A proposed regulation could unlock billions of dollars in investment for so-called opportunity zones.
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How Governments Can Help Put the "Opportunity" in Opportunity Zones
First introduced by the tax reform legislation signed into law in late 2017, Opportunity Zones present a new opportunity for taxpayers to defer and/or eliminate tax liability and, at the same time, spur much needed economic development in underserved communities. With opportunity knocking at the door, the key question that the leaders of governmental units (including cities, counties, special districts, states, and territories such as Puerto Rico) that include one or more Opportunity Zones must now ask themselves is: What steps can be taken by the public sector to induce investment in MY Opportunity Zone? As was the case with communities that sought to attract Amazon’s HQ2, coordinating policies, programs and creative approaches to deploy public sector resources, including economic development tools, could make all the difference.
Brief Summary of the Tax Incentive
In general, taxpayers who sell appreciated capital assets are required to pay the resulting capital gains tax in the year of the sale. Opportunity Zones provide a way to change this result by giving many taxpayers the ability to elect to defer, and potentially eliminate, the required tax payment if all or a portion of the capital gain is reinvested in an “Opportunity Fund” within 180 days from the date of the sale. The Opportunity Fund, in turn, must hold at least 90% of its assets in Qualified Opportunity Zone Property, which generally consists of investments (direct or indirect) in one or more Qualified Opportunity Zone Businesses (i.e., an active trade or business in which substantially all of its property is used in the Opportunity Zone). Except for golf courses, country clubs, massage parlors, hot tub facilities, suntan facilities, gambling facilities, or liquor stores, almost any type of business could qualify as a Qualified Opportunity Zone Business. For example, qualifying businesses would include grocery stores, multi-family housing, and manufacturing or other industries that could produce significant tax revenues and employment opportunities with the Opportunity Zone.
States with high populations, such as Texas, have as many as 628 census tracts designated by a state’s governor and certified by the Treasury Department as Opportunity Zones (a list of the tracts designated by the Treasury Department is available here). Although the Opportunity Zone provisions have been effective all year, the opportunity remained mostly untapped while Treasury drafted much needed regulations to clarify certain aspects of the new law. Fortunately, that wait is now over, as the IRS issued proposed regulations (which can be relied upon) on October 19, 2018, as well as a Revenue Ruling that provides additional guidance.
(Click here for a technical summary of Opportunity Zone provisions under the Internal Revenue Code and the recently released proposed Treasury Regulations).
How Can Governments Encourage Local Investment
Governmental units that have one or more Opportunity Zones located in their jurisdiction should consider what role they can play in attracting a portion of the predicted $100 billion of investments resulting from the new tax law, which likely will include the development of a strategy that leverages the efforts of a cross-disciplinary team of economic development, banking, finance and legal experts, and ultimately produces clear and unambiguous policies that the private sector may rely upon in determining investment opportunities in an Opportunity Zone.
For example, a successful strategy might include an inventory of key infrastructure elements, including streets, drainage, parks, schools, transportation and other existing attributes of the area that would be relevant to an investor and provide a detailed plan of enhancements that are planned in that area. Those enhancements could also be accelerated to the extent that investments are planned by the private sector. Additionally, this inventory would chronicle other data such as the existence of nearby educational institutions that produce an available workforce, a dependable public transportation system, favorable climate, affordable housing options and access to health care, and/or a strong economy in the area surrounding the Opportunity Zone. If any of these or other attributes are present, the governmental unit could advertise the benefits through an effective public relations campaign that utilizes multimodal avenues of communication, including reaching out directly to fund managers, advertising on local and national media outlets, and hosting discussions with business leaders. Further, the governmental unit could work in tandem with civic-minded local and regional business leaders to promote the investment in the Opportunity Zone.
In addition to considering the attractive features of the Opportunity Zones, investors will also be looking for other economic incentives that will make a project more likely to succeed financially. Thus, governmental units also should consider leveraging other incentives that make an investment in a particular Opportunity Fund more attractive to potential investors and businesses. For example, the governmental unit (or a related governmental entity, such as a management district or a tax increment reinvestment zone) could issue bonds to finance capital improvements to provide needed infrastructure such a utilities and roads to support a project in an Opportunity Zone. Likewise, governmental investment in public transportation would demonstrate the governmental unit’s commitment to supporting investments in the Opportunity Zones. Similarly, the governmental unit could consider whether property tax abatement programs could be offered as an incentive to entice businesses to expand or locate in the Opportunity Zone. Finally, multiple governmental units (e.g., a city, a county, and a transit authority) could work together to package incentives to promote and attract investment in their coterminous jurisdictional area. However accomplished, a key concept is identifying ways that the private sector can work to improve the chances that businesses investing in these areas will be successful.
Opportunity Zones present a new platform for a public-private partnership between governmental units, investors, and businesses. Governmental units with Opportunity Zones need to develop their “story” regarding what sets them apart and why Opportunity Funds and Qualified Opportunity Zone Businesses should invest in their community. However that story is best told, now is the time for governmental units to act – given the national interest that this new tax incentive has garnered, there is sure to be fierce competition among governmental units to attract investors.
Hospital Loses its Section 501(c)(3) Status Due to Noncompliance with Section 501(r)
The IRS recently issued a Private Letter Ruling (the “PLR”) revoking a hospital organization’s section 501(c)(3) status for failing to comply with the section 501(r) requirements.1 In what may be a sign of things to come, the PLR serves as a reminder of the importance of complying with section 501(r) in order to escape an audit unscathed and, in light of the IRS’s pre-audit techniques discussed in the PLR, highlights the emphasis that should be placed on maintaining an easy-to-navigate, compliant website to decrease the likelihood of an audit occurring in the first place.
Facts of the PLR
The Hospital was a “dual status” hospital that was exempt from federal income tax by virtue of being both a governmental hospital and a section 501(c)(3) organization (i.e., the Hospital, which was jointly created by a city and a county, had previously submitted a Form 1023 to the IRS applying for section 501(c)(3) status). According to the PLR, the IRS selected the Hospital for examination in light of possible deficiencies relating to section 501(r) compliance. Because the Hospital was a governmental entity that was exempt from filing Forms 990 (and particularly Schedule H thereto), the IRS sought information regarding the Hospital’s section 501(r) compliance from other sources, including the Hospital’s website.
Upon review of the Hospital’s website, the IRS could find no evidence of compliance with section 501(r). Specifically, the IRS could not locate the Hospital’s (i) Community Health Needs Assessment (“CHNA”) or a link or instructions identifying where the CHNA is located, (ii) its implementation strategy addressing the CHNA; (iii) Financial Assistance Policy (“FAP”); (iv) Emergency Medical Care Policy; or (v) Billing and Collection Procedures.
In light of the perceived noncompliance, the IRS sent an initial contact letter to the Hospital, along with several Information Document Requests. After initially failing to respond, the Hospital eventually contacted the IRS and stated that the CHNA had been prepared, but not posted to the Hospital’s website, and that an implementation strategy had not been completed. In addition, the Hospital stated that it was unaware that dual status hospitals are required to comply with the provisions of section 501(r).
The Hospital’s board of directors met to discuss the audit and determined that there was no tangible benefit for its continued status as a section 501(c)(3) organization because the reasons that a governmental hospital might elect dual status were not applicable. Accordingly, the Hospital informed the IRS that it wished to terminate its section 501(c)(3) status and requested advice on the proper method for doing so in order to avoid financial penalties, if at all possible.
General Overview of Section 501(r) and the Final Regulations
Section 501(r), enacted in 2010 as part of the Affordable Care Act, imposes certain requirements on hospital organizations that are (or seek to be) exempt from federal income tax under section 501(c)(3). In general, section 501(r) requires a hospital organization to (i) conduct a CHNA at least once every three years and adopt an implementation strategy (updated annually) to address community health needs identified in the CHNA, (ii) establish a written FAP and a written policy governing emergency medical care, (iii) in the case of emergency medical care and other medically necessary care, refrain from charging persons eligible for financial assistance more than amounts generally billed to insured patients, and (iv) make reasonable efforts to determine whether patients are eligible for financial assistance before engaging in extraordinary collection efforts.
After issuing two sets of proposed regulations in 2012 and 2013, the IRS and the Department of the Treasury released final regulations (the “Final Regulations”), effective for tax years beginning after December 29, 2015, that set forth guidance regarding section 501(r) and the consequences for failing to meet any of its requirements.
A hospital organization that fails to comply with section 501(r) and the specific requirements set forth in the Final Regulations for each hospital facility that it operates can suffer extreme consequences, including the imposition of an excise tax and even loss of tax-exempt status in cases of willful or egregious non-compliance.
Takeaways from the PLR
Because the Final Regulations have now been in effect for multiple tax years, it is quite possible that we will see an uptick in IRS audits to determine compliance with section 501(r) and the Final Regulations. As the PLR reminds us, this includes not only section 501(c)(3) organizations that are required to file Forms 990, but also dual status hospitals that are exempt from the Form 990 filing requirement. Although the Hospital in the PLR saw no reason to continue its section 501(c)(3) status, that will not be the case for every dual status hospital. Accordingly, all section 501(c)(3) hospital organizations should ensure compliance with section 501(r) and, if noncompliance exists, take corrective actions.
In addition, because several provisions of the Final Regulations require items to be made widely available to the public, including by posting on a website, it is imperative that hospital organizations and their information technology personnel understand the importance that the website plays in ensuring section 501(r) compliance. As the PLR indicates, the IRS will review a hospital organization’s website not only during an audit, but also potentially before an audit is commenced to determine whether there is any noncompliance to address. Thus, hospital organizations will be well-served if their websites are easy to navigate and the information and policies required by section 501(r) and the Final Regulations are readily identifiable. In other words, the best audit for a hospital isn’t the one that is successfully closed – it’s the one that’s never opened in the first place.
Bracewell LLP’s Healthcare Practice Group is able to provide a variety of services related to section 501(r) compliance, including reviewing and drafting the required documents, policies, and content for webpages, as well as conducting educational sessions for hospital staff regarding the Final Regulations. For more information, please contact Todd Greenwalt, Nancy Legros, or Brian Teaff.
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