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By: Hunter Atherton, Lee+ Associates College Intern
In a previous article, I discussed the opportunities that New Markets Tax Credits can bring for investors and how they leverage those investments to their own success. As I mentioned, there is little to no information on the success or failure rates of these projects funded by NMTCs, but I want to outline what NMTCs could look like for you and your nonprofit organization should you want to consider the opportunity.
The Community Renewal Tax Relief Act was passed in 2000 allowing investors to receive federal income tax credits as compensation for their investment into Qualified Active Low-Income Community Businesses (QALICBs) for a variety of project types through the Community Development Financial Institutions Fund (CDFI) and Community Development Entities (CDEs).
So how does it work from the organization’s point of view?
The CDFI gives CDEs tax credits that they can dole out to private investors like national banks and venture capital funds in exchange for an investment of cash. The CDEs then allocate the investments to QALICBs that have requested funding through NMTCs. Important to note here that though the title of the invested includes the word ‘business’, the inclusion of nonprofit and tax-exempt organizations is approved in seeking funding through NMTCs. Along with their role as the invested, nonprofits can also take on roles as CDEs, leverage lenders, or developers.
NMTCs allow projects to be funded if they are struggling to get financed traditionally. They accept non-traditional collateral which is a strong positive for nonprofits, and the program has many options for payment and end-of-term exiting such as the option to purchase the interest on the loan for a negligible amount. The arrangement is contracted for seven years during which the investor is paid back by the QALICB through interest payments on the principal at a rate that is at or below 50% of the fair market value. The QALICB is required to continue the arrangement throughout all seven years. During this time, the QALICB will be monitoring and reporting for compliance through the NMTC program.
While this sounds like a great opportunity (and depending on circumstances actually may be), there are some weighty negatives that should be considered alongside the positives. The constant compliance monitoring comes with expensive fees that should be researched before entering an agreement. The NMTC program requires repayment to the investor; there is no option other than to pay even in crisis. Indemnities must be provided to the investor from the QALICB meaning the “nonprofit unconditionally agrees to pay, reimburse, exonerate, indemnify, and hold the investor harmless against any loss, damage, liability, cost or claim incurred by the investor as a result of the loss, recapture, disallowance, or inability to claim the tax credits ” in case anything violates the program’s agreement. Also, if the investor chooses not to release the investment at a “put” rate below fair market value to the QALICB after the seven year period, then they will be forced to assume it at a “call” rate equivalent to fair market value, resulting in a significantly larger purchase price.
Michael I. Sanders, a partner in Blank Rome LLP’s tax department and an author on NMTCs, lists other possible “snares.” He mentions that an unforeseen shift in project focus from the original conception and investment that could change the NMTC eligibility for the investor leading to alterations in the arrangement terms for the QALICB. Also, in order to qualify for NMTCs, an investor can not formally agree to forgive a loan at the end of the seven year period for any QALICB, so if the investor retracts that informal agreement, the project can be left in a very bad spot with huge and unexpected payments to make. Sanders notes that each CDE involved in any single project will also charge its own fee for the allocation and oversight of the tax credits and investments, which can rack up a big bill for an organization.
The Nonprofit Timeswrote that a nonprofit “should consult with its advisor to weigh the financial benefits against the related costs and burdens” when considering funding through New Markets Tax Credits, and I agree wholeheartedly. The NMTC program is a unique opportunity that nonprofits should investigate if their projects require funding. They offer significant financial opportunities in ways that can benefit many. But in your organization’s research into NMTCs and how they could apply to you, bear in mind that they are incredibly complex and require extensive knowledge of the program and its limits for an organization.
I would also urge you to remember that all reports given for compliance are internal; there are no articles or data on success and failure rates of NMTC program projects because that information is not available to the public making it harder to understand just how they work. New Markets Tax Credits can offer you everything in terms of funding, but make sure to protect your organization with ample research into the program and those involved just in case something doesn’t go as planned.