Partners (Winter 2000)
Partners (Winter 2000)
Work Opportunity Tax Credit Program
By J. Paul Compton, Jr.
Banks searching for innovative ways to meet their Community Reinvestment Act (CRA) obligations, particularly under the investment test, may have a new alternative to the tried and true approaches of affordable housing supported by low income housing tax credits, municipal bonds, and micro-enterprise equity.
The staff of the Board of Governors of the Federal Reserve System has determined that an investment in a limited liability company that would engage in the business of hiring, training, and leasing out the services of persons who are members of "targeted groups" under the provisions of the Internal Revenue Code for work opportunity tax credits is a "listed permissible activity" under Regulation Y. Opinion letter to J. Paul Compton, Jr., dated January 29,1999 (reproduced in CCH Banking L Rep. ¶ 80-284).
The program initiated by Financial Investors of the South, Inc., Birmingham, Alabama, and its wholly-owned subsidiary, Bank of Alabama, a State member bank, melds together potentially attractive after-tax investment returns, reinforces partnerships with local nonprofit institutions, and provides job training for disadvantaged persons.
Recognizing that businesses employ resources for the purpose of earning a profit and that the attainment of some public goals are inherently unprofitable, the government subsidizes these activities with tax credits. Work opportunity tax credits (WOTCs) under Section 51 of the Internal Revenue Code are intended to provide an incentive to companies for hiring disadvantaged workers such as recipients of food stamps. Credits are based on a graduated scale. After 400 hours are worked, the credit is equal to 40% of total wages paid. The maximum credit is equal to $2,400 per worker.
The WOTC incentive works like other business tax credits, such as low income housing tax credits under Section 42 of the Internal Revenue Code, in that a dollar of tax credits offsets a dollar of federal income tax liability. The Section 51 credit, which previously had a one-year sunset, was extended by Congress in 1999 until 2004. Banks historically have not been permitted to be equity investors in real estate developments. At the same time, government saw a need for affordable housing managed and financed through the private sector. Recognizing the opportunity for banks to fulfill some of their obligations under the CRA, regulators have permitted banks to become equity investors in projects supported by low income housing tax credits. In the early 1990s, many banks overcame the cultural gulf of being a real estate investor in affordable housing and now actively make equity investments in low- and moderate-income housing supported by the low income housing tax credit.
The key innovation of Bank of Alabama's WOTC program is the combination of employee training and nonprofit organizations. This is similar to the case of the low income housing tax credit, which establishes a preference for nonprofits serving as the general partner of the partnership owning the low-income housing development. The limited partner of the same partnership is a for-profit entity with a substantial tax burden that can use the credits. Thus, the establishment of public-private partnerships is encouraged. The parallel continues in that a third party may provide administrative services for the WOTC in much the same way that a property manager provides management for a low income housing tax credit development.
Here's how the program would work in a typical situation. The bank agrees to pay the wages and training costs in a qualifying employee situation arranged by a nonprofit. In turn, the bank receives a tax credit. The employer, nonprofit, or an outside party provides the actual employee training for a fee paid by the bank. The dollar outlay of the final wage itself is reimbursed to the bank by the employer. The incentive to the bank is that the value of the tax credit exceeds its net unreimbursed costs, including any fees paid to the nonprofit beyond training costs. Thus, the bank is able to combine an existing business practice in a way that creates an innovative, profitable, and community service oriented program. This program is not without risks, but there appear to be viable routes to mitigate these risks. Key advantages are that the program is portable - meaning that a bank's investment in WOTC programs can be targeted to almost any urban market - and scalable - meaning that the amount of investment may be as small or as large as desired by the bank. It is limited only by transaction costs and the number of qualifying workers available in the targeted locale (which number in the millions nationally). WOTCs are not restricted on a per capita basis or subject to allocation, unlike the low income housing tax credit.
Although the Federal Reserve generally doesn't address whether specific investments will qualify under the lending, investment, or service tests under the CRA, the Federal Reserve's authorization letter cited the community development activities section of Regulation Y. The program, as structured by Bank of Alabama, involves an investment in training and, depending on the training, might qualify under the CRA service test by providing financial skills training to the employee as well.
This multi-faceted program offers the possibility of a win-win-win situation for banks, nonprofit organizations and employers, and especially, disadvantaged workers.
J. Paul Compton, Jr., is an attorney with Bradley Arant Rose & White, LLP, Birmingham, Alabama. He is the Alabama Chariman of the American Bar Association Forum on Affordable Housing and Community Development Law.
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