Many states and localities give incentives for business to move or transact in their locations. There has always been a question of whether these incentives are taxable income under federal income tax law. Internal Revenue Code (IRC) section 118, as amended by the Tax Cuts and Jobs Act, P.L. 115-97, provides that “[i]n the case of a corporation, gross income does not include any contribution to the capital of the taxpayer….(b) For purposes of subsection (a), the term “contribution to the capital of the taxpayer” does not include—…(2) any contribution by any governmental entity or civic group (other than a contribution made by a shareholder as such).”

In a recent case, the US Tax Court ruled that certain cash grants given by the State of New Jersey fit squarely within IRC section 118, and were not taxable to the corporate taxpayer.Brokertec Holdings, Inc. v. Commissioner, T.C. Memo. 2019-32.

Brokertec Holdings is a financial services company based in Jersey City, New Jersey. It owns two subsidiaries whose office space in the World Trade Center was destroyed during the September 11 attacks. In searching for new office space, the subsidiaries ultimately chose to locate in Jersey City, in part due to cash grants from the New Jersey Business Employment Incentive Program (BEIP), a state program designed to attract businesses to locate in New Jersey.

In its consolidated tax returns for 2010 through 2013, Brokertec excluded a total of approximately $55.6 million in BEIP cash grants from its gross income, asserting that they were nontaxable as nonshareholder contributions to capital under IRC section 118. IRC section 118 provides that gross income does not include any contributions to the capital of a corporation. At the time, IRC section 118 and the regulations thereunder also generally provided that contributions to capital included contributions of property by a governmental unit for the purpose of inducing the corporation to locate its business in a particular community.

The Tax Court, applying precedent, stated that the key to determining whether a grant to a corporation is a nontaxable contribution to capital is the intent of the donor, and that the clear purpose of the BEIP grants was to induce the Brokertec subsidiaries to locate in Jersey City. The IRS attempted to distinguish prior precedents by arguing that an intent to induce a corporation to locate in a particular area exists only if the governmental unit requires the corporation to construct capital assets, such as factories, in that area. The Tax Court rejected this argument, stating that the governmental unit need only intend that the corporation bring economic benefits to the area, which included jobs and revitalization as well as capital assets. The Tax Court thus concluded that the BEIP grants fell squarely within the section 118 regulations and were nontaxable.

Practice Point

States and municipalities offer substantial economic incentives to corporate taxpayers to move and invest in their areas. Central to those decisions is the belief that these economic incentives are received “tax free.” Because of the change in the Tax Code by the Tax Cuts and Jobs Act, taxpayers have to be extra careful in the way those incentives are structured.