In 2005, the authors produced a public policy report for the National Trust for Historic Preservation on state tax credits for historic preservation. At that time roughly half the states in the country had laws creating historic tax credits. Many were relatively new. That report attempted to address the question, why do some state credits work better than others? The report also provided guidance to states adopting tax credit laws for the first time and to those attempting to improve existing statutes that were producing mixed or minimal results.
At this writing, 34 states have historic tax credit programs in place. This article will focus on the nine of them that have provisions in their laws that, in varying degrees, make such credits refundable. The nine states include Iowa, Kentucky, Louisiana, Maine, Maryland, Minnesota, Mississippi, New York, and Ohio. Refundability exists where the holder of a tax credit has the option of claiming a refund from the state in the amount by which the credit exceeds that holder’s tax liability to the state.
A state tax credit typically has value only to the extent that the credit holder has sufficient liability for state taxes that the credit can be used to offset. Although state tax rates vary, they are far lower than federal income tax rates. As a consequence, an apparently valuable state tax credit may wind up in the hands of a party unable to use it.
Refundability directly addresses this problem by making the state tax liability of the credit holder irrelevant. The amount by which the credit exceeds the holder’s state tax liability is returned to the holder in the form of a refund check from the state treasurer.
The Federal Penalty
Unlike the federal tax credit, which is not taxed by the federal government, state tax credits in almost all cases are subject to federal income tax at ordinary income rates. The problem is not unique to refunds. It applies as well to the transfer of state historic [End Page 29] tax credit certificates, where such transfer is permitted, and to credits passed through to partners and other pass-through entities that are recipients of the credits. Although strategies have been devised to avoid the penalty, they are complex and are economically feasible only for large projects with sophisticated investors.
Why are Some State Refundability Provisions More Promising than Others?
This article addresses the question, why do some refundability provisions appear more likely to work than others? In answering this question, based on our examination of the statutes of the nine states with refundability provisions, and to the extent possible, their experience with refundable credits, we have attempted to identify those factors that impact negatively and positively on the effectiveness of those provisions. The following two factors appear to be the most important:
■. The existence of significant statutory limitations on the dollar amount of credits that may be issued annually in the aggregate, and/or for any single project.
■. Limitations on the amount refundable and restrictions on the manner in which the refund may be claimed.
Not included in this short list is the rate of the credit. The rate is calculated as a percentage of the amount expended on the appropriate rehabilitation of a historic property. Each of the nine states examined provides a base credit in the range of 20 to 25 percent. Minnesota sets its rate at 100 percent of the federal credit, which is 20 percent, and requires that the federal credit be awarded. In the event that the federal credit is not used, Minnesota will award a state grant equal to 90 percent of the amount that a federal credit would have provided.
Maine also fixes its somewhat more generous credit by referencing the federal credit, but setting the percentage at 25 percent, and providing the credit not only to taxpayers who use the federal credit but also to those who do not, provided that the latter incur appropriate expenditures in the $50,000 to $250,000 range.
Other states provide bonuses for types of projects favored by the legislature. Kentucky provides a rate...