The American Recovery and Reinvestment Act of 2009 (ARRA) created several new types of tax-exempt bonds and qualified tax credit bonds under the Internal Revenue Code, including: Build America Bonds (BABs) Recovery Zone Economic Development Bonds (RZEDBs) In General What are BABs? BABs are taxable governmental bonds eligible for certain tax advantages under the Code. BABs must qualify as tax-exempt governmental bonds under section 103 of the Code. Is interest on BABs tax-exempt? No, even though BABs must qualify as tax-exempt under section 103 of the Code, interest paid on BABs is taxable to investors. Are all BABs the same? No. There are three types of BABs: BABs (Tax Credit), BABs (Direct Pay) and RZEDBs (Direct Pay). Each type has a different subsidy, a different purpose for which it may be issued, and other varying rules. How does the issuer make an “irrevocable election” to have BABs apply? Prior to issuing bonds, the issuer must elect on its books and records to apply the BAB provisions under section 54AA of the Code. Does the reporting requirement of Section 149(e) that applies to tax- exempt bonds apply to BABs? Yes, the IRS has now introduced new Form 8038-B, Information Return for Build America Bonds and Recovery Zone Economic Development Bonds, to be used to report all BABs and RZEDBs. For 2009 and before the publication of Form 8038-B, the issuer was required to report the issuance of BABs on Form 8038-G, Information Return for Tax-Exempt Governmental Obligations. Even if the issue was less than $100,000, Form 8038-G was used instead of Form 8038- GC. Do Sections 103, 141 and 148 of the Code apply to BABs? Yes, section 103 of the Code (including the private activity bond tests under section 141 of the Code) and the arbitrage yield restriction and rebate requirements under section 148 of the Code apply to BABs. What does it mean that BABs may not be issued with more than a DE minimis amount of premium? Section 54AA(d)(2)(C) provides that a bond shall not be treated as a build America bond if the issue price has more than a de minimis amount (determined under rules similar to the rules of section 1273(a)(3)) of premium over the stated principal amount of the bond. Generally, the issue price of bonds that are publicly offered is the first price at which at least 10% of the bonds are sold to the public. For additional rules on issue price, see section 1.148-1(b). De minimis amount of premium for a bond generally means .25% of the stated redemption price at maturity of the bond multiplied by the number of complete years from the bond’s issue date to its maturity date. For additional information on the premium limitation, see section 6.2 of Notice 2010-35 (April 26, 2010) and Notice 2009-26 (April 3, 2009). A similar rule shall apply in determining refundable credit payments under section 6431(f) on a Direct Pay Tax Credit Bond. The Treasury Department and the IRS are reviewing the definition of issue price in this area and also are considering further limitations or special rules with respect to the bond issuance premium on BABs and Direct Pay Tax Credit Bonds. The Treasury Department and the IRS expect to address any such further limitations or special rules in future prospective administrative or regulatory guidance. Can BABs be issued for private conduit borrowers? No. BABs may be issued for governmental purposes only excluding all private activity bonds. Do BABs sunset? Yes, unless extended by future legislation, BABs must be issued before January 1, 2011. Build America Bonds (Tax Credit) under IRC Section 54AA For what purposes can BABs (Tax Credit) be issued? BABs (Tax Credit) may be issued for any governmental purpose for which tax-exempt governmental bonds (excluding private activity bonds) could be issued under section 103 of the Code. For example, BABs (Tax Credit) may be issued to finance capital expenditures, working capital, current refundings, and one advance refunding. Who can issue BABs (Tax Credit)? BABs (Tax Credit) can be issued by any State or political subdivision (as defined for purposes of section 103 of the Code), as well as entities authorized to issue bonds on their behalf. What is the Federal subsidy for BABs (Tax Credit)? BABs (Tax Credit) provide a Federal subsidy through Federal tax credits to investors equal to 35% of the total interest payable by the issuer to investors. For BABs (Tax Credit) what is the benefit to the investor? The investor receives taxable interest income on BABs (Tax Credit) as well as the tax credit equal to 35% of that interest. Both the interest and the tax credit are includable in the investor’s gross income. The tax credit is generally allowed against both regular and alternative minimum tax. If the credit allowable exceeds the investor’s limitation for that taxable year, the unused credit may be carried forward until used. Do BABs (Tax Credit) require volume cap? No. BABs (Tax Credit) do not require national volume cap, but may require volume cap under section 141(b)(5) of the Code. Because Section 148 of the Code applies to BABs (Tax Credit), how is calculation of the yield affected by the tax credit? The yield on BABs (Tax Credit) is calculated without an adjustment for the tax credit. Do the prevailing wage labor standards of Davis-Bacon apply to projects financed by BABs (Tax Credit)? No, Davis-Bacon does not apply to projects financed with proceeds of BABs (Tax Credit). Build America Bonds (Direct Pay) under IRC Section 54AA For what purposes can BABs (Direct Pay) be issued? BABs (Direct Pay) may be issued for the same general governmental purposes as BABs (Tax Credit) except that BABs (Direct Pay) may only be issued to finance capital expenditures. Specifically, 100 percent of the excess of “available project proceeds” must be used only for capital expenditures. Available project proceeds are the sale proceeds the issuer receives from the bonds minus proceeds it is allowed to spend on costs of issuance (up to 2%), minus proceeds it is allowed to spend to fund a reasonably required reserve (generally up to 10%), plus proceeds from investment earnings. Thus, investment earnings on BABs (Direct Pay) must also be spent on project capital expenditures. Generally, BABs (Direct Pay) cannot be used to refinance capital expenditures in refunding issues. Who can issue BABs (Direct Pay)? BABs (Direct Pay) can be issued by any State or political subdivision (as defined for purposes of section 103 of the Code), as well as entities authorized to issue bonds on their behalf. What is the Federal subsidy for BABs (Direct Pay)? BABs (Direct Pay) are qualified bonds that provide a Federal subsidy through a refundable tax credit allowed under section 6431 of the Code equal to 35% of the interest payable by the issuer to investors. This cash payment is paid by the Federal government directly to the issuer or to the authorized agent for the issuer that pays interest on the bonds. How does the issuer elect BABs (Direct Pay) as qualified bonds? Prior to issuing the bonds, the issuer must make an election on its books and records that it intends to apply section 54AA(g) of the Code, the qualified BABS (Direct Pay) provisions. This election for BABs (Direct Pay) is in addition to the election described above under section 54AA of the Code to elect to apply the provisions of BABs. For BABS (Direct Pay) what is the benefit to the investor? The investor receives taxable interest income on BABs (Direct Pay) that is includable in the investor’s gross income. Do BABs (Direct Pay) require volume cap? No, BABs (Direct Pay) do not require national volume cap, but may require volume cap under section 141(b)(5) of the Code. How does the issuer of BABS (Direct Pay) apply to receive the cash payment subsidy from the Federal government? The issuer of BABs (Direct Pay) must file Form 8038-CP, Return for Credit Payments to Issuers of Qualified Bonds. Because section 148 of the Code applies to BABs (Direct Pay), how is calculation of the yield affected by the Federal subsidy cash payment allowed to the issuer under section 6431 of the Code? The yield on BABs (Direct Pay) is calculated by reducing the amount of interest paid on the bonds by the amount of the Federal subsidy payments allowed to the issuer under section 6431 of the Code, without regard to amounts offset for delinquent debts owed to Federal and state government agencies. Do the prevailing wage labor standards of Davis-Bacon apply to projects financed by BABs (Direct Pay)? No, Davis-Bacon does not apply to projects financed with proceeds of BABs (Direct Pay). Recovery Zone Economic Development Bonds (Direct Pay) under IRC Section 1400U-2 For what purposes can RZEDBs be issued? Issuers of RZEDBs must spend 100% of the “available project proceeds” for one or more qualified economic development purposes. A qualified economic development purpose means expenditures for promoting development or other economic activity in a recovery zone, including capital expenditures and working capital expenditures paid or incurred in such zone, expenditures for public infrastructure and construction of public facilities, and expenditures for job training and educational programs. Available project proceeds are the sale proceeds the issuer receives from the bonds minus proceeds it is allowed to spend on costs of issuance (up to 2%), minus proceeds it is allowed to spend to fund a reasonably required reserve (generally up to 10%), plus proceeds from investment earnings. Thus, investment earnings on RZEDBs must also be spent on a qualified economic development purpose. Generally, RZEDBs cannot be used to refinance capital expenditures in refunding issues. Who can issue RZEDBs? RZEDBs can be issued by any State or political subdivision (as defined for purposes of section 103 of the Code), as well as entities authorized to issue bonds on their behalf. All proceeds of RZEDBs must be used within the jurisdiction of the issuer. What constitutes a recovery zone? A recovery zone is any area designated by the issuer as having significant poverty, unemployment, rate of home foreclosures, or general distress; any area designated by the issuer as economically distressed by reason of the closure or realignment of a military installation under the Defense Base Closure and Realignment Act of 1990; or, any area for which a designation as an empowerment zone or renewal community is in effect as of February 17, 2009. What is the Federal subsidy for RZEDBs? All RZEDBs are direct pay qualified bonds that provide a Federal subsidy through a refundable tax credit allowed under section 6431 of the Code equal to 45% of the interest payable by the issuer to investors. This cash payment is paid by the Federal government directly to the issuer or to the authorized agent for the issuer that pays interest on the bonds. How does the issuer designate RZEDBs? Prior to issuing the bonds, the issuer must designate on its books and records that it intends to issue qualified RZEDBs under section 1400U-2 of the Code. For RZEDBs what is the benefit to the investor? The investor receives taxable interest income on RZEDBs which is includable in the investor’s gross income. Do RZEDBs require volume cap? Yes, the national volume cap limitation for RZEDBs is $10,000,000,000. For allocations by State, see Notice 2009-50. All proceeds of RZEDBs must be used within the jurisdiction of the entity allocating volume cap to the RZEDBs. Additionally, RZEDBs may require volume cap under section 141(b)(5) of the Code. How does the issuer of RZEDBs apply to receive the cash payment subsidy from the Federal government? The issuer of RZEDBs must file Form 8038-CP, Return for Credit Payments to Issuers of Qualified Bonds. Because Section 148 of the Code applies to RZEDBs, how is calculation of the yield affected by the Federal subsidy cash payment allowed to the issuer under Section 6431 of the Code? The yield on RZEDBs is calculated by reducing the amount of interest paid on the bonds by the amount of the Federal subsidy payments allowed to the issuer under section 6431 of the Code without regard to any amounts offset for delinquent debts owed to Federal and state government agencies. Do the prevailing wage labor standards of Davis-Bacon apply to projects financed by RZEDBs? Yes, Davis-Bacon labor standards apply to projects financed with proceeds of RZEDBs. The Davis-Bacon contract clauses stated in 29 CFR 5.5(a)(1) through (10) must be incorporated into covered contracts for construction, alteration, or repair work. Additional information regarding the application of Davis-Bacon labor standards is available at the U.S. Department of Labor Wage and Hour Division website at www.dol.gov/esa/whd/recovery/index.htm. May state and local government entities use Build America Bond issuance proceeds to purchase SLGS securities? Yes. Proceeds of bonds issued under code section 54AA (Build America Bonds) which are subject to the rules imposed by section 148, including yield restriction, may be used to purchase SLGS securities. Proceeds of such bonds may be used to acquire SLGS for any situation in which the yield on the invested bond proceeds must be restricted. For more information about the Treasury’s State and Local Government Series Securities Program, check out their website (SLGS).
