Tax Incentive

Guide for

Businesses 

in the Renewal Communities, 

Empowerment Zones,

and Enterprise Communities

U.S. Department of Housing 

and Urban Development

FY 2001
Contents

i

About the Empowerment Zone/Enterprise Community

and Renewal Community Initiatives . . . . . . . . . . . . . . . . . . . . . . . . .1

Empowerment Zone Employment Credit/

Renewal Community Employment Credit . . . . . . . . . . . . . . . . . . . .11

Work Opportunity Tax Credit . . . . . . . . . . . . . . . . . . . . . . . . . . . . .19

Welfare to Work Tax Credit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .25

Indian Employment Tax Credit . . . . . . . . . . . . . . . . . . . . . . . . . . . .31

Increased Section 179 Deduction . . . . . . . . . . . . . . . . . . . . . . . . . .37

Commercial Revitalization Deduction . . . . . . . . . . . . . . . . . . . . . . .41

Environmental Cleanup Cost Deduction (Brownfields) . . . . . . . . . . .47

Depreciation of Property Used on Indian Reservations . . . . . . . . . . .51

Enterprise Zone Facility Bonds . . . . . . . . . . . . . . . . . . . . . . . . . . . .55

Qualified Zone Academy Bonds . . . . . . . . . . . . . . . . . . . . . . . . . . .67

Zero Percent Capital Gains Rate for Renewal Community

and District of Columbia Enterprise Zone Assets . . . . . . . . . . . . . . .75

Nonrecognition of Gain on Sale of Empowerment

Zone Assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .81

Partial Exclusion of Gain on Sale of Empowerment

Zone Stock . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .85

New Markets Tax Credit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .89

Low-Income Housing Tax Credit . . . . . . . . . . . . . . . . . . . . . . . . . .97

Appendix A: Questions & Answers on Enterprise Zone

Businesses and Renewal Community Businesses . . . . . . . . . . . . . . .99

Appendix B: Current Urban and Rural Empowerment

Zones and Enterprise Communities . . . . . . . . . . . . . . . . . . . . . . .105
About the Empowerment Zone/

Enterprise Community and

Renewal Community Initiatives 

1

Round I and Round II Empowerment Zones and

Enterprise Communities 

Launched in 1993, the Empowerment Zone and Enterprise Community (EZ/EC) Initiative

is an interagency effort focused on the creation of self-sustaining, long-term development

in distressed urban and rural areas throughout the Nation. The Initiative is based on a

holistic, participatory approach that requires community stakeholders to work together

to develop and implement comprehensive strategic plans for revitalization. Using a combination of Federal tax incentives and flexible grant funds, these partners are reinvigorating many communities that have been in decline for decades. Businesses are opening or

expanding, residents have greater access to jobs, services, and new economic opportunities, and crime and violence are down.

At the time of publication, a total of 23 urban EZs, 8 rural EZs, and 115 urban and rural

ECs have been designated. In 1994, the U.S. Department of Housing and Urban Development (HUD) designated 6 urban EZs and 65 urban ECs, and the U.S. Department of

Agriculture (USDA) designated 3 rural EZs and 30 rural ECs. In 1998, 15 additional

urban EZs, 5 rural EZs, and 20 rural ECs were designated. Congress authorized two

supplementary communities, Cleveland and Los Angeles, to become full urban EZs

beginning in January 2000 and created a District of Columbia Enterprise Zone with

tax incentives commencing January 1, 1998. EZs receive the greatest level of Federal

tax incentives and grant funding. 

Round III Empowerment Zones and Renewal

Communities 

In December 2000, Congress authorized a third round of Empowerment Zones, 7 in

urban areas and 2 in rural areas. Congress also approved the designation of 40 new

Renewal Communities (RCs); like the EZ/EC Initiative, the goal of this new program

is to promote economic development in distressed communities. Of the 40 RCs to be

designated, at least 12 will be located in rural areas. Like Round I and Round II EZ/

ECs, businesses located in the new EZs and the RCs (to be designated by December 31,

2001) will be eligible to take advantage of Federal tax incentives to hire residents and

to expand or improve their operations. As no grant funding will be available to Round III 

EZs and RCs, this guide will be a valuable tool for communities and businesses alike.
2

About the EZ/EC and RC Initiatives

About This Publication 

The Federal tax benefits available in EZs, ECs, and RCs are designed to encourage businesses to invest in these areas. Expanding business development and commerce leads to

greater job opportunities for residents and to improved access to goods and services,

both of which help energize long-term revitalization. 

This guide summarizes the rules applicable to Federal tax incentives available to businesses operating in EZs, ECs, and RCs and to those hiring residents of these areas. As you use

the guide, keep in mind that some tax incentives will work well for labor-intensive businesses, whereas others benefit those with capital needs. Some incentives make sense only

for large companies while others work best for small ones. Several incentives discussed in

this guide also apply to businesses and residents outside EZ/EC/RC communities. Please

contact your tax attorney or accountant for details regarding your eligibility to claim

these incentives. The following sections list the incentives discussed in this guide.

Incentives 

Wage Credits 

■ Empowerment Zone Employment Credit (EZ Wage Credit). IRS Tax Form 8844.

■ Renewal Community Employment Credit (RC Wage Credit). IRS Tax Form 8844.

■ Work Opportunity Tax Credit (WOTC). IRS Tax Forms 5884 and 8850.

■ Welfare to Work (WtW) Credit. IRS Tax Forms 5884, 8850, and 8861.

■ Indian Employment Tax Credit. IRS Tax Form 8845.

Deductions

■ Increased Section 179 Expensing. IRS Tax Form 4562.

■ Commercial Revitalization Deduction. No applicable IRS tax form identified at time

of publication; see IRS Publication 946.

■ Environmental Cleanup Cost Deduction (Brownfields). No applicable IRS tax forms.

■ Depreciation of Property Used on Indian Reservations. See IRS Publication 946.
3

About the EZ/EC and RC Initiatives

Bond Financing 

■ Enterprise Zone Facility Bonds. No applicable IRS tax forms.

■ Qualified Zone Academy Bonds (QZABs). IRS Tax Form 8860.

Capital Gains 

■ Zero Percent Capital Gains Rate for RC Assets and DC Zone Assets. No applicable

IRS tax form identified at time of publication.

■ Nonrecognition of Gain on Sale of Empowerment Zone Assets (EZAs). No applicable

IRS tax form identified at time of publication.

■ Partial Exclusion of Gain from Sale of Empowerment Zone Stock.

No applicable IRS tax form identified at time of publication.

Other Incentives 

■ New Markets Tax Credit. No applicable IRS tax form identified at

time of publication.

■ Low-Income Housing Tax Credit (LIHTC). IRS Tax Forms 8609

and 8586.

For More Information 

To find out more about the EZ/EC and RC Initiatives, to learn how to reach your

local EZ/EC/RC contact person, or to obtain more copies of this guide, please call

HUD’s Community Connections Hotline at 1–800–998–9999 or visit www.hud.gov/

offices/cpd/ezec for urban EZ/ECs and urban and rural RCs or www.ezec.gov for rural

EZ/ECs. To obtain copies of IRS Publication 954, Tax Incentives for Empowerment Zones

and Other Distressed Communities, and all other tax forms, call 1–800–829–3676 or visit

www.irs.ustreas.gov.
4

1. Cleveland only. 2. Los Angeles received $450 million; Cleveland received $177 million.3. Subject to annual appropriation. 4. After December 31, 2001.5. Also applicable to District of Columbia Enterprise Zone. 

Table 1. Tax Incentive Matrix for Urban and Rural EZs/ECs/RCs 

2 Round I 

Supplemental 

EZs (Los Angeles 4 Round I 

Type of Benefit Round I EZs and Cleveland) Enhanced ECs Round I ECs Round II EZs Round 

Grants/Loan Guarantees$100 million SSBG grant X$3 million SSBG grant X1 X XHUD EDI grant/Section 108 Loan Guarantee X2 XHUD EZ grant X3Wage CreditsEZ Employment Wage Credit X X X4 XRenewal Community Employment Credit Work Opportunity Tax Credit X X X X X X Welfare to Work Wage Credit X X X X X X Indian Employment Tax Credit X X X X X X DeductionsIncreased Section 179 Deduction X X X X Commercial Revitalization Deduction Environmental Cleanup Cost Deduction X X X X X X Depreciation of Property Used onIndian Reservations X X X X X X Bond FinancingEnterprise Zone Facility Bonds X X X X X XQualified Zone Academy Bonds (QZABs) X X X X X X Capital GainsZero Percent Capital Gains Rate for RC Assets and DC Zone Assets Nonrecognition of Gain on Sale of Empowerment Zone Assets X X X XPartial Exclusion of Gain on Sale of Empowerment Zone Stock X X X XOther IncentivesNew Markets Tax Credit X X X X X X Low-Income Housing Tax Credits X X X X X X 
5

About the EZ/EC and RC Initiatives

Table 2. Summary of Tax Incentives: Tax Credits, Deductions,

Bonds, and Capital Gains 

Wage Credits Description Availability

Empowerment Zone Credit against Federal taxes up Available currently for Round I EZs;

Employment Credit to $3,000 for businesses for each available for all EZs beginning 

(EZ Wage Credit) year of EZ designation for every January 1, 2002, through Decexisting employee and new hire ember 31, 2009. Cannot count 

who lives and works in the EZ. wages for both the WOTC and 

WtW credits and the EZ Wage 

Credit.

Renewal Community Credit against Federal taxes up Available beginning January 1, 

Employment Credit to $1,500 for businesses for each 2002, through December 31, 2009.

(RC Wage Credit) year of RC designation for every Cannot count wages for both the 

existing employee and new hire WOTC and WtW credits and the

who lives and works in the RC. RC Wage Credit.

Work Opportunity Tax Credit up to $2,400 against Expires for individuals who begin 

Credit (WOTC) Federal taxes for businesses for work after December 31, 2003.

each new hire from groups that Business does not have to be in 

have high unemployment rates an EZ, EC, or RC to qualify. Cannot 

or other special employment be combined with WtW Credit. 

needs, including youth ages 18 State Employment Services Agency 

to 24 who live in an EZ, EC, or must certify employee is in 

RC, and summer hires ages 16 targeted group. 

to 17 who live in an EZ, EC

or RC.

Welfare to Work (WtW) Two-year credit against Federal Expires for individuals who begin 

Credit taxes for businesses that hire work after December 31, 2003. 

long-term family assistance Business does not have to be in an

recipients. Credits up to $3,500 EZ, EC, or RC to qualify. Cannot 

for the first year, and $5,000 be combined with WOTC. State 

for the second year for each Employment Services Agency 

new hire. must certify employee is in targeted group.

Indian Employment Tax Credit against Federal taxes A business does not have to be 

Credit calculated on wages (including located in an EZ, EC, or RC to 

employee health insurance costs) qualify for this credit. The majority

up to $20,000 for each qualified of the services performed by the 

employee who is an enrolled employee must be on an Indian 

member of an Indian tribe (or reservation. The credit does not 

spouse) who lives on or near apply for taxable years beginning

an Indian reservation. Available after December 31, 2003.

for existing employees and 

new hires.

(continued)
6

About the EZ/EC and RC Initiatives

Table 2. Summary of Tax Incentives: Tax Credits, Deductions,

Bonds, and Capital Gains (continued) 

Deductions Description Availability

Increased Section Allows businesses to claim in- Can be used only in EZs and RCs.

179 Deduction creased Section 179 deduction Cannot be used in developable 

(up to $20,000 in additional sites until after December 31,

expensing increasing to $35,000 2001. Cannot be used in ECs. 

for property acquired after December 31, 2001) if the businesses 

qualifies as an Enterprise Zone

Business or Renewal Community

Business. Can be claimed on

certain depreciable property such

as equipment and machinery. 

Commercial Revitalization Deduction of either one-half of Available in RCs for buildings 

Deduction qualified revitalization expendi- placed in service after December 

tures (QREs) in the first year a 31, 2001, and before January 1, 

building is placed in service or 2010. State may allocate up to 

all of QREs on ratable basis over $12 million in deductions (not 

10 years if QREs have been more than $10 million per project) 

allocated to revitalization of a for each year 2002–2009 for each 

commercial building located in RC in the State. Business does not 

an RC. have to be a Renewal Community 

Business. 

Environmental Cleanup Businesses can elect to deduct Property is not required to be 

Cost Deduction qualified cleanup costs of located in an EZ, EC, or RC. Need 

(Brownfields) hazardous substances in certain certification from State environareas (brownfields) in the tax mental agency. Includes costs 

year the business pays or incurs paid or incurred prior to January 1, 

the costs. 2004.

Depreciation of Property Special accelerated depreciation A business does not have to use 

Used on Indian Reservations rules apply to qualified property the property in an EZ, EC, or RC to

placed in service on an Indian use these special rules, but generally

reservation after 1993 and before the property must be used on an

2004. Certain public infrastruc- Indian reservation. Property must

ture used or located off the be placed in service after 1993 

Indian reservation also qualifies. and before 2004.

(continued)
7

About the EZ/EC and RC Initiatives

Table 2. Summary of Tax Incentives: Tax Credits, Deductions,

Bonds, and Capital Gains (continued) 

Bond Financing Description Availability

Enterprise Zone Facility State and local governments can $3 million per borrower limit in

Bonds issue Enterprise Zone Facility any Round I EZ for bonds issued 

Bonds (a type of tax-exempt prior to January 1, 2002, or in any

bond) to make loans at lower EC, with a $20 million per borrower

interest rates to Enterprise Zone nationwide limit; must have State

Businesses to finance Qualified volume cap allocated. $130 million

Zone Property. or $230 million available in urban 

Round II EZs ($60 million in rural 

Round II EZs) over designation 

period and for all EZs after 

December 31, 2001, including 

developable sites (no per-borrower

limit and bonds are not subject 

to State volume cap) for EZ- or 

EC-based commercial, retail, or 

industrial property; 35 percent 

of employees must be EZ or EC 

residents. 

Qualified Zone Academy State or local governments can Federal allocation to States annually 

Bonds (QZABs) issue bonds at 0-percent interest from 1998–2001. State education 

cost to them to finance public agency allocates credit to a Qualschool programs with private ified Zone Academy to finance

business partnerships. Private materials, teacher training, building

businesses must contribute renovation, or equipment for 

money, equipment, or services programs that prepare students 

equal to 10 percent of bond for jobs or college. Schools must 

proceeds (which may qualify as be located in an EZ or EC or have 

a charitable contribution). The 35 percent of students eligible for 

Federal Government pays inter- free or reduced-cost lunch program.

est in the form of tax credit to

banks, insurance companies, and

certain lending corporations that

hold QZABs.

(continued)
8

About the EZ/EC and RC Initiatives

Table 2. Summary of Tax Incentives: Tax Credits, Deductions,

Bonds, and Capital Gains (continued) 

Capital Gains Description Availability

Zero Percent Capital Gains The holder, for a minimum of 5 Exclusion applies only to an interest

Rate for RC and DC Zone years, of a District of Columbia in, or property of, certain businesses

Assets Enterprise Zone (DC Zone) asset operating in the District of Columacquired between January 1, bia or an RC. The following qualify 

1998, and December 31, 2002, as DC Zone or RC assets: DC Zone 

or an RC asset acquired between or RC business stock, DC Zone or 

January 1, 2002, and December RC partnership interests, and DC 

31, 2009,will not have to include Zone or RC business properties. 

in its gross income any qualified Only gain attributable to the period 

capital gain from the sale or from January 1, 1998, through 

exchange of the asset. December 31, 2008, for the DC

incentive, and from January 1,

2002, through December 31, 2014,

for RCs, may be excluded.

Nonrecognition of Gain Capital gain on EZAs (stock, Election by taxpayer for EZA 

on Sale of Empowerment partnership interests, and busi- acquired after December 21, 2000,

Zone Assets (EZA) ness property) of an Enterprise and before January 1, 2010, for 

Zone Business held for more all EZs (not available in District of

than 1 year is not recognized Columbia Enterprise Zone, ECs, 

(and is rolled over) if replace- or RCs).

ment EZA is acquired within

60 days.

Partial Exclusion of Gain on Exclusion of 60 percent of the Stock must be acquired after 

Sale of Empowerment Zone gain on sale of small business December 21, 2000, and before 

Stock stock of a C Corporation that January 1, 2010, at original issuance

is an Enterprise Zone Business in exchange for cash. Sixty-percent 

located in an EZ if the stock is exclusion does not apply to gain 

held for at least 5 years. after December 31, 2014. Business 

must be an Enterprise Zone Business in an EZ (other than the

District of Columbia Enterprise

Zone).

(continued)
9

About the EZ/EC and RC Initiatives

Table 2. Summary of Tax Incentives: Tax Credits, Deductions,

Bonds, and Capital Gains (continued) 

Other Incentives Description Availability

New Markets Tax Credit Equity investors in qualified Allocations of the credit will be

Community Development made annually from 2001 to 2007

Entities (CDEs) can obtain a tax to qualified CDEs. Investors must 

credit against Federal taxes of purchase stock or partnership

5 to 6 percent of the amount interest in a CDE for cash at

invested for each of the years original issuance. Credit available

the investment is held, for up at time of purchase (1 year) and 

to 7 years of the credit period. on 6 anniversary dates of acquisition of investment.

Low-Income Housing Tax Ten-year credit against Federal Project must receive allocation of 

Credit (LIHTC) taxes for owners of newly State’s annual credit ceiling or use 

constructed or renovated rental multifamily housing tax-exempt 

housing who set aside a speci- bonds that receive allocation of 

fied percentage of units for low- State’s bond volume cap. Alloincome persons for a minimum cations are made on basis of 

of 15 years. The credit varies for State plan. The project does not 

new construction and renovation. have to be located in an EZ, EC,

or RC to qualify.
11

Empowerment Zone

Employment Credit/Renewal

Community Employment Credit 

Applicable IRS Tax Form: Form 8844

Wage Credit Description Availability

Empowerment Zone Credit against Federal taxes of up Available currently for Round I 

Employment Credit to $3,000 for businesses for each EZs; available for all EZs beginning 

(EZ Wage Credit) year of EZ designation for every January 1, 2002, through 

existing employee and new hire December 31, 2009. Cannot count 

who lives and works in the EZ. wages for the WOTC and WtW 

credits and the EZ Wage Credit.

Renewal Community Credit against Federal taxes up to RC Wage Credit available 

Employment Credit $1,500 for each year of Renewal beginning January 1, 2002,

(RC Wage Credit) Community (RC) designation for through December 31, 2009. 

every existing employee and new Cannot count wages for the 

hire who lives and works in WOTC and WtW credits and

the RC. the RC Wage Credit.

The Empowerment Zone Employment Credit (EZ Wage Credit) and

Renewal Community Employment Credit (RC Wage Credit) give businesses an incentive to retain or hire individuals who both live and work

in an Empowerment Zone (EZ) or a Renewal Community (RC), respectively. (Individuals who work in the DC Enterprise Zone may live anywhere in the District of Columbia.) Businesses can claim the credit if

they pay or incur “qualified zone wages” to a qualified employee. The

credit can be as much as $3,000 per qualified employee per year for the

EZ Wage Credit and up to $1,500 for the RC Wage Credit. The credit is

available with respect to all EZs and RCs beginning January 1, 2002.

Round I Zones are currently eligible for the EZ Wage Credit, continuing

through December 31, 2009.

Target Audience 

■ Businesses relocating to an EZ or RC that will have large hiring needs.

■ Businesses expanding within an EZ or RC that will be hiring new employees.
EZ Employment Credit/RC Employment Credit

12

■ Businesses with relatively high turnover that often need new employees.

■ Businesses with a stable workforce of employees living in an EZ or RC.

■ Businesses looking to reduce tax liability.

■ Businesses seeking to qualify as an Enterprise Zone Business or a Renewal

Community Business that must meet the 35-percent EZ/RC resident employee

requirement.

Incentive Not Relevant to 

■ Startup businesses that may not have large tax liabilities.

■ Nonprofit organizations.

■ Businesses whose employees spend the majority of their time (by pay period or on

average over the year) working outside an EZ or RC.

Additional Resources 

■ Accountants and lawyers preparing business tax returns.

■ Local bar associations or accountant groups to identify accountants or lawyers to

field questions.

■ Local schools, vocational schools, junior or community colleges, 4-year colleges, and

job-training programs that may have EZ or RC residents participating in their programs. These training programs should be linked to employment agencies and job

banks working with businesses that have operations in an EZ or RC.

■ Job banks that have established relationships with businesses located in an EZ or RC.

■ Instructions for IRS Form 8844. For copies call 1–800–829–3676 or visit

www.irs.ustreas.gov.
EZ Employment Credit/RC Employment Credit

13

Questions & Answers on Empowerment Zone and

Renewal Community Employment Credits

Are there any employer incentives for hiring

employees who work in an EZ or RC?

Yes. The tax code allows employers a credit against Federal taxes for

hiring and retaining employees who live and work in an EZ or RC.

The EZ Wage Credit has been available since 1994 for Round I EZs

and since 1998 for the District of Columbia. The EZ Wage Credit and RC Wage Credit

will be available in all EZs and RCs beginning January 1, 2002, and will continue for all

EZs and RCs through December 31, 2009.

Can a business use this credit for current 

employees?

Yes. The EZ Wage Credit and RC Wage Credit are incentives to hire

and retain individuals who live in an EZ or RC, so it is available each

year throughout the EZ Wage Credit and RC Wage Credit periods.

How does a business document that an

employee is an EZ or RC resident?

The employer should obtain a statement from the employee, under

penalty of perjury, that gives the address of the employee’s principal

residence and provides assurance that the employee will notify the

employer of a change in the employee’s principal residence. The local EZ or RC can confirm that the address is in the EZ or RC or a business can obtain the information over 

the Internet using the EZ/EC/RC address locator at www.hud.gov/ezec/locator. The statements are not filed with the business’s tax return, but should be retained like any other

documents supporting a tax return.

What if the employee works part-time?

The credit is available for both part-time and full-time employees as

long as they have been employed by the employer for at least 90 days.

The amount of the credit is tied to the amount of wages paid rather

than to the number of hours worked.
EZ Employment Credit/RC Employment Credit

14

What is the definition of qualified wages?

Qualified wages are generally wages subject to the Federal Unemployment Tax Act (FUTA). The credit is calculated against a maximum

of $15,000 in wages for the EZ Wage Credit and $10,000 for the RC

Wage Credit. A business may pay the employee more than $15,000 for

EZs or $10,000 for RCs, but the maximum for purposes of calculating

the credit is $15,000 for an EZ or $10,000 for an RC. The instructions for IRS Form

8844 provide additional information on qualified wages.

What is the credit amount?

The EZ Wage Credit amount is 20 percent of wages up to the $15,000

wage amount. The credit amount for the RC Wage Credit is 15 percent

of wages up to the $10,000 wage amount.

Is there a limit on the number of employees

for which a business can take the credit?

An employer can take the credit for as many employees as qualify.

What if the employee works in an EZ or RC

for only part of the year?

An employer can use either the pay-period or calendar-year method

for determining the period of time the employee performs services in

an EZ or RC. No other time periods can be used to prorate the credit.

For example, if an employee works in several factory locations and is paid weekly, an

employer can claim the wage credit for the weekly pay periods during which the employee works substantially all of his or her time in the factory located in an EZ or RC.

“Substantially all” is defined as 85 percent for the purposes of some of the tax incentives

discussed in this guide, but the regulations on the EZ and RC Wage Credits do not define

substantially all. The employer must use the same method for all employees, but may

change the method applied to all employees from one taxable year to another.
EZ Employment Credit/RC Employment Credit

15

What if the business is located in an EZ or RC,

but the employees spend part of their time

working outside the boundaries of the EZ or RC?

The credit is available only if substantially all of the services performed

during the period (see answer to question above on pay-period and

calendar year calculations) are in an EZ or RC. “Substantially all” is defined as 85 percent

for purposes of some of the tax incentives discussed in this guide, but the regulations on

the EZ and RC Wage Credits do not define substantially all. If an employee does not perform substantially all services inside an EZ or RC within the calculation period selected,

the credit cannot be prorated and no portion of the wages for that period would qualify

for the credit.

What if the Federal tax liability of the business

is less than the total credit amount?

The EZ Wage Credit and RC Wage Credit generally are subject to the

same rules as other business tax credits. As with other business tax

credits, unused credit amounts can be carried forward for up to 20

years and carried back a year. However, the credit cannot be carried back prior to the 

EZ or RC designation.

Are there special procedures for taking the EZ 

or RC Wage Credit?

The credit is accounted for on IRS Form 8844 and would be part of a

business’s tax filing.

Can nonprofit organizations benefit from the 

EZ or RC Wage Credits?

Tax-exempt organizations, other than certain cooperatives, are ineligible for the credits.
EZ Employment Credit/RC Employment Credit

16

Can a pass-through entity, such as a partnership

or S-corporation, use the credit?

The EZ Wage Credit and RC Wage Credit are general business tax

credits for Federal tax purposes and may be passed through under 

the rules similar to other business tax credits.

Does the EZ Wage Credit or RC Wage Credit

reduce Alternative Minimum Tax (AMT) liability?

AMT may be reduced by 25 percent of the EZ Wage Credit or RC

Wage Credit amount.

Can the EZ Wage Credit or RC Wage Credit for

an employee be taken concurrently with Work

Opportunity Tax Credits (WOTC) or Welfare to

Work (WtW) credits?

Yes, but wages are not taken into account for the EZ Wage Credit

or RC Wage Credit if they are being used in determining WOTC or WtW. In addition,

the $15,000 or $10,000 cap on wages taken into account for the EZ Wage Credit or

RC Wage Credit, respectively, would be reduced by any wages taken into account in 

computing WOTC or WtW.

Which categories of employees would not 

qualify for the EZ and RC Wage Credits?

The EZ and RC Wage Credits cannot be taken for any individual

employed at any private or commercial golf course, country club, 

massage parlor, hot tub facility, suntan facility, racetrack or other 

gambling facility, or store whose principal business is the sale of alcoholic beverages

for consumption off premises.

The EZ and RC Wage Credits are not available for family members of the employer,

including sons, daughters, parents, stepchildren, stepmothers, stepfathers, in-laws, and

other persons treated as dependents under the tax code. Similar exclusions apply to 5-

percent owners related to the employer and family members of majority shareholders 

or partners of the employer.
EZ Employment Credit/RC Employment Credit

17

Can entities that lease their employees use

the credit?

Employers should check with their tax advisors. The EZ and RC Wage

Credits are based on FUTA wages, so the ability to take the credit will

depend on who the employer is for purposes of the FUTA wages.

Is there a definition of employee?

The credit is tied to wages as defined for purposes of FUTA. Any individual treated as an employee under FUTA would generally be treated

as an employee for purposes of the EZ Wage Credit.

Can the EZ Wage Credit and RC Wage Credit be

taken for farmworkers?

If the employer’s principal activity is farming, the credit is available 

for employees only if the sum of value of the assets owned or leased

by the employer for use in the farming business does not exceed

$500,000. The definition of farming and the method for calculating the value of the

assets are found in the tax laws, and the employer should consult its legal advisor on

this matter before taking the credit.

How does the credit affect the deduction for

salaries and wages?

A business must reduce the deduction for salaries and wages by the

amount of the credit taken.

Where can a business obtain more information

on this incentive?

A business should consult with its tax advisor. IRS Publication

954 and IRS Form 8844 describe this incentive. For copies call

1–800–829–3676 or visit www.irs.ustreas.gov.
19

Applicable IRS Tax Forms: Forms 5884 and 8850

Wage Credit Description Availability

Work Opportunity Credit up to $2,400 against Expires for individuals who begin 

Tax Credit (WOTC) Federal taxes for businesses for work after December 31, 2003.

each new hire from groups that Business does not have to be in an

have high unemployment rates EZ, EC, or RC to qualify. Cannot

or other special employment be combined with WtW credit. 

needs, including: youth ages 18 State Employment Services Agency

to 24 who live in an EZ, EC, or must certify employee is in 

RC, and summer hires ages 16 targeted group.

to 17 who live in an EZ, EC,

or RC.

The Work Opportunity Tax Credit (WOTC) provides businesses with an incentive to hire

individuals from groups that have particularly high unemployment rates or other special

employment needs. Businesses do not have to be located in an Empowerment Zone (EZ), Enterprise Community (EC), or Renewal Community

(RC) to qualify for this credit. They can claim the credit if they pay or

incur qualified first-year wages to a targeted-group employee who began

work after September 1996. Groups that qualify include:

■ High-risk youth (ages 18 to 24 who live in an EZ, EC, or RC).

■ Veterans.

■ Ex-felons.

■ Vocational rehabilitation referrals.

■ Summer youth employees (ages 16 and 17) who live in an EZ, EC, or RC.

■ Food stamp recipients.

■ Recipients of assistance under Aid to Families with Dependent Children (AFDC) 

or its successor program, Temporary Assistance for Needy Families (TANF).

■ Supplemental security income (SSI) recipients.

Work Opportunity

Tax Credit 
Work Opportunity Tax Credit

20

Each qualifying category has specific requirements. Employers should consult their tax

advisors and the State Employment Services Agency (SESA).

Target Audience 

■ Businesses outside an EZ, EC, or RC that will have large hiring needs.

■ Businesses expanding within an EZ, EC, or RC that will be hiring new employees.

■ Businesses with relatively high turnover that often need new employees.

■ Businesses looking to reduce tax liability.

■ Businesses participating in summer youth employment programs.

■ Businesses seeking to qualify as an Enterprise Zone Business or a Renewal Community

Business that must meet the 35-percent EZ, EC, or RC resident employee requirement.

Incentive Not Relevant to 

■ Startup businesses that may not have large tax liabilities.

■ Nonprofit organizations.

■ Businesses with highly specialized employees, unless a local training program can

supply appropriately trained employees.

Additional Resources 

■ Accountants and lawyers preparing business tax returns.

■ Local bar associations or accountant groups to identify accountants or lawyers to

field questions.

■ The SESA assigned to handle WOTC certifications (may be at State or local level).

The SESA staff should be included in informational meetings held for employees

and EZ, EC, and RC residents as well as in job-training programs. The SESA is also

likely to have materials prepared on the incentives.

■ Local schools, vocational schools, junior or community colleges, 4-year colleges, 

and job-training programs that may have EZ, EC, or RC residents of the appropriate

age participating in their programs. The training programs should be linked to the

SESA or other employment agencies and job banks.
Work Opportunity Tax Credit

21

■ Job banks with established relationships with the SESA so that EZ, EC, and 

RC residents can have conditional certification as qualifying for WOTC.

■ Instructions for IRS Forms 8850 and 5884. For copies call 1–800–829–3676 or 

visit www.irs.ustreas.gov.

Questions & Answers on the Work Opportunity

Tax Credit 

Are there any incentives for hiring residents 

of an EZ, EC, or RC?

Yes. The tax code gives employers a credit (WOTC) against Federal

taxes for hiring residents of an EZ, EC, or RC ages 18 to 24. WOTC

also applies to EZ, EC, and RC residents ages 16 and 17 who are hired

for summer work and is available for the hiring of certain other groups identified as having difficulty entering the job market.

Can a business use this credit for current 

employees?

No. WOTC is an incentive to hire individuals, and the credit is calculated against wages paid only during the first year an employee works

for an employer. To take advantage of the credit, the business must

obtain information from the employee prior to offering him or her a job.

What paperwork is involved?

A business must have a prospective employee fill out IRS Form 8850

prior to making a job offer. The employer also signs the form. In some

cases, the prospective employee may bring a precertification form to

the interview. Form 8850 must be forwarded to the SESA within 21

days of the date the employee starts work. WOTC may be taken only for employees who

have been certified by the SESA as qualifying for the incentive.
Work Opportunity Tax Credit

22

How does a business document that an EZ, EC,

or RC resident is qualified?

In most cases, a driver’s license will serve to establish the age and

address of a prospective employee. The EZ, EC, or RC can confirm

that the address is within designated boundaries, or a business can

obtain the information using the EZ/EC/RC address locator at www.hud.gov/ezec/locator.

The SESA can provide a business with other ways to establish the age and address when

a prospective employee does not have a driver’s license.

What if the employee leaves during the first 

year of employment?

The credit is available for any person who works at least 120 hours for

a business. The credit rate is 25 percent of wages paid to an individual

who works at least 120 hours. If the employee works at least 400 hours,

the credit rate is increased to 40 percent of first-year wages.

What if the employee works part-time?

The credit is available for both part-time and full-time employees. 

The credit percentage is tied to the total number of hours worked.

What is the definition of qualified wages?

Qualified wages are generally wages subject to the Federal Unemployment Tax Act. The credit is calculated against a maximum of

$6,000 in first-year wages or $3,000 in the case of summer youth. 

A business may pay the employee more than $6,000 in the first year,

but the maximum for purposes of calculating the credit is $6,000. The instructions for

IRS Form 5884 provide additional specific information on qualified wages.
Work Opportunity Tax Credit

23

Is there a limit on the number of employees 

for which a business can take the credit?

An employer can take the maximum $2,400 credit (40 percent of

$6,000) for as many new hires as are qualified. 

What if the Federal tax liability of the business

is less than the total credit amount?

WOTC is one of several business credits and generally is subject to

the same rules as other business tax credits. As with other business

tax credits, unused WOTC amounts can be carried forward for up

to 20 years and carried back 1 year.

Can nonprofit organizations benefit from WOTC?

Tax-exempt organizations, other than certain cooperatives, are ineligible for the credits.

Can a pass-through entity, such as a partnership

or S-corporation, use the credit?

WOTC is a general business credit for Federal tax purposes and may

be passed through under the rules similar to other business credits.

Is there a time limit for taking WOTC?

WOTC is not a permanent provision of the tax code; rather, it is available for individuals who start work by a specified date. A business

should check with its tax preparer or visit www.doleta.gov to determine that date. Currently, individuals must start work before January

1, 2004.
Work Opportunity Tax Credit

24

Can both WOTC and Welfare to Work (WtW)

credits be claimed for the same employee?

If an employer takes the WtW credit, that individual does not qualify

as a member of a WOTC-targeted group. An employer cannot claim

both credits with respect to the same individual in any 1 taxable year.

The WtW credit may be claimed for the second-year wages of a qualifying individual

regardless of whether the employer took WOTC or WtW for the first-year wages.

How does the credit affect the deduction for

salaries and wages?

A business must reduce the deduction for salaries and wages by the

amount of the credit taken.

Are there special procedures for taking the 

tax credit?

The credit is accounted for on IRS Form 5884 and would be part of 

a business’s tax filing. Form 8850 and certification by the SESA are 

not filed with the tax return but should be retained by the business

to substantiate the credit.

Where can a business obtain more information

on this incentive?

A business should consult its tax advisor. IRS Publication 954 and

IRS Forms 5884 and 8850 describe this incentive. For copies call

1–800–829–3676 or visit www.irs.ustreas.gov. Questions about the

certification process should be directed to the SESA.
25

Welfare to Work Tax Credit 

Applicable IRS Tax Forms: Forms 5884, 8850, and 8861

Wage Credit Description Availability

Welfare to Work Two-year credit against Federal Expires for individuals who begin 

(WtW) Credit taxes for businesses that hire work after December 31, 2003. 

long-term family assistance Business does not have to be in an 

recipients. Credits up to $3,500 EZ, EC, or RC to qualify. Cannot

for the first year, and $5,000 be combined with WOTC. State 

for the second year for each Employment Services Agency must

new hire. certify employee is a long-term 

family assistance recipient.

The Welfare to Work (WtW) credit provides businesses with an incentive to hire 

long-term family assistance recipients. Businesses do not have to be located in an

Empowerment Zone (EZ), Enterprise Community (EC), or Renewal Community

(RC) to qualify for this credit. They can claim the credit if they pay or

incur qualified wages (during the first 2 years of employment) to a longterm family assistance recipient who began work after December 1997

but before January 1, 2004. This incentive applies only to new hires.

Target Audience 

■ Businesses with large hiring needs.

■ Businesses expanding that will be hiring new employees.

■ Businesses with relatively high turnover that often need new

employees.

■ Businesses looking to reduce tax liability.

Incentive Not Relevant to 

■ Startup businesses that may not have large tax liabilities.

■ Nonprofit organizations.
26

Welfare to Work Tax Credit

Additional Resources 

■ Accountants and lawyers preparing business tax returns.

■ Local bar associations or accountant groups to identify accountants or lawyers to

field questions.

■ The State Employment Services Agency (SESA) assigned to handle Welfare to Work

certifications (may be at State or local level). SESA staff should be included in informational meetings held for employees and EZ, EC, and RC residents as well as in

job-training programs. The SESA is also likely to have materials prepared on the

incentives.

■ Local schools, vocational schools, junior or community colleges, 4-year colleges, and

job-training programs for members of families who have been long-term recipients of

family assistance (Aid to Families with Dependent Children (AFDC) or Temporary

Aid for Needy Families (TANF) payments) participating in their programs. The

training programs should be linked to the SESA or other employment agencies and

job banks.

■ Job banks with established relationships with the SESA so that long-term welfare

recipients can have conditional certification as qualifying for Welfare to Work.

■ Instructions for IRS Forms 5884, 8850, and 8861. For copies call 1–800–829–3676

or visit www.irs.ustreas.gov.

Questions & Answers on Welfare to Work 

Tax Credit 

Are there any incentives for hiring individuals

who have received family assistance payments?

Yes. The tax code gives employers a Welfare to Work (WtW) Credit

against Federal taxes for hiring members of families who have been

long-term recipients of family assistance (AFDC or TANF payments),

or who have ceased to qualify for such assistance because of time limitations imposed by

Federal or State laws.
27

Welfare to Work Tax Credit

Can a business use this credit for current 

employees?

No. WtW is an incentive to hire individuals, and the credit is calculated against wages paid only during the first and second years an

employee works for an employer. To take advantage of the credit, a

business must obtain information from a prospective employee prior to offering him

or her a job.

What paperwork is involved?

A business must have the prospective employee fill out IRS Form

8850 prior to making a job offer. The employer also signs that form.

In some cases, the prospective employee may bring a precertification

form to the interview. Form 8850 must be forwarded to the SESA

within 21 days of the date the employee starts work. WtW may be

taken only for employees who have been certified by the SESA as qualifying for the

incentive.

How does a business document that a

prospective employee is qualified?

The SESA will verify that an employee is eligible based on information

from Form 8850.

What if an employee leaves during the first year

of employment?

The credit is available for any person who works at least 400 hours or

180 days for a business. If the minimum is not met, the credit may not

be taken with respect to that employee.
28

Welfare to Work Tax Credit

What if the employee works part-time?

The credit is available for part-time and full-time employees. The

credit is available once the minimum 400-hour/180-day test is met.

What is the definition of qualified wages?

Qualified wages are generally wages subject to the Federal Unemployment Tax Act. The credit is calculated against a maximum of

$10,000 per year in first- and second-year wages. A business may

pay the employee more than $10,000 in either year, but the maximum

for purposes of calculating the credit is $10,000. The instructions for

IRS Form 5884 provide additional specific information on qualified wages. Wages for

this purpose include employer-provided health and accident insurance, educational

assistance, and dependent care assistance.

Is there a limit on the number of employees

for which a business can take the credit?

An employer can take the maximum $8,500 credit over 2 years

(35 percent times $10,000 for the first year plus 50 percent times

$10,000 for the second year) for as many new hires as qualify. 

Table 3. Welfare to Work Tax Credits for Long-Term

Family Assistance Recipients 

Years Employed Maximum Rate Qualified Wages Maximum Credit

1 35% $10,000 $3,500

2 50% $10,000 $5,000

Are there special procedures for taking the

tax credit?

The credit is accounted for on IRS Form 8861 and would be part of a

business’s tax filing. Form 8850 and certification by the SESA are not

filed with the tax return but should be retained by the business to 

substantiate the credit.
29

Welfare to Work Tax Credit

Is there a time limit for taking WtW?

WtW is not a permanent provision of the tax code; rather, it is available for individuals who start work by a specified date. A business

should check with its tax preparer or visit www.doleta.gov to 

determine that date. Currently, individuals must start work before

January 1, 2004.

Can both Work Opportunity Tax Credit (WOTC)

and WtW credits be claimed for the same

employee?

If an employer takes the WtW credit, that individual does not qualify

as a member of a WOTC-targeted group. An employer cannot claim

both credits with respect to the same individual in any 1 taxable year. The WtW credit

may be claimed for the second-year wages of a qualifying individual regardless of

whether the employer took WOTC or WtW for the first-year wages.

How does the credit affect the deduction for

salaries and wages?

A business must reduce the deduction for salaries and wages by the

amount of the credit taken.

Where can a business obtain more information

on this incentive?

A business should consult its tax advisor. IRS Publication 954 and

IRS Forms 8861 and 8850 describe this incentive. For copies call

1–800–829–3676 or visit www.irs.ustreas.gov. Questions about the

certification process should be directed to the SESA.
31

Indian Employment Tax Credit 

Applicable IRS Tax Form: Form 8845

Wage Credit Description Availability

Indian Employment Credit against Federal taxes A business does not have to be 

Tax Credit calculated on wages (including located in an EZ, EC, or RC to 

employee health insurance costs) qualify for this credit. The majority

up to $20,000 for each qualified of the services performed by the 

employee who is an enrolled employee must be on an Indian

member of an Indian tribe (or reservation. The credit does not

spouse) who lives on or near an apply for taxable years beginning

Indian reservation. Available for after December 31, 2003.

existing employees and new hires.

The Indian Employment Tax Credit provides businesses with an incentive

to hire and retain individuals who are enrolled members of an Indian tribe

(or the spouse of an enrolled member) who live on or near an Indian

reservation. The majority of the services performed by the employee must

take place on the Indian reservation. The business does not have to be

located in an Empowerment Zone (EZ), Enterprise Community (EC), or

Renewal Community (RC) to qualify for this credit. The credit is calculated on wages (including employee health insurance costs) of up to $20,000

per employee.

Target Audience 

■ Businesses new to an Indian reservation that will have substantial hiring needs.

■ Businesses expanding within an Indian reservation that will be hiring new employees.

■ Businesses with operations on an Indian reservation that have relatively high

turnover and often need new employees.

■ Businesses looking to reduce tax liability.

Incentive Not Relevant to 

■ Businesses that do not have employees who perform services on an Indian reservation.

■ Startup businesses that may not have large tax liabilities.

■ Nonprofit organizations.
32

Indian Employment Tax Credit

■ Businesses that pay a qualified employee more than the maximum wage

($30,000 in 1993, to be adjusted by cost of living).

Additional Resources 

■ Accountants and lawyers preparing business tax returns.

■ Local bar associations or accountant groups to identify accountants or lawyers to

field questions.

■ Local schools, vocational schools, junior or community colleges, 4-year colleges, and

job-training programs that may have Indian reservation residents participating in

their programs.

■ Job banks with established relationships with Indian tribal members.

■ Instructions for IRS Form 8845. For copies call 1–800–829–3676 or visit

www.irs.ustreas.gov.

Questions & Answers on the Indian Employment

Tax Credit 

Are there any incentives to increase employment

of members of Indian tribes?

Yes. The tax code gives employers a credit against Federal taxes for

employees that are enrolled members of an Indian tribe, or the spouse

of an enrolled member. The employee must perform substantially all

of its services for the employer on an Indian reservation and must live

on or near that reservation.

Can a business use this credit for current

employees?

Yes. The credit is an incentive for both hiring and retaining employees

and may be taken so long as the enrolled member works on the Indian

reservation and lives on or near the reservation.
33

Indian Employment Tax Credit

What is the amount of credit?

The credit is calculated as a percentage of increases in wages. The

credit is 20 percent of the excess of the current year wages (including

certain employee health insurance costs) for all qualifying employees

over the sum of the corresponding amounts paid or incurred by an

employer during calendar year 1993 for qualifying employees. If no

qualified employees worked for a business in 1993, the 20-percent credit would be

applied to the current year wages.

Is there any cap on the credit?

The aggregate amount of wages (including health insurance) taken

into account for any employee cannot exceed $20,000.

What if an employee is paid more than $20,000

in a year?

An employee’s wages can exceed $20,000, but the credit cannot be

taken with respect to an employee that a business pays more than

$30,000 (a 1993 figure adjusted for cost of living) during a taxable

year, or at a rate that, if applied for the entire year, would cause an employer to pay an

employee more than $30,000.

What is the definition of qualified wages?

Qualified wages are generally wages subject to the Federal Unemployment Tax Act. Wages for the purpose of this credit also include

any qualified health insurance costs a business pays or incurs on

behalf of an employee. Costs for health insurance under a salary

reduction plan do not count.
34

Indian Employment Tax Credit

Is there a minimum time the employee must

work for a business before the credit can be

taken?

Generally, if you terminate a qualified employee less than 1 year after

the date of initial employment, you cannot claim a credit for that

employee for the tax year the employment is terminated. Also, you may have to recapture

credits allowed in earlier years. These rules do not apply in the following situations:

■ The employee voluntarily quits.

■ The employee is terminated because of misconduct.

■ The employee becomes disabled. However, if the disability ends before the end of the

first year of employment, a business must offer reemployment to its former employee.

How does an employer determine if an employee

is an enrolled member of an Indian tribe?

Indian tribe means any Indian tribe, band, nation, pueblo, or other

organized group or community, including any Alaska Native village or

regional or village corporation, as defined in, or established under, the

Alaska Native Claims Settlement Act, that is recognized as eligible for the special programs and services provided by the United States to Indians because of their status as

Indians. The list of federally recognized Indian tribes is published annually in the Federal

Register. (See, for example, the Federal Register dated March 13, 2000 (65 FR 13298)).

What if the Federal tax liability of the business is

less than the total credit amount?

The Indian Employment Tax Credit is one of several business credits

and generally is subject to the same rules as other business tax credits.

As with other business tax credits, unused Indian Employment Tax

Credits can be carried forward for up to 20 years and carried back 1 year.
35

Indian Employment Tax Credit

Can a nonprofit organization benefit from

the credit?

Tax-exempt organizations, other than certain cooperatives, are 

ineligible for the credit.

Can a pass-through entity, such as a partnership

or S-corporation, use the credit?

The Indian Employment Tax Credit is a general business tax credit 

and may be passed through under the rules similar to other business

credits. 

Can gambling establishments located within 

an Indian reservation use the credit?

The credit is not available for any individual who performs services

involving the conduct of Class I, II, or III gaming as defined in section

4 of the Indian Gaming Regulatory Act and any individual performing

any services in a building housing such gaming activity.

Are there other categories of employees who

would not qualify for the credit?

The credit is not available for family members of the employer, including sons, daughters, parents, stepchildren, stepmothers, stepfathers, 

in-laws, and other persons treated as dependents under the tax code.

Similar exclusions apply to 5-percent owners of the business and majority shareholders

or partners of the employer and any family members of majority shareholders or partners.
36

Indian Employment Tax Credit

Can the credit be used against Federal

Alternative Minimum Tax (AMT) liability?

The credit may not be used to reduce AMT tax liability.

Can both the Work Opportunity Tax Credit

(WOTC) and the Indian Employment Tax 

Credit be taken for an employee who 

qualifies for both credits?

Any portion of wages used to determine the WOTC does not 

qualify for the Indian Employment Tax Credit. An employer must choose between 

the two credits.

How does the credit affect the deduction for

salaries and wages?

A business must reduce the deduction for salaries and wages and

health insurance costs by the amount of the credit taken.

Is there a time limit on the credit?

The Indian Employment Tax Credit will expire for taxable years beginning after December 31, 2002. A business should check with its tax

advisor to see if the expiration date is extended.

How can a business get more information on

this credit?

The credit is taken on IRS Form 8845 and the instructions to this form

provide additional information. For copies call 1–800–829–3676 or

visit www.irs.ustreas.gov. A business should also check with its tax

advisor with respect to the specific details.
Increased Section

179 Deduction

37

Applicable IRS Tax Form: Form 4562

Deduction Description Availability

Increased Section Allows businesses to claim Can be used only in EZs and RCs. 

179 Deduction increased Section 179 deduction Cannot be used in developable

(up to $20,000 in additional sites until after December 31,

expensing increasing to $35,000 2001. Cannot be used in ECs.

for property acquired after December 31, 2001) if the business

qualifies as an Enterprise Zone

Business or Renewal Community

Business. Can be claimed on

certain depreciable property such 

as equipment and machinery.

Section 179 of the Internal Revenue Code allows businesses to choose to deduct all

or part of the cost of certain qualifying property in the year they place it in service.

Businesses can do this instead of recovering the cost by taking depreciation deductions

over a specified recovery period. There are limits, however, on the amount businesses

can deduct in a tax year. Businesses may be able to claim an increased

Section 179 deduction of as much as $20,000 (increasing to $35,000

after December 31, 2001) if they qualify as Enterprise Zone Businesses or Renewal Community Businesses. A business cannot claim

this increased deduction, however, if it operates in an Enterprise

Community (EC). 

Target Audience 

■ Businesses with relatively small (less than $200,000) equipment

needs in any taxable year, such as labor-intensive businesses with

computer costs.

■ Existing businesses that need to update equipment but are not otherwise purchasing

equipment.

■ Businesses moving into an Empowerment Zone (EZ) or Renewal Community (RC)

from another location that own the majority of their equipment but have additional

new equipment needs. (Note: see appendix A, Questions & Answers on Enterprise

Zone Businesses and Renewal Community Businesses.)
38

Increased Section 179 Deduction

Incentive Not Relevant to 

■ Businesses in ECs, or in developable site portions of Round II EZs, until after

January 1, 2002.

■ Businesses that cannot meet the definition of an Enterprise Zone Business or

Renewal Community Business (see appendix A).

■ Consolidated companies with large equipment needs within the entire consolidated group.

■ Equipment that will be used outside of an EZ or RC (such as delivery equipment).

■ Companies with large or expensive equipment needs on yearly basis.

■ Startup businesses that expect tax losses or other normal business expenses to

equal income.

■ Businesses with equipment that has a short economic life.

Additional Resources 

■ Accountants and lawyers preparing business tax returns.

■ Local bar associations or accountant groups to identify accountants or lawyers to

field questions.

■ Instructions for IRS Form 4562. For copies call 1–800–829–3676 or visit

www.irs.ustreas.gov.

Questions & Answers on Increased Section 

179 Deduction 

What assistance is available to businesses located

in an EZ or RC for equipment purchases?

The tax code allows an Enterprise Zone Business or Renewal Community Business to take an additional expense deduction of up to

$20,000 per year (increasing to $35,000 after December 31, 2001) on

purchases of tangible personal property (equipment) for use in an EZ or RC, respectively.
39

Increased Section 179 Deduction

What is the benefit of additional expensing?

Expensing permits a business to take a deduction for the full cost of

equipment in the year it is purchased. In addition, this writeoff of

costs means that a business does not have to set up a tax depreciation

schedule and deduct the expense over time. Expensing is particularly

helpful for equipment with a long recovery period.

Are some businesses ineligible for this incentive?

Certain business activities do not qualify, such as residential rental

activity; commercial real estate, unless at least 50 percent of the 

gross rental income is from Enterprise Zone Businesses or Renewal

Community Businesses; rental of personal property, such as car rental

agencies, unless at least 50 percent of the rentals are to Enterprise Zone Businesses or

Renewal Community Businesses, or to EZ or RC residents; businesses that predominantly

hold or develop intangibles for sale or license; country clubs; liquor stores; golf courses;

racetracks; or gambling facilities.

Is expensing available in the Round II 

developable sites?

Expensing is not available for property located in a Round II 

developable site until after December 31, 2001.

What type of property qualifies?

The additional expensing allowance is available only for a Qualified

Zone Property (QZP) or Qualified Renewal Property (QRP), defined as

the following:

■ Eighty-five percent of the use of the property must be in the

active conduct of an Enterprise Zone Business or Renewal Community Business 

by a taxpayer in an EZ or RC.

■ The taxpayer acquired the property by purchase after the date of EZ or RC 

designation.

■ Original use of the property in an EZ or RC commences with the taxpayer (that 

is, the taxpayer is the first person to use the property inside an EZ or RC), or the
40

Increased Section 179 Deduction

taxpayer meets the substantial renovation rule. Property is substantially renovated if,

during any 24-month period beginning after EZ or RC designation, there are additions to the basis of the property equal to either 100 percent of the adjusted basis 

of the property or $5,000, whichever is greater.

How do the expensing phase-out limits work?

The general tax rule is that for each $1 of Section 179 property greater

than $200,000 placed in service in a tax year, the expensing allowance

is reduced by $1. However, for each $1 of QZP or QRP greater than

$200,000 in a tax year, the expensed amount is reduced by 50¢.

How does a business file for this incentive?

The additional expensing amount is recorded on IRS Form 4562. This

form has a special line, along with instructions, for QZP and QRP. A

business should consult with its tax advisor.
Commercial Revitalization

Deduction 

41

Applicable IRS Tax Form: No applicable IRS tax form identified

at time of publication; see IRS Publication 946

Deduction Description Availability

Commercial Revitalization Deduction of either one-half of Available in Renewal Communities

Deduction qualified revitalization expendi- (RCs) for buildings placed in service

tures (QREs) in the first year a after December 31, 2001, and

building is placed in service or before January 1, 2010. State 

all of QREs on ratable basis over may allocate up to $12 million in

10 years if QREs have been deductions (not more than $10

allocated to revitalization of a million per project) for each year

commercial building located 2002–2009 for each RC in the

in an RC. State. Business does not have to

be a Renewal Community Business.

Businesses that construct or rehabilitate commercial property in Renewal Communities 

(RCs) can deduct a portion of the costs of acquisition and rehabilitation over a shorter

period of time than permitted under standard depreciation rules. A business can elect a

deduction of one-half of “qualifying revitalization expenditures” (QRE) up to $10 million

for any one project in the year the building is placed in service or can deduct all QRE pro

rata over 10 years. The project must receive an allocation from the State (up to $12 million allocated for each RC in the State from 2002 through 2009).

Target Audience 

■ Developers and businesses specializing in redeveloping abandoned

and underutilized buildings in RCs.

■ Developers and businesses undertaking new building construction

projects in RCs.

■ Businesses located in RCs that cannot meet the Renewal Community

Business definition (that is, their employees perform services outside

the RC, they do not meet the 35-percent RC resident employee

requirement, or too much of their gross income is earned outside

the RC).
42

Commercial Revitalization Deduction

Incentive Not Relevant to 

■ Developers of residential rental projects.

■ Building acquisitions that do not involve substantial renovation expenditures.

■ Land speculation purchases.

■ Startup or similar businesses with insufficient income to take advantage of

accelerated depreciation.

Additional Resources 

■ Accountants and lawyers preparing business tax returns.

■ Local bar associations or accountant groups to identify accountants or lawyers to

field questions.

■ Real estate developers familiar with local property markets.

■ Local chambers of commerce or business associations involved in economic 

development.

■ Tax lawyers and accountants associated with developers and current or prospective

business owners in RCs.

■ IRS Publication 946. For copies call 1–800–829–3676 or visit www.irs.ustreas.gov.

Questions & Answers on Commercial 

Revitalization Deduction 

Are there any incentives for commercial building

investment in an RC?

In 2000, Congress created a new “commercial revitalization deduction” (CR Deduction) that is intended to increase economic development in RCs. The incentive is a deduction from income

before calculating Federal income tax liability, and provides a way to deduct costs

on an accelerated basis. 
43

Commercial Revitalization Deduction

Are there limits on the deduction?

The amount of the deduction is subject to a State limitation of up 

to $12 million of “commercial revitalization expenditures” (CREs) 

for each RC located within a State for each calendar year after 2001

and before 2010. In addition, the CREs for a particular building 

cannot exceed the actual qualifying costs and there is an overall limit per building

of $10 million.

Is the CR Deduction available only for new

construction?

The deduction is calculated on the basis of qualifying CREs. CREs

include the depreciable costs of a new building or the costs associated

with an existing building that is substantially rehabilitated. Substantial

rehabilitation means that, within a 24-month period, rehabilitation expenditures exceed

the greater of the adjusted basis of the building (and its structural components) or $5,000.

For purposes of determining whether a building has been substantially rehabilitated,

rehabilitation expenditures do not include enlarging a building. If the substantial rehabilitation test is met (without taking into account the costs of expansion), the cost of

expanding the building could qualify as a CRE. 

To what extent do building acquisition costs

qualify for the CR Deduction?

A taxpayer can include the cost of the building acquisition in taking

a CR Deduction, but only to the extent that the acquisition cost does

not exceed 30 percent of the aggregate qualifying CREs (determined

without regard to the acquisition cost). For example, if the building cost $500,000 to

acquire and renovations eligible for CREs were $1 million, up to $300,000 of the acquisition cost could qualify as a CRE.

Could an investor obtain special tax advantages

for land speculation in an RC?

The CR Deduction is permitted only for the cost of acquiring a building and rehabilitating it, not for land costs. Acquisition of land for

speculation would not qualify.
44

Commercial Revitalization Deduction

Is the CR Deduction available for residential

rental property?

The building must be used for commercial purposes, so a residential

rental property would not qualify. However, if a developer were to 

provide commercial facilities at or near the residential rental property,

these expenditures might be eligible, assuming the commercial development is located 

in an RC.

Who will make the allocation of the CR

Deduction?

This incentive requires that each State identify an entity to act as the

community revitalization agency (CRA). The CRA will develop the

procedures for allocating the $12 million in CR Deductions permitted

for each RC. 

How can a developer determine if a particular

project might be competitive for obtaining the

CR Deduction?

The CRA must develop a plan for allocating the CR Deduction and

must submit the plan to a public hearing. The plan must then be

approved by the governmental unit of which the RC is a part. The Federal statute provides guidelines for the qualified allocation plan, requiring the CRA to take into account

full-time jobs created by the project, active community involvement and contribution to

the implementation of the Strategic Plan of the RC. The developer of a potential project

should obtain a copy of the plan to determine the priorities of the CRA where the project

might be located.

What is the accelerated period for the CR

Deduction?

The taxpayer may elect one of two permitted accelerated deduction

methods. A taxpayer can elect either to (a) deduct one-half of the

CREs for the taxable year the building is placed in service or (b) 

amortize all the CREs ratably over a 120-month period beginning the month the building

is placed in service. The method selected will depend on a taxpayer’s particular tax 
45

Commercial Revitalization Deduction

situation. This special deduction provision would be in lieu of depreciating the property

over a period up to 39 years.

What if the building was purchased and renovated

prior to RC designation?

The CR Deduction is available only to buildings placed in service after

the RC designation and before January 1, 2010. If the building was

purchased before RC designation, but the renovation was not completed until after RC designation, the renovation expenditures would be treated as a separate

building for purposes of determining when it was placed in service and could qualify for

the CR Deduction on that basis.

What other tax consequences arise from using

the CR Deduction?

No depreciation is allowed for amounts deducted as CR Deduction.

The adjusted basis of the building is reduced by the amount of

the CR Deduction, and the deduction is treated as a depreciation

deduction in applying the depreciation recapture rules. 

Does a CR Deduction affect Alternative

Minimum Tax (AMT) liability?

The CR Deduction is allowed as a deduction in computing a taxpayer’s

AMT income.

Do the passive loss limitation rules apply to the

CR Deduction?

The CR Deduction is treated in the same manner as the Low-Income

Housing Tax Credit in applying the passive loss rules. That means 

that an individual taxpayer can have up to $25,000 of passive activity

deductions (the CR Deduction together with the other deductions and credits not subject

to the passive loss limitation), regardless of the taxpayer’s adjusted gross income. Corporations are not subject to the $25,000 passive loss limitation.
Environmental Cleanup Cost

Deduction (Brownfields)

47

Applicable IRS Tax Form: No applicable IRS Tax Forms. For more

information about the Environmental Cleanup Cost Deduction,

see IRS Publication 954.

Deduction Description Availability

Environmental Cleanup Businesses can elect to deduct Property is not required to be 

Cost Deduction qualified cleanup costs of haz- located in EZ, EC, or RC. Need 

(Brownfields) ardous substances in certain certification of State environmental

areas (brownfields) in the tax agency. Includes costs paid or

year the business pays or incurs incurred prior to January 1, 2004.

the costs.

This deduction provides businesses with an incentive to clean up certain sites that are

contaminated with hazardous substances. Businesses can choose to deduct qualified 

environmental cleanup costs in the tax year they pay or incur the cost. A business can do

this instead of adding the cost to the basis of its property (and, if the property is depreciable, recovering the cost by taking depreciation deductions over a specified recovery

period). Businesses do not have to be located in an Empowerment Zone (EZ), Enterprise

Community (EC), or Renewal Community (RC) to qualify for this deduction. This special tax treatment is generally available for qualified environmental cleanup costs that

businesses pay or incur after August 5, 1997, and before January 1, 2004.

Target Audience 

■ Prospective purchasers of contaminated property willing to pay the

cost of cleanup rather than having the seller pay.

■ Businesses with sufficient income to be able to use the full deduction of cleanup costs in the year expenditures are paid or incurred.

■ Current owners of contaminated property who wish to expand or

improve property.

■ Businesses interested in developable sites.
48

Environmental Cleanup Cost Deduction (Brownfields)

Incentive Not Relevant to 

■ Startup businesses that may not generate enough income initially to deduct

remediation expenses.

■ Sites listed on the National Priorities List under the Comprehensive Environmental

Response, Compensation, and Liability Act (CERCLA) of 1980 (Superfund sites).

■ Sites with cleanup that does not involve hazardous substances.

■ Businesses with cleanup costs that are not capitalized costs.

Additional Resources 

■ Accountants and lawyers preparing business tax returns.

■ Local bar associations or accountant groups to identify accountants or lawyers to

field questions.

■ State environmental agency staff who will be involved in certification procedures.

■ Local environmental agency staff who maintain a list of brownfield sites in the 

jurisdiction.

■ Real estate developers familiar with local property markets.

■ Local tax lawyers and accountants who can serve as speakers on the topic at informational meetings or whose clients can take advantage of the incentive. For copies call

1–800–829–3676 or visit www.irs.ustreas.gov.

Questions & Answers on Environmental Cleanup

Cost Deduction 

Is there any tax incentive for cleaning up contaminated industrial sites in an EZ, EC, or RC?

The tax code allows a business to elect to deduct qualified environmental cleanup costs in the tax year the business pays or incurs the

cost. The deduction enhances the bottom line if a business can take

a deduction for the full amount when paid, rather than recovering the amount over time 

in the form of depreciation deductions.
49

Environmental Cleanup Cost Deduction (Brownfields)

Does the business have to meet any special

requirements, such as being an Enterprise Zone

Business or Renewal Community Business, to

take advantage of this incentive? 

The ability to expense cleanup expenditures depends on the hazardous

substance status of the land and the nature of the expenditures. The business does not

have to be an Enterprise Zone Business or Renewal Community Business to qualify for

this deduction or even be located in an EZ, EC, or RC.

What sites qualify for this incentive?

A site qualifies if it meets all of the following requirements: 

■ It is held for use in a trade or business, for the production of 

income, or as inventory. 

■ There has been a release (or threat of release) of a hazardous 

substance at or on the site.

Does a business need to obtain a designation

from any government official?

The State environmental agency must certify that there has been a

release, or a threat of release, of a hazardous substance or substances.

What is meant by hazardous substances?

The tax code generally uses the same definition of hazardous substances as that used in CERCLA. Some additional limitations apply

to asbestos and similar substances within buildings, certain naturally

occurring substances such as radon, and certain other substances

released into drinking water supplies due to deterioration through ordinary use.
50

Environmental Cleanup Cost Deduction (Brownfields)

What costs qualify for this incentive?

Qualified environmental cleanup costs are generally costs paid or

incurred to abate or control a hazardous substance at the site. The

costs must be expenditures that would otherwise be chargeable to 

capital accounts. The incentive is governed by the normal tax rules

relating to the deduction or capitalization of expenditures. A business should consult

with its tax advisor.

Is there a time limit for deducting these 

expenditures?

This special tax treatment is generally available for qualified environmental cleanup costs paid or incurred after August 5, 1997, and before

January 1, 2004. This period may be extended by Federal tax legislation, so a business should consult with its tax advisor or an accountant to be assured 

that expenditures will qualify.

Are the costs expensed even for purposes of

Alternative Minimum Tax (AMT)?

Expensing of these remediation costs applies for both regular taxes

and AMT tax liability.

What happens if a business later sells the

property?

The deduction may have to be recaptured as ordinary income when

property is sold or the owner otherwise disposes of it.

What forms must a business file for this

incentive?

There are no separate tax forms for this incentive. The qualified 

environmental remediation expenditures are included as Other

Deductions on a business tax return (or Other Expenses if on an

individual tax return) with a notation that these represent a Section 198 Election.
Depreciation of Property 

Used on Indian Reservations

51

Applicable IRS Tax Form: For more information,

see IRS Publication 946, How to Depreciate Property.

Deduction Description Availability

Depreciation of Property Special accelerated depreciation A business does not have to use 

Used on Indian Reservations rules apply to qualified property the property in an EZ, EC, or RC to

used on an Indian reservation. use these special rules, but generCertain public infrastructure used ally the property must be used on

or located off the Indian reser- an Indian reservation. Property

vation also qualifies. must be placed in service after

1993 and before 2004.

Special accelerated depreciation rules apply to qualified property placed in service on

an Indian reservation after 1993 and before 2004. A business does not have to use the

property in an Empowerment Zone (EZ), Enterprise Community (EC), or Renewal

Community (RC) to use these special rules. The property generally must be used on an

Indian reservation, but certain public infrastructure used on and off an Indian reservation

may qualify. (See description under Target Audience.) These rules allow a business to use

shorter recovery periods to calculate a depreciation deduction for the qualified property.

As a result, the annual deduction is larger.

Target Audience 

■ Businesses with real property and equipment used in the active conduct of business,

including rental of real property, on an Indian reservation.

■ Businesses that own infrastructure (for example, power lines, water

systems, or communication facilities) used in conjunction with

business on an Indian reservation (even if a portion is not located

on the reservation) if the property is available to the general public.

Incentive Not Relevant to 

■ Property placed in service before 1993 and after December 31,

2003.

■ Equipment that will be used outside of an Indian reservation (such as

delivery equipment).

■ Business property used in certain gaming activities.
52

Depreciation of Property Used on Indian Reservations

Additional Resources 

■ Accountants and lawyers preparing tax returns for businesses.

■ Bar associations or accountant groups in areas that include an Indian reservation,

which can identify accountants or lawyers who can answer questions.

■ Instructions for IRS Form 4562 and IRS Publication 946. For copies call

1–800–829–3676 or visit www.irs.ustreas.gov.

Questions & Answers on Depreciation of Property

Used on Indian Reservations 

Are there any special depreciation provisions for

property used by a business within an Indian

reservation?

The tax code provides for an accelerated depreciation schedule for

property used predominantly in the active conduct of business on an

Indian reservation. Real property rented to others on an Indian reservation is also eligible

for an accelerated depreciation schedule.

Are there any categories of property that would

not qualify?

The following property is not qualified property:

■ Property used or located outside an Indian reservation on

a regular basis.

■ Property acquired directly or indirectly from certain related persons.

■ Property placed in service for purposes of conducting or housing certain

gaming activities.
53

Depreciation of Property Used on Indian Reservations

What about infrastructure property used both

on and off an Indian reservation?

Infrastructure property includes, but is not limited to, roads, power

lines, water systems, railroad spurs, and communications facilities.

A business can take accelerated depreciation on property used off the

Indian reservation if it is used to connect “qualified infrastructure” within the reservation

and it meets all of the following requirements:

■ It meets the requirements listed in the previous answer under qualified property

(except that it can be outside the reservation).

■ It benefits the tribal infrastructure.

■ It is available to the general public.

■ It was placed in service in connection with the active conduct of a trade or business

within a reservation.

What is the definition of Indian reservation?

An Indian reservation is defined in section 3(d) of the Indian

Financing Act of 1974 or section 4(10) of the Indian Child Welfare

Act of 1978.

How does the accelerated depreciation affect

Federal Alternative Minimum Tax (AMT)?

The shortened period also applies for purposes of determining AMT 

so that this depreciation is not a tax preference.

Is there a time limit for qualifying for accelerated

depreciation?

This depreciation incentive is available only for property placed in

service after calendar year 1993 and before January 1, 2004.
54

Depreciation of Property Used on Indian Reservations

How does a business obtain more information

on this tax incentive?

IRS Publication 946 and the instructions to IRS Form 4562 contain

additional information. For copies, call 1–800–829–3676 or visit

www.irs.ustreas.gov.
Enterprise Zone

Facility Bonds 

55

Applicable IRS Tax Form: No applicable IRS Tax Forms. For more

information about the Enterprise Zone Facility Bonds, see IRS

Publication 954.

Financing Description Availability

Enterprise Zone State and local governments can $3 million per borrower limit in any

Facility Bonds issue Enterprise Zone Facility Round I EZ for bonds issued prior

Bonds (a type of tax-exempt to January 1, 2002, or in any EC, 

bond) to make loans at lower with $20 million per borrower

interest rates to Enterprise Zone nationwide limit; must have State

Businesses to finance Qualified volume cap allocated. $130 

Zone Property. million or $230 million available in

urban Round II EZs ($60 million in

rural Round II EZs) over the EZ 

designation period and for all EZs

including developable sites for

bonds issued after December 31,

2001 (no per-borrower limit and

bonds are not subject to State 

volume cap), for EZ- or EC-based

commercial, retail, or industrial

property; 35 percent of employees

must be EZ or EC residents.

State or local governments can issue Enterprise Zone Facility Bonds (a type of exempt

facility tax-exempt bond) to make loans to an Enterprise Zone Business to finance

Qualified Zone Property. At least 95 percent of the net proceeds from the

bond issue must be used to finance Qualified Zone Property principally

used by an Enterprise Zone Business, and certain land used for a related

purpose (for example, land where the business and its customer and

employee parking lot is located). Tax-exempt bonds generally have

lower interest rates than conventional financing because the purchaser

of the bonds does not have to pay Federal income tax on the interest

income received from the bonds.

Target Audience 

■ Zone businesses with a capital project of sufficient cost for going to the public bond

market (generally $2 million or more) with a good credit rating or a letter-of-credit

bank. (Note: For Round I Empowerment Zones (EZs) prior to January 1, 2002, and

all Enterprise Communities (ECs), the maximum amount in a Zone is $3 million 
56

Enterprise Zone Facility Bonds

per borrower. It is $15 million per borrower in the District of Columbia’s Enterprise Zone.)

■ Large national businesses setting up branch stores or operations in a Zone.

■ Local banks that may be interested in lower cost capital to lend to qualifying businesses (and may need to meet their Community Reinvestment Act requirements). 

Incentive Not Relevant to 

■ Businesses that cannot meet the definition of an Enterprise Zone Business (see

appendix A) and are not leasing to tenant businesses that meet the definition.

■ Startup businesses with minimal equity.

■ Businesses with employees likely to perform most of their work outside the Zone

(such as delivery services or offsite services).

■ 501(c)(3) tax-exempt organizations (unless the financing would be for an activity

that generates unrelated business income).

■ Businesses with small capital needs.

■ Businesses seeking operating or working capital funds.

■ Closely held businesses unwilling to make public disclosures about finances in

securities marketing documents.

■ Businesses seeking grant monies rather than loans.

Additional Resources 

■ Local issuers of tax-exempt bonds. These may be State or local governments, State or

local industrial or economic development boards or authorities, or State bond banks.

Issuers will have established procedures for applications, evaluation of projects, and

fee arrangements.

■ Bond counsel to issuers. Many issuers have attorneys under contract who specialize

in tax-exempt bonds or who may also be able to refer businesses to firms with

experience in this type of legal work.

■ Investment banking firms and local bankers. These firms make their money by

marketing tax-exempt bonds. Many regional investment banking firms specialize
57

Enterprise Zone Facility Bonds

in placing or marketing smaller principal amounts of tax-exempt bonds or have

pooled borrowings together for larger issuance amounts.

■ Local developers and real estate agents. Both developers and real estate agents are

aware of capital projects and building or site acquisitions. The availability of taxexempt financing in the EZ or EC may help them sell or develop property.

■ IRS Publication 954. For copies call 1–800–829–3676 or visit www.irs.ustreas.gov.

A Tax-Exempt Bond Transaction 

■ All Enterprise Zone Businesses using tax-exempt bonds may be required to pay an

administrative fee to the respective State and local governments or industrial development authorities authorized by the Federal tax code to confer tax-exempt status 

on the bond issuance.

■ A State or local bond issuer sells bonds (debt) through an underwriter to investors

in the market.

■ The issuer lends the bond proceeds to an Enterprise Zone Business.

■ The Enterprise Zone Business makes loan payments to the issuer.

■ The issuer passes the payments through to the investor.

Technical Steps, Documents, and Players 

■ A private business that meets the definition of an Enterprise Zone Business makes

an application to its State or local government issuer.

■ The business obtains an Inducement Resolution or Intent Declaration from the 

bond issuer.

■ The issuer reviews and approves the financing after a published notice and a 

public hearing.

■ The issuer enters into a bond purchase agreement with an underwriter or placement

agent (investment banking firm).

■ The investment banker, Enterprise Zone Business, and issuer prepare securities offering documentation for the bonds, describing the terms of the bonds, the project to 

be financed, and the security for repayment.

■ Legal counsel specializing in Federal tax laws related to municipal bonds reviews the

transaction and delivers an opinion that interest income bond purchasers receive will
58

Enterprise Zone Facility Bonds

be exempt from Federal income tax (and also usually exempt from State and local

income taxes in the issuer’s State).

■ The investor is willing to charge a lower interest rate for the issuer’s debt because the

interest income is exempt. (The investor gets a higher return with exempt income.)

■ The underwriter sells the issuer’s bonds in the public debt market based on the credit

of the Enterprise Zone Business (or a letter-of-credit bank).

■ The issuer enters into a loan agreement with the Enterprise Zone Business to lend

the money from the sale of the bonds to the Enterprise Zone Business.

■ The issuer passes on a lower rate on the issuer’s bonds to the Enterprise Zone

Business, but the issuer may charge the Enterprise Zone Business an upfront or

continuing fee for its debt program.

■ The loan agreement will have financial and tax covenants that the Enterprise Zone

Business must comply with throughout the term of the bonds. Financial covenants

will be based on what the underwriter believes is needed to sell the bonds to 

the public.

■ The issuer enters into a trust indenture with a trustee bank to carry out the issuer’s

obligations to the investors.

■ The Enterprise Zone Business requisitions money from the trustee bank to pay the

costs of the project.

■ The Enterprise Zone Business makes loan payments to the trustee, who passes the

payments on to investors.

Some Suggestions for Making a Bond

Program Work 

■ Determine who will be the issuer of the bonds (a State or local government unit or

agency) and involve the issuer’s staff and bond counsel in marketing this program.

They will review the transaction and determine whether the project qualifies for

financing under the tax laws.

■ Do not assume that all Enterprise Zone Businesses will be small startup businesses.

Look to market the bond program to national chain stores or businesses with strong

credit ratings that are interested in low-cost financing.

■ Involve the financial institutions that participated in the Strategic Plan in the bond

program. They can participate by:
59

Enterprise Zone Facility Bonds

— Buying the bonds for their own portfolios.

— Placing the bonds with trust customers (particularly in States where the trust 

customer may benefit from having interest on the bonds exempt from State and

local taxes).

— Providing a letter of credit to secure payment of the bonds. The bank analyzes 

the credit risk and charges a fee for the letter of credit. The bonds are more 

marketable because they are based on the bank’s credit.

— Participating in a “loans to lenders” program. The issuer loans the money to the

bank, giving the bank a source of lower cost funds. The bank then loans this

money to Enterprise Zone Businesses. The bank must repay the bonds, but it

expects to use payments from its EZ loans to make those bond payments.

■ Identify an investment banking firm that has experience with tax-exempt bonds.

Prior to 1986 tax law changes, investment banks successfully marketed similar types

of bonds called industrial development bonds, or IDBs. They can now apply this

experience to these bond offerings.

■ Place the bonds with local businesses that want to invest in their community. They

will receive tax-exempt income and be closer to evaluating the potential for the success of the Enterprise Zone Business. Many cities have successfully sold so-called

mini bonds to their residents for various municipal projects.

■ Pool or do a composite issue of bonds for several EZs or ECs (or for several businesses

within EZs or ECs) in one offering. This permits the smaller borrowers to share costs

associated with offering the bonds. Timing the projects so that they are all offered at

once can be difficult, but a bank may be able to provide taxable bridge financing

until a sufficient number of projects are ready to proceed.

Questions & Answers on Enterprise Zone

Facility Bonds 

What is tax-exempt financing?

A tax-exempt bond is a debt instrument issued by a State or local 

government that is sold in the public market or placed with investors

by an investment banking firm. Bond purchasers do not have to pay

Federal income tax on the interest income received from a tax-exempt

bond if certain tax rules are met. Interest on the bond may also be exempt from State and

local income taxes. 
60

Enterprise Zone Facility Bonds

Who can issue a tax-exempt Enterprise Zone

Facility Bond?

Only a State or local government unit, or an economic or industrial

development authority authorized by a State or local government unit

to issue bonds, can issue a tax-exempt Enterprise Zone Facility Bond.

A borrower cannot issue debt on its own and qualify it as tax-exempt debt.

Who purchases tax-exempt bonds?

At present, the majority of tax-exempt bonds are purchased by individuals, but corporations, mutual funds, and insurance companies also

purchase a large portion of tax-exempt bonds. Technically, the investment banking firm serving as the underwriter of the bonds will purchase the bonds from the State or local government issuer, then re-offer the bonds for

sale to the public. A bank or investment banking firm may also place the bonds with a

small group of purchasers.

How will businesses in the Zone benefit from

tax-exempt financing?

The primary benefit of tax-exempt financing is a lower interest rate

than the rate on a conventional loan. Bond purchasers are willing to

take a lower interest rate because they will not have to pay tax on the

interest income that they receive from the bond. The government issuer loans the proceeds of the bonds to a business, passing on the lower interest rate. Lower interest rates

mean a better cash flow for Enterprise Zone Businesses. Another benefit is the time period of the debt. Tax-exempt bonds may be issued for 120 percent of the average useful 

life of the capital investment. It is also possible—depending on many financial circumstances—to issue tax-exempt bonds to finance 100 percent, or nearly 100 percent, of the

transaction. In addition, up to 2 percent of the issuance can be used to pay for the costs

of issuance, thus allowing the borrower to finance those expenses instead of paying them

out of pocket.
61

Enterprise Zone Facility Bonds

Can real estate developers use this bond

financing?

Real estate developers would have to meet the qualified business 

definition. At least 50 percent of the developer’s gross rental income

must be derived from Enterprise Zone Businesses. If the developer

then meets all of the income and property locational tests of the Enterprise Zone

Business definition, tax-exempt financing could be used to finance the whole project.

If the developer, as owner of the project, does not meet the Enterprise Zone Business

test but does have 50 percent of the gross rentals from Enterprise Zone Businesses, 

regulations permit the developer to finance the portion of the project allocable to

Enterprise Zone Business tenants.

At what point in the process should a business

contact the government issuer?

Tax-exempt financing typically takes longer to complete than a standard conventional loan. To expedite the process, a business should

contact the government issuer in the very early planning stages. The

issuer will select attorneys (bond counsel) who specialize in tax-exempt bonds to work

with the borrower on understanding the tax, securities, and other rules associated with

the financing. Once the borrowing and repayment details are determined, the bond counsel will give an opinion stating that interest on the bonds is excludable from Federal

income taxes. In addition, a business will need an intent declaration or inducement resolution from the issuer indicating its intent to finance costs with tax-exempt bonds if the

business expects to use tax-exempt bond proceeds to reimburse itself for any costs paid

before tax-exempt bonds are issued.

What types of businesses can take advantage of

bond financing?

Only an Enterprise Zone Business can use this type of tax-exempt

bond financing. In general, a business has to meet several criteria to

demonstrate it is an Enterprise Zone Business. This definition is discussed in appendix A.

These requirements may be met by treating operations of a business within the Zone as

if it were separately incorporated. Certain business activities are not qualified Zone

Business activities, including residential rental activities; commercial real estate rentals,
62

Enterprise Zone Facility Bonds

unless at least 50 percent of the gross rental income is from Enterprise Zone Businesses

meeting the qualifications described above; rental of personal property, such as car

rentals, unless 50 percent of the rental income is from Enterprise Zone Businesses or

Zone residents; businesses that hold or develop intangibles for sale or license; country

clubs; liquor stores; golf courses; racetracks; or gambling facilities. Nonprofit organizations are not automatically precluded merely because the activities carried on by them

are on a not-for-profit basis.

Must a business meet the Enterprise Zone

Business test when the bonds are issued?

A business is allowed a startup period for coming into compliance

with the Enterprise Zone Business test. Generally, a business would

have 2 years from the date the bonds were issued or the date the

financed property is placed in service, whichever is later. A business must make bona

fide efforts to meet the definition by the end of the startup period.

How long must a business meet the Enterprise

Zone Business definition?

A business must meet all the requirements for at least 3 taxable years

(beginning after any startup period) and must meet the requirement

that 35 percent of its employees be Zone residents throughout the

term of the bonds. This 3-year period is called the testing period.

Do the 3 years of the testing period have to be

consecutive?

The testing period is the 3 consecutive taxable years of the business

following the startup period (if any).
63

Enterprise Zone Facility Bonds

What happens if a business ceases to be an

Enterprise Zone Business within the 3-year

testing period or it fails the Zone resident

employee requirement at a later date?

If the failure to meet the tests is corrected within a year of when the

failure is discovered, a business is deemed to have met the rules. If the EZ or EC designation is terminated early or the business goes into bankruptcy, the business is not treated

as failing the tests. The tax laws allow a borrower a reasonable time to cure any noncompliance. If the noncompliance is not cured, the borrower will lose the deduction for its

interest expense on the loan of the bond proceeds from the issuer, and interest on the

bonds received by the purchasers of the bonds may become taxable. If interest becomes

taxable, the borrower may be required to redeem the bonds as soon as possible, pay a

penalty to the Internal Revenue Service, or pay a higher taxable interest rate to the 

purchasers.

What is considered a reasonable time to cure

any noncompliance?

Reasonable time to cure is defined in the tax regulations as up to a

year from the date the failure to comply is discovered. To take advantage of this period, the borrower must annually demonstrate to the

issuer of the bonds that the borrower is monitoring compliance. Presumably, each issuer

will establish its own procedures.

What types of projects can be financed with

Enterprise Zone Facility Bonds?

Bond proceeds can be used only to construct a building; renovate an

existing building or equipment; or acquire land, new equipment, or 

a new building. However, bond proceeds can be used to acquire used

equipment or an existing building if an amount equal to 15 percent of the adjusted basis

of the equipment or building or $5,000, whichever is greater, is spent to recondition or

rehabilitate the equipment or building within a 2-year period.
64

Enterprise Zone Facility Bonds

Can a business use bond proceeds for working

capital purposes?

At least 95 percent of the bond proceeds (including any investment

earnings) must be used to pay costs that are capitalized for Federal tax

purposes. Any amounts available for working capital would be minimal.

Are there any limits on the amount that can be

borrowed on a tax-exempt basis?

For Enterprise Zone Facility Bonds issued by Round I EZs (prior to

January 1, 2002) and ECs, a business entity (including any related persons) can have no more than $3 million ($15 million in the District of

Columbia Enterprise Zone) in Enterprise Zone Facility Bonds outstanding in the Zone.

An entity could have bonds issued in other EZs or ECs around the Nation, but the total

amount outstanding in those EZs and ECs per borrower can be no more than $20 million. In addition, before any bonds can be issued, the State in which the EZ or EC is

located must allocate a portion of the State’s annual private activity bond volume cap in

an amount equal to the amount of the bonds.

Every Round II EZ (and after December 31, 2001, every EZ except the District of

Columbia) has a limit on the total principal amount of tax-exempt Enterprise Zone

Facility bonds that can be issued over the period of designation. For example, rural

EZs may issue $60 million, urban EZs with a population less than 100,000 may issue

$130 million, and urban EZs with a population of 100,000 or more may issue $230

million. Beyond this overall limit, there is no tax law limit on the size of borrowing

for any one borrower. The size of any borrowing will also, of course, be limited by the

business’s ability to repay the loan.

What costs are involved in tax-exempt financing?

Certain costs involved in tax-exempt financing may be higher than

those involved in a conventional loan. A business may need to consider the costs of tax-exempt borrowing compared with interest savings

over the term of the bond. These costs include fees to a bond counsel

who reviews the transaction and delivers an opinion that interest on the bonds is exempt

from Federal income taxes; fees to an underwriter who markets the bond; and fees to a

trustee who disburses bond proceeds and collects loan payments from the business. The

tax laws allow up to 2 percent of the bond proceeds to be used to pay costs of issuance of

the bond. Additional amounts must come from the equity of the business or from taxable
65

Enterprise Zone Facility Bonds

financing. An Enterprise Zone Business using tax-exempt bonds may be required to pay

an administrative fee to the State or local government industrial development authorities

authorized by Federal tax code to confer tax-exempt status on the bond issuance.

What information must a business make

available to the public?

The tax laws require a public notice and hearing regarding the bond

issuance, including the amount to be borrowed, the name of the borrower, and the nature and location of the financed property. Following

the hearing, the bond issue must be approved by an elected executive or the legislative

body of the issuer. Other proceedings of the issuer and documents submitted to the

issuer may be subject to public disclosure requirements. The financial condition of the

borrower will also be included in offering materials made available to prospective purchasers of a bond.

Will tax-exempt financing affect any other tax

rules of a business?

A business will not be able to take advantage of accelerated depreciation for any depreciable property purchased with proceeds of the

bonds. Bond-financed property must be depreciated over the class

life of the property using the straight line method. 

What forms would a business have to file 

with the Internal Revenue Service (IRS) for

tax-exempt financing?

The business would not file any specific forms with the IRS beyond

forms usually filed with a tax return. When bonds are issued, the

issuer files an information return on the bonds with the IRS, and there may be certain

other informational filings. However, all filings will be made by the issuer based on information supplied by the borrower. For example, any investment income earned on bond

proceeds above the yield on the bonds must be paid to the IRS every 5 years, but the

filing itself would be signed by the issuer. If the IRS audits the bond transaction, the

business would likely be called on to submit documentation.
66

Enterprise Zone Facility Bonds

Can nonprofit organizations take advantage

of Enterprise Zone Facility Bonds when they

develop facilities such as shopping centers or

mixed-use residential/commercial centers?

Would the rent generated from these centers

be considered unrelated business income?

Nothing in the Enterprise Zone Facility Bond provisions directly precludes nonprofit

organizations from taking advantage of Enterprise Zone Facility Bonds. However, a nonprofit organization must obtain a determination from the IRS that its activities are within

the exemption categories of the tax laws. A nonprofit organization considering this type

of activity would need to consult its own legal advisor to determine whether conducting

such an activity would be within its exempt purpose, whether the activity would generate unrelated business income in light of that exempt purpose, and whether involvement

in the activity might jeopardize its nonprofit status.
Qualified Zone

Academy Bonds 

67

Applicable IRS Tax Form: Form 8860

Bond Financing Description Availability

Qualified Zone State or local governments can Federal allocation to States annually 

Academy Bonds issue bonds at 0-percent interest from 1998 to 2001. State educacost to them to finance certain tion agency allocates credit to

public school programs with Qualified Zone Academy to finance 

private business partnerships. materials, teacher training, building

Private businesses must contribute renovation, or equipment for promoney, equipment, or services grams that prepare students for

equal to 10 percent of bond pro- jobs or college. Schools must be

ceeds (which may qualify as a located in an EZ or EC, or have

charitable contribution). The 35 percent of students eligible for

Federal government pays interest free or reduced-cost lunch program.

in the form of tax credit to banks,

insurance companies, and certain lending corporations that 

hold QZABs.

Beginning in 1998, State or local governments can issue Qualified Zone Academy Bonds

(QZABs) to raise funds for a Qualified Zone Academy. However, these bonds require that

the Qualified Zone Academy receive a private business contribution (which may be tax

deductible as a charitable contribution). Certain banks, insurance companies, and corporations actively engaged in the business of lending money can receive a tax credit as an

incentive to hold these bonds. 

Target Audience 

■ Banks, insurance companies, or corporations in the business of lending

money that are eligible to receive tax credits (in lieu of receiving interest payments) as holders of the bonds.

■ Local businesses with specific employee skill sets that could be taught

at the secondary school level.

■ Businesses interested in providing mentorship or internship opportunities to secondary school students.

■ School districts seeking to upgrade schools located in Empowerment

Zones (EZs), Enterprise Communities (ECs), or Renewal Communities (RCs).
68

Qualified Zone Academy Bonds

Incentive Not Relevant to 

■ Potential holders (banks or insurance companies) that have insufficient Federal tax

liability to use the tax credit or are interested only in receiving tax-exempt income.

■ Businesses unable to benefit from charitable deductions if contributions are made

to schools.

Additional Resources 

■ Local school districts (the real beneficiaries of this incentive) that are willing to take

on the primary marketing role.

■ Chambers of commerce or business associations that can help identify the educational

programs needed by the local labor force.

■ State or local job-placement agencies that may help identify job-skill gaps and the

employers that would be most interested in seeing appropriate programs established

in schools.

■ State education agencies (SEAs) that are responsible for allocating the State’s volume

cap for QZABs. These agencies should be contacted to determine the application

process and selection criteria.

■ Instructions for IRS Form 8860. For copies call 1–800–829–3676 or visit

www.irs.ustreas.gov.

Questions & Answers on Qualified Zone 

Academy Bonds 

How can a business improve the training and

skill levels of potential employees coming from

the public schools in an EZ or EC?

Public schools located in an EZ or EC can obtain interest-free loans if

they partner with private businesses to establish programs within public schools. A business can partner through contributions or, in certain cases, by lending

money to schools to improve the academic curricula, enhance graduation and employment rates, and better prepare students for college and the workforce.
69

Qualified Zone Academy Bonds

What schools can qualify?

A Qualified Zone Academy must be a public elementary or secondary

school located in either an EZ or an EC, or the school must have a reasonable expectation when the bonds are issued that at least 35 percent

of the school’s students (or Qualified Zone Academy participants) will

be eligible for free or reduced-cost lunches. The Qualified Zone Academy must receive an

allocation of the State’s QZAB limit from the SEA. The academy must have a comprehensive education plan approved by its local education agency (LEA).

How does a business benefit from lending

money to public schools?

If the loan is structured as a QZAB, the interest on the bond is paid 

by the Federal Government in the form of an annual tax credit to the

lender. This tax credit is available only to banks, insurance companies,

and companies in the business of lending money. The credit rate is generally equivalent

to the market taxable interest rate. The bond is not a tax-exempt bond. The interest

QZAB credit is treated as taxable income but is also a credit against Federal tax liability. 

What contributions can a business make to a

school to qualify the school for QZAB financing?

Before a QZAB can be issued, the school must obtain written commitments from private entities for qualified contributions with a present

value (as of the bond issue date) of not less than 10 percent of the 

proceeds of the bond issue. Qualifying contributions include:

■ Equipment for use in a Qualified Zone Academy.

■ Technical assistance in developing curricula or in training teachers to promote appropriate market-driven technology in the classroom at a Qualified Zone Academy.

■ Employee services as volunteer mentors in a Qualified Zone Academy.

■ Internships, field trips, or other educational opportunities for students outside a

Qualified Zone Academy.
70

Qualified Zone Academy Bonds

What can the school finance with the proceeds

of the QZAB?

The proceeds from the bond issue are to be used to rehabilitate or

repair facilities at Qualified Zone Academies, obtain equipment, 

develop course materials, or train teachers and other school personnel.

Proceeds cannot be used for new construction.

Are there any other tax benefits to participating

private entities?

The contributions to the school from the business would be treated

(for Federal tax purposes) like any other charitable deductions to a

State or local government.

Who issues the bond?

The bond must be issued by a State or local government, including 

the District of Columbia and any possessions of the United States.

How does the school repay a QZAB?

A school would likely repay the QZAB from the school system’s general revenues. The entire principal amount could be repaid in a lump

sum at maturity to maximize the credit to the holder, or the bondholder can negotiate intermediate principal repayments. If the entire

amount is due at maturity, the bondholder may require that the borrower deposit payments of principal in a sinking fund pledged to repayment of principal at maturity.

Is the creditworthiness of the borrower an issue?

The tax laws provide for single interest regardless of the creditworthiness of the school. A purchaser may feel the interest rate is too low 

for borrowers with a lower credit rating. To reflect this increased risk

of not being repaid, the purchaser may reduce the amount borrowed

by purchasing the bonds at a discount. This has the effect of increasing the yield on the

bond to the purchaser but reduces the amount of proceeds for the project that the borrower receives. For borrowers with better credit ratings, QZAB may be sold at a premium.
71

Qualified Zone Academy Bonds

Are “charter” schools eligible for these tax 

credits?

Whether charter schools qualify varies from jurisdiction to jurisdiction. The tax laws require that a Qualified Zone Academy be established by and operated under the supervision of an eligible LEA, that

the comprehensive educational plan of the academy be approved by the LEA, and that

the students in the academy be subject to the same academic standards and assessments

as other students educated by the LEA. Charter schools seeking to use QZAB financing

must consult with and obtain the approval of the LEA.

Certain banks, insurance companies, and investment corporations receive tax credits to offset

the interest payment of the bond, thus lowering

the cost to the borrower. What types of organizations can use these credits, and what criteria

are used to determine which companies can participate?

A holder of a QZAB must anticipate that it will have a Federal tax liability that could be

offset by the tax credit it receives from the QZAB. Some banks may also be able to obtain

Community Reinvestment Act credit for a QZAB. Such a credit would make the QZAB an

attractive investment.

Some of the employment tax credit provisions

expire on December 31, 2001. Do QZABs have

a similar expiration date?

The QZAB provision has a termination date based on when the bonds

are issued. QZAB allocations to the States have been extended through

2001. The allocation of a State’s QZAB volume cap can be carried forward for up to 2 or

3 years after its termination. For updates on any extensions or increases in QZAB allocations, visit www.ed.gov/inits/construction/technicalqzab.html.
72

Qualified Zone Academy Bonds

How can QZABs be used to create apprenticeship programs in schools to develop skills

needed by area employers?

Both the contribution requirements and the permitted uses of QZAB

proceeds can be used to develop an apprenticeship program at a

Qualified Zone Academy. QZAB proceeds can be used to develop curricula and train

teachers, and a business can contribute mentorship opportunities and employee time.

The employee time could be used to assist the academy in developing curricula related to

the background skills (such as math, computers, or drafting) necessary for a particular

apprenticeship opportunity. The business can contribute equipment and training materials to be used in the academy to support initial or continuing training. The business

can also provide personnel, workspace, and equipment at a worksite to train academy

students.

Qualified Zone Academy Bond Example 

A for-profit hospital is a major employer in the EZ. During the development of the

Strategic Plan for Federal designation as an EZ, the hospital indicated a willingness

to cooperate with an EZ school to establish a special academic program that would

prepare students for jobs at the hospital. The hospital indicated that it is willing to

donate state-of-the-art medical equipment and computer software to the school

and to provide internship and mentoring experiences for students. The school

determined that it needs to renovate a classroom to accommodate the donated

equipment, purchase appropriate instructional materials, and train teachers to

instruct students on the use of the equipment and oversee the internship and mentoring components of the program. The school estimates its costs at $500,000.

To obtain the benefits of the low-cost capital afforded through the QZAB tax credit,

the school needs to take the following steps.

■ The school obtains from the hospital an estimate of the value of the equipment,

personnel time, and facility cost associated with the internship and mentorship

opportunities. As a for-profit organization, the hospital will be able to take a

charitable deduction for the equipment and should readily be able to value this

part of the donation. The determination of the value of the time of personnel

and any facility cost involved in an internship and mentoring program may

require more of an effort.
73

Qualified Zone Academy Bonds

■ If the value of the hospital’s donation is equal to at least 10 percent of the cost

the school expects to incur for the training program (simplified in this example

to 10 percent of $500,000, or $50,000), the hospital would provide the school

with a written commitment for this donation.

■ The school contacts the financial officer and other school system personnel

responsible for debt issuance. The QZAB must be issued by a State or local 

governmental unit. In most cases, the likely issuer would be the school system

but the local or State government may be the issuer in other cases.

■ The parties must determine the source of repayment of the $500,000. The

QZAB tax credit mechanism basically eliminates any interest cost, but QZABs

are still loans that must be repaid; they are not grants.

■ The school system seeks an allocation from the State department of education

(DOE) of the State’s QZAB allocation equal to $500,000 (the amount the school

expects to borrow). The State DOE must provide written verification of an allocation of the QZAB volume limitation.

■ The school identifies a financial institution, insurance company, or corporation

in the business of lending money to purchase the QZAB. In this case, assume

the school sells the QZAB to a financial institution in the area that commits to

providing assistance in the strategic planning process associated with acquiring

EZ designation. The financial institution and the school system enter into a loan

agreement for the $500,000. 

■ The credit rate on the loan and the maximum term for the loan are set under

the QZAB provisions, and posted daily by the U.S. Department of the Treasury,

Bureau of Public Debt (www.publicdebt.treas.gov/spe/speqzab). Assume

the rate posted for the date the QZAB is issued is 7 percent. The school system

agrees to pay the $500,000 back in 10 years. The loan documents, the hospital’s written commitment, and the school’s cost estimate are reviewed by a tax

lawyer to obtain an opinion for the financial institution that the transaction is a

QZAB and enables the holder to take the tax credit.

Continued on page 74
74

Qualified Zone Academy Bonds

Continued from page 73

■ The financial institution requires the school system to set aside $50,000 each

year into a segregated fund to ensure that the debt will be repaid when the

loan matures. Any interest on this fund belongs to the school system. In each 

of the 10 years the QZAB is outstanding, the financial institution receives a tax

credit equal to $35,000 (7 percent times $500,000) and can reduce its Federal

tax liability by that amount each year. The school does not pay interest.
Zero Percent Capital Gains

Rate for Renewal Community

and District of Columbia

Enterprise Zone Assets 

75

Applicable IRS Tax Form: For more information, see IRS Publication

954, Tax Incentives for Empowerment Zones and Other Distressed

Communities.

Capital Gains Description Availability

Zero Percent Capital Gains The holder, for a minimum of 5 Exclusion applies only to an interest

Rate for Renewal Com- years, of a District of Columbia in, or property of, certain businesses

munity Assets and District Enterprise Zone (DC Zone) asset, operating in the DC Zone or an 

of Columbia Enterprise acquired between January 1, RC. The following qualify as DC

Zone Assets 1998, and December 31, 2003, Zone or RC assets: DC Zone or RC

or an RC asset, acquired between business stock, DC Zone or RC

January 1, 2002, and December partnership interests, and DC

31, 2009, will not have to include Zone or RC business properties.

in its gross income any “qualified Only gain attributable to the

capital gain” from the sale or period from January 1, 1998,

exchange of the asset. through December 31, 2008, for

the DC incentive, and from January

1, 2002, through December 31,

2014, for RCs, may be excluded.

If a business holds a District of Columbia Enterprise Zone (DC Zone) Business asset

acquired between January 1, 1998, and December 31, 2003, or a Renewal Community

Business asset acquired after December 31, 2001, and before January 1, 2010, for a

minimum of 5 years, the business does not have to include any “qualified capital gain” from the asset’s sale or exchange in its gross income.

This exclusion applies only to an interest in, or property of, certain

businesses operating in the District of Columbia or a Renewal

Community (RC). The following qualify as DC Zone or RC assets: 

DC Zone or RC business stock, DC Zone or RC partnership interests,

or DC Zone or RC business properties. Only gain attributable to the

period from January 1, 1998, through December 31, 2008, may be

excluded for the DC Zone and to the period from January 1, 2002,

through December 31, 2014, for RCs.
76

Zero Percent Capital Gains Rate

Target Audience 

■ New business partnerships or corporations that issue new stock or ownership

interests for entities with operations in the expanded DC Zone or in an RC.

■ Existing businesses with operations in the expanded DC Zone or in an RC that

issue new stock or acquire new ownership interests.

■ Qualified business entities that purchase real estate in the expanded DC Zone or

in an RC.

Incentive Not Relevant to 

■ Businesses that cannot meet the definition of an Enterprise Zone Business or the 

definition of a Renewal Community Business. With the expanded DC Zone, the 

35-percent resident employee requirement does not apply, and 80 percent rather 

than 50 percent of gross income must come from the active conduct of business

in the expanded DC Zone.

■ Businesses that acquire stock or partnership interests issued before or after the DC

Zone or RC designation period.

■ Businesses that purchase existing assets (such as buildings) that will not be rehabilitated substantially within a 2-year period.

■ Taxpayers who do not expect to hold stock, partnership interests, or assets for the

minimum 5-year holding period.

■ Taxpayers with capital gains on intangible assets or who own land that is not an

integral part of a DC Zone Business or an RC Business.

Additional Resources 

■ Accountants and lawyers preparing business tax returns.

■ Local bar associations or accountant groups to identify accountants or lawyers to

field questions.

■ Developers and real estate brokers who have knowledge of DC Enterprise Zone or

RC boundaries.

■ Tax attorneys and accountants in the District of Columbia or an RC area.

■ IRS Publication 954. For copies call 1–800–829–3676 or visit www.irs.ustreas.gov.
77

Zero Percent Capital Gains Rate

Questions & Answers on Zero Percent Capital

Gains Rate for Renewal Community and District

of Columbia Enterprise Zone Assets 

Is there any special capital gain treatment

for property in an Empowerment Zone (EZ),

Enterprise Community (EC), or RC?

The capital gain on certain assets is eligible for 0-percent capital gains

rate in all RCs and the District of Columbia Enterprise Zone. Assets in

other EZs or ECs are not eligible.

What assets are eligible for 0-percent capital

gains in RCs and the DC Zone?

The 0-percent capital gains rate applies to gain from the sale of a DC

Zone asset acquired after December 31, 1997, and before January 1,

2004, or for an RC asset acquired after December 31, 2001, and before

January 1, 2010. Qualifying assets include (1) stock in a domestic company acquired by

the taxpayer at its original issue from the corporation solely in exchange for cash, (2)

any capital or profits interest in a domestic partnership if the interest was acquired by 

the taxpayer from the partnership solely in exchange for cash, and (3) tangible business

property acquired by the taxpayer by purchase, in which either the original use of the

property in an RC or the DC Zone commences with the taxpayer or the taxpayer substantially improves the property. In the case of stock or partnership interests and ownership of the tangible business property, the business must be a Renewal Community Business or DC Enterprise Zone Business when the stock, interest, or property is acquired (or

be formed with the purpose of being a Renewal Community Business or DC Enterprise

Zone Business) and must remain a Renewal Community Business or DC Enterprise Zone

Business for substantially all of the holding period. (See appendix A.)

If the asset was purchased before an area

receives an RC or DC Zone designation does

the 0-percent capital gains rate apply?

No. The asset must be purchased after designation. If additional stock

or partnership interests of an entity are purchased at original issuance

after the RC or the DC Zone designation, these additional interests might qualify.
78

Zero Percent Capital Gains Rate

What if a taxpayer purchased a DC Zone asset or

RC asset, such as an existing building, from the

taxpayer’s parents?

The 0-percent capital gains rate is not available for transactions

between related parties. “Related persons” include sons, daughters,

parents, stepchildren, stepmothers, stepfathers, in-laws, and other persons treated as

dependents under the tax code. Similar restrictions apply to sales to majority shareholders or partners of the business.

What if a business ceases to meet the definition

of a DC Enterprise Zone Business or Renewal

Community Business?

The business must meet the requirements for substantially all of the

5-year holding period. “Substantially all” generally means 85 percent

of the period. If the business ceases to meet the test after the 5-year holding period, the

0-percent rate applies, but only to the extent of the gain to the date the business failed

to meet the requirements.

How long must the asset be held?

The minimum holding period is 5 years.

If the asset is sold before the end of the 

5-year period, can the 0-percent gain feature

be preserved for the subsequent holder?

A subsequent purchaser of an asset that otherwise qualifies for 

0-percent capital gain treatment is eligible for the incentive. The 

original purchaser would not be able to exclude any gain attributable to the period the

asset was held, however, because the asset was not held by that original purchaser for

the minimum period.
79

Zero Percent Capital Gains Rate

What if the asset is held beyond the DC

Enterprise Zone or RC designation period?

The 0-percent rate applies only to gain attributable to the period after

December 31, 1997, and before January 1, 2009, in the case of a DC

Zone asset and after December 31, 2001, and before January 1, 2015,

in the case of an RC asset. The taxpayer is not required to sell the asset in 2008 (in the

case of a DC Zone asset) or in 2015 (for an RC asset), but must determine and substantiate the gain attributable to that period and may apply the 0-percent rate to that amount.

What if the stock or partnership interest is

redeemed before the end of the minimum

holding period?

The asset would not be eligible for the 0-percent capital gains rate.
Nonrecognition of Gain on Sale

of Empowerment Zone Assets

81

Applicable IRS Tax Form: No applicable IRS tax form identified at

time of publication.

Capital Gains Description Availability

Nonrecognition of Gain Capital gain on EZAs (stock, part- Election by taxpayer for EZAs

on Sale of Empowerment nership interests, and business acquired after December 21, 2000,

Zone Assets (EZAs) property) of an Enterprise Zone and before January 1, 2010, for 

Business held for more than 1 all EZs (not available in District of 

year is not recognized (and is Columbia Enterprise Zone, ECs, 

rolled over) if a replacement EZA or RCs).

is acquired within 60 days.

A taxpayer can elect to postpone gain on the sale of certain stock, partnership interests,

or business property of an Enterprise Zone Business if replacement property is purchased

within 60 days. The amount of gain rolled over cannot exceed the cost of the replacement asset. The incentive does not eliminate the payment of tax but postpones payment,

which can be advantageous for tax planning purposes.

Target Audience

■ Businesses in Empowerment Zones (EZs) that frequently replace

property used by the business with similar property.

■ Investors interested in holding stock or partnership interests in an

Enterprise Zone Business for a short term.

■ Businesses interested in locating in an EZ and postponing gain on

investments for tax planning purposes.

Incentive Not Relevant to

■ Businesses that cannot meet the definition of an Enterprise Zone Business.

■ Investors seeking long-term stock or partnership investments.
82

Nonrecognition of Gain on Sale of EZAs

Additional Resources

■ Accountants and lawyers preparing business tax returns.

■ Local bar associations or accountant groups to identify accountants or lawyers

to field questions.

■ Tax attorneys and accountants with clients in EZs.

■ Investment advisors familiar with EZs and EZ businesses.

Questions & Answers on Nonrecognition of 

Gain on Sale of Empowerment Zone Assets

Are there any special provisions for

nonrecognition of gain for property

in an EZ, Enterprise Community (EC),

or Renewal Community (RC)?

In 2000, Congress created a new incentive for EZs that permits a taxpayer to roll over

gain from the sale of certain assets held for more than 1 year. The incentive is not available for ECs, the District of Columbia Enterprise Zone, or RCs. The tax law permits the

“nonrecognition” or so-called “rollover” of gain, at the taxpayer’s election, for a qualifying Empowerment Zone Asset (EZA) if the proceeds from the sale are used to purchase

other qualifying EZA in the same Zone (“replacement zone asset”) within 60 days of the

sale of the original EZA.

What is the advantage of rollover of gain?

A business may be able to delay payment of capital gains to a taxable

year where the gain is netted against a capital loss or to a year when

the gain is otherwise beneficial to the taxpayer’s calculation of taxes.
83

Nonrecognition of Gain on Sale of EZAs

Can gain on any asset used in the EZ qualify

for the rollover treatment?

Only certain assets of a business that meet the definition of Enterprise

Zone Business will qualify. (See appendix A.) EZA includes (1) stock

in a domestic company acquired by the taxpayer after December 21,

2000, and before January 1, 2010, at its original issue from the corporation solely in

exchange for cash, (2) any capital or profit interest in a domestic partnership if the interest was acquired by the taxpayer after December 21, 2000, and before January 1, 2010,

from the partnership solely in exchange for cash, and (3) tangible business property

acquired by the taxpayer by purchase after December 21, 2000, and before January 1,

2010, where either the original use of the property in the EZ commences with the taxpayer or the taxpayer substantially improves the property. 

Does the incentive apply to gain on sale of

real property or intangible property?

Any gain attributable to real property or an intangible asset can be

rolled over only if it is an integral part of an Enterprise Zone Business.

Are there any limits on the dollar amount of gain

that can be rolled over?

The amount of gain rolled over cannot exceed the cost of the replacement EZA, and that cost is reduced by any gain that previously has

not been recognized under this special rollover provision.

Are there any other tax consequences?

Any gain that is not recognized reduces the basis of the replacement EZA.
84

Nonrecognition of Gain on Sale of EZAs

Is replacement EZA eligible for the same rollover

treatment?

The gain on the replacement EZA may also be rolled over, but only if

the actual holding period of the replacement EZA is more than 1 year. 

How is the incentive reflected on a tax return?

There is no special form for this provision, and the gain that is not

being recognized would be accounted for in the same manner that

capital gains generally are taken into account.
Partial Exclusion of Gain on Sale

of Empowerment Zone Stock

85

Applicable IRS Tax Form: No applicable IRS tax form identified at

time of publication; see IRS Publication 550.

Capital Gains Description Availability

Partial Exclusion of Gain Exclusion of 60 percent of gain Stock must be acquired after 

on Sale of Empowerment on sale of small business stock of December 21, 2000, and before

Zone Stock a C Corporation that is an Enter- January 1, 2010, at original

prise Zone Business located in an issuance in exchange for cash. 

EZ if the stock is held for at least Sixty-percent exclusion does

5 years. not apply to gain after December 31, 2014. Business must be

an Enterprise Zone Business in

an EZ (other than the District of

Columbia Enterprise Zone).

A taxpayer can exclude 60 percent of gain realized on the sale of stock in a small business that meets the definition of an Enterprise Zone Business and is located in an

Empowerment Zone (EZ). The exclusion of gain encourages investment in small EZ

businesses whose stock is expected to appreciate prior to 2014.

Target Audience

■ Small corporations starting up or seeking additional cash infusion that locate in EZs.

■ Startup corporations that expect rapid appreciation in the value of their stock.

■ Investment banking firms that specialize in selling stock of emerging,

small corporations.

■ Local investment clubs seeking to invest in small businesses in an EZ.

■ Taxpayers with stock portfolios looking to reduce capital gain.
86

Partial Exclusion of Gain on Sale of EZ Stock

Incentive Not Relevant to

■ Businesses formed as partnerships.

■ Investors interested in investments in partnerships.

■ Investors with large capital losses.

■ Investors in businesses that are not likely to meet the definition of an Enterprise

Zone Business for the 5-year holding period.

Additional Resources

■ Accountants and lawyers preparing business tax returns.

■ Local bar associations or accountant groups to identify accountants or lawyers to

field questions.

■ Investment advisors familiar with small corporations and businesses within an EZ.

■ IRS Publication 550. For copies call 1–800–829–3676 or visit www.irs.ustreas.gov.

Questions & Answers on Partial Exclusion of

Gain on Sale of Empowerment Zone Stock

Are there any incentives for investing in small

startup companies located in economically

depressed areas?

In 2000, Congress extended an existing tax incentive encouraging investment in small companies to target small corporations located in EZs.

What is meant by “small companies”?

This is generally a C corporation with gross assets of $50 million

or less. A business should consult its tax advisor for more specific

requirements.
87

Partial Exclusion of Gain on Sale of EZ Stock

What if the taxpayer already owns stock in the

company?

The stock qualifies only if the taxpayer acquires the stock upon

original issuance. Gain would not qualify for the 60-percent

exclusion if the stock was purchased before December 21, 2000.

Must the business be an Enterprise Zone

Business when the stock is purchased?

The corporation must either be an Enterprise Zone Business when

the stock is purchased or be formed for purposes of meeting the

definition and must meet the definition for substantially all of the

taxpayer’s 5-year holding period. (See appendix A.)

What amount of gain is excluded?

The tax code will permit 60 percent of the gain realized to be excluded. This exclusion would not apply to gains after December 31, 2013.

What if the stock is held for less than 5 years?

The favorable exclusion treatment applies only if the stock is held for

more than 5 years.

What if the business ceases to be an Enterprise

Zone Business?

The exclusion is available only if the business meets the Enterprise

Zone Business definition for substantially all of the 5-year holding

period. Substantially all generally means 85 percent of the period.

An investor would not be eligible for the benefit if the business was not able to meet

the requirements.
88

Partial Exclusion of Gain on Sale of EZ Stock

How is the incentive shown on a tax return?

The exclusion is included in the general portion of taxpayer’s return

related to capital gain and loss (such as Schedule D of IRS Form 1040)

when the stock is sold or otherwise disposed of. There are no regulations on how an investor should document that a business met the

small stock and Enterprise Zone Business requirements. An investor may want to consult

his or her tax advisor for advice on documenting compliance.
New Markets Tax Credit

89

Applicable IRS Tax Form: No applicable IRS tax form identified at

time of publication.

Tax Credit Description Availability

New Markets Tax Credit Equity investors in qualified Allocations of the credit will be

Community Development made annually from 2001 to 2007

Entities (CDEs) can obtain a tax to qualified CDEs. Investors must

credit against Federal taxes of purchase stock or partnership

5 to 6 percent of the amount interest in a CDE for cash at origiinvested for each of the years nal issuance. Credit available at 

the investment is held, for up time of purchase (1 year) and on 

to 7 years of the credit period. 6 anniversary dates of acquisition

of investment.

The New Markets Tax Credit provides individuals and corporations with an incentive

to invest in a community development entity (CDE) that provides capital and financial

advisory services to low-income communities. The investor receives a credit against

Federal tax liability equal to a percentage of the amount invested in the CDE. The credit

can be taken for up to 7 years. The credit will be available for up to $15 billion in investments in CDEs designated by the U.S. Treasury Department over the 2001–2007 period.

Target Audience

■ Corporations and individuals looking to reduce Federal tax liability up to a

7-year period.

■ Investors wanting to invest in low-income community businesses.

■ Financial institutions seeking to reduce Federal tax liability and

obtain Community Reinvestment Act credit through the same

investment.

■ Investors in Low-Income Housing Tax Credit (LIHTC) projects

that may want a similar tax credit investment for commercial

development.

■ Community development corporations seeking to broaden their

source of capital through investments in for-profit subsidiaries.
90

New Markets Tax Credit

Incentive Not Relevant To

■ Startup or similar businesses that may not have large tax liabilities.

■ Individuals who are unable to benefit from the investment because of passive 

loss limitations.

■ Individuals or corporations paying the Federal Alternative Minimum Tax.

Additional Resources

■ Accountants and lawyers preparing business tax returns.

■ Local bar associations or accountant groups to identify accountants or lawyers to

field questions.

■ Community development corporations, community bankers, and business associations that are familiar with business opportunities in low-income communities.

■ Syndicators of low-income housing tax credits familiar with credit syndication.

Questions & Answers on New Markets Tax Credits

Are there any incentives for persons wishing

to invest in commercial enterprises located

in economically distressed communities?

In 2000, Congress added a New Markets Tax Credit against Federal

tax liability for taxpayers who hold an equity investment in certain

CDEs. The CDE, in turn, makes loans to, or investments in, qualifying businesses in

low-income communities. The investor in the CDE obtains the tax benefit based on

the amount invested in the CDE. 

What type of entity qualifies as a CDE?

A CDE is any domestic corporation or partnership for Federal tax

purposes that

■ Has a primary mission serving or providing investment capital for

low-income communities or low-income persons.
91

New Markets Tax Credit

■ Maintains accountability to residents of low-income communities through their

representation on any governing board or on any advisory board of the CDE.

■ Is certified by the Treasury Department as an eligible CDE. 

In allocating the credits, the Treasury Department will give priority to entities with

records of having successfully provided capital or technical assistance to disadvantaged

businesses or communities, as well as to entities that intend to invest substantially all

of the proceeds from their investors in businesses in which persons unrelated to the

CDE hold the majority of the equity interest. A “small business investment company”

(as defined in the tax laws) and a “community development financial institution”

(as defined in Federal banking laws) are treated as meeting these requirements.

How does an investor get an allocation of

the credit?

The investor does not receive the credit directly from the Federal

Government. Instead, CDEs that are eligible for the credit will be

selected by the U.S. Treasury Department. The Treasury Department

can allocate credits to qualified CDEs of $1 billion for 2001, $1.5 billion each year

for 2002–2003, $2 billion each year for 2004–2005, and $3.5 billion each year for

2006–2007. The CDE will have up to 5 years to allocate the credit to specific investments. The credit is available when the investor makes an equity contribution to the

qualified CDE.

How does an investor determine which CDEs

have received an allocation of the credit?

The Treasury Department will publish a list of CDEs designated

each year.

How will the CDE use the equity that qualifies

for the New Markets Tax Credit?

The CDE must use at least 85 percent of the cash infusion to make

a “qualified low-income community investment” (a Qualified Investment). A Qualified Investment includes 1) a capital or equity investment in, or loan to, a “qualified active low-income community business” or a qualified

CDE, 2) the purchase of a loan made by another qualified CDE to a qualified active
92

New Markets Tax Credit

low-income community business, or 3) the provision of financial counseling and other

similar services to businesses and residents located in low-income communities. There

are no limits on the use of the remaining 15 percent of the equity raised by the CDE.

What is a “qualified active low-income community

business” (Qualified Active Business)?

A “qualified active low-income community business” is defined as

a corporation, partnership, or sole proprietorship that meets the

following tests: 

■ At least 50 percent of its gross income comes from the active conduct of a qualified

business within any low-income community.

■ A “substantial portion” of the use of tangible property of the business (whether

owned or leased) must be located within a low-income community.

■ A substantial portion of employee services must be performed in a low-income

community.

■ No more than 5 percent of the property of the business can be “nonqualified financial

property,” generally defined as debt, stock, partnership interests, and various financial instruments (other than reasonable amounts of working capital held in cash or

short-term debt instruments or accounts receivable arising from sales of inventory).

■ No more than 5 percent of the property of the business can be works of art or other

“collectibles,” unless held for sale to customers.

This definition is a modification of the definition of an Enterprise Zone Business (see

appendix A). There is no requirement that a specified percentage of employees live in

the low-income community, however.

Are there any types of business operations that

do not qualify as a Qualified Active Business?

Certain businesses cannot qualify, including residential rental property;

a business, whose predominant activity of which is the development

or holding of intangibles for sale or license; a golf course, country

club, massage parlor, hot tub facility, suntan facility, race track, or a facility used for gambling; or a store, whose principal business is selling alcoholic beverages for consumption

offpremises. In addition, as distinguished from the Enterprise Zone Business definition,

rental of improved commercial real estate located in a low-income community is a

Qualified Active Business regardless of the characteristics of the commercial tenants
93

New Markets Tax Credit

of the property. The purchase and holding of unimproved real estate is not a Qualified

Active Business. A Qualified Active Business can include a nonprofit organization.

Where must a Qualified Active Business

be located?

The tax credit is based on assistance to certain businesses in a lowincome community. A low-income community is defined as census

tracts with either (1) poverty rates of at least 20 percent (based on the

most recent census data), or (2) a median family income that does not exceed 80 percent

of the greater of metropolitan area income or statewide median family income (for a 

nonmetropolitan census tract, 80 percent of nonmetropolitan statewide median family

income). In addition, the Treasury Department may designate any area within any census

tract as a low-income community provided that (1) the boundary of the area is continuous, (2) the area (if it were a census tract) would satisfy the poverty rate or median

income requirements within the targeted area, and (3) an inadequate access to investment capital exists in the area.

How long must an investor hold the investment?

There is no minimum holding period. The investment is eligible for

the credit on the date the investment is made and on six subsequent

anniversary dates. The credit is equal to 5 percent of the amount

invested for the first three allowance dates, with an increase to 6 percent for the remaining four allowance dates. The investor must hold the investment on

the “credit allowance date,” which is the date on which the investment is initially made

and on each of the six subsequent anniversaries of the date on which the investment is

initially made. If the investment is not held on the credit allowance date, the investor is

not eligible to take the New Markets Tax Credit.

What if an investor is unable to use the credit in

a specific tax year?

The New Markets Tax Credit is a general business tax credit, and can

be carried forward 20 years and carried back 1 year (except for tax

years ending prior to January 1, 2001). 
94

New Markets Tax Credit

Will an investor be able to sell the investment in

the CDE with the credit attached?

The credit is available to subsequent purchasers of the investment. If

an initial investor is unable to use the tax credit, the investment can be

transferred with the credit available to the subsequent purchaser.

Are there any tax benefits for an owner of a

potential Qualified Active Business?

The tax benefit itself does not go to the business. There is no requirement that the CDE pass through the value of the benefit of the tax

credit, for example, in the form of a lower interest rate on a loan. The

credit merely provides an incentive for creating a source of capital for organizations that

have a mission and a proven track record for stimulating economic development in economically depressed areas. The ultimate benefit to the business owner will be access to

the new capital infusion in low-income communities.

Is the New Markets Tax Credit subject to

recapture like other credits?

The credit is subject to recapture during the 7-year credit period if

the entity invested in ceases to be a CDE, the proceeds of the investment are not used to make Qualified Investments, or the investment 

in the CDE is redeemed by the CDE. The recapture amount is generally based on tax

benefit derived from the credit.

Are there any other tax consequences to holding

this tax credit investment? 

The taxpayer’s basis in the investment is generally reduced by the

amount of the credit. The credit is subject to the general business

credit and passive loss limitation rules.
95

New Markets Tax Credit

Can this credit be used to reduce Federal

Alternative Minimum Tax (AMT) liability?

No. The credit cannot be used to reduce the AMT liability of an individual or corporation.

Can an investor contribute property to a CDE

to obtain an equity investment that qualifies

for the credit?

The credit is available only in cases in which the stock of a corporation, a membership interest of a limited liability company, or capital

interest in a partnership is acquired at original issuance for cash. An investment

acquired through an underwriter at original issuance would meet this requirement.

How is this credit different from LIHTC?

LIHTC is based on the eligible costs of a residential rental project that

sets aside units for low- and moderate-income persons. It cannot be

used for commercial projects. An investor receiving the New Markets

Tax Credit receives the credit based on its investment in the CDE.

Investment by the CDE in residential rental real estate is not a Qualified Investment for

purposes of meeting the requirement that 85 percent of the cash be used to acquire

Qualified Investments.
Low-Income Housing

Tax Credit

97

Applicable IRS Tax Form: Forms 8609 and 8586

Housing Tax Credit Description Availability

Low-Income Housing Ten-year credit against Federal Project must receive allocation of

Tax Credit (LIHTC) taxes for owners of newly con- State’s annual credit ceiling or use

structed or renovated rental multifamily housing tax-exempt

housing who set aside a specified bonds that receive allocation of 

percentage of units for low- State’s bond volume cap. Alloincome persons for a minimum cations are made on basis of 

of 15 years. The credit varies for State plan. The project does not 

new construction and renovation. have to be located in an EZ, EC,

or RC to qualify.

The Low-Income Housing Tax Credit (LIHTC) is available over a 10-year period to the

tax owners of rental projects who set aside a specified percentage of units for low-income

persons for a minimum of 15 years. The project owner must receive an

allocation of tax credits to qualify for this incentive. Information on the

LIHTC can be obtained from IRS Publication Form 8586 and from the

National Council of State Housing Agencies on their Internet site at

www.ncsha.org. (Little information on this credit is provided here

because LIHTC is not included in the Internal Revenue Service (IRS)

publication 954. Because this is a very complicated tax credit, please

contact the IRS for more information.)
Appendix A

99

Questions & Answers on Enterprise Zone

Businesses and Renewal Community Businesses

Tax incentives are generally designed to encourage businesses to locate or expand

operations in an Empowerment Zone (EZ), Enterprise Community (EC), or Renewal

Community (RC) and to hire residents of an EZ, EC, or RC. Five of the Federal tax

incentives—Increased Section 179 Deduction, Enterprise Zone Facility Bonds, Zero

Percent Capital Gains Rate for DC Zone Assets, Nonrecognition of Gain on Sale of

Empowerment Zone Assets, and Partial Exclusion of Gain on Sale of Empowerment 

Zone Stock—require that the business meet the definition of “Enterprise

Zone Business.” Two of the RC incentives—Increased Section 179

Expensing Deduction and Zero Percent Capital Gains for RC Assets—

require that the business meet the definition of “Renewal Community

Business” in order to qualify for the incentive. 

A business qualifies as an Enterprise Zone Business or Renewal

Community Business if it actively conducts business in an EZ, EC, or

RC, has its tangible and intangible property located and used in the

active conduct of business in an EZ, EC, or RC, employs residents of

an EZ, EC, or RC (a required 35 percent of its employees), and has its

employees perform services in an EZ, EC, or RC. The business can be a

sole proprietorship, partnership, or corporation for Federal tax purposes. Some businesses are excluded from qualifying. The business must meet the requirements of being an

Enterprise Zone Business or Renewal Community Business continuously for several

years, depending on the incentive.

What is an Enterprise Zone Business or Renewal

Community Business?

In general, an Enterprise Zone Business or Renewal Community

Business is a corporation, partnership, or sole proprietorship that,

for each taxable year, meets the following tests:

■ Except with respect to a sole proprietorship, every trade or business of the entity is

actively conducted in an EZ, EC, or RC (legally separate entities are not aggregated

with related entities for these tests). 

■ At least 50 percent of the total gross income of the entity is derived from the active

conduct of business within an EZ, EC, or RC.

■ A substantial portion of the use of the tangible property of the entity (whether owned

or leased) is within an EZ, EC, or RC.
100

Appendix A

■ A substantial portion of the intangible property of the business is used in the active

conduct of the business.

■ A substantial portion of the services performed for the employer by its employees

occur within an EZ, EC, or RC.

■ At least 35 percent of the employees reside in an EZ, EC, or RC. (This does not apply

in the District of Columbia Enterprise Zone.)

■ No more than 5 percent of the property is nonqualified financial property (such as

debt, stock, and various financial instruments) except for reasonable amounts of

working capital held in cash, cash equivalents, or debt instruments with a term of

18 months or less and certain accounts receivable arising from sales of inventory.

■ No more than 5 percent of the property is works of art or other collectibles unless

held for sale to customers.

How does a business know whether its building

is in the Zone or an RC?

The local EZ, EC, or RC entity can provide businesses with information on its boundaries, or businesses may obtain the information over

the Internet at www.hud.gov/offices/cpd/ezec for urban EZ/ECs and

for urban and rural RCs or www.ezec.gov for rural EZ/ECs.

Are there any types of businesses that cannot

be Enterprise Zone Businesses or Renewal

Community Businesses?

Yes. The tax laws exclude certain businesses from the definition,

including liquor stores, golf courses, racetracks, gambling facilities,

country clubs, residential rental properties, businesses that predominantly hold or

develop intangibles for sale or license, or businesses that rent personal property, such

as car rental agencies (unless at least 50 percent of the rentals are to Enterprise Zone

Businesses or Renewal Community Businesses or to EZ, EC, or RC residents). Nonprofit organizations are not automatically precluded merely because the activities

carried on by the organization are conducted on a nonprofit basis.
101

Appendix A

Can a high-technology company qualify as an

Enterprise Zone Business or Renewal Community

Business?

The answer depends on its operations. The tax law states that no

business consisting predominantly of the development or holding

of intangibles for sale or license can qualify as an Enterprise Zone Business or Renewal

Community Business.

Can a real estate developer qualify as an

Enterprise Zone Business or Renewal

Community Business?

A business that develops and owns commercial real estate can qualify

only if at least 50 percent of its gross rental income from real property

is from Enterprise Zone Businesses or Renewal Community Businesses. The owner is

permitted to accept certifications of lessees in determining whether the lessee is an

Enterprise Zone Business or Renewal Community Business. If the project is residential

rental property, the business is automatically excluded by statute from the definition of

an Enterprise Zone Business or Renewal Community Business.

Is farming a qualified business for purposes

of the Enterprise Zone Business or Renewal

Community Business definition?

Farming is a qualified business only if the sum of the value of the

assets owned or leased by the employer for use in the farming business

does not exceed $500,000. The definition of farming and the method for calculating the

value of the assets are found in the tax laws. An employer should consult its legal advisor

on this matter.
102

Appendix A

How does a business apply the tests if it has

several locations?

The tests generally apply to legally separate entities. If a single business entity has locations both within and outside an EZ, EC, or RC,

all of the tests apply to the overall operations. If the various locations

are operated by legally separate entities, the tests apply only to that location’s operations

even if the various legal entities are related for Federal tax purposes. For example, if a

national chain store or restaurant set up operations in an EZ, EC, or RC, the tests would

be measured with respect to the EZ, EC, or RC location store only if that store or restaurant was separately incorporated from other stores or restaurants in the chain. 

What does it mean that “legally separate entities

are not aggregated with related entities for the

Enterprise Zone Business tests?”

This rule permits businesses to set up separate corporations or partnerships to conduct business in an EZ, EC, or RC. All Enterprise Zone

Business or Renewal Community Business tests would be measured based on the EZ, EC,

or RC business, and a business would not have to include any activities of other related

entities outside of the EZ, EC, or RC. Many other tax law provisions treat related entities

as one business and require adding together the activities of all entities. This rule for

Enterprise Zone Businesses and Renewal Community Businesses is more lenient than

other tax rules.

How does a business apply the active conduct

of business within an EZ, EC, or RC test if raw

materials and customers come from outside

the EZ, EC, or RC?

The tax regulations relating to Enterprise Zone Facility Bonds describe

a mail-order clothing business that is located in an EZ. The business purchases the supplies for its clothing business from suppliers located both within and outside the EZ and

expects that orders will be received both from customers who will reside or work within

the EZ and from others outside the EZ. All orders are received, filled at, and shipped

from the clothing business located in the EZ. The income generated from the sales would

be treated as gross income derived from the active conduct of business within an EZ. 
103

Appendix A

How do the tests apply if a business makes

deliveries inside and outside an EZ, EC, or RC?

The tax regulations for Enterprise Zone Facility Bonds give an example of a printing operation located in an EZ. All orders are taken and

completed, and all billing and accounting activities are performed, at

the print shop located in the EZ. The business, on occasion, uses its equipment (including its trucks) and employees to deliver large print jobs to customers who reside outside

the EZ. As long as the business is able to establish that its trucks are used in the EZ

a substantial portion of the time and that its employees perform a substantial portion 

of their services for the business in the EZ, the business meets the requirements with

respect to the use of tangible property and location of services performed by employees.

How does a business calculate the requirement

that 35 percent of its employees be EZ, EC, or

RC residents?

The tax regulations relating to tax-exempt bonds permit calculation

either on a per-employee fraction or an employee actual work-hour

fraction. In the per-employee fraction method, the business would compare the number

of EZ, EC, or RC resident employees in a taxable year to the total number of employees

during the same taxable year. Employees include persons employed for at least 90 days

and who work at least 15 hours per week. The employee actual work-hour fraction seeks

to accommodate businesses with full- and part-time workers and compares actual hours

worked by EZ, EC, or RC residents to total employee hours worked in a taxable year.

A business must apply the same method consistently over the period of the tax incentive

once a method is selected. The same methods of determining whether the 35-percent test

is met may apply for purposes of the other EZ incentives and the incentives that require

a Renewal Community Business, but the Internal Revenue Service (IRS) has not formally

extended the rules.

Are there any waivers for businesses that 

meet requirements in all other areas but the

“35-percent rule” for EZ, EC, or RC employees?

The 35-percent EZ, EC, or RC employee requirement is statutory

and cannot be waived. For purposes of tax-exempt financing, the

Enterprise Zone Business is permitted to average yearly percentages over a rolling, 

consecutive 5-year period. There are no tax regulations on whether the averaging

provision applies to any of the other EZ incentives or the RC incentives.
104

Appendix A

Do employees contracted through a temporary

agency meet the definition of employee for

purposes of the Enterprise Zone Business or

Renewal Community Business tests? Do

employees who are also relatives meet the

definition of employee for this purpose?

The tax laws do not directly address these issues with respect to the Enterprise Zone

Business or Renewal Community Business definition. If the business treats the individuals as employees for other Federal tax purposes, the business presumably could treat

them as employees for this purpose.

How does a business know it qualifies as

an Enterprise Zone Business or Renewal

Community Business?

There is no formal application or certification process for being an

Enterprise Zone Business or Renewal Community Business. A business

must analyze the requirements in light of its own operations and use the same standards

it applies for taking any position on its Federal tax return. This requires a legal determination, so a business should consult a tax attorney or its tax preparer. The business

should retain documents that establish that it is an Enterprise Zone Business or Renewal

Community Business, such as statements that an employee is an EZ, EC, or RC resident,

in case of an audit by the IRS.
Appendix B

105

Current Urban

and Rural

Empowerment

Zones and

Enterprise

Communities

Round I

Empowerment

Zones

Georgia

Atlanta

Illinois

Chicago

Maryland

Baltimore

Michigan

Detroit

New York

New York

Pennsylvania

Philadelphia/Camden

(New Jersey)

Round I

Supplemental

Empowerment

Zones

California

Los Angeles

Ohio

Cleveland

Round I Enterprise

Communities

Alabama

Birmingham

Arkansas

Little Rock/Pulaski

Arizona

Phoenix

California

Los Angeles

San Diego

San Francisco

Colorado

Denver

Connecticut

Bridgeport

New Haven

District of Columbia

Washington

Delaware

Wilmington

Florida

Miami/Dade County

Tampa

Georgia

Albany

Illinois

East St. Louis

Springfield

Indiana

Indianapolis

Iowa

Des Moines

Kentucky

Louisville

Louisiana

New Orleans

Ouachita Parish

Massachusetts

Lowell

Springfield

Michigan

Flint

Muskegon

Minnesota

Minneapolis

St. Paul

Missouri

St. Louis

Mississippi

Jackson

Nebraska

Omaha

New Hampshire

Manchester

New Jersey

Newark

New Mexico

Albuquerque

Nevada

Las Vegas

New York

Albany/Schenectady/Troy

Buffalo

Newburgh/Kingston

Rochester

North Carolina

Charlotte

Ohio

Akron

Columbus

Oklahoma

Oklahoma City

Oregon

Portland
106

Appendix B

Pennsylvania

Harrisburg

Pittsburgh

Rhode Island

Providence

South Carolina

Charleston

Tennessee

Memphis

Nashville/Davidson

Texas

Dallas

El Paso

San Antonio

Waco

Utah

Ogden

Vermont

Burlington

Virginia

Norfolk

Washington

Seattle

Tacoma

West Virginia

Huntington

Wisconsin

Milwaukee

Round I Enhanced

Enterprise

Communities

California

Oakland

Massachusetts

Boston

Missouri

Kansas City

Texas

Houston

Round II

Empowerment

Zones

California

Santa Ana

Connecticut

New Haven

Florida

Miami/Dade County

Indiana

Gary/Hammond/

East Chicago

Massachusetts

Boston

Minnesota

Minneapolis

Missouri

St. Louis/East St. Louis

(Illinois)

New Jersey

Cumberland County

Ohio

Cincinnati

Columbus

South Carolina

Columbia/Sumter

Tennessee

Knoxville

Texas

El Paso

Virginia

Norfolk/Portsmouth

West Virginia

Huntington/Ironton

(Ohio)

Round III

Empowerment

Zones

To be designated by 

December 31, 2001

Renewal

Communities

To be designated by 

December 31, 2001

Rural

Round I

Empowerment

Zones

Kentucky

Kentucky Highlands

Mississippi

Mid-Delta

Texas

Rio Grande Valley

Round II

Empowerment

Zones

California

Desert Communities

Georgia

Southwest Georgia United

Illinois

Southernmost Illinois

Delta

North Dakota

Griggs-Steele

South Dakota

Oglala Sioux Tribe

Round I Enterprise

Communities

Alabama

Chambers County

Greene/Sumter Counties

Arizona

Arizona Border Region
107

About the Empowerment Zone/Enterprise Community

Arkansas

East Arkansas

Mississippi County

California

Imperial County

City of Watsonville

Florida

Jackson County

Georgia

Central Savannah

River Area

Crisp/Dooly

Louisiana

Macon Ridge

Northeast Louisiana Delta

Michigan

Lake County

Mississippi

North Delta

Missouri

City of East Prairie

New Mexico

La Jicarita

North Carolina

Halifax/Edgecombe/

Wilson

Robeson County

Ohio

Greater Portsmouth

Oklahoma

Southeast Oklahoma

Oregon

Josephine County

Pennsylvania

City of Lock Haven

South Carolina

Williamsburg-Lake City

South Dakota

Beadle/Spink

Tennessee

Fayette/Haywood County

Scott/McCreary Area

(Kentucky)

Virginia

Accomack-Northampton

Washington

Lower Yakima County

West Virginia

Central Appalachia

McDowell County

Round II Enterprise

Communities

Arizona

Four Corners

Alaska

Metlakatla Indian

Community

California

Central California

Florida

Empowerment Alliance

of Southwest Florida

Hawaii

Molokai

Indiana

Town of Austin

Kansas

Wichita County

Kentucky

Bowling Green

Maine

Empower Lewiston

Michigan

Clare County

Montana

Fort Peck Assiniboine

and Sioux Tribe

New Mexico

City of Deming

Oklahoma

Tri-County Indian Nations

Pennsylvania

Fayette

South Carolina

Allendale ALIVE

Tennessee

Clinch-Powell

Texas

FUTURO Communities

Washington

Five Star

West Virginia

Upper Kanawha Valley

Wisconsin

Northwoods NiiJii