On March 1, 2013, President Obama signed an executive order, as required by the Budget Control Act of 2011 and the American Taxpayer Relief Act of 2012, reducing the spending authority in accounts subject to sequestration in accordance with the report issued by the Office of Management and Budget. The order requires that spending for all accounts in the “domestic mandatory spending” category, which includes interest subsidy payments to issuers of build America bonds and other so-called “direct pay bonds,” be reduced for the current federal fiscal year. This category includes five types of direct pay bonds—build America bonds (including recovery zone economic development bonds), qualified zone academy bonds, qualified school construction bonds, qualified energy conservation bonds and clean renewable energy bonds. The President’s March 1 order does not affect interest subsidy payments for future years, although under the Budget Control Act of 2011 there could be additional sequester orders for future fiscal years through and including FY 2021.

On March 4, 2013, the office of Tax Exempt Bonds within the Internal Revenue Service (IRS-TEB) released a statement entitled Effect of Sequestration on Certain State & Local Government Filers of Form 8038-CP, providing details regarding the implementation of the President’s sequester order with respect to direct pay bonds for the balance of the current federal fiscal year.

According to the IRS-TEB release, interest subsidy payments made to issuers of direct pay bonds on or after March 1, 2013, through and including September 30, 2013, will be reduced 8.7 percent, unless Congress takes action subsequently to change the reduction percentage. IRS-TEB has advised that issuers of direct pay bonds should continue to complete IRS Form 8038-CP as directed in the instructions for the form and has noted that issuers will receive correspondence concerning the subsidy payment reduction after they file the form.

A copy of the IRS-TEB statement can be found here.

In light of the implementation of sequestration, issuers of direct pay bonds may want to consider whether and to what extent they are currently in a position to exercise a special or extraordinary call right (if any) under the terms governing their direct pay bonds. The answer to this question will turn in part on the specific language creating a special call right in the relevant bond document or statutory authorization, and on the economics of refinancing the direct pay bonds from other sources and paying the redemption price associated with the call of those bonds.