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Novogradac New Markets Tax Credit Working Group Submits Recommendations to Senate Finance Committee
Discussions around tax reform can represent an important opportunity to support and defend community development tax incentives. So when Senate Finance Committee Chairman Orrin Hatch, R-Utah, in June requested recommendations for tax reform, the Novogradac & Company New Markets Tax Credit Working Group (NMTC Working Group) submitted recommendations on how the new markets tax credit (NMTC) could be retained and enhanced. As the Senate turns to tax reform this fall, Hatch’s staff will review stakeholder letters for ideas on what to include in tax reform legislation.
The NMTC Working Group made five recommendations for the New Markets Tax Credit program (NMTC) to further ensure the program’s efficiency in delivering benefits to qualified businesses located in low-income communities and serving low-income populations around the country. These recommendations are:
- Make the NMTC an indefinite part of the Internal Revenue Code (IRC),
- Increase the annual credit authority and index it for inflation,
- Allow the NMTC to offset the alternative minimum tax (AMT),
- Repeal the NMTC basis adjustment and
- Modify the recapture rules to enable greater efficiency.
The reasoning behind each of these recommendations is detailed below.
Make NMTC Permanent
The working group’s letter highlighted the need to make the NMTC a permanent part of the tax code because permanency would reduce uncertainty within the industry. Ongoing short-term extensions create uncertainty for investors, which limits the number of investors and community development entities (CDEs) willing to participate in the NMTC program. Making the NMTC a permanent part of the tax code would remove uncertainty for investors and CDEs, thereby increasing the number of investors and CDEs willing to participate in the program.
Increase Annual Allocations
Next, the working group suggested increasing the annual NMTC authority. Current demand for NMTCs far exceeds availability. For example, as of the last $7 billion round of application (two $3.5 billion rounds combined), there were 238 applications requesting $17.6 billion of allocation. Increasing annual NMTC allocations would result in greater investments in low-income community and improved community impacts.
NMTC Offset AMT
In its letter the working group also suggested amending the tax code in order to allow NMTCs to offset AMT. This amendment would put the NMTC on par with other tax credits, such as the low-income housing tax credit (LIHTC), historic tax credit (HTC), and renewable energy tax credits (RETCs). Allowing NMTCs to offset AMT would result in increased investor demand, which would drive up NMTC pricing. An uptick in pricing would result in a greater amount of subsidy reaching qualified businesses in low-income communities.
Repeal NMTC Basis Adjustment
Next, the working group’s letter suggested repealing the NMTC basis adjustment. Currently, investors are required to reduce the adjusted basis of a qualified equity investment (QEI) by an amount equal to the amount of credits taken over the seven-year term and investors are required to pay taxes on any capital gain or profit generated by/from the QEI investment. The working group supports removing the requirement that the basis of a QEI be reduced by the amount of any NMTC claimed over the seven-year period. This would result in investors being able to realize a loss and the tax benefits associated with a loss, at the end of the credit period. Additionally, if investors did not have to take a basis reduction, the after-tax credit percentage would be close to full 39 percent rate. Because the NMTC is a taxable credit, even though the NMTC credit percentage is nominally 39 percent, the after-tax credit rate is closer to 25 percent. Without a basis reduction, the after-tax credit percentage would be close to the full 39 percent rate. This would result in an increase in NMTC equity pricing and enable more subsidies to flow to low-income community businesses for each tax credit dollar.
Revising NMTC Recapture Rules
Finally, the letter suggested revising the NMTC recapture rules. The stringent form of NMTC recapture inhibits the program’s efficiency. Under the NMTC, investors are required to repay the government the aggregated amount of credits previously claimed in addition to penalties and interest. The harsh recapture rules far exceed that of other tax credit programs. While these recapture rules ensure goals of the program are achieved, the cost of compliance and potential recapture impacts the overall price of NMTCs and the types of investments that investors are willing to make. A phased reduction in recapture risk would result in a lower discount being applied to NMTCs.
The NMTC meets a critical need for private-sector investment in economically distressed urban, suburban and rural communities. It blends the market incentive of former Rep. Jack Kemp’s Enterprise Zones with a flexible community-driven approach. Furthermore, data on NMTC impact demonstrates that it has not only achieved the purpose Congress intended, but it has done so at a relatively low cost to the federal government, particularly when compared to traditional economic development grant programs. Perhaps most importantly, these investments catalyze additional investments to the community, creating a ripple effect of economic development in some of the poorest and hardest hit areas in America. With dwindling government resources, the priority should be given to programs that achieve their purpose efficiently, and the NMTC clearly meets that standard. It should be retained and enhanced in tax reform.
The Novogradac NMTC Working Group is committed to improving the NMTC. If you are interested in joining the group, you can find additional information here.