Safe Tax Exempt Investments - DOC

Document Sample
Safe Tax Exempt Investments - DOC Powered By Docstoc
					TO:          Large Public Power Council

FROM:        Mitch Rapaport

DATE:        February 12, 2009

RE:          American Recovery and Reinvestment Tax Act—Municipal Finance Provisions


On February 11, 2009, Congressional leaders reached agreement on a compromise version of the American
Recovery and Reinvestment Tax Act (the “Act”). The Act had previously been approved in both the House and the
Senate, although in slightly different forms. The Act creates several new tax-exempt bond and tax-credit
bond programs and expands and modifies existing tax-credit bond programs. The Act would make a
relatively modest $1.6 billion increase to the CREBs program while making significant improvements to
the production tax credit. The Act also makes several changes to the tax treatment of certain tax-exempt
bond investments. With limited exceptions, the provisions in the Act related to tax-exempt bonds and
tax-credit bonds apply only to bonds issued through 2010. The tax-exempt finance and energy tax
provisions relevant to the LPPC are described below.

                                          Energy Tax Provisions

Increase to New Clean Renewable Energy Bonds Limitation

Present law authorizes the issuance of $800 million of New Clean Renewable Energy Bonds (“New
CREBs”). New CREBs are a tax-credit bond that may be used by electric cooperatives, public power
systems, and other State or local governments to finance renewable energy facilities that qualify for the
production tax credit under the Internal Revenue Code).

The Act increases the amount of New CREBs authority by an additional $1.6 billion, divided equally
among electric cooperatives, public power systems, and other State or local governments. The Act
would apply the Davis-Bacon rules to New CREBs and Old CREBs (as well as to certain other tax credit
bonds). The Act make no other modifications to the present-law New CREBs program.

Increase to Energy Conservation Bonds Limitation

Present law authorizes the issuance of $800 million of tax-credit bonds for broadly-defined qualified
conservation purposes (“Energy Conservation Bonds”), including any capital expenditures incurred to
implement a green community program, demonstration projects designed to promote the
commercialization of green building technology, and various other energy-related measures.

 The Act increases the amount of Energy Conservation Bonds authority by $2.4 billion; this cap
continues to be allocated to States and cities. The Act makes no other modifications to the present-law
Energy Conservation Bonds program (other than requiring the application of the Davis-Bacon rules).
12396870.1
                                                    -2-




Improvements for PTCs

         The Act makes several significant changes to the production tax credit (“PTC”) provisions of the
Internal Revenue Code. First, the PTC program would be extended by an additional 3 years. Second,
for most facilities qualifying for PTCs, taxpayers may elect to convert the PTC into an investment tax
credit, resulting in up-front tax credit equal to 30 percent of the cost of the facility (rather than a tax
credit received only as electricity is produced). Third, taxpayers can elect to convert the tax credit into a
direct grant from the Department of Energy, making the PTC effectively refundable. This “grant”
provision is not available to public power or nonprofit electric cooperatives.


                Newly Authorized Tax-Exempt Bond and Tax Credit Bond Programs

Taxable “Build America Bonds”

For 2009 and 2010, the Act creates a new type of tax credit bond, Build America Bonds, under which
the issuer pays investors taxable interest and the holder receives a federal tax credit equal to 35 percent
of that interest. State and local governments, including public power systems, may elect to issue Build
America Bonds in lieu of issuing traditional tax-exempt governmental bonds. Similar to existing tax-
credit bond programs, the tax credit may be stripped from the underlying bond. Importantly, issuers
may elect to receive a direct rebate from the IRS of 35 percent of the interest paid on the bonds in lieu of
investors receiving the tax credit. Build America Bonds may be issued only for those purposes for
which tax-exempt governmental bonds may be issued under present-law. Further, in order to qualify for
the direct payment to the issuer (rather than a tax credit), the proceeds of the bonds can only be used for
capital expenditures, costs of issuance, and to fund reserves.

New Tax-Exempt Private Activity Bond: Recovery Zone Facility Bonds

The Act authorizes the issuance of $15 billion of a new category of tax-exempt private activity bonds
(“Recovery Zone Facility Bonds”) for use in areas designated as Recovery Zones during 2009 and 2010.
The Act defines Recovery Zones as areas designated by State and local governments as having
significant poverty, unemployment, or home foreclosure rates, as well as areas designated as
empowerment zones or renewal communities under present law.

The Act imposes the following limits on property financed with the proceeds of Recovery Zone Facility
Bonds: (1) property must be acquired after the date on which a Recovery Zone designation took effect;
(2) property previously used in the Recovery Zone cannot be financed; (3) property must be used in the
active conduct of a business and substantially all of the use of the property must occur in the Recovery
Zone; and (4) 95 percent of the net proceeds must be used to finance depreciable property. It would
appear that investor owned electric utilities could benefit from these new tax-exempt bonds. The $15
billion volume limitation for Recovery Zone Facility Bonds would be allocated to the States in
proportion to their respective 2008 job losses.

New Tax Credit Bond: Recovery Zone Economic Development Bonds/Build America Bonds.

The Act authorizes the issuance of $10 billion of a new category of tax credit bonds during 2009 and
2010 that, like Build America Bonds, provide issuers with a rebate for a portion of interest payments:
12396870.1
                                                    -3-


Recovery Zone Economic Development Bonds. Recovery Zone Economic Development Bonds operate
in the same manner as Build America Bonds (described above) for which the issuer has made the
election to receive a rebate for a portion of the interest paid on the bonds. The rebate amount for these
bonds is 45 percent (as opposed to 35 percent for Build America Bonds). The $10 billion volume
limitation for Recovery Zone Economic Development Bonds would be allocated to the States in
proportion to their respective 2008 job losses.

Recovery Zone Economic Development Bonds/Build America Bonds may be issued for any purpose
that promotes development or economic activity in a specified zone. Examples of permitted
expenditures include (1) capital expenditures paid or incurred with respect to property located in a the
zone; (2) expenditures for public infrastructure and public facilities; and (3) expenditures for job training
and educational programs.

                 Amendments to Tax Treatment of Investors in Tax-Exempt Bonds

      In response to the current difficulties in the municipal bond market, the Act would make the
changes described below in an attempt to increase investor demand for tax-exempt bonds.

Bank Deductibility of Interest Related to Tax-Exempt Investments

Federal tax law disallows the deduction for interest on indebtedness incurred to purchase or carry tax-
exempt obligations. For financial institutions and dealers, the disallowance is based on the percentage
of a taxpayer’s assets comprised of tax-exempt obligations (the “pro-rata rule”). In the case of
obligations issued by a “small issuer”, the general pro-rata rule does not apply and 20 percent of the
interest allocable to the tax-exempt obligations of a qualified small issuer is disallowed. Second, under
IRS rules, an interest deduction generally is not disallowed if the average adjusted basis of the
taxpayer’s tax-exempt obligations is two percent or less of the average adjusted basis of the taxpayer’s
assets. This “two-percent safe harbor” does not apply to dealers in tax-exempt obligations or to
financial institutions.

The Act would create a temporary two-percent safe harbor for financial institutions, under which
financial institutions would be permitted an 80 percent deduction for interest on indebtedness related to
tax-exempt obligations. The two-percent safe harbor would apply only to “new money” bonds issued in
2009 and 2010. Although of limited interest to LPPC, the Act also increase the definition of “small
issuer” for purposes of the bank qualified bond rules from $10 million to $30 million, but only with
respect to bonds issued in 2009 and 2010.

Application of AMT to Private Activity Bonds

The alternative minimum tax (“AMT”) imposed on individuals and corporations is computed by
adjusting a taxpayer’s taxable income to take into account certain preference items and adjustments. In
the case of a corporation, one AMT preference item is determined, in part, by taking into account 75
percent of certain items, including tax-exempt interest, that are excluded from taxable income but
included in the corporation’s earnings and profits (the “ACE Adjustment”). This ACE Adjustment
applies to interest on tax-exempt governmental bonds, as well as interest on most private activity bonds.
Under the Act, the ACE Adjustment would not apply to new money bonds issued in 2009 and 2010 and
refundings of bonds issued after 2003.


12396870.1

				
DOCUMENT INFO
Shared By:
Categories:
Stats:
views:7
posted:11/14/2010
language:English
pages:3
Description: Safe Tax Exempt Investments document sample