New Markets Tax Credit (NMTC)

How the New Markets Tax Credit Works

The mechanics of the NMTC involve a relationship between three key parties: the CDFI Fund, the CDE, and the Investor. 1. **Allocation:** The CDFI Fund grants "allocation authority" to certified CDEs through a competitive application process. This authority allows the CDE to issue a specific dollar amount of tax credits. 2. **Investment:** An investor (typically a large financial institution) makes an equity investment (called a "Qualified Equity Investment" or QEI) in the CDE. In exchange, the investor receives the right to claim a tax credit worth 39% of the investment value over seven years. 3. **Deployment:** The CDE uses the cash proceeds from the investor to make a loan or equity investment (called a "Qualified Low-Income Community Investment" or QLICI) in a business or project located in a qualifying low-income census tract. 4. **Credit Schedule:** The 39% credit is not claimed all at once. The investor claims a 5% credit for each of the first three years and a 6% credit for each of the final four years. Because the investor receives a substantial subsidy via the tax credit, the CDE can offer financing to the local business at highly favorable terms—often with below-market interest rates, interest-only periods, or loan forgiveness features.

Key Elements of the NMTC Structure

The NMTC transaction structure involves several specialized entities.

• **Community Development Entity (CDE):** The intermediary that receives the tax credit allocation and manages the investment.
• **Qualified Equity Investment (QEI):** The cash investment made by the investor into the CDE.
• **Qualified Low-Income Community Investment (QLICI):** The loan or investment made by the CDE into the local business.
• **Leverage Lender:** Often, the investor combines their own equity with debt from a separate lender to maximize the size of the investment pool (the "leverage model").
• **Compliance Period:** The seven-year period during which the investment must remain in the low-income community to avoid recapture of the credits.

Important Considerations

Investing in NMTCs is highly complex and requires rigorous legal and accounting due diligence. The most critical risk is **recapture risk**. If the CDE fails to deploy substantially all of the cash into qualified businesses within 12 months, or if the underlying business ceases to qualify (e.g., moves out of the low-income zone or redeems the investment too early), the IRS can "recapture" (take back) the tax credits claimed by the investor, plus interest. Furthermore, because the tax credit is claimed over seven years, investors must have a sufficient and predictable federal tax liability over that long horizon to utilize the credits effectively. The transaction costs (legal fees, consulting fees, syndication costs) are substantial, making NMTCs generally viable only for large projects—typically those requiring $5 million to $10 million or more in financing.

Advantages of NMTC

For **investors** (typically banks), the NMTC offers a double bottom line: a predictable financial return (via the tax credits and potential loan interest) and Community Reinvestment Act (CRA) credit, which regulators require banks to earn. The 39% credit provides a powerful buffer against potential losses on the underlying loan. For **businesses and communities**, the advantage is access to "patient capital." NMTC financing is often structured as interest-only debt for seven years, with the principal often forgiven or refinanced at the end. This essentially acts as a partial grant or subsidized equity, allowing projects to proceed that would otherwise be financially unfeasible—like a grocery store in a high-poverty urban neighborhood or a manufacturing plant in a rural area with high unemployment.

Disadvantages of NMTC

The primary disadvantage is complexity. An NMTC closing often involves dozens of lawyers, accountants, and consultants, leading to closing costs that can exceed $500,000. This high barrier to entry effectively shuts out smaller businesses from accessing the program directly. Additionally, the program is highly competitive. The demand for tax credit allocations far exceeds the supply authorized by Congress each year, meaning many worthy projects go unfunded. There is also criticism that the complexity allows consultants and lawyers to capture a significant portion of the subsidy intended for the poor community.

FAQs

Common questions about the New Markets Tax Credit.

• Who can claim the New Markets Tax Credit? Generally, only the CDE's equity investor can claim the credit. Individuals rarely invest directly due to the complexity; it is dominated by large banks and corporations.
• Does the business get the tax credit directly? No. The business (QALICB) receives the *benefit* of the credit in the form of below-market financing terms from the CDE, but it does not claim the credit on its own tax return.
• What qualifies as a low-income community? A census tract with a poverty rate of at least 20% or a median family income that does not exceed 80% of the area median income.
• Can NMTC be combined with other credits? Yes, NMTC is often "twinned" with Historic Tax Credits (HTC) or Renewable Energy Tax Credits (ITC) to finance complex projects like renovating historic buildings.
• How long does the program last? The NMTC is not permanent; it must be reauthorized by Congress periodically. It has been extended multiple times since its creation in 2000.

Bottom Line

The New Markets Tax Credit is one of the federal government's most powerful tools for economic development. By using the tax code to incentivize private investment, the NMTC directs billions of dollars into America's most distressed communities. While the structure is complex and the transaction costs are high, the impact is tangible: new jobs, new facilities, and new hope in areas that the market often overlooks. For corporate investors, it offers a strategic way to manage tax liabilities while fulfilling social responsibility goals. For community leaders, understanding the NMTC is essential for unlocking capital for transformative local projects.