Summary of Municipal Bond Provisions in the American Recovery and Reinvestment Act
February 5, 2009
On January 28, 2009, the House of Representatives passed an $888 billion fiscal stimulus package, H.R. 1, titled the American Recovery and Reinvestment Act (the “Bill”). A corresponding bill is currently being debated on the floor of the Senate.
The Bill authorizes or expands eight types of bonds that state and local governments may issue: (1) taxable government bonds; (2) qualified school construction bonds; (3) recovery zone facility bonds; (4) recovery zone economic development bonds; (5) clean renewable energy bonds; (6) qualified energy conservation bonds; (7) qualified zone academy bonds; and (8) industrial development bonds. In addition, the Bill amends the tax treatment of investors in tax-exempt bonds to make owning such bonds more attractive. With some exceptions, the Bill applies only to municipal bonds issued through 2010.
Below is a general summary of the municipal bond provisions contained in the House bill and an explanation of differences that are contained in the Senate bill.
New Tax-Exempt Bond and Tax-Credit Bond Programs
Build America Bonds (Taxable Government Bonds)
The Bill provides state and local governments the option of issuing taxable government bonds in lieu of issuing traditional tax-exempt bonds. The bonds, similar to other tax-credit bonds, would provide investors with taxable interest and a federal income tax credit equal to 35 percent of the interest received. However, due to the lack of interest in tax-credit bonds, for bonds issued in 2009 and 2010, state and local governments may also receive a payment of 35 percent of the interest paid on the bonds from the federal government in lieu of bondholders receiving the tax credit.
State and local governments may use the bond proceeds for any purpose in which tax-exempt bonds may be used under current law, including government program expenditures such as building roads, bridges and schools, or issuing qualified private activity bonds on behalf of nongovernmental entities. The rules that apply to tax-exempt bonds (e.g., private use restrictions, arbitrage rebate and yield restrictions) would apply to these taxable governmental bonds.
The Bill does not limit the amount of taxable government bonds that may be issued or provide a termination date for this provision.
Qualified School Construction Bonds
The Bill creates a new category of tax-credit bonds for the construction, rehabilitation, or repair of public school facilities or for the acquisition of land on which a public school facility will be constructed. The Bill contains a national limitation capping the amount of qualified school construction bonds that may be issued ($10 billion in the Senate version and $20 billion in the House version). The national limitation amount will be split between the states, which will receive 60 percent, and large local school districts, which will receive the remaining 40 percent. The allocation to the states will be divided according to each state’s proportionate number of school-aged children. The allocation to the large local school districts will be divided in proportion to respective amounts each district receives as basic grants under the Elementary and Secondary Education Act. The Bill also provides an additional $200 million of annual authority for 2009 and 2010 that is allocated to Indian tribal schools by the Secretary of the Interior.
Qualified school construction bonds will provide the bondholders/investors with a tax credit in lieu of their receiving interest, resulting in an interest-free or very low-interest loan to the state or local government issuing the obligation. Qualified school construction bonds are subject to certain arbitrage restrictions, however, available construction proceeds invested during the three-year temporary period are not subject to yield restrictions or to arbitrage rebate, and certain amounts deposited to a “reserve fund” may be invested at a yield that exceeds the yield of such bonds and would not be subject to rebate.
Recovery Zone Facility Tax-Exempt Bonds
The Bill authorizes the creation of a new category of tax credit bonds, called Recovery Zone Facility Bonds, with authority for the issuance of $15 billion of bonds by state and local governments. The $15 billion will be allocated to states in proportion to their 2008 job losses. Those amounts will be reallocated to the counties and large municipalities (i.e., a municipality with a population of more than 100,000) in proportion to each local government’s employment decline. The local government will then issue private activity bonds to finance depreciable property in an area having significant poverty, unemployment, rate of home foreclosures, or an area already designated as an empowerment zone or renewal community. These bonds are not subject to the volume cap under Section 146 of the Code.
Recovery Zone Facility Bonds must be issued by January 1, 2011.
Recovery Zone Economic Development Taxable Bonds
The Bill authorizes the creation of a new category of tax credit bonds, called Recovery Zone Economic Development Bonds, with authority for the issuance of $10 billion of bonds by state and local governments. Similar to Recovery Zone Facility Bonds, the $10 billion allocated towards Recovery Zone Economic Development Bonds will be issued to the states, and in turn each state’s counties and large municipalities, in accordance with declines in employment. The local governments will then issue tax-credit Recovery Zone Economic Development Bonds. The bond proceeds may be used to promote development and other economic activity in a recovery zone, including for expenditures on property, public infrastructure or construction, and job training and educational programs. In addition, the rules that apply to tax-exempt bonds (e.g., private use restrictions, arbitrage rebate and yield restrictions) would apply to these Recovery Zone Economic Development bonds.
While Recovery Zone Economic Development Bonds are taxable bonds, and thus, the local government will be required to pay higher interest than it would if it issued tax-exempt bonds, the issuing local government will receive a payment from the federal government equal to 40 percent of the interest paid on the bonds.
Recovery Zone Economic Development Bonds must be issued by January 1, 2011.
Existing Bond Programs
Increase in Clean Renewable Energy Bonds Limitation
The Bill authorizes an additional $1.6 billion in new clean renewable energy bonds (“New CREBs”) to finance facilities that generate electricity from the following resources: wind, closed-loop biomass, geothermal, small irrigation, hydropower, landfill gas, marine renewable, and trash combustion facilities. The authorization will be subdivided into thirds: one-third will be available for qualifying projects of state, local and tribal governments; one-third for qualifying projects of public power providers; and one-third for qualifying projects of electric cooperatives.
New CREBs provide bondholders/investors with a tax credit in lieu of interest, resulting in an interest-free or very low-interest loan to the issuer/borrower.
Increase in Qualified Energy Conservation Bonds Limitation
The Bill authorizes an additional $2.4 billion for qualified energy conservation bonds. Qualified energy conservation bonds are tax-credit bonds that may be used to fund, among other things, qualified conservation purposes, such as reducing energy consumption, facilities or grants that support research, mass commuting facilities and education campaigns that promote energy efficiency.
Allocations of qualified energy conservation bonds will be made to the states according to their respective populations. Sub-allocations will be made to large local governments, which are defined as any municipality or county if such municipality or county has a population of 100,000 or more, in proportion to each large local government’s population within its respective state.
Similar to New CREBs, qualified energy conservation bonds are tax-credit bonds that provide bondholders with a tax credit in lieu of interest, resulting in an interest-free or very low-interest loan to the issuer.
Extension of Qualified Zone Academy Bonds Authority
The Bill extends and expands the Qualified Zone Academy Bond Program. Under current law, $400 million is allocated to the states according to their respective populations of individuals below the poverty line. Each state reallocates its funds to qualified zone academies within its boundaries. The Bill authorizes an additional allocation of $2.8 billion – $1.4 billion for 2009 and $1.4 billion for 2010 – for Qualified Zone Academy Bonds.
Proceeds from the sale of Qualified Zone Academy Bonds must be used for the purpose of renovating, providing equipment to, developing course materials for use at, or training teachers and other school personnel at a qualified zone academy. A qualified zone academy is a public school that provides education and training below the college level, operates a special academic program in cooperation with businesses to enhance the academic curriculum and increase graduation and employment rates.
Qualified zone academy bonds are tax-credit bonds that provide bondholders with a tax credit in lieu of interest, resulting in an interest-free or very low-interest loan to the issuer.
Expansion of Manufacturing Facilities Definition for Industrial Development Bonds
The Senate’s version of the Bill expands the definition of manufacturing facilities for tax-exempt bonds issued by state and local governments to finance business manufacturing facilities. The current definition, which provides that a manufacturing facility means a facility that is used in the manufacturing, creation, or production of tangible property, will be expanded to include intangible property (i.e., any patent, copyright, formula, process, design, format, or other similar item). The House’s version of the Bill does not contain a similar provision.
Amendments to Tax Treatment of Investors in Tax-Exempt Bonds
Deductibility of Interest Related to Tax-Exempt Investments for Financial Institutions
Generally, present law disallows a deduction for interest on debt incurred to purchase or carry tax-exempt obligations. For financial institutions, the amount disallowed is based on the entity’s tax-exempt obligations in comparison to its total assets.
In the case of tax-exempt obligations issued by a “small issuer” (generally, an issuer that expects not to issue more than $10 million in tax-exempt obligations within a calendar year), the general pro-rata rule does not apply and only 20 percent of the interest allocable to the tax-exempt obligations of a small issuer is disallowed.
The Bill provides a 2 percent safe harbor. Thus, financial institutions would be able to deduct the interest on debt incurred to purchase or carry tax-exempt obligations issued during 2009 and 2010 if the obligations do not exceed 2 percent of the institution’s total assets.
The rules for “bank qualified” obligations would be modified under the Bill. Under the Bill, the definition of “small issuer” would be increased from $10 million to $30 million for 2009 and 2010. Additionally, when determining whether an issuer meets the requirements of the small issuer exception, bonds issued in 2009 and 2010 for the benefit of 501(c)(3) organizations will be treated as if they were issued by the 501(c)(3) organization and not the actual issuer of the bonds. In other words, under the proposed Bill each 501(c)(3) corporation may benefit from the issuance of $30 million in bank qualified debt in 2009 and 2010, without regard to the amount of bank qualified debt expected to be issued by the governmental issuer in such year.
Repeal of AMT on Tax-Exempt Bonds
Present law requires individuals and corporations to account for tax-exempt interest from private activity bonds when computing their alternative minimum tax. The Bill provides that interest on private activity bonds issued in 2009 and 2010 does not have to be taken into account for alternative minimum tax purposes.
If you have any questions or require further information, please call your Holland & Knight
contact or feel free to get in touch with any of the following attorneys listed below:
John E. Theberge
202.862.5968
john.theberge@hklaw.com
Richard B. Stephens Jr.
863.499.5351
rick.stephens@hklaw.com
Harold R. Bucholtz
202.457.5930
harold.bucholtz@hklaw.com
Edward W. Vogel III
863.499.5356
ed.vogel@hklaw.com
Randolph A. DelFranco
212.513.3282
randy.delfranco@hklaw.com
Mark E. Raymond
561.650.8349
mark.raymond@hklaw.com
Stephen L. Taber
415.743.6965
steve.taber@hklaw.com
About Our Public Finance Practice
Related Practices