicable property for the entire useful life or longer.
Although TIFs are favoured by some jurisdictions because of the flexibility allowed for local authorities, the use of TIFs is not without critics. This criticism adds to the political complexity of getting some TIFs approved. TIFs are sometimes combined with other federal or state incentives to achieve viable overall financing. Careful planning for the use of TIF proceeds is required. We can no longer assume that incremental property taxes will automatically be there to service the bonds. No two TIFs are alike, and caution is important. Partnerships or other non-corporate recipients of TIF proceeds have to be particularly diligent to avoid tax surprises. Government opposition may mean that any legislative relief for partnerships will be prospective only.