D.C. Council Eliminates Most QHTC Tax Incentives

The District of Columbia’s Fiscal Year 2021 Budget Support Emergency Act of 2020 (A23-0404), which received Mayoral approval on August 19, 2020, repeals most of the D.C. tax incentives that have been available for Qualified High Technology Companies (QHTC) for almost 20 years. The permanent version of the legislation (B23-0670) has also been signed by the Mayor and is expected to receive the required Congressional approval. The legislation, which will take effect starting with tax year 2020, repeals a number of the QHTC incentives, reduces others and causes the smallest of technology companies to no longer be eligible for any QHTC incentives.

The tax benefits that have been completely eliminated include:

• The 5-year corporate franchise tax exemption;
• The additional 5-year credit, which effectively provided for a reduced corporate franchise tax rate of 6% up to a maximum benefit of $250,000 per year;
• The credit for employment relocation costs; and
• The 10-year personal property tax exemption (personal property tax change will take effect next year).

Further, the QHTC tax incentives that have been curtailed include the following:

• The maximum tax credit for retraining costs for qualified disadvantaged employees will reduce from $20,000 to $10,000 per qualifying employee;
• The 10-year carry-forward of unused qualified wages credit for disadvantaged employees has been eliminated; and
• The 3% capital gains rate on the sale or exchange of a QHTC investment has been temporarily repealed for tax year 2020 through 2024.

Finally, the definition of a “qualified high technology company” has been amended to require a business to have at least 10 employees in the District, as opposed to only two employees. This change will eliminate any QHTC incentives being available for technology startup companies. Further, based on regulatory amendments adopted by the Office of Tax Revenue earlier this year, the 10 employees will have to spend the majority of their time working in an office owned or leased by the taxpayer in the District of Columbia.

The significant reduction to the QHTC program comes one year after the D.C. Council made more modest curtailments to QHTC tax benefits. The failure of the program to attract new companies to the District, combined with budget gaps as a result of the current public health emergency, were cited by the councilmember that introduced the budget amendment as the impetus for the legislation.

One of the shortcomings of the program has been significant tax incentives going to businesses that were already transacting business in the District and were not likely to stop doing business in the District but for the establishment of the QHTC program. For example, a government contractor that has provided certain technology services to federal agencies has likely significantly reduced its D.C. tax bill for a number of years by being a QHTC. Such a business needs to maintain an office in the District to be a QHTC, and that activity does help the District’s economy. However, the QHTC status of the government contractor likely did not create any jobs in the District that were not already going to be created through the contract with the federal government. This very sentiment was reflected in the Review of Economic Development Tax Expenditures issued by the Office of Revenue Analysis in November 2018. In describing a number of flaws in the program, including the untargeted nature of the incentives and lack of administrative oversight, the report provides: “…[i]t is possible existing technology firms that already met the eligibility requirements can claim QHTC credits without making new investments, such as relocating or expanding their business in the District.”

Ironically, what remains of the QHTC program (e.g., a $3,000 qualifying wage per new employee) may not be incentive enough for the businesses that one would think would be the targeted beneficiary of the program. The increase to the required employee headcount from two to 10 will preclude many startups from eligibility altogether. Plus, needing to own or lease an office in the District where those employees work is out of touch with the modern work environment. Many growing technology companies utilize flexible shared workspace offerings (e.g., Regus). If this type of space renders a company ineligible for the QHTC program, then there is possibly little incentive to having space in the District where the rates are likely higher than neighboring jurisdictions.

The Review referenced above issued by the Office of Revenue Analysis did make a handful of recommendations to improve the QHTC program, none of which appear to be included in the budget legislation. Understandably, the cuts to the QHTC program in the current budget legislation are first and foremost a response to the immediate need to increase revenue. Once the economy recovers from the impact of the current pandemic, it will be interesting to see if the District considers altering the QHTC program to better incentivize targeted technology companies to engage in new economic activity in the District.

Contact an experienced Aprio advisor for help with navigating what this tax update could mean for you.