WASHINGTON — Lawmakers will return from vacations next month to restart work on a slew of unfinished legislative proposals — some of which include new municipal bond provisions — that were left on the table last week when Congress took its holiday recess.
Among other bills, work had stalled this month on alternative minimum tax relief; the farm, energy, and trade bills; and a package of so-called tax extenders, which includes an extension of the expired qualified zone academy bond program and the optional deduction for state and local sales taxes.
Congress managed to approve a last-minute, one-year AMT “patch” after a long and drawn-out partisan battle over whether the patch’s $50 billion price tag should be offset by revenue-raising measures. The patch prevents over 20 million more taxpayers from becoming subject to the AMT, which applies to interest earned on private-activity bonds. But House Ways and Means Committee chairman Charles Rangel, D-N.Y., and other lawmakers have vowed to try to permanently repeal the AMT next year.
Lawmakers also finished work on the energy bill before leaving town. The bill originally contained several tax-credit bond proposals, but all tax provisions were stripped from the legislation before it went forward for President Bush’s signature last week. Groups, such as the American Public Power Association, have said they will continue to push for some of those proposals next year.
Still to come is House action on the farm bill, which contains a $1.5 billion proposal for tax-exempt timber conservation bonds, $400 million for “rural renaissance” bonds, and several technical changes to the small-issue “aggie” bond program. The Senate may act on a trade bill that includes $9 billion in tax-exempt and tax-credit bonds for manufacturing redevelopment in areas with a high percentage of abandoned or under-utilized manufacturing facilities.
Muni market participants, however, are more concerned with the tax extenders, which would allow for another $400 million in QZAB issuance and maintain the state and local sales taxes deduction, “something that is very important to our members, especially in non-income tax states,” said Susan Gaffney, federal liaison director of the Government Finance Officers Association.
Qualified zone academy bonds are used by municipalities to finance renovations and repairs to existing school facilities. Congress has authorized $400 million for the program each year for the past decade. Some states have QZAB allocations left over from 2006 and 2007, since they have had difficulty adjusting to recently enacted arbitrage restrictions for the tax-credit bonds, according to Laurence Peters, vice president of the National Education Foundation and cyberlearning.org. Still, a “good two-thirds of the states” are planning to immediately start issuing QZABs from their 2008 capacity “to satisfy pent-up demand,” he said.
“If we can get a two-year extension passed soon, one that ameliorates the problems caused by last year’s over-broad arbitrage rules, it will go far to re-stablizing a program only just now getting back on course,” Peters said.
Gaffney said last week that the GFOA and other market groups will be “closely monitoring” any congressional action on the subprime mortgage crisis. The Treasury Department has said it hopes Congress will enact an increase in the annual private-activity bond volume cap to allow state and local governments to issue tax-exempt mortgage revenue bonds to refinance subprime mortgages, many of which are set to adjust to higher rates in 2008 and 2009.
Such refinancings with bond-backed, fixed-rate mortgages would mean cheaper mortgages for borrowers. The proposal requires a legislative change because the tax code currently allows single-family mortgage revenue bonds to finance only new mortgages, not refinancings.
Senate Finance Committee members indicated that $15 billion to $20 billion of additional bonding authority could be provided to housing finance agencies over the next three years. One bill was introduced last week just before the congressional session ended, but more are expected next year.
The usefulness of such a proposal “really depends on how Congress structures it,” said Bruce Serchuk, an attorney with Nixon Peabody LLP here.
“State and local governments are in the business of making loans to first-time homebuyers whose income is generally on the lower side. They certainly understand that business,” he said, but the introduction of potentially weaker mortgages into state housing finance agencies’ pools carries with it certain risks that HFAs will have to evaluate.
“It’s firmly in the lap of Congress now, and we’ll see where they go with it,” said NABL president J. Foster Clark, a partner at Balch & Bingham LLP in Birmingham, Ala. “The whole credit area is a very large and very complex problem the country’s facing right now. This mortgage revenue bond [proposal] is relatively small in comparison to the problem, but it’s one tool that occurred to us in September and seems to make sense. We will watch with interest.”
Another group monitoring the action is the National Association of Health and Educational Facilities Finance Authorities, which looks for “fallout” from some legislative proposals on hospitals and higher education.
“There’s talk now about forcing university endowments to provide particular-percentage payouts, like foundations do; there’s talk about hospitals having to meet certain criteria in order to maintain their full tax-exempt status,” said NAHEFFA counsel Charles Samuels, a partner with Mintz Levin Cohn Ferris Glovsky & Popeo PC here.
“We don’t have particular position on those legislative suggestions, except that … we would oppose them including restrictions on bonds,” he said. “If the Congress is going to define what a university needs to do or what a hospital needs to do, that’s up to those communities and the Congress. From our point of view, though … those qualified entities should continue to be allowed to issue 501(c)(3) bonds.”
Market advocates are keeping an eye out for a Congressional Budget Office report on university endowments and their relationship to tax-exempt bonds, which is expected sometime in late winter or early spring. “That certainly is important to us,” Samuels said.
This fall, the National Council of Health Facilities Finance Authorities and the National Association of Higher Educational Facilities Authorities agreed to merge and create the NAHEFFA on Jan. 1.
“People are looking at it with a lot of enthusiasm,” because the group will provide a broad representation of 501(c)(3) bond issuers, according to Samuels.
The group’s legislative agenda lines up between two bills, the first of which would authorize the Federal Home Loan Banks to issue letters of credit backing municipal debt.
Samuels said a coalition of local governments, as well as health care, higher educational, and economic development authorities, and banks sees the legislative change as a chance “to use letters of credit particularly for small deals that are underserved, for which the bond insurance community has no interest.” In light of the financial difficulties bond insurers have experienced in the subprime mortgage crisis, they are likely to be “even more conservative, understandably, and are going to be even less interested in small, unrated deals,” he added.
“We would really like this to finally come to fruition. We’ve got lots of co-sponsors, particularly on the House side,” Samuels said. “It would be a very, very low-cost way to enhance getting reasonably priced funding in the hands of small governments and small charities, and even for very small economic development projects.”
The other bill NAHEFFA is pushing would liberalize a bank deductibility rule enacted as part of the 1986 tax reforms. It allows banks an 80% deduction for the cost of purchasing and carrying the tax-exempt bonds of issuers that reasonably expect to sell $10 million of bonds or less a year.
Legislation introduced in January 2007 by Rep. Bobby Jindal, R-La., would permit banks to determine their interest expense deduction without regard to tax-exempt bonds issued to provide certain small loans for health care or educational purposes.
The bill would make banks “interested in buying some of these bonds,” Samuels said. “One would hope, if Congress looks at ways of making sure the economy stays strong, that this would be one small, inexpensive thing that could be done.”
The Council of Development Finance Agencies, which represents local economic development agencies around the country, also has lobbied for the bank deductibility bill. The council’s top legislative priority, however, is the modernization of a tax code requirement for small-issue industrial development bonds to accommodate new, high-tech types of manufacturing.
Current tax code rules limit the use of small-issue IDBs to a “manufacturing facility,” defined as a facility that is “used in the manufacturing or production of tangible personal property, including processing resulting in a change in the condition of such property.”
The proposal, which the CDFA hopes to have introduced as legislation early next year, would add intangible property to that definition, allowing “knowledge-based” companies to be eligible for access to tax-exempt financing, according to CDFA executive director Toby Rittner.
“While certain market forces, i.e. the subprime lending issues, are putting pressure on underwriters and insurers, we feel that the municipal bond market, such as IDBs, [tax-increment financing], and other economic development tools will weather the storm in 2008,” Rittner said.
“Our early indications show that issuers will continue to actively use private-activity bonds for manufacturers, 501(c)(3)s, and other development projects. In fact, based simply on industry discussions, we see a very active year in 2008,” he said. “Capital market underwriters have diversified their portfolios and are braced for market changes and the issuers have gotten very creative on packaging deals that work very well financially.”
For its part, according to Clark, NABL is planning projects that include technical comments to be released “soon” on changes Treasury proposed this year for the arbitrage regulations, which restrict the amount of earnings municipal issuers can receive and retain on investments of tax-exempt bond proceeds.
Treasury’s proposed changes would accommodate interest rate swaps with floating payments based on taxable rates, such as the London Interbank Offered Rate. So-called Libor swaps, which have become commonplace in the muni market, would be eligible for simple integration, under which variable-rate bonds subject to an integrated floating-to-fixed rate swap are treated as variable-yield bonds. But such swaps would not be eligible for super integration, which has a separate set of requirements that allow the bonds to be treated as fixed-yield bonds.
The revamped rules would allow issuers to make yield reduction payments on certain variable-rate advance refunding bond issues in which the issuers have entered into a qualified floating-to-fixed swaps. They also would provide that the floating rate on a taxable-index hedge and the variable rate on the hedged bonds will be treated as “substantially the same” for purposes of the hedging rules if the rates are no more than 0.25% apart, and if, for a three-year period ending on the date the issuer enters into the swap, the average difference between the rates does not exceed 0.25%.
Gaffney said the GFOA “greatly appreciates the recently proposed changes to the arbitrage rules, and hopes that there are more to come, especially on topics such as issue price.”
Indeed, in 2008, a second package of arbitrage rules is expected, along with updated guidance on the tax-exempt bond voluntary closing agreement program, arbitrage rebate refunds, and proposed regulations on public approval requirements for private-activity bonds.
The Treasury Department’s 2007-2008 priority guidance plan also includes tighter partnership rules for tender option bonds; final regulations on solid-waste bonds; final allocation and accounting rules for private-activity bonds; and temporary regulations on clean renewable energy bonds.
The IRS’ exempt organizations division aims to issue guidance on the excise tax on prohibited tax shelter transactions — a category that includes about 15 tax-exempt sale-in, lease-out and lease-in, lease-out deals — as well as on qualified tuition savings plans under Section 529 of the tax code.
IRS officials announced Thursday that tax-exempt entities with more than $100,000 in outstanding bonds will not be required to fill out Form 990’s new Schedule K in the 2008 tax year.
The schedule, part of the annual information return filed by exempt organizations, asks for a breakdown of outstanding bond issues’ gross proceeds in reserve funds, proceeds in refunding or defeasance escrows, issuance costs, working capital expenditures, capital expenditures, and other unspent proceeds.
The schedule’s “arbitrage” section asks whether the issuer has invested bond proceeds in a guaranteed investment contract or identified a hedge on its books. The section specifically asks the groups to specify the providers’ names and the terms of their hedges or GICs. It also asks whether the regulatory safe harbor for establishing a GIC’s fair market value was satisfied, and whether the bond issue qualified for an exception to arbitrage rebate requirements.
In addition, the schedule asks whether the entity maintains “adequate books and records to support the final allocation of proceeds,” routinely engages bond counsel to review contracts related to bond-financed property, and uses procedures to ensure post-issuance compliance with tax code rules.
“It reflects a major effort on the Service’s part to encourage better post-issuance tax compliance,” said Maxwell D. Solet, a partner at Mintz Levin Cohn Ferris Glovsky & Popeo PC. “[It is] a strong inducement to have such practices, so that you’ll be able to fairly honestly answer yes.”
“I believe that given the sophistication of the questions on Schedule K, nonprofits will need to hire outside experts to assist with ongoing tax compliance and private use monitoring on an annual basis,” said Ed Oswald, a partner at Orrick Herrington & Sutcliffe LLP here. “As a practical matter, borrowers would be best served by engaging an outside expert for these duties.”
The final form, which was revised from a version proposed in June, lessens the burden on exempt organizations somewhat by not requiring reporting of bonds issued before 2003. For the 2008 tax year, exempt organizations will merely be required to provide the IRS with a list of outstanding bond issues and a description of each issue’s purpose, issue price, and Cusip.
The agency has been holding one-day workshops around the country for small and mid-sized exempt organizations, explaining the new form and other requirements for maintaining tax-exempt status. The remaining workshops, which will be held in Austin, Arlington, Va., and Columbus this spring, also include a discussion of required disclosures.
In addition, Treasury and the IRS are tackling modifications to the allocation and accounting regulations they proposed Sept. 26. The rules set forth standards for “mixed-use” facilities, which in addition to governmental use, have private business use in excess of the 10% permitted for tax-exempt private-activity bonds. The rules would allow issuers to finance mixed-use facilities with a combination of municipal bonds and “qualified equity,” which can come from taxable bonds or other funds.
“The proposed regulations that are out there are complex, but provide much-needed flexibility,” Clark said. “People are still sorting through how they would apply to particular situations. Treasury has been cooperative; they’ve been very open to comments and suggestions, and we plan to send some more.”
NABL also will be working on comments about older revenue procedures that deal with reissuance and qualified management contracts, according to Clark.
“People who practice in [the nonprofit sector], particularly in the health care field and educational field, tell us that the way these management contracts are drafted has evolved significantly in the last 10 years,” he said. “That’s a project that’s worth doing … to see if there are suggestions that can be made to modernize [Rev. Proc. 97-13].”
In general, NABL wants to continue “to make progress on our efforts at raising our profile and credibility with our government regulators,” Clark said. “We’ll continue to do the best job we can to provide credible, technical comments and suggestions in response to proposed regulations and legislation, and other initiatives and questions that get thrown at us from time to time.”