Continued from Part 3 by May 20, 2013, By Robert Salazar, CPA – Tax Alliance Group, LLP
Another incentive businesses in enterprise zones should explore is the net interest deduction. In an effort to encourage business growth and development in enterprise zones, California Revenue and Taxation Code section 24384.5 allows taxpayers an interest deduction on loans (payments of indebtedness) made to a trade or business located in an enterprise zone. Because the taxpayer is allowed to deduct the full amount of the interest received, substantial tax savings can be achieved. The credit, however, is primarily geared toward banks and financial institutions.
Intent of the Net Interest Deduction
The net interest deduction is intended to provide taxpayers an incentive to invest in economically depressed areas. To receive the deduction, only three requirements must be satisfied. The first condition that must be met is that the trade or business receiving the loan must be located within an enterprise zone. The second condition requires that the indebtedness be incurred in connection with an activity within an enterprise zone. This means the borrower must use the loan proceeds in connection with her business in the zone. Finally, the taxpayer cannot have any ownership interests in the debtor.
Unlike the enterprise zone sales or use tax credit and the enterprise zone hiring tax credit, the net interest deduction requires the taxpayer to determine whether the borrower is in an enterprise zone. Most standard loan applications do not ask the borrower if they are in an enterprise zone. As a result, many loans that are eligible for the net interest deduction are overlooked. For medium and large financial institutions this missed opportunity can translate into significant tax over reporting. Therefore, lenders should consider including on their loan applications a location for the borrower to indicate whether they are in an enterprise zone.
For loans that have already been dispersed, the lender can contact the borrower and find out if the borrower is in an enterprise zone. If the borrower does not know whether they are in an enterprise zone, the lender can review the borrower’s address on the loan application. The lender can then call the local enterprise zone coordinator and find out whether the borrower’s address is within the zone. Alternatively, the lender can check the California Trade and Commerce Agency’s World Wide Web site to determine whether the borrower’s address is in an enterprise zone. The point is that with a little bit of resourcefulness a lender can participate in a tax savings opportunity.
The tax savings opportunities offered by the three enterprise zone incentives discussed above provide banks and corporations an opportunity to reduce their California income tax exposure. Businesses that are not taking full advantage of these incentives need to review their California tax strategies. This review can be very beneficial to the business and even uncover additional tax savings opportunities. The bottom line is that the enterprise zone sales or use tax credit, the enterprise zone hiring credit, and the enterprise zone net interest deduction can translate into meaningful California tax savings.