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Federal Income Tax Issues
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  1. Federal Income Tax Issues Matthias Edrich Erick Stowe January 30, 2009

  2. Presenters • Matthias Edrich, is a second year associate of Peck Shaffer with a focus on transaction structure, documents, disclosure and tax matters • Erick Stowe, more than 30 years’ practice in public finance, partner at Peck Shaffer with a focus on tax matters

  3. Basic Tax Rule Interest on debt of a state or political subdivision is excluded from federal gross income unless the debt is a private activity bond (that is not a qualified private activity bond) and unless the debt is an arbitrage bond. There are also some technical rules that must be met.

  4. Issuers • State or Local Governmental Issuer • State, D.C., Possession or Political Subdivision • On Behalf Of/Constituted Authority • 63-20 Issuers • Indian Tribal Governments • Other

  5. Debt • Valid Exercise of Borrowing Power • Nonrecourse, Conduit or Revenue Financings • Debt Must Be Incurred • May be Lease or Installment Sale in Form -- Interest Must Be Separately Stated

  6. Private Activity Bonds • Use of Proceeds • Governmental Bond • Qualified Private Activity Bond • Private Business Use Test • Private Loan Test

  7. Private Activity Bonds • Two-Part Private Business Test: • More Than 10% Private Business UseAND • More Than 10% Private Payment or Security • Reasonable Expectations

  8. Private Business Use? • Use By a “Nongovernmental Person” • Federal Government • Section 501(c)(3) Organization • Other Private Entity (Corporation, Partnership, LLC)

  9. Private Business Use? • Use Includes • Ownership • Lease/Sublease • Certain Management/Services Contracts • Certain Sponsored Research Agreements • Certain Output Contracts • “Special Legal Entitlement” • “Special Economic Benefit”

  10. Private Business Use? • Exceptions • “General Public Use” • Short, Incidental and Temporary Use • Measuring Private Business Use • Generally Measured Over Time • Allocation for Mixed Use Facilities

  11. Private Payment Test • Measure Private Payments • Present Value (PV) of all Private Payments over Term of Bonds • All private Payments Benefiting Issuer • Limited to the Amount of Private Use • Excludes Operating Expenses • Generally applicable taxes are not private payments

  12. Private Loan • Alternative to Private Business Test • Measure Loans • In Amounts More Than the Lesser of • 5% of the Bond Proceeds or • $5 million • Used to Make or Finance Loans to Nongovernmental Persons • Tax Assessment Exception

  13. Qualified Private Activity Bonds • 501(c)(3) Bonds • Small Issue (Maximum $10 million) for Manufacturing and 1st Time Farmers • Acquisition of Non-Government Output Facility Bonds • Student Loan Bonds • Qualified Redevelopment Bonds • Low- and Moderate-Income Single Family Mortgage Bonds • Exempt Facilities

  14. PABs – Exempt Facility Bonds • Airports Docks and Wharves Mass Commuting Environmental Enhancement of Hydroelectric Facilities • Residential Rental Facilities Water Furnishing Sewage Facilities Solid Waste Facilities Local Furnishing of gas or electricity Local District Heating or Cooling Qualified Hazardous Waste Facilities High Speed Intercity Rail Facilities Public Educational Facilities Enterprise Zone Facilities

  15. Requirements For All Bonds • Reimbursement Rules • Declaration of Official Intent By Issuer of Bonds (or 501(c)(3) Organization) Specifying Project and Principal Amount • Can Reimburse Costs Paid No More Than 60 Days Before Declaration of Intent (Exceptions for Preliminary Expenditures and De Minimis Amount)

  16. Requirements For All Bonds • Reimbursement Rules • Reimbursement Within 18 Months of Later of Date Expenditure Paid or Project Placed In Service (Overall 3 Year Limit From Date Expenditure Paid)

  17. Requirements For All Bonds • Bonds Must Be In Registered Form • Federal Guarantee Restriction • Exceptions For Housing Bonds, Refunding Escrows, Certain Agency Guarantees • Information Reporting • Form 8038, Form 8038-G, Form 8038-GC • Filing Deadlines, Late Filing • Source of Information

  18. Arbitrage – Basic Rule • Proceeds of an issue cannot be invested at above the yield on the bonds except during temporary periods, as part of a reasonable reserve, as part of a minor portion, and arbitrage earnings must generally be rebated.

  19. Arbitrage – Basic Questions • Arbitrage- - Can you earn it? • Temporary Periods • Minor Portion ($100,000) • Invested at yield not materially higher

  20. Arbitrage • Definition of Gross Proceeds • Sale Proceeds • Investment Proceeds • Replacement Funds (Sinking Fund, Pledged Fund, Negative Pledge) • Transferred Proceeds

  21. Arbitrage • Temporary Periods • Construction or Other Capital Projects (3-Year) • Must expect to satisfy “Expenditure Test” • Bona Fide Debt Service Fund

  22. Arbitrage • Temporary Periods • Construction (3 years) • Refunding Escrow (30 days) • Investment Income (1 Year) • Replacement Proceeds (30 Days) • Working Capital (13 Months)

  23. Arbitrage • Yield • General Calculation Method • Initial Offering Price • Guarantee Fees • Costs of Issuance • Materially Higher • Generally 1/8 of 1% • Acquired Program Investment 1.5% • Replacement Proceeds and Restricted Escrows 1/1000 of 1%

  24. Reasonably Required Reserve Fund • Sizing Limits • MADS, 125% AADS, 10% issue • Funding limit: 10% of issue • “Reasonably Required”

  25. Rebate – Basic Rules • Rebate- - Can you keep it? • Small Issuer Exception • 6 month Exception (includes refundings) • 18 Month Exception • 2-Year Construction Exception • Calculation Periods • Yield Reduction Payments

  26. Rebate – Basic Rules • Rebate- - Can you keep it? • Small Issuer Exception • 6 month Exception (includes refundings) • 18 Month Exception • 2-Year Construction Exception • Calculation Periods • Yield Reduction Payments

  27. Voluntary Closing Agreement Program • If ongoing post-issuance compliance efforts have not prevented violation of rules applicable to qualified 501(c)(3) bonds, voluntary closing agreement program (“VCAP”) is available in some situations

  28. CONCLUSIONWhere Do We Go From Here?

  29. I. Bond Audit A. Take Stock of Existing Bond Financings and Potential Issues► May involve an outside consultant B. Addressing of Issues Discovered

  30. II. Ongoing Compliance Program A. Designate Responsibility for Monitoring Compliance with Conditions Required to Maintain Tax Exemption of Interest on Bonds► May be internal responsibility, external responsibility or combination ► Centralized responsibility

  31. B. Rebate/Spend-Down Monitoring C. Tracking of Bond Proceeds ► Must know how bond proceeds were spent, what portions of facilities bond-financed

  32. D. Review of Management Contracts/Research Agreements by Bond Counsel to Ensure Compliance with Qualified Management Contract Rule E. Special Care for Investment of Bond Proceeds to Address IRS Concerns With Yield-Burning ► Involve Bond Counsel in process of bidding GICs

  33. F. Keep Records With Respect to Expenditures and Investment of Bond Proceeds Until 3-6 Years Following Retirement of Bonds ► Don’t rely on others for record-keeping

  34. Presenters’ Information Matthias Edrich and Erick Stowe Peck, Shaffer & Williams LLP Suite 1700 1801 Broadway Denver, Colorado 80202 (303) 296-3996 Main (877) 296-0333 WATTS (Toll Free) (303) 296-0344 Facsimile medrich@peckshaffer.com estowe@peckshaffer.com www.peckshaffer.com