Dave Stewart: Welcome to the podcast, I'm David Stewart, editor in chief of Worldwide Tax Daily. This week: New opportunities. We have talked a lot on this podcast about various aspects of the Tax Cuts and Jobs Act, but one area that remains ripe for development are the provisions on Opportunity Zones. My guest this week is Tax Notes Today Senior Legal Reporter Stephanie Cumings, who will walk us through the details. But before we begin, I would like to thank William Mitchell for suggesting this topic. Stephanie, welcome to the podcast.
Stephanie Cumings: Thanks for having me Dave.
Dave Stewart: Why don't we start with some background on what is this Opportunity Zone program?
Stephanie Cumings: First, I'd like to give a disclaimer, which is that the Opportunity Zone program has a lot of technical rules, and I've heard a lot of practitioners say this as well, which is that, I kind of want to stay big-picture on this, because I don't want to confuse anyone too much. So, starting with the background, this sort of began as the Investing in Opportunity Act, which was sponsored by Senators Tim Scott and Cory Booker. So it's sort of a bipartisan program that kind of got into the Tax Cuts & Jobs Act without a lot of people noticing it. I didn't really hear anything about it until sort of well after the bill had been passed, and then all of a sudden everybody was like, what's this about? Like, this could be huge, what's going on? I don't know how it escaped everybody's notice for so long, but now it's like the talk of tax.
Dave Stewart: So what is an Opportunity Zone? How does some area become an Opportunity Zone?
Stephanie Cumings: So basically, the government delegated this to state officials. I think it was governors, who pretty much pulled census data and designated different tracts of land. So all of that is sort of set in stone right now. The areas that are designated as Opportunity Zones has already been determined. It could obviously with future legislation be changed. But one interesting thing about the zones that were picked was that the census data that was used was sort of outdated. So a lot of the zones are actually areas that are doing pretty well. They were supposed to be low-income communities. Obviously, this is about attracting investment into those communities. But a lot of the zones, because the data was sort of out of date, are kind of already on the up and up, so that's been sort of one criticism of the program.
Dave Stewart: So how does this program work?
Stephanie Cumings: So there are three basic benefits. Basically, you can take capital gains and invest in these qualified opportunity funds, so you defer capital gains tax by investing in the funds. Now, at five years it reduces your capital gains tax by 10 percent, and at seven years it reduces it a further 5 percent. But the real big benefit is the 10-year benefit, so after 10 years any additional gains you got on the gains you initially invested are tax free. So no capital gains tax at all, and that's what has people really excited.
Dave Stewart: With any program of this size and with this sort of benefit, I would assume that there's a lot that wasn't spelled out in the legislation, so we're going to need regulations for that.
Stephanie Cumings: Yes, and fortunately we have some. So the first set of proposed regs came out last October along with a revenue ruling. And then, just on April the 17th, I think it was last Wednesday, we got the second set of proposed regulations, which we had been expecting for months. They were originally promised back in December, but now we have them. And so the other thing is that Treasury officials had previously confirmed to Tax Notes that there would be a third set of regulations. But now they're saying that they hope that the second set answers all the questions. Now, that remains to be seen. So they have said that there might be a third set of regulations, if they need it, but not so sure.
Dave Stewart: So walk us through, what answers did we get in the regs we have?
Stephanie Cumings: So basically, the goal of the regs seems to be to obviously provide clarity, but also a lot of flexibility. They're really trying to make this program kind of user-friendly to encourage people to invest. But there's also really a broad — I just want to highlight — there's a broad antiabuse provision in the newest set of regs that says basically abuse will be determined based on all the facts and circumstances. That sounds kind of broad to me. But basically, so there was a sort of controversial requirement in the first set of regs about the active business conduct rule, where basically a qualified Opportunity Zone business must derive at least 50 percent of its gross income from the active conduct of a trade or business within the Opportunity Zone. That's had people worried that that meant 50 percent of your sales have to be within the zone, and Treasury and the IRS kind of went way out of their way to confirm in the regs that that's not the case. They basically provided three safe harbors that are sort of based on hours worked in the zone or wages paid in the zone and also a facts and circumstances test. So it seems like meeting that rule is actually going to be not too difficult. Other kind of flexible provisions they added were a six-month grace period for deploying cash. So basically you won't be tested on this 90 percent asset test for at least sort of six months after you've been holding cash that you've raised. There's a new vacant buildings rule in the new set of regs that basically says, if a building has been vacant for at least five years, you can kind of consider that the original use of the building, almost if it had never existed. So that kind of counts as a good asset now. So there was also a request for information issued along with the newest set of regs that's on reporting. There's a lot of concern about tracking the effectiveness of this program. And so the request for information is basically asking how should we be doing that, how are we going to kind of monitor and figure out if this program is actually working.
Dave Stewart: So I understand the IRS held a hearing that you attended. Can you tell me about the hearing?
Stephanie Cumings: This was the most interesting hearing I've ever been to. The line was out the door, it was insane. The room, the auditorium holds about 200 people, I think. I think they had to turn people away. There were so many people there. There were over 20 people speaking. So they basically apologized to everyone that got turned away at the door. And the new hearing is actually going to be held at a separate location that I assume can hold —
Dave Stewart: I find that interesting because a lot of these hearings I've sent reporters to attend, they talked about going in there and the room being practically empty and there being only one speaker .
Stephanie Cumings: Right, that's pretty typical for IRS hearings, but this was nothing like that, and I think they were a little unprepared for it. There was a lot of testimony from people who are concerned about this program having the intended effect. Will this really help low-income communities? So there was a lot of talk about you need to institute guardrails. You need to repeal the program entirely, which is obviously outside of the IRS's power, but a lot of people are sort of fired up about this. It's a pretty political issue, which is why I think there were so many people there. There's also a lot of talk about that 50 percent active business conduct rule. That was kind of the main issue that people kind of kept harping on, and so that was clearly something that the regs addressed.
Dave Stewart: Alright, so the regs answered some of our questions. What are the other big issues out there that we should be keeping an eye on?
Stephanie Cumings: So, like I said, Treasury and IRS were hoping that this new set of regulations would answer most of the questions. But it's only been a few days, but I feel like the reaction is that there's going to be more questions. It might take time for people to sort of suss out what the specific questions are. But it seems like, especially in the area of partnerships, that there are going to be a lot of questions that still need to be answered. One thing officials kind of kept saying over and over again in the past few months was they're doing their best to harmonize the Opportunity Zone rules with the partnership rules. But it seems to be an area that's particularly challenging for them, and I don't think that this latest set of regs necessarily answered all of those questions
Dave Stewart: Now might the lack of guidance on some of these issues cause problems for people trying to invest in these Opportunity Zones?
Stephanie Cumings: That's been sort of the biggest outstanding issue here is that the program is live. The government wants people to start using it. They want people to start investing, but there are a lot of people who have still hesitated because they've been waiting on guidance. And so the big question is, now that we have this second set of proposed regulations, is that going to be enough guidance? Is that going to answer enough questions to get more people investing in the program? And I think that sort of remains to be seen. I've heard a lot of practitioners talking about developing their own rules of the road. And sort of saying like, well, we can't wait, we have to start going now. So let's come up with our own kind of what we think the regs are going to say, basically kind of a good-faith interpretation, and just hope that eventually the regs will confirm what we thought the rules would be. And I think in general the administration has been trying to really assuage people's fears, they get the sense to it. There have been a lot of officials out there talking to state and local government groups, and trying to encourage them to go ahead and invest in the program by saying don't worry about it, the rules are going to be favorable, they're going to be flexible. And that is sort of what we've seen. We've seen a lot of rules that are sort of favorable and flexible, but you kind of never know. I mean, you're out there on a limb making assumptions about what the regs would say. And at the end of the day, this is a program that is being criticized a lot for being potentially abusive, just being a way for people to sort of save money. And so, I think Treasury is also cognizant of making sure there are some antiabuse provisions, they're not letting people go too far. So it really has been a big problem. People want to start investing but there are sort of open issues.
Dave Stewart: Stephanie, this has been great. We'll definitely have to have you back as we get more answers on this. Thank you for being here.
Stephanie Cumings: Thanks, Dave.
Dave Stewart: And now, Coming Attractions. Each week we preview commentary that'll be appearing in the next issue of the Tax Notes magazines. We're joined by executive editor for commentary, Jasper Smith. Jasper, what will you have for us?
Jasper Smith: In Tax Notes, David Hariton argues that the BEAT fails to adequately target base erosion. And Phyllis Epstein considers whether an LLC taxed as a passthrough entity pays its owners in wages or guaranteed payment, in light of the 199A qualified business income deduction.
In State Tax Notes, Roxanne Bland considers the long history of treaties between Indian tribes and the U.S. federal government and reviews recent cases that have developed standards to evaluate treaty language. While Billy Hamilton looks at how cities have reacted to the phenomenon of electric scooter rentals.
And in Tax Notes International, Oliver Hoor analyzes the scope and mechanics of Luxembourg’s new CFC rules and considers problems such as overlap with transfer pricing rules and the risk of double taxation. And Raul-Angelo Papotti and Lorenzo Ferro examine a new tax regime that Italy is offering to individuals with foreign pensions who move their tax residence to Southern Italy.
We also want to remind students and professors about the Christopher E. Bergin Award for Excellence in Writing. Papers should be submitted by June 30th, and for more information, please visit taxnotes.com/contest.
Dave Stewart: You can read all that and a lot more in the April 29th editions of Tax Notes, State Tax Notes, and Tax Notes International.
That's it for this week. You can follow me on Twitter @TaxStew, that's S-T-E-W. If you have any comments, questions, or suggestions for a future episode, you can email us at podcast@taxanalysts.org. And as always, if you like what we're doing here, please leave a rating or a review wherever you download this podcast. We'll be back next week with another episode of Tax Notes Talk.
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