PDF How Nonprofit Organizations Can Use the New Markets Tax Credit

[Pages:17]How Nonprofit Organizations Can Use the New Markets Tax Credit

By Michael I. Sanders

MICHAEL I. SANDERS is a partner in the Business Tax Group of the Washington, DC tax department of Blank Rome LLP and author of Joint Ventures Involving Tax-Exempt Organizations (John Wiley & Sons 2007). Mr. Sanders extends his thanks and appreciation to Megan Christensen of Blank Rome for her assistance in the preparation of this article.

The New Market Tax Credit ("NMTC"), enacted as part of the Community Renewal Tax Relief Act of 20001 and codified in I.R.C. Section 45D, was designed to stimulate investment in new private capital, which in turn would facilitate economic and community development in distressed communities. It is a program nonprofit organizations may use to their advantage consistent with their exempt function. The NMTC provides investors that make a qualified equity investment ("QEI") in a community development entity ("CDE") a 39 percent tax credit over a seven-year period.2 For an investor to claim the credit, the CDE must, inter alia, designate the QEI as such to the Community Development Financial Institutions Fund ("CDFI Fund")3 and use substantially all of the QEI to make a qualified low-income community investment ("QLICI").4 The NMTC may serve as a way to provide subsidy or gap financing to charitable organizations that have real estate development, business activities, or charitable operations planned in qualified census tracts.

A tax-exempt organization may participate in the NMTC program in several ways. First, via for-profit affiliates (i.e., a subsidiary of the non-profit organization), it may seek certification from the CDFI Fund as a CDE. A CDE is an entity that serves, or provides investment capital for, low-income communities or people. Entities certified as CDEs may apply for an allocation

1 P. L. No. 106-554, ? 121, 114 Stat. 2763A-605 (2000). 2 See ? 45D(a). 3 ? 45D(b)(1)(C). The CDFI Fund is a division of Treasury Department. It's "mission is to expand the capacity of financial institutions to provide credit, capital, and financial services to underserved populations and communities in the United States." CDFI Fund, About the CDFI Fund, (last visited August 20, 2009). The CDFI Fund is charged with the duties of certifying entities as CDE and allocating the NMTC to those certified CDEs. Since the inception of the NMTC, the CDFI fund has allocated $21 billion in available NMTCs and will allocate another $5 billion before the end of 2009. 4 ? 45D(b)(1).

Page 1

"How Nonprofit Organizations Can Use the New Markets Tax Credit," Michael I. Sanders, Taxation of Exempts, Volume20 /Issue3, November/December 2009, Copyright ? 2009 Thomson Reuters/RIA.

of the NMTC from the CDFI Fund and will serve a central role in any NMTC transaction for which its allocated NMTCs are designated. Alternatively, a tax-exempt organization may serve in the role of leverage lender in a NMTC transaction. The leverage lender, by providing debt financing to be combined with an investor's equity financing, will allow an investor to increase the amount of tax credits it receives in exchange for its equity investment. Finally, a tax-exempt entity may act as a qualified active low-income community business ("QALICB"). A QALICB is the entity that actually engages in the development, business, or charitable activity in the distressed community.

For example, a university may use the NMTCs to develop a law school facility in a highly distressed community. The university would receive "gap" financing that has passed through the NMTC structure, resulting in funds received from an investor and leverage lender that are contributed as an equity investment in a CDE, which passes substantially all of the funds it receives to the QALICB university. The university would use the funds it receives to build its law school building and operate the law school over a seven-year compliance period. During that period, the investor will benefit from the tax credits to offset the tax it would otherwise owe on its taxable income. At the end of the seven years, the transaction would typically unwind, allowing the investor and the CDE to exit the NMTC structure with the use of a put/call technique, liquidating the investment fund, and repaying the leverage loan. The university would then be left with its new law school.

The CDFI Fund ? Step One

The CDFI Fund allocates NMTCs to CDEs through a competitive application process. For each round (year) in which NMTCs are available for allocation, the CDFI Fund issues a Notice of Allocation Availability ("NOAA"), which provides specific guidance on how a CDE may apply to receive an allocation of the NMTC. In order for an NMTC allocation application to be considered, the applicant either (1) must be certified as a CDE at the time of the application or (2) have applied to the CDFI Fund for certification by a particular date, set forth in the NOAA, that is prior to the allocation application deadline. The CDE application deadline typically is in March, while the allocation application deadline usually occurs in early April. The

Page 2

"How Nonprofit Organizations Can Use the New Markets Tax Credit," Michael I. Sanders, Taxation of Exempts, Volume20 /Issue3, November/December 2009, Copyright ? 2009 Thomson Reuters/RIA.

CDFI Fund reviews the allocation applications and scores each applicant in each of four areas (up to 25 points per area).5 An applicant CDE will receive a more favorable score on the

"Community Impact" portion of the allocation application if it commits to providing at least 75

percent of its QLICIs in "highly distressed" areas. Such areas include census tracts with (1)

poverty rates in excess of 30 percent, (2) median family income that does not exceed 60 percent

of statewide median family income or the metropolitan area median family income, whichever is applicable, or (3) unemployment rates at least one and a half times the national average.6

The allocation application is reviewed primarily in two phases. First, three reviewers

independently evaluate each application in the four areas, scoring each area as weak, limited, average, good, or excellent.7 Additionally, the reviewers rate the applications in the two areas for which the additional five priority points are available.8 In the second phase of the review, an

Allocation Recommendation Panel from the staff of the CDFI Fund reviews the results of from the first phase.9 For an organization's application to be considered for an allocation at this point,

the application must have received an aggregate score that was at least in the "good" range (i.e.,

5 The four areas are: business strategy (25 points), community impact (25 points), management capacity (25 points), and capitalization strategy (25 points). An additional ten "priority points" may be awarded for prior experience in providing capital or technical assistance to disadvantaged business communities (5 points), and a commitment to investing in businesses with owners unrelated to the applicant (5 points). See, CDFI Fund, NMTC Program 2009 Allocation Application, (last visited August 28, 2009) 6 Areas with at least two of the following criteria are also considered to be highly distressed: (1) poverty rates greater than 25 percent, or median family income that does not exceed 70 percent of the applicable statewide or metropolitan area median family income, or unemployment rates of at least 1.25 times the national average; (2) federally designated Empowerment Zones, Enterprise Communities, or Renewal Communities; (3) SBA-designated HUB Zones to the extent QLICIs will support businesses with such certification; (4) brownfields sites; (5) areas encompassed by a HOPE VI redevelopment plan; (6) federally designated native areas; (7) areas designated as distressed by the Appalachian Regional Commission or Delta Regional Authority; (8) colonias areas, (9) federally designated medically underserved areas, to the extent QLICIs will result in the support of health-related services; (10) projects serving "Targeted Populations" as defined in Treasury regulations; (11) high-migration rural counties; (12) state Enterprise zone programs or similar programs targeted toward economically distressed communities; (13) non-metropolitan counties; (14) FEMA disaster areas; and (15) businesses certified by the Department of Commerce as eligible for assistance under the Trade Adjustment Assistance for Firms Program. See NMTC Program 2009 Allocation Application, Question 27. 7 Each category represents a five-point range. For example a weak score is zero to five points, a good score is between sixteen and twenty points. CDFI Fund, 2008 New Markets Tax Credit Program Allocations, (All%20Documents).pdf , at 22, (last visited August 28, 2009). 8 Id. 9 Id.

Page 3

"How Nonprofit Organizations Can Use the New Markets Tax Credit," Michael I. Sanders, Taxation of Exempts, Volume20 /Issue3, November/December 2009, Copyright ? 2009 Thomson Reuters/RIA.

a minimum of 192 total points) and must also achieve a minimum score of good in each of the four application areas (i.e., a minimum of 48 points in each area).10 In 2008, 40% of non-profit applicants received allocations.11 Non-profit organizations or subsidiaries of non-profit organizations received $1.92 billion in tax credit allocations, representing 57% of all allocates in 2008.12

A CDE that scores high enough in the competitive allocation application process and is awarded an NMTC allocation must ensure that it is, at all times, in compliance with the NMTC program, according to the allocation agreement that the CDE must enter into with the CDFI Fund. First, the CDE has five years from the date on which it executes the allocation agreement with the CDFI Fund to enter into QEIs with investors that total the amount of allocation awarded to the CDE. The CDE also has 12 months from the date it receives a QEI to use that QEI to make one or more QLICIs. Additionally, the CDE must provide information to the CDFI Fund, on an annual basis, in order to demonstrate its compliance with the Code, the regulations, and the requirements of the allocation agreement. Finally, the CDE must ensure that no event occurs during the seven-year period beginning on the date of the original issue of the QEI (the "compliance period") that would cause the NMTC to be recaptured. Such recapture events include the CDE's ceasing to be a qualified CDE, the failure of the CDE to use substantially all of the investment proceeds in one or more QLICIs, or the redemption of the investment in the QALICB by the CDE. If a recapture event occurs, the investor will retroactively lose all of the credits previously claimed under the NMTC and will owe interest on that amount.

NMTC Structuring

The basic structure of an unleveraged NMTC transaction involves an investor, such as a national bank,13 that makes a QEI in a certified CDE with an NMTC allocation. The CDE then uses substantially all of the QEI to make a QLICI in a specified manner. A QLICI includes "any

10 See id. 11 Id. at 17. 12 Id. at 16. 13 A bank would receive Community Reinvestment Act ("CRA") credit for such an investment.

Page 4

"How Nonprofit Organizations Can Use the New Markets Tax Credit," Michael I. Sanders, Taxation of Exempts, Volume20 /Issue3, November/December 2009, Copyright ? 2009 Thomson Reuters/RIA.

capital or equity investment in, or loan to, any [QALICB]."14 In general, a QALICB includes any corporation -- including a nonprofit corporation -- partnership, or limited liability company ("LLC") provided that, with respect to any tax year, (1) 50 percent or more of the total gross income of the entity derives from the active conduct of a qualified business within any lowincome community, (2) at least 40 percent of the entity's tangible property, owned or leased, is used within any low-income community, (3) at least 40 percent of the services performed by the entity's employees are performed within any low-income community, and (4) "less than 5 percent of the average of the aggregate unadjusted bases of the property of such entity is attributable to" either nonqualified financial property or collectibles, other than collectibles held primarily for sale to customers in the ordinary course of the business.15

A qualified business is generally any trade or business, not including "the development or holding of intangibles for sale or license,"16 certain "sin businesses"17 and farming.18 Finally, the rental to others of real property is a qualified business only if it is located in a low-income

14 ? 45D(d)(1)(A). A CDE may also use substantially all of the QEI to (i1 purchase a QLICI loan from another CDE, (2 provide financial counseling and other services to businesses and residents of low-income communities, or (3) make an equity investment in, or loan to, another CDE. ? 45D(d)(1). 15 ? 45D(d)(2). Collectibles for purposes of the QALICB rules are those defined in ? 408(m)(2), and nonqualified financial property has the meaning ascribed to that term in ? 1397C(e). 16 See ? 45D(d)(3);. Reg. ? 1.45D-1(d)(5)(iii)(A). 17 "Sin businesses" include operating any private or commercial golf course, country club, massage parlor, hot tub facility, suntan facility, racetrack or other facility used for gambling, or any store with the principal business of selling alcoholic beverages for consumption off premises. See ? 45D(d)(3);. Reg. ? 1.45D-1(d)(5)(iii)(B). A QALICB engaged in the rental of real property must also preclude its tenants from operating these sin businesses, so the leases executed by such a QALICB and its tenants must include a provision that prohibits the tenant from engaging in such businesses. See Reg. ? 1.45D-1(d)(5)(ii). 18 Farming is an excluded business for purposes of the NMTC if the sum of the aggregate unadjusted bases of assets owned by the taxpayer and used in the business, and the aggregate value of assets leased by the taxpayer and used in the business, exceed $500,000. See ? 45D(d)(3); Reg. ? 1.45D-1(d)(5)(iii)(C).

Page 5

"How Nonprofit Organizations Can Use the New Markets Tax Credit," Michael I. Sanders, Taxation of Exempts, Volume20 /Issue3, November/December 2009, Copyright ? 2009 Thomson Reuters/RIA.

 ................
................

In order to avoid copyright disputes, this page is only a partial summary.

Google Online Preview   Download