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Tax Reform Takes Aim at the Municipal Securities Market

November 6, 2017

Only one week after Congressman Kevin Brady, Chairman of the House Ways and Means Committee, announced "very strong bipartisan support" for the preservation of the tax exemption for municipal bonds,1 H.R. 1 — the Tax Cuts and Jobs Act — was introduced in the House of Representatives on November 3, 2017 with provisions that, if enacted into law, would eliminate significant segments of the tax-exempt bond market.2 While H.R. 1 represents only the first step in the legislative process, special budget reconciliation rules will allow the Senate to enact tax reform with a simple majority, rather than the typical 60 vote filibuster-proof total, greatly enhancing the likelihood that Congress will be able to get a tax reform bill to the President's desk.

H.R. 1 would terminate the issuance of four types of tax-exempt or tax-advantaged bonds: private activity bonds, advance refunding bonds, tax credit bonds, and bonds for professional stadiums, as outlined below. Even if enacted into law, state and local governments would still be permitted to issue all of these categories of bonds; however, such issuances would be on a federally taxable basis.

Termination of Private Activity Bonds3

No private activity bonds could be issued on a tax-exempt basis on or after January 1, 2018. Private activity bonds include a broad range of sectors together representing a significant proportion of total municipal bond volume each year. While many private activity bonds are issued specifically for the benefit of particular private sector firms that otherwise would issue debt on a taxable basis, many other types of private activity bonds are issued for public facilities or purposes that, while involving more than a de minimis amount of private sector participation, are more generally viewed as providing a public good. Categories of private activity bonds that could no longer be issued on a tax-exempt basis include, among others:4

  • Private not-for-profit hospitals and other healthcare-related facilities (governmentally-owned hospitals could continue issuing tax-exempt bonds)
  • Private not-for-profit colleges, universities and other educational institutions (governmentally-owned institutions like state universities and community colleges could continue issuing tax-exempt bonds)
  • Other types of not-for-profit institutions
  • Many charter schools, depending on their legal status in particular jurisdictions
  • Privately-owned low- and moderate-income multifamily housing developments
  • Single-family mortgage programs for first-time homebuyers
  • Airport and seaport facilities, even if governmentally-owned
  • Certain mass transportation facilities
  • Private utilities or waste disposal facilities, as well as certain governmentally-owned facilities that significantly benefit one or a small number of private sector entities
  • Other private commercial enterprises in distressed communities
  • Many state and local government debt components of public-private partnership (P3) arrangements where the governmental bond component would be private activity bonds

Although private activity bonds generally are thought of as financings fitting into these and other specific categories of projects, the various private activity bond tests under the federal tax code would continue to apply and financings for governmentally-owned facilities would still need to be evaluated against these tests to ensure that they are not considered private activity bonds that no longer qualify for tax-exempt financing.

Repeal of Advance Refunding Bonds5

No advance refunding bonds could be issued, even for purely governmental purposes, on a tax-exempt basis on or after January 1, 2018.6 Advance refunding bonds consist of bonds issued to refinance previously-issued bonds where the advance refunding bonds are issued more than 90 days prior to the redemption of the bonds being refinanced. Depending on current market rates, refundings can make up as much as half of the entire municipal bond volume in a given year, although a portion of those refundings consist of current refundings (where outstanding bonds are redeemed in 90 days or sooner) that could still be undertaken on a tax-exempt basis under the bill.

While state and local governments issue refunding bonds for various purposes, the primary reason typically is to achieve interest cost savings if market rates have dropped (or if the issuer's credit profile has improved appreciably) since the initial issuance. These refinancings at lower rates can save considerable taxpayer money over the life of a bond-financed capital project. Under H.R. 1, for a governmental bond issue with a traditional 10-year no call provision, such bond issue could not be refinanced with tax-exempt bonds until 9 years and 9 months after initial issuance — that is, the issuer's interest rates for all bonds outstanding on or after January 1, 2018 (including currently existing bond issues and new offerings after that date) would be locked-in for so long as the bonds are in their no-call period (subject to the permitted 90-day escrow period). This is likely to accentuate issuers' hesitancy to incur indebtedness to finance public infrastructure during periods of higher interest rates since they will have significantly limited alternative options for seeking to reduce their debt service burden if market rates drop in the future.

Repeal of Tax Credit Bonds7

No tax credits would be allowed for any clean renewable energy bonds, qualified tax credit bonds or Build America Bonds issued on or after January 1, 2018. Qualified tax credit bonds include qualified forestry conservation, energy conservation, zone academy, and school construction bonds. Although many of these categories of bonds already could not be issued due to their legislative authorization, H.R. 1 would terminate issuances of all categories of these tax credit bonds and would remove these provisions from the federal tax code. In addition, with the elimination of private activity bonds, the bill would terminate the ability to use the low-income housing tax credit (LIHTC) in conjunction with the issuance of tax-exempt bonds, although the LIHTC would be retained as a stand-alone credit.

No Tax-Exempt Bonds for Professional Stadiums8

No professional stadium bonds could be issued on a tax-exempt basis, even if qualified as a purely governmental offering, on or after November 2, 2017 (the date on which H.R. 1 was introduced). Professional stadium bonds are defined as any bond issued to finance or refinance capital expenditures for a facility or related real property used for as few as five days per year as a stadium or arena for professional sports exhibitions, games or training. Tax-exempt private activity bonds for sports stadiums had previously been eliminated.

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State and local governments, not-for-profit hospitals or other healthcare organizations, private universities and colleges, and other private sector entities that benefit from the issuance of tax-exempt bonds may wish to contact their Clark Hill attorneys to discuss in greater detail the potential ramifications of H.R. 1 and to consider what action they can take to help persuade Congress to take a different approach to tax reform that does not eliminate these important bond financing tools. Congress intends to act swiftly on this legislation and many trade associations are launching intensive action plans to reverse or narrow this unexpected course of action before the bill gets enacted into law. We can help you to connect with the appropriate association so you can take action to save your tax-exempt financing alternative or simply to keep abreast of developments.

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If you have any questions regarding this alert, please contact Ernesto A. Lanza, Kevin F. Kelly, Charles R. Spies, or your Clark Hill attorney.



1 Speaking at the Securities Industry and Financial Markets Association's Annual Capital Markets Conference, as quoted in the Bond Buyer on October 23, 2017. For a discussion of the history of the municipal tax exemption, see Clark Hill PLC Client Alert, "Tax Reform and the Forgotten Context of the Municipal Tax Exemption," February 27, 2017.

2 The "Chairman's mark" offered on the morning of November 6, 2017 for purposes of the House Ways and Means Committee markup, available here, did not modify the municipal bond provisions of the bill as originally introduced.

3 H.R. 1, Section 3601.

4 The tax law names for the categories of terminated private activity bonds include exempt facility bonds, mortgage revenue bonds, qualified small issue bonds, qualified student loan bonds, qualified redevelopment bonds, and qualified 501(c)(3) bonds.

5 H.R. 1, Section 3602.

6 A similar prohibition on advance refunding certain categories of private activity bonds on a tax-exempt basis has existed since the last major revision to the federal income tax code in 1986.

7 H.R. 1, Section 3603.

8 H.R. 1, Section 3604.

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