Tax increment financing – it’s a term that’s reached in-the-know buzzword status. But what exactly is it?
Nearly every commonwealth city looking to recondition and reinvigorate its core areas is looking to tax increment financing (TIF). But TIF requires highly specialized legal expertise – just to get started.
To find out about the TIF process, The Lane Report consulted Ken Sagan and Mike Harrington of the Stites & Harbison law firm; Ken Harkenrider, chief state forecasting specialist with the Governor’s Office for Policy Research in the office of the state budget director; and Mark Johnson, tax policy analyst in the office of the commissioner of the Kentucky Department of Revenue – and currently the only employee in the Division of Tax Increment Financing.
Tax increment financing is a mechanism to pay for a project with money generated by the tax base growth that it creates. TIF dollars may pay only for the public infrastructure involved, though. But since necessary infrastructure can easily be 40 percent of the cost of a major development, TIF can be a large piece of the financing – enough to make an expensive dream feasible.
It’s not a simple process. Anyone serious about using TIF money should plan on working intensively with attorneys, accountants, government officials, property developers and investment bankers.
The TIF process captures money from the increase in tax revenue that occurs as a result of a project. For instance, improved property values generate higher property tax payments; increased business and new businesses generate higher levels of sales tax and business taxes.
There are restrictions to using the process, however. First and foremost, TIF revenues may be used only for portions of development to be owned by the public – read, government. TIF money may go to a private entity, but only be used to pay for public infrastructure improvements the private developer made.
There are four flavors of TIF projects under Kentucky law: Local, Blighted Urban Mixed Use, State Real Property Tax, and Signature.
Signature project rules apply to all TIF developments involving $200 million or more in private and public capital. As of this year, they required an economic cost-benefit analysis study demonstrating the project will increase business activity in the state – not merely shuffle existing work.
There are a variety of tax streams that may be tapped via TIF. For each, however, developers must decide how much of the potential stream they want to tap, then gain the assent of the government entity that would be giving up some of its revenue.
The state of Kentucky is the primary party because the main revenue streams are state property tax, state sales tax, individual income tax as well as earned income tax for work performed by the self-employed, corporate income tax, and limited liability entity taxes, which apply to limited-liability corporations and partnerships. Additionally, there are local property taxes, sales taxes, occupational license taxes and special local levies such as those for libraries.
School taxes are exempt from inclusion in TIF projects. All the others are subject to negotiation to what portion of the growth in that tax base can be diverted to pay for infrastructure. The incentive for government to share its dollars with a developer is that a project’s improvements create tax base growth that otherwise would not occur.
The law governing TIF in Kentucky was rewritten last year. The most significant new term, according to Sagan, is the requirement for a cost-benefit analysis study for the Signature TIF projects. This adds to the time and cost to structure such a project.
State lawmakers also limited the retail element in these largest of the TIF projects. A maximum 20 percent of the capital investment or final square footage may be devoted to retail. The rest must be general public space, residential or non-retail commercial.
There are several steps common to all TIF projects.
First, a geographic area or TIF footprint must be defined and approved. Also, existing rates of tax revenue the district is generating must be determined because it is increases above this base rate – the tax increments – that are subject to being captured.
Project developers must negotiate deals for the percentages of each tax stream to be captured as well as the length of time that tax dollars will be shared. Thirty years is the maximum term TIF money can be captured and 80 percent is the maximum increment collected in most cases.
And one more thing: Project principals must convince Wall Street investment banks that the whole thing will work and the bonds necessary to pay for it all are marketable.
If that all happens, there will be lots of books to keep for the various streams of dollars from within the TIF footprint, the percentage of each being captured, and ensuring everyone pays and receives the money they owe or are due. To complicate that tricky task, the tax base adjusts upward each year in synch with the consumer price index.
Annual filings for each tax stream require multiple levels of approval at the state level. Among those who will review and sign off on annual filings are the Kentucky Office of Income Taxation, the commissioner of the Department of Revenue and the secretary of the Cabinet for Finance Administration.
There is yet another major decision for the developer: when to activate a TIF capture. The developer may wait until all is finished and expected business growth kicks in, or opt to pull the trigger during construction to tap taxes paid by those doing the work to build the project.
Johnson expects plenty of division co-workers in the Division of Tax Increment Financing as TIF projects in the works now progress through the approval process and are “activated.”
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