State and local governments use a variety of incentives—typically in the form of cash grants, land, equipment, tax exemptions, loans, or infrastructure development—to entice businesses to begin or extend operations within government jurisdictions. Prior to the Tax Cuts and Jobs Act of 2017 (TCJA), Internal Revenue Code (IRC) §118 allowed corporations to exclude many of these incentives from their gross income. But following changes to §118 introduced by the TCJA, corporations in general must now include in their gross income the value of incentives received after December 22, 2017. These changes seem likely to reduce the effectiveness of incentives by increasing taxes on corporations that receive incentives.


Before modification by the TCJA, IRC §118(a) excluded from the gross income of a corporation “any contribution to the capital of the taxpayer.” Treas. Reg. §1.118-1 describes voluntary payments from a corporation’s shareholders as qualifying for exclusion. In addition to shareholder contributions, §1.118-1 states that, “Section 118 also applies to contributions to capital made by persons other than shareholders. For example, the exclusion applies to the value of land or other property contributed to a corporation by a governmental unit or by a civic group for the purpose of inducing the corporation to locate its business in a particular community, or for the purpose of enabling the corporation to expand its operating facilities.”

As modified by the TCJA, IRC §118(b) now says, “the term ‘contribution to the capital of the taxpayer’ does not include…any contribution by any governmental entity or civic group (other than a contribution made by a shareholder as such).” That is, incentives provided to a corporation by governmental units such as cities or states must now be included in the corporation’s gross income, potentially diminishing the after-tax benefits of the incentives.



While the TCJA didn’t end exclusion treatment for all corporate incentives, businesses might reasonably be expected to hesitate when selecting a U.S. jurisdiction where significant portions of the incentives are considered taxable income. For example, a $10 million grant in the form of land to be used as a plant site might result in an additional $2.1 million in corporate taxes as a result of the TCJA.

The problem could be worse in U.S. states that follow the federal income tax treatment. Companies that haven’t yet begun operations may be especially hard-pressed for cash to pay the tax, so the changes to IRC §118 may have a dampening effect on start-up companies when compared to prior law. The effects, however, won’t be limited to companies that haven’t yet reached mature stages of operation.

One compensation for the detrimental effects of the changes relates to the basis of property received as part of an incentive package. Under prior law, when a corporation received an incentive in the form of a contribution from a governmental or civic entity, the corporation was required to reduce its basis in the property received. The starting point for determining basis is often the cost of the property or, in the case of an incentive received, its fair market value at the time of receipt.

Basis is used to determine gain or loss upon disposition of an asset and affects depreciation. For example, if the corporation received a grant of land with a fair market value of $10 million, the basis of the land to the corporation was $0 because the value of the property wasn’t included in taxable income. Now that IRC §118 requires the $10 million value of the land to be included in gross income, the corporation will have a basis of $10 million in the property received. This will result in a lower tax when and if the company liquidates the property at some future time.


Prior to the TCJA, businesses would sometimes use the corporation entity structure as a simple way to take advantage of the incentive exclusion because IRC §118 only applies to corporations. There is no analog to the IRC §118 exclusion that applies, for example, to partnerships.

Certain businesses, such as those from outside the United States, found themselves having to set up operations as a partnership due to their worldwide tax situation. The value of incentives provided to partnerships wasn’t excluded from gross income before the TCJA, and that situation remains the same following the changes made by the TCJA. This suggests that choice of entity is less important after the TCJA, but this isn’t true under all circumstances.

Although the tax treatment of incentives that partnerships and corporations receive are now similar, there remain differences in how some incentives are treated by corporations and partnerships. This is especially true with respect to tax credits. For example, certain credits directly offset the income tax liability of an entity. A partnership doesn’t have an income tax liability; rather, its partners bear the tax on the income generated by the partnership. The partners, particularly if they’re individuals, may or may not be able to take a credit against their personal income tax liability. There are other credits, however, that reduce withholding taxes that must be remitted by an entity. In this case, the credit could be equally applied to both a corporate and partnership entity.


With the effectiveness of these incentive offerings reduced, local and state governments might look to possible alternatives, such as providing corporations more help in the way of financing, abatements, credits, rate reductions, or tax exemptions. Rather than providing operating assets, focusing on these alternatives might allow corporations to have more after-tax resources.

Other options that may be even more effective in the long run include improvements to infrastructure, education, and changes to a jurisdiction’s regulatory environment. These would obviously be more complex in terms of implementation.

Initial site selection and relocation decisions are often complex for corporations and may require the consideration of many variables. Tax minimization may or may not be a primary factor. What seems certain, however, is that the TCJA changed the way some incentives affect businesses, and there may be significant benefit to taking the changes into consideration when deciding where to locate or expand operations. Jurisdictions that are sensitive to the changes when structuring incentive packages are more likely to be successful at attracting businesses.

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