COVID-19 Impact on Incentives — What Changes Are Needed and What Comes Next

While COVID-19 continues to affect the U.S. economy, the virus’s long-term impact on the fiscal health of the private and public sectors remains uncertain. Various iterations of federal government stimulus were enacted to support individuals and businesses nationally, yet many state and local governments are experiencing drastic reductions in tax revenue without a replacement revenue stream. In part because of limited stimulus funding to date, a growing number of businesses are struggling to maintain liquidity and operations. So the question must be asked: Despite revenue shortfalls, how can state and local governments support their operations while at the same time support the business community? Is this sustainable? While the long-term impacts are uncertain, one can glean from the evolving market that legislative and policy changes can provide key insights into how and if a rebound is possible.

The delicate balance of supporting the business community and maintaining a healthy fiscal policy continues to be important to policymakers. Many state and local budget agencies are feeling the impact of projected reductions in tax revenue. To be proactive, states are developing different policy approaches to both assist companies by alleviating cash flow shortages and encouraging businesses to continue to operate in the state. Because COVID-19 is an active pandemic, government departments are frequently issuing guidance and updates to adapt to the new economic environment. Since the onset of the pandemic, both state and local governments have enacted or amended legislation to combat the rise in unemployment across the nation, while accommodating the new work-from-home culture. Since the first quarter of 2020, states have seen their unemployment levels increase overall, despite an incremental employment increase in May and June following the initial economic shock of the pandemic. Many states have increased tax allowances for businesses to reduce tax obligations and decrease the economic hardships the business community is facing. However, many business decisions affecting state economies are outside government control.

While state and local governments are struggling alongside the business community, other matters are working their way through the economy. After government-mandated stay-at-home orders were relaxed or lifted, the ways in which business is conducted dramatically changed. Nationally, businesses are weighing the consequences of reopening in the traditional environment against their financial needs and the safety of their employees. Many businesses have opted for phased reopening or continued work-from-home allowances; few companies have chosen, or are able, to work at full capacity for several reasons. While making these changes, businesses are reevaluating their future and how best to model the working environment for their employees and are considering the following: work-from-home policies, the need for on-site personnel, the necessity of a corporate or support office, the salaries of employees who chose to relocate, the burdens of office restructuring, and the risk of using public transportation in metropolitan areas.

Questions abound. How will these new corporate policies affect existing incentive agreements? How will companies pursue incentives under this new paradigm? Will state and local economic development agencies adjust? How can state and local agencies continue to support business growth absent historical levels of tax revenue? These are the central themes of this article, as we provide insights into the evolving policy environment from a credits and incentives perspective. In the following sections, we identify examples of actions taken by governments and highlight when governments have yet to act or provide guidance. Either way, we are seeing two areas in which governments have acted: (1) new incentives to alleviate reopening expenses; and (2) amending existing incentive programs and providing administrative relief.

I. New Incentives Alleviate Reopening Expenses

On a limited scale, state and local governments are developing incentives to aid struggling businesses. In May Arkansas allocated $55 million in government spending to its Ready for Business grant program. This program aims to increase consumer and employee safety by funding Arkansas business expenses for health and safety equipment purchased from March 1 through December 31, 2020. Eligible businesses will receive grant funding for personal protective equipment, no-contact thermometers, no-contact point-of-sale payment equipment, and other items necessary for a safe reopening.¹

New York and Wisconsin have established programs to aid businesses in their reopening. New York is using the New York Forward Loan Fund to provide small business and nonprofit companies with funding as they reopen and make purchases to comply with new health and safety guidelines.² Wisconsin implemented the We’re All In grant program, a $50 million initiative providing direct assistance to small businesses with 50 or fewer full-time employees that have been affected by COVID-19. The grant money may be used to cover businesses’ operating costs, including wages, rent, and inventory.³

II. Amending Existing Incentives and Administrative Relief

While some states have responded to business needs by enacting new support programs, most have focused on administrative corrections, statutory filing extensions, and extended project commitments that are covered under a negotiated agreement.

A. Extending Incentive Filing Deadlines

Nebraska issued guidance to help companies unable to meet requirements of the Nebraska Advantage Act because of COVID-19. Nebraska businesses that do not meet the job creation requirements will not be penalized under the act if they can show that their failure was a direct result of COVID-19.⁴ Similarly, North Carolina attempted to minimize defaults in its Job Development Investment grant program by extending the reporting deadline. Grantees may request to shift thefirst grant year forward by one year, and to include home-office locations for the 2020 and 2021 grant years. Grantees have until January 31, 2021, to take the compliance relief.⁵

B. Allowing for Contract Renegotiations

State and local governments have also begun to allow businesses to renegotiate their incentive agreement requirements to provide additional time to reach the employment thresholds in these agreements. For some businesses, this means amending the definition of eligible employees to include those working from home. For others, it is an informal extension of the deadline to meet employment thresholds. Ultimately, the government will consider the benefit the business is bringing and the realistic expectations for growth in the current economic climate. Several jurisdictions are indicating a willingness to assist companies through this process, and many economic development agencies are inundated with requests at this time because of the economic conditions and the amount of employee furloughs that were put in place during the second quarter of 2020.

C. Sourcing Rule Considerations

Job-related income tax credits and negotiated incentives also are affected by the work-from-home environment. To address these issues, some state governments temporarily are amending payroll sourcing rules. Normally, payroll and withholding tax is allocated to the state where the service or employment is performed. However, this is becoming increasingly difficult to determine because many Americans are working from home. To adapt, some businesses have begun tracking employee location and changing withholding rates accordingly. However, many businesses are unable to commit the time and financial resources necessary to properly track employees. This struggle affects states that risk losing tax revenue if businesses cannot properly source their employees’ income. In response, some states have changed their sourcing requirements, while others have decreased payroll reporting requirements. New Jersey is allowing businesses to source their employees’ income based on the employer’s jurisdiction.⁶ These changes benefit businesses worried their employees working from home will not qualify for job tax credits. Oklahoma, on the other hand, has granted forgiveness to companies unable to meet the payroll requirements of the Oklahoma Quality Jobs Program Act. Under the recent Oklahoma legislation, businesses will still receive benefits under the act, even if an employee is working from home in another state.⁷

While these solutions are beneficial to businesses in the short term, they are not sustainable solutions. Oklahoma may be able to temporarily forgive payroll requirements, but the state will eventually need the revenue from payroll and withholding tax dollars. Further, New Jersey may be able to temporarily amend its laws and determine jurisdiction based on employer location, but for how long? Eventually, the state will need to conform with long-standing sourcing laws.

III. Responding to a Changing Environment

Several state and local incentive programs require employees to work on-site for a period of time to be eligible for benefits. The Texas Enterprise Zone Program (EZP) generally provides companies a sales tax rebate of $2,500 per employee eligible under the program.⁸ To be eligible, the company must create or retain jobs in Texas and spend at least $5 million in capital investment over a five-year period. The company benefit is capped at $1.25 million per location.⁹ The EZP requires all qualifying jobs to be filled by employees working on-site at the qualified business location for at least 50 percent of the time.¹⁰ In 2020 most companies participating in this program are not expected to be able to meet these commitments. While the on-site requirement may not have been an issue for businesses before the pandemic, it is now a great concern for businesses applying for, and participating in, the program. Program applicants and participants are reconsidering retaining or are postponing hiring new employees (which would have previously met program requirements for benefits) until employees can return to working on-site safely at the qualified facility. Most of these issues could be alleviated if the EZP allowed as eligible jobs those that would be on-site if not for COVID-19 restrictions. For now, many businesses are forced to reconsider the value of the EZP. The state has yet to provide guidance on this point, although it is expected in the upcoming legislative session. Meanwhile, dozens of companies are delaying filing for benefits, thus losing significant dollars otherwise helpful to sustaining operations.

Further, programs like Illinois’s economic development for a growing economy tax credit may be affected by alternative work policies. To qualify, businesses must increase job creation and capital investment in Illinois. Businesses with more than 100 worldwide employees may qualify if they: (1) create the lesser of 50 new full-time jobs, or the equivalent of 10 percent of the business’s worldwide employment; and (2) invest at least $2.5 million in the state. Businesses with 100 or fewer worldwide employees do not have to meet an investment threshold but must create the equivalent of 5 percent of the business’s worldwide employment. If eligible, businesses receive a nonrefundable income tax credit equal to 50 percent of the income tax withholdings from new jobs created in the state. Thus, job creation in Illinois directly affects the benefit received.¹¹ Before COVID-19, the number of Illinois jobs created could be determined by the number of employees working at an Illinois facility regardless of employee residency. Throughout the COVID-19 pandemic, employees accurately reporting time worked from home has made it more difficult to determine the number of Illinois jobs created and eligible for the credit. This becomes much more of an issue for Illinois businesses located near the borders with Wisconsin, Indiana, Missouri, or Iowa. Further, corporate headquarters operations that employ senior executives who may permanently reside in other states are affected. Businesses are asking themselves whether an employee staffed to the Chicago office, but working from home in Michigan, is deemed to have an Illinois job. Many companies will struggle with these issues as the compliance reporting begins in February/March 2021.

In Pennsylvania, businesses participating in the Keystone Opportunity Zone (KOZ) program receive state and local tax credits, exemptions, and abatements for actively conducting a business within KOZ boundaries.¹² The commonwealth manages this program to increase development in these distressed areas. In particular, the state and local income tax benefits are computed as an apportioned credit against the tax. The credit’s apportionment numerators are the property and payroll in the KOZ and the denominators are the total Pennsylvania property and payroll.¹³ Businesses that located in a KOZ did so with expectations of how the credit would be computed. However, with mandated stay-at-home orders and the limited ability to return on a full-time basis to traditional work locations, the treatment of the KOZ payroll apportionment may be in question. Does the payroll remain assigned to the original base of operations in the KOZ where the employee traditionally worked, or does it track the employee’s actual work location? The difference could significantly affect the credit calculation and the tax ultimately due. While the commonwealth has not provided specific guidance, it has indicated that if an employee worked in the KOZ physically before the COVID-19 restrictions, the payroll may still be sourced to the KOZ. An employee directed to work remotely after restrictions are lifted may not receive the same treatment and would need to rely on the business’s base of operations, or from where the work is directed or controlled. Like many other situations, a relatively simple analysis becomes more nuanced as mandated restrictions are gradually replaced with business-specific changes stemming from an evolving work environment.

IV. Conclusion: What Comes Next?

While most state and local governments continue to work in triage mode, it is helpful to step back to better understand what comes next. As mentioned earlier, many businesses were forced into an evaluation of the most effective way to manage their workforce. Coming out of the pandemic, companies will be evaluating real estate needs, work-from-home arrangements, and even where their employees need to be located to perform their jobs. How will traditional incentive programs be reconsidered in this context? Many states require employees to work on-site at a specific location for a specific number of hours, while others require employees to work in their state or be state residents. In states such as New York, how can a company that traditionally had 100 employees working in its Manhattan office, but now has 50 working from their homes in New Jersey and Connecticut, plan for incentives? How does this affect existing incentive agreements or even new agreements as they consider expansion?

All these considerations should be evaluated not only by businesses applying for state incentives, but also government policymakers. The issues presented in this article do not have easy answers, as many of these programs have long been in place and have history and precedent. Further, jurisdictions impose these requirements for a reason. Many programs like enterprise zones require on-site employees to encourage economic development in those areas. Residency requirements are put in place to create job opportunities for the state and drive state revenues. Governments are looking at the economic and fiscal impacts in return for providing such corporate benefits. The next struggle for policymakers is how to balance the two competing ideas of business and job creation with an understanding of rapidly evolving workforce needs and requirements.