The New Markets Tax Credit: An Introduction
Order Code RS22680
June 19, 2007
The New Markets Tax Credit: An Introduction
Donald J. Marples
Specialist in Public Sector Economics
Government and Finance Division
Summary
The New Markets Tax Credit (NMTC) is a non-refundable tax credit intended to
encourage private capital investment in eligible low-income communities. NMTCs are
allocated by the Community Development Financial Institutions Fund (CDFI) under a
competitive application process. Investors who make qualified equity investments
reduce their federal income tax liability by claiming the credit. The NMTC program,
enacted in 2000, is currently authorized to allocate $18.5 billion through the end of
2008. To date, $12.1 billion in NMTCs has been allocated.
In the 110th Congress, legislative attention has focused on extending the NMTC
program authorization past its currently scheduled 2008 expiration. H.R. 2075 and S.
1239 propose to extend the NMTC through 2013. Both bills propose an additional
allocation authority of $3.5 billion per year through 2013, indexed for inflation.
This report will be updated as warranted by legislative changes.
Overview
The New Markets Tax Credit (NMTC) was enacted by the Community Renewal
Tax Relief Act of 2000 (P.L. 106-554, 113 Stat. 2763) to provide an incentive to
stimulate investment in low-income communities (LIC). The original allocation of tax
credits eligible for the NMTC program was $15 billion from 2001 to 2007. Qualified
investment groups apply to the U.S. Department of the Treasury’s Community
Development Financial Institutions Fund (CDFI) for an allocation of the New Markets
Tax Credit. The investment group, known as a Community Development Entity (CDE),
will seek taxpayers to make qualifying equity investments in the CDE. The CDE then
makes equity investments in low-income communities and low-income community
businesses, all of which must be qualified. After the CDE is awarded a tax credit
allocation, the CDE is authorized to offer the tax credits to private equity investors in
the CDE.
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The tax credit value is 39% of the cost of the qualified equity investment and is
claimed over a seven-year credit allowance period.1 In each of the first three years, the
investor receives a credit equal to 5% of the total amount paid for the stock or capital
interest at the time of purchase. For the final four years, the value of the credit is 6%
annually. Investors must retain their interest in a qualified equity investment throughout
the seven-year period.
Program Components
The process by which the NMTC affects eligible low-income communities involves
multiple agents and steps. Figure 1 illustrates the key agents in the NMTC process.
Figure 1. Key Components in the NMTC Process
Source: CRS analysis of NMTC program components
The multiple steps and agents are designed to ensure that the tax credit achieves its
primary goal: encouraging investment in low-income communities. For example, the
CDFI reviews NMTC applicants by CDEs, issues tax credit authority to those CDEs
deemed most qualified, and plays a significant role in program compliance.
Community Development Entities (CDE)
A CDE is a domestic corporation or partnership that is an intermediary vehicle for
the provision of loans, investment funding, or financial counseling in low-income
communities (LICs). To become certified as a CDE, an organization must submit an
application to the CDFI that demonstrates that it meets three criteria: (1) it is a domestic
corporation or partnership duly organized under the laws of the jurisdiction in which it
is incorporated; (2) it has a primary mission of serving low-income communities; and
1 In present value terms, the credit is equal to approximately 30% of the eligible investment at
a 6.7% discount rate.
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(3) it maintains accountability to residents of these low-income communities. A CDE
may demonstrate meeting the third criterion by filling at least 20% of either its advisory
or its governing board positions with representatives of low-income communities.2
Only CDEs may apply for the NMTC. Upon receipt of NMTC allocation, CDEs
attract investors using the credits. While both for-profit and nonprofit CDEs may apply
for the NMTC, only for-profit CDEs may pass the NMTC on to investors. To ensure
that projects are selected on economic merit, nonprofit CDEs awarded NMTCs must
transfer their allocations to for-profit subsidiaries prior to offering NMTCs to investors.
As Figure 1 illustrates above, CDEs play a critical role in a properly functioning
NMTC process. CDEs are the intermediaries between the potential low-income
community investments and the CDFI during the application process. CDEs also
present investors with investment opportunities and provide the CDFI the majority of
its compliance data.
Qualifying Low-Income Communities
Under the tax code’s NMTC provisions, only eligible investments in qualifying
low-income communities are eligible for the NMTC. Qualifying low-income
communities include census tracts that have at least one of the following criteria: (1) a
poverty rate of at least 20%; (2) in a metropolitan area, a median family income below
80% of the greater of the statewide or metropolitan area median family income; or (3)
outside a metropolitan area, a median family income below 80% of the median statewide
family income. As defined by the criterion above, about 39% of the nation’s census
tracts covering nearly 36% of the U.S. population are eligible for the NMTC.
Additionally, designated targeted populations may be treated as low-income
communities.3 Further, the definition of a low-income community includes census tracts
with low populations and census tracts within high migration rural counties. As a result
of the definition of qualified low-income communities, virtually all of the country’s
census tracts are potentially eligible for the NMTC.
Qualified Investors and Investments
All taxable investors are eligible to receive the NMTC. As noted above, investors
receiving the credit can claim the NMTC over a seven-year period, starting on the date
of the investment and on each anniversary: at a rate of 5% for each of the first three
years and a rate of 6% for each of the next four years, for a total of 39%. Once the
investor begins claiming the NMTC, the credit can be recaptured if the CDE: (1) ceases
to be a CDE, (2) fails to use substantially all of the proceeds for eligible purposes, or (3)
redeems the investment principal.4
2 In addition, all Community Development Financial Institutions or Specialized Small Business
Investment Companies automatically qualify as CDEs. To be recognized as CDEs, these entities
are required to register through the CDFI Fund website.
3 See Internal Revenue Bulletin 2006-29, Notice 2006-60, issued July 17, 2006, for a more
complete description of the definition of designated targeted populations.
4 According to IRS regulations, the “substantially all” requirement is met if at least 85% of
investor proceeds are used to make eligible investments in the first six years of the NMTC period
(continued...)
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Almost all investments in low-income communities or serving a low-income
population could be eligible for investment for which investors receive the NMTC.
These eligible investments are referred to as qualified low-income community
investments (QLICIs). QLICIs are categorized in four ways: (1) loans or investments
to qualified active low-income community businesses (QALICB), (2) the provision of
financial counseling, (3) loans or investments in other CDEs, and (4) the purchase of
loans from other CDEs.5 All QLICIs, including QALICBs, are explicitly prohibited
from investing in residential rental property and certain types of businesses, such as golf
courses and casinos.
NMTC Allocation Process and Compliance
To receive an allocation, a CDE must submit an application to the CDFI, which
asks a series of standardized questions about the track record of the CDE, the amount
of NMTC allocation authority being requested, and the CDE’s plans for any allocation
authority granted.
The application covers four areas: (1) the CDE’s business strategy to invest in low-
income communities, (2) capitalization strategy to raise equity from investors, (3)
management capacity, and (4) expected impact on jobs and economic growth in low-
income communities where investments are to be made. In addition, priority points are
available for addressing the statutory priorities of investing in unrelated entities and
having demonstrated a track record of serving disadvantaged businesses or communities.
The application is reviewed and scored to identify those applicants most likely to have
the greatest community development impact and ranked in descending order of
aggregate score.
Tax credit allocations are then awarded based upon the aggregate ranking, until all
of the allocation authority is exhausted. In each of the four completed NMTC rounds,
significantly more CDEs applied for allocations than were able to receive allocations,
with only 22% of applicants receiving allocations. Additionally, allocation authority of
$107 billion was requested, compared with the $12.1 billion in allocation authority
available.6
Prior to receiving the authority to offer tax credits to investors, every CDE allocatee
must sign an allocation agreement. The allocation agreement clarifies the terms and
conditions of the allocation authority, such as the total tax credit authority, service areas,
4 (...continued)
and at least 75% in year seven of the investment.
5 For a business to be a QALICB, it must be located in a qualifying census tract, derive at least
50% of gross income from activity conducted in a LIC, have at least 40% of both the use of
tangible property and services provided located or performed in the LIC, and have less than 5%
of the aggregate unadjusted bases of the property attributable to collectibles or non-qualified
financial property.
6 See U.S. Government Accountability Office, TAX POLICY: New Markets Tax Credit Appears
to Increase Investment by Investors in Low-Income Communities, but Opportunities Exist to
Better Monitor Compliance, GAO-07-296, January 31, 2007, for detailed breakdowns of
application and allocation statistics.
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and authorized uses of the allocation. Failing to meet the terms of the allocation
agreement subjects the CDE to the potential revocation of allocation authority.
Additionally, the Internal Revenue Service (IRS) monitors compliance with the tax
consequences of NMTC allocations, focusing on the “substantially all” requirement.
As specified in the IRS regulations, CDE allocatees must issue tax credits to
investors within five years of signing their allocation agreements and invest the QEIs in
QLICIs within 12 months. If these requirements are not satisfied, the CDE loses the
authority to allocate the unused NMTC. In addition, CDEs that receive principal
payments from their QLICIs have 12 months to reinvest those funds in QLICIs to avoid
recapture.
Legislative Developments
Modifications to the NMTC program have been made in the past two Congresses.
In the 108th Congress, the American Jobs Creation Act of 2004 (P.L. 108-357, 118 Stat.
1418) included provisions expanding the authority of the Secretary of the Treasury to
treat certain other tracts and targeted populations as low-income communities.7
During the 109th Congress, the Gulf Opportunity Zone Act of 2005 (P.L. 109-135,
119 Stat. 2577) was enacted to provide tax relief to businesses and individuals affected
by Hurricane Katrina. The bill, which created the Gulf Opportunity Zone (or GO Zone),
provided an additional $1 billion in allocation authority to CDEs with a significant
mission in the recovery and redevelopment of low-income communities in the Katrina
GO Zone.
Also during the 109th Congress, the Tax Relief and Health Care Act of 2006 (P.L.
109-432, 120 Stat. 2922) extended the NMTC for one year, through 2008, with an
additional allocation of $3.5 billion, and mandated Treasury to promulgate regulations
to ensure that non-metropolitan counties receive a proportional allocation of investments
under the NMTC.
In the 110th Congress, H.R. 2075 and S. 1239 have been introduced.8 Both bills
would amend the Internal Revenue Code of 1986 to extend the NMTC through 2013 and
would authorize allocations of $3.5 billion, indexed for inflation, for each of the years.
Policy Considerations
The New Markets Tax Credit Program is currently set to expire at the end of 2008.
As mentioned above, H.R. 2075 and S. 1239 have been introduced in the 110th Congress
7 The term ‘’Targeted Population,’‘ as defined in 12 U.S.C. 4702(20), means individuals, or an
identifiable group of individuals, including an Indian tribe, who (A) are low-income persons
(Low-Income Targeted Population); or (B) otherwise lack adequate access to loans or equity
investments.
8 H.R. 2075 has been referred to the House Committee on Ways and Means, and S. 1239 has been
referred to the Senate Finance Committee.
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proposing to extend the NMTC through 2013. The following policy considerations could
be pertinent to any consideration of these bills.
The NMTC is primarily intended to encourage private capital investment in eligible
low-income communities. However, the source of the investment funds has implications
for the effectiveness of the program in achieving its objective. From an economic
perspective, the impact of the NMTC would be greatest in the case where the investment
represents new investment in the U.S. economy that would not have occurred in the
absence of the program. Conversely, the impact of the NMTC is diminished to the extent
the tax credit is applied to investment that would have otherwise occurred or been funded
by a shift in investment from more productive alternatives.9 To date, only one study has
empirically assessed the question of whether NMTC investment is funded through shifted
investment or whether it represents new investment, finding mixed results.10
The NMTC is one of several programs designed to improve conditions in low-
income communities. In a 2004 assessment of the NMTC, the Office of Management and
Budget noted that the goal of the NMTC overlaps that of several other tax credits and
numerous programs administered by the departments of Housing and Urban Development
and Commerce.11 Given this overlap and the desire to target federal funds to their most
productive uses, it follows that information on the performance of the NMTC relative to
other programs with a similar goal would be of use. However, to date, no comparative,
empirical study of this nature has been undertaken.
9 However, from a policy perspective, the desire to minimize the distortion of investment choice
caused by the NMTC is usually balanced against other objectives, such as equity.
10 U.S. Government Accountability Office, TAX POLICY: New Markets Tax Credit Appears to
Increase Investment by Investors in Low-Income Communities, but Opportunities Exist to Better
Monitor Compliance, GAO-07-296, January 31, 2007.
11 See [http://www.whitehouse.gov/omb/expectmore/detail/10002230.2004.html].