Wrap It in a Bow: Practical Aspects of the Written Plan Requirement
Three weeks ago, our article [https://www.josephdarbylaw.com/post/covid-emergency-ends-and-puts-written-plan-revisions-on-the-clock] noted that everyone in the OZ space has 120 days from the declared end of the COVID emergency (which was May 11, 2023) to revise and upgrade any existing written plan (Written Plan) prepared under the Working Capital Safe Harbor (WCSH) that was impacted by COVID. (We think the 120 days runs to September 8, 2023, but the OZ Regulations sometimes count days oddly so to be safe assume it is September 7, 2023).
Also, businesses holding working capital assets intended to be covered by WCSH before June 30, 2021, receive not more than an additional 24 months (on top of 31 months), for a maximum safe harbor period of not more than 55 months total (not more than 86 months total for start-up businesses), and eligible Written Plans should be modified accordingly.
Two weeks ago, our article [https://www.josephdarbylaw.com/post/wrapping-your-oz-project-how-to-tie-a-bow-around-the-written-plan-requirement] looked at how to create a two- to three-page “Wrapper” around your Written Plan that helps meet all the technical legal requirements contained in Treas. Reg. §1.1400Z2(d)-1 (Regulations). These Regulations include three very specific requirements with respect to the Written Plan:
1) amounts are designated in writing for the development of a trade or business in a qualified opportunity zone (as defined in section 1400Z–1(a)), including when appropriate the acquisition, construction, and/or substantial improvement of tangible property in such a zone;
2) the plan includes a written schedule consistent with the ordinary start-up of a trade or business for the expenditure of the working capital assets, and such plan provides that the working capital assets must be spent within 31 months of the receipt by the business of the assets; and
3) the working capital assets are actually used in a manner that is substantially consistent with the writing and written schedule described in paragraphs (d)(3)(v)(A) and (B) of this section.
The Actual Substance of the Written Plan
Using the Wrapper described above, we pay (very careful) lip service to the specific language of the Regulations and state comprehensive aspirational commitments to comply with all applicable requirements.
This week, we will look at the more practical elements of the Written Plan, including the statement of the amount of funds required, the schedule of expenditures, time allowances for various implementation steps, and the relatively complete technical description of the relevant project.
The first practical requirement of a Written Plan is that the “amounts are designated in writing for the development of a trade or business in a qualified opportunity zone…” We believe this is satisfied not by any specific accounting, financial or other convention or criteria, but rather by describing the business plan pragmatically and with sufficient financial specificity that it meets the aspirational requirements of the Regulations. The entire point of the working capital safe harbor (WCSH) is to allow cash to be held at the QOZB level for up to 31 months without being characterized as the dreaded ‘non-qualified financial property” or NQFP.[1] First of all, note that the Written Plan is not automatically allowed to run a full 31 months if less time is realistically required to implement the business plan.
For example, if a project realistically expects to spend $1 million to create a start-up business over 24 months, then the Written Plan (in theory) needs to specify 24 months and not a full 31 months. However, let’s put an immediate and heavy caveat on this observation, because any good plan naturally provides flexibility in achieving various milestones. Obtaining permits may take 3 months, but it could also take a year. Legal fees might be $3,000 for a specific task, or it could cost $10,000. For this reason, one of the most important keys on your computer keyboard when writing your Written Plan is the hyphen (-) that allows numbers to become a “spread”: Thus, the permitting period is estimated to take 3-12 months, and the legal fees are estimated to be in the range of $3,000-$10,000.
Each tranche of funding contributed to the QOZB for a start-up business can and should have its own separate 31-month period and separate Written Plan, up to a maximum of 62 months consecutive months (or 86 if you qualify for the COVID extension). Use this opportunity to your advantage.
For example, the Written Plan needs to identify the amount of the capital contribution covered by the plan, e.g., $1.6 million contributed by a QOF to the QOZB on June 21, 2023, and how that amount will be spent within the specified time frame of not greater than 31 months. Identify ranges for completion dates and costs, but always make sure your capital contribution is fully covered by the projected expenditures. Clearly, if you contribute $5 million to the QOZB and then the Written Plan specifies maximum spending of $2 million, then $3 million sitting in the QOZB bank account is not being accounted for. On the other hand, if you specify $5 million in expenditures and contribute only $2 million, that’s OK – but, for the sake of logic alone, you will then need to explain where the other $3 million is going to come from, which could be either borrowed funds or subsequent contributions under the next 31-month period and relate Written Plan. A good working capital plan from the outset should necessarily take into account anticipated financing from banks, as well as sequential capital contribution, so that the whole plan hangs together and makes sense.
The next practical element is that the spending plan should address, “…when appropriate the acquisition, construction, and/or substantial improvement of tangible property in such a zone….” Almost every substantial construction project will have detailed projections that address timing, materials costs, construction labor costs, costs for legal, architectural and accounting fees, and other similar expenses, and these are already documented with some reasonable degree of specificity. The concept of the “wrapper” was originally developed for a client on an OZ project where the client sent an email attaching spreadsheets that came to 987 pages. It was very impressive, and the Wrapper was the equivalent of tying a “bow” around the underlying spreadsheets, which were prepared for the bank financing the construction loan. In that project, the loan documents specified that the business would provide and spend its capital first and then draw down funds against a revolving line of credit. The expenditure of the contributed capital was assured, since the borrowed funds were structured to be drawn down only after contributed capital was fully spend.
The Written Plan should include “… a written schedule consistent with the ordinary start-up of a trade or business for the expenditure of the working capital assets…” This schedule requirement is designed to push money out of the QOZB and into actual business expenses, and obviously one must identify the anticipated expenditures in the overall budget, when the amounts are projected to be spend, possible allowances for a changing price in materials, and some reasonable range of expectations regarding possible deferral or delay in timing. As noted above, we believe hyphens are a necessary and integral part of a Written Plan – be realistic about possible outcomes, and ALWAYS provide an outside spending limit of 31 months for each respective capital contribution.
One trenchant question is the degree to which the Written Plan can be updated periodically to reflect actual experience to date. In this regard, note that the IRS guidance on COVID contained in the Proposed Regulations issued in April 2021 suggests that there is great freedom in amending the Written Plan up to, and including, 120 days following the end of the COVID Emergency but also strongly implies by the wording of the language that modifications thereafter are not allowed. However, no one in the OZ industry ever thought or understood that the Written Plan requirement called for a rigid, perfect document to be put in place at the very beginning of a business development procrss and then followed with exacting zealotry and pedantic fervor for the next 31 months. Rather, it was expected that the Written Plan would be a good faith, aspirational effort to identify the actual spending requirements to complete the project, understanding that there was a strong public policy that sought to push money expeditiously from bank accounts into viable businesses located in opportunity zones, and thus to take appropriate actions to execute the plan with reasonable promptness.
COVID, of course, intervened and blew up the world, and of necessity forced the complete rewriting of many Written Plans, because those plans became obsolete due to the dramatic change in circumstances. However, it is the strongly held view of this author, and of almost everybody else in the OZ industry, that a Written Plan necessarily involves both compressions and extensions of time, and changes in the expenditures for various items, depending on factors such as weather, issuance of permits, changes in the cost of materials over 2 1/2 years, supply chain interruptions and other “real world” events. The completion of a major business project – ranging from writing new software to completing construction of a building -- will always be subject to real world factors that force any Written Plan to be a living, breathing, aspirational statement of intent, rather than a rigid and final blueprint ready for perfect execution in a perfect world.
In fact, many of the Written Plans in my experience, particularly those for construction projects, have a month-by-month timeline for drawing down and spending funds. This document is provided to the financing bank long before it is offered (belatedly) to the IRS, and therefore has extraordinary credibility. Any document submitted to a bank to support a construction line of credit or other similar financing will have great credibility and should easily support the good faith requirements of a Written Plan. Probably the single most important requirement in the Regulations is the statement that “…the working capital assets are actually used in a manner that is substantially consistent with the writing and written schedule…” This is where revisions to the Written Plan make particular sense, to show that the taxpayer is in fact TRYING to comply with the written schedule and is taking steps to implement the original intent of the project in good faith despite inevitable, real-world changes in circumstance. This “substantially consistent” requirement should obviously be interpreted and applied in the context of the project, as affected by both common and extraordinary events, from shipping delays to labor strikes to extreme weather conditions.
Summary
The Written Plan is a very important requirement in the Regulations, and one that may get less attention than it deserves in the day-to-day implementation of many qualified opportunity zone businesses. The 120-day “free pass” is a great time to revisit, revise and refresh all existing Written Plans, and at the same time to gage whether the taxpayer is giving enough attention to this central and necessary part of operating a qualified opportunity zone business. [1] A QOZB is allowed to have less than 5% of the unadjusted bases of its assets on any applicable testing date held in NQFP as defined in Code section 1397C(b)(8), and violating this rule results in absolute disqualification of a business from QOZB status. Cash is generally NQFP unless it is held as a reasonable amount of working capital. The WCHS provides an elaborate set of rules that determines when cash contributed to a QOZB for purposes of building a business will be considered to be working capital.