Board Of Aldermen - Minutes - 11/26/2018 - P20
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Chapter 1
Basics of Tax Credit Finance
‘Tax credits are a form of investment by federal, state, or local governments, and provide
important incentives to eligible businesses, nonprofit organizations, and developers to
develop projects. The goal of this Guide is to introduce readers to tax credit financing, types
of tax credits available, and strategies and techniques for enhancing the value of tax credits.
Finally, and importantly, this Guide also provides examples and case studies where creative
tax credit financing structures and techniques were used to develop communities across the
United States.
What is a Tax Credit?
A tax credit is a dollar for dollar reduction of a taxpayer's tax liability. It is different from a deduction, which is a reduction
of a taxpayer's income subject to tax, on which the taxpayer's ultimate tax liability will be determined. Tax credits can be
used to reduce both federal taxes and state taxes (if authorized by state legislatures).
Example
Ifa cn has $100,000 of taxable income at the 35% income tax bracket (i.e., the highest rate for individuals), a
$1,000 deduction is equivalent to a tax savings of $350 (i.e., $1,000 x 35% or, more explicitly: $100,000 x 35% =
$35,000 of tax vs. $99,000 x 35% = $34,650. $35,000 - $34,650 = $350). However, a $1,000 tax credit results in a
$1,000 tax savings ~ regardless of tax bracket.
‘Thus, a key condition that must exist in order for tax credits to be valuable is that the taxpayer must have taxable income.
However, certain types of tax credits are “refundable,” which means that a taxpayer can receive a payment from the taxing
authority to the extent that the taxpayer's tax liability becomes “negative” after factoring in a tax credit.
Example
If a taxpayer's income tax liability before application of a $1,000 refundable tax credit is $800, the taxpayer will be
eligible for a $200 refund after application of the tax credit (i.e., $800 - $1,000 = negative $200).
Viewed differently, both tax deductions and tax credits are different forms of government subsidies used to reward or
encourage certain activities (e.g., home mortgage interest, child care expenses),
Example
Ifa taxpayer in the 35% bracket has a choice between leasing a home for $1,000/month vs. purchasing the home for
interest-only payments of $1,500/month, the taxpayer may choose to purchase because the taxpayer's after-tax cost to
purchase is $975/month because of the home mortgage interest deduction ($1,500 x 35% = $525 and $1,500 - $525 =
$975).
Example
Ifa taxpayer pays $5,000 for child care and receives a $1,000 tax credit, the taxpayer's after-tax cost is reduced to $4,000.
A tax credit is a government vehicle designed to encourage investment in certain socially or economically favored
industries or activities. They accomplish important public policy objectives by encouraging the private sector to provide
social benefits through projects that probably would not be developed but for the tax credits. Accordingly, tax credit
programs are intended to promote “public-private” partnerships in order to accomplish the goals of Congress. As
illustrated above, although tax credits are available to both individuals and businesses, these important public policy
goals with tax credits are achieved by developing tax credit programs designed for businesses to utilize. Unless otherwise
indicated, this Guide deals with non-refundable business federal tax credits.
‘Tax credits, while they come in many forms, are authorized incentives under the Internal Revenue Code (and some state
tax codes) to implement public policy. Congress, in an effort to encourage the private sector to provide a public benefit,
allows a participating taxpayer a dollar for dollar reduction of their tax liability for investments in projects that probably
would not occur but for the credits,
Tax Credit Finance Reference Guide
Council of Development Finance Agencies
