State and Local Governments: New IRS Guidance Opens the Door for Direct Payment Build America Bonds

April 8, 2009

On April 3, 2009, the Internal Revenue Service (IRS) issued Notice 2009-26 (the Notice), which provides highly-anticipated guidance on the Build America Bond (BAB) program.

A BAB is a new type of municipal bond authorized under the American Recovery and Reinvestment Act of 2009 (the Act). The BAB program is intended to promote economic development by reducing borrowing costs for state and local government issuers. Under the BAB program, issuers may choose to finance governmental projects by issuing Direct Payment BABs. Direct Payment BABs are bonds (i) which pay market-rate taxable interest to the bond holder and (ii) with respect to which the federal government pays directly to the issuer a subsidy payment of 35% of the interest paid by the issuer on each payment date. (Alternately, issuers may elect to issue Tax Credit BABs. Tax Credit BABs provide a non-refundable tax credit to bond holders on each interest payment date in an amount equal to 35% of the interest payable by the issuer on that date.)

Proceeds of Direct Payment BABs may only be used to finance capital expenditures that otherwise could be financed with a governmental tax-exempt bond, such as costs incurred to acquire, construct, or improve land, buildings, and equipment. Direct Payment BAB proceeds may not be used to finance any working capital expenses, such as operating expenses. Direct Payment BAB proceeds generally may not be used to refinance existing indebtedness, but may be used to reimburse capital expenditures that were (1) paid or incurred after February 17, 2009, and (2) financed originally with temporary short-term financing issued after February 17, 2009.

To receive the direct subsidy, an issuer must use Form 8038-CP to request payment of the credit within a prescribed time surrounding each applicable interest payment date. The exact timing depends on whether the BABs are fixed- or variable-rate bonds. Issuers should expect to receive payments within 45 days after the Form 8038-CP is filed. The IRS will be prepared to accept Form 8038-CP for processing by May 1, 2009, and the IRS and Treasury Department will be prepared to make timely payments with respect to interest payment dates around July 1, 2009.

With the issuance of the Notice, state and local government issuers now have the necessary guidance to enable them to begin issuing Direct Payment BABs.

The Notice contains additional technical details describing the procedures to be satisfied before an issuer is eligible to receive the direct subsidy payments. If you have any questions regarding BABs, these procedures, the Notice, or the state and local government financing provisions of the Act in general, please contact our Public Finance group or one of the authors. You can also refer to our Stimulus Package section for more updates on the Act.