A magic trick consists of three parts: the pledge, the turn, and the prestige.1 For the pledge, the magician uses something ordinary like a deck of cards. The audience may inspect the object and confirm its legitimacy. Next is the turn, where the magician uses an ordinary object and makes something impossible happen. However, the trick is not finished until the magician completes the illusion and provides some resolution that amazes the audience. When a magician makes something disappear and reappear (the prestige), all three parts are present.
At times, the New Markets Tax Credit (NMTC) Program can seem like a bit of magic. Something seemingly simple turned into a complex mystery. Unfortunately, NMTC magic leaves the audience without resolution and often leaves them wondering, “What just happened?” Much like a magician revealing the tricks of the trade, this article will explore some of that missing resolution and solve a few mysteries associated with the NMTC Program. We will look at three statements to help demystify the NMTC process.
1. The NMTC Program Is Just a Form of Economic Development
First, the name of the program, while informative, lacks context. Yes, a tax credit is in play, but how communities benefit from the tax credit is where the mystery lies. A name such as the “Low-Income Community Capital Investment & Development Tax Credits” would be a more informative description. However, the acronym of LICCIDTC is a mouthful, so NMTC seems to be the hand we must play.
Next, think about what the NMTC Program is trying to accomplish. Many years ago, Congress recognized that lower-income communities were often overlooked by traditional capital markets. Lending institutions would frequently evaluate two projects side by side and make investment decisions based on one or two minor differentiators. One of those differentiators could be poverty rates or average median income. One can understand the argument concerning the viability of a business when, rightly or wrongly, the “safer” bet was on a borrower located near customers with more disposable income. In a vacuum that decision is not necessarily harmful, but when that decision happens repeatedly, over time, that community falls further and further behind. The absence of consistent capital investment ultimately reinforces a cycle of distress.
So, Congress created an investment incentive program that provided “extra” motivation for lenders to select borrowers who may have been overlooked in the past. The NMTC Program provides a tax credit to investors who make certain qualified investments in communities that have higher poverty rates and lower-than-average median incomes. The tax credit is the benefit that a potential lender, all else equal, would not otherwise receive from lending activity outside the NMTC Program.
The incentive is essentially a risk mitigation tactic that leads to direct investment into distressed communities. That direct investment may lead to local healthcare options, additional job prospects, stable housing, and reductions in poverty rates. All of these probable outcomes can be clear signs of economic development when measured and evaluated. A tax credit designed to encourage investment can create tangible economic development activity and bring forgotten communities out of a vicious disinvestment cycle.
2. The NMTC Program Is Community Project Funding
People understand economic development in broad strokes, such as an investment into something that aims to bolster economic activity. People also understand economic development concepts such as job creation, tax abatement, and training. Because traditional economic activity is both easy to understand and tangible, there is an innate comfort in traditional economic development tools. The NMTC Program is also a tool, but the path to implementation is winding, resulting in the NMTC Program feeling like the misunderstood relative of economic development.
The NMTC Program is simply a grant-style funding economic development incentive. It is a form of capital funding, and it is not a grant. At the same time, it has many characteristics similar to grant funding. A recipient may be a business or nonprofit that intends to expand an existing space, buy a new building, renovate a new facility, or buy a new large piece of equipment, but lacks the funding needed. There are groups looking to support businesses or nonprofits that plan to expand, revitalize old buildings, add capacity, and create new jobs.
Grant funding decisions are made by the granting organization and go directly to recipients. You apply, your application is reviewed, and dollars are awarded. Some reporting may also be involved, depending on the granting organization.
The NMTC process is fundamentally the same. Like any grant, NMTC funds are delivered directly to the sponsor, business, or nonprofit. Because it’s a taxpayer-funded program, those funds require stricter oversight, which generally means more upfront vetting and additional back-end reporting. Moreover, because tax credits are at issue, the government has outlined which structures and procedures are permissible along with specific guidance to help ensure the NMTC funds are delivered appropriately. The difference is not in the program itself. Rather, it is in the rules around the delivery of the benefit to the community. The NMTC Program can turn simple funding into something extraordinary.
3. The NMTC Program Is Cash
Imagine you need a bottle of water. It’s a hot day, and you are thirsty. Unfortunately, you only have 80 cents and all water bottles cost a dollar. Now, what if I said, my goal in life is to reduce thirst and I have 20 cents worth of funding that you might be able to have so long as you meet a few qualifications. You might say no right away. But what if I said, “Just stick with me for a few years, and if all goes well, you don’t need to pay me back.” Now would you be interested?
The NMTC Program can provide two benefits for an organization. On the front end, an organization, through participation in the NMTC Program, borrows project funding that is low interest, below market rates, and more flexible than other more traditional borrowing avenues. In addition, an organization is prohibited from paying principal related to the funding. Only interest payments are allowed. Then, assuming all goes well for seven years, after the transaction is unwound, the borrowing organization may not need to ever pay back the full amount borrowed through an NMTC transaction.
You get both: upfront cash to reduce costs and access to funds where the principal received may never need to be paid back. For some organizations, there can be further implications (third-party debt repayment, tax implications, etc.), but those are understood prior to entering an NMTC transaction. Like the water bottle example above, the cost of the project is now less than the original budget and, in many cases, will never rise to the full cost.
The NMTC Program, though complex and often mysterious, is simple. You take a distressed community, partner with a community development project, show it something simple like project funding, and help transform that community into something special.
How Forvis Mazars Can Help
Professionals at Forvis Mazars can help organizations navigate the NMTC Program throughout the process, whether you’re a community development entity (CDE), NMTC investor, or have a project needing funding.
To learn more about how Forvis Mazars supports communities through the NMTC Program or to speak with one of our team members, please contact our Consulting team.
- 1“The Prestige,” Christopher Priest, 1995.