It’s spring-cleaning time, and this year Congress’s efforts could include tidying up the Opportunity Zone program. The discussion over how best to do that got a fresh injection of energy recently.
The Opportunity Zones Transparency, Extension, and Improvement Act was introduced on April 7, and it proposes significant changes to sections 1400Z-1 and -2. Like all the attempts to update the Opportunity Zone program since its passage as part of the Tax Cuts and Jobs Act, the Transparency, Extension, and Improvement Act would add reporting requirements. It includes an early sunset for zones with a high median family income, coupled with a mechanism for states to designate other qualifying census tracts as Opportunity Zones. And, as the title suggests, it would extend the deferral period from December 31, 2026, to December 31, 2028, and lower the requirement to receive a 5 percent step-up in basis from holding the investment in the qualified Opportunity Zone fund from seven to six years.
The new bill notably has the support of both the original sponsors of the legislation that was the genesis of sections 1400Z-1 and -2 — Sens. Cory A. Booker, D-N.J., and Tim Scott, R-S.C. — as well as a collection of Democrats and Republicans in both the Senate and House. Bipartisan support is probably necessary for the bill even to gain traction, and it could augur a shift in the nature of the discourse around the Opportunity Zone incentive.
At a November 16 hearing of the House Ways and Means Oversight Subcommittee, Chair Bill Pascrell Jr., D-N.J., said that the program “does not appear to be helping the neediest communities” and that Congress should evaluate it and “determine what changes should be made to improve it.” That’s a bit more conciliatory than what Pascrell said in 2019, when he accused then-Treasury Secretary Steven Mnuchin of corruption in implementing the program and wrote that it, “much like the rest of the tax scam law, has been perverted to profit the super-rich.”
There’s a steady drumbeat from nearly every quarter to add statutory information reporting requirements because collecting data is the first step in analyzing how well the incentive works to accomplish the community improvement goals of the original statutory regime. As investments in qualified opportunity funds continue and Congress considers extending the program, that information will become even more important. The Government Accountability Office reported in October 2021 that preliminary IRS data for tax year 2019 showed that nearly 18,000 taxpayers were invested in more than 6,000 QOFs, which collectively held almost $29 billion in qualified property.
John Lettieri of the Economic Innovation Group said that if the Transparency, Extension, and Improvement Act passes, it will improve the Opportunity Zone program’s function, transparency, and effectiveness. In a time of economic turmoil, policy tools that help drive recovery for lower-income, high-poverty communities are particularly important, he said. Lettieri noted widespread government interest in ensuring the policy works as intended. “We’ve known from the beginning that there are areas [in the Opportunity Zone law] that could and should be improved,” he said.
The extension proposal appears to be a move in the direction of making the Opportunity Zone program permanent, whether that happens in a de facto way through successive extensions or directly through removal of the sunset provision. The rationale in the press release on the bill for the proposed two-year extension is that Treasury took two years to issue final regulations.
The proposed changes are a major expansion that would make the program a lot more expensive, said Brett Theodos of the Urban Institute. “The expense of the program is not justified by its slim social benefits,” he added.
Once More Unto the Breach
Among the more egregious mischief made by using the budget reconciliation process to pass tax legislation is the removal of the information reporting provisions from the Opportunity Zone program. Multiple bills since then have proposed to close the information gap in one way or another, but none has succeeded.
The proposed information reporting requirements in the Transparency, Extension, and Improvement Act would add sections 6039K, 6039L, and 6039M to the tax code, which would expand Form 8996, “Qualified Opportunity Fund,” and Form 8997, “Initial and Annual Statement of Qualified Opportunity Fund Investments.” Qualified Opportunity Zone businesses (QOZBs) would be required to give QOFs information for the Form 8996. QOFs would have to break down each investment they hold by interest; North American Industry Classification System code that applies to the trade or business conducted by the corporation or partnership in which the interest is held; the census tracts where the qualified Opportunity Zone property of the corporation or partnership is located; the number of residential units of real property held; and the approximate average number of full-time employees.
The goal of the employee reporting is to determine the employment impact, so Treasury can pick another method of indicating that in regulations. Treasury would also gain authority to collect from investors information in addition to that specified in new section 6039L.
The reporting requirements for QOFs would be bolstered by a $500-per-day penalty for failure to file a complete and correct Form 8996. Failure by an investor to file a complete and correct Form 8997 would result in a $5,000 penalty, unless the failure is corrected before 60 days after the filing date. Failures attributable to intentional disregard would carry a $2,500 penalty. All the penalties would be indexed for inflation.
Treasury would be tasked with making a public report on QOFs “as soon as practical after the date of enactment,” and the report would be issued annually. It would include more aggregated data on assets held in QOFs, investments made by QOFs based on their North American Industry Classification System code, full-time employees, residential units, and investments made by QOFs in each census tract. There would be a report from Treasury in the sixth and 11th years after the bill is enacted on socioeconomic measures such as job creation, poverty reduction, and new business starts.
Lettieri said that the proposed reporting changes would make the Opportunity Zone program the most carefully measured, transparent initiative ever passed through a comprehensive approach to reporting and data gathering. The selection process allows for a natural comparison group to Opportunity Zones in the eligible census tracts that were not selected, and the proposal would require Treasury to study how both groups fared on a number of factors. “Comparing those two groups over time is an important part of understanding whether being designated as an Opportunity Zone changes the trajectory of those communities,” Lettieri said.
The Opportunity Zone program ran into early public relations difficulties following the designation process for zones, because not every selected census tract is a low-income community. The new bill would disqualify some currently designated tracts and allow states to swap other low-income zones into those newly opened spots.
Section 1400Z-1(e) allowed up to 5 percent of census tracts that are not low-income communities to be QOZs as long as they (1) are contiguous with a designated QOZ that is a low-income community, and (2) have a median family income not above 125 percent of the median income of the contiguous tract.
That resulted in the selection of some census tracts as zones that had higher median household incomes. The GAO’s study shows a median income of $57,746 for contiguous zones versus $38,037 for low-income communities selected as QOZs.
Revising section 1400Z-1 would be the method for jettisoning the higher-income zones through an early sunset mechanism and replacing them with new ones. In proposed new subsection (g)(3), census tracts that were designated as QOZs with median family incomes over 130 percent of the national median family income would be disqualified unless they also have a poverty rate of at least 30 percent after excluding college students. State governors could request that Treasury leave some current QOZs alone if the designation of those population census tracts was consistent with the purposes of the Opportunity Zone program or the median family income for the tract doesn’t exceed 130 percent of the national median family income.
The disqualified census tracts would lose QOZ status 30 days after the date the Treasury secretary publishes a final list of disqualified tracts. The department would be statutorily mandated to publish an initial list within a year of the date of enactment and the final list within 105 days of the initial list. States would be unable to renominate the disqualified zones to be QOZs.
Because of the potential loss of QOZ status for some tracts, the bill would create a new creature of tax law — the qualified preexisting trade or business. This would allow qualified Opportunity Zone funds or QOZBs that were sufficiently invested before the disqualification of their zone to carry on under section 1400Z-2 as if the disqualification had never happened. To be a qualified preexisting trade or business, you need one of three things: to have a filed registration statement under the Securities Act of 1933 or a comparable offering memorandum that shows intent to invest in the census tract before the date of enactment of the Transparency, Extension, and Improvement Act; to be in a binding agreement to invest at least $250,000 in the tract before the initial disqualified tract list is published; or to convince Treasury that you relied on the designation of the tract as a QOZ and suffered a loss because of the disqualification.
QOFs or QOZBs that are grandfathered in can’t use the Opportunity Zone benefits for new projects or new trades or businesses. If the bill passes, Treasury will get to write guidance “to prevent speculative investment solely for the purpose of falling within the definition of a qualified preexisting trade or business.”
Formerly industrial census tracts that have no population and are brownfields that are contiguous with a QOZ, or that were merged into a contiguous tract after the 2020 census, may be nominated as a QOZ by the state governor. “Contiguous” in this case includes along both land and water boundaries. Brownfield tracts that become QOZs through this process aren’t taken into account in calculating the requirement that no more than 25 percent of the low-income communities in the state be QOZs.
The idea is to boost the incentive for investment in brownfield sites so that they become “centers of economic activity in the community,” as the section-by-section description puts it. This proposal harkens back to the origin of place-based tax policies in the 1970s, which was the United Kingdom’s attempt to revitalize mostly small, uninhabited, formerly industrial areas and turn them into economic centers to support employment in the surrounding communities.