Global Tax Blog

By Gary Bornholdt

Under the Internal Revenue Code of 1986 (the “Code”), the interest on bonds issued by State and local governments generally is excluded from gross income for federal income tax purposes.  This exclusion lowers the borrowing costs for State and local governments because purchasers are willing to accept a lower rate of interest on tax-exempt bonds than they could receive on taxable bonds.  The exclusion generally does not apply, however, to a bond that is guaranteed directly or indirectly by the Federal government (or by its agencies and instrumentalities).

The Housing and Economic Recovery Act of 2008 (the “Act”) created the first new exception to the prohibition on federal guarantees since 1984.  Specifically, the Act permits the Federal Home Loan Bank to provide credit enhancement on a tax-exempt bond during the period from July 30, 2008 through December 31, 2010, without causing such bond to be treated as federally guaranteed under the Code.  It is important to note that this provision applies only to a Federal Home Loan Bank guarantee provided in made in connection with the “original issuance” of a tax-exempt bond.  For this purpose, an original issuance includes the refunding of an outstanding bond or a bond that is “reissued” under general tax principles.

By providing issuers of tax-exempt debt with access to credit enhancement provided by the Federal Home Loan Bank system, this provision can lower the borrowing costs of the beneficiaries of tax-exempt financing, including State and local governments, section 501(c)(3) organizations, and certain other private parties.