On March 29, 2018, the National Association of Bond Lawyers (NABL) formally requested guidance from the IRS regarding the ability of municipal issuers to issue tax-exempt advance refunding bonds to refund taxable bonds after the enactment of the Tax Cuts and Jobs Act (TCJA). The request comes on the heels of public statements by Treasury and IRS representatives regarding their belief that notwithstanding the passage of TCJA, municipal issuers may continue to issue tax-exempt advance refunding bonds to refund taxable bonds, so long as the taxable bonds to be refunded are not tax-advantaged bonds such as Build America Bonds, and the refunding otherwise complies with the requirements of section 149 of the Code and the regulations thereto.
TCJA amended Section 149 of the Code to explicitly prohibit the issuance of a tax-exempt bond after December 31, 2017 to advance refund another bond. As revised, the section reads as follows: “Nothing in section 103(a) or in any other provision of law shall be construed to provide an exemption from Federal income tax for interest on any bond issued to advance refund another bond.” An advance refunding bond is any bond issued more than 90 days before the bond which it is refunding is redeemed.
The revised language of section 149, when read literally, would appear to prohibit the issuance of any advance refunding bond, including bonds issued to advance refund a prior, taxable bond. So why would NABL request guidance that a different interpretation should apply – and, for that matter, why would representatives of the IRS and Treasury make public statements agreeing with NABL’s position?
The answer lies in the legislative history of TCJA and the prior 1986 Code. Congress has viewed with disfavor tax-exempt advance refundings, because they result in multiple issues of tax-exempt bonds outstanding at the same time. Until the prior bond which is to be advance refunded reaches its call date, the holders of that bond continue to receive interest payments which are exempt from federal income tax. Thus, during that period Congress effective subsidizes the same tax-exempt project twice. As a result, Congress previously limited the number of advance refundings that an issuer may undertake for a particular bond issue, to one.
This concern is not present with a tax-exempt advance refunding of a prior taxable bond that is not a tax-advantaged bond. In this situation, only one tax-exempt bond is outstanding, and there is no doubling of the subsidy associated with the tax exemption for the interest paid by the issuer. Consequently, under regulations in effect before the passage of TCJA the IRS generally permitted the tax-exempt advance refunding of a prior taxable bond, so long as the transaction was not undertaken to avoid the limitation on advance refundings.
Thus, NABL is requesting that this exception to the general prohibition on advance refundings be continued. Assuming the IRS formally confirms that this is the position of the agency, issuers will be able to issue tax-exempt, advance refunding bonds to refund a prior series of bonds, if the prior series was federally taxable and not a tax-advantaged bond, and the bonds otherwise comply with the requirements of the IRS regulations on advance refundings.