To operate a business in a Qualified Opportunity Zone (QOZ), certain criteria must be met to be designated as a Qualified Opportunity Zone Business (QOZB). Opportunity Zones were established under the Tax Cuts and Jobs Act (TCJA) of 2017.
The legislative intent behind this enacted tax code was to stimulate economic growth by incentivizing new, old, small, or even large organizations to establish their businesses within a designated zone. What is the incentive? In exchange for investing in these locations, taxpayers are offered deferred tax benefits based on the duration of time the business is owned or leased within the designated QOZ.
There are currently 8,764 designated opportunity zones. The governors of each state and territory nominated opportunity zone locations that have been approved by the US Treasury as qualified opportunity zones. Section 13823 of the TCJA includes section 1400Z-1, which identifies these specific census tracts as eligible qualified opportunity zones.
Active Business Requirement
From QSBS to corporate spin-offs, under IRC 355, many regulations have an “active business” requirement. QOZB has an active business requirement that forces Qualified Businesses to meet a percentage threshold in order to receive tax benefits under Opportunity Zones. As seen in QSBS, an active business requirement is satisfied if more than 80% of the business’s assets are used in the active conduct or trade of the qualified business; however, in QOZB, the active business requirement is satisfied if more than 50% of the gross income is used in the active conduct or trade of the qualified business. The major difference is QOZB looks at the business’s gross income rather than the business’s assets.
What Determines a QOZB’s Active Business Requirement?
The rules specifying a QOZB’s Active Business requirements may be found in 1400Z2(d)-1(2), (3)(i)-(iv) of Section 13823 in the TCJA. To qualify as an Opportunity Zone business, an active trade or business must have more than 70% of its business in tangible property, whether owned or leased, through a Qualified Opportunity Fund (QOF.) The business must also meet general requirements, including the “50% gross income test,” which states at least 50% of total gross income must come from the active conduct of the trade or business. When intangible property of a trade or business is assessed, a “substantial” portion of the intangible property must be used in the active operation of the business or trade within the Opportunity Zone. Throughout the community, “substantial” has never been defined but is interpreted to mean “at least 80%.” Less than 5% of the average of the aggregate unadjusted tax basis of the trade or business property may be applied to nonqualified financial property.
Investors are encouraged to pay special attention to the 50% total gross income test. While many use this benchmark exclusively to determine a company’s active business status, the safe harbor test provides additional parameters allowing investors to confidently claim this requirement.
What is the Safe Harbor Test?
- More than 50% of the service hours must be performed within the QOZ for the business by its employees and independent contractors;
- More than 50% of compensation for the business’s employees and independent contractors must be incurred within the QOZ; or
- The QOZB must operate its management of operations and locate its tangible property within a QOZ and gross 50% of its total income within the QOZ.
In short, a business will be able to pass the 50% gross income requirement if, by a totality of circumstances, they would be able to prove at least 50% of such business’s gross income comes from the active conduct of said business. The other satisfactions of the test are from the three safe harbor tests, as presented above.
QOZB Active Business Requirement Summary
When analyzing whether your business meets the Active Business criteria of a QOZB, the following should be considered:
- Determine if your business is qualified opportunity zone business.
- Determine if the qualified business uses at least 50% of its gross income in the active conduct or trade of the business. If it does, then it satisfies the active business requirement. If it doesn’t or the initial assessment is inconclusive, follow the safe harbor three step test.
- If the business satisfies the three step safe harbor test or the 50% gross income requirement, then the business satisfies the active business requirement.
Does your Business Meet these Requirements?
At CapGains, our QOZB Experts are here to help answer any questions you may have about your business’s QOZB eligibility and can answer any questions related to the 50% gross income test and safe harbor provisions required. Contact us for more information.