Publications

12 Dec 2011

New markets tax credits: treasury explains qualifications for entities serving targeted populations

US Tax Alert

Lee Sheller
Stephen M. Sharkey

The new markets tax credit (the NMTC) is a federal subsidy that is designed to provide an incentive, in the form of federal income tax credits, for taxpayers to invest in qualifying businesses (referred to in the statute as qualified active low-income community businesses, or QALICBs).  The core objective of the program – to encourage investments in businesses operating  within low-income communities – is implemented through the definition of QALICBs.

Originally, QALICBs were defined by a geographic limitation, under which a qualifying business needed to be physically located within a low-income community.  In 2004, the statute was amended to provide an alternative test, under which businesses that serve certain targeted populations would satisfy the requirements to be a QALICB.  A targeted population means individuals, or an identifiable group of individuals, including an Indian tribe, who (A) are low-income persons or (B) otherwise lack adequate loans or equity investments.  The latter category only applies in the context of NMTC that are utilized for recovery and redevelopment of the Gulf Opportunity Zone, where individuals are displaced as a result of Hurricane Katrina or have lost their employment as a result of Hurricane Katrina.  This latter category of targeted population is outside the scope of this Alert.

Proposed regulations on targeted populations were issued in September 2008.  On December 5, 2011, final regulations were published which clarify issues in applying the NMTC program to businesses that serve targeted populations (the Targeted Population Regulations).

With the issuance of the Targeted Population Regulations, businesses that do not focus their activities within a low-income community but which serve certain targeted populations will now be able to access the subsidy from NMTC. 

Qualified businesses under the Targeted Population Regulations

In general.  Under the Targeted Population Regulations, a business will be a QALICB by serving a targeted population if it meets one of three tests:  (i) at least 50 percent of the business’s total gross income for any taxable year must be derived from sales, rentals, services or other transactions with individuals who are “low-income persons” (the 50-percent gross-income requirement); (ii) at least 40 percent of the business’s employees must be individuals who are “low-income persons”; or (iii) at least 50 percent of the business must be owned by individuals who are “low-income persons.” 

Low-income persons.  Under the Targeted Population Regulations, “low-income persons” are defined as individuals whose family income is generally not more than:

(i)         For metropolitan areas, 80 percent of the area median family income; and

(ii)        For non-metropolitan areas, the greater of 80 percent of the area median family income, or 80 percent of the statewide non-metropolitan area median family income

Area median family income is determined in a manner consistent with the determinations of median family income under section 8 of the Housing Act of 1937, as amended, and taxpayers must use the annual estimates of median family income released by the Department of Housing and Urban Development (HUD).  An individual’s family income is determined using household income as measured by the US Census Bureau or HUD, or using the individual's total family income reported on Form 1040.

Under the Targeted Population Regulations, a business that is serving a low-income population cannot qualify for the NMTC if it is located (as determined under the Targeted Population Regulations) in a population census tract for which the median family income exceeds 120 percent of, in the case of a tract located outside of a metropolitan area, the statewide median family income, or in the case of a tract located within a metropolitan area, the greater of statewide median family income or metropolitan area median family income.  Under certain circumstances, the 120 percent income restriction does not apply to a business located within a population census tract with a population of less than 2,000. 

Safe harbors for ownership and employment tests.  The Targeted Population Regulations provide very helpful safe harbors that allow businesses that intend to rely on either ownership by low-income persons or the employment of low-income persons to make these test when the NMTC  investment is made (rather than continuously over the seven-year NMTC compliance period).

Rental of real property.  Finally, the Targeted Population Regulations provide clarity as to how a business that is engaged solely in the rental of real property to others will qualify under the 50 percent gross-income requirement.  Because such a business will often have no employees, the business will have to satisfy the 50 percent gross-income requirement or the ownership requirement for low-income persons.  As the preamble to the Targeted Population Regulations states, in the case of a business engaged solely in the rental of property, the business's gross income would only be derived from rents, and in many instances, the tenants would not be individuals (i.e., “low-income persons”) as required.  The Targeted Population Regulations provide a special rule that generally treats a business whose only activity is the rental to others of real property as satisfying the 50 percent gross-income requirement if at least 50 percent of the business’s total gross income is derived from rentals to individuals who are low-income persons or rentals to a qualified active low-income community business that meets the requirements for low-income targeted populations.

Summary

The recently issued Targeted Population Regulations added much needed specificity and clarity in many areas to allow taxpayers to structure investments in businesses serving targeted populations, and thereby expand the businesses that can access the NMTC.

For more information about using the NMTC subsidy, please contact your DLA Piper tax lawyer or Lee Sheller or Steve Sharkey.