Market commenters have suggested that billions of dollars in
municipal bonds may be subject to par redemptions if the
much-discussed "28% cap" on the value of certain federal
income tax deductions or exclusions is enacted and if the capped
items include municipal bond interest. While such commenters
flag an issue worthy of consideration, enactment of a 28% cap
applicable to muni interest should not result in a wave of
unanticipated tax calls.
Tax call language comes in a variety of permutations. The
language of most tax calls focuses on whether interest on the bonds
is excluded from gross income. Legislation implementing a
28% cap may or may not be written in a manner that directly
includes a portion of the value of tax-exempt interest in gross
income (versus, for example, using an alternative tax calculation
methodology, as is used in calculating the AMT tax).
Even assuming that a 28% cap clearly includes a portion of
municipal bond interest in gross income for higher tax bracket
holders, it is far from clear that tax call language would
apply. Many variations of tax calls distinguish between
taxability caused by the issuer/borrower versus by change in law.
Those that don't make such a distinction typically are
written (as is the case with the particular tax call language
referenced in a recently disseminated article sounding the alarm on
tax call risk) to require a redemption of all of the bonds upon an
IRS or judicial (or in some cases bond counsel) determination that
interest on "the bonds" is not excluded from gross
income. Such redemption language suggests a triggering event
that affects all the interest on all the bonds - otherwise it is
overkill. It seems unlikely that a court would interpret such
language as permitting or requiring an issuer to redeem all its
bonds because a portion of interest on some of the bonds (those
held by higher bracket bondholders) is or may be taxable.
It is possible that there are some specially negotiated tax call
provisions among the billions of dollars of municipal bonds that
are triggered by absence of full tax exemption on any of the bonds,
but those would be outliers. (Such specially negotiated
provisions would likely be bondholder-friendly and therefore would
likely involve a redemption premium rather than a par
In any event, concerned holders will want to look at the
specific tax call language in their bonds and perhaps seek a bond
or tax lawyer's interpretation if the language seems unclear in
the context of a potential 28% cap. But the odds are against
tax calls being triggered on a widespread basis.
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