New Markets Tax Credit: An Introduction

^Pr^ep^ar^{ed f}^o^r^M^e^m^b^ers^an^d^Com^mⁱ^t^t^ees^of^C^ong^r^e^ss

The New Markets Tax Credit (NMTC) is a non-refundable tax credit intended to encourage
private capital investment in eligible, impoverished, low-income communities. NMTCs are
allocated by the Community Development Financial Institutions Fund (CDFI), a bureau within
the United States Department of the Treasury, 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 $23 billion
through the end of 2009. To date, the CDFI has made 294 awards totaling $16 billion in NMTC’s
allocation authority.
In the 110^th Congress, legislative attention has focused primarily on extending the NMTC
program authorization. This attention came to fruition with the enactment of P.L. 110-343, which
extended the NMTC program authorization one year, through the end of 2009. This one-year
extension was also proposed in H.R. 6049, S. 2886, S. 3098, and H.R. 7060. 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. H.R. 3907 proposes to make
the NMTC permanent.
This report will be updated as warranted by legislative changes.

Overvi ew ....................................................................................................................... .................. 1
Program Components......................................................................................................................1
Community Development Entities (CDE)................................................................................2
Qualifying Low-Income Communities.....................................................................................3
Qualified Investors and Investments.........................................................................................3
NMTC Allocation Process and Compliance.............................................................................4
NMTC Investment Activity.............................................................................................................4
Legislative Developments...............................................................................................................5
Policy Considerations......................................................................................................................6
Figure 1. Key Components of the NMTC Process..........................................................................2
Table 1. NMTC Qualified Equity Investment, by Allocation Round..............................................5
Author Contact Information............................................................................................................7

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 authority eligible for the NMTC program was ¹
$15 billion from 2001 to 2007. Congress, subsequently, has increased the total allocation ²
authority to $23 billion and extended the program through 2009. 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), seeks 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.
The tax credit value is 39% of the cost of the qualified equity investment and is claimed over a ³
seven-year credit allowance period. In each of the first three years of the investment, 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.

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.

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Figure 1. Key Components of the NMTC Process
^Source:^{CRS analysis of NMTC}^{program compo}^nents
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 Treasury Department’s
CDFI reviews NMTC applicants submitted by CDEs, issues tax credit authority to those CDEs
deemed most qualified, and plays a significant role in program compliance.
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 (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-⁴
income communities.
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.

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^Fun^d^w^e^bsite^.

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.
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) is
located in a metropolitan area, a median family income below 80% of the greater of the statewide
or metropolitan area median family income; or (3) is located 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 ⁵
treated as low-income communities. 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.
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 ⁶
proceeds for eligible purposes, or (3) redeems the investment principal.
Almost all qualified equity investments (QEI) in low-income communities or serving low-income
populations could be eligible to 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 ⁷
loans from other CDEs. All QLICIs, including QALICBs, are explicitly prohibited from
investing in residential rental property and certain types of businesses, such as golf courses and
casinos.

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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 ⁸
with the $12.1 billion in allocation authority available.
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, authorized uses of the allocation,
and CDE reporting requirements. 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 of
signing their allocation agreements. 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.

Once an allocatee signs its allocation agreement and receives its NMTC allocation authority, it
may begin soliciting capital from investors. Column 2 of Table 1 lists the total allocation awarded
to date by the NMTC, by funding round. Investors receive the right to claim NMTCs on a portion
of their investment, by acquiring stock or a capital interest in a CDE with an allocation. The CDE,
in turn, must invest the proceeds in qualified low-income community investments. Investors have,
to date, invested $12,176,317,994 in CDEs. Columns 3 and 4 list the remaining available NMTC

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allocation, in dollars and as a percentage, that have not yet been allocated to an investor, by
round. Note that allocatees for Round 5 of the NMTC were announced on October 5, 2007.
Table 1. NMTC Qualified Equity Investment, by Allocation Round
^{Allocation R}^ound^{Total Allocation}^{Remaining Available}^{Percent Remaining}
^(Year)^Allocation
^{Round 1 (2}⁰⁰^1-20⁰²⁾^$2,49^1,00^0,00⁰^$41,9^90,4³⁷^1.7%
^{Round 2 (2}⁰⁰^3-20⁰⁴⁾^$3,50^0,00^0,00⁰^$23^4,31^0,21⁸^6.7%
^{Round 3 (2}⁰⁰⁵⁾^$2,00^0,00^0,00⁰^$18^0,23^9,66¹^9.0%
^{Round 4 (2}⁰⁰⁶⁾^$4,10^0,00^0,00⁰^$80^0,77^3,31³^19.5%
^{Round 5 (2}⁰⁰⁷⁾^$3,90^9,00^0,00⁰^$2,56^6,36^8,37⁷^65.7%
^Total^a^$16,0^00,0^00,0⁰⁰^$3,82^3,68^2,00⁶^23.9%
^Source:^{CRS analysis of NMTC}^{Qualified Equity I}^nvestme^{nt Repo}^{rt (October}^{1, 2}⁰⁰⁸⁾
^a.^{Columns may}^{not sum to total, due to rounding.}

Modifications to the NMTC program have been made in the past two Congresses. In the 108^th
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 ⁹
targeted populations as low-income communities.
During the 109^th 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 Hurricanes Katrina,
Wilma, and Rita. 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 ¹⁰
and redevelopment of low-income communities in the Katrina GO Zone.
Also during the 109^th 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 110^th Congress, legislative attention has focused primarily on extending the NMTC
program authorization. This attention came to fruition with the enactment of P.L. 110-343, which
extended the NMTC program authorization one year, through the end of 2009. This one-year
extension was also proposed in H.R. 6049, S. 2886, S. 3098, and H.R. 7060. In addition, H.R.

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2075 and S. 1239¹¹ propose to extend the NMTC through 2013 and would authorize allocations ^th

of $3.5 billion, indexed for inflation, for each of the years. Also introduced during the 110 ¹²
Congress, H.R. 3907 proposes to make the NMTC permanent.

The New Markets Tax Credit Program is currently set to expire at the end of 2009. As mentioned
above, H.R. 2075 and S. 1239 propose extending the NMTC through 2013; and H.R. 3907
proposes a permanent extension of the NMTC. 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 ¹³
otherwise occurred or been funded by a shift in investment from more productive alternatives.
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 ¹⁴
results.
Although important, understanding the source of NMTC investments alone is not sufficient to
determine the effectiveness of the NMTC. A comprehensive review of the program would require
an accounting of both the social and economic costs and benefits of the NMTC, an undertaking
which may pose considerable challenges. For example, this would include examining the
efficiency and opportunity costs of the NMTC investments, while a comprehensive accounting of
the NMTC benefits would need to identify and value “spillovers” such as its effect on
neighboring businesses and communities. The CDFI Fund is working with a contractor on a
comprehensive review of the NMTC, which may include an assessment of the effectiveness of
the NMTC.
Finally, 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 ¹⁵
administered by the Departments of Housing and Urban Development and Commerce. Given
this overlap and the desire to target federal funds to their most productive uses, it follows that

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^{31, 20}⁰⁷^.
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^upda^te^{d J}^a^nua^r^y^29,²⁰⁰⁸^{, ht}^tp:/^/^w^w^w^.^w^hite^hous^e^.^g^o^v^/^om^b/e^x^pe^ctm^o^r^e^/^d^e^t^a^il/¹⁰⁰⁰²²³^0.2⁰⁰⁴^.^h^tm^l.

information on the performance of the NMTC relative to other programs with a similar goal
would be of use. To date, however, no comparative, empirical study of this nature has been
undertaken.
^Doⁿ^a^ld^J^.^Mar^p^les
^Sp^{ecialist i}ⁿ^P^u^b^{lic Fi}ⁿ^aⁿ^ce
^dm^arpl^es@^c^rs^.l^oc.^g^ov^{, 7-}³⁷³⁹