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Publication 954 2002 Tax Year

Tax Incentives for Empowerment Zones &
Other Distressed Communities
(Revised 6/2001)

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This is archived information that pertains only to the 2002 Tax Year. If you
are looking for information for the current tax year, go to the Tax Prep Help Area.

Work Opportunity Credit

The work opportunity credit provides businesses with an incentive to hire individuals from groups that have a particularly high unemployment rate or other special employment needs. Your business does not have to be in an empowerment zone, enterprise community, or renewal community to qualify for this credit. You can claim the credit if you pay or incur qualified first-year wages to a targeted group employee.

At the time this publication was printed, this credit was set to expire for individuals who begin work for you after December 2001.

Targeted group employee.   A targeted group employee is any employee who has been certified by your state employment security agency (SESA) as a:

  1. Recipient of assistance under Temporary Assistance for Needy Families (TANF),
  2. Veteran,
  3. Ex-felon,
  4. High-risk youth,
  5. Vocational rehabilitation referral,
  6. Summer youth employee,
  7. Food stamp recipient, or
  8. Supplemental security income (SSI) recipient.

The employee must meet the requirements explained in the instructions to Form 8850.

State certification required.   An employee is not considered a targeted group employee without SESA certification. To receive certification, submit Form 8850 to your SESA.

You must either:

  1. Receive the certification by the day the individual begins work, or
  2. Do both of the following:
    1. Complete Form 8850 by the day you offer the individual a job, and
    2. Submit the form to your SESA by the 21st day after the individual begins work.

Qualified first-year wages.   Qualified first-year wages are qualified wages you pay or incur for work performed by a targeted group employee during the 1-year period beginning on the date the individual begins work for you. Qualified wages are generally wages subject to the Federal Unemployment Tax Act (FUTA) without regard to the FUTA dollar limit, but not more than $6,000 each tax year for each employee ($3,000 each tax year for a summer youth employee).

If the work performed by the employee during more than half of any pay period qualifies under FUTA as agricultural labor, the first $6,000 of that employee's wages subject to social security and Medicare taxes are qualified wages. For a special rule that applies to railroad employees, see section 51(h)(1)(B) of the Internal Revenue Code.

Nonqualified wages.   See Form 5884 for a complete list of wages that do not qualify for the credit. Some of the most common wages that do not qualify include wages you pay or incur to an employee who:

  1. Has worked for you for more than 1 year,
  2. Is your relative or dependent,
  3. You rehired, if he or she was not a targeted group employee when employed earlier, or
  4. Does not work for you for at least 120 hours.

Amount of credit.   The following table shows the rate you apply to qualified first-year wages you pay or incur each tax year to a targeted group employee who works the number of hours shown. The table also shows the maximum credit you can claim each tax year for each targeted group employee. Table 2. Rate and Maximum Credit Each Tax Year for Each Targeted Group Employee

    Maximum  
    Qualified  
    First-Year Maximum
Hours Worked Rate Wages Credit
At least 400 40% $6,000* $2,400
Fewer than 400 but at least 120 25% 6,000* 1,500
            

*$3,000 for a summer youth employee

Claiming the credit.   Use Form 5884 to claim this credit.

Effect on salary and wage deduction.   In general, you must reduce the deduction on your income tax return for salaries and wages by the amount of your work opportunity credit.

Effect on empowerment zone and renewal community employment credits.   Wages you use to claim the work opportunity credit cannot be used to figure the empowerment zone or renewal community employment credits. In addition, they reduce the maximum wage amount you can use to figure either of those credits.

Effect of welfare-to-work credit.   You cannot claim both the work opportunity credit and the welfare-to-work credit for the same employee during the same tax year.

More information.   For more information about the work opportunity credit, see Form 5884.

Welfare-to-Work Credit

The welfare-to-work credit provides businesses with an incentive to hire long-term family assistance recipients. Your business does not have to be in an empowerment zone, enterprise community, or renewal community to qualify for this credit. You can claim the credit if you pay or incur qualified wages during the first 2 years of employment to a long-term family assistance recipient who begins work for you after December 1997.

At the time this publication was printed, this credit was set to expire for individuals who begin work for you after December 2001.

Long-term family assistance recipient.   A long-term family assistance recipient is an individual who has been certified by your state employment security agency (SESA) as a member of a family that:

  1. Has received assistance payments from Temporary Assistance for Needy Families (TANF) for at least 18 consecutive months ending on the hiring date,
  2. Receives assistance payments from TANF for any 18 months (whether or not consecutive) beginning after August 5, 1997, and is hired not more than 2 years after the end of the earliest 18-month period, or
  3. Stops being eligible after August 5, 1997, for assistance payments because federal or state law limits the maximum period that assistance is payable, and is hired not more than 2 years after that eligibility for assistance ends.

State certification required.   An individual is not considered a long-term family assistance recipient without SESA certification. To receive certification, submit Form 8850 to your SESA.

You must either:

  1. Receive the certification by the day the individual begins work, or
  2. Do both of the following:
    1. Complete Form 8850 by the day you offer the individual a job, and
    2. Submit the form to your SESA by the 21st day after the individual begins work.

Qualified wages.   Qualified wages are generally wages subject to the Federal Unemployment Tax Act (FUTA) without regard to the FUTA dollar limit, but not more than $10,000 each tax year for each employee.

If the work performed by the employee during more than half of any pay period qualifies under FUTA as agricultural labor, the first $10,000 of that employee's wages subject to social security and Medicare taxes are qualified wages. For a special rule that applies to railroad employees, see section 51A(b)(5)(C) of the Internal Revenue Code.

For this credit, qualified wages also generally include the following amounts paid or incurred by the employer that are normally excludable from the employee's gross income.

  1. Amounts received for medical care under accident and health plans.
  2. Employer-provided coverage under accident and health plans.
  3. Certain amounts excludable under an educational assistance program, or that would be excludable but for the expiration of the exclusion. (At the time this publication was printed, this exclusion was set to expire for courses beginning after December 2001.)
  4. Amounts excludable under a dependent care assistance program.

Nonqualified wages.   See Form 8861 for a complete list of wages that do not qualify for the credit. Some of the most common wages that do not qualify include wages you pay or incur to an employee who:

  1. Has worked for you for more than 2 years,
  2. Is your relative or dependent,
  3. You rehired, if he or she was not a long-term family assistance recipient when employed earlier, or
  4. Does not either:
    1. Work for you for at least 180 days, or
    2. Complete at least 400 hours of service.

Amount of credit.   The following table shows the rate you apply to the qualified wages you pay or incur during each year of employment. The table also shows the maximum credit you can claim each tax year for each qualified employee. Table 3. Rate and Maximum Credit Each Tax Year for Each Long-Term Family Assistance Recipient

    Maximum  
    Qualified Maximum
  Rate Wages Credit
Qualified first-year wages 35% $10,000 $3,500
Qualified second-year wages 50% 10,000 5,000

Qualified first-year wages.   Qualified first-year wages are qualified wages you pay or incur for work performed by a long-term family assistance recipient during the 1-year period beginning on the date the individual begins work for you.

Qualified second-year wages.   Qualified second-year wages are qualified wages you pay or incur for work performed by a long-term family assistance recipient during the 1-year period beginning on the day after the last day of the first-year wage period.

Claiming the credit.   Use Form 8861 to claim this credit.

Effect on salary and wage deduction.   In general, you must reduce the deduction on your income tax return for salaries and wages by the amount of your welfare-to-work credit.

Effect on empowerment zone and renewal community employment credits.   Wages you use to claim the welfare-to-work credit cannot be used to figure the empowerment zone or renewal community employment credits. In addition, they reduce the maximum wage amount you can use to figure either of those credits.

Effect of work opportunity credit.   You cannot claim both the welfare-to-work credit and the work opportunity credit for the same employee during the same tax year.

More information.   For more information about the welfare-to-work credit, see Form 8861.

Indian Employment Credit

The Indian employment credit provides businesses with an incentive to hire certain individuals who live on or near an Indian reservation. Your business does not have to be in an empowerment zone, enterprise community, or renewal community to qualify for this credit. You can claim the credit if you pay or incur qualified wages to a qualified employee.

At the time this publication was printed, this credit was set to expire for tax years beginning after 2003.

Qualified employee.   A qualified employee, for any tax period, is any employee who meets all the following tests.

  1. The employee is an enrolled member of an Indian tribe or the spouse of an enrolled member of an Indian tribe.
  2. The employee performs substantially all of his or her services for you within an Indian reservation.
  3. While performing those services, the employee has his or her main home on or near that reservation.

Also, more than 50% of the wages you pay or incur to the employee during the year must be for services performed in your trade or business.

Nonqualified employees.   The following individuals are not qualified employees.

  1. Any employee to whom you pay or incur wages (including wages for services outside an Indian reservation) at a rate that would cause you to pay the employee more than $30,000 if the rate applied for an entire year. (This wage limit may be adjusted for inflation for tax years beginning after 2000.)
  2. Certain related taxpayers.
  3. Certain dependents.
  4. Any 5% owner.
  5. Any individual who performs services involving certain gaming activities.
  6. Any individual who performs services in a building housing certain gaming activities.

Qualified wages.   Qualified wages are any wages you pay or incur for services performed by an employee while the employee is a qualified employee (defined earlier). Wages are generally defined as those wages subject to the Federal Unemployment Tax Act (FUTA) without regard to the FUTA dollar limit.

Also treat as qualified wages any qualified employee health insurance costs you pay or incur on behalf of a qualified employee. However, do not include any amount you pay or incur for health insurance under a salary reduction arrangement.

The total amount of qualified wages (including qualified employee health insurance costs) you can use to figure the credit cannot be more than $20,000 for each employee each tax year.

Effect of work opportunity credit.   Qualified wages do not include any amount you pay or incur for work performed by a qualified employee during the 1-year period beginning on the date the individual begins work for you, if you use any part of these wages to claim the work opportunity credit.

Amount of credit.   In most cases, the credit is 20% of the excess of your current year qualified wages and qualified employee health insurance costs over the sum of the corresponding amounts you paid or incurred during calendar year 1993.

Claiming the credit.   Use Form 8845 to claim this credit.

Effect on salary and wage deduction.   In general, you must reduce the deductions on your income tax return for salaries and wages and health insurance costs by the amount of your Indian employment credit.

Early termination of employee.   Generally, if you terminate a qualified employee sooner than 1 year after the date of initial employment, you cannot claim a credit for that employee for the tax year the employment is terminated. Also, you may have to recapture credits allowed in earlier years.

These rules do not apply in the following situations.

  • The employee voluntarily quits.
  • The employee is terminated because of misconduct.
  • The employee becomes disabled. However, if the disability ends before the end of the first year of employment, you must offer reemployment to the former employee.

More information.   For more information about the Indian employment credit, see Form 8845.

Depreciation of Property Used on Indian Reservations

Depreciation is a loss in the value of property over the time the property is being used. You can get back your cost of certain property by taking deductions for depreciation. This includes the cost of certain buildings and equipment you use in your business.

Special depreciation rules apply to qualified property that you place in service on an Indian reservation after 1993 and before 2004. These special rules allow you to use shorter recovery periods to figure your depreciation deduction for qualified property. As a result, your deduction is larger. Your business does not have to use the property in an empowerment zone, enterprise community, or renewal community to use these special rules.

Qualified property.   Property eligible for the shorter recovery periods is 3-, 5-, 7-, 10-, 15-, and 20-year property and nonresidential real property. You must use this property predominantly in the active conduct of a trade or business within an Indian reservation. Real property you rent to others that is located on an Indian reservation is also eligible for the shorter recovery periods.

The following property is not qualified property.

  1. Property used or located outside an Indian reservation on a regular basis, other than qualified infrastructure property.
  2. Property acquired directly or indirectly from certain related persons.
  3. Property placed in service for purposes of conducting or housing certain gaming activities.
  4. Any property you must depreciate under the Alternative Depreciation System (ADS).

Qualified infrastructure property.   Item (1) above does not apply to qualified infrastructure property located outside the reservation that is used to connect with qualified infrastructure property within the reservation.

Qualified infrastructure property is property that meets all the following requirements.

  1. It is qualified property, as defined earlier (except that it is outside the reservation).
  2. It benefits the tribal infrastructure.
  3. It is available to the general public.
  4. It is placed in service in connection with the active conduct of a trade or business within a reservation.

Infrastructure property includes, but is not limited to, roads, power lines, water systems, railroad spurs, and communications facilities.

Recovery periods.   The following table shows the shorter recovery periods you can use to depreciate qualified property. Table 4. Recovery Periods for Qualified Property

  Recovery
Property Class Period
3-year 2 years
5-year 3 years
7-year 4 years
10-year 6 years
15-year 9 years
20-year 12 years
Nonresidential real property 22 years

More information.   For more information about depreciation, including the special rules that apply to property used on Indian reservations, see Publication 946.

Exclusion of Capital Gains From DC Zone Assets

If you hold a District of Columbia Enterprise Zone (DC Zone) asset more than 5 years, you will not have to include any qualified capital gain from its sale or exchange in your gross income. This exclusion applies to an interest in, or property of, certain businesses operating in the District of Columbia.

DC Zone Asset

A DC Zone asset is any of the following.

  • DC Zone business stock.
  • DC Zone partnership interest.
  • DC Zone business property.

In determining whether any property is a DC Zone asset, continue to treat the DC Zone as an empowerment zone for years after 2003.

DC Zone business stock.   DC Zone business stock is any stock in a U.S. corporation that is originally issued after 1997, if all the following requirements are met.

  1. You acquired the stock before January 1, 2004, at its original issue solely in exchange for cash. (This requirement is also met if you acquired the stock before, on, or after January 1, 2004, from another person in whose hands it was DC Zone business stock.)
  2. The corporation was a DC Zone business (or was being organized as a DC Zone business) at the time the stock was issued.
  3. The corporation qualified as a DC Zone business during substantially all of your holding period for the stock. (This requirement is also met if the corporation ceased to qualify as a DC Zone business after the 5-year period beginning on the date you acquired the stock. However, your qualified capital gain cannot be more than what it would have been if you had sold the stock on the date the corporation ceased to qualify.)

Redemptions of business stock.   Stock will not qualify as DC Zone business stock if the issuing corporation makes certain redemptions of its stock within 2 years before or 2 years after the date the stock was issued. For details, see sections 1400B(b)(2)(B) and 1202(c)(3) of the Internal Revenue Code.

DC Zone partnership interest.   A DC Zone partnership interest is any capital or profits interest in a U.S. partnership that is originally issued after 1997, if all the following requirements are met.

  1. You acquired the partnership interest from the partnership before January 1, 2004, in exchange for cash. (This requirement is also met if you acquired the partnership interest before, on, or after January 1, 2004, from another person in whose hands it was a DC Zone partnership interest.)
  2. The partnership was a DC Zone business (or was being organized as a DC Zone business) at the time the partnership interest was acquired.
  3. The partnership qualified as a DC Zone business during substantially all of your holding period for the partnership interest. (This requirement is also met if the partnership ceased to qualify as a DC Zone business after the 5-year period beginning on the date you acquired the partnership interest. However, your qualified capital gain cannot be more than what it would have been if you had sold the partnership interest on the date the partnership ceased to qualify.)

Redemptions of partnership interest.   A partnership interest will not qualify as a DC Zone partnership interest if the partnership makes certain acquisitions of its partnership interests within 2 years before or 2 years after the date the partnership interest was issued. For details, see sections 1400B(b)(3), 1400B(b)(2)(B), and 1202(c)(3) of the Internal Revenue Code.

DC Zone business property.   DC Zone business property is tangible property acquired after 1997 that meets all the following requirements.

  1. You acquired the property before January 1, 2004. (This requirement is also met if you acquired the property before, on, or after January 1, 2004, from another person in whose hands it was DC Zone business property.)
  2. You did not acquire the property from a related person or member of a controlled group of which you are a member.
  3. Your basis in the property is not determined either by its adjusted basis in the hands of the person from whom you acquired it or under the stepped-up basis rules for property acquired from a decedent.
  4. You were the first person to use the property in the DC Zone. (This requirement is also met if you acquired the property from another person in whose hands it was DC Zone business property.)
  5. Substantially all of the use of the property was in your DC Zone business during substantially all of your holding period for that property. (This requirement is also met if you stopped using the property in your DC Zone business, or your business ceased to qualify as a DC Zone business, after the 5-year period beginning on the date you acquired the property. However, your qualified capital gain cannot be more than what it would have been if you had sold the property on the date you stopped using the property in your DC Zone business or on the date your business ceased to qualify.)

Special rule for substantially improved buildings.   Buildings (and land on which they are located) will be treated as having met requirements (1) and (4) if you substantially improve the buildings before January 1, 2004. You substantially improve a building if, during any 24-month period beginning after 1997, your additions to the basis of the property are more than the greater of the following amounts.

  1. 100% of the adjusted basis of the property at the beginning of the 24-month period.
  2. $5,000.

DC Zone business.   A DC Zone business for this capital gains exclusion is an enterprise zone business as defined earlier under Increased Section 179 Deduction in the discussion of empowerment zones, with the following exceptions.

  • The 35% employee residence requirement listed in item (6) does not apply.
  • The 50% of gross income requirement listed in item (2) is increased to 80%.
  • No area other than the DC Zone can be treated as an empowerment zone or enterprise community.

For this purpose, the DC Zone is treated as including all census tracts in the District of Columbia with a poverty rate of 10% or more as determined by the 1990 census.

Qualified Capital Gain

Qualified capital gain is any gain recognized on the sale or exchange of a DC Zone asset that is a capital asset or property used in a trade or business as defined in section 1231(b) of the Internal Revenue Code (generally real property or depreciable personal property). But it does not include any of the following gains.

  • Gain attributable to periods before 1998 or after December 31, 2008.
  • Section 1245 gain. See chapter 3 in Publication 544, Sales and Other Dispositions of Assets.
  • Section 1250 gain figured as if section 1250 applied to all depreciation rather than the additional depreciation. See chapter 3 in Publication 544.
  • Gain attributable to real property or an intangible asset that is not an integral part of a DC Zone business.
  • Gain attributable, directly or indirectly, in whole or in part, to a transaction with a related person. For the definition of a related person, see chapter 2 in Publication 544.

Other rules.   Rules similar to certain rules in section 1202 of the Internal Revenue Code apply to interests in pass-through entities, certain tax-free transfers, contributions to capital after the original stock issuance date, and short positions.

How To Get Tax Help

You can get help with unresolved tax issues, order free publications and forms, ask tax questions, and get more information from the IRS in several ways. By selecting the method that is best for you, you will have quick and easy access to tax help.

Contacting your Taxpayer Advocate.   If you have attempted to deal with an IRS problem unsuccessfully, you should contact your Taxpayer Advocate.

The Taxpayer Advocate represents your interests and concerns within the IRS by protecting your rights and resolving problems that have not been fixed through normal channels. While Taxpayer Advocates cannot change the tax law or make a technical tax decision, they can clear up problems that resulted from previous contacts and ensure that your case is given a complete and impartial review.

To contact your Taxpayer Advocate:

  • Call the Taxpayer Advocate at 1-877-777-4778.
  • Call the IRS at 1-800-829-1040.
  • Call, write, or fax the Taxpayer Advocate office in your area.
  • Call 1-800-829-4059 if you are a TTY/TDD user.

For more information, see Publication 1546, The Taxpayer Advocate Service of the IRS.

Free tax services.   To find out what services are available, get Publication 910, Guide to Free Tax Services. It contains a list of free tax publications and an index of tax topics. It also describes other free tax information services, including tax education and assistance programs and a list of TeleTax topics.

Personal computer. With your personal computer and modem, you can access the IRS on the Internet at www.irs.gov. While visiting our web site, you can select:

  • Frequently Asked Tax Questions (located under Taxpayer Help & Ed) to find answers to questions you may have.
  • Forms & Pubs to download forms and publications or search for forms and publications by topic or keyword.
  • Fill-in Forms (located under Forms & Pubs) to enter information while the form is displayed and then print the completed form.
  • Tax Info For You to view Internal Revenue Bulletins published in the last few years.
  • Tax Regs in English to search regulations and the Internal Revenue Code (under United States Code (USC)).
  • Digital Dispatch and IRS Local News Net (both located under Tax Info For Business) to receive our electronic newsletters on hot tax issues and news.
  • Small Business Corner (located under Tax Info For Business) to get information on starting and operating a small business.

You can also reach us with your computer using File Transfer Protocol at ftp.irs.gov.

TaxFax Service. Using the phone attached to your fax machine, you can receive forms and instructions by calling 703-368-9694. Follow the directions from the prompts. When you order forms, enter the catalog number for the form you need. The items you request will be faxed to you.

Phone. Many services are available by phone.
 
 

  • Ordering forms, instructions, and publications. Call 1-800-829-3676 to order current and prior year forms, instructions, and publications.
  • Asking tax questions. Call the IRS with your tax questions at 1-800-829-1040.
  • TTY/TDD equipment. If you have access to TTY/TDD equipment, call 1-800-829-4059 to ask tax questions or to order forms and publications.
  • TeleTax topics. Call 1-800-829-4477 to listen to pre-recorded messages covering various tax topics.

Evaluating the quality of our telephone services. To ensure that IRS representatives give accurate, courteous, and professional answers, we evaluate the quality of our telephone services in several ways.
  • A second IRS representative sometimes monitors live telephone calls. That person only evaluates the IRS assistor and does not keep a record of any taxpayer's name or tax identification number.
  • We sometimes record telephone calls to evaluate IRS assistors objectively. We hold these recordings no longer than one week and use them only to measure the quality of assistance.
  • We value our customers' opinions. Throughout this year, we will be surveying our customers for their opinions on our service.

Walk-in. You can walk in to many post offices, libraries, and IRS offices to pick up certain forms, instructions, and publications. Also, some libraries and IRS offices have:

  • An extensive collection of products available to print from a CD-ROM or photocopy from reproducible proofs.
  • The Internal Revenue Code, regulations, Internal Revenue Bulletins, and Cumulative Bulletins available for research purposes.

Mail. You can send your order for forms, instructions, and publications to the Distribution Center nearest to you and receive a response within 10 workdays after your request is received. Find the address that applies to your part of the country.

  • Western part of U.S.:
    Western Area Distribution Center
    Rancho Cordova, CA 95743-0001
  • Central part of U.S.:
    Central Area Distribution Center
    P.O. Box 8903
    Bloomington, IL 61702-8903
  • Eastern part of U.S. and foreign addresses:
    Eastern Area Distribution Center
    P.O. Box 85074
    Richmond, VA 23261-5074

CD-ROM. You can order IRS Publication 1796, Federal Tax Products on CD-ROM, and obtain:
 

  • Current tax forms, instructions, and publications.
  • Prior-year tax forms, instructions, and publications.
  • Popular tax forms which may be filled in electronically, printed out for submission, and saved for recordkeeping.
  • Internal Revenue Bulletins.

The CD-ROM can be purchased from National Technical Information Service (NTIS) by calling 1-877-233-6767 or on the Internet at www.irs.gov/ cdorders. The first release is available in mid-December and the final release is available in late January.

IRS Publication 3207, Small Business Resource Guide, is an interactive CD-ROM that contains information important to small businesses. It is available in mid-February. You can get one free copy by calling 1-800-829-3676 or visiting the IRS web site at www. irs.gov/prod/bus_info/sm_bus/smbus-cd.html.

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