Specific Conditions a Qualified Active Low-Income Community Business Must Meet to Receive NMTC
Are you seeking additional capital to expand your business, or do you have a gap in your capital stack for your new development project? If you have considered New Market Tax Credits (NMTC), you must be a Qualified Active Low-Income Community Business (QALICB) to qualify for a NMTC loan or equity investment. As we anxiously await the Community Development Financial Institutions (CDFI) Fund’s announcement of the next round of New Market Tax Credit allocations later this summer, we thought a quick reminder about what a QALICB is, would be helpful.
You cannot ignore the fact that capital is necessary to bring about quantifiable quality outcomes to disenfranchised communities throughout the United States. You need a Qualified Low-Income Community Investment (QLICI) in the form of capital, an equity investment, or loan. Savage & Associates can provide the necessary answers and guidance to help you find what you need.
Before an entity is eligible to receive NMTCs it must meet specific conditions set forth by the Internal Revenue Service. Below are several points to consider determining whether your business is eligible for NMTCs:
- Does your Business Activity Qualify?
- Are You Actively Engaged in a Qualified Business?
- Does Your Entity’s Income, Activities and Assets Qualify?
Issue 1 – Is your Business a Qualifying Business?
A qualifying business entity can be a corporation, including a non-profit corporation or a partnership. A sole proprietorship can also qualify if it would meet the necessary requirements had it been incorporated.
A Community Development Entity (CDE) can treat any trade or business as a QALICB if the entity would meet all the requirements if separately incorporated and maintains separate books and records specifically for that trade or business. At the time of the investment, the CDE must reasonably expect that the entity will continue to satisfy all requirements of a QALICB throughout the entire term of the investment.
Issue 2 – Does Your Business Activity Qualify?
According to the IRS rules, all types of business activities qualify except:
- businesses that develop or hold intangible assets for sale or license
- golf course operators
- country clubs
- massage parlors
- hot tub facilities
- tanning businesses
- gambling locations
- alcoholic sales for off-premise consumption
- farming operations with business assets valued more than $500,000
Also, general real estate rental does not qualify unless it is non-residential rental property, located in a low-income community, and there are substantial improvements on the property. A determination of whether the real estate property is non-residential is based on the percentages of revenue derived from residential and non-residential activity. The 80/20 Rule requires that at least 20% of the income is generated by commercial revenue and not residential rental income.
Issue 3: Are You Actively Engaged in a Qualified Business?
According to Treasury Regulation §1.45D-1(d)(4)(i), an entity is considered engaged in the active conduct of a trade or business if at the time a CDE invests, that CDE reasonably expects the entity to generate revenues within the three years following the investment.
Issue 4: Does Your Entity’s Income, Activities and Assets Qualify?
According to the IRS New Market Tax Credit circular, the following definitions apply to determine whether an entity’s income, activities, and assets qualify for the entity to be considered a QALICB:
- Gross-income requirement – at least 50% of the total gross income of the entity must be derived from the active conduct of a qualified business within a low-income community.
- Use of tangible property requirement – at least 40% of the use of the tangible property of such entity (whether owned or leased) is within a low-income community. The percentage is determined based on the average value of the tangible property that is used in a low-income community divided by the average value of all the property used during the year.
- Services performed requirement – at least 40% of the services performed by the entity’s employees are performed in a low-income community. Employees need not live in the low-income community. If the business has no employees, this requirement and the gross-income requirement can be met if the use of tangible property requirement above is 85% instead of 40%.
- Percentage of Collectibles – Collectibles must amount to less than 5% of the average of the aggregate unadjusted basis of the entity’s property. Collectibles that are primarily for resale to customers in the ordinary course of business are excepted.
- “Non-qualifying financial property” – This property must be less than 5% of the average of the entity’s aggregate unadjusted bases. The term non-qualifying financial property refers to stock, options, debt, partnership interests, options, futures and forward contracts, annuities, and other similar property. There are a few exceptions to this requirement.
Generally, a newly formed special purpose entity designated to operate the new development project will meet the test above.
The Devil is in the Details
The team at Savage & Associates recognizes the complexity of the NMTC program. We are devoted to providing timely advice and assistance through every step of your NMTC transaction. We will also assist you with other related legal issues. Our founder, Dionne Savage is a frequent presenter at NMTC seminars and is available to speak at live or virtual events on this NMTCs and other related topics.
If you have any questions about the New Market Tax Credit program, the application process, or other development matters, call us at 215.880.9441 in Philadelphia, or 202.817.3941 in Washington, D.C. Visit us at Savage & Associates anytime for more information or to set up a consultation. Let’s improve our communities together!