Property Tax Abatement Basics
roperty tax implications can have a significant impact on how and where a company chooses to grow. Economic tools such as property tax abatement can enable the company to offset some of its operational costs, and to apply those tax savings towards further investment and innovation.
Property tax abatement is a deduction in property taxes from the assessed value that a designated governing body places on the property. The deduction amount can be agreed to in the form of a phased or flat percentage schedule, or at a specific dollar amount over a predetermined period typically spanning 3 to 10 tax years.
PROPERTY TAX ABATEMENT OBJECTIVES
From a community’s standpoint, there are various objectives to offering property tax abatement:
- Incentivize growth now to increase the tax base later
- Promote diversification of the industrial base
- Provide employment opportunities (job creation)
- Attract companies within certain industries
- Provide economic stimulus to other business activities
The Q1 2017 Area Development Magazine Consultant’s survey shows 66% of site selection clients citing tax concerns as a primary reason for relocation and 75% of clients consider tax incentives (such as property tax abatement) as one of the most important incentives in making a location decision. This indicates property tax abatement is a tool that can be effectively used as a business attraction or retention tool when aligned with a company’s needs.
Primary Reason for Domestic Relocation
Area Development Annual Consultant’s Survey, Q1 2017
Most Important Types of Incentives when Making a Location Decision
Area Development Annual Consultant’s Survey, Q1 2017
PROPERTY TAX ABATEMENT IMPACT
In the U.S. there are over 90,000 local taxing units (counties, municipalities, townships, special districts, and school districts) in addition to the 50 state governments, which poses significant constraints on property tax data collection. While property tax at the state level accounts for less than 2% of states’ tax collection on average, it is responsible for 72.5% of revenue at the local level according to the Tax Foundation’s review of fiscal year 2014 U.S. Census Bureau data. The U.S. Census Bureau is able to compile the vast amounts of data and navigate data collection issues through surveying local governments and statistical sampling. According to data collected from the U.S. Census Bureau 2015 Annual Surveys of State and Local Government Finances (the most current combined state and local data available at the time this article was written), property taxes yield the largest combined state and local tax revenue of approximately 31.1%, followed by sales and gross receipts at 23.5%, individual income tax at 23.5%, excise taxes and other miscellaneous taxes at 18.2%, and corporate income tax at only 3.7%.
Property taxes tend to be higher in Northeastern states like New Hampshire and Vermont, and lower in Southern states. However, it should be noted that lower property tax rates can mean higher taxation of other tax types such as sales or income, and vice versa. Fourteen states have no state level property tax collection, but local governments tax property to some extent in all 50 states. Regardless of the tax jurisdictions, property taxes can be a large burden on businesses, and as a result can have a significant impact on location decisions. This tax environment has created opportunities for effective economic tools like property tax abatements to help reduce the tax burden for select companies.
TYPES OF PROPERTY TAX ABATEMENT
Real Property Tax Abatement
Real property tax abatements reduce the assessed values of certain land parcels or real estate improvements as a result of a project. Real estate improvements include property permanently affixed to land such as buildings and parking lots. While abatements could be structured to abate the tax on the land, the improvements, or both, we mostly see this program applied to the increased value of the improvements and not the land itself. Abatement percentages vary, and can include up to 100% of real property assessed values for a period up to a 10 years in most cases.
Personal Property Tax Abatement
Personal property tax abatements reduce the assessed values on equipment by designated governing bodies that are generally levied on business personal property. Qualified equipment for abatements can range from new manufacturing machinery to material handling and racking systems. Business personal property can also include qualified research and development equipment such as lab equipment, computers, telecommunications and testing equipment or property necessary for information technology. Just like real property tax abatements, personal property tax abatements can be applied to 100% of the increased assessed value, and typically range anywhere from 3 to 10 years.
Recent research from the Tax Foundation has found that state and local governing bodies have slowly but steadily been moving away from the taxation of personal property for years. While a large number of taxing jurisdictions still do so, it is anticipated that this growing shift away from personal property taxation will continue.
Although different from property tax abatement, there are a couple of other economic incentive tools designed to reduce or repurpose property taxation. These programs are not reviewed in detail in this article, but we have provided brief overviews for reference of alternatives to property tax abatement.
Property Tax Exemption
While tax abatements reduce the amount of taxes owed, tax exemptions fully reduce the assessed value of property to be taxed. In the case of a real or personal property tax exemption, taxes related to the property are partially or fully waived for a predetermined period of time. An exemption could be for up to ten years, or in some cases, for the life of the property (or until legislative changes occur). These exemptions may be statutorily restricted to specific types of property, or to certain types of property owners. Although it will vary by jurisdiction, we typically see full property tax exemptions for non-profit entities and for property owned and operated by a municipal corporation or other government entity using the property for public purpose. Partial property tax exemptions are more frequently seen for residential homeowners and businesses by jurisdiction.
Tax Increment Financing
A common alternative to property tax abatement or exemption is a Tax Increment Financing program or TIF. TIF can be found in all 50 states and is administered by local governments that designate TIF districts as areas targeted for development or redevelopment. The structure and exact use of TIF proceeds will vary by taxing jurisdiction and project, but future proceeds are used to either refund or divert a portion of property taxes to help finance a present day development on or near a project site. TIF is usually used to help pay for infrastructure improvements such as roads, parking areas, and sewers. However, in some instances the proceeds could be used to acquire land, demolish existing structures, or even help fund employee training initiatives. These funds are frequently made available by local government through the issuance of bonds. The bonds are then repaid over time with the increase in incremental property tax revenue realized as a result of the project development.
STRUCTURING PROPERTY TAX ABATEMENT AGREEMENTS
Short and long-term incentives are negotiated in an agreement between the company or developer and the designated governing body in the community. This is most often times a city, town, school district, or combination thereof. These agreements can be structured in many creative ways. An abatement can be an agreement to forgive a partial or full tax amount on the increased value over a period of time, defer the taxes to a later predetermined date, phase-in the full tax amount over a scheduled period of time, or even create a fixed payment for some or all of the tax revenue lost.
Here are a few examples:
EXAMPLE A: A company can receive a 50% property tax abatement for 10 years. This means that the company only pays half of the taxes they would normally owe on the increased assessed value during each of those ten tax years. For a capital intensive project, such as the development of a new manufacturing plant, this can be a substantial offset to the project costs to expand or relocate in a specific community.
EXAMPLE B: A company’s property tax on the increased assessed value can be phased in over time. A company may pay zero of the normal property tax in the first year, 20% in the second year, 40% in the third year, 60% in the fourth year, 80% in the fifth year, and then pay the full tax amount in year 6 and going forward.
EXAMPLE C: Tax abatements can also be structured to freeze current property taxes at a certain level for a specific period of time. In this example, improvements to the land such as new building construction or expansions that add value would not be taxed until the abatement period ends.
Property tax abatement awards are most often times a part of a comprehensive economic development incentives package designed by communities to increase the capital investment, quality jobs created or retained, and to attract new employers. It’s critical to note that property tax abatement, like many economic development incentives, is most often tied to anticipate economic impact and company performance in the binding agreement. Here are some conventional factors used by governing bodies when considering financial support for company expansion or relocation projects:
- Number of new jobs created
- Average wage of new jobs being created
- Total capital investment of the project
- Cost between expanding in a current location or relocating to another community or the cost difference between two competing communities for a new project
- The impact of the project on the state or local community
There are numerous strategies to structure property tax abatement as part of an overall economic development incentives package. A thorough understanding of the local governing body, including key decision-makers, policies, and motivating factors is the best way to obtain the most favorable economic development incentives package. Experts in economic development incentives can assist in advising the best overall strategies based on individual company priorities.
VIOLATION OF PROPERTY TAX ABATEMENT AGREEMENTS
There is an inherent risk in financing tax abatements and other economic incentives that the project will not yield the expected results. A tax jurisdiction may authorize property tax reduction or tax forgiveness now with the expectation of defined future job creation or retention, capital investment, or other improvements that will increase future tax revenues for the jurisdiction. Therefore, taking measures to tie the abatement incentive to company performance is an essential component of a successful tax abatement policy. The performance is agreed upon in a contract executed between the designated governing entity and the company. This contract will include certain milestones or thresholds for a company to achieve and maintain during the contracted project period of time. In the event a company does not meet the agreed upon performance, there are usually several different means of recourse:
Clawback: Recovery or repayment of a portion or all money already disbursed by a tax authority under the terms of the agreement.
Rescission: Complete cancellation of the incentives. This can be the cancellation of remaining incentives not yet disbursed, or all agreed upon incentives.
Penalty: Fines charged when firms do not meet a certain required level of performance or if they relocate. Penalties may be defined in the agreement as a fixed amount, a percentage of the amount of under-performance, or some other method.
Recalibration: Provision for changing the structure of the abatement in order to accommodate a change in the company or the economic climate. This option represents an effort to maintain some level of support for a project so that all parties can continue to benefit from the agreement.
Depending on the contract terms and expected economic impact of the project changes, a tax authority may implement any one or a combination of these methods. Repayment provisions safeguard the community and help ensure that its investment in the company results in the jobs and performance indicators that were agreed to and expected.
Regardless of how they are collected, property taxes are the largest source of combined state and local tax collection, and therefore are an important revenue tool for state governments and especially for local governments. It’s important to keep in mind that property taxes vary not only among states, but within states as well, with a tendency for higher property tax bills to cluster around urban and higher income areas. While property tax abatement is not the sole location decision driver, tax and regulatory environments are usually high on the list along with qualified labor force availability and cost, distance to market, and utility costs. The greater a business’s tax implications are in comparison to the other key site selection factors, the more effective tax abatement will be in influencing the site decision. With that in mind, a community’s ability to effectively utilize tax abatement could sway a company’s location decision.
Some states put off major changes to their tax codes in 2017 due to uncertainty regarding federal tax reform. Now that a federal tax reform bill was adopted, this has created both budgetary and legislative challenges, as well as increased tax revenues for state and local taxing units. This opportunity for state and local tax reform to make tax policies more competitive should drive much of the legislative conversation through 2018. Having a clear understanding of a municipality’s tax environment, tax abatement policies, and the positive and negative effects on a company’s location decision are essential pieces in a location modeling and site selection process.