In March 2026, the Internal Revenue Service (IRS) released proposed guidance aimed at clearing up lingering questions around arbitrage rules and the treatment of certain bond proceeds. While technical in nature, the takeaway for bond issuers and conduit borrowers is straightforward: this guidance is intended to provide clarity and reduce unintended compliance risk—not introduce new hurdles.

Of significant note, the proposed guidance makes clear that in order to accomplish a “reallocation” of an expenditure from one source (bond proceeds) to another source (taxable proceeds or equity), the source to which the expenditure is being allocated must be held or present on the date of the expenditure. This means, to reallocate bond proceeds away from a “bad cost,” an issuer or borrower must have at least an equal portion of other funds on the date the expenditure is made; there must be money in the right and left pocket.

Also, many issuers rely on State and Local Government Series (SLGS) securities as a safe, compliant way to temporarily invest bond proceeds and avoid arbitrage concerns. The IRS’s proposed rules formally clarify that when SLGS demand deposit securities roll into short term (90 day) Treasury certificates, those certificates are still treated as tax exempt bonds for arbitrage purposes.

Why This Matters

Without these clarifications, issuers worried that routine SLGS mechanics could unexpectedly trigger arbitrage rebate or yield restriction requirements. Also, the clarifications provide certainty for reallocation analysis.

Helpful Context for Refunding Transactions

The guidance is part of a broader IRS effort focused on tax exempt refunding bonds, including certain student loan bond structures. Refunding transactions often involve short term investment of proceeds, making arbitrage considerations especially important. By tightening and clarifying definitions, the IRS is giving issuers and their advisors more confidence when structuring these deals.

Importantly, practitioners quoted in the Bond Buyer note that these proposed rules are not expected to have a broad or disruptive impact across the municipal bond market. Instead, they are designed to codify positions the IRS has communicated informally over time and to address specific fact patterns that previously caused concern.

What Issuers and Borrowers Should Do Now

At this stage, the guidance is still proposed and subject to a comment period. However, issuers and borrowers can take comfort in knowing that:

• The IRS is signaling a practical approach to arbitrage compliance;
• Common SLGS investment practices are being explicitly recognized and protected;
• Any impact is likely to be transaction specific, not systemic; and
• Issuers and borrowers should analyze current and upcoming transactions to be confident sufficient sources other than bond proceeds exist if a reallocation will be desirable.

Bond issuers should continue working closely with bond counsel and financial advisors to monitor developments and assess whether the final rules have implications for specific financings.

This publication is intended for general information purposes only and does not and is not intended to constitute legal advice. The reader should consult with legal counsel to determine how laws or decisions discussed herein apply to the reader's specific circumstances.