IRS Releases Final Regulations on Reissuance and Retirement of Tax-Exempt Tender Option Bonds
The IRS released on Dec. 30, 2024, final regulations on Sections 1.150-3 and 1.1001-3(a)(2) (the Regulations) regarding the reissuance and retirement (debt extinguishment) of tax-exempt tender option bonds.
Tender option bonds include variable rate demand bonds and auction rate bonds that generally include the ability to change the interest rate on the bonds to certain pre-arranged modes (e.g., weekly, monthly, to maturity, etc.) or the ability to set the rate at a pre-set index rate such as the Secured Overnight Financing Rate (SOFR) at the market rate necessary to remarket the bonds at par, except for a permitted premium for bonds remarketed to maturity. In connection with the resetting of the interest rate, the holder of the bonds has the ability or the requirement to tender the bonds back to the issuer for purchase at par.
Prior IRS guidance under Notice 88-130 generally provided that the resetting to prearranged modes for tender option bonds does not constitute a material change to the bonds and thus does not result in a reissuance of the bonds under Section 1001 of the Internal Revenue Code (IRC). However, the fiscal crisis of 2007 and 2008 resulted in many failed remarketings of tender option bonds, especially auction rate bonds, resulting in the issuer being left holding the bonds.
Under the so-called "merger" doctrine where the maker of the debt also holds the debt obligation, debt can be treated as extinguished when held by the issuer of the debt, which results in the bonds being retired and thus no longer tax-exempt. As a consequence, the IRS provided in Notice 2008-41 that bonds held by an issuer for up to 90 days while using best efforts to remarket the bonds are not treated as extinguished for federal income tax purposes. It also provided that bonds held by other entities such as liquidity providers or guarantors as a result of failed remarketings or defaults are not treated as extinguished.
Finally, Notice 2008-41 provided a specialized rule for program obligations relating to auction rate bonds where those bonds were held by the borrower in failed remarketings to continue to qualified as program obligations, thus retaining the ability to earn 1.5 percent above the bond yield.
Key Provisions and Considerations
The Regulations finalize much of the guidance set forth in the Notices referenced above for tender option bonds:
- The conversion to a new mode for tender option bonds does not constitute a material change to the bonds or the rate changes pursuant to a predetermined index rate such as SOFR does not constitute a material change to the bonds and thus does not result in a reissuance of the bonds under Section 1001 of the IRC. Bonds converting to a fixed rate to maturity may be remarketed at a discount or premium, unlike the par requirement for shorter tender option bond conversions. Any premium received upon a remarketed to fixed-rate bond is treated as additional proceeds for arbitrage purposes.
- Tendered bonds held by an issuer, its agent or another party for up to 90 days while using best efforts to remarket the bonds are not treated as extinguished. Tendered bonds held by entities such as liquidity providers or guarantors are also not treated as extinguished. If tendered bonds held by issuers for more than 90 days are later resold, that is treated as a new issue of bonds as of the date of resale and a deemed refunding of the tendered bonds. However, unlike Notice 2008-41, the Regulations did not adopt the special program obligation rule for borrowers holding auction rate bonds in failed remarketings.
- It is unclear under the Regulations whether the addition of a new interest rate mode to tender option bonds would constitute a reissuance as had previously been the case.
- Similar to the Notices, the stated maturity date of tender option bonds is limited to 40 years from closing. In addition, interest on tender option bonds must be unconditionally payable at least annually.
- The Regulations do not apply to taxable tax-advantaged tender option bonds such as Build America bonds.
The Regulations apply to actions taken after Dec. 30, 2025, but may be applied retroactively to actions taken after Dec. 30, 2024. The prior Notices above are obsoleted as of Dec. 30, 2025.
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