IRS Announces Rules for Separating Tax Credits and Qualified Tax Credit Bonds

April 12, 2010

On March 23, 2010, the Internal Revenue Service (IRS) released IRS Notice 2010-28 (Notice), that provides guidance on how issuers may properly separate the ownership of qualified tax credit bonds (QTCBs) and the entitlement to the tax credit associated with these bonds, and how such “stripping” transactions are to be reported to the IRS. A QTCB is a taxable municipal obligation that generally allows the holder to receive a non-refundable credit against the holder’s federal income tax liability.

The American Recovery and Reinvestment Act of 2009 authorized billions of dollars in QTCBs, which include qualified forestry conservation bonds, new clean renewable energy bonds, qualified energy conservation bonds, qualified zone academy bonds, and qualified school construction bonds. Federal law permits the ownership of QTCBs to be separated from the entitlement to the associated tax credit, and the Notice provides guidance to effectuate such a separation.

Generally, the Notice identifies four requirements that must be satisfied in order to separate tax credits from QTCBs.

  1. On or before the date of issuance of the underlying QTCBs, the issuer must state in the bond documents that the tax credits are subject to separation from the underlying bonds.*
  2. The issuer must identify the issue of QTCBs as a “strippable” issue on the first information return filed with the IRS with respect to the QTCB issue.*
  3. The issue of QTCBs must be issued in registered or “book-entry” form.
  4. Separate CUSIP numbers must be assigned to the issue of QTCBs, to all rights to receive tax credits on each credit allowance date, and to all rights to receive cash (i.e., principal and interest, if any) with respect to the QTCB issue.

*QTCBs issued prior to March 31, 2010, and failing to meet the bond document designation requirement and/or the information return requirement may meet these respective requirements retroactively by designating such QTCBs as strippable bonds in the bond documents, filing an amended information return with the IRS identifying the QTCBs as strippable bonds, and listing the required CUSIP numbers. Any such corrective designation or amended return filing must be effected prior to May 17, 2010, in order to comply with the Notice.

The ability to separate the entitlement to receive a tax credit from the underlying QTCB is expected to improve the marketability of such obligations by attracting certain investors who have a specific interest in a tax credit without the associated bond.

If you have any questions regarding the separation of tax credits from QTCBs or about QTCBs in general, please contact one of the authors, or visit McGuireWoods’ public finance practice website. You also can refer to prior alerts on, and recent changes to, QTCBs and other newly available financing tools, such as Build America Bonds, Recovery Zone Economic Development Bonds, and Recovery Zone Facility Bonds, in our news archive and the Stimulus Package section of our website.