The 2009 American Recovery and Reinvestment Act (Stimulus Package) increases the amount of credits that are available in the New Markets Tax Credit (NMTC) program. The NMTC program provides investors with a substantial tax credit and qualified businesses with a substantially lowered cost of capital. Prior to the Stimulus Package amendments, New Markets Tax Credits for 2008 and 2009 were limited to 3.5 billion in each year. The Stimulus Package increases the NMTC amount to $5.0 billion for each year. The changes for 2008 are retroactive. The extra allocation is to be given to community development entities that either did not receive an allocation or received less than the amount for which they applied.
Like many tax incentives, however, the rules are complex. Here is a basic overview of how the NMTC program works.
What is the NMTC Program?
- The NMTC program is designed to encourage investment in businesses located in low-income areas, by providing federal income tax credits to investors. The program permits significant flexibility in how the participants structure investments.
- The NMTC program is particularly attractive in tight credit markets, such as we are now experiencing, because of the significant financing subsidy the NMTC provides.
What types of clients does Dykema represent in connection with NMTC?
- Dykema represents investors, lenders, CDEs (described below) and project owners in connection with the NMTC.
Where can a NMTC project be located?
- The project must be in a low-income community i.e., a census tract with at least 20% poverty or median family income below 80% of area median.
What types of businesses are eligible for the NMTC program?
- Generally, any trade or business can qualify, including a nonprofit organization. Businesses that do not qualify are those with more than 80% residential rental, businesses that involve sales of intangibles or private golf courses, country clubs, massage parlors, hot tubs, suntan facilities, racetracks, gambling facilities or liquor stores.
What other requirements must be met?
- 40% of the qualified business’s tangible property must be located in a low-income community, 40% of its employees must live in a low-income community (but not necessarily the one where the project is located) and 50% of its gross receipts must be derived from business in the low-income community.
Who allocates the credit?
- Credits are allocated by the Community Development Financial Institutions Fund (“CDFI Fund”) within the U.S. Department of Treasury to certified Community Development Entities (“CDE”).
- The CDE must first apply to the CDFI Fund to be certified. Generally, the certification standards are easy to meet, as long as the CDE can show community involvement and that its goals advance the purposes of the NMTC program.
- Once certified, the CDE must apply to the CDFI fund for an allocation. The allocations as revised by the Stimulus Package, are limited to $5.0 billion nationally in 2008 and 2009. Requests for allocations historically have exceeded availability.
How much is the credit?
- The credit equals 39% of the investor’s “qualified equity investment” in a CDE.
- The credit is allocated over seven years, 5% in each of the first three years and 6% in each of the last four years.
When is the credit earned?
- The NMTC is earned (but claimed over seven years) when the credit investor makes an equity investment in the CDE.
Is the credit subject to recapture?
- Yes. If the CDE returns any portion of the investor’s investment (other than a reasonable return on equity, which includes interest due on any loan to the investor) in the seven-year credit period, the entire credit is subject to recapture. Certain other events also can trigger a recapture.
Can the investor use borrowed money?
- Yes. The IRS has ruled that the investor can include the proceeds of a nonrecourse loan as part of its equity contribution.
- Often, but not always, the investor and the lender are related.
- The ratio of investor equity to borrowed funds varies, but typically equity is 20% – 35% of the overall investment, the balance being nonrecourse loan proceeds.
What types of investment can the CDE make with the investor’s money?
- The CDE can make a loan or an equity investment in the project business. The most common structure is a loan with interest only for the recapture period.
Can the NMTC be combined with other tax incentives?
- Yes. Projects frequently combine Federal Historic Rehabilitation Credits as well as state credits, such as state Brownfield or state historic credits with NMTC.
How does the project owner benefit from the NMTC program?
- The CDE will be required to demonstrate that its investment in the project is at favorable rates or contains other nonmarket terms.
- Typically, the qualified business borrower obtains a very low interest rate or the transaction is structured so that a portion of the debt (often, about 20% - 25%) is cancelled at the end of the seven-year recapture period.