Will the new markets tax credit stimulate low-income communities?

• Author: Lederman, Alan S.
• Position: Part 1

EXECUTIVE SUMMARY

* A CDE must use substantially all the cash contributed in exchange for the equity interest to make qualified low-income community investments.

* Domestic S and C corporation and partnerships (including multiple-member limited liability companies and business trusts) can qualify as CDEs.

* A taxpayer investing directly in a non-CDE qualified active low-income community business does not qualify for NMTCs.

As part of the Community Renewal Tax Relief Act of 2000, Section 121(a), Congress enacted Sec. 45D, the new markets tax credit (NMTC) program. Sec. 45D is designed to attract $15 billion in taxpayer investments in low-income community businesses, by providing investors with a 39% Federal income tax credit. Investors will benefit from the NMTCs; low-income community businesses will benefit from the tax-subsidized equity and debt financing NMTCs create. The complexities of the NMTC program will no doubt also provide significant work for CPAs, attorneys, underwriters, financial advisers, loan broken, lobbyists and other professionals.

Under the program, a taxpayer obtains NMTCs by making an equity investment in a Federally certified for-profit entity (a "qualified community development entity" (CDE)) that has received a Federal NMTC allocation permitting it to designate NMTCs to its equity investors.

Apparently, the premise is that taxable investors will accept a somewhat lower pre-tax return (or somewhat higher business risk) from CDE investments in recognition of the NMTCs. Accordingly, CDEs should be able to offer equity financing and loans at below prevailing risk-adjusted market yields to qualified active low-income community businesses, which are the intended beneficiaries of the NMTC program.

This two-part article discusses (1) how an entity obtains CDE status; (2) how CDEs receive NMTC allocations; (3) how taxpayers receive NMTCs by reason of their equity investment in CDEs; (4) permissible uses by CDEs of taxpayers' NMTC-eligible capital contributions; (5) NMTC recapture; (6) availability of NMTCs in addition to other Federal tax incentives; and (7) limits on NMTC use. Part I, below, examines the first three listed items.

Who Benefits?

Most active businesses conducted in low-income census tracts (except for rental apartments and developing intangible property for sale or license, for which other types of tax benefits may be available), can be active low-income community businesses that qualify for low-cost loans and equity investments from a CDE. Thus, practically any class of retail, wholesale, manufacturing or service business (and their equity investors and lenders) can potentially benefit from the tax-advantaged financing the NMTC program generates. The commercial real estate industry (including shopping centers, offices and warehouses) is expected to be a major beneficiary. Exhibit 1 on p. 391 illustrates how the NMTC program will work.

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Certifying CDEs

Treasury has delegated to its Community Development Financial Institutions Fund (Fund) the certification of CDE status and allocation of NMTCs to CDEs. As of April 1,2002, the Fund had issued extensive guidance and application forms for obtaining CDE sums, but had not yet done the same for obtaining NTMC allocations. (1) Such Fund guidance, comments from the public in response to the Fund's solicitation of comments, CDE status application forms and related Fund materials are available at...