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Government Update: Effects of Tax Reform on Local Government

December 20, 2018

Government Update: Effects of Tax Reform on Local Government

By: Melissa Szot, CPA, CGMA

The Tax Cuts and Jobs Act of 2017 (Public Law 115-97) (“TCJA”) is the most sweeping tax reform measure in more than 30 years. Although many of the changes significantly impact individual and business tax provisions, there were several changes that affect local government entities. Two of the more notable provisions that local governments should be aware of are the repeal of advance refunding of municipal bonds and the repeal of tax-credit bonds.

REPEAL OF ADVANCE REFUNDING OF MUNICIPAL BONDS

Advance refundings are done by municipalities to take advantage of the favorable interest rate environment, which, in turn, reduces the borrowing costs and frees up resources to complete new or ongoing projects. During an advance refunding, the bonds are refinanced by issuing new bonds, of which the proceeds are usually placed into an escrow account to pay future debt service payments on the refunded bonds.

The key difference between a current and advance refunding is timing. If the refunded bonds are issued within 90 days of the call date, these are considered current refunding transactions. However, if they are issued after the 90 days, they are considered an advance refunding.

Under the TCJA legislation, the interest on advance refunding bonds would no longer be tax-exempt. This  is effective for all advance refundings that were issued after December 31, 2017. The legislation did not affect the current refundings, which remain tax-exempt.

REPEAL OF TAX-CREDIT BONDS

A majority of the bonds issued by local governments are tax-exempt bonds. This means the interest payments are not included in the bondholder’s federal taxable income.

A tax-credit bond offers the bondholder a federal tax credit instead of interest. Prior to 2009, the tax-credit bond activity was minimal. However, when the American Recovery and Reinvestment Act  of 2009 (“ARRA”) was implemented, there was a significant influx of tax-credit bonds issued. Some of these bonds include Build America Bonds, Recovery Economic Zone Bonds, Qualified School Construction Bonds, Qualified School Academy Zone Bonds, Clean Renewable Energy Bonds and Qualified Energy Conservation Bonds.

With the TCJA, issuance of all tax-credit bonds after December 31, 2017 is prohibited.