Some payments are not subject to Federal income tax. State subsidies are an example. But what is the difference between a non-taxable subsidy and a taxable benefit? The court addresses this in Ginsberg v. United States, No. 2018-1788 (Fed. Cir. 2019), in the context of the New York state brownfield tax credit.
Facts & Procedural History
The taxpayers converted an old shoe factory into residential development in Brooklyn.
The taxpayers received a New York brownfield redevelopment credit. To qualify for the credit, the taxpayers had to sign a brownfield site cleanup agreement with the state and obtain a certificate of completion from the state after the cleanup.
The benefit of doing this is that the taxpayers were relieved of liability for future environmental issues and they received an allocable share of a $6.5 million state tax credit. Their share was ~$5 million.
The taxpayers did not report the payment on their Federal income tax return. The IRS audited the return and included the payment as income. Litigation ensued.
The question for the court was whether the payment was a non-taxable subsidy or a benefit subject to tax.
About State Tax Credits, Generally
State tax credits are generally not taxable for Federal income tax purposes. This is because most state tax credits simply reduce the state income tax the taxpayer paid to the state or would have owed the state. The idea is that a state can choose to grant a state tax credit that reduces the state income tax if it chooses to do so. This is the same as if the state decides not to impose tax on one or more taxpayers or transactions.
Refundable credits–those that are paid to the taxpayer that exceed the amount of tax paid to the state–or grants are generally taxable for Federal income tax purposes. With these state credits, the idea is that the taxpayer has an accession to wealth or an increase in its net worth. This is the very basis for subjecting income to our income tax system.
There are a few exceptions to the accession-to-wealth concept. One is where the payment is a non-taxable subsidy. There are a number of tax planning opportunities associated with this.
A non-taxable subsidy is different than a taxable benefit. Generally, a non-taxable subsidy is for the benefit of the public. A taxable benefit is generally for the benefit of the recipient.
The appeals court in this case compared the case to Baboquivari Cattle Co. v. Commissioner, 135 F.2d 114 (9th Cir. 1943). In Baboquivari, the taxpayer was paid by the U.S. government for the cost incurred in installing dirt reservoirs and earthen tanks to prevent erosion. The court reasoned that the funds were not earmarked or restricted to be spent by the taxpayer in certain ways, but required the taxpayer to use the property and the use benefited the taxpayer rather than the public. This made the payment a taxable benefit rather than a non-taxable subsidy.
The appeals court in this case concludes that the state tax refund was a taxable benefit. It reached this conclusion by noting that the taxpayers were not restricted in how they could use the funds. They funds were not earmarked.
The court went on and interpreted Baboquivari to say that a payment to make an improvement is a subsidy and a payment that is earned in-part by specific use of the land is a benefit. Here, court concludes that the tax refund was conditioned on specific use of the land.
That a payment provides a private benefit and is conditioned on specific use of property helps clarify what counts as a taxable benefit vs. a nontaxable subsidy.