Community Development: Information on the Use of Empowerment Zone and
Enterprise Community Tax Incentives (Letter Report, 06/30/1998,
GAO/RCED-98-203).
The Empowerment Zone and Enterprise Community program, which is designed
to help revitalize urban and rural communities, targets federal grants
for social services and community redevelopment and provides three tax
incentives to attract or retain businesses in distressed areas. These
tax incentives include tax-exempt private activity enterprise zone
facility bonds that make financing available to qualified businesses at
lower rates than conventional financing, an employment and training
credit, and a $20,000 increase in the expensing allowance for the
depreciable business property of qualified businesses. During an October
1997 congressional hearing on the program, questions arose about how
well these initiatives are working and whether the current law provides
the right mix of tax incentives. This report examines the extent to
which data exist to determine how the tax incentives have been used. To
make this determination, GAO examined the availability of data from the
Internal Revenue Service on each of the three tax incentives, as well as
data from state officials on the use of the tax-exempt enterprise zone
facility bonds.
--------------------------- Indexing Terms -----------------------------
REPORTNUM: RCED-98-203
TITLE: Community Development: Information on the Use of
Empowerment Zone and Enterprise Community Tax Incentives
DATE: 06/30/1998
SUBJECT: Community development programs
Tax exempt status
Statistical data
Surveys
Tax credit
Economically depressed areas
Data integrity
IDENTIFIER: HUD Empowerment Zones and Enterprise Communities Program
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GAO/RCED-98-203
Cover
================================================================ COVER
Report to Congressional Requesters
June 1998
COMMUNITY DEVELOPMENT -
INFORMATION ON THE USE OF
EMPOWERMENT ZONE AND ENTERPRISE
COMMUNITY TAX INCENTIVES
GAO/RCED-98-203
Availability of Data on EZ Tax Incentives
(385708)
Abbreviations
=============================================================== ABBREV
EC - Enterprise Community
EZ - Empowerment Zone
IRS - Internal Revenue Service
SOI - Statistics of Income
XX - x
Letter
=============================================================== LETTER
B-279566
June 30, 1998
The Honorable Bill Archer
Chairman, Committee on Ways and Means
House of Representatives
The Honorable Nancy Johnson
Chairman, Subcommittee on Oversight
Committee on Ways and Means
House of Representatives
The Honorable Christopher Shays
Chairman, Subcommittee on Human Resources
Committee on Government Reform and Oversight
House of Representatives
The Empowerment Zone and Enterprise Community (EZ/EC) program is
designed to help revitalize urban and rural communities. This
10-year federal effort was enacted as part of the Omnibus Budget
Reconciliation Act of 1993 as a comprehensive approach to addressing
the problems of distressed communities. The program targets federal
grants for social services and community redevelopment and provides
three tax incentives to attract or retain businesses in distressed
areas. These tax incentives include tax-exempt private activity
enterprise zone facility bonds that make financing available to
qualified EZ and EC businesses at lower rates than conventional
financing; an employment and training credit, called the EZ
employment credit; and a $20,000 increase in the expensing allowance
for the depreciable business property of qualified EZ businesses.
During an October 1997 hearing on the EZ/EC program, questions arose
about how well these initiatives are working and whether the current
law provides the right mix of tax incentives. To help answer these
questions, you asked us to examine the extent to which data exist to
determine how the tax incentives have been used. To make this
determination, we examined the availability of data from the Internal
Revenue Service (IRS) on each of the three tax incentives, as well as
data from state officials on the use of the tax-exempt enterprise
zone facility bonds.
RESULTS IN BRIEF
------------------------------------------------------------ Letter :1
Reliable data for only one of the three tax incentives are currently
available from IRS--the agency to which taxpayers report their use of
the tax incentives. Specifically, IRS has reliable information on
businesses' use of tax-exempt enterprise zone facility bonds during
1995, which we corroborated and updated through a survey of officials
in the District of Columbia and the 43 states that contain
empowerment zones and enterprise communities. IRS' data indicate,
and our survey confirmed, that three tax-exempt enterprise zone
facility bonds were issued in 1995, and the state officials we
surveyed reported that five other such bonds were issued in the next
3 years--one in 1996, two in 1997, and two in 1998. The eight bonds
totaled $17.7 million. IRS has not yet completed its computer
processing and analysis of the original returns for bonds issued in
1996 and 1997. Because IRS' information on businesses' use of the
other two tax incentives--the employment credit and the additional
$20,000 expensing allowance for depreciable business property--is not
reliable, according to Treasury and IRS officials, we were not able
to determine how often these incentives were used. For both
incentives, the number of businesses and business owners that were
included in IRS' samples for tax years 1994 through 1996 and that
reported using these incentives was too small to project reliably to
all empowerment zone businesses and owners that filed tax returns.
As a result, IRS started collecting data from all businesses and
owners on their use of the empowerment zone employment credit, but
problems with the quality of the corporation data for tax years 1994
through 1996 prevent the use of these data. IRS plans to issue a
directive to its responsible executives and managers on problems with
the employment credit data and on steps to take in addressing these
problems. IRS also plans to conduct special studies of the credit
using returns already filed. It does not, however, plan to make any
changes in the way it collects information on the additional
expensing allowance for depreciable business property because the tax
forms on which the expensing is claimed are not computerized and the
tax incentive is considered small.
BACKGROUND
------------------------------------------------------------ Letter :2
The Omnibus Budget Reconciliation Act of 1993 established the EZ/EC
program as a comprehensive approach to help designated communities
revitalize deteriorating areas. The guidelines for implementing the
program describe it as one in which solutions to communities'
problems are to originate from the neighborhood up rather than from
Washington, D.C., down. Business tax incentives, together with other
provisions, such as federal grants for community redevelopment and
social services,\1 were intended to revitalize the distressed areas.
In December 1994, 9 EZs and 95 ECs were designated in the first round
of this program. The Taxpayer Relief Act of 1997 provided a second
round of the program and authorized the designation of up to 22
additional EZs--2 additional first-round EZs and up to 20
second-round EZs. Parts of Cleveland, Ohio, and Los Angeles,
California, have been designated by the Department of Housing and
Urban Development as the two additional first-round EZs, to be
effective on January 1, 2000. The remaining 20 second-round EZs are
to be designated by January 1, 1999, by the Department of Housing and
Urban Development and the Department of Agriculture.\2
The Omnibus Budget Reconciliation Act of 1993 established three tax
incentives that are designed to lower the cost of doing business in
an EZ or EC: (1) a tax-exempt enterprise zone facility bond, (2) an
employment credit, and (3) an increase of $20,000 in the expensing
allowance for depreciable business property authorized under section
179 of the Internal Revenue Code. While both EZs and ECs can use the
tax-exempt facility bond incentive, the two remaining tax incentives
are available for use only in the EZs. For the first 5 years of the
EZ/EC program, the dollar value of these tax incentives was estimated
to be $2.5 billion.
Enterprise zone facility bonds were authorized for the EZ/EC program
as a new category of tax-exempt private activity bonds offering lower
rates to businesses than conventional financing. These bonds can be
used by EZ/EC businesses to finance business property and land, as
well as to finance new facilities or the expansion or renovation of
existing facilities. However, like most private activity bonds, they
are subject to an annual private activity bond volume cap that is
established for each state.\3 Additionally, the aggregate face amount
of these bonds for each qualified EZ/EC business may not exceed $3
million per EZ or EC and $20 million for the same business in all
zones nationwide. The authorizing legislation requires each business
that benefits from these bonds to ensure that at least 35 percent of
its employees are residents of an EZ or EC, as well as to comply with
other financing rules.
The EZ employment credit is a credit for up to 20 percent\4 of the
first $15,000 in wages paid to a resident of the zone who also works
in the zone. This is a maximum tax credit of $3,000 per year for
each employee who lives in the EZ and works for an EZ business.
Section 179 of the Internal Revenue Code allows businesses to recover
the cost of certain depreciable property, such as equipment and
machinery, by deducting all or part of the cost in the year that the
property is placed in service rather than over several years. For
qualified EZ businesses, however, the limit is $20,000 above that set
for other businesses, currently $18,500 per year.\5 This additional
$20,000 expensing deduction can be used for all qualifying EZ
property and lowers capital costs for EZ businesses by allowing them
to deduct the cost of an asset in the year it is purchased, up to the
limit for that year.
Individuals and businesses use three different forms to report data
to IRS on their use of the three tax incentives. Enterprise zone
facility bonds are reported only once, within about 45 days after the
quarter in which they are issued, on Form 8038--Information Return
for Tax-Exempt Private Activity Bond Issues--by the state or local
governmental unit that issues the bonds. An individual or business
uses Form 8844--Empowerment Zone Employment Credit--to claim the
20-percent wage credit and uses Form 4562--Depreciation and
Amortization--to claim the additional expensing allowance. Both of
these forms are filed with the regular tax returns each year.
IRS has two principal sources of tax data that it uses for analysis.
The first is an electronic master file system, which includes a
business master file and an individual master file, each of which
contains selected line-item data reported on IRS tax forms from
businesses and individuals. The second is a set of data files based
on a sample of tax returns maintained by IRS' Statistics of Income
(SOI) Division.\6 IRS maintains selected information on the EZ/EC
program's tax incentives in its business and individual master files
and in the SOI samples for tax years 1994 through 1996.
--------------------
\1 Federal grant funding came from amending title XX of the Social
Security Act to authorize the special use of Social Services Block
Grant funds for the EZ/EC program. The allotted funds are granted by
the Department of Health and Human Services to the state, which is
fiscally responsible for the funds.
\2 The Taxpayer Relief Act of 1997 also designated parts of the
District of Columbia as an enterprise zone eligible for many of the
same tax incentives as the EZs.
\3 Under current law, each state has the authority to issue
tax-exempt private activity bonds in an amount equal to $50 per
resident. If a state's population results in the authority to issue
less than $150 million, the state's allocation is automatically
raised to $150 million.
\4 The credit will be reduced by 5 percentage points per year
starting in 2002 for the nine initial EZs and in 2005 for the two EZs
that were designated in January 1998.
\5 The limit for this deduction--which was $17,500 until 1997--will
be raised in annual increments until it reaches $25,000 for the years
after 2002.
\6 SOI designs and draws statistical samples of tax returns, extracts
and edits data from the returns, weights the data to represent the
universe of sampled returns, and provides these data in tabular and
other forms with supporting material to users inside and outside the
federal government. SOI's data are used primarily to analyze federal
tax policy.
RELIABLE DATA ARE CURRENTLY
AVAILABLE FOR ONLY ONE OF THE
THREE EZ/EC TAX INCENTIVES
------------------------------------------------------------ Letter :3
We obtained information on the use of tax-exempt facility bonds from
IRS, as well as from officials responsible for keeping track of such
bonds in the District of Columbia and the states. However, no
reliable data are currently available on EZ businesses' use of the
employment credit or the additional expensing allowance for
depreciable business property.
EIGHT TAX-EXEMPT FACILITY
BONDS HAVE BEEN ISSUED
---------------------------------------------------------- Letter :3.1
Enterprise zone facility bonds have been used eight times since 1995.
IRS' data show that three enterprise zone facility bonds totaling
$7.2 million were issued in 1995.\7 Our survey of officials from the
District of Columbia and all 43 states with EZs or ECs confirmed IRS'
data for 1995 and showed that five other enterprise zone facility
bonds have been issued--one in 1996, two in 1997, and two in 1998.\8
These eight bonds, totaling $17.7 million, ranged from $1.2 million
to $3.0 million and were for a variety of projects, including a
convention hotel project, a uniform rental project, and a residential
finance project. In addition, since 1995, four states each received
an application for an enterprise zone facility bond that was either
not approved or was approved but not issued. Table 1 provides more
information on the bonds that were issued.
Table 1
Enterprise Zone Facility Bond Issues
(Dollars in millions)
Date of Name of issuing authority and/or
issue Location Amount project
------- --------------- -------------- --------------------------------------
Aug. 9, Detroit, MI $3.0 Michigan Strategic Fund--Mechanics
1995 Uniform Rental Project
Nov. Waco, TX $3.0 Central Waco Development Corporation-
20, -Central Texas Convention Hotels 1
1995 Project
Dec. Cordele, GA $1.2 Crisp County Cordele Industrial
21, Development Authority--Florida Seed
1995 Company
Sept. San Diego, CA $3.0 California Statewide Communities
19, Development Authority--JTF
1996 Enterprises/Figi Graphics
Mar. Albany, GA $3.0 Albany/Dougherty County Payroll
21, Development Authority--Flint River
1997 Services, Inc.
June Rosedale, MS $1.9 Jimmy Sanders, Inc.
19,
1997
Jan. Atlanta, GA $1.4 Urban Residential Finance Authority--
29, Black Bear Apartments
1998
Apr. 9, Wilmington, DE $1.2 City of Wilmington--Loans to Lenders
1998 program
--------------------------------------------------------------------------------
Source: GAO's survey of state officials who track state volume caps
for private activity bond issues.
--------------------
\7 At this time, IRS has data on enterprise zone facility bonds from
1995--the first full year after the EZs and ECs were designated. IRS
has not yet completed its computer processing and analysis of the
original information in returns for bonds issued in 1996 and 1997.
IRS officials expected the 1996 bond data to be processed in the
summer of 1998 and the 1997 bond data to be available in the spring
of 1999.
\8 Although our survey did not ask why these bonds were not used more
extensively, three respondents said that the requirements were so
restrictive that companies were discouraged from using the bonds.
EZ EMPLOYMENT TAX CREDIT
DATA ARE NOT YET AVAILABLE
FROM IRS
---------------------------------------------------------- Letter :3.2
According to Treasury and IRS officials, data from sampled returns of
qualified EZ businesses on their use of the employment tax credit
during tax years 1994, 1995, and 1996 are not reliable.\9 For
example, SOI officials said that the number of returns in their
samples (for corporations and individuals) for tax year 1996 that
included an Empowerment Zone Employment Credit Form 8844 was too
small for a reliable estimate of the use of this tax incentive. They
noted that the samples are not drawn to project business activity in
the EZs. Specifically, the preliminary data sample of about 90,000
returns from corporations included only 100 returns with a Form 8844,
while the sample of about 115,000 individual returns (some business
owners may also claim this credit) included only 28 returns with a
Form 8844. In addition, according to information in IRS' business
master file, in processing year 1997 only 340 corporations claimed
the EZ wage credit out of about 5 million corporations. When IRS
officials compared the EZ wage credit data from these 340 returns
with the data from the 100 returns in their preliminary corporate
sample, they found inconsistencies between the two sets of data,
raising questions about the reliability of the data.\10
IRS officials told us about possible reasons for these
inconsistencies. For example, they said that the corporate tax
returns that could include a Form 8844 are not checked as extensively
for consistency during IRS' processing as the individual returns that
include the form; therefore, the data on the EZ wage tax credit
entered from individual returns into the individual master file are
considered more accurate than the data entered from corporate returns
into the business master file. Specifically, they said that the tax
data reported for the EZ employment credit on an individual tax
return are checked for consistency with the data reported for the
other credits listed on the same form, while the data reported on a
corporate return do not undergo such a check. Treasury officials
also pointed out that the IRS staff who code and edit data could
overlook the Form 8844 when they enter data from large corporate tax
returns.
IRS officials also told us that the agency will soon issue a
management control directive to alert responsible IRS executives and
managers to problems associated with the EZ employment tax credit
data in the business master file and to indicate what steps managers
should take to address these problems. Problems identified in the
directive include the omission of EZ tax credit data, reported on
original returns, from the business master file; and the incorrect
entry of data from the original returns into the business master
file. In addition, the EZ tax credit amounts were inconsistently
entered into the business master file from the tax returns,
preventing the master file from being useful as a source of data for
the corporate population. In response to this situation, the
proposed control directive calls on IRS executives and managers to
improve the quality of the data by regularly monitoring the master
file's products and conducting follow-up training at IRS service
centers as needed. Managers are also to ensure that the instructions
for processing the EZ employment credit are clear and consistent.
Other actions to improve the data available on the EZ employment
credit include the following:
-- To better analyze the recent and upcoming use of the EZ wage tax
credit, SOI started a master list of all corporations with
returns in the business master file or in the SOI files that
claimed this credit in processing years 1995 through 1998. SOI
will add the corporations with tax returns processed in 1999 and
use the resulting list to analyze returns from these potential
users of the EZ credit. Using actual tax returns will allow SOI
to analyze the use of this EZ wage tax credit and to verify the
accuracy of the data in SOI's master lists.
-- In February 1998, SOI requested the processing year 1997
corporate returns for the 340 businesses that, according to the
business master file, claimed the EZ wage tax credit. As of May
1998, SOI had received 245 of these returns, which the division
was reviewing to evaluate, among other things, the accuracy of
the business master file's data for the EZ wage tax credit, as
well as to provide data on the credit's use.
-- Beginning in January 1999, the business master file will include
additional data that will facilitate the identification of
corporate returns that include the Form 8844.
--------------------
\9 Each of SOI's annual samples of corporations covers returns with
accounting periods ending between July 1 and June 30. For example,
SOI's sampling for tax year 1996 covers corporations whose accounting
period ended between July 1, 1996, and June 30, 1997. However, the
information entered into IRS' master file system uses a different
time frame, called a processing year. This processing year follows
the year for which the tax returns were filed. For example,
processing year 1996 is for tax returns filed for 1995. Corporate
returns will be part of the processing year in which they are
received.
\10 A similar comparison of the processing year 1997 EZ wage credit
data from the 1,128 returns in the master file for individuals with
the 28 returns in the sample for individuals found relatively few
inconsistencies.
IRS DOES NOT HAVE RELIABLE
DATA ON THE ADDITIONAL
EXPENSING ALLOWANCE
---------------------------------------------------------- Letter :3.3
IRS officials reported that none of the information on expensing and
depreciation that businesses or individuals file on Form 4562
(Depreciation and Amortization) is computerized and entered into a
master file. Therefore, IRS' master files do not indicate which or
how many returns include a Form 4562. When SOI samples tax returns
and examines the originals, it identifies those that include a Form
4562. However, according to SOI, the information from such sampling
is not reliable for estimating the use of this tax incentive because
the tax incentive occurs infrequently and the sample is not drawn in
order to project information for businesses in the EZs.
In a review of SOI's corporate sample for tax year 1996, IRS
identified 124 returns with expensing deductions large enough to
indicate that they might be eligible for the additional EZ expensing
allowance. According to an IRS official, a further review indicated
that almost none were, in fact, eligible because of errors in
taxpayers' calculation and reporting of the additional EZ expensing
allowance. Treasury found similar results for the tax year 1995
individual returns, identifying only six returns that claimed the
additional EZ expensing allowance. However, a closer review of these
returns indicated that they did not appear to claim the additional
allowance. IRS officials considered these results too small to
project reliably to all EZs. IRS officials added that it was not
feasible for them to identify all of the returns claiming the
additional expensing allowance because data from Form 4562 are not
entered into the master file and a manual review of all tax returns
is not possible. IRS does not plan to make any changes to its
operations to improve its identification of returns claiming the EZ
expensing benefits.
AGENCY COMMENTS
------------------------------------------------------------ Letter :4
We provided copies of a draft of this report to IRS and the
Department of the Treasury for their review and comment. We received
comments from both agencies, including comments from the Chief of the
Corporation Research Section in IRS' Statistics of Income Division
and the Director of Treasury's Office of Tax Analysis. They
generally agreed with the information presented in the report but
provided a number of technical corrections, such as suggesting the
use of the term "expensing" to distinguish the additional section 179
expensing deduction provided to EZs from other types of deductions
for depreciation. We have incorporated their comments where
appropriate.
SCOPE AND METHODOLOGY
------------------------------------------------------------ Letter :5
To determine the extent to which the three EZ/EC tax incentives have
been used, we interviewed IRS officials responsible for analyzing tax
data and Treasury officials involved in studying and analyzing EZ/EC
tax information. We reviewed the tax forms and instructions used to
report data for these tax incentives, as well as preliminary data
from IRS on the EZ employment tax credit. We reviewed other relevant
reports and documents, such as related GAO reports and testimonies;
agencies' publications, studies, and materials; enabling
congressional legislation with accompanying reports and testimony;
and articles from the private sector on these tax incentives.
To obtain more recent data on the extent to which qualified
enterprise zone facility bonds have been issued, we surveyed
officials responsible for keeping track of the private activity bond
volume caps in the District of Columbia and in each state that
contains at least one EZ or EC. We compared IRS' 1995 data on
enterprise zone facility bonds with the states' data, and the
information was the same. We performed our work in accordance with
generally accepted government auditing standards from October 1997
through May 1998.
---------------------------------------------------------- Letter :5.1
As agreed with your offices, unless you publicly announce its
contents earlier, we plan no further distribution of this report
until 10 days after the date of this letter. At that time, we will
send copies to the appropriate congressional committees, the
Secretary of the Treasury, and the Commissioner of Internal Revenue.
Copies will be made available to others upon request.
Please call me at 202-512-7631 if you or your staff have any
questions. Major contributors to this report are listed in appendix
I.
Stanley J. Czerwinski
Associate Director, Housing and
Community Development Issues
MAJOR CONTRIBUTORS TO THIS REPORT
=========================================================== Appendix I
Nancy Boardman
Bess Eisenstadt
Kim Hutchens
Joan Mahagan
John McGrail
Pat McGuire
Hattie Poole
Nancy Simmons
Jim Wozny
*** End of document ***