The American Taxpayer Relief Act of 2012 (the Act), passed by the Senate and the House and Representatives on New Year’s Day and signed by the President on January 2, 2013, includes several direct and indirect consequences for the municipal bond market. The Act averted the looming “fiscal cliff” by making permanent certain Bush-era tax rates and allowing taxes on wealthy individuals to increase. The Act only postponed the “sequestration” budget cuts enacted in 2011, however, and did not address the fact that the federal government has again reached its borrowing limit.
Notably, the Act limits the itemized deductions that high-income taxpayers can claim but does not restrict the exclusion of interest on state and local bonds from gross income. By raising rates payable by high-income taxpayers, the Act may increase the value of tax exemptions on bonds. Further, the Act permanently increases the alternative minimum tax threshold and indexes it for inflation, which may benefit issuers of “tax preference” private activity bonds.
The 2011 sequestration legislation included a reduction in the federal subsidy to issuers of Build America Bonds and other direct-pay bonds such as Qualified School Construction Bonds and Qualified Zone Academy Bonds. The potential spending cuts now set to occur on March 1, 2013, still threaten direct payments to issuers of such bonds.
On a more positive note, the Act extends and re-authorizes a number of items of interest to municipal market participants. Specifically, the Act does the following:
Qualified Public Educational Facility Bonds
The Act makes permanent the ability to issue private activity bonds for qualified public educational facilities. Proceeds of such bonds may be loaned to a for-profit corporation to finance facilities leased to a public school. These bonds are subject to a separate annual volume cap equal to $10 per capita for each state, with a minimum allocation of $5 million.
Small Issuer Rebate Exception Increase for Bonds Financing Public School Capital Expenditures
The Act makes permanent the increase in the small issuer rebate exception limit for bonds financing public school capital expenditures. Under this provision, an issuer may exempt from rebate up to an additional $10 million of bonds annually beyond the $5 million generally permitted under this exception if the additional bonds finance the construction of public school facilities.
Qualified Zone Academy Bonds
The Act provides for a $400 million national Qualified Zone Academy Bond volume authorization for 2012 and 2013. These bonds are available to finance the rehabilitation and repair of certain public schools or to provide equipment, course materials, or teacher training for such schools. The volume cap can be carried forward for two years, making the 2012 volume cap available for bonds issued by December 31, 2014. The bonds issued under the 2012 and 2013 volume caps provide the holder with a credit against federal tax liability and may not be issued as direct-pay bonds.
New York Liberty Zone Bonds
The Act extends the deadline to issue New York Liberty Zone Bonds, which provide tax-exempt financing to the area surrounding the former World Trade Center, to December 31, 2013.
Empowerment Zone Tax Incentives
The Act extends the effective period of federal empowerment zone designations through December 31, 2013. This change allows Empowerment Zone Facility Bonds to be issued in 2013, provided that the original empowerment zone volume cap has not been exhausted. Ninety-five percent or more of the net proceeds of Empowerment Facility Bonds must be used to finance new or substantially renovated property that is subject to depreciation, and that is to be used in the active conduct of certain qualifying businesses within empowerment zone communities.
New Markets Tax Credit
The Act provides for $3.5 billion of New Markets Tax Credit allocation for both 2012 and 2013. This program was established to provide federal tax credits as an incentive for investment in certain low-income community businesses.
Low Income Housing Tax Credit
The Act extends the 9 percent fixed-credit percentage to non-federally subsidized buildings that receive a housing tax credit dollar amount allocation before January 1, 2014. The provision sets the credit calculation at 9 percent, rather than at a fluctuating number for qualified costs related to buildings that are newly constructed or that involve certain rehabilitation expenditures, and that set aside a certain percentage of units for low- and moderate-income families and individuals. Prior law required such buildings to be placed in service before December 31, 2013, to receive this fixed-credit percentage.
As a result of the failure of Congress to raise the debt limit, the Treasury has suspended the sale of its State and Local Government Series of Treasury bonds (SLGS). SLGS provide state and local governments with a streamlined way to meet yield restriction rules without having to purchase Treasury securities on the open market. Issuers requiring yield-restricted investments for defeasance escrows should be aware that certain bidding procedures must be followed to ensure that the yield-restriction rules are met.
Further, issuers with existing escrows that require the reinvestment of maturing amounts in “zero coupon SLGS” during the period when SLGS are not available are permitted under IRS guidance to purchase alternate securities and make certain yield reduction payments to the government, in each case within specified time periods. Issuers needing to acquire escrow securities or to reinvest should consult bond counsel to assure that the appropriate procedures are followed.
Over the next two to three months, Ballard Spahr will be monitoring ongoing negotiations between Congress and President Obama regarding deficit reduction, sequestration, and tax reform. These negotiations will likely include discussions of changes to, or restrictions on, the excludability from gross income of interest on state and local bonds.
If you have questions on the Act and its implications for the municipal bond market, please contact Kimberly C. Betterton at 410.538.5551 or email@example.com, or Scott W. Cockerham at 202.661.2295 or firstname.lastname@example.org.