What Is New Markets Tax Credit?
The New Markets Tax Credit (NMTC) is a federal tax incentive program designed to stimulate investment capital and economic development in distressed communities across the United States. It falls under the broader category of economic development finance and aims to attract private capital to areas historically underserved by traditional financial markets. Through the New Markets Tax Credit program, investors receive a credit against their federal income taxes for making qualified equity investments (QEIs) in certified community development entities (CDEs). These CDEs then use the investment to provide loans, investments, or financial counseling in low-income urban and rural areas, fostering community development and job creation.
History and Origin
The concept of using tax credits to spur investment in disadvantaged areas gained traction in the late 1990s. The New Markets Tax Credit Program was officially established on December 21, 2000, as part of the Community Renewal Tax Relief Act of 200016. The legislation aimed to address the persistent lack of private investment capital in low-income communities, which often experience higher rates of poverty and unemployment. The program is administered by the Community Development Financial Institutions (CDFI) Fund, a bureau within the U.S. Department of the Treasury. Since its inception, the New Markets Tax Credit has been extended multiple times by Congress, demonstrating ongoing commitment to its goals of stimulating local economies through private investment14, 15.
Key Takeaways
- The New Markets Tax Credit (NMTC) encourages private investment in economically distressed communities.
- Investors receive a federal tax credit for making qualified equity investments in certified Community Development Entities (CDEs).
- The credit totals 39% of the investment, disbursed over a seven-year period.
- CDEs use the funds to finance businesses and real estate development projects in low-income areas.
- The program aims to foster job creation and economic growth in underserved markets.
Formula and Calculation
The New Markets Tax Credit is not calculated via a complex financial formula but rather as a fixed percentage of a qualified equity investment (QEI) over a specified period. The total credit equals 39% of the original QEI. This credit is claimed by the investor over a seven-year period.
The distribution of the credit is as follows:
- 5% of the QEI in each of the first three years.
- 6% of the QEI in each of the subsequent four years.
Investors must maintain their interest in the QEI throughout the entire seven-year credit period to receive the full benefit. If the investment is redeemed or if the Community Development Entity (CDE) ceases to meet program requirements, the credit can be subject to recapture13. This structure provides a predictable return for investors while ensuring the capital remains deployed in the designated low-income community for a substantial duration.
Interpreting the New Markets Tax Credit
The New Markets Tax Credit is designed to make otherwise financially challenging projects in low-income areas more attractive to private investors. By offering a significant tax credit, the program effectively reduces the cost of investment capital for projects in distressed communities. This encourages financial institutions and other private entities to allocate funds to ventures that might be perceived as higher risk or offer lower traditional returns. The credit's value is interpreted as a direct offset against an investor's federal tax liability, enhancing the overall return on investment for participating capital. The presence of NMTC financing often indicates that a project is located in an area with substantial economic need, as defined by criteria such as poverty rates and median family income levels.
Hypothetical Example
Consider a hypothetical scenario where an investor, ABC Corporation, decides to make a qualified equity investment of $10 million in a certified community development entity (CDE). The CDE plans to use these funds to finance the construction of a new manufacturing facility in a designated low-income community, aiming to create local jobs.
Over the seven-year credit period, ABC Corporation would receive a total New Markets Tax Credit of $3.9 million (39% of $10 million).
- In Year 1, 2, and 3, ABC Corporation would claim a tax credit of $500,000 each year (5% of $10 million).
- In Year 4, 5, 6, and 7, ABC Corporation would claim a tax credit of $600,000 each year (6% of $10 million).
This credit directly reduces ABC Corporation's federal income tax liability. For the manufacturing facility project, the NMTC would help bridge a financing gap, enabling the CDE to offer more favorable loan terms to the developer, ultimately supporting the economic growth and revitalization of the community.
Practical Applications
The New Markets Tax Credit is broadly applied to stimulate various forms of community development and economic growth in low-income areas. It frequently supports projects that address critical community needs and create opportunities. Common practical applications include:
- Commercial and Industrial Real Estate Development: Financing the construction or rehabilitation of manufacturing plants, retail centers, and office spaces that bring jobs and services to the area.
- Community Facilities: Supporting the development of schools, healthcare facilities, and community centers, improving access to essential services for residents.
- Small Business Expansion: Providing flexible investment capital to small businesses in distressed areas, enabling them to expand operations, purchase equipment, and hire local workers.
- Mixed-Use Projects: Blending commercial and residential components to revitalize urban cores or rural centers.
The program has financed thousands of projects across all 50 states, generating significant private investment and supporting job creation and retention, as reported by the CDFI Fund12. These initiatives often involve complex public-private partnerships and are designed to fill financing gaps where traditional capital might be scarce.
Limitations and Criticisms
Despite its successes, the New Markets Tax Credit program has faced scrutiny and criticism. One key concern relates to the complexity of its financial structures, which can involve multiple layers of financing and fees. Critics argue that these complexities may reduce the total amount of capital directly reaching low-income businesses and communities11.
A 2014 Government Accountability Office (GAO) report highlighted a lack of adequate data and controls to ensure the program's effectiveness, particularly regarding the ability to track whether projects continue to benefit communities after the seven-year credit period concludes9, 10. The GAO also raised questions about the potential for unnecessary duplication of government subsidies when NMTCs are combined with other federal, state, or local funding sources8.
Some criticisms also point to instances where the credit has been used for projects that might have proceeded without the subsidy or for projects whose direct community benefit has been questioned, such as large commercial ventures or luxury developments in areas that technically qualify as low-income7. This raises concerns about the efficiency of the tax incentives and whether they consistently achieve their intended goal of empowering truly distressed communities.
New Markets Tax Credit vs. Low-Income Housing Tax Credit
The New Markets Tax Credit (NMTC) is often confused with the Low-Income Housing Tax Credit (LIHTC), as both are federal tax incentives designed to stimulate investment in underserved communities. However, their primary focuses and mechanisms differ significantly.
| Feature | New Markets Tax Credit (NMTC) | Low-Income Housing Tax Credit (LIHTC) |
|---|---|---|
| Primary Focus | Commercial, industrial, and community facility development; job creation; and general economic growth. | Development and rehabilitation of affordable rental housing. |
| Investment Type | Encourages equity financing into Community Development Entities (CDEs) that then invest in businesses and projects. | Incentivizes equity investment in affordable housing projects. |
| Credit Amount | 39% of the qualified equity investment over seven years. | Varies based on project costs, typically 30% or 70% of qualified basis, over ten years. |
| Recapture Risk | High risk of recapture if CDE or project fails to meet compliance within seven years. | Risk of recapture if compliance (e.g., affordable rent, tenant income) is not met over a 15-year period. |
While both programs aim to deliver capital to areas of need, the NMTC is more broadly focused on revitalizing local economies through diverse business and community facility investments, whereas the LIHTC is specifically dedicated to increasing the supply of affordable housing. Investors may utilize both credits in different capacities or even in conjunction for mixed-use developments that include both commercial space and affordable housing units.
FAQs
What types of projects are eligible for the New Markets Tax Credit?
The New Markets Tax Credit supports a wide range of projects, including the construction or rehabilitation of commercial facilities, manufacturing plants, retail spaces, schools, healthcare centers, and other community infrastructure. The key requirement is that the project must be located within a designated low-income community and typically aims to create jobs or provide essential services6.
How do investors receive the New Markets Tax Credit?
Investors receive the New Markets Tax Credit by making a qualified equity investment (QEI) in a certified community development entity (CDE). The CDE acts as an intermediary, deploying these funds into eligible projects in low-income areas. The investor then claims the credit against their federal income tax liability over a seven-year period5.
Is the New Markets Tax Credit a permanent program?
No, the New Markets Tax Credit program is not a permanent part of the U.S. tax code. It has a set expiration date and requires reauthorization by Congress periodically to continue4. Historically, Congress has extended the program multiple times since its creation in 2000.
What is a Community Development Entity (CDE)?
A community development entity (CDE) is a specialized financial intermediary certified by the U.S. Treasury Department's CDFI Fund. Its primary mission is to provide investment capital and financial services to low-income communities. CDEs are the vehicles through which New Markets Tax Credits are allocated to investors, and they are responsible for deploying those funds into eligible projects3.
Can individuals claim the New Markets Tax Credit?
Yes, both individual and corporate taxpayers are eligible to receive the New Markets Tax Credit for making qualified equity investments in certified CDEs1, 2. While large financial institutions are common investors, the program is open to any eligible taxpayer.