New Markets Tax Credit Program: Progress Made in Implementation, but Further Actions Needed to Monitor Compliance
Published: 2004-01-30T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: The Community Renewal Tax Relief Act of 2000 authorized up to $15 billion under the New Markets Tax Credit (NMTC) program to stimulate capital investment in low-income and economically distressed communities. The act mandated that GAO report to Congress on the NMTC program by January 31, 2004, 2007, and 2010. Based on consultation with staff at appropriate congressional committees, this report (1) describes the status of the NMTC program, (2) profiles community development entities (CDE) that were selected to receive NMTC allocations in 2003, and (3) determines whether systems are in place or planned to ensure compliance and evaluate the success of the NMTC program.
section_title: What GAO Found
paragraphs: Although Congress authorized the NMTC program to provide credit against federal taxes for billions of dollars starting in 2001 to spur investments in community development projects, CDFI Fund officials said that it is unlikely that many projects had started by the end of 2003 and that they will not know the status of projects for all CDEs until early 2005. Progress was made in developing data systems, selection processes, and program rules, but allocations were delayed because of the various start-up tasks associated with a new program, especially in establishing the rules on using the allocated credits. CDEs that received NMTC allocations (allocatees) proposed projects to serve urban, rural, and mixed areas, as well as local, state, multiple-local, multistate, and national areas. The distribution of state and local allocations was not concentrated in any one state or in a few states. All allocatees reported at least some prior experience in low-income communities, particularly in providing capital to low-income communities. The CDFI Fund and IRS have identified data with which to monitor compliance with allocation agreements and tax laws, and are developing systems to collect the data. However, many details remain to be settled on how the data will actually be used to monitor compliance. Agency officials believe they have time to devise their compliance monitoring processes. However, they do not have schedules or documented plans for ensuring that compliance monitoring processes will be in place when needed, and they have other tasks to complete. In terms of evaluating the NMTC program, the CDFI Fund intends to contract for an evaluation, and officials believe they are collecting significant amounts of data that will be useful for the evaluation and that CDEs will maintain additional relevant data.

section_title: Letter
paragraphs: Access to credit and investment capital is essential for creating and  retaining jobs, developing affordable housing, revitalizing neighborhoods,  and promoting the development of small businesses.   However, such  access through conventional sources is often limited for communities  comprising large low-income populations or suffering from economic  distress.
The Community Renewal Tax Relief Act of 2000 authorized up to   $15 billion in equity that is eligible for tax credits under the New Markets  Tax Credit (NMTC) program.  This program is expected to stimulate capital  investment in low-income communities.  The Community Development  Financial Institutions (CDFI) Fund in the Department of the Treasury  allocates the available tax credit authority to community development  entities (CDE), which are entities that manage NMTC investments in low- income community development projects.  In return for the tax credit,  which may be claimed over 7 years, investors supply capital to the CDEs  that are to invest the capital in low-income communities.
As we discussed in a previous report, the CDFI Fund is to administer the  NMTC program over annual increments of allocations and has been  developing processes and systems to allocate the tax credits under  allocation agreements, monitor compliance with allocation agreements and  CDE certification requirements, and evaluate the program.   In addition, the  Internal Revenue Service (IRS) is responsible for overseeing taxpayer and  CDE compliance with applicable provisions of the Internal Revenue Code.
The act mandated that we report to Congress on the NMTC program by  January 31, 2004, 2007, and 2010.  Based on consultation with staff at  cognizant congressional committees, this report (1) describes the status of  the NMTC program (including the allocations), (2) profiles CDEs that were  selected to receive NMTC allocations in 2003 by the issues raised most  frequently by the congressional committee staffs (proposed geographical  distribution, prior experience in low-income communities, and type of  proposed service), and (3) determines whether systems are in place or  planned to ensure compliance and evaluate the success of the NMTC  program in achieving its goals.
To accomplish the reporting objectives, we met with CDFI Fund and IRS  officials and collected documents on the program status as well as on the  status of data and systems to be used to monitor compliance and evaluate  the program, collected data on the profile of CDE applicants based on the  issues raised by congressional staff, and reviewed any plans for using the  data and systems to monitor compliance and evaluate the NMTC program  given the program goals.  (Our scope and methodology section provides  more details on how we did our work.)
subsections: section_title: Background
paragraphs: As discussed in our previous report, according to congressional supporters  of the legislation, the goals of the NMTC program are to direct new  business capital to low-income communities, facilitate economic  development in these communities, and encourage investment in high-risk  areas. The program strives to meet these goals by providing tax credits as  investment incentives to prompt investors to provide capital that in turn,  will facilitate development in low-income communities and businesses.
For purposes of the NMTC program, low-income communities generally  are defined as census tracts that meet specified poverty rate or median  family income levels.  The darkened areas of figure 1 illustrate that census  tracts qualifying for NMTCs are widely distributed across the nation.   Specifically, about 39 percent of all census tracts qualify for NMTCs and 36  percent of the nation’s population lives in these census tracts (see app. I for  a table of NMTC eligibility as a percentage of state population and of state  census tracts).
subsections: section_title: Certification and Allocation Process
paragraphs: The CDFI Fund has the authority to allocate NMTCs under the direction of  the Secretary of the Treasury. The legislation limits the allocation of equity  eligible for tax credits from 2001 through 2007 from $1 billion to $3.5 billion  per year, totaling $15 billion over the 7 years.
The first step in the NMTC program is to apply to the CDFI Fund for  certification as a CDE, which is an entity that manages investments for  community development.  Nonprofit entities and for-profit entities may be  certified as CDEs.  To be certified, the CDE must be a domestic corporation  or partnership, for federal tax purposes, and be duly organized under the  laws of the jurisdiction in which it is incorporated or established. A CDE  must have a primary mission of serving or providing investment capital for  low-income communities or low-income persons, and must maintain  accountability to residents of these low-income communities by filling at  least 20 percent of the CDE governing or advisory board positions with  low-income community representatives.
The second step for a CDE is to apply for an allocation of tax credits from  the CDFI Fund.  CDEs are to use the tax credits allocated to attract  investors.  Both for-profit and nonprofit CDEs can apply for allocations of  NMTCs.  However, only a for-profit CDE may offer NMTCs to its investors  while a nonprofit CDE must intend to transfer the allocation to one or more  for-profit subsidiaries.  The application asks a series of questions about the  CDE, its track record, the dollar amount of allocated tax credits being  requested, and the plans for using the credits to support activities in low- income communities.
Applications are then reviewed and scored by a mix of CDFI Fund staff and  external reviewers who have experience in business, real estate, or  community development finance.  The CDFI Fund considers reviewers’  scores, reviews applications, and awards an amount of allocated tax credits  to those applicants judged to be the most highly qualified.  These decisions  on scoring applications and awarding allocations are to be based on a range  of criteria under which applicants can receive scores of up to 25 points in  each of the four following areas:    community impact, which is the extent to which the applicant targets  particularly economically distressed communities, has the active  participation of community representatives in designing and  implementing its business plan, and can demonstrate community  development and economic impacts;   business strategy, which is having prior performance providing similar  kinds of products and services—applicants can score an additional 5  points by demonstrating a record of successful investment in  disadvantaged communities or businesses and another 5 points by  investing in businesses unrelated to the applicant;  capitalization strategy, which is securing investor commitments; and   management capacity, which is experience investing in low-income  communities.
Figure 2 shows what happens after the allocations are made to CDEs  (i.e.,  CDE allocatees).  The basic process is that investors acquire stock or  capital interest in CDEs in order to receive the tax credits.  In turn, these  CDEs must use “substantially all” of the proceeds in making qualified low- income community investments (QLICI).  Eligible QLICIs might include  loans or investments to businesses; development of commercial, industrial,  and retail real estate projects; and development of for-sale housing in low- income areas.
Beginning with the first year of the investment in a CDE, investors are  entitled to claim the tax credit over a 7-year period with 5 percent of the  initial investment claimed for each of the first 3 years and 6 percent for  each of the final 4 years, or a total of 39 percent over the 7 years. During the  7-year period, NMTCs could be subject to a recapture event if the CDE  allocatee (1) ceases to be a CDE, (2) does not satisfy the “substantially all”  requirement, or (3) redeems the investment.  In general, a recapture event  means that investors in that CDE are required to increase their income tax  liability by the credits previously used plus interest for each resulting  underpayment of tax.  The recapture of credits affects the investor who  originally purchased the equity investment and subsequent holders.    Investors cannot continue to claim the tax credit if their equity investment  is returned to them before the end of the 7-year period.  A CDE is required  to provide notice, within a certain period, to (1) any investor who acquires  a qualified equity investment (QEI) in the CDE that entitles the investor to  claim the NMTC and (2) each current and prior holder of a QEI if a  recapture event has occurred.
section_title: NMTC Allocation Agreements
paragraphs: After being selected to receive an allocation, each CDE allocatee must sign  an allocation agreement with the CDFI Fund before officially designating  QEIs and offering tax credits to its investors.  The agreement is to set forth  the terms and conditions, such as the amount of NMTC allocation,  approved uses of the allocation, approved service area, and reporting  requirements.  While most sections of the agreement are the same for every  allocatee, other sections, such as the authorized uses of an allocation (e.g.,  loans to businesses and equity investments in other CDEs), are tailored to  each CDE allocatee.
As specified in the IRS regulations, CDE allocatees must issue the NMTCs  to investors within 5 years of receiving an allocation.  CDEs that receive  returns of capital from investing in QLICIs have 12 months to reinvest those  funds in QLICIs; reinvestment is not required in the final year of the 7-year  credit allowance period.  CDEs also must agree to periodically report data  on investors and project activities.
The rules also govern the types of businesses that can participate in NMTC  projects.  In general, a qualified active low-income community business  (QALICB) is a corporation (including nonprofit corporations) or  partnership that satisfies certain requirements, including the following:   Gross income. Generally, at least 50 percent of the total gross income  must be derived from the active conduct of a qualified business within  any low-income community.
Tangible property. At least 40 percent of the use of tangible property  must be within a low-income community.
Services performed. At least 40 percent of the services performed by  its employees must be performed in a low-income community.
Regulatory requirements preclude some types of business activities from  qualifying as QALICBs (e.g., residential rental property, golf courses,  massage parlors, liquor stores, race tracks or other gambling facilities, and  farms).  In general, for a business to be treated as a QALICB, the CDE  must have “reasonably expected” at the time of the investment that the  business would remain in compliance with the QALICB requirements for  the term of the investment.  Except for those requirements that affect a  QALICB, the CDE is not required to monitor whether a business continues  to comply with requirements after the initial investment is made.
As investors provide equity to CDEs and CDEs invest in low-income  communities, the CDFI Fund is to monitor compliance with the allocation  agreements.  IRS is to monitor compliance with the tax consequences of  NMTC allocations, focusing on whether CDEs met the “substantially all”  requirement.  If this requirement is not satisfied, the tax credits claimed by  investors plus interest thereon are potentially subject to recapture.
section_title: Scope and Methodology
paragraphs: To describe the status of the NMTC program, we interviewed various CDFI  Fund and IRS officials tasked with program design and implementation.   We reviewed CDFI Fund notices and planning documents on program  milestones and implementation.  We also attended conferences sponsored  by the CDFI Fund and various industry groups to better understand the  NMTC program implementation as it proceeded.
To profile CDEs that received NMTC allocations based on the issues raised  most frequently by the staff of congressional committees, we analyzed both  certification and allocation application data provided by the CDFI Fund.   We identified the issues and counted their frequency based on interviews  with majority and minority staff at seven congressional committees and  subcommittees as we prepared our 2002 report (see app. II).  We could  not analyze one of the issues on the size of the CDEs because of concerns  about the data reported.  The identified issues that we could analyze were  as follows:  geographic distribution of the community development projects  proposed by CDE allocatees, including the scope of the area to be  served ranging from local to national, the type of community served  such as urban or rural, and the specific states to be served;  experience in serving low-income communities; and  type of service activity proposed for the community development  project.
Because the data on these issues came from proposals made in  applications filed by the 66 CDE allocatees rather than the signed  allocation agreements, we cannot say that the CDEs will actually serve the  geographic areas or provide the types of service proposed.   Much of the  data on actual investments and projects will not be known until later in  2004.  To better understand the issues and data, we interviewed officials  from five CDEs in the Washington, D.C., area that had received NMTC  allocations and from groups representing venture capitalists, community  development corporations, and historic preservation interests.
To determine whether the CDFI Fund and IRS have systems in place or  planned to ensure compliance with the NMTC program and to evaluate the  success of the NMTC program in achieving its goals, we interviewed  various CDFI Fund and IRS officials on the systems for obtaining the data  to be used for compliance monitoring and evaluation.  We reviewed the  NMTC legislation and our 2002 NMTC report to determine the goals of the  NMTC program.  We reviewed the CDFI Fund’s 2003-2008 Strategic Plan to  help determine overall CDFI Fund goals related to the NMTC program.  We  reviewed various CDFI Fund notices and Treasury regulations and rulings  on NMTC provisions that may affect NMTC compliance.  We met with CDFI  Fund and IRS officials about the data they intend to collect and their  strategies for identifying noncompliance.  We reviewed draft versions of  the CDFI Fund’s data collection instruments to identify the data to be  captured for compliance monitoring and program evaluation. To gain  understanding of evaluation approaches and issues, we reviewed literature  on economic development evaluation and reviewed our previous reports  and other government documents on economic development evaluation.
We did our work at the CDFI Fund’s and IRS’s offices in Washington, D.C.,  from June 2003 through December 2003 in accordance with generally  accepted government auditing standards.  We requested written comments  on a draft of this report from the CDFI Fund and IRS; their comments are  reprinted in appendixes IV and V.
section_title: Initial NMTC Investments in Community Development Projects Were Unlikely Until Late 2003 due to NMTC Program Start-up Delays
paragraphs: Although Congress authorized billions of dollars in annual NMTC  allocations beginning in 2001 to spur investments in community  development projects, it is unlikely that many investments had been made  as of December 2003, according to CDFI Fund officials.   The CDEs were  not notified of their allocation awards until March 2003, and according to  CDFI Fund officials, very few CDEs had offered credits to investors until  the last week in August 2003. According to CDFI Fund officials, they made  the allocations to CDEs in 2003 instead of 2001 because of the time taken  for various start-up tasks for the new program, such as establishing the  rules for using the allocations.
subsections: section_title: Most NMTC Investments Were Just Being Initiated by December 2003
paragraphs: Congress provided a schedule limiting the annual NMTC allocation for  calendar years 2001 through 2007.  Table 1 shows this schedule of NMTC  limitations.
The CDFI Fund allocated to CDEs the authority to issue to their investors  up to the aggregate amount of $2.5 billion in equity for which NMTCs may  be claimed (the authority includes the aggregate amounts of $1 billion for  calendar year 2001 and $1.5 for 2002); it plans to allocate up to the  aggregate amount of $3.5 billion for 2003 and 2004 in April 2004.  After the  March 2003 allocations, the CDFI Fund generated allocation agreements  for the 66 CDEs that received the allocations.  These agreements govern  the use of the allocations and the actions to be taken by CDEs to stay in  compliance with the NMTC program.  Once agreements have been properly  executed and notification is provided to the allocatees, the CDEs can offer  tax credits in negotiating with investors on community development  projects.  The CDFI Fund finished these agreements by September 2003  and CDEs had 60 days to sign them.  By January 21, 2004, 57 of the 66 CDEs  had signed their agreements.  CDFI Fund officials expected that the other 9  CDEs would sign by the end of January 2004.
As a result of the timing of the NMTC allocation agreements and  investments, CDFI Fund officials did not anticipate that many NMTC  community development projects would start in 2003. The CDFI Fund is  prepared to start receiving data about specific investor activities in CDEs.   In contrast, according to a CDFI Fund official, because CDE allocatees are  required to report project-level data annually (through the Community  Investment Impact System) at the end of their fiscal years, it is unlikely that  significant QLICI activities will be reported until their fiscal year 2004  reports are submitted, which in most cases will not be until the first part of  calendar year 2005.
section_title: The CDFI Fund Attributes Delays in Initiating Investments to NMTC Program Start-up Tasks and Points Out Efforts to Overcome the Effects of Delays
paragraphs: CDFI Fund officials said that various NMTC program start-up tasks  contributed to the delays in meeting self-imposed deadlines for making  allocations and finalizing the allocation agreements.  Officials have taken  steps, like combining the allocation limitations for the first 4 years into 2,  which they believe will mitigate any adverse effects of the delays.
To prepare to make the allocations and negotiate the allocation  agreements, the CDFI Fund used a three-phased approach that started after  Congress authorized the NMTC program in December 2000.    These phases  implemented a variety of tasks, as follows:  Phase 1 on Initial Policy and Regulatory Development (January 2001 to  December 2001):  The CDFI Fund developed program guidance,  certification applications, and other documents; assisted IRS in  developing regulations; and reached out to CDEs and other  stakeholders.
Phase 2 on Policy Refinement and Award Implementation (January 2002  to March 2003):  The CDFI Fund certified 1,021 CDEs, developed  applicant selection policies, reviewed 345 allocation applications, and  announced the allocations in March 2003.
Phase 3 on Ongoing Allocations, Post-Award Activities, and Compliance  Monitoring (March 2003 projected through July 2004):  The CDFI Fund  negotiated allocation agreements and debriefed the 279 applicants that  did not receive allocations in round one.  It is continuing to develop  processes to monitor NMTC compliance.
At the same time that the CDFI Fund is doing phase 3 tasks, it is also doing  tasks for the second round of allocations and making refinements as  needed.  For example, it is continuing to certify new CDEs, refine  allocation materials and selection policies, and work with IRS on resolving  rule making and other issues.
CDFI Fund officials said that delays in meeting self-imposed deadlines on  making the NMTC allocations and finalizing the allocation agreements  could be attributed to the many start-up tasks for a new program, such as  developing application documents and processes, writing rules and  regulations, and addressing comments.  For example, CDFI Fund officials  noted that they had hoped to make the allocation decisions for 2001 and  2002 during 2002 rather than in March 2003, but they experienced delays in  publishing the application announcement, developing the application  review system, and dealing with a larger pool of applicants than  anticipated.  Similarly, CDFI Fund officials said they had hoped to have  allocation agreements ready about the same time as the allocation  announcement in March 2003 rather than in September 2003 but were  delayed due to the longer than anticipated time to publish the initial  document; delays in developing and clearing the document; and handling  comments from allocatees, investors, and attorneys on the program’s rules  and processes.
It is not clear whether the 3-year period between program authorization  and the first potential NMTC investments had any effects beyond delaying  the projects to assist low-income communities and persons.  CDFI Fund  officials believe that delays have not hurt the program and that they took  some steps to minimize any effects.  For example, the CDFI Fund released  multiple draft versions of the allocation agreement template, in part so that  investors wishing to make investments into CDEs in advance of the  allocation agreements being finalized would better understand the terms  and conditions of those aggreements.  Also, the first four annual rounds  were aggregated into two multiyear rounds—$2.5 billion for 2001 and 2002  and $3.5 billion for 2003 and 2004.  The CDFI Fund has legislative authority  to carry over unused limitations on annual allocations.  Additionally,  given the delays in finalizing the allocation agreements and application system, the CDFI Fund  extended the deadline for CDEs allocatees in the first round to prove their  eligibility for the second allocation round from February 17, 2004, to   March 5, 2004.
section_title: Profile of CDE Allocatees Indicates Variation in Proposed Projects and Experience
paragraphs: The profile of the 66 CDE allocatees reflected variation among the issues  we analyzed—geographical distribution in areas to be served by  community development projects, type of proposed service, and  experience with low-income communities.  Geographically, allocatees  proposed community development projects that served areas ranging from  local to national in scope, all types of communities (e.g., urban and rural),  and at least 20 states.  Also, the proposed projects covered all types of  services listed in the allocation application.  Finally, all allocatees reported  at least some experience in assisting low-income communities.
subsections: section_title: Allocatee Profile by Geographic Distribution
paragraphs: The 66 allocatees had the following profiles for the three geographical  issues—service area, type of community, and states served by proposed  projects (see app. III for details).
Proposed service area: Table 2 shows the number of CDE allocatees and  amount of equity that is eligible for credits by the area an allocatee  proposed to serve.  Of the 66 allocatees, 54, or 82 percent, proposed  projects that serve local, state, or national service areas. The remaining  proposed projects covered multiple-local areas or multiple states.  In terms  of the $2.5 billion in equity eligible for NMTC allocated to CDEs, nearly   $1.2 billion, or nearly half of the total, went to allocatees with proposed  projects having a national scope.
Proposed type of community:  The 66 allocatees proposed projects that  focused more on urban areas (70 percent) than rural areas or  mixed/suburban areas.  Of the $2.5 billion in equity eligible for NMTCs, the  urban projects received 86 percent while rural and mixed/suburban areas  received the rest.  However, CDEs proposing to serve predominantly urban  areas might also serve some rural areas, and vice versa.
State and local allocations across states:  Of the 66 CDE allocatees, 39  proposed local or single state projects.  These 39 projects covered 20 states  and the District of Columbia. California and Ohio had the highest number  of allocatees.  An Arizona allocatee received the largest allocation while the  smallest allocation went to a Pennsylvania allocatee.  Table 3 shows the  number of CDEs receiving allocations and the total amount of equity that is  eligible for NMTCs only for projects proposed within one state.
section_title: CDE Allocatee Profile by Experience with Low- Income Communities and Proposed Type of Services
paragraphs: The profile of experience in low-income communities and the proposed  services to be provided among the 66 CDE allocatees follows.
Experience serving low-income communities:  Prior experience in serving  low-income communities was common among allocatees.  All 66 allocatees  reported that they have successfully deployed capital to low-income  communities and 61 reported successfully providing financial counseling  and other services or technical assistance to disadvantaged businesses or  communities.
Proposed types of services in projects:  The proposed projects cover the  five types of services included in the NMTC allocation application, as  shown in table 4.  Some of the 66 CDE allocatees proposed more than one  service, which resulted in 171 proposed types of services.  Of the 66 CDEs,  78 percent proposed development or rehabilitation of real estate (e.g.,  retail, manufacturing, office, and community facilities) and 61 percent  proposed financial counseling or advice on organizing or operating a  business.
section_title: Data Have Been Identified for Monitoring Compliance, but How the Data Are to Be Used Is Not Defined; a Contractor Is to Evaluate the NMTC Program
paragraphs: CDFI Fund and IRS officials have made progress in identifying the data for  monitoring NMTC compliance, and the CDFI Fund has developed systems  to collect some of these data.  However, a number of details remain to be  settled on how the data will actually be used to monitor compliance.   Officials believe they still have adequate time to complete their plans for  monitoring compliance.  However, previous deadlines in implementing the  NMTC have been missed, many other tasks have to be done, and the  agencies have not established schedules or documented plans for ensuring  that compliance monitoring processes will be in place when needed.  CDFI  Fund officials intend to use contractors to evaluate the effectiveness of the  NMTC program.  The CDFI Fund and CDEs are expected to have  significant amounts of data that should be useful for the evaluation.
subsections: section_title: Progress Made in Identifying Compliance Monitoring Data and Developing Systems to Collect the Data, but Methods for Using the Data Are Not Developed
paragraphs: CDFI Fund and IRS officials have identified data for monitoring  compliance with NMTC provisions, and the CDFI Fund has made progress  in implementing data collection systems.  These officials also mentioned  various methods for how the data could be used to monitor compliance.   However, many details remain to be settled on which methods will be used  and how.  Officials from both agencies believe they have time to complete  their plans for monitoring compliance, but they do not have schedules or  documented plans for ensuring that compliance monitoring processes will  be in place when needed.
subsections: section_title: Data and Systems to Support Compliance Monitoring
paragraphs: NMTC compliance monitoring will focus on (1) events that could lead to  recapture of NMTCs from investors and (2) CDEs’ compliance with the  terms of their allocation agreements.  For both of these areas, the CDFI  Fund and IRS will rely on some data that will be routinely collected.
The statute establishing the NMTC provide three events that trigger  recapture of tax credits for an equity investment in a CDE: the entity ceases to be a CDE,  the proceeds of the equity investment cease to be used in a manner that  satisfies the “substantially all” requirement, and  the investment is redeemed by the CDE.
IRS is responsible for determining whether a recapture event has occurred.   IRS officials said that they will focus primarily on the “substantially all”  requirement and rely on the CDFI Fund to help monitor whether a CDE  ceases to be qualified.  Further, IRS will rely on data collected by the CDFI  Fund to some extent in identifying whether any of the three events leading  to recapture occur.
To determine whether CDEs remain qualified for the NMTC program, data  will be needed on whether CDEs continue to meet the primary mission and  accountability tests. To meet the primary mission test, a CDE must show  that it has a primary mission of serving or providing investment capital for  low-income communities or low-income persons and that at least 60  percent of its activities are dedicated to serving low-income communities  or persons.  The accountability test is met by demonstrating that 20 percent  of the members of either the governing board or advisory board(s)  represent the low-income communities or persons in the CDE’s service  area.  Adherence to these two tests is required as long as an entity  participates in the NMTC program as a CDE.
To determine whether the entity has a primary mission of serving low- income communities or low-income persons during the initial application  for CDE certification, the CDFI Fund reviews an organization’s mission  statements (as contained in its bylaws, articles of incorporation, board  resolutions, etc.) during the initial application for CDE certification.  The  CDFI Fund requires applicants to certify that at least 60 percent of its  products and services will be directed to low-income communities or low- income persons.  To determine whether CDEs meet their accountability  test, the CDFI Fund reviews the composition of the governing boards,  advisory boards, or both at the time of the initial application.  According to  an official, the CDFI Fund requires all CDE allocatees, subsidiary  allocatees, and CDE investees to certify annually that they continue to  meet their certification requirements.  CDFI Fund officials indicated that  they might conduct audits or reviews to determine whether CDEs continue  to meet these tests.
IRS officials said that to monitor whether CDEs continue to meet the  “substantially all” test, they will review data that the CDEs are required to  report, such as the type, amount, and timing of investments.  IRS officials  also said they will use data on various IRS forms to identify NMTC  investors and investment-related data reported by taxpayers.  In addition,  CDEs will report identifying data on investors and the amount of  investments they made to the CDFI Fund, which IRS may use in its  compliance monitoring activities.
In terms of whether CDEs redeem investments, the CDFI Fund plans to  collect data annually on whether CDEs have redeemed any portion of the  QEIs received in the previous year.  A CDFI Fund official said the Fund was  considering whether to request more data on possible redemptions.   However, he thought it unlikely that a CDE would redeem any investments  prior to the end of the 7-year investment period, since this would disqualify  it from the NMTC and would trigger a recapture event.
While IRS will monitor compliance with events that could lead to a  recapture of tax credits, the CDFI Fund will monitor CDEs for adherence  to their allocation agreements.  To monitor allocation agreement  compliance, CDFI Fund officials said that they would focus on data in  section 3.2 of the allocation agreement.  Section 3.2 is unique and will be  tailored to each allocatee based on specific assertions a CDE made in its  allocation application on its proposed use of the tax credits.  For example,  question 67 of the application for the first round of allocations asked if an  applicant’s investments or activities would be targeted principally to  communities with higher levels of distress than the minimum poverty and  income criteria required by the NMTC program.  Section 3.2 is to include  related information from those CDEs that checked “Yes” to question 67.
Web-based systems designed by the CDFI Fund are expected to be the  primary sources of the data that the CDFI Fund and IRS plan to use to  monitor compliance.  CDFI Fund officials said that all the systems and  processes for capturing and using the data from all CDE allocatees should  be ready by August 2004.  Figure 3 shows the planned integration of the  data systems.
A fuller description of the purposes and time frames for these systems  follows.
Allocation Agreement System (AAS):  AAS populates fields in the  allocation agreements with certain allocatee information and sends an  uneditable electronic copy of the allocation agreement to the CDE.   CDFI Fund officials told us that AAS was functional in August 2003.
Allocation Tracking System (ATS):  ATS allows reporting by CDEs of  specific data about the use of approved allocations, such as the type,  amount, and timing of investments.  It will also track various self- reported data on investors in the CDEs.  IRS may use the data to track  compliance with timing requirements in the IRS regulations.  ATS was  on-line in November 2003, according to CDFI Fund officials.
Community Investment Impact System (CIIS):  CIIS is an annual  reporting system that collects various data about the CDEs as  institutions and about their transactions.  These data are to be used to  analyze what is happening with CDEs and investment projects as well as  to monitor compliance.  The CDFI Fund plans to test and implement  CIIS by February 2004, receive data from CDEs in June 2004, and verify  the data by August 2004.
Compliance Monitoring (CM) Tool:  The CM Tool extracts data from  other databases to monitor for compliance with allocation agreements  and helps IRS monitor for recapture events.  The CDFI Fund plans for  the CM Tool to include “red flags” where appropriate and feasible.  The  Fund plans to complete the CM Tool by July 2004.
section_title: CDFI Fund and IRS Have Incomplete Plans for Monitoring Compliance
paragraphs: CDFI Fund and IRS officials have many details to finish on how they will  use the data that are routinely collected for actually monitoring NMTC  program compliance.  While officials from both agencies have listed  possible monitoring processes (e.g., audits, compliance checks, or site  visits) and have said that they will develop “red flags” to monitor  compliance, neither agency could provide specific details about its  proposed compliance monitoring processes.  Officials believe they will  have sufficient time to develop their compliance monitoring plans more  fully.
A number of details remain to be settled in determining how the actual  monitoring of compliance will occur and how the CDFI Fund and IRS will  share data.  For example, the CM Tool is to include various “red flags” on  noncompliance by CDEs related to their adherence to IRS regulations and  CDFI Fund compliance concerns.  Presumably, the flags would trigger  follow-up to determine whether CDEs actually have been noncompliant.   According to officials at both agencies, neither the CDFI Fund nor IRS has  yet developed its “red flags.”  Furthermore, whether, when, and how follow- up would occur has not been determined by either agency.  The CDFI Fund  also expects that audits will be used to help determine CDEs’ compliance  with recapture events and allocation agreements.  What remains to be  defined is how many audits will be conducted, who will perform them, and  how extensive those audits will be.  Similarly, processes beyond audits for  following up on potential noncompliance have not been defined.
IRS expects to monitor CDEs’ adherence to the “substantially all” test in  part by accessing the CDFI Fund’s data.  IRS also expects that audits will be  a tool for determining CDEs’ compliance and is considering options for  selecting CDEs for audit.  IRS has told us that it may conduct 5 to 10  random audits of CDEs to help gather baseline data on CDEs.  Other audit  selection options include use of the CDFI Fund’s data to trigger an audit or  as an adjunct to other IRS audit work that may relate to an investor or CDE.
CDFI Fund and IRS officials have been developing a memorandum of  understanding that would define the relationship between the agencies and  their respective roles in monitoring aspects of CDEs’ compliance.  For  example, both agencies have an interest in monitoring whether an  investment has been redeemed.  The memorandum is expected to, for  example, define how IRS would access the CDFI Fund’s data and how and  when the CDFI Fund should alert IRS to CDEs that no longer qualify due to  violations of the primary mission and accountability tests.  As of   January 15, 2004, the memorandum had not been finalized.
CDFI Fund and IRS officials believe that they have time to finalize their  processes for ensuring NMTC compliance.  According to a CDFI Fund  official, due to the timing of the allocation agreements, very few CDE  allocatees are likely to receive QEIs and make QLICIs in 2003.  Thus the  first significant data available to be used for aspects of compliance  regarding QLICIs will not be available until CDEs file CIIS reports at the  conclusion of their fiscal year 2004; some data will not be available to IRS  until 2005, after CDEs and investors file tax returns for tax year 2004.   Additionally, CDFI Fund and IRS officials note that the potential for  recapture of tax credits also provides an incentive to investors to help  ensure that CDEs comply with the NMTC program.  Finally, allocatees will  be required to supply the CDFI Fund with copies of their audited financial  statements, with which the CDFI Fund plans to verify some data reported  by allocatees.
Although the CDFI Fund and IRS have some time to complete their  processes for monitoring compliance, officials do not have schedules or  documented plans for ensuring that compliance monitoring processes will  be in place when needed.  To date, some CDFI Fund self-imposed deadlines  for making allocations and finalizing allocation agreements have been  missed.  CDFI Fund officials also face a continuing workload apart from  finalizing and implementing these monitoring plans.  Officials are currently  managing the second round of allocations and, as discussed below,  considering how to evaluate the outcomes of the NMTC program.  Further,  although much of the activity that will need to be monitored may not occur  until well into 2004, some parts of the compliance monitoring may need to  be developed before others.  The “red flags” that are intended to surface  potential noncompliance could be needed during 2004 to alert the CDFI  Fund and IRS to possible recapture events.  Finally, completion of the  compliance monitoring plans would help CDFI Fund and IRS officials judge  what type and mix of resources they will need to adequately monitor  compliance so they can make a more informed budget request for fiscal  year 2006.
section_title: The CDFI Fund Plans to Contract for an NMTC Evaluation
paragraphs: CDFI Fund officials intend to issue a contract for an evaluation of the  NMTC program.  They expect that the contractor will use some of the data  that CDEs will report to the CDFI Fund or maintain in their records  pursuant to their allocation agreements.
Even though the law authorizing NMTC does not charge the CDFI Fund  with responsibility for evaluating the success of the NMTC program, CDFI  Fund officials began considering how to evaluate the NMTC program  shortly after it was authorized.  For example, officials sought the advice of  experts in March 2002 on the types of data that would be useful for  evaluating the program.  However, there was no consensus on the specific  data required to evaluate the NMTC program.  CDFI Fund officials also  drafted a document in May 2002 outlining a broad preliminary framework  for evaluating the NMTC program.  The preliminary evaluation proposal  outlines topics to consider in measuring NMTC program impacts.  The  topics proposed for assessment are the (1) flow of private capital to CDEs,  (2) CDE performance, and (3) outcomes at the community level.
However, evaluating the success of economic development programs like  the NMTC program is challenging.  Our 2002 report detailed some of those  challenges, all of which apply in the case of the NMTC program.  For  example, program impact is usually difficult to determine because it is hard  to know what participants and others who invest in low-income  communities would have done absent the program.  If a program did not  exist, what would investors have done with their capital?  Would the low- income communities have had more or less economic development due to  business growth?  Further, program effectiveness is difficult to measure  when the program is small relative to total economic activity within the  geographic area of interest.  These challenges will be particularly  problematic for the NMTC program because 36 percent of the U.S.  population and 39 percent of the census tracts are eligible.  Many of the  eligible communities would already have significant business activities that  could mask the NMTC impacts.
In part due to these challenges and the amount of expertise needed to deal  with them, CDFI Fund officials have decided to contract for evaluation  services.  CDFI Fund officials expect to have a contractor design and  implement an NMTC program evaluation.  Officials plan to issue a request  for proposals in summer 2004 and hire a contractor in early fiscal year  2005.  CDFI Fund officials have not yet developed the statement of work  for the contract and do not have an expected completion date for the  evaluation design or the study itself.  CDFI Fund officials note that since  initial investments under the program will not likely begin until 2004 (as  described above), program results will not be available for evaluation until  enough time elapses for the investments to generate an effect.
To assist the contractor, the CDFI Fund is collecting significant amounts of  data that officials believe may be useful for the evaluation.  Additionally,  the CDFI Fund requires CDEs to maintain additional records.  According to  CDFI Fund officials, data on whether an investment recipient (a QALICB)  is minority- or woman-owned are to be captured by the CDFI Fund data  systems for all CDE allocatees specifically for evaluation purposes.  In  addition, CDFI Fund officials said that some of the other data collected  from CDE allocatees through these data systems could be useful to future  evaluators, for example, the location and type of investments made, the  type of business receiving the investment, and the gross revenues of the  business.  Also, officials noted that section 6.4 of the allocation agreement  provides that CDEs “shall retain all financial records, supporting  documents, and any other records pertinent to the NMTC Allocation.”   Officials expect that the data maintained under section 6.4 may also be  used for the evaluation.  Finally, officials recognize that the contractor may  identify other necessary data and, if appropriate, will consider collecting  the data.
section_title: Conclusions
paragraphs: The NMTC program provides billions of dollars over multiple years as an  incentive to stimulate additional billions of dollars in investments in low- income communities.  Given the significant sums involved, ensuring that  funds are properly used to accomplish the economic development  envisioned by Congress in creating the program is vital.  CDFI Fund and  IRS officials have taken a number of steps to implement the program and  begin collecting information needed to monitor compliance with the tax  laws and the allocation agreements between the CDFI Fund and CDEs.
However, the CDFI Fund and IRS have not defined how they will share  data, use the data in monitoring compliance, and develop other processes  required for an effective monitoring program.  Although the agencies do  have some time to develop the processes they will use to monitor  compliance, they do not have schedules and other documented plans for  developing the processes.  Having such schedules and plans would help  ensure that compliance monitoring processes and resources will be in  place when needed, particularly given the other tasks that need to be done  and other deadlines that have been missed.
section_title: Recommendations for Executive Action
paragraphs: To ensure that compliance monitoring processes will be in place when  needed, we recommend that the Secretary of the Treasury instruct the  Director of the CDFI Fund and the Commissioner of Internal Revenue to  develop plans, including milestones, for designing and implementing  compliance monitoring processes for the NMTC program.
section_title: Agency Comments and Our Evaluation
paragraphs: We received written comments on a draft of this report from the CDFI Fund  Director and IRS Commissioner (see app. IV and V).  Both agencies cited  the importance of compliance monitoring in the NMTC program and agreed  with our recommendation to develop plans and milestones for designing  and implementing compliance monitoring processes for the NMTC  program.  Staffs at both agencies have been directed to work together to  implement a comprehensive compliance program and appropriate  information sharing arrangements.  In addition, officials from both  agencies provided technical comments that we have incorporated into the  report where appropriate.
The CDFI Fund also attached three other written comments for our  consideration (see app. IV).  A summary of these comments and our  evaluation of them follows.
First, the CDFI Fund said that it provided us with a schedule and dates for  the major compliance and monitoring tools, such as AAS and ATS.   This is  true.  We made no changes to the report because we had already described  these schedules and dates.  In making our recommendation, we recognized  that progress had been made in ensuring that data would be available for  monitoring compliance.  However, we had not received schedules or  documented plans for ensuring that the processes for monitoring  compliance using data from these and other systems would be in place  when needed.
Second, the CDFI Fund also said that it and IRS took steps to expedite  investments in CDEs and build investor confidence, such as IRS  incorporating a “look back provision” in its regulations so that investors  could claim tax credits for certain investments made before the CDE  entered into an allocation agreement, and the CDFI Fund releasing draft  versions of the allocation agreement template so that potential investors in  CDEs could understand the terms and conditions before an allocation  agreement was finalized.  Although we did not have evidence that investor  confidence was built, we agree that both agencies took steps to offset the  delays in finalizing allocation agreements.  Although the look back  provision may have helped offset delays, we did not change our report  because we had already mentioned the release of the draft templates as  well as other steps.
Third, the CDFI Fund said that although data about any investments being  made in CDEs are already being collected through ATS, data on the use of  those investments in actual projects are not yet being collected.  Such  project-related data will be collected annually at the end of each CDE’s  fiscal year.  This was one of the technical comments that we discussed with  CDFI Fund officials and incorporated into the final report.
We are sending copies of this report to the interested congressional  committees; the Commissioner of Internal Revenue, the Director of the  Community Development Financial Institutions Fund, and other interested  parties.  We will make copies available to others on request.  In addition,  the report will be available at no charge on the GAO Web site at  http://www.gao.gov.
If you or your staff have any questions on matters discussed in this report  or would like additional information, please contact me or Tom Short at  (202) 512-9110 or at brostekm@gao.gov or shortt@gao.gov.  Major  contributors to this report are acknowledged in appendix VI.
section_title: Distribution of New Markets Tax Credit Eligibility by State
section_title: Congressional Staff Interviews
paragraphs: To provide a profile of community development entities (CDE) that  received New Markets Tax Credit (NMTC) allocations, we reviewed the  congressional contact file from a recent GAO report.  For that report, we  conducted 14 interviews with congressional staff of majority and minority  members serving on the following committees.
section_title: Profile of Participants
paragraphs: As of the August 2002 allocation application deadline for the first round of  NMTC allocations, the Community Development Financial Institutions  (CDFI) Fund had certified 1,033 CDEs.  Of these 1,033 certified CDEs, 345  applied in the first round of NMTC allocation, requesting nearly $26 billion  of equity related to NMTCs.  From this applicant pool, 66 CDEs received  NMTC allocations.
These 66 allocatees requested $5.1 billion in equity, but the allocation  limitation for the first round was $2.5 billion.  While the average and  median amounts requested were $76.8 million and $40.0 million,  respectively, the amounts allocated were $37.9 million and $18 million.   Furthermore, while 11 of the 66 allocatees received the full amounts  requested, the typical allocation was reduced by 58 percent to reach the  2002 allocation limitation.
Tables 5 and 6 profile CDEs according to their structure and profit status.  Of the 1,033 CDEs certified by the CDFI Fund, nearly 60 percent were  structured as single entities and 16 percent were parents with at least one  subsidiary CDE.  Also, 57 percent of CDEs were certified as for-profit  entities and 39 percent as nonprofit entities.
The equity allocations for NMTCs ranged from $500,000 to $170 million in  credits with  13 allocatees receiving $5 million or less,  20 allocatees receiving more than $5 million to $20 million,   16 allocatees receiving more than $20 million to $50 million,   10 allocatees receiving more than $50 million to $100 million, and   7 allocatees receiving over $100 million.
The goals of the NMTC program are not stated in the legislation that  authorizes it.  Interested congressional staff said they are interested in how  the program will affect different community types and service areas.   Tables 7 and 8 profile NMTC activity by community types and service areas  in terms of the number and percentage of participants, respectively.   Over  three-quarters of the CDEs applied for NMTC allocations primarily to serve  urban areas, while less than 20 percent intended to focus primarily on rural  areas.  Additionally, a majority of applicant CDEs were planning to serve  specific local areas, while 18 percent intended to serve specific states.
For type of service area, allocatees proposing local projects received 63  percent of what was requested and multiple-local projects received 37  percent; state, national, and multistate projects received about half of what  they requested.  Regardless of the type of community (e.g., urban or rural)  they proposed to serve, the 66 allocatees received about half of the  requested allocations.
section_title: Comments from the Community Development Financial Institutions Fund
section_title: Comments from the Internal Revenue Service
section_title: GAO Contacts and Staff Acknowledgments
subsections: section_title: GAO Contacts
section_title: Acknowledgments
paragraphs: In addition to the individuals named above, key contributors to this report  included C. Robert DeRoy, Evan Gilman, Donna Miller, John Mingus,  Cheryl Peterson, Amy Rosewarne, and Kim Young.
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