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Blake Christian
Blake Christian

Build America Bonds

Federal subsidies and tax advantages.

October 29, 2009
by Blake Christian, CPA/MBT

The 2009 Federal Stimulus Package made new Build America Bonds (BABs) available to state and local governments. The purpose of these bonds is to stimulate state and municipal capital spending by allowing the issuing governments to cost effectively finance infrastructure projects, thereby creating jobs, stimulating local and regional businesses and reinvigorating communities. In addition to the following tax advantages, the federal subsidies may be appealing to some investors.

BABs come in two basic forms:

1. BAB Federal Tax Credit Bonds — Investors receive periodic interest payments and periodic federal tax credits in the amount of:

  • 35 percent times
  • gross bond coupon interest.

Therefore, an investor holding a $100,000 BAB with a six-percent coupon will receive annual gross interest of approximately $6,000 and can then claim a federal tax credit equal to $2,100 [($6,000 x 35 percent credit rate]. See IRS Notice 2009-26 and IRS Form IRS Form 8912 (currently in draft Form for 2009).

2. BAB Federal Subsidy Bonds — The federal government pays either 35 percent or 45 percent (in Recovery Zones) of the coupon interest amount directly to the state or local government agency. The higher 45-percent subsidy is only allowed for projects in economically challenged regions such as Enterprise Zones, Renewal Communities and Empowerment Zones.

Unlike other governmental bonds, the gross interest earned on these bonds is still fully taxable for federal and most state purposes; however, the tax credits available under the BAB Federal Tax Credit Bonds can offset the federal tax on the related interest income, or other taxes, including Alternative Minimum Tax. Another benefit to both types of BABs is that the interest income received from BABs is not subject to AMT for the first two years.

Since their implementation by the Treasury in early April, these bonds have quickly caught on. Total BAB project funding exceeds $35.6 billion for the first six months and involves over 443 projects. Since April 2009, BABs represent approximately 20 percent of the local municipal bond funding of projects.

Higher populated states have garnered the larger project funding (albeit not exactly proportional to population). Examples include:

California — 33 bond issues totaling $7.9 billion
Florida — 12 bond issues totaling $1.3 billion
Illinois — 55 bond issues totaling $2.9 billion
New Jersey — Eight issues totaling $1.9 billion
New York — Six issues totaling $2.5 billion
Texas — 30 issues totaling $6.3 billion

The Build America Bond projects cover a wide range of infrastructure upgrades. A sampling of larger projects include: $1.75 billion of MTA and other public works infrastructure in New York City, $1.2 billion of highway improvements in Texas, $1 billion of improvements to the University of California system, and $600 million of sewer upgrades in Chicago.

Review a complete list of all 443 BAB projects here.

And it is not only the big states and urban areas that have benefited under these newest of federally-sponsored financing tools — BABs have also funded approximately $1 billion of Native American tribal land assistance, $400 million of Kansas public-school enhancements and $100 million of Louisiana hospital and nursing home improvements. In total, 39 states have now taken advantage of the Build America Bonds Program.

Senate Finance Committee Chairman Charles Rangel (NY-D) is a big fan of BABs and is considering extending the program beyond 2010. “These bonds give city and state governments a new, direct injection of capital to jumpstart infrastructure projects that will create jobs and improve neighborhoods and towns across our nation.” Patrick McCoy, NY MTA Director of Finance added: “The Build America Bond program allowed the MTA access to significant capital resources at a critical moment in the MTA’s finances. These bonds will allow MTA to save $46 million over 30 years …”

In addition to the tax benefits to investors and the access to project funding for municipalities, BABs can be an attractive investment option for individual, corporate and pension investors. According to Oppenheimer & Company’s Los Angeles Managing Director and Cash Management Expert, Vincent Woo: “What initially started as an investment product geared towards the institutional investor, including pension funds and sovereign entities, has quickly gravitated towards the retail or individual investor. In one of the toughest credit market I’ve ever experienced, I have seen corporate bond spreads widen out significantly to the point where the yields have become quite attractive but if you can receive corporate like spreads in the BABs with the enhanced creditworthiness of municipalities over uncollateralized corporate bonds, I would say that is a safer investment bet for the individual investor looking for yield.”

Conclusion

With the still tight credit markets and ongoing unemployment concerns, BABs offer welcome relief to state and local government agencies as well as construction companies and workers.

For additional information about Build America Bonds, also see Charles Swenson’s article.

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Blake Christian, CPA/MBT, is a tax partner in the Long Beach, California office of HCVT, LLP. Christian is also co-founder of National Tax Credit Group, LLC.