American Recovery And Reinvestment Act: Bank Qualified Bonds Expanded

For many 501c3 non-profits, the bank qualified (BQ) provisions

will be the most important tax-exempt bond changes contained in the

American Recovery and Reinvestment Act of 2009 (the "Recovery

Act"). These changes will enable many non-profits to

potentially lower the borrowing rate on their new bonds or to

privately place debt with banks in tax-exempt financings of up to

$30,000,000.

Section 265 of the Internal Revenue Code (the "Code")

was amended in the 1986 Tax Act to make it disadvantageous for

banks to purchase and hold tax-exempt bonds. Basically, the bank

loses its deduction for its interest expense on its own borrowings

in an amount proportional to the amount of interest it receives on

its tax-exempt bonds. The economic result is that banks are not

able to take advantage of tax-exempt bond interest.

Section 265 of the Code contains an exception to this rule for

governmental bonds or 501c3 non-profit bonds known as the

"small issuer exception." If the issuer (together with

certain subordinate entities of the issuer) issues not more than

$10,000,000 of such tax-exempt bonds in a given calendar year, then

the issuer can designate the bonds for special treatment under

Section 265. Under this special tax treatment, a bank can receive

80% of the benefit of the tax-exempt interest on the BQ bonds. This

treatment makes BQ bonds attractive to banks.

The Recovery Act (Section 1502) amends the BQ "small issuer

exception" in three important respects for bonds issued in

2009 or 2010. First, it increases the maximum dollar amount under

the exception from $10,000,000 to $30,000,000. This will allow many

more bond issues to obtain BQ status. For example, a college that

wants to build a new academic building for $18,000,000 now has the

ability to finance it through one bond issue that receives BQ

treatment.

Second, with respect to 501c3 bond issues, the Recovery Act

permits the $30,000,000 limit to be applied at the level of the

501c3 borrower rather than at the level of the conduit issuer. For

example, under prior law, a health or education authority wanting

to meet the BQ "small issuer exception" could only issue

up to $10,000,000 in total bonds a year for the benefit of 501c3

entities. This meant that a state or county authority that issues

bonds for many health systems or colleges could never use the BQ

"small issuer exception." Now such authorities can issue

many such bonds on a BQ basis since the $30,000,000 test is applied

at the level of the...