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Washington Wire: Uncle Sam Wants You! … to Comment on the New Markets Tax Credit Regulations

Published by Michael J. Novogradac on Friday, July 1, 2011

Journal cover July 2011   Download PDF

On June 3, the Treasury Department and the Internal Revenue Service proposed changes to the new markets tax credit (NMTC) program. The proposed modifications to the credit are intended to promote greater investment in non-real estate businesses under the New Markets Tax Credit program while still maintaining the structure of the credit, which has been successful for other types of investments.

The changes were proposed in a set of two notices that will have a limited immediate impact, but may yield significant longer term benefits. Potential changes to the tax credit include, among others, revising reinvestment requirements for entities investing in operating businesses, streamlining compliance requirements, and modifying ownership rules to reduce noncompliance risk over the course of an investment. Treasury and IRS are also seeking public comments on other potential changes that would promote greater investment in non-real estate qualified active low-income community businesses (QALICBs).

Proposed Rule
In a notice of proposed rulemaking, the IRS suggests changes that would allow those CDEs that make investments in non-real estate QALICBs to reinvest any repayments in unrelated, certified CDFIs. Such repayments would have to be reinvested with a certified CDFI within 30 days. There do not appear to be any NMTC-related limits on the money’s use by the certified CDFIs. The proposed regulations would allow an increasing aggregate amount to be invested in certified CDFIs and treated as continuously invested in a qualified low-income community investment (QLICI) as follows:

  • 0 percent of the underlying qualified equity investment (QEI) in Year 1
  • 15 percent in Year 2
  • 30 percent in Year 3,
  • 50 percent  in Year 4
  • 85 percent in Years 5 and 6

This proposal would help CDEs that want to provide amortizing, 5- to 7-year financing to non-real estate operating businesses. Such financing would be helpful, for example, to non-real estate operating businesses seeking longer-term equipment financing. This proposal would also help certified CDFIs by providing a source of rolling financing.

Speaking to attendees at Novogradac & Company’s Spring New Markets Tax Credit Conference in Washington, D.C. on June 9, Julie Hanlon-Bolton, an attorney with the IRS Office of Tax Policy, explained that the proposal is important because it reduces the risk of recapture for non-real estate investments. “I think the big issue here is people were talking about reinvestment—how hard it is to reinvest, especially with small business …” she said. “So we’re allowing CDEs to park those reinvestment funds back into unrelated, certified CDFIs.”

Included in the notice of proposed rulemaking is an IRS request for comments from the new markets tax credit community on a number of points. And in her remarks on June 9, Hanlon-Bolton emphasized the IRS’s desire to hear from the public. “I really encourage everyone to send in comments whether it’s positive or negative,” she said.

Hanlon-Bolton reviewed for attendees each question in the notice and shed light on the motivation behind some of them. For example, the notice of proposed rulemaking asks the public to comment on whether the change would encourage venture capital investments, and if not, how the proposed rules could be modified to accomplish that goal.

“In the legislative history for the new markets tax credit, one of the reasons for enacting [the program] was to start up venture capital in low-income communities,” she said. However, she acknowledged that the NMTC regulations have not had the intended effect on venture capitalism. “So the Administration feels it’s very important that we try to get back to the new markets tax credit roots and try to promote venture capital investments,” Hanlon-Bolton said.

The IRS also asks whether the definition of a non-real estate QALICB is sufficient for CDEs and investors to rely on. “What did people think about that? Is it too broad? Is it too narrow? Should we be focusing on something else?” Hanlon-Bolton asked. “I would love to hear everyone’s opinion on that one.”

She also indicated that one question in the notice points to a key motivation behind the proposal: whether CDEs will be able to determine whether an entity satisfies the requirements to be a non-real estate QALICB without incurring unduly burdensome costs. “We had heard that you can’t do a new markets tax credit deal for less than $2 million because of transaction costs,” Hanlon-Bolton said. “I don’t know if that’s true or not, but that’s what we’ve heard. The big push in both the [proposed rule and the advanced notice of proposed rulemaking] is to reduce transaction costs, so this question is getting at that issue.“

Request for Additional Comments
In a second notice, an advance notice of proposed rulemaking, the IRS invited specific comments on whether lessening substantiation requirements in certain structures would facilitate more investments in non-real estate operating businesses.

The advance notice of proposed rulemaking posits simplifying the substantiation rules governing investments in cases where a CDE invests in another CDE, and the second CDE uses the new markets tax credit proceeds to make smaller-sized loans, for example, less than $250,000, to non-real estate businesses. The second CDE would need to demonstrate that at the time of initial investment in the non-real estate business, the non-real estate business receiving the new markets tax credit proceeds met some basic qualifying requirements (for example, the business is in a low-income community). The IRS is asking taxpayers to submit comments as to whether this change would facilitate greater new markets tax credit investment in non-real estate businesses.

“There’s a big push at Treasury and in the Administration for what I term ‘microlending,’” Hanlon-Bolton said. “I think this is sort of what they are trying to do here.”

The notice also includes open-ended requests for ideas.  “We are really looking for lots of comments on these issues that are being proposed and also just questions that we have,” Hanlon-Bolton said. “[These are] issues that we haven’t dealt with before so we’d love to hear from the market … We strongly recommend that you send in comments with any ideas on how we can use the regulations to encourage more equity investment for the new markets tax credit.”

Comment Period and Public Hearing
It should be noted that the June 3 Federal Register notices list two different due dates for comments; the notice of proposed rulemaking requests comments by September 8 and the advanced notice of proposed rulemaking asks for comments by September 6. Hanlon-Bolton told Novogradac conference attendees on June 9 that the IRS had spoken to the Federal Register Liaison Office of the IRS and it had confirmed that public comments for both items will be accepted through the later date: September 8, 2011.
The broader NMTC community now has an opportunity to focus on the specific ideas in the notices and to also expand the discussion to other areas. Based on Hanlon-Bolton’s remarks on June 9, the IRS is eager to hear what the tax credit sector thinks. “We’re asking the market to … collaborate with us to help us find what will work,” she said.

The NMTC Working Group will provide detailed comments on the matter and will present its comments at a public hearing that is scheduled for September 29, 2011.

The timing is unclear from that point. In her conference remarks, Hanlon-Bolton indicated her goal was to finalize the regulations before the end of the 2011 calendar year. But she also noted that the priority guidance year lasts until June, so she suggested the most likely time frame for a final rule to be released would fall somewhere between December 2011 and June 2012.

Update on Other NMTC Regulations Projects
The proposed regulations released last month were only one of the three projects that were included on the IRS’s 2010-2011 Priority Guidance List for the NMTC program. Hanlon-Bolton confirmed with conference attendees that the other two projects were still under way.

First, she indicated that final regulations providing targeted populations rules were in clearance at the time of her June 9 remarks. She suggested it was possible they could be released by June 30, which is the end of the IRS’s guidance year, but warned that there was no guarantee. As the Journal of Tax Credits went to press, the final targeted populations regulations had not yet been released.

She also spoke about a project to amend the final NMTC regulations, a project that will address some recapture matters, as well as function as a chance to clean up some other issues in the regulations. Hanlon-Bolton indicated that the project was still in review as of June 9.

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