Tax Free Bond Overview

The Internal Revenue Code (IRC) is extremely complex and has strict rules as to which projects qualify. Each bond issued will include the participation of a Bond Counsel that will provide an opinion that the project qualifies under the IRC. Below are some of the general rules associates with tax-exempt projects.

• Tax-Exempt or Tax-Free Income – The Internal Revenue Code (IRC) allows interest received under certain types of financing to be excluded from gross income for federal income tax purposes.
• Qualified Private Activity Bonds – These bonds are for borrowing entities that are privately owned such as manufacturing companies, private multi-family housing developers and private water companies. The federal tax code allows these private companies to be eligible for this kind of financing because they are deemed to have a public benefit.
• Testing for Private Activity Bonds – A bond will be a private activity bond if, as of the bond issue date or at any time while the bonds are outstanding, the bond issue exceeds the limits set forth in either: the private business, private use, private payments or private loan financing tests. Generally, if more than 10% of the proceeds from the bond issue are used for any private business, and the principal and interest payment on more than 10% of the sale proceeds of the issue is secured by a private business property or private security; or if more than 10% of the proceeds of the bond issue is directly or indirectly secured by any interest in property used or to be used for a private business use; or payments in respect of the property to be derived from payments in respect of property, or borrowed money, used or to be used for a private business use, or if the amount of proceeds of the issue used to make loans to non-governmental borrowers exceeds 5% of the
  proceeds or $5 million, whichever is lesser.
• Specific Activities NOT Eligible – There are specific activities under the federal tax ncode that are NOT eligible, such as an airplane, skybox or other private luxury box, certain health club facilities, a gambling facility, a stadium, a golf course, an oil refinery, or a liquor store.
• Alternative Minimum Tax (AMT) – Under Section 103(a) of the Internal Revenue Code (IRC), interest on private activity bonds is not excluded from gross income unless the bond is a qualified bond. Interest from private activity bonds became subject to the Alternative Minimum Tax (AMT) after the Tax Reform Act of 1986, with the exception of the hospital and non-profit college bonds. All things equal, yields on private activity bonds are higher due to this tax treatment.
•  Land Acquisition – Under IRC Section 147(c), a private activity bond is not a qualified bond if 25% or more of the net proceeds of the bond issue are to be used for the acquisition of land or any portion of the proceeds of the issue is to be used for the acquisition of land to be used for farming purposes, with some exceptions.
• New Equipment – The federal tax code allows certain expenditures for new equipment, used equipment generally does not qualify unless it is classified as “substantially rebuilt”.
• Volume Cap – The IRC, under Section 146, limits the amount of private activity bonds that may be issued in any calendar year for some Private Activity Bonds that is referred to as “Volume Cap”. This limit restricts the amount of certain qualified private activity bonds that all issuers within a state may issue during a calendar year. If, during a given year, an issuing authority issues more qualified private activity bonds than its allocable volume cap, the tax-exempt status of those excess bonds is jeopardized. Not all private activity bonds are subject to the volume cap limitation.
• Issuance Costs – The amount of proceeds used to pay issuance cost is generally limited to 2% of the size of the bond.