HHM Tax Strategies: PILOT Agreements and Franchise Tax Savings
December 14, 2015 | admin
Companies that have PILOT (payment-in-lieu-of-taxes) agreements with local industrial development boards (IDBs) can potentially save on franchise taxes.
Local governments offer PILOT agreements as an incentive for companies considering large capital investments within the area. In return for establishing a facility in the municipality — and creating jobs and stimulating the local economy as a result — companies receive reduced property taxes.
The structure of PILOT agreements is complex. Under a PILOT agreement, the company transfers the title of the property to the IDB and then leases the property back (known as the PILOT payment). Because the property is legally owned by the IDB, it is exempt from property taxes. PILOT payments are typically calculated as a percentage — usually 50 percent or less — of what the property taxes would have been without a PILOT agreement.
A Look at Franchise Tax Savings
Franchise tax savings result from the structure of the PILOT agreement. Since the company doesn’t own the property, it can elect to exclude the book value of the property from its franchise tax base. Instead, the taxpayer can elect to treat the PILOT payments as rent paid to calculate the franchise tax base of the property.
Consider this example:
- A manufacturer signs a PILOT agreement where $10 million worth of manufacturing equipment is transferred to the IDB and the company makes a $50,000 PILOT payment in the first year.
- The company elects to use the PILOT payment as rent paid to calculate the franchise tax base of the property.
- The PILOT payment of $50,000 is multiplied by three, making the amount of the Tennessee franchise tax base $150,000.
In this example, there has been a reduction of $9.85 million ($10 million minus $150,000) in Tennessee franchise tax base, resulting in a tax savings of $24,625.
Over time, manufacturing equipment depreciates, decreasing the book value of the equipment each year. When the book value becomes less than what the calculated franchise tax base otherwise would have been using the PILOT payment, the taxpayer can make a one-time election to switch to the book value method of calculating the franchise tax base.
Franchise tax savings can be substantial over the duration of a PILOT agreement; therefore, this tax strategy is worth a second look. To learn more, contact Alan King, CPA, at (423) 702-7276 or firstname.lastname@example.org.