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2018-156 New Market Tax CreditsDate: October 26, 2018 Report No. 2018-156 INFORMAL STAFF REPORT TO MAYOR AND CITY COUNCIL SUBJECT: New Market Tax Credits EXECUTIVE SUMMARY: During its October 9, 2018, regular meeting, Council received a Citizen Report on the New Market Tax Credit (NMTC) program from Pat Smith of Serve Denton. Staff prepared this report to provide further information on NMTCs. It includes regulatory information, terminology, an overview of the NMTC process, Serve Denton’s local example, and the pros and cons of using the NMTC program. BACKGROUND: The New Market Tax Credits program was created in the Community Renewal Tax Relief Act of 2000. Regulations for the program fall under Section 45D of the Internal Revenue Service (IRS) Code. The agency that is charged with overseeing and administering the program is the Certified Development Financial Institution (CDFI), a division of Treasury Department. The credit authority for the program is authorized by Congress. DISCUSSION: The NMTC Program was created to encourage private investment in low-income communities through the use of federal income tax credits. The annual allocations are awarded on a discretionary basis and are very competitive. The program was designed to grant individual and corporate investors a tax credit against their federal income tax. Definitions A number of terms are necessary to understand the NMTC Program and the roles of the different entities involved in the process. The main ones are included below. Certified Development Financial Institution (CDFI): a division of Treasury Department with the credit authority for the program authorized by Congress. The agency is charged with oversight of the NMTC program. New Market Tax Credits (NMTCs) are granted for a 7-year term. This allows for a 5% credit in years 1-3 and a 6% credit in years 4-7 for a total credit of 39% of the investment. Certified Development Entity (CDE): an intermediary that makes the investment or the loan. The CDE must be certified by the CDFI. Banks, developers and local governments are eligible to become a CDE. Qualified Equity Investment (QEI): an investment paid to the CDE to obtain equity in the CDE. The CDE grants this investment as a QEI. Qualified Low-Income Community Investment (QLICI) is typically a loan or investment. Date: October 26, 2018 Report No. 2018-156 Qualified Active Low-Income Community Business (QALICB) is a recipient of a loan; it can be a business or a non-profit. Low Income Community designation requires a census tract with a poverty rate which exceeds 20% or the median income is below 80% of the greater of the state or metropolitan statistical area (Dallas-Fort Worth-Arlington) median income. The eligible NMTC 2010 Census tracts in Denton are included in Exhibit 1. Process Visual depiction of the NMTC Process from Capital Impact Partners The first step in the application process is certification. A Certified Development Entity (CDE) intermediary must be certified by the CDFI in order to be eligible under the NMTC program. The second step is the completion and submittal of an application. The funding cycle opens in with the Notice of Allocation Availability (NOAA) in May and is awarded the following winter. The application consists of five parts: Business Strategy, Community Outcomes, Management Capacity, Capitalization Strategy and Previous Awards. If selected, the third step in the application process is the award announcement, which is followed by the allocation Agreement. The final step is compliance and reporting on the measurable community impact of the NMTC project. Date: October 26, 2018 Report No. 2018-156 If selected for funding, a CDE identifies equity investors. The NMTCs usually are combined with other funding sources, such as historic tax credits, in order to make the projects work. Examples of projects CDEs invest in are: manufacturing, retail, or healthcare facilities. NMTCs are subject to recapture if the QEI does not pass the “substantially-all” requirement. This involves a failure to: invest 85% of the original QEI, meet QALICB requirements, or meet the one-year investment requirement. A table with the six Texas CDEs that received NMTC allocations in 2016 and 2017 is included in Exhibit 2. Please note that the table has active links for more information on each project. Exhibit 3 provides a link to a video which does a good job of explaining the NMTC process. NMTC Example Pat Smith of Serve Denton spoke to Council on October 9, 2018, regarding the nonprofit’s use of NMTC’s as a portion of the funding for its new facility. Staff contacted Mr. Smith to discuss how Serve Denton structured its NMTC project. Serve Denton engaged an NMTC consultant, a law firm specializing in NMTCs, and an accounting firm specializing in NMTCs to vet the project and guide them through the process. They used a bank in Washington, D.C. called Capital Impact Partners as the CDE. Mr. Smith said that one of the key elements with an NMTC project is that all of the components (funding, permitting, etc.) have to be in place at closing – in other words, it has to be a “shovel ready” project. He added that NMTCs, while difficult to establish, were easier to administer in the long term than other federal grant programs. Pros and Cons Some of the advantages and disadvantages of the NMTC program are included in the table below. Advantages Disadvantages Mixed use projects can be a qualifying business Residential rental property not considered a qualifying business Tax credits can be claimed in 7 years Tax credit claims are 5% each year for the for the 1st 3 years and 6% each year for the next 4 years for a total of 39%, usually need to be combined with other funding Can be combined with historic rehabilitation tax credits Cannot be combined with low income tax credits QALICB (business) generally receives favorable terms or equity, but need to provide collateral to the CDE Local government and quasi-governmental CDEs were awarded less often and for smaller allocations, 2% of projects in 2013 were associated with governmental or tribal organizations2 Leveraging of the equity investment and the loan allow for a return that is closer to a conventional loan1 Credit allocation process is very complicated and competitive (25% of applicants receive the allocation) NMTC administration is easier to administer in the long term than some federal grant programs. The tax credit equals 39% of the Qualified Equity Investment (QEI). Investor may have borrowed to make the equity investment A CDE may be able to provide a grant and/or a bridge loan to assist with closing The initial program is difficult to establish and requires funding and permitting components to be in place at closing Date: October 26, 2018 Report No. 2018-156 1 Holland and Knight's Leveraged Model 2Source: Tax Policy Center Briefing Book "A Citizen's Guide to the Fascinating (though often Complex) Elements of the Federal tax System," 2016 CONCLUSION While NMTCs present an alternative avenue for project funding, local government projects typically make up under 5% of the project awards in a given year. When considering the use of NMTCs, careful consideration must be given to the benefits and drawbacks of this federal program. ATTACHMENT(S): Exhibit 1 – NMTC Map by Baker and Tilly Exhibit 2 – NMTC Awardees in Texas 2016-2017 Exhibit 3 – NMTC Video Link STAFF CONTACT: Erica Sullivan, Economic Development Analyst Economic Development Department 940-349-7731 Exhibit 1 Denton’s NMTC Eligibility Map Exhibit 2 NMTC Allocatees in Texas 2016-2017 Awardee City State Year Program Amount Service Area Dallas Development Fund Dallas TX 2017 NMTC $55,000,000 Local Pacesetter CDE, Inc. Fort Worth TX 2016 NMTC $35,000,000 National PeopleFund NMTC LLC Austin TX 2017 NMTC $30,000,000 State PeopleFund NMTC LLC Austin TX 2016 NMTC $30,000,000 Statewide Texas Mezzanine Fund, Inc. Dallas TX 2016 NMTC $75,000,000 Statewide TransPecos Development Corp San Antonio TX 2017 NMTC $65,000,000 State Source: CDFI Note: Awardee column has active links for more details on each award Exhibit 3 Baker Tilly’s “New Market Tax Credit program: how it works” video link: https://www.bakertilly.com/insights/new-markets-tax-credit-program-how-it-works