The District of Columbia enacted emergency legislation that significantly curtails incentives for Qualified High Technology Companies (QHTCs). The move comes less than a year after the District began requiring taxpayers claiming QHTC status to provide additional information when certifying for various QHTC tax benefits, such as historical benefits claimed by the taxpayer and employment data pertaining to D.C. residents. The legislation also coincides with the Office of Tax and Revenue’s recent flurry of QHTC audit activity. These events seem to reflect, at the very least, the District’s belief that the program has not fully met the desired expectations.
The changes to the QHTC program were enacted as part of the District’s Fiscal Year 2020 Budget Support Emergency Act of 2019, which took effect on July 22. The same day, D.C. Mayor Muriel Bowser also signed into law the Fiscal Year 2020 Budget Support Act of 2019, which generally mirrors the emergency legislation. However, the Budget Support Act must undergo congressional review prior to becoming effective.
Three changes have been made to the QHTC program, all of which are significant for taxpayers currently claiming QHTC status. Below is a breakdown of these three changes and how they impact taxpayers.
- The replacement of the reduced 6.0% corporate franchise tax rate for QHTCs with a temporary corporate franchise tax credit
Arguably the most notable of the changes to the QHTC program is the elimination of the reduced corporate franchise tax rate. QHTCs subject to the corporate franchise tax have historically enjoyed a reduced 6.0% tax rate. However, for tax years beginning after December 31, 2019, a QHTC will be subject to the normal corporate franchise tax rate of 8.25%. Despite removing the reduced corporate franchise tax rate, the legislation kept the five-year exemption from the corporate franchise tax for QHTC’s intact. The permanent rate reduction was also replaced with a temporary corporate franchise tax credit. The new credit can be claimed for five years in an amount equal to the lesser of $250,000 or the difference between the tax imposed under the regular and reduced 6.0% corporate franchise tax rates.The legislation effectively changes the 6.0% corporate franchise tax rate from a permanent rate reduction to a five-year temporary rate reduction up to $250,000 for each taxable year. For newly certified QHTCs and QHTCs that are still within the five-year corporate franchise tax exemption period, the credit will be allowed for the five taxable years after the expiration of the five-year tax exemption. For QHTCs for which the five-year exemption has expired and are currently subject to the corporate franchise tax at the reduced 6.0% rate, the five-year credit will begin with the first taxable year beginning after December 31, 2019.
- A reduction to the QHTC corporate franchise tax credit for wages paid to qualified employees
The second change to the QHTC program also impacts the corporate franchise tax. The legislation has limited the QHTC corporate franchise tax credit for wages paid to qualified employees. Under current law, a QHTC can claim a credit for the lesser of $5,000 or 10% of the wages of a qualified employee each taxable year during the first 24 months of the individual’s employment. Any unused credit can be carried forward for 10 years. Effective for taxable years beginning after December 31, 2019, the Fiscal Year 2020 Budget Support Emergency Act of 2019 decreases the credit for wages paid to qualified employees from 10% to 5% of the wages paid during the first 24 calendar months of employment. Further, the maximum credit for each qualified employee in a taxable year has been reduced to $3,000. Finally, the 10-year credit carryforward will no longer be allowed for any qualified employee hired after October 1, 2019. The impact of this change means that a QHTC will no longer be able to generate qualified wage credits during the five-year exemption period, as the credit carryforward has been removed. It is important to note that the legislation did not change a QHTC’s ability to claim other employment-based credits, namely (1) the credit for retaining costs for qualified disadvantaged employees; (2) the credit for wages paid to qualified disadvantaged employees; and (3) the credit for certain relocation costs.
- The repeal of certain sales tax exemptions for QHTCs
The legislation removes the two sales tax exemptions afforded to a QHTC. First, otherwise taxable sales made or services performed within the District by a QHTC of certain intangible property are no longer exempt from sales and use tax. Thus, a QHTC will be required to begin collecting the District’s tax on these previously exempt transactions. This includes, but is not limited to, a QHTC’s license or subscription to software-as-a-service or other software products, information services, digital product, and data processing services. Second, the District has repealed the sales and use tax exemption for purchases made by a QHTC of computer software or hardware used in connection with the operation of the QHTC. Both of the changes to the sales tax law are effective October 1, 2019.
Despite the 2020 Budget Support Emergency Act removing some key benefits available to QHTCs, the program can still result in significant tax savings to certain taxpayers. The five-year corporate franchise tax exemption remains in effect, and the qualified wage credit can still lead to a material reduction in tax to a QHTC expanding its workforce. Further, the 10-year personal property tax exemption was untouched.
As was the case before the legislative change, it is still crucial that a taxpayer consult with a tax advisor about the requirements that must be met to certify as a QHTC and the extent of the anticipated benefits. These benefits are greatly impacted by the District’s unique tax treatment of pass-through entities, as well as the potential tax treatment and incentives that the surrounding jurisdictions may offer.
If you have any questions regarding the District taxation of QHTCs, please contact your Aronson tax advisor or Michael L. Colavito, Jr. at 301.231.6200.