As part of the American Recovery and Reinvestment Act of 2009 (“ARRA”), Congress added Section 54AA of the Internal Revenue Code of 1986, as amended (the “Code”), permitting a state or local government, including school districts, to issue anew type of taxable obligation called Build America Bonds (“BABs”) to finance governmental projects.
Unlike traditional governmental bonds, the interest on BABs is included in the income of the holders for federal income tax purposes. To qualify as a BAB, interest on the bond would need to be excludable from gross income under Section 103 of the Code (but for treatment as a BAB under Section54AA of the Code), and the bond must not have more than a de minimus amount of premium.
Until December 31, 2010, ARRA permits two types of BABs to be issued: Direct Payment BABs and Tax Credit BABs.
Direct Payment BABs
For Direct Payment BABs, the federal government will pay to the issuer or its designee an amount equal to 35% of the coupon interest payable to the bond holders. This provides a direct subsidy of 35% of the issuer’s taxable borrowing cost.
Sale proceeds of Direct Payment BABs may only be used for 1) capital expenditures,2) costs of issuance not exceeding 2% of the proceeds, and 3) a reasonably required debt service reserve fund. Proceeds of Direct Payment BABs may not be used for refundings or working capital expenses.
At the time of issuance of Direct Payment BABs, the issuer must file Form 8038-B with the IRS. Additionally, Form 8038-CP must be filed by the issuer or its designee at least 45 days (but not more than 90 days) before each interest payment date.
The Form 8038-CP is a two-page document requiring: 1) the name and address of the entity to receive the payment, 2) general information about the issuer and the bonds, and 3) the calculation of the amount of the direct payment to be made.
Tax Credit BABs
If an issuer elects to designate its BABas a Tax Credit BAB, on each interest payment date the bondholders will be entitled to a tax credit equal to 35% of each interest payment payable on such date. The credit is non-refundable, but the unused portion may be carried forward to successive years. Because the 35% credit must be included in the bondholders’ income, the amount of the federal subsidy is closer to 25% in the case of Tax Credit BABs.
Unlike Direct Payment BABs, the uses of Tax Credit BABs are not limited to capital expenditures and are not subject to the 2%cost of issuance limitation. Tax Credit BABs may be issued for capital expenditures or working capital costs and may be issued forboth new money and refunding purposes.
Although the provisions of ARRA authorizing BABs expire on December 31, 2010, there are proposals to extend the BABs program with a permanent 28% federal subsidy.
In addition, consideration is being given to allow Direct Payment BABs to finance certain current governmental refundings and working capital financings, as well as financings for certain 501(c)(3)organizations.
Although an issuer may contract with a trustee to handle the additional IRS filings associated with Direct Payment BABs, the issuer will still likely face additional paperwork. The IRS is in the process of conducting “compliance checks” of all existing BABs issues and it appears likely that BABs will continue to garner extra IRS scrutiny.
If you have any questions regarding Build America Bonds, please contact any Gust Rosenfeld Public Finance Attorney.