Here is what we know so far about the implications of the budget on the Enterprise Zones.

There are two budget trailer bills that impact the usage of the tax credits: AB 1452 and SBX1 28, neither of which have been signed by the Governor yet.

AB 1452 has three provisions that could effect Enterprise Zone businesses:

• Suspends the NOL for two years 2008-2009
• Limits the ability to reduce tax below 50% of liability with tax credits (such as Enterprise Zone credits) for tax years 2008-2009
• Beginning in 2010, allows corporations to assign all or a portion of any unused tax credits to an affiliated corporation that is a member of the same combined reporting group.

Taxpayers with less than $500,000 in “net business income” are exempt from both the NOL suspension and the credit usage limitation.  Any credits that go unused because of the limitation in 2008-2009 will carry forward.

The most interesting, and confusing, area is, of course, this new ability to reassign credits between entities.  My understanding is that this compromise was primarily, if not exclusively, targeted to placate large taxpayers with large Research & Development credits who have been lobbying for this kind of reform for years.  How this provision could be used by taxpayers with excess Enterprise Zone credits is unclear, at least to me.

In a posting on the left-wing website California Progress Report,  California’s Treasurer Bill Lockyer warned:

These tax provisions also affect enterprise zone tax credits. The Legislature created this program to encourage businesses to locate and create jobs in economically-disadvantaged communities. The budget undermines the entire purpose of the program by allowing enterprise-zone businesses to transfer tax credits they don’t use to affiliates outside the zone.

Currently, there are $768 million worth of unused enterprise zone tax credits in California. It’s likely a good portion of those credits will be shifted to businesses outside these areas if this budget becomes law. This is another tax shelter that will drain more revenues and further weaken the state’s fiscal health.

Leaving aside the discussion regarding the wisdom of a business incentive program that leaves $768 million of unusable credits on the books, I was not sure that Mr. Lockyer’s assessment of the bill was correct. I thought that once assigned, the assignee would then be subject to the same tax code rules governing the use of whatever tax credits had been assigned.  Apparently, there were some in the legislature who agreed that Mr. Lockyer’s concern needed to be addressed and that’s where we come to SBX1 28 where we find:

SEC. 8. (a) For purposes of applying Section 23663 of the Revenue and Taxation Code, as added by Assembly Bill 1452 of the 2007-08 Regular Session, any limitations on allowance of any credit against the “tax” that would apply to the assigning taxpayer in the absence of an assignment shall also apply to the same extent to the allowance of that assigned credit against the “tax” of the eligible assignee.

The Enterprise Zone tax credit includes a significant inherent limitation on credit usage known as the apportionment limitation.  Taxpayers with EZ tax credits can only reduce the tax which results from income in an Enterprise Zone.   Not only that, but for taxpayers who operate in more than one zone, tax credits generated in one zone can only be used to reduce tax resulting from income in that very same zone.  One question that arises regarding this new language in SBX1 28 is, does “shall apply to the same extent” mean that credits generated in a particular zone must be used only against tax generated in that same zone even if the credits are assigned to an affiliate with tax generated in a different zone? In any case, it is difficult to think of scenarios in which the ability to reassign tax credits to affiliates will help Enterprise Zone businesses.

Furthermore, the fact that EZ credits are already so limited in their usage means that the largest taxpayers will be unaffected by the 50% limit imposed by AB 1452.  Large taxpayers operating throughout the state (such as Wal-Mart) can never hope to reduce their tax anywhere near 50% with EZ tax credits as it is.  Very small businesses are exempted.  So who will AB 1452 hurt the most?  Just those profitable, small businesses who are wholly locally owned and operated, and contribute a significant number of jobs to the local distressed communities.