Bank Qualified Bonds Primer Bank Qualified Bonds Primer

Bank Qualified Bonds Primer

The general rule in Section 265 of the Internal Revenue Code is a financial institution cannot deduct interest expense on tax-exempt bonds in its portfolio.
 
IRC 265(b) provides an exception to this general rule for interest expense on “qualified tax-exempt obligations” (or “bank-qualified issues”) issued by “qualified small issuers” (“BQ Bonds”):
 
  • 501(c)(3) borrowers may borrow using bank-qualified 501(c)(3) bonds issued through a qualified small issuer (that is, a governmental issuer that does not reasonably expect to issue more than $10 million in tax-exempt bonds during a calendar year).
  • Obligations that count toward the $10 million limit (the “BQ Limitation”) include tax-exempt governmental use bonds and 501(c)(3) bonds. Other kinds of tax-exempt bonds, for example tax-exempt bonds issued to finance exempt facilities (e.g. low income housing, airports, docks and wharves) or manufacturing facilities, do not count against the BQ Limitation.
  • Under the 2009 Stimulus Act, 501(c)(3) borrowers were treated as issuers of bonds with separate authority to issue BQ Bonds through a conduit governmental issuer without regard to whether the governmental issuer would qualify as a “qualified small issuer.”  This authority expired at the end of 2010.
  • The governmental issuer must designate the bonds as BQ Bonds. This designation typically occurs in a resolution or ordinance of the governing body and should be reiterated in the tax documents signed in connection with the issue.
The interest rate payable by a financial institution for BQ Bonds will typically be lower than the rate it would pay for non-BQ Bonds.
 
For projects over $10 million, where a borrower seeks to finance an eligible project with BQ Bonds, there are several potential strategies (all of which should be reviewed with bond counsel):
 
  • Spread tax-exempt financing over more than one calendar year, where BQ Bonds can be issued by a qualified small issuer in both years. In such a case, if costs are to be paid from borrower equity in advance of a borrowing, the borrower should adopt a resolution evidencing its intent to reimburse itself with the proceeds of tax-exempt bonds. In addition, the sale of the two issues should be separated by at least 15 days in order to ensure the bonds are treated as separate series.
  • Issue BQ tax-exempt and taxable bonds at the same time, and refund the taxable bonds with BQ tax-exempt bonds in a subsequent calendar year. 
  • Utilize separate issuers (for example, two or more port authorities) that may act as qualified small issuers to issue BQ Bonds to fund the project.
For more information about bank qualified bonds, contact a member of Ice Miller’s Municipal Finance Group.
 
This publication is intended for general information purposes only and does not and is not intended to constitute legal advice. The reader must consult with legal counsel to determine how laws or decisions discussed herein apply to the reader's specific circumstances.
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