When Overburdening isn’t a Burden

Cindy Mog recently reacquainted us with abusive arbitrage devices, including the factors that evidence overburdening of the tax-exempt bond market (issuing bonds too early, issuing too many bonds, and issuing bonds with an excessive weighted average maturity) and factors that countervail what would otherwise constitute overburdening (bona fide cost underruns, bona fide need to finance extraordinary working capital items, and an issuer’s long-term financial distress).

The IRS released a timely private letter ruling (PLR 202309014) on March 3 that analyzes the foregoing factors. This private letter ruling deals with whether an issue of long-term working capital (re)financing bonds was subject to the proceeds-spent-last rule and whether the issue overburdened the tax-exempt bond market. The IRS concluded that the issue was not subject to the proceeds-spent-last rule and did not overburden the tax-exempt bond market, because the issue refinanced extraordinary, nonrecurring working capital expenditures that were not covered by insurance or a reserve fund.

Perhaps if Cindy writes a post on tax-exempt advance refunding bonds, Congress will enact a law that restores them.

Abusive Arbitrage Devices – It’s Time to Get Reacquainted

(Episode 3 – What Happens to the Arbitrage Sinners and the Arbitrage Saints?)

As you may remember, in Episode 1 we discussed some background regarding the prohibition against abusive arbitrage devices and the policy behind that prohibition – to encourage investment of tax-exempt bond proceeds in long-lived, tangible assets, while discouraging the generation of arbitrage on the investment of such proceeds.  In Episode 2 we discussed the three factors the federal government examines to determine whether an issuer has overburdened the tax-exempt bond market, which results in an abusive arbitrage device if the issuer has also successfully exploited the difference between taxable and tax-exempt interest rates.  In this episode, we will describe the penalties imposed upon rule-breakers and the rewards offered to rule-followers.

What happens if you have an abusive arbitrage device?  The tax-exempt bonds become taxable arbitrage bonds.   Thus, issuers of tax-exempt bonds will want to be mindful of the rules (i.e., the guardrails) set by the federal government to avoid an abusive arbitrage device.  A more fun way to think about it is that, given the serious consequences of straying off of the envisioned path, issuers will want to drive the old-fashioned cars at the amusement park that keep you on track, rather than the Dodgems. 

What happens if you follow the arbitrage rules?  The tax-exempt bonds will remain tax-exempt (assuming, of course, that all non-arbitrage rules governing tax-exempt bonds are followed).  As a bonus, the issuer may also qualify for an exception to rebate and be able to retain its positive arbitrage.  For a detailed description of the various spending exceptions to rebate, please tune in to our spin-off rebate miniseries which will be coming soon to the Public Finance Tax Blog. 

What is the moral of the arbitrage story for issuers?  Know the basic rules.  Reach out to your favorite tax-exempt bond lawyer at SPB to make sure you are complying with the finer points of the basic rules.  Invest and spend your tax-exempt bond proceeds wisely and efficiently while adhering to the rules, and you may end up with both tax-exempt bonds and arbitrage that you can keep. 

The end.

Abusive Arbitrage Devices – It’s Time to Get Reacquainted

(Episode 2 – Overburdening (Generally) Not Allowed)

As you may remember, in the first episode, we discussed how the federal government’s primary goal in subsidizing tax-exempt bonds is to encourage investment by issuers in long-lived, tangible assets. We also discussed how the federal government has tried to keep issuers on the intended path by preventing them from exploiting the difference between the tax-exempt and taxable markets. Finally, we noted that bonds will generally be taxable arbitrage bonds if the issuer has successfully exploited the difference between tax-exempt and taxable interest rates and has also overburdened the tax-exempt bond market.

This episode will discuss the three rules intended to prevent the overburdening of the tax-exempt bond market – (1) You shall not issue too early; (2) You shall not issue too much; and (3) You shall not issue for too long. 

Why would you issue too early?   To take advantage of a low interest rate environment.  For example, an issuer might not have a capital project for Year 1 when interest rates are low, but anticipates having a capital project in Year 3 when interest rates might be higher.  The rule imposed by the federal government to prevent the issuer from issuing tax-exempt bonds too early is a requirement that the issuer reasonably expect on the issuance date of the tax-exempt bonds that it will spend at least 85% of the spendable proceeds within three years of the issuance date.  Even though the test involves “reasonable expectations,” remember that hindsight is always 20/20, and thus issuers should strive to actually meet this goal.  

Why would you issue too much?  To take advantage of a low interest rate environment. If an issuer reasonably expects that the proceeds of its tax-exempt bond issue will exceed the governmental purpose of the issue by more than $100,000, that constitutes evidence that the issuer overburdened the tax-exempt bond market by issuing too many tax-exempt bonds. Thus, it is best to avoid having over $100,000 of unspent proceeds upon completion of the bond-financed project. Unexpected excess sale and investment proceeds of the tax-exempt bond issue can be used to redeem or defease bonds of the issue to comply with this $100,000 limitation on unspent proceeds.

Why would you issue for too long?  To take advantage of a low interest rate environment, and possibly for cash flow reasons (i.e., to defer principal payments).  If the weighted average maturity (WAM) of the bond issue exceeds 120% of the weighted average economic life of the assets financed by the bond issue, that is evidence that the issuer overburdened the tax-exempt bond market by letting its bonds remain outstanding too long.  In other words, the federal government does not want issuers issuing 30-year tax-exempt bonds to finance computers with a 5-year useful life (unless, of course, the amortization of the bonds is front-loaded, such that the WAM of the bond issue does not exceed 6 years).

When overburdening isn’t actually overburdening.  Even if an issuer satisfies one or more factors discussed above, the issuer’s action will be excused (meaning that no overburdening will be deemed to occur) if the issuer can demonstrate that the action was necessitated by factors such as unexpected construction delays, bona fide cost underruns, a bona fide need to finance extraordinary working capital expenditures (e.g., a litigation settlement), or the issuer’s long-term financial distress.  Exceptions.  They are what keep tax lawyers employed. 

Preview of Episode 3 – What Happens to the Arbitrage Sinners and the Arbitrage Saints?

Next week’s Season Finale will discuss what happens to issuers that violate the arbitrage rules, along with some potential rewards for the rule-followers.

Stay tuned . . .

Abusive Arbitrage Devices – It’s Time to Get Reacquainted

(Episode 1 – Background and Arbitrage Basics)

Sometimes it is a good exercise to remind ourselves of some basic rules governing tax-exempt bonds.  One such rule is that bonds are taxable arbitrage bonds if an “abusive arbitrage device” is used in connection with the bonds.  An abusive arbitrage device is any action that has the effect of: (1) enabling the issuer to exploit the difference between tax-exempt and taxable interest rates to obtain a material financial advantage; and (2) overburdening the tax-exempt bond market.[1]  (Keep in mind that an “abusive arbitrage device” is only one specific type of “arbitrage bond.”  We chose to cover abusive arbitrage devices because they are of renewed relevance and they touch on many arbitrage concepts.)  The first element of an abusive arbitrage device has been difficult (to the point of impossibility) to satisfy since Mad Men first aired.[2]  However, the Federal Reserve’s hawkish monetary policy has now made it much easier to exploit the difference between tax-exempt and taxable interest rates.  Thus, it’s time to get reacquainted (or acquainted, depending on where you are in your career) with the concept of abusive arbitrage devices.  The Public Finance Tax Blog is here to help, with a three-part mini-series of posts on this topic.

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I Know It When I See It – What is a Capital Expenditure?

Window with a view.

According to Wikipedia, the fount of all knowledge, the phrase “I know it when I see it” is a colloquial expression by which a speaker attempts to categorize an observable fact or event, although the category is subjective or lacks clearly defined parameters.   This phrase was famously used in a U.S.  Supreme Court decision to describe the threshold test for obscenity.  (See Jacobellis v. Ohio, 378 U.S. 184 (1964)).  Although this blog post will, unfortunately, likely not become as well known as the Jacobellis case, it will discuss, “What is a Capital Expenditure?”  My guess is that a lot of tax-exempt bond advisors use intuition when determining that certain expenditures qualify as “capital expenditures” for tax-exempt bond purposes.   In other words, they know a capital expenditure when they see one.   However, the question as to what constitutes a “capital expenditure” under the tax-exempt bond rules may be difficult to answer at times.

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Toll-Free Telephone TEFRA Hearings Available Permanently

The IRS will permanently allow state and local governments to hold public hearings using a toll-free telephone number to satisfy the TEFRA hearing requirement for private activity bonds.[1] No in-person option will be required to satisfy the TEFRA public hearing requirement, but state and local governments must continue to follow applicable local laws, which may require public meetings to be held in person.

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“Administrative History?” – President Releases Guidebook for Infrastructure Law

Following in the footsteps of pioneers such as Matthew Lesko, the White House has released a guidebook to the funding available under the Infrastructure Investment and Jobs Act. (It should be at least somewhat more authoritative than Gobs and Gobs of Free Stuff,[1] at least as it pertains to the legislation in question.)

The approach in the Infrastructure Investment and Jobs Act to providing funding for state and local infrastructure focused on grants and direct aid, and new borrowing programs were somewhat limited. While its precedential status in the courts remains an open question, the guidebook is an essential tool for state and local governments in determining whether their projects are eligible for federal funds and, if so, how much money they can get. The guidebook weighs in at a doorstop-y 465 pages, but the real star of the show is the sortable spreadsheet of programs, which is available here: https://www.whitehouse.gov/build/. We are known here for our unrepentant bias in favor of spreadsheets, but the efficiency of the spreadsheet of programs will be obvious to even the most ardent skeptic.


[1] 3rd ed. (August 1, 1996).

Even When it Comes to the Mundane Forms 8038, the One Constant is Change

To all of our readers, Belated Happy New Year!  We will ring in 2022 with some belated news.  Back in November of 2021, the IRS once again issued a memorandum that extends the ability to use an electronic or digital signature on Form 8038 (Tax-Exempt Private Activity Bond Issues), Form 8038-G (Tax-Exempt Governmental Obligations) and Form 8038-GC (Small Tax-Exempt Governmental Obligations).  This current extension will remain in effect until October 31, 2023.  (I have no idea why Halloween (of 2023) was selected as the deadline, but it should be easy to remember!).  In additional good news, when announcing this most recent extension on its website, the IRS stated that it is considering further extensions, but needs to balance the convenience of electronic signatures against the possibility of identity theft and fraud.   This enquiring mind is curious as to who is filing fraudulent Forms 8038, and what benefit are they getting by doing so? Continue Reading

Telephonic TEFRA hearings are now available through March 31, 2022

On November 4, 2020, we all thought that the COVID-19 pandemic was going to be long over by now. We certainly did not think we were going to get so far down the Greek alphabet of variants of this virus. And, this author certainly did not think that she was going to have to keep looking up what the next letter of the Greek alphabet is.  Now we are at mu, and there does not seem to be an end in sight.

It seems like when the IRS issued Revenue Procedure 2020-49, it thought that the COVID-19 pandemic was going to be over by now too.  As a reminder, on November 4, 2020, the IRS issued Revenue Procedure 2020-49, which allowed telephonic TEFRA hearings to continue through September 30, 2021.  Specifically, during this period, a governmental unit can meet the TEFRA requirement that the public hearing be held in a convenient location for affected residents by affording the general public access to the hearing by toll-free telephone call.[1]

With September 30th right around the corner, public finance tax attorneys were starting to get nervous[2] about whether these hearings were going to have to be in-person as cases are back on the rise.  We can all breathe a sigh of relief because yesterday the IRS has further extended the period during which telephonic TEFRA hearings can be held in lieu of in-person TEFRA hearings until March 31, 2022 through issued Revenue Procedure 2021-39.

Hopefully this will be the last extension that we need, and we won’t have variants that start sounding like sororities.

[1] The authors of this blog are still explaining to people what constitutes a toll-free number.

[2] More nervous than we usually are.

A “Good” Tax-Advantaged Bond Bill Tells Issuers Whether They Can Refund – A Case Study

This is the second in a series of posts about neutral principles that make for “good” tax-advantaged bond legislation.

We pick up our series as the Senate prepares for a final vote on a bipartisan infrastructure bill in the coming days. In the last post, we stated the general rule that a good piece of tax-advantaged bond legislation tells issuers how and when they can refund bonds issued under any new bond program. Here’s an example in current law to illustrate the point.

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