Over the past twelve years, Congress has launched an array of tax credit bond programs to permit state and local governments to finance eligible high-priority projects such as the construction or renovation of public schools, clean renewable energy and other types of “green” projects, and economic recovery initiatives. Tax credit bonds offer the prospect of very low-cost financing. The purchaser of a tax credit bond receives all or part of his or her return in the form of a federal income tax credit in lieu of interest paid by the state or local government issuer/borrower. In effect, the federal government is paying all or part of the interest.
Until this year, however, widespread acceptance of tax credit bonds by investors was hampered by the complexity of the tax credit bond provisions, the limited availability of bonds to be issued and the thinness of the market. The American Recovery and Reinvestment Act of 2009 (the Act) may be the game-changer. The Act added a number of new types of tax credit bonds and significantly increased the amount of tax credit bonds that can be issued. This update focuses on two tax credit bond programs – Qualified School Construction Bonds (QSCBs) and Qualified Zone Academy Bonds (QZABs).
Most types of tax credit bonds, including QSCBs and QZABs, are designed to bear little or no interest. The tax credit amount is based on a percentage of the outstanding bond principal. The credit accrues quarterly, is included in gross income as if it was a taxable interest payment, and can be applied to offset federal income tax or AMT liabilities. The credit may also be stripped from the bonds and sold to a third party.
The QSCB program was added by the Act. A QSCB may finance the construction, rehabilitation or repair of a public school facility, and may cover the cost of acquiring the site on which such a facility is to be constructed. The issuer can be any state or local government located within the same jurisdiction in which the school or school district is located.
The Act authorizes $11 billion of QSCBs to be issued nationwide in each of calendar years 2009 and 2010, after which the program is scheduled to sunset. Sixty percent of the bonds are allocated to states based on the prior year’s allocation of federal basic grants for education of disadvantaged children. The other forty percent are allocated to the 100 largest school districts nationally, measured by the number of school age children living below the poverty level.
Congress first authorized QZABs in 1997. The Act dramatically increases the annual nationwide allocation from $400 million to $1.4 billion for each of 2009 and 2010. Each state’s allocation is driven by its respective population of individuals below the poverty line. QZABs can be used for renovations, equipment, course materials and faculty/staff training at existing public schools designated as qualified zone academies. Proceeds of QZABs cannot be used to fund new construction. The QZAB issuer must obtain private contributions to the qualified zone academy at least equal to 10 percent of the principal amount of the QZAB.
Both QCSBs and QZABs are subject to arbitrage yield restrictions and rebate requirements almost identical to those imposed on tax-exempt bonds. If you have any questions regarding QSCBs, QZABs or the state and local government financing provisions of the Act in general, please contact one of the authors, or visit McGuireWoods’ Public Finance practice. You can also refer to our Stimulus Package section for more updates on the Act.