On May 14, 2020, South Carolina enacted the Workforce and Senior Affordable Housing Act (the “Act”), which created a state tax credit for owners of qualified low-income buildings (the “State Credit”). The State Credit is based on the federal low-income housing credit provided in Section 42 of the Internal Revenue Code (the “Federal Credit”). The State Credit is available for qualified projects placed in service between January 1, 2020 and December 31, 2030, is equal to the Federal Credit, and may be carried forward for five (5) years. Significantly, the State Credit may be used to offset SC bank taxes, in addition to SC individual or corporate income taxes, corporate license fees, and insurance premium and retaliatory taxes.
On March 1, 2021, the South Carolina Department of Revenue (the “Department”) published SC Revenue Ruling #21-5 (“Ruling 21-5”), which provided additional guidance regarding the State Credit.
In Ruling 21-5, the Department confirmed that the State Credit cannot be freely sold or transferred to a third party, but the State Credit can be disproportionally allocated among the partners of a partnership owning the qualified project in any manner agreed to by such partners, regardless of whether a partner is allocated any portion of the Federal Credit.
Based on this language, it appeared that the State Credit could be disproportionately allocated to investors of a State Credit fund (such as banks and insurance companies). For instance, a bank could purchase a 1% membership interest in a State Credit fund in return for 100% of the State Credits awarded to the project. However, a footnote explained that because the Act did not include explicit language to allow an allocation that is treated as a “disguised sale” under federal law (like the express language contained in the SC abandoned building credit), such an allocation would not be permitted.
Fortunately, on May 17, 2021, SC Governor Henry McMaster signed S.B. 677 into law, which supplemented the Act by stating the following:
A tax credit earned by a partnership or limited liability company taxed as a partnership pursuant to Section…12-6-3795…, including any unused credit amount carried forward, may be passed through to the partners or members and may be allocated among any of its partners or members on an annual basis, including, without limitation, an allocation of the entire credit to any partner or member who was a partner or member at any time in the year in which the credit or unused carryforward was allocated. The allocation must be allowed without regard to any provision of the Internal Revenue Code, or regulation promulgated pursuant to it, that may be interpreted as contrary to the allocation, including, without limitation, the treatment of the allocation as a disguised sale” (emphasis added).
While the contradictory footnote in Ruling 21-5 has not yet been superseded or repealed, this statutory change suggests that South Carolina will respect a disproportionate allocation of State Credits to an investor in a State Credit fund that is categorized as a “disguised sale” for federal income tax purposes.
This statutory change may create an opportunity for SC taxpayers (such as banks subject to the SC bank tax or insurance companies subject to the SC premiums tax) to invest in a State Credit fund and receive a disproportionate allocation of State Credits through a “disguised sale.”