Tax Credit Finance Flashcards
(15 cards)
What is a tax credit?
A tax credit is a dollar for dollar reduction of a taxpayer’s liability. It is different from a deduction, which is a reduction of a taxpayer’s income subject to tax, on which the taxpayer’s ultimate tax liability will be determined.
Example:
*Taxable Income = $100,000
*Marginal Rate = 35%
*Deduction = $1,000
Tax Credit = $1,000
**Tax Liability = $35,000
**Tax Liability after Deduction = $99,00035% = $34,650
**Tax Liability after Tax Credit (no deduction) = $34,000
The taxpayer must have taxable income to use tax credits.
What are refundable tax credits?
Refundable tax credits enable taxpayers to receive payment from the taxing authority to the extent that the taxpayer’s tax liability becomes “negative” after factoring in a tax credit.
Example:
*Tax Liability = $800
*Refundable Tax Credit = $1,000
*Tax Liability after Tax Credit Applied = -$200 (= $200 refund to the taxpayer)
Why are tax credits used?
Tax credits are used to encourage investment in certain socially or economically flavored industries or activities. They accomplish important public policy objectives by encouraging the private sector to provide social benefits through projects that probably would not be developed “but for” the tax credits. They are authorized incentivizes under the Internal Revenue Code.
What are the major federal tax credits used for development finance?
- Low-Income Housing Tax Credit (LIHTC):
It is used to promote the development and renovation of affordable housing for low-income persons. The U.S. Treasury Dept allocates tax credits to each state based on population. Tax credits are awarded to developers, who with an equity partner, develop and maintain apartments as affordable units. Primary benefits are in the form of tax credits. - Federal Historic Rehabilitation Tax Credit:
It is used to promote preservation of historically significant properties. Under the program, a 20% tax credit is available for the rehabilitation of historic buildings, and a 10% credit is available for buildings that were first placed in service before 1936. - New Market Tax Credit (NMTC):
It is used to encourage investment in commercial, non-residential businesses in low-income areas. The NMTC program provides federal tax credits to investors that make investments into community development entitites, which in turn, make investments in eligible businesses and projects located in qualified low-income census tracts. NMTC are awarded by the CDFI to a community. - Energy Tax Credit:
It is used to promote the development of alternative energy means and processes. It is allowed for investment in certain types of energy property with no maximum credit limit. Tax credits are generated at the time the qualifying facility is placed in service. May also benefit from accelerated depreciation and cash flow over a 6-8 year period.
Example: How Tax Credits Work Financially
AH costs = $2,000,000
Tax credit (over 10 years) - $1,500,000
Tax liability annually = $50,000 / year
Unused tax credits: 100,000/year
If the tax cuts are sold = $0.00 in unused tax credits.
What is tax credit syndication?
Syndication refers to combining investments in tax credits of several taxpayers into a vehicle that in turn invests directly in specific tax credit projets.
What are the “pros” of tax credits?
- Societal benefits: tax credits promote development activity in areas aligned with public policy goals
- Source of financing: tax credits provide predictable means by which activities can be financed by society
- Stable markets: there are markets for tax credits that provide a reasonably efficient means by which tax credits can be purchased and sold
- Developer incentives: they provide essential economic benefits that make development projects feasible.
- Economic development: tax credit projects provide a significant means by which government encourages investment and redevelopment activities in low-income and brownfield areas.
- Bank investment: banks and certain other lenders receive credit under the CRA for providing financing and investment in designated low-income projects. CRA credits are available for investments under both the LIHTC and NMTC programs.
What are the “cons” of tax credits?
- Expenses/Inefficiencies: tax credit projects can be expensive to develop, construct, and operate.
- Compliance: failing to comply with the rules of tax credit programs can lead to government action to recapture tax credit value. Some tax credit programs (such as LIHTC) have onerous compliance monitoring requirements.
- Guarantees: to ensure regulatory compliance, investors and lenders will require a developer to provide guarantees that tax credits will not be recaptured.
- Recapture: the IRS will recapture the original value of the tax credits plus interest.
Distinctions between tax credit deals and non-tax credit deals?
- Allocation of tax credits is competitive
- The developer’s control over the project’s developer commitments is limited
*Underwriting may be more restrictive
What are the potential sources of rules, guidelines, and procedures that pertain to tax credit programs?
*IRS
*State tax statutes
*Federal and state regulations
*Federal agency administrative guidance
*State allocating agency guidelines
Strategies for engaging in tax credit projects
- Form a partnership with a nonprofit organization
- Conduct demographic and statistical analysis to identify where tax credit projects are most needed.
- Establish a good track record with syndicators and local allocating agencies/entities
- Vertically integrate project operations within the same developer’s corporate structure
- Develop expertise in non-tax credit financing arrangements to address financing gaps.
- Partner with a nonprofit developer
What sets of procedures must projects usings LIHTC comply with?
- Qualified Allocation Plan:
Each state is required to established a QAP, which will include the role of the state allocating agency in developing the state’s affordable housing program, the goals of the state’s housing program based on housing needs, and evaluation or scoring factors considered by the state allocating agency. - Compliance Manuals:
Manuals have been developed by governmental agencies that provide details beyond the QAP with respect to tax credit compliance. - Deed restrictions:
LIHTC projects are required to have a Land Use Restriction Agreement that helps to ensure the program will remain accessible to the low-income residents that were intended to benefit under the program. - Reporting requirements:
Tax credit projects are subject to various reporting requirements from the stakeholders such as investors/syndicators, local/state agencies, and the IRS.
What is tax credit project due diligence?
Due diligence involves confirmation of each of the items provided by a developer in the tax credit application. Following an award or reservation of tax credits, key stakeholders will want to confirm the project can be developed and operated in the manner set forth in the application.
What is tax credit project performance monitoring?
Performance monitoring of a tax credit project occurs throughout the lifetime of the project, but it will vary by stakeholder and by project phase.
What are the key milestones for measuring project success?
- Initial or preliminary commitment of award of tax credits.
- Credit delivery (construction / closing / lease up)
- Achievement of cash flow projections
- Ongoing compliance with tax credit program requirements
- Absence of state and local code violations or infractions.
- Payment of the Developer Fee.
