New Market Tax Credits: A Guide to NMTC
Tax credits allow taxpayers to subtract a specific amount from their tax bill. These credits are available at both the state and federal level. In general, the purpose of tax credits is to provide an incentive for the taxpayer to take a specific action. For example, tax credits are available for adding renewable energy features to your home, pursuing an education, or donating to a charitable organization.
One of the most common examples is the child and dependent care tax credit, which you get for the children or other dependents in your household.
Some tax credits, including the New Markets Tax Credit Program, are for investors or business entities.
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What Is the New Markets Tax Credit?
The New Markets Tax Credit (NMTC) Program provides an incentive for businesses and investors to financially support development in low-income areas to decrease the number of people under the poverty line, offer employment or financial services to community residents, and increase the overall quality of life.
The NMTC began as part of the broader Community Renewal Tax Relief Act of 2000. The credits are available to businesses and equity investors who fund development projects, establish facilities that offer financial services and education, or support business development in approved areas. To qualify for tax credits, the entity that runs the business needs to prove that its efforts focus on ending the cycle of poverty within a community.
Programs that qualify for tax credits are run by Community Development Entities (CDEs). A CDE is a corporation or partnership whose primary mission is investing in low-income areas. An investor can purchase equity in a already-existing CDE. You can also establish a CDE yourself and channel your investments through it.
The Community Development Financial Institutions (CDFI) Fund, which is part of the Department of the Treasury, approves Community Development Entities and facilitates investment in target communities. They also define the parameters of the tax credit program and make judgments about who qualifies.
New Markets Tax Credits Eligibility
To qualify for the NMTC, a CDE needs to make specific types of investments in qualifying low-income areas, known as Low-Income Communities (LICs). The CDFI assesses census data and chooses communities eligible for CDE investment based on factors such as the number of citizens under the poverty line and the median family income (MFI).
Under current standards, more than 20% of a community must live below the poverty line and the MFI must be no more than 80% of the state average.
Program administrators approve each project, which becomes known as a Qualified Equity Investment (QEI). In addition to focusing the investment within qualified LICs, the CDE’s funds need to go to Qualified Active Low Income Community Businesses (QALICBs), a development that benefits the community, or an organization that provides financial services or financial education to people within the community.
The CDFI calls these investments “Qualified Low-Income Community Investments (QLICIs).”
To protect against businesses “outsourcing” labor to low-income communities and conducting business elsewhere, the QALICB must operate within the target community. At least 50% of the revenue needs to come from activities within the community. At least 40% of the tangible property needs to be located there as well.
Many projects focus on retail or mixed-use properties, healthcare facilities, and manufacturing businesses.
New Markets Tax Credit Amount
New markets tax credits are spread out over seven years. Investors receive the credit in the form of a reduction in their federal tax liability of 5% on their total investment for each of the first three years. For the next four years, the credit amount is 6%. This means that, after seven years, your tax credit is equal to 39% of the investment you pay out.
How to Initiate NMTC Projects
There are three ways to invest in an NMTC project. You can invest in an established CDE, purchase a loan from an existing CDE, or establish your own CDE. When creating a new CDE, you need to meet specific criteria and gain approval from the Community Development Financial Institution (CDFI).
If you choose to establish an independent CDE, you need to meet certification requirements. You cannot participate in projects that qualify for NMTC status without first gaining approval from the CDFI. You need to follow the application process before you begin your first investment or project.
Applying to the CDFI
You apply for CDE certification through the Treasury Department’s Community Development Financial Institution. You submit an application that proves your business entity will meet all requirements necessary to participate in the program.
The materials you need to provide include documentation that shows your status as a legal company or nonprofit entity and an explanation of how your work will impact your target low-income communities. You also need to show how you plan to maintain accountability to the residents of the target area.
The NMTC provides a market-based way for businesses and organizations to invest in underprivileged communities. Though the program is meant to encourage widespread investment, the guidelines are strict and the approval process requires extensive documentation on planned investments. With proper planning, investors can gain favorable tax benefits while also helping to improve the communities around the country.
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This post was updated December 4, 2019. It was originally published December 4, 2019.