WASHINGTON — The National Association of Bond Lawyers is suggesting that the Internal Revenue Service revisit the methodology used to calculate adjusted applicable federal rates for tax-exempt bonds.

The comments are in response to Notice 2013-4 which requested comments from the public on different methods of determining adjusted AFRs, which was published in February.

“We agree with the IRS to modify the methodology for computing the tax exempt AFR and make sure that it would never be equal to or higher than the regular AFR,” said Scott Lilienthal, NABL president and partner with Hogan Lovells. AFRs are important for debt to debt exchanges where parties can renegotiate the terms of the debt, Lilienthal said.

Each month since 1986 the IRS has published the adjusted AFRs based on a calculation that looks at the general obligation of tax-exempt bonds and the composite yield of Treasury obligations. When the AFR provision was first adopted in the tax code, the intended result was to reflect the “difference between comparable tax-exempt and taxable obligations, without factoring in credit quality,” NABL wrote.

“As credit spreads between highly-rated tax-exempt obligations and U.S. Treasuries [have] widened, the application of the adjustment factor in determining adjusted AFRs has led to unintended results,” NABL said.

For example, in February 2013 the short-term, long-term and mid-term adjusted AFRs all exceeded the corresponding AFRs.

NABL said of all the options the IRS suggested, the group supports determining future adjusted AFRs using a modified adjustment factor that is based on federal tax rates applicable to interest on federally-taxable municipal obligations. For the purposes of determining an appropriate tax rate, NABL suggested that the Service use the highest marginal individual tax rate.

“Such an approach would be simple to apply and consistent,” the group wrote. “NABL recognizes that there is some rough justice in using the highest marginal income tax rate; however, there is much to be said for simplicity in administration.”

This is the first time the IRS has sought comments on modifying calculations for adjusted AFRs, Lilienthal said.

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