An overlooked tax credit for startups: empowerment zone tax credits

Tax credits are some of the most powerful tax incentives. However, the world of tax credits is often daunting and filled with traps and landmines. One such opportunity that often goes unnoticed is the Empowerment Zone Tax Credit. Although this credit has been around for quite a long time, it is rare we see business owners take advantage of this.

Designed to stimulate economic growth in distressed areas, this credit can provide significant financial benefits to businesses. In this blog, we'll explore the legislative history, how to claim and quantify the credit, and answer some frequently asked questions, including detailed do's and don'ts.

Understanding the legislative history of Empowerment Zone Tax Credits

From time to time, Congress creates niche tax credits to stimulate the economy. The Empowerment Zone Tax Credit was established as part of the Omnibus Budget Reconciliation Act of 1993. The original aim and premise was to revitalize economically distressed communities by encouraging businesses to invest and create jobs in these areas. Empowerment zones (EZs) were designated by the federal government based on specific criteria, including poverty rates and economic conditions.

The initiative was expanded and extended by subsequent legislation, including the Taxpayer Relief Act of 1997 and the Community Renewal Tax Relief Act of 2000. For those familiar with Opportunity Zones, the concept may sound familiar.

EZs (like OZs) were created to provide tax incentives to businesses to hire residents and promote economic development. These zones are located in urban and rural areas where poverty rates are high, and economic opportunities are limited. While the tax benefits have not received much attention, the Trump administration did extend these through at least 2025.

Claiming and quantifying the credit

To take advantage of the Empowerment Zone Tax Credit (EZ), follow these key steps:

1. EZ locations: Ensure your business operates in a designated Empowerment Zone. The IRS and Department of Housing and Urban Development (HUD) websites provide maps and lists of these areas. This is crucial because only businesses within these zones are eligible for the credit. The vast majority of these zones are portions of inner cities, but there are also a few rural zones. As of 2024, the cities that have qualifying portions include:

• Boston, MA (our hometown)!
• Baltimore, MD
• Chicago, IL
• Cincinnati, OH
• Cleveland, OH
• Columbia/Sumter, SC
• Columbus, OH
• Cumberland County, NJ
• Detroit, MI
• El Paso, TX
• Fresno, CA
• Gary/Hammond/East Chicago, IN
• Huntington, WV/Ironton, OH
• Jacksonville, FL
• Knoxville, TN
• Los Angeles, CA (city and county)
• Miami/Dade County, FL
• Minneapolis, MN
• New Haven, CT
• New York, NY
• Norfolk/Portsmouth, VA
• Oklahoma City, OK
• Philadelphia, PA/Camden, NJ
• Pulaski County, AR
• San Antonio, TX
• Santa Ana, CA
• St. Louis, MO/East St. Louis, IL
• Syracuse, NY
• Tucson, AZ
• Yonkers, NY

1. Eligible employees: The credit is available for wages paid to employees who live and work in the Empowerment Zone. This means you need to track the residence and work location of your employees accurately. An eligible employee must perform substantially all of their services within the EZ and have their principal residence within the EZ during the period of employment.
   • As an example, if your business is in the Seaport section of Boston, which is a qualifying EZ, the employees must both work AND live there. Thus, most remote businesses will not qualify given the work/live rule.
2. Credit calculation: The credit is equal to 20% of the first $15,000 of qualified wages paid to each eligible employee annually. Therefore, the maximum credit per employee is $3,000 per year. For example, if you pay an eligible employee $30,000 in a year, you can claim a credit of $3,000. There is NO cap on the amount of employees or the dollar value of the credit you can claim.
3. Record-keeping requirements: The IRS puts the burden of proof on you as the business owner to ensure that your exact location qualifies for the credit and your employees' addresses are correct. A common mistake we see is assuming the ENTIRE city qualifies for the EZ. In most cases, they do not. There are specific portions of the city that qualify.
4. Claiming the credit: Your CPA or tax strategist should complete IRS Form 8844, "Empowerment Zone Employment Credit," and attach it to your annual business tax return. If you operate a pass-through business (single member LLC, partnership, S corporation) this credit will flow to your personal tax return to offset your personal income taxes.

Do's and don'ts

Do's:

• Do verify zone designation within the specific city (or rural area): Confirm that your business and employees are located within an Empowerment Zone using official maps and resources. HUD does have a locator tool but it can be frustrating to use at times given the archaic nature of it.
• Do keep detailed records: Maintain records of employee residency and wages to substantiate your credit claims. In the event of an audit, you are responsible for providing this information.
• Do update employee information: Regularly update and verify employee residency status and work locations to ensure ongoing eligibility. If and when an employee leaves the Zone, they no longer have qualifying wages for the credit.

Don'ts:

• Don't assume all employees qualify: Only employees who both live and work in the Empowerment Zone are eligible for the credit. We often see employers get excited, only to learn that a particular young employee left the city and now lives in the suburbs.
• Don't overlook documentation: Failing to keep proper records can result in the disallowance of the credit during an IRS audit.
• Don't miss deadlines: Ensure timely filing of Form 8844 with your annual tax return to claim the credit. If you have missed the original deadline, speak to your CPA about amending your tax returns to claim the credits.

Frequently asked questions about the Empowerment Zone Tax Credit

• What types of businesses qualify for the Empowerment Zone Tax Credit?
  • Any business operating in an Empowerment Zone can qualify for the credit. This includes corporations, partnerships, and sole proprietorships. There are some industry-specific restrictions including farms and “sin businesses”.
• How do I know if my business is in an Empowerment Zone?
  • You can use the maps and resources provided by the IRS and HUD to determine if your business is located within a designated Empowerment Zone. These resources are available online and are regularly updated. There are also multiple third party tools that can be accessed.
• Can I claim the credit for part-time employees?
  • Yes, the credit can be claimed for both full-time and part-time employees, as long as they meet the residency and wage criteria.
• Is there a limit to the number of employees?
  • No, there is no limit to the number of employees. You can claim the credit for all eligible employees, maximizing your potential tax savings.
• What if my business moves out of the Empowerment Zone?
  • If your business relocates outside of the Empowerment Zone, you will no longer be able to claim the credit for wages paid after the move. It's important to consider the impact of relocation on your eligibility for this and other location-based tax credits.
• Can I claim other tax credits in addition to the Empowerment Zone Tax Credit?
  • Yes, you can claim other applicable tax credits. However, you cannot use the same wages to claim multiple credits. For example, if you claim WOTC and ERC, you cannot double dip on the same wages.
• How long will the Empowerment Zone designation last?
  • Empowerment Zone designations have been subject to extensions by Congress. It is currently available through 2025.
• Are there any state-specific Empowerment Zone credits?
  • Some states may offer additional incentives for businesses in designated zones. New York, for example, does have strong EZ benefits, in addition to the federal tax credits.

Final thoughts on the Empowerment Zone Tax Credit

The world of tax credits can be a maze for business owners and even CPAs to navigate. The Empowerment Zone Tax Credit offers an opportunity for businesses operating in designated areas to reduce their tax liability while contributing to community revitalization.

Small business owners and startups should take advantage of all federal, state, and local programs that allow them to keep more cash in their business. Thus, we urge all startups to use various tools to determine if they are operating within an EZ and then seek assistance from their CPA to start the credit claim process.

The information provided in this article does not constitute accounting, legal or financial advice and is for general informational purposes only. Please contact an accountant, attorney, or financial advisor to obtain advice with respect to your business.