TAX CREDIT: NEW MARKET TAX CREDIT

Income taxes

Tax credits are every business owner’s friend when it comes to saving money by reducing income taxes owed. Tax credits are not tax deductions; there is a difference. Tax deductions reduce taxable income, while tax credits reduce income taxes owed. Therefore, one area every business owner should peek into is that of business tax credits.  

Why?
As mentioned earlier, tax credits reduce a business’s taxes owed dollar-for-dollar. There are several different tax credits available for small businesses across the US. The New Markets Tax Credit, established in 2000, is one such credit. This blog will briefly examine its purpose, requirements, and some limitations. Please note that the information shared in this blog presents only an overview of the tax credit. Please visit the IRS’s website for a more detailed understanding of the NMTC.

Purpose of The New Market Tax Credit [NMTC]
The tax credit offers investors an incentive when they invest in low-income communities. The IRS defines a “low-income community” as

any population census tract where the poverty rate for such tract is at least 20% or in the case of a tract not located within a metropolitan area, median family income for such tract does not exceed 80 of statewide median family income, or in the case of a tract located within a metropolitan area, the median family income for such tract does not exceed 80% of the greater of statewide median family income or the metropolitan area median family income.

In order to receive the credit, investors must make qualified equity investments (QEIs) in qualified community development entities (CDEs). We will take a closer look at both of these soon.

Requirements
For an investment to be considered a QEI, the IRS has laid out three main requirements. As with many tax rules, there are exceptions. Please refer to the IRS’s website for further details on QEI requirements. The three main requirements are:

  • The investor must acquire the investment at its original issue (directly or through
  • an underwriter) solely in exchange for cash,
  • Substantially all (at least 85%) of the cash must be used by the CDE to make qualified low-income community investments (QLICI) and
  • The CDE must label the investment as a QEI on its books and records using any reasonable method.

It is important to note that the QEI amount designated by the CDE cannot exceed the amount allocated to the CDE by the Community Development Financial Institutions Fund (CDFI).
The timing of the QEI is crucial. It can not occur before the CDE enters into an allocation agreement with the CDFI Fund. For exceptions to this rule, see Treas. Reg. §1.45D-1(c)(3)(ii).

A CDE is a corporation or a partnership certified as a CDE by the CDFI Fund whose central purpose is serving or providing investment capital for low-income communities or persons.

How much is the tax credit? For how long can it be taken? How does a taxpayer file for the tax credit? We will respond to these questions next.

How Much of the Tax Credit Can Be Applied
The NMTC equals 39% (that is, 5 percent for the first three credit allowance dates and 6 percent for the last four credit allowance dates) of the investment and is claimed during a seven-year credit period. It is important to note that investors can not redeem or close out their investments before the seven-year period is up.

To file for the NMTC, the investor will need to file Form 8874, New Market Credit, for each of the seven tax years that she is eligible for the tax credit.

Ideal Small Business Investors
A small business, either a corporation or partnership, with a large net income and wanting to invest in a low-income community would be an ideal investor for the NMTC. Not only does the business get to reduce its overall taxable income, but it also gets to give back to a community that is in need so it can develop and remain above the poverty line. It is a win-win for everyone.

The rules and calculations for the New Market tax credit can be confusing, especially around the rules and exceptions to them. Therefore, it is advisable to seek the assistance and expertise of a CPA or tax accountant.

DISCLAIMER: The information provided herein does not constitute the provision of legal advice, tax advice, accounting services, or professional consulting of any kind. The information provided herein should not be used as a substitute for consultation with professional legal, tax, accounting, or other professional advisers. Before making any decision or taking any action, you should consult a professional adviser who has been provided with all pertinent facts relevant to your particular situation and for your particular state(s) of operation.