H.R. 1, The American Recovery and Reinvestment Act of 2009 (the “Act”), contains numerous provisions that affect bonds issued by states and political subdivisions. 501(c)(3) organizations will be the beneficiaries of some of the amendments made to existing law. The Act liberalizes the rules governing the use of tax-exempt bonds to benefit such entities. Consequently, the use of tax-exempt bonds as a source of funding for capital projects undertaken in 2009 and 2010 has become an option worth more consideration for 501(c)(3) organizations.
The amendments to the Internal Revenue Code make tax-exempt bonds potentially more attractive to investors, which could lead to lower interest rates. 501(c)(3) entities may now borrow up to $30 million – an increase from $10 million - for capital projects in 2009 and 2010 and designate such obligations as “bank qualified” – a designation that will allow financial institutions that purchase such bonds to avoid certain deduction disallowance provisions otherwise applicable to many tax-exempt bonds. The net effect is that a bank that invests in bank qualified 501(c)(3) bonds will no longer be penalized for owning tax-exempt bonds.
Additionally, the bank qualification designation will be easier to come by for two reasons. First, the limitation will be calculated treating a 501(c) (3) beneficiary of such bonds as the “issuer” for tax purposes, not the governmental entity that actually issues the bonds, as was formerly the case. This means that 501(c)(3) entities will not be in competition with general governmental organizations for the bank qualification designation. Second, the $30 million is to be calculated on a user by user basis instead of on a jurisdictional basis as under the prior law. Effectively this means that multiple 501(c)(3) entities within a jurisdiction have the potential to benefit from up to $30 million each of bank qualified bonds.
Many traditional lending considerations exist in the context of the use of tax-exempt bonds. A 501(c)(3) entity that wishes to use such a financing vehicle must still be deemed creditworthy by potential bond purchasers. And, since the arrangement is a loan, the money must be paid back. The principal benefit of the changes to tax law is that more 501(c) (3) organizations may be able to qualify for treatment that will enable them to get lower interest rates than would have been possible under prior law.
501(c)(3) bonds are also subject to numerous rules and requirements under federal and state law and anyone considering their use should seek the advice of bond counsel early on in the process to assess the usefulness of this financing option.