To promote the provision of disaster relief and the development (or redevelopment) of economically distressed areas, Congress will at times enact targeted bond programs that authorize the issuance of specialized tax-exempt bonds. Tax-exempt targeted bond programs frequently contain both a cap on the amount of tax-exempt bonds that can be issued under the program and an expiration date. For example, in response to Hurricane Katrina, Congress permitted the issuance of tax-exempt Gulf Opportunity Zone Bonds, which were subject to an aggregate volume cap of about $14.8 billion and which had to be issued before January 1, 2012.
Where a tax-exempt targeted bond program features volume cap limitations or issuance deadlines (or both) and is silent about whether bonds issued under the program can be currently refunded on a tax-exempt basis, uncertainty might exist as to whether program bonds can be currently refunded by tax-exempt bonds issued after the expiration of the program and, if such refunding bonds can be issued, whether they require additional volume cap. The IRS has previously rendered guidance on specific targeted bond programs to address these questions. To achieve efficiency and uniformity in this guidance for existing and future tax-exempt targeted bond programs that are silent regarding refunding matters, the IRS yesterday released Notice 2019-39. This Notice sets forth helpful guidance on the tax-exempt current refunding of bonds issued under a targeted bond program, but it also creates unwarranted confusion regarding the tax-exempt current refunding of Build America Bonds. For more on both of these aspects of the Notice, read on.
Notice 2019-39 allows certain tax-exempt current refunding bonds to be issued to refinance bonds issued under a targeted bond program without regard to whether the program has expired and without the need for additional volume cap. The Notice, in effect, allows the initial legislative gift of a tax-exempt targeted bond program to live past the program’s expiration date.
This administrative gift does have some strings attached. Volume cap and issuance deadlines are waived for bonds that currently refund tax-exempt targeted program bonds only where: (1) the targeted program bonds were issued with the required volume cap allocation and before any applicable issuance deadline; (2) the current refunding issue satisfies all applicable requirements to be issued on a tax-exempt basis (aside from volume cap and any original issuance deadline); and (3) the issue price of the current refunding issue does not exceed the outstanding stated principal amount of the refunded targeted program bonds. This helpful, clear guidance applies to current refunding issues that are issued on or after May 22, 2019, and it can be applied at the election of the issuer to current refunding issues that were issued before that date.
To the bafflement of many (or at least to the authors of this post), Notice 2019-39 includes Build America Bonds within the scope of tax-exempt targeted bond programs. The issuance of BABs was not subject to any volume cap, but there was a deadline – no BABs could be issued after December 31, 2010. BABs are not, however, tax-exempt bonds. BABs could be issued either to afford a tax credit to the bondholders (no such BABs were issued) or a direct-payment subsidy to the issuer (many such BABs were issued). The IRS lacks the ability to authorize the issuance of BABs after December 31, 2010, so the inclusion of BABs within the scope of Notice 2019-36 cannot mean that bonds that currently refund BABs are themselves BABs. Moreover, the December 31, 2010 issuance deadline applies to BABs, not to any tax-exempt bond, including tax-exempt bonds that currently refund BABs. Thus, in this instance there is no ambiguity regarding the potential application of an issuance deadline that Notice 2019-39 must resolve.
It’s unclear why Notice 2019-39 extends to bonds that currently refund BABs. Because BABs must satisfy the requirements for issuance as tax-exempt bonds, it is self-evident that BABs can be currently refunded by an issue of tax-exempt bonds. Perhaps the IRS was trying to make even clearer a point that is manifestly clear, but it has succeeded instead in creating uncertainty. It is absurd to conclude that tax-exempt bonds can be issued to currently refund BABs only if the issue price of the current refunding bonds does not exceed the outstanding par amount of the BABs (which would mean that interest through the call date of the BABs and issuance costs would need to be financed from sources of funds other than tax-exempt bonds). Notice 2019-39, however, could potentially be interpreted in this manner. A clarification from the IRS on this point is in order.
 If, however, the tax-exempt targeted program bonds were issued with more than a de minimis amount of original issue discount or premium, the present (no pun intended) value of the refunded targeted program bonds will be used instead of their outstanding stated principal amount.
 This would also contradict the IRS’s position in Notice 2009-26 that direct-payment BABs cannot be issued to refund other obligations.