BB&K Attorneys Analyze Possible Impacts to Tax Exemptions on State and Local Governmental Bonds
Lawmakers in Washington, D.C. have created a present day
difficult situation as a result of the budget process in 2010. That
year they could not agree to increase the federal debt ceiling and
Tea Party Republicans held the debt ceiling hostage with demands to
make spending cuts. Fast forward to today and the time has come for
Congress and the President to make a deal by December 31 or
significant cuts will take effect that were first laid out in 2010
as a short-term compromise tactic.
You have likely heard that Democrats have taken cuts to
"entitlements" off of the table and that the Republicans
have taken tax increases off of the table. What's
left? One item is the tax exemption for municipal bonds. The
chatter on this item appears to range from subsidy payments on
Build America Bonds issued in 2009 and 2010 being reduced or
eliminated to the tax exemption itself being capped for high income
earners or eliminated altogether.
President Obama first proposed a 28 percent cap on the value of the
tax exemption in his jobs bill in 2011 and reintroduced it earlier
this year in his fiscal 2013 budget. It failed to gain momentum,
but municipal market participants were unsettled and have said it
would increase borrowing costs for state and local
governments. Recently, Municipal Bonds for America (MBFA), a
coalition of municipal market groups and participants, is fighting
threats to tax exemption and has urged lawmakers to preserve
tax-exemptions on state and local governmental bonds as they
consider new forms of revenue for tax reform and proposals to avoid
the now infamous "fiscal cliff." Many years past,
the market has reacted severely to threats to the municipal bond
tax exemption, however, there may be momentum on both sides of the
aisle to reduce the benefit to high income earners, which could
ultimately raise borrowing costs of state and local
government.
While it is likely that many proposals on reducing or eliminating
the tax exemption on state and local governmental bonds will be
introduced as the end of 2012 approaches, it is also possible that
January arrives without a deal and Congress and the President act
in 2013 to have a retroactive effect on taxpayers. It will be
important for local agencies to consider the impacts of a
diminished tax exemption when planning for construction of capital
projects and finding the means to pay for such projects.
As we wait to see what our lawmakers have in store for us in terms
of the fiscal cliff, other issues – such as post issuance
compliance regarding your existing bonds – must continue to
be dealt with.
Consider the following scenario: you and your finance team have
spent months planning and negotiating the issuance of your
bonds. The documents have been signed, the closing
certificates and legal opinions delivered, and the closing date has
come and gone. You and your staff can breathe a collective
sigh of relief. You are free to move on to more pressing
matters (like constructing the project, next year's budget, and
completing the annual audit). Eventually the bond transcript
arrives in the mail. What do you do with it? What do you
do with construction invoices and other receipts?
Maintaining the exclusion from gross income of interest on the
bonds requires more than signing the tax certificate at closing.
Governmental issuers are routinely required to covenant to comply
with many complex provisions of the Tax Code and
Regulations. These covenants continue for the life of the
bonds, which can be 30 years or longer. Local governments need
procedures that are understandable and that can be implemented over
time, as the officials responsible for monitoring compliance with
tax laws may change. Assigning responsibility for post
issuance compliance with tax law and assurance that sufficient
information is routinely identified and maintained to allow those
who later inherit that responsibility to successfully continue the
job is critical for local governments' finance
programs. Special care must be given to record retention
policies for bond issues, as record retention requirements for bond
issues may differ significantly from those required under state law
or other governing rules for other governmental actions. Post
issuance compliance has also been a target question for the
Internal Revenue Service in their process of routine or targeted
audits of bond issues.
Post issuance tax compliance is an integral part of an issuer's
debt management process. In some organizations, compliance may
be adequately supported by ad hoc procedures or by the
efforts of a single individual. However, consideration should
be given to whether ongoing timely, reliable institutional
compliance should be supported by practices integrated within the
core policies and procedures of the institution. Local
agencies should review existing policies on contract compliance,
record retention, and investments coincide with managing tax-exempt
debt and whether a comprehensive statement of policies and
procedures should be adopted.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.