State and Local Governments – New IRS Guidance Regarding Recovery Zone Economic Development Bonds and Recovery Zone Facility Bonds

June 19, 2009

On June 12, 2009, the Internal Revenue Service (“IRS”) issued Notice 2009-50 (the “Notice”), which provides guidance on the Recovery Zone Economic Development Bond (“RZEDB”) and Recovery Zone Facility Bond (“RZFB”) programs. In accordance with the American Recovery and Reinvestment Act of 2009 (the “Act”), the Notice allocates the $10 billion national RZEDB limitation and the $15 billion national RZFB limitation among the states and counties and large municipalities (i.e., municipalities with populations of more than 100,000) within each state in accordance with their relative declines in employment in 2008. A list of the suballocations to counties and large municipalities within each state may be found here.

The RZEDB and RZFB programs are intended to promote job creation and economic recovery in areas referred to as recovery zones. Recovery zones generally include areas designated by the local jurisdiction as having significant unemployment or as otherwise being economically distressed.

A RZEDB is a special type of direct payment Build America Bond (see our previous news item relating to Build America Bonds), available exclusively for governmental projects. RZEDBs, however, provide a greater federal subsidy to issuers than direct payment Build America Bonds and are subject to different requirements relating to eligible uses of proceeds. Issuers of RZEDBs receive a federal subsidy payment of 45 percent of the interest payable (compared to 35 percent for the direct payment Build America Bonds). Proceeds of RZEDBs may be used for qualified economic development purposes in a recovery zone, including capital expenditures paid or incurred for property in a recovery zone, expenditures for public infrastructure and construction of public facilities and expenditures for job training and educational programs. RZEDB proceeds may be used to refinance existing indebtedness only if the original expenditures were (i) paid or incurred after February 17, 2009, and (ii) 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 period of time surrounding each applicable interest payment date.

A RZFB is a new category of exempt facility bond under Section 142 of the Internal Revenue Code. Therefore, RZFB proceeds may be used for private activity purposes, including projects owned by private non-profit and for-profit entities. Proceeds of RZFBs may be used to finance recovery zone property, which includes depreciable property (i) constructed, reconstructed, renovated or acquired by purchase by the taxpayer after the date on which the recovery zone designation took effect, (ii) the original use of which in the recovery zone commences with the taxpayer and (iii) substantially all of the use of which is in a recovery zone and is in the active conduct of a qualified business by the taxpayer. In general, any trade or business constitutes a qualified business, subject to certain limitations on the rental to others of real property and exceptions for businesses operating golf courses, country clubs, massage parlors, hot tub and suntan facilities, racetrack or other gambling facilities and stores the principal business of which is the sale of alcoholic beverages for consumption off premises.

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

The Notice contains additional technical details describing the RZEDB and RZFB programs. If you have any questions regarding RZEDBs or RZFBs, 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 authors listed. Please visit our Stimulus Package section for more updates on the Act.