Tax Legislation Update
NEW MARKETS TAX CREDIT CONNECTION
Prepared by:
Kevin Beattie, Reznick Group
Fall 2011
Tax Legislation Update
Proposed Regulations The New Markets Tax Credit (NMTC) program has been an effective tool for promoting community investment in low-income areas of the country since its creation in 2000. Although they encompass a broad range of industries, NMTC investments have predominantly been made in real estate projects. On June 7, 2011, the Internal Revenue Service (IRS) published two related items in the Federal Register aimed at promoting greater NMTC investment in non-real estate businesses. The first item is a set of proposed regulations to facilitate and encourage investments in non-real estate businesses in low-income communities. The proposed regulations are a response to requests from industry participants who see an opportunity to expand the reach of the program, but are constrained by the existing guidelines governing reinvestment. Currently, when a community development entity (CDE) is repaid its investment, in whole or in part, it must reinvest that money in another low-income business within 12 months in order for the investment to be considered continually invested for purposes of the 85 percent IRS substantially all test. Along with the 7- year length of the NMTC compliance period, the current reinvestment requirements make it difficult for CDEs to provide working capital and equipment loans to non-real estate businesses, as these loans are typically amortizing loans with terms of 5 years or less. The two important aspects of the proposed regulations are the definition of a non-real estate qualified active low-income community business (QALICB) and the recipients and method of reinvestments. According to the definition, the predominant business of non-real estate QALICBs cannot include development, management or leasing of real estate. Business activity that generates more than 50 percent of the businesss gross income is considered predominant. In addition, the purpose of the nonreal estate qualified low-income community investment (QLICI) cannot be connected to, or support, the development, management or leasing of real estate. Proposed reinvestment guidelines address the types of entities eligible to receive the reinvestment as well as the framework dictating the annual amount of non-real estate QLICI that is considered continuously invested. Under the proposed regulations, certified community development financial institutions (CDFIs) that are also CDEs are allowed to receive reinvestments of non-real estate QLICIs. The CDE must reinvest the non-real estate QLICI within 30 days of receipt, and the certified CDFI receiving the reinvestment must be unrelated to the CDE. The proposed regulations contain an annual schedule limiting the amount that can be reinvested in a certified CDFI during each year of the 7-year credit period. The limitation is expressed as a percentage of the qualified equity investment and ranges from 15 percent in the second year of the credit period to 30 percent in the third year, 50 percent in the fourth year and 85 percent in the fifth and sixth years. This staggered schedule is a means of controlling the amount of non-real estate QLICI invested in the original non-real estate QALICB and ensuring that it falls within the framework of a typical short-term, amortizing working capital or equipment loan. Recognizing that the proposed regulations for non-real estate investment may not address all concerns of the program, the IRS is soliciting public comment on both streamlining substantiation requirements for second-tier CDEs making small loans to non-real estate QALICBs as well as encouraging equity investments in non-real estate QALICBs. The questions offered by the IRS on the matter of streamlining
substantiation requirements seek to address the difficulties encountered when a primary CDE makes a QLICI into a second CDE. The current regulations require the primary CDE to ensure that the proceeds of its QLICI are ultimately invested in a QALICB and/or used to provide financial counseling and other services. This added compliance monitoring brings with it additional costs, regardless the size of the QLICI. In the context of a non-real estate loan, the primary CDEs QLICI into the second CDE could result in the second CDE making multiple QLICIs, thus increasing the primary CDEs monitoring costs. Concerning equity investments in non-real estate QALICBs, the IRS is trying to determine what requirements in the current regulations can be revised to encourage more equity investments, including potential modifications to the reasonable expectations test that would continue to maintain the integrity and purpose of the existing test while encouraging more non-real estate equity QLICIs. A public hearing has been scheduled for September 29, 2011 to discuss comments on the proposed regulations and other topics above that are received by the IRS. Original text of the IRS announcements containing the details for submission of public comments and the location of the hearing can be found by following the links below. Proposed regulations for NMTC non-real estate investments Invitation for public comments on NMTC non-real estate investments
