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Tax Law Changes for 2011 Affect Municipal Bonds

Public Finance Law Update Scott M. Berg, Elizabeth S. Blutstein, John W. Daniels, Julianna Ebert, Brian G. Lanser, Matthew Mehr, Ann M. Murphy, Jeff Peelen, Jennifer V. Powers, Michael L. Roshar, Kevin Slaughter, Rebecca A. Speckhard, Kathleen J. Swan, Margaret E. Utterback, Bridgette DeToro, Alexander J. Gore, Allison M. Buchanan

The new year will bring a number of federal tax law changes that will affect issuers of municipal obligations. These changes are due to the expiration of various provisions contained in the American Recovery and Reinvestment Act of 2009 ("ARRA"). Among the most significant changes are the following:

  • "Bank Qualified" Obligations. The small issuer limit that determines eligibility to issue "qualified tax-exempt obligations" under Section 265(b)(3) of the Internal Revenue Code of 1986, as amended, will revert back to
    $10 million, from the $30 million authorized under ARRA. In addition, 501(c)(3) organizations will no longer be treated as issuers for purposes of Section 265(b)(3), meaning that qualified 501(c)(3) bonds issued after the end of 2010 will again count against the municipal issuer's limit.
  • Adjusted Current Earnings for Corporate Alternative Minimum Tax. The exclusion of interest on certain municipal obligations from the adjusted current earnings of corporations for purposes of the alternative minimum tax will not apply to obligations issued after December 31, 2010. This exclusion now applies to new money financings and to refundings of obligations issued after January 1, 2004.
  • Interest on private activity bonds issued after December 31, 2010, will be a tax preference item for purposes of the alternative minimum tax on corporations and individuals. This change will not affect governmental bonds or qualified 501(c)(3) bonds but will be applicable to industrial revenue bonds and other types of private activity bonds.
  • Build America Bond and Recovery Zone Bond Programs Expire. The legislative authorization for Build America Bonds, Recovery Zone Economic Development Bonds and Recovery Zone Facility Bonds expires at the end of 2010. Therefore, unless Congress acts to extend these programs, these types of bonds cannot be issued after December 31, 2010. There is a proposal to renew the Build America Bond program. The prospects for its enactment are uncertain at this time. If enacted as proposed, it would extend the Build America Bond program for another year, but would reduce the amount of the interest rate subsidy (from 35% to 32% for Build America Bonds).

Another significant regulatory development affects municipal obligations issued as draw-down loans. On November 23, 2010, the IRS issued Notice 2010-81 which interprets the meaning of "issue date" in the context of draw-down loans. In the Notice, the IRS has stated that, for purposes of statutory deadlines on the issuance of bonds, each draw is considered a separate bond that is not issued until the draw is made and interest begins to accrue on that portion of the loan. Notice 2010-81 has a number of significant impacts:

  • Build America Bonds and Recovery Zone Bonds. Since authorization for these programs expires at the end of 2010, only draws made in 2010 will qualify for Build America Bond or Recovery Zone Bond status. Therefore, municipalities that issued Build America Bonds or Recovery Zone Bonds (including State Trust Fund Loans) on a draw-down basis should draw the balance of the obligations by December 31, 2010 in order to assure that they will be eligible for interest subsidy on the full amount of the obligations.
  • Alternative Minimum Tax. The favorable treatment for obligations with respect to the alternative minimum tax (which is described above) will only be available for draw-down loans to the extent draws are made by the end of 2010.

Notice 2010-81 is not applicable for purposes of the bank-qualified rules and the de minimis exception to the tax-exempt carrying cost disallowance provision under Section 265. For those purposes, the entire amount of a draw-down loan will be considered issued on the date on which more than a de minimis amount of the loan was first advanced.

If you have any questions or would like additional information, please contact any member of Quarles & Brady's Public Finance Group.