Eaton Peabody

NEW MARKETS TAX CREDITS

Introduction

The New Markets Tax Credit (“NMTC”) program is a relatively new provision of the Internal Revenue Code, enacted by Congress on December 21, 2000 as part of the “Community Renewal Tax Relief Act of 2000”. The program is one of a number of measures in that legislation intended to encourage new private investment in economically distressed areas. NMTC is not a grant program, but provides important federal tax benefits to private investors. The focus of the program is on generating new private investment in for-profit business activity.

Description

The New Markets Tax Credit program works as follows:              

1. A for-profit development entity is created and certified by the Secretary of the Treasury as a “qualified community development entity” (“CDE”). Although the Code provisions refer to a “corporation or partnership”, limited liability companies (LLCs) have also been recognized for this purpose. To obtain CDE certification the entity must (a) have as its primary mission serving or providing investment capital for low-income communities or low-income persons; and (b) “maintain accountability” by having residents of the low income community concerned on its governing or advisory board.

Eligible low income communities are determined based on average household income. Under the current statute, this determination is made based on U.S. census tract boundaries. The basic requirement is that the census tract must have a poverty rate of 20% or more, or must have a median family income that is 80% or less of the median family income for the adjacent area. At this writing (December, 2006), a proposed amendment to section 1.45D-1 of the Internal Revenue Service Income Tax Regulations would make some projects located outside of qualifying census tracts eligible for New Markets Tax Credit investments, based on the income levels of persons hired by the project as a result of the investment. 

Qualified CDEs in Maine include two for-profit affiliates of Coastal Enterprises, Inc. of Wiscasset (“CEI”).  NMTC financing is provided by CEI through CEI Ventures, Inc. and CEI Community Ventures, Inc.  

2. The qualified CDE applies for and receives an allocation of investment tax credits from the Secretary of the Treasury. Under the NMTC legislation as currently in force, new allocations of tax credits will be made annually through 2007. Applications for the 2004 allocation cycle were due by October 6, 2004. Allocations are made competitively, on a nation-wide basis. There is no automatic set-aside for particular states or regions. 

Currently, Coastal Enterprises Inc.’s CDE affiliates received a total of $129 million in the first two rounds of NMTC allocations. No additional allocation was made to Coastal Enterprises for the third round. CEI received an additional allocation of tax credits in October, 2006 (round 4).

3. Investors purchase equity interests in the qualified CDE (stock ownership, partnership interests, etc.).  Investors must pay cash for their interests. IRS regulations limit use of borrowed funds for this purpose.  Taxpayers making such investments receive a tax credit, which they may apply against their federal income tax liability over the next seven years. The investor’s purchase must be made within five years after the tax credit allocation to the qualified CDE. The total credit is equal to 39% of the amount invested by that taxpayer. The credit for years 1-3 is 5%; for years 4-7, 6%.

4. Investors may not divest themselves of their equity interest in the qualified CDE for the full seven year period. If they do, recapture provisions apply.

5. The qualified CDE then invests “substantially all” of its cash (a minimum of 85% of aggregate gross assets under the Code’s safe harbor provision) in “qualified low-income community investments” (“QLICI”). These consist primarily of investments in or loans to “qualified active low-income community businesses” (“QALICB”), which have their own qualification requirements. Essentially, the qualified CDE acts as an investment entity, and not as a direct business owner or project developer. Although most CDE investments are made as loans, the Code provisions are very flexible in allowing CDEs to also acquire equity interests, such as stock ownership, LLC or partnership interests, etc.

The total return to the individual investor consists of interest, profits or dividends generated on their original investment, a return of capital at the end of the seven year investment holding period, and a total 39% federal income tax credit on the original investment amount. 

6. The Code also provides for recognition of qualified “Community Development Financial Institutions” (“CDFI”) which may also receive allocations of NMTC credits. Bangor Savings Bank is among the financial institutions in Maine having CDFI status. CDFI status enables a bank to make loans at below-market interest rates to QALICBs. The bank can then place or remarket its loan to private investors, who become eligible for the 39%, seven-year federal income tax credit. In this manner, a below-market interest rate loan to a qualifying business can generate an above-market rate of return to an individual investor.

Further Information

The Eaton Peabody law firm and its affiliated Eaton Peabody Consulting Group offer a wide range of economic development services to Maine businesses and municipalities.  

For further information on the New Markets Tax Credits program or other financing options for local economic development projects, please contact Noreen Norton of Eaton Peabody Consulting Group at

(207) 622-3747 or Erik Stumpfel of the Eaton Peabody law firm at 947-0111 ext. 746.

This paper is provided as general information, and is not a substitute for legal or other professional advice.