NMTC Compliance

There are several levels of compliance that must be monitored and controlled as part of an effective NMTC compliance and asset management program.  What follows is a summary outline of the significant compliance areas.  Each item has many sub-items that aren’t detailed here, but can have very significant economic impacts if violated.  It is essential that tax credit investors are satisfied that the CDE overseeing NMTC compliance is familiar and experienced with the IRC Section 45D program and regulations.

The most significant risk is the risk of tax credit recapture.  NMTCs can be recaptured if:

• A CDE fails to maintain its status as a qualified CDE, or
• Substantially all of the QEI proceeds fail to be invested in a QLICI, or
• A QEI is redeemed during the seven year compliance period.

To maintain status as a CDE, the CDE must demonstrate that

1. at least 60% of its products and services are directed towards serving Low Income Communities or Low Income Persons, and
2. at least 20% of its governing or advisory board members are representatives of low income communities within the CDE’s service territory.

To demonstrate that substantially all of QEI proceeds are invested in QLICIs, records must be maintained that show that at least 85% of QEI proceeds are invested in QLICIs within one year.  This is usually done by directly tracing amounts through bank statements of the CDE (the “direct trace test”) for each QEI, or by methods of aggregating QEIs (the “safe harbor test”).  If this test is failed, there are provisions which allow for a one time correction.  It is important that CDEs track the age of their QEIs if they are using the direct trace test to ensure that all QEIs are invested in QLICIs before the requisite twelve-month period.

To avoid redemption of a QEI, the CDE must not make a capital distribution in excess of its Operating Income.  There is a specific calculation for Operating Income that must be applied.  This is an annual test and should be performed prior to the end of a test period to allow time for corrective measures. 

Returns of capital from a QALICB to a CDE must be reinvested in another QALICB within 12 months.  CDEs typically try to minimize the amortization of QALICB investments in order to avoid the requirement to reinvest.  The requirement to reinvest does not apply in year seven.

In addition to recapture risk, CDEs must maintain compliance with their allocation agreement with the CDFI in order to remain eligible for future allocation awards.  An individual CDE’s allocation agreement may require that greater than 85% of QEI proceeds be invested in QLICIs. 

For an investment to qualify as a QLICI, it must be an investment in a QALICB.  There are detailed rules for determining a QALICB, but generally the business must be located in a qualified census tract ("QCT") and cannot be (i) a “Sin” business – defined as operating a country club, golf course, massage parlor, hot tub facility, suntan facility, racetrack or other gambling facility, or liquor store, (ii) a business that develops, licenses or sells intangibles, or (iii) certain farming businesses.  It is possible for a QALICB to be a subset or division of a larger business which might not otherwise qualify as a QALICB in its entirety (e.g. a chain of hospitals may have individual facilities that qualify as QALICBs).