Recipients of qualified empire zone enterprise (QEZE) tax benefits beware: New York is reviewing your qualifications to receive a QEZE credit. On April 28, 2011, an administrative law judge upheld the Department of Taxation and Finance (Department) denial of the taxpayer’s QEZE credit claims because the taxpayer did not establish the credit for a valid business purpose. In the Matter of the Petition of Ward Lumber Co., Inc., Dkt. Nos. 823209, 823163 (N.Y. Div. Tax App. Apr. 28, 2011).

The taxpayer, Ward Lumber Co., was incurring substantial losses and appeared destined for bankruptcy. In an effort to prevent Ward Lumber, one of Essex County’s largest employers and businesses, from going under, several local officials recommended that Ward Lumber pursue QEZE credits to ease its financial difficulties. One state official told Ward Lumber that it would have to form a new entity to qualify for the QEZE program. Ward Lumber merged with a Delaware corporation in 2001, kept the original business’s name, and qualified for and received QEZE benefits for 2002 through 2004.

To qualify for the QEZE credit, the recipient must be a “new business.” It became common practice for businesses to re-incorporate to satisfy the “new business” requirement to qualify for QEZE credits. In 2005, the New York legislature amended the tax law to narrow the definition of new business and eliminate the perceived reorganization loophole. The amendment added a new requirement for businesses first certified as eligible to receive QEZE tax benefits prior to August 1, 2002, whereby those businesses had to demonstrate that they were formed for a valid business purpose and not solely to gain QEZE benefits.    

The Department challenged whether the reorganization was done for a valid business purpose, arguing that the taxpayer reorganized solely to receive the benefits of the QEZE credit. The Department supported its claim with the taxpayer’s 2001 federal tax return, which included a signed statement of one of its officers declaring that the purpose of the reorganization was to qualify for QEZE benefits.

Because Ward Lumber failed to prove that it had a valid business purpose for undertaking the reorganization, the judge disallowed its claims for QEZE tax benefits for 2005 through 2008. It is important to note that the judge applied the “valid business purpose” requirement, added to the statute in 2005, only prospectively—Ward Lumber’s QEZE benefits for 2001 through 2004 went unchallenged.