IRS Guidelines Narrow Exclusion of State and Local Incentives for Developers


Section 118 provides an exclusion from the income of a corporation for capital contributions made by parties other than shareholders. For many years, developers utilized Section 118, particularly for urban renewal projects. State and local governments provided incentives that were treated as capital contributions to the development entity, which excluded them from income.

About five years ago, the Internal Revenue Service began a study of Section 118. It has since issued a number of public statements about that statute.

From what can be seen, the result of the Internal Revenue Service study was an institutional decision to narrow the exclusion as much as possible. There has been a series of announcements, most of which have focused on what is not available for exclusion.

The Internal Revenue Service recently issued two Audit Technique Guidelines that further the trend of narrowing the utility of Section 118. One states definitively that Section 118 is available only for a corporation, not for an LLC or a partnership. The other states that the Internal Revenue Service will not accept a gambit that has recently been in vogue, where a corporation utilizes Section 118 to deduct its state and local taxes, even though it receives abatements or reductions of those taxes.

If you are receiving state or local incentives in exchange for development, make sure you know the tax rules while you are planning the capital structure of the development entity.

IRS Circular 230 Notice

Internal Revenue Service regulations state that only a formal opinion that meets specific requirements can be used to avoid tax penalties. Any tax advice in this communication is not intended or written to be used, and cannot be used by a taxpayer, for the purpose of avoiding penalties that may be imposed on the taxpayer, because it does not meet the requirements of a formal opinion.

LOADING PDF: If there are any problems, click here to download the file.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

© Armstrong Teasdale LLP | Attorney Advertising

Written by:


Armstrong Teasdale LLP on:

JD Supra Readers' Choice 2016 Awards
Reporters on Deadline

"My best business intelligence, in one easy email…"

Your first step to building a free, personalized, morning email brief covering pertinent authors and topics on JD Supra:

Sign up to create your digest using LinkedIn*

*By using the service, you signify your acceptance of JD Supra's Privacy Policy.

Already signed up? Log in here

*With LinkedIn, you don't need to create a separate login to manage your free JD Supra account, and we can make suggestions based on your needs and interests. We will not post anything on LinkedIn in your name. Or, sign up using your email address.