The Indiana tech community could be on the cusp of two significant legislative changes making their way through the General Assembly.
First, Senate Bill 541, currently under review by the Tax and Fiscal Policy Committee, would provide nonrefundable tax credits to companies for training expenses incurred. This is an encouraging move by legislators who are attempting to bridge the gap between Indiana’s workforce skills and the needs of Hoosier employers.
However, while this legislation is a step in the right direction, a nonrefundable tax credit has its disadvantages, especially for tech companies. With these tax credits, a company would incur expenses to train its employees, and the training expenses incurred would translate into a nonrefundable tax credit. Nonrefundable means the credit can only be used if there is a tax liability to apply the credit against. And there’s the rub.
Most tech companies are LLCs and S corporations. These entities don’t pay tax but rather pass through income – and any taxes that come along with that income – to the owners. Any tax credit would pass through to the owners, too. As many owners of start-ups and early-stage companies know all too well, most new tech companies don’t have income in their early years, nor do some of their owners. Because of this, a tax credit would have no immediate value.
What’s worse, for out-of-state owners there may never be any value if they don’t have Indiana taxes to apply the credit against.
Even in cases where an owner can use the credit, the company doesn’t directly benefit. That means the link between the desired behavior and outcome is marginalized: “Employers, you should spend money on training. But, employers, only your owners will benefit.”
Again, not to say tax credits have no value. But an incentive diluted and arbitrarily impactful is less than it can be. Luckily, a smarter, much easier fix exists.
It so happens Indiana already has a training grant program in place that is the best of its kind in the country. The program is the Skills Enhancement Fund, or SEF. SEF reimburses 50 percent of a company’s training expenses. SEF is transformative and popular. So popular, in fact, that it is perpetually low on funding. The supply of SEF dollars can’t keep up with demand.
SEF is far better than a training grant because it is cash, not a tax credit. And it goes to the company, not the owners. Plus, it’s an established program already in place with all the kinks worked out.
In sum, the solution is simple: Rather than create a well-intended-but-flawed new incentive program, simply increase the funding for SEF.
The second legislative proposal in the works affecting tech companies involves changes to Indiana’s VCI tax credit. VCI gives a tax credit to investors in start-ups and early-stage companies. With House Bill 1503, which has been referred to the Ways and Means Committee, the legislature looks to enhance funding and caps for VCI awards, and, drum roll please: make VCI assignable.
Increasing funding and caps is a no-brainer. As tech companies expand here, so must the tools designed to promote their growth. But making the credit assignable is a radical departure from VCI in its current state. Assignable means VCI credits could be sold.
Here’s why that matters so much:
VCI credits are nonrefundable, so their usefulness varies. Because many investors in tech companies do have income tax liability, there’s a much greater chance they’ll be able to use VCI credits than some owners of start-ups. Still, a good amount of VCI credits doled out by the Indiana Economic Development Corporation goes unused. By making VCI credits assignable and eligible for sale, some of the credits currently “trapped” by their owners’ lack of income tax liability could be converted into cash.
Still, anything that makes these credits more valuable to investors increases the chances these investors will take a chance on Indiana tech companies. Making them assignable will be a positive change.
Better still would be making VCI refundable, even if just a portion of it. By making the tax credit refundable, any unused credit becomes cash. The value here is immediate to the investor, and reduces the bureaucracy and discounted value that would come with selling the credit.
Despite all of Indiana’s great progress in the tech sector, the fact remains raising money here can be brutal. Making the VCI tax credit more versatile would get the VC world’s attention and be change the way Indy tech firms look for capital to launch and operate their businesses.
Tim Cook is chief executive officer of KSM Location Advisors.