Though the administration said it wants BABs to be a permanent fixture of the muni market, it was silent on the future of other programs stemming from the American Recovery and Reinvestment Act, such as relaxed rules encouraging banks to invest in tax-exempt debt.
In the “Analytical Perspectives” document accompanying the president’s fiscal 2011 budget proposal, the administration said it is recommending that BABs be extended permanently “in a way designed to be approximately revenue neutral in comparison to the federal tax cost from traditional tax-exempt bonds.”
An outline provided by the Treasury Department says that under the proposal, the subsidy rate for BABs would be reduced to 28% from 35%.
In addition to being made permanent, the permitted use of BABs would be expanded. Specifically, state and local governments could issue BABs for refundings and working capital purposes, and 501(c)(3) charitable organizations could also sell them. The administration estimated that reforming and extending BABs would cost $24 million over the next 10 years.
In explaining the push for permanence, the Treasury cited several reasons. First, BABs have enabled muni issuers to access a broader market of investors, such as pension funds, which have no appetite for tax breaks. BABs also provide a more efficient subsidy to issuers than tax-exempt bonds, the Treasury said.
Furthermore, BABs offer a more streamlined compliance framework between issuers and the Internal Revenue Service, and have relieved supply pressures in the tax-exempt market, reducing rates as a result.
“Making the [BAB] program permanent could promote market certainty and greater liquidity,” the Treasury said in its document providing general explanations of revenue proposals.
Charles Samuels, a lawyer with Mintz Levin Cohn Ferris Glovsky & Popeo PC who is counsel to the National Association of Health and Educational Facilities Finance Authorities, was delighted to learn of the expansion of BABs to include charitable organizations.
“It makes sense and ... will assist nonprofit education and health care in a time of great stress,” he said.
However, he noted that the association still strongly supports making permanent an ARRA provision encouraging banks to buy bonds. That measure expanded to $30 million from $10 million the small-issuer limit for bank-deductible bonds through 2010.
Banks can deduct 80% of the cost of buying and carrying the tax-exempt bonds sold by issuers whose annual bond issuance is less than $30 million. In addition, the ARRA extended the application of the $30 million limit to individual borrowers participating in conduit deals.
Samuels said this provision “has been a proven stimulus and jobs promoter all around the country.”
The administration also is sticking to its plan to reinstate the marginal tax rates of the wealthy to 36% and 39.6% beginning in fiscal 2011, a move market participants say could boost demand in munis. The administration would define wealthy as married couples earning over $250,000 and individuals earning $200,000 or more.
The administration also wants to see the “economic substance doctrine,” which has been used in court cases, become statutorily added to the tax code. That doctrine has been applied by courts to disallow tax benefits stemming from transactions that do not meaningfully change a taxpayer’s economic position even if they technically comply with the tax code.
Under the proposal, a 30% penalty would be applied to any tax breaks stemming from a deal lacking economic substance. The penalty would be reduced to 20% if the transactions are adequately disclosed in tax returns or statements attached to returns. That proposal would bring in an estimated $4.24 billion over the next 10 years, according to the budget.
The judicial principle recently came into play when the Court of Federal Claims rejected Wells Fargo & Co.’s attempt to claim a $115 million tax deduction stemming from 26 sale-in, lease-out transactions, 17 of which involved public transit agencies. The court determined the SILO deals lacked economic substance.
On the housing front, the Department of Housing and Urban Development’s budget would slightly decrease in fiscal 2011 to $41.590 billion from $43.581 this fiscal year.
The administration also recommends extending a program that permits states to exchange low-income housing tax credits for federal cash grants through 2010. However, states participating in the exchange would be required to spend any cash obtained from the program on construction or rehabilitation projects by the end of 2012.
The budget also would fully fund the community development block grant program, to the tune of $4.83 billion. However, that is a slight decrease from fiscal 2010, when the program received $4.45 billion.
The budget also would restructure the New York Liberty Zone bond program, but those modifications would affect tax credits for construction or transportation expenditures, and not the bonds, a special type of private-activity bond created to help boost economic development in lower Manhattan after the Sept. 11, 2001, terrorist attacks.