Empowerment Zones and Enterprise Communities

This section describes the areas that have been designated empowerment zones and explains the tax benefits available to businesses in those zones. Enterprise communities are also discussed.

Designated Zones and Communities

The following paragraphs describe current and planned designations of empowerment zones and enterprise communities. The empowerment zone designations will generally remain in effect until the end of 2009. The enterprise community designations will generally remain in effect until the end of the 10th calendar year beginning on or after the date of designation.

The Community Renewal Tax Relief Act of 2000 authorizes the Secretary of Housing and Urban Development (HUD) and the Secretary of Agriculture (USDA) to designate up to 9 additional empowerment zones before January 1, 2002 (seven in urban areas and two in rural areas). Businesses in the new zones will be eligible for the same tax incentives that are available in the existing zones.

Urban designations effective December 21, 1994. The Secretary of HUD has designated 65 urban enterprise communities. The Secretary has also designated parts of the following cities as urban empowerment zones.

1. Atlanta, GA (9.29 square miles).
2. Baltimore, MD (6.8 square miles).
3. Chicago, IL (14.33 square miles).
4. Detroit, MI (18.3 square miles).
5. New York City, NY (the Bronx and Manhattan; 7.6 square miles).
6. Philadelphia, PA/Camden, NJ (4.4 square miles).

Rural designations effective December 21, 1994. The Secretary of USDA designated 30 rural enterprise communities. The Secretary has also designated the following rural empowerment zones.

1. The Kentucky Highlands (part of Wayne and all of Clinton and Jackson counties).
2. Mid-Delta, Mississippi (parts of Bolivar, Holmes, Humphreys, Leflore, Sunflower, and Washington counties).
3. Rio Grande Valley, Texas (parts of Cameron, Hidalgo, Starr, and Willacy counties).

District of Columbia Enterprise Zone (DC Zone). Effective January 1, 1998, parts of Washington, D.C. are treated as an empowerment zone. This treatment will remain in effect until the end of 2003.

Urban designations effective December 31, 1998. HUD has designated parts of the following cities as urban empowerment zones.

1. Boston, MA (about 6 square miles).
2. Cincinnati, OH (about 7 square miles).
3. Columbia/Sumter, SC (about 19 square miles).
4. Columbus, OH (about 14 square miles).
5. Cumberland County, NJ (about 4 square miles).
6. El Paso, TX (about 10 square miles).
7. Gary/East Chicago, IN (about 17 square miles).
8. Huntington, WV/Ironton, OH (about 10 square miles).
9. Knoxville/Knox County, TN (about 16 square miles).
10. Miami/Miami-Dade County, FL (about 13 square miles).
11. Minneapolis, MN (about 7 square miles).
12. New Haven, CT (about 5 square miles).
13. Norfolk/Portsmouth, VA (about 10 square miles).
14. Santa Ana, CA (about 4 square miles).
15. St. Louis, MO/East St. Louis, IL (about 14 square miles).

Rural designations effective December 31, 1998. USDA has designated the following rural empowerment zones.

1. Desert Communities Empowerment Zone, California (parts of Riverside county).
2. Steele-Griggs County Empowerment Zone, North Dakota (part of Griggs county and all of Steele county).
3. Oglala Sioux Tribe Empowerment Zone, South Dakota (parts of the Pine Ridge Indian Reservation).
4. Southernmost Illinois Delta Empowerment Zone, Illinois (parts of Alexander, Johnson, and Pulaski counties).
5. Southwest Georgia United Empowerment Zone, Georgia (parts of Crisp county and all of Dooly county).

Designations effective January 1, 2000. HUD has designated parts of the following cities as urban empowerment zones.

1. Cleveland, OH.
2. Los Angeles, CA.

More information. For more information, call HUD at 1-800-998-9999 or USDA at 1-800- 645-4712.

Or you can find out whether your area has been designated as an empowerment zone or an enterprise community by using the Internet address www.ezec.gov.

Empowerment Zone Employment Credit

The empowerment zone employment credit provides businesses with an incentive to hire individuals who both live and work in an empowerment zone. (Individuals who work in the DC Zone may live anywhere in the District of Columbia.) You can claim the credit if you pay or incur "qualified zone wages" to a "qualified zone employee."

The credit is 20% of the qualified zone wages paid or incurred during a calendar year. The amount of qualified zone wages you can use to figure the credit cannot be more than $15,000 for each employee for each calendar year. As a result, the credit can be as much as $3,000 (20% of $15,000) per qualified zone employee each year.

You cannot claim this credit for wages paid before 2002 for a business you operate in one of the 15 urban or 5 rural zones whose designation was effective December 31, 1998. But you can claim the credit in these zones for wages paid after 2001.

Qualified zone employee. A qualified zone employee is any employee who meets both of the following tests.

1. The employee performs substantially all of his or her services for you within an empowerment zone and in your trade or business.
2. While performing those services, the employee has his or her main home within that empowerment zone (or within the District of Columbia, for services performed within the DC Zone).

Both full-time and part-time employees may qualify.

Nonqualified employees. The following individuals are not qualified zone employees.

1. An individual you employ for less than 90 days. However, this 90-day requirement does not apply in either of the following situations.
   1. You terminate the employee because of misconduct as determined under the state unemployment compensation law that applies.
   2. The employee becomes disabled before the 90th day. However, if the disability ends before the 90th day, you must offer to reemploy the former employee.
2. Certain related taxpayers.
3. Certain dependents.
4. Any 5% owner.
5. An individual you employ at any:
   1. Private or commercial golf course,
   2. Country club,
   3. Massage parlor,
   4. Hot tub facility,
   5. Suntan facility,
   6. Racetrack, or other facility used for gambling, or
   7. Store whose principal business is the sale of alcoholic beverages for off-premise consumption.
6. Any individual you employ in a farming trade or business if, at the close of the tax year, the sum of the following amounts is more than $500,000.
   1. The larger of the unadjusted bases or fair market value of the farm assets you own.
   2. The value of the farm assets you lease.

Qualified zone wages. Qualified zone wages are any wages you pay or incur for services performed by an employee while the employee is a qualified zone employee (defined earlier). Wages are generally defined as those wages subject to the Federal Unemployment Tax Act (FUTA) without regard to the FUTA dollar limit.

Also treat as qualified zone wages certain training and education expenses you pay or incur on behalf of a qualified zone employee.

Effect of welfare-to-work or work opportunity credit. Qualified zone wages do not include any amount you take into account in figuring the welfare-to-work credit or the work opportunity credit. In addition, reduce the $15,000 maximum qualified zone wages for each qualified zone employee by the amount of wages you use to figure either of those credits for that employee.

Claiming the credit. Use Form 8844 to claim this credit. Although the empowerment zone employment credit is a component of the general business credit, a special tax liability limit applies to this credit. Therefore, you figure the credit separately and never carry it to Form 3800, General Business Credit.

Effect on salary and wage deduction. In general, you must reduce the deduction on your income tax return for salaries and wages and certain education and training costs by the amount of your empowerment zone employment credit.

More information. For more information about the empowerment zone employment credit, see Form 8844.

Increased Section 179 Deduction

Section 179 of the Internal Revenue Code allows you to choose to deduct all or part of the cost of certain qualifying property in the year you place it in service. You can do this instead of recovering the cost by taking depreciation deductions over a specified recovery period. There are limits, however, on the amount you can deduct in a tax year.

You may be able to claim an increased section 179 deduction if your business qualifies as an "enterprise zone business." The increase can be as much as $20,000 ($35,000 for 2002 and later years). This increased section 179 deduction applies to "qualified zone property" you place in service in an empowerment zone.

You cannot claim this increased deduction for a business you operate in an enterprise community. 

Enterprise zone business. For the increased section 179 deduction, a corporation, partnership, or sole proprietorship is an enterprise zone business if all the following statements are true for the tax year.

1. Every trade or business of the corporation or partnership is the active conduct of a qualified business (defined later) within an empowerment zone. (This rule does not apply to a sole proprietorship.)
2. At least 50% of its total gross income is from the active conduct of a qualified business within a zone.
3. A substantial part of the use of its tangible property is within a zone.
4. A substantial part of its intangible property is used in the active conduct of the business.
5. A substantial part of the employees' services are performed within a zone.
6. At least 35% of the employees are residents of an empowerment zone. (This rule does not apply to businesses in the DC Zone.)
7. Less than 5% of the average of the total unadjusted bases of the property owned by the business is from:
   1. Nonqualified financial property (generally, debt, stock, partnership interests, options, futures contracts, forward contracts, warrants, notional principal contracts, and annuities), or
   2. Collectibles not held primarily for sale to customers.

For a sole proprietorship, the term "employee" in (5) and (6) includes the proprietor.

Qualified business. A qualified business is generally any trade or business except one that consists primarily of the development or holding of intangibles for sale or license.

However, the rental to others of real property located in an empowerment zone is a qualified business only if the property is not residential rental property and at least 50% of the gross rental income from the property is from enterprise zone businesses.

The rental to others of tangible personal property is a qualified business only if at least 50% of the rentals of the property are to enterprise zone businesses or zone residents.

Also, a qualified business does not include any business listed earlier in item (5) or item (6) under Nonqualified employees in the Empowerment Zone Employment Credit section.

Qualified zone property. For the increased section 179 deduction, qualified zone property is any depreciable tangible property if all the following are true.

1. You acquired the property after the zone designation is in effect.
2. You did not acquire the property from a related person or member of a controlled group of which you are a member.
3. Your basis in the property is not determined either by its adjusted basis in the hands of the person from whom you acquired it or under the stepped-up basis rules for property acquired from a decedent.
4. You were the first person to use the property in an empowerment zone.
5. At least 85% of the property's use is in an empowerment zone and in the active conduct of a qualified trade or business in the zone.

Buildings are qualified zone property, but they do not qualify for the section 179 deduction. Used property may be qualified zone property if it has not previously been used within an empowerment zone.

Special rule for substantially renovated property. Property will be treated as having met requirements (1) and (4) if you substantially renovate the property. You substantially renovate property if, during any 24-month period beginning after the zone designation takes effect, your additions to the property's basis are more than the greater of the following amounts.

1. 100% of the adjusted basis of the property at the beginning of the 24-month period.
2. $5,000.

Property used in developable sites. For tax years beginning before 2002, property is not qualified zone property if substantially all of its use is in a developable site. A developable site is a site to which both of the following apply.

1. The site could be developed for commercial or industrial purposes.
2. The site was included in one of the 15 urban or 5 rural zones whose designation was effective December 31, 1998, under an exception for developable sites that allowed it to be excluded from the poverty rate requirement.

For tax years beginning after 2001, property can be qualified zone property even if it is used in a developable site.

Section 179 deduction limits. There are limits on the amount you can deduct under section 179. The following sections explain how these limits are increased for certain qualified zone property placed in service by an enterprise zone business.

Maximum dollar limit. The total cost of section 179 property that you can deduct for a tax year generally cannot be more than the maximum section 179 dollar limit. However, if you place section 179 property that is qualified zone property in service during the year, this maximum dollar limit is increased by the smaller of the following amounts.

1. The cost of that property.
2. $20,000 ($35,000 for 2002 and later years).

The following table shows these maximum dollar limits.

These maximum dollar limits are reduced if you go over the investment limit (discussed next) in any tax year.

Investment limit. For each dollar of your business cost over $200,000 for section 179 property placed in service in a tax year, reduce the maximum dollar limit by $1 (but not below zero). However, take only one-half of the cost of section 179 property that is qualified zone property into account when reducing the maximum dollar limit.

Example. In 2000, your enterprise zone business placed in service section 179 property that is qualified zone property costing $420,000. Because all of this property is qualified zone property, only $210,000 (one-half of its cost) is used to figure the investment limit. Because $210,000 is $10,000 more than $200,000, you must reduce the maximum dollar limit by $10,000. Your maximum dollar limit for 2000 is $40,000. You can claim a section 179 deduction of $30,000 ($40,000 - $10,000) for 2000 (if your taxable income from trades or businesses is at least $30,000).

Recapture. The recapture rules of section 179 apply when qualified zone property is no longer used in an empowerment zone by an enterprise zone business.

More information. For more information about the section 179 deduction, see Publication 946. For more information about the increased section 179 deduction, see sections 1397A, 1397C, and 1397D of the Internal Revenue Code.

Rollover of Gain From Sale of Empowerment Zone Assets

You may qualify for a tax-free rollover of certain gains from the sale of qualified empowerment zone assets. This means that if you buy certain replacement property and make the choice described in this section, you postpone part or all of the recognition of your gain.

You qualify to make this choice if you meet all the following tests.

1. You hold a qualified empowerment zone asset for more than 1 year and sell it at a gain.
2. Your gain from the sale is a capital gain.
3. During the 60-day period beginning on the date of the sale, you buy a replacement qualified empowerment zone asset in the same zone as the asset sold.

Qualified empowerment zone asset. This means certain stock or partnership interests in an enterprise zone business (defined earlier). It also includes certain tangible property used in an enterprise zone business. You must have acquired the asset after December 21, 2000.

The DC Zone is not treated as an empowerment zone for this purpose. For the treatment of gain from the sale of a DC Zone asset, see Exclusion of Capital Gains From DC Zone Assets, later.

Amount of gain recognized. If you make the choice described in this section, you must recognize gain only up to the following amount:

1. The amount realized on the sale, minus
2. The cost of any qualified empowerment zone asset that you bought during the 60-day period beginning on the date of sale (and did not previously take into account in rolling over gain on an earlier sale of qualified empowerment zone assets).

If this amount is equal to or more than the amount of your gain, you must recognize the full amount of your gain. If this amount is less than the amount of your gain, you can postpone the rest of your gain by adjusting the basis of your replacement property as described next.

Basis of replacement property. You must subtract the amount of postponed gain from the basis of the qualified empowerment zone assets you bought as replacement property.

More information. For more information about the rollover of gain from the sale of empowerment zone assets, see section 1397B of the Internal Revenue Code.

Increased Exclusion of Gain From Qualified Small Business Stock

Taxpayers other than corporations generally can exclude from income 50% of their gain from the sale or trade of qualified small business stock held more than 5 years. If the stock is in a corporation that qualifies as an enterprise zone business (defined earlier under Increased Section 179 Deduction) during substantially all of the time you hold the stock, you can exclude 60% of your gain.

To claim this increased exclusion, you must have acquired the stock after December 21, 2000. Gain from periods after 2014 will not qualify for the increased exclusion.

The requirement that the corporation must qualify as an enterprise zone business during substantially all of the time you hold the stock will still be met if the corporation ceased to qualify after the 5-year period beginning on the date you acquired the stock. However, the gain that qualifies for the 60% exclusion cannot be more than the gain you would have had if you had sold the stock on the date the corporation ceased to qualify.

If you sell the stock after 2009, disregard the end of the empowerment zone designation on December 31, 2009, in determining whether the corporation qualified as an enterprise zone business during substantially all of the time you held the stock.

For more information about this exclusion, including a definition of qualified small business stock, see chapter 4 of Publication 550, Investment Income and Expenses.

Tax-Exempt Bond Financing

State or local governments can issue enterprise zone facility bonds (a type of exempt facility tax-exempt bond) to raise funds to provide an "enterprise zone business" with "qualified zone property." At least 95% of the net proceeds from the bond issue must be used to finance:

1. Qualified zone property whose principal user is an enterprise zone business, and
2. Certain land used for a related purpose (for example, land where the business is located and a parking lot for customers and employees).

Tax-exempt bonds generally have lower interest rates than conventional financing.

Contact the appropriate state or local government agency to find out if this type of financing is available in your empowerment zone or enterprise community.

Enterprise zone business. For tax-exempt bond financing, a corporation, partnership, or sole proprietorship is generally an enterprise zone business if all the following statements are true for the tax year.

1. Every trade or business of the corporation or partnership is the active conduct of a qualified business (defined later) within an empowerment zone or an enterprise community. (This rule does not apply to a sole proprietorship.)
2. At least 50% (80% for bonds issued before August 6, 1997) of its total gross income is from the active conduct of a qualified business within a zone or community.
3. A substantial part of the use of its tangible property is within a zone or community. (For bonds issued before August 6, 1997, at least 85% of the use of its tangible property must be within a zone or community.)
4. A substantial part of its intangible property is used in the active conduct of the business. (For bonds issued before August 6, 1997, at least 85% of its intangible property must be used in, and exclusively related to, the active conduct of the business.)
5. A substantial part of the employees' services are performed within a zone or community. (For bonds issued before August 6, 1997, at least 85% of the employees' services must be performed within a zone or community.)
6. At least 35% of the employees are residents of an empowerment zone or enterprise community. (This rule does not apply to businesses in the DC Zone.)
7. Less than 5% of the average of the total unadjusted bases of the property owned by the business is from:
   1. Nonqualified financial property (generally, debt, stock, partnership interests, options, futures contracts, forward contracts, warrants, notional principal contracts, and annuities), or
   2. Collectibles not held primarily for sale to customers.

For a sole proprietorship, the term "employee" in (5) and (6) includes the proprietor. Also, a business located in a zone or community that would qualify if it were separately incorporated is treated as an enterprise zone business. For example, a business that is part of a national chain could qualify, providing it would meet the definition of an enterprise zone business if it were separately incorporated.

Qualified business. A qualified business is generally any trade or business except one that consists primarily of the development or holding of intangibles for sale or license.

However, the rental to others of real property located in an empowerment zone or enterprise community is a qualified business only if the property is not residential rental property and at least 50% of the gross rental income from the property is from enterprise zone businesses.

The rental to others of tangible personal property is a qualified business only if at least 50% of the rentals of the property are to enterprise zone businesses or zone or community residents. (For bonds issued before August 6, 1997, at least 85% of the rentals of the property must be to enterprise zone businesses or zone or community residents.)

Also, a qualified business does not include any business listed earlier in item (5) or item (6) under Nonqualified employees in the Empowerment Zone Employment Credit section.

Relaxed requirements during start-up period. For bonds issued after August 5, 1997, a business will be treated as an enterprise zone business during a start-up period if both of the following apply.

1. It is reasonable, at the beginning of the start-up period, to expect the business to be an enterprise zone business by the end of the start-up period.
2. The business makes bona fide efforts to be an enterprise zone business.

The start-up period is the period that ends with the start of the first tax year beginning more than 2 years after the later of the following two dates.

1. The issue date of the bond issue financing the qualified zone property.
2. The date this property is first placed in service (or, if earlier, the date that is 3 years after the issue date).

Requirements during and after testing period. For bonds issued after August 5, 1997, a business that qualifies as an enterprise zone business at the end of the start-up period must continue to qualify during a testing period that ends 3 tax years after the start-up period ends.

After the 3-year testing period, a business will continue to be treated as an enterprise zone business as long as it meets an employee residency requirement. To meet this requirement, at least 35% of its employees must be residents of an empowerment zone or enterprise community. However, the following businesses are not treated as enterprise zone businesses even if they meet the employee residency requirement.

1. Any business that consists primarily of the development or holding of intangibles for sale or license.
2. Any business listed earlier in item (5) or item (6) under Nonqualified employees in the Empowerment Zone Employment Credit section.

A business in the DC Zone does not need to meet the employee residency requirement to continue to be treated as an enterprise zone business after the testing period.

Qualified zone property. For tax-exempt bond financing, qualified zone property is any depreciable real or tangible personal property if all the following are true.

1. You acquired the property after the zone or community designation is in effect.
2. You did not acquire the property from a related person or member of a controlled group of which you are a member.
3. Your basis in the property is not determined either by its adjusted basis in the hands of the person from whom you acquired it or under the stepped-up basis rules for property acquired from a decedent.
4. You were the first person to use the property in an empowerment zone or enterprise community.
5. At least 85% of the property's use is in an empowerment zone or enterprise community and in the active conduct of a qualified trade or business in the zone or community.

Used property may be qualified zone property if it has not previously been used within an empowerment zone or enterprise community.

Special rule for substantially renovated property. Property will be treated as having met requirements (1) and (4) if you substantially renovate the property. You substantially renovate property if, during any 24-month period beginning after the zone or community designation takes effect, your additions to the property's basis are more than the greater of the following amounts.

1. 15% (100% for bonds issued before August 6, 1997) of the adjusted basis of the property at the beginning of the 24-month period.
2. $5,000.

Special rule for bonds issued after July 30, 1996. Generally for bonds issued after July 30, 1996, property that you reasonably expect by exercising due diligence to be qualified zone property by an initial testing date will be treated as qualified zone property for the period before that date.

The initial testing date is generally the date that is 18 months after the later of the following dates.

1. The issue date of the bond issue financing the qualified zone property.
2. The date this property is first placed in service (or, if earlier, the date that is 3 years (5 years for certain construction projects) after the issue date).

However, the issuer of the bonds can choose to use any earlier date that comes after the bond issue date as the initial testing date.

Interest not deductible. No deduction will be allowed for interest on any financing provided from a bond if the interest accrues during the period beginning on the first day of the calendar year in which either of the following occurs.

1. Substantially all of the facility that was financed ceases to be used in an empowerment zone or enterprise community.
2. The principal user of the facility ceases to be an enterprise zone business.

This rule does not apply if the use of the facility ceases to qualify because of bankruptcy or the termination or revocation of the designation as an empowerment zone or enterprise community.

In addition, interest will remain deductible if the issuer and principal user try in good faith to meet the requirements and any failure is corrected within a reasonable period after discovery.

More information. For more information, see section 1394 of the Internal Revenue Code and the regulations under that section.