Impact of the American Recovery and Reinvestment Act of 2009 on the Public Finance Community

On February 17, 2009, the President signed the American Recovery and Reinvestment Act of 2009 (the "Stimulus Act") into law.  Several provisions of the Stimulus Act affect state and local governments and may present new financing opportunities.  The Stimulus Act contains a number of other provisions that grant certain tax credits designed to encourage development, and provisions that provide financial relief to state and local governments generally.  This advisory provides a brief  summary of the provisions of the Stimulus Act that pertain to municipal bonds.

If you have any questions regarding the Stimulus Act or its possible impact on your activities and operations, please contact a member of Sherman & Howard's public finance group:

Denver Office:  - Main Number:  (303) 297-2900

Reno Office: - Main Number:  (775) 323-1980

The Stimulus Act creates a new category of tax credit bonds and provides additional authority for three categories of existing tax credit bonds.  In particular, the Stimulus Act creates qualified school construction bonds ("QSCBs") and provides additional authority for qualified zone academy bonds ("QZABs"), new clean renewable energy bonds ("NCREBs"), and qualified energy conservation bonds ("QECBs").  Tax credit bonds are designed to provide the holders thereof with an annual tax credit in lieu of interest that typically accrues quarterly; the amount of the annual credit being determined by multiplying the applicable tax credit rate by the applicable principal amount of the bond.

a.  Qualified School Construction Bonds

QSCBs are tax credit bonds issued for the construction, rehabilitation, or repair of a public school facility or for the acquisition of land on which such a facility is to be constructed.  In order to qualify, all of the available project proceeds (excess of sale proceeds over costs of issuance (not to exceed 2%), plus investment earnings on such excess) (hereinafter "Available Project Proceeds") of the issue have to be spent for the preceding purposes, the bonds must be issued by a state or local government within the jurisdiction of which the school is located, and the issuer must designate the bonds as QSCBs.  The Stimulus Act establishes a national bond limitation of $11 billion for QSCBs for each of 2009 and 2010, which is allocated among the States in proportion to the respective amounts each State is eligible to receive under Section 1124 of the Elementary and Secondary Education Act of 1965 for the most recent fiscal year ending before such calendar year.

Notwithstanding the foregoing, 40 percent of the national bond limitation for QSCBs must be allocated among "large local educational agencies," defined generally as (i) the 100 local educational agencies with the largest numbers of children aged 5 through 17 from families living below the poverty level or (ii) one of not more than 25 local educational agencies that the Secretary of Education deems to be in particular need of assistance, based on a low level of resources for school construction, a high level of enrollment, or certain other factors.  State allocations are reduced by the amount of any allocations to "large local educational agencies" within such State.  Also, see Section 7 below for information regarding the prevailing wage requirement that must be met with respect to projects financed by QSCBs.

b. Qualified Zone Academy Bonds

QZABs are tax credit bonds issued by qualified issuers for the benefit of "qualified zone academies."  Generally speaking, a school is a qualified zone academy if (i) the school is a public school that is designed or has a program designed to cooperate with business to enhance the academic curriculum, increase graduation and employment rates, and better prepare students for the rigors of college and the workforce; (ii) students in the school or program will be subject to the same academic standards as other students educated in the school; (iii) the comprehensive education plan of the school or program is approved by the eligible local education agency; and (iv) such school is located in an empowerment zone or enterprise community or there is a reasonable expectation that at least 35 percent of the students attending the school or participating in such program will be eligible for free or reduced-cost lunches.  The Stimulus Act increases the national bond limitation for QZABs from $400 million to $1.4 billion for 2009 and sets the national bond limitation at $1.4 billion for 2010.  The national bond limitation is allocated among the States on the basis of their respective populations of individuals below the poverty line. 

Ninety-five percent of QZAB proceeds must be spent for "qualified purposes," generally defined as (i) the rehabilitation or repair of public school facilities; (ii) providing equipment for use in such school facilities; (iii) developing course materials for education to be provided in such public school facilities; and (iv) training teachers and other school personnel in such school facilities.  The issuer of such bonds must be a state or local government within the jurisdiction of such qualified zone academy, the bonds must be designated as QZABs, and certain private contributions having a present value of not less than 10 percent of the proceeds of the issue must be obtained prior to issuing QZABs.  Also, see Section 7 below for information regarding the prevailing wage requirement that must be met with respect to projects financed by QZABs issued after the effective date of the Stimulus Act.

c. New Clean Renewable Energy Bonds

NCREBs are tax credit bonds issued by qualified issuers to finance facilities that generate electricity from wind, closed-loop biomass, open-loop biomass, geothermal or solar, small irrigation, landfill gas, trash combustion, or hydropower.  Qualified issuers are defined as public power providers, cooperative electric companies, governmental bodies, clean renewable energy bond lenders, or not-for-profit electric utilities which have received a loan or loan guarantee under the Rural Electrification Act.  The Stimulus Act authorizes an additional $1.6 billion for NCREBs.  Of this authorization, not more than one-third may be allocated to qualified projects of public power districts, not more than one-third may be allocated to qualified projects of governmental bodies, and not more than one-third may be allocated to qualified projects of cooperative electric companies.  All of the Available Project Proceeds of NCREBs issues must be spent on the qualified renewable energy facilities described above, and the issuer must designate such bonds as NCREBs.  Also, see Section 7 below for information regarding the prevailing wage requirement that must be met with respect to projects financed by NCREBs.

d. Qualified Energy Conservation Bonds

QECBs are tax credit bonds issued by qualified issuers for qualified conservation purposes.  The term "qualified conservation purpose" means:

(i) capital expenditures incurred for purposes of reducing energy consumption in publicly-owned buildings by at least 20 percent; implementing green community programs; rural development involving the production of electricity from renewable energy resources;  or any qualified facility (other than Indian coal and refined coal production facilities), as defined in Section 45(d) of the Internal Revenue Code of 1986, as amended (the "Code");

(ii) expenditures with respect to research facilities, and research grants, to support research in (a) development of cellulosic ethanol or other nonfossil fuels, (b)     technologies for the capture and sequestration of carbon dioxide produced through the use of fossil fuels, (c) increasing the efficiency of existing technologies for producing nonfossil fuels, (d) automobile battery technologies and other technologies to reduce fossil fuel consumption in transportation, or (e) technologies to reduce energy use in buildings;

(iii) mass commuting facilities and related facilities that reduce the consumption of energy, including expenditures to reduce pollution from vehicles used for mass commuting;

(iv) demonstration projects designed to promote the commercialization of (a) green building technology, (b) conversion of agricultural waste for use in the production of fuel or otherwise, (c) advanced battery manufacturing technologies, (d) technologies to reduce peak use of electricity, or technologies for the capture and sequestration of carbon dioxide emitted from combusting fossil fuels in order to produce electricity; and

(v) public education campaigns to promote energy efficiency.

QECBs were originally authorized in the fall of 2008 as a component of the TARP legislation.  The Stimulus Act increases the national limitation for QECBs from $800 million to $3.2 billion. 

Generally speaking, allocations of QECBs will be made to the States in proportion to the population of the States.  However, the Stimulus Act requires that "large local governments" be allocated a portion of such State's allocation which bears the same ratio to the State's allocation as the population of such large local government bears to the population of such State.  The term "large local government" is defined as any municipality or county if such municipality or county has a population of 100,000 or more.

QECBs may be issued by State or local governments.  Indian tribal governments may also issue QECBs to the extent such bonds are issued for purposes that satisfy the present law requirements for tax-exempt bonds of tribal governments, and may be able to issue QECBs for any qualified conservation purpose depending on the future interpretation of the impact of the Stimulus Act's provisions on tribal economic development bonds.  All of the Available Project Proceeds of a QECB issue must be used on one or more qualified conservation purposes and the issuer must designate such bonds as QECBs.  Also, see Section 7 below for information regarding the prevailing wage requirement that must be met with respect to projects financed by QECBs.

2. Build America Bonds
The Stimulus Act creates a so-called "taxable bond option" for issuers of traditional tax-exempt governmental bonds.  Styled as "Build America Bonds" ("BABs"), an issuer may irrevocably elect to treat any bond (other than a private activity bond) issued before January 1, 2011, the interest on which would otherwise qualify to be tax-exempt under Section 103 of the Code as a taxable bond.  Any taxpayer holding a BAB on any interest payment date during any taxable year would be entitled to receive a tax credit equal to 35 percent of the amount of the interest payable by the issuer of the bond on such date.  Alternatively, the issuer may elect to receive the credit directly so long as 100 percent of the excess of the Available Project Proceeds over the amounts in a reasonably required reserve are to be used for capital expenditures and the issuer irrevocably elects to receive the credit instead of the bondholder.  The intent of this program appears to be to provide issuers with the ability to issue bonds into the larger taxable market, yet still have an overall borrowing cost that is the same as, or lower than, what its cost of borrowing would be in the traditional tax-exempt market.  It is unclear at this time whether such a market for BABs will develop in a way that makes financial sense for traditional governmental issuers.

3. Recovery Zone Bonds

The Stimulus Act creates new classes of taxable bonds and tax-exempt bonds to stimulate economic development in specified "recovery zones."  The term "recovery zone" is defined as (i) any area designated by the issuer as having significant poverty, unemployment, rate of home foreclosures, or general distress; (ii) any area designated by the issuer as economically distressed by reason of the closure or realignment of a military installation pursuant to the Defense Base Closure and Realignment Act of 1990; and (iii) any area for which a designation as an empowerment zone or renewal community is in effect.  The taxable bonds carry an imbedded tax credit and are called recovery zone economic development bonds ("RZEDBs").  The tax-exempt bonds are a new form of exempt facility bond and are called recovery zone facility bonds ("RZFBs").

The Stimulus Act creates a national bond limitation of $10 billion for the RZEDBs and a national bond limitation of $15 billion for the RZFBs.  The Secretary of the Treasury is authorized to allocate the bond limitations for each type of bond among the States in the proportion that each such State's 2008 State employment decline bears to the aggregate of all States' 2008 State employment declines, provided no State shall receive less than 0.9 percent of each respective limitation.  The term "2008 State employment decline" means, with respect to any State, the excess (if any) of (i) the number of individuals employed in such State determined for December 2007 over (ii) the number of individuals employed in such State determined for December 2008.  Each State must then reallocate its allocation of the limitation for each type of bonds among the counties and large municipalities (populations in excess of 100,000) in such State in the proportion that each such county's or municipality's 2008 employment decline bears to the aggregate of the 2008 employment declines for all of the counties and municipalities in such State.

a. Recovery Zone Economic Development Bonds

RZEDBs are defined as any BAB if 100% of the excess of the Available Project Proceeds over the amounts in a reasonably required reserve are to be used for qualified economic development purposes.  The term "qualified economic development purposes" means expenditures for purposes of promoting development or other economic activity in a recovery zone, including (i) capital expenditures paid or incurred with respect to property located in such zone, (ii) expenditures for public infrastructure and construction of public facilities, and (iii) expenditures for job training and educational programs.  The issuer is entitled to receive a credit equal to 45 percent of the interest paid on RZEDBs on each interest payment date, payable directly from the U.S. Treasury.  Also, see Section 7 below for information regarding the prevailing wage requirement that must be met with respect to projects financed by RZEDBs.

b. Recovery Zone Facility Bonds

RZFBs are defined as any bond issued as part of an issue in which (i) 95 percent or more of the net proceeds of such issue are to be used for recovery zone property; (ii) such bond is issued before January 1, 2011; and (iii) the issuer designates such bond as an RZFB.  The term "recovery zone property" generally means any property that is subject to accelerated cost recovery under the Code if (i) such property was constructed, reconstructed, renovated, or acquired by purchase by the taxpayer after the date on which the designation of the recovery zone took effect; (ii) the original use of which in the recovery zone commences with the taxpayer; and (iii) substantially all of the use of which is in the recovery zone and is in the active conduct of a qualified business by the taxpayer in such zone.  Additionally, the term "qualified business" means any trade or business except that (i) the rental to others of real property located in a recovery zone shall be treated as a qualified business only if the property is not residential rental property and (ii) such term shall not include any trade or business consisting of the operation of any private or commercial golf course, country club, massage parlor, hot tub facility, suntan facility, racetrack or other facility used for gambling, or any store the principal business of which is the sale of alcoholic beverages for consumption off premises.

4. Tribal Economic Development Bonds

In most cases, the ability of Indian tribes to issue tax-exempt bonds is more limited than that of state or local governments.  The proceeds of tribal bonds must be used to fund an "essential government function," which does not include many of the projects that are available to other tax-exempt issuers. 

The Stimulus Act authorizes the Secretary of the Treasury, in consultation with the Secretary of the Interior, to allocate a total of $2 billion of tax-exempt bonds to be issued by tribal governments that are not subject to the "essential government function" requirement.  Such bonds will be designated by the tribal government as tribal economic development bonds ("TEDBs") and will be tax-exempt if the same bonds would be tax-exempt if issued by a state or local government.  However, TEDBs may not be used to fund certain gaming facilities or facilities outside the Indian reservation. 

The Stimulus Act further requires the Secretary of the Treasury to perform a study on the effects of this program within a year and to report the results to Congress, including whether the essential government function test should be removed or modified for all tribal bonds.

5. Changes to Bank Qualification and Other Provisions Affecting Financial Institutions

Generally speaking, banks and other financial institutions may not take tax deductions for much of the interest cost associated with investing in tax-exempt bonds.  In past years, the Code has allowed an exception to this rule that allowed financial institutions to deduct 80 percent of the interest allocable to investments in tax-exempt bonds that are "bank qualified."  For this reason, issuers of bank qualified bonds can often issue bonds that will be purchased by financial institutions with lower interest rates.

Bank qualified bonds are those issued by "qualified small issuers."  Since 1986, a qualified small issuer was one that reasonably anticipated issuing $10 million or less in tax-exempt obligations (with certain exceptions) during the calendar year.  The Stimulus Act raises the $10 million limit for qualified small issuers to $30 million per year for 2009 and 2010.  Thus, any issuer that reasonably anticipates issuing $30 million or less in tax-exempt obligations in 2009 and/or 2010 may issue bank qualified bonds during the applicable year.  Further, for the first time, the Stimulus Act specifies that bonds issued by political subdivisions on behalf of 501(c)(3) organizations do not count against the political subdivision's annual limit, but instead each 501(c)(3) borrower is treated as an "issuer" subject to its own $30 million annual limit.

In addition, the Stimulus Act allows financial institutions to deduct interest allocable to non bank-qualified bonds as if the bonds were bank qualified, but the bonds treated in this manner may not exceed two percent of the financial institution's assets.  This provision applies only to bonds issued in 2009 and 2010, and will not apply to refundings of bonds issued before 2009 as refunding bonds are treated as issued during the year in which the refinanced new money obligation was issued.

6. Limited Repeal of Alternative Minimum Tax Applications to Tax-Exempt Bonds

In past years, interest on tax-exempt private activity bonds was subject to the alternative minimum tax and interest on all tax-exempt bonds was required to be included in calculating the "adjusted current earnings" adjustment applicable to corporations for purposes of computing the alternative minimum taxable income of corporations.  These provisions made the affected tax-exempt bonds less attractive to some investors, which generally led to higher borrowing costs.

The Stimulus Act provides that neither of these alternative minimum tax provisions will apply to bonds issued in 2009 and 2010.  Refunding bonds are considered issued for the purpose of the repeal on the date the refinanced new money obligation was issued.  However, the Stimulus Act also removes the alternative minimum tax applications with respect to bonds issued in 2009 or 2010 to refund bonds that were issued from 2004 through 2008.  This provision will have the greatest impact on private activity bonds but will also affect governmental bonds that are purchased by corporations.

7. Prevailing Wage Requirement

Historically, federal law has not required any particular labor standards be enforced with respect to projects financed with tax-exempt bonds.  However, the Stimulus Act applies the "prevailing wage" requirements applicable to certain federal projects, more commonly known as "Davis Bacon," to projects financed with the proceeds of any NCREB, QECB, QZAB QSCB OR RZEDB issued after the date of enactment of the Stimulus Act.  It should be noted that this requirement is not applied to Clean Renewable Energy Bonds issued pursuant to the statute existing prior to the Stimulus Act (pursuant to Section 54 of the Code) as opposed to New Clean Renewable Energy Bonds that are governed by the Stimulus Act (Section 54C of the Code).

The U.S. Government Printing Office maintains a website explaining the Davis Bacon requirements and setting forth the required wage rates at http://www.gpo.gov/davisbacon/.

8. Qualified Small Issue Private Stimulus Activity Bonds

Prior to the adoption of the Stimulus Act, qualified small issue private activity bonds could be issued to finance manufacturing facilities and directly related and ancillary property; provided that the directly related and ancillary property could not exceed 25 percent of the bond proceeds.  The Stimulus Act provides that bonds issued in 2009 and 2010: (a) may be used to finance facilities that create or produce "intangible property," which consists of many forms of intellectual property; and (b) may be used to finance directly related and ancillary property without regard to the 25% limitation so long as the ancillary property is located on the same site as the manufacturing property.

Sherman & Howard has prepared this advisory to provide general information on recent legal developments that may be of interest. This advisory does not provide legal advice for any specific situation. This does not create an attorney-client relationship between any reader and the Firm. If you want legal advice on a specific situation, you must speak with one of our lawyers and reach an express agreement for legal representation

© 2009 Sherman & Howard L.L.C.                                              February 24, 2009