The federal government’s automatic spending cuts, referenced informally as “sequestration”, went into effect on Friday, March 1, 2013. According to guidance issued on March 4, 2013, by the Tax-Exempt Bond Office of the Internal Revenue Service (the “Service”), federal subsidy payments authorized for issuers of direct-pay tax credit bonds will be reduced by the “sequestration reduction rate” of 8.7%. The following types of direct-pay tax credit bonds will be affected by sequestration: (i) Build America Bonds (“Build America Bonds”), including Recovery Zone Economic Development Bonds (“Recovery Zone Bonds”), (ii) Qualified School Construction Bonds, (iii) Qualified Zone Academy Bonds, (iv) New Clean Renewable Energy Bonds, and (v) Qualified Energy Conservation Bonds.

In 2009 and 2010, many issuers in Alabama took advantage of the American Recovery and Reinvestment Act of 2009 (the “Recovery Act”), which was intended to stimulate the capital markets available to issuers of traditional tax-exempt bonds. As an alternative to tax-exempt bonds, the Recovery Act allowed state and local governments to elect instead to issue taxable bonds and to receive cash subsidy payments directly from the Secretary of the Treasury to offset a specified portion of the interest payments due under qualifying bonds. The Recovery Act provided subsidy payments equal to 35% of the interest payments on Build America Bonds and 45% of the interest payments on Recovery Zone Bonds; the subsidies for the other forms of direct-pay tax credits bonds varied by classification.

As a result of sequestration, the subsidy payments due from the Secretary of the Treasury for all issuers of Build America Bonds and Recovery Zone Bonds will be prorated (that is, reduced) by 8.7% for the remainder of the fiscal year ending September 30, 2013, unless otherwise determined by Congress. This subsidy reduction will apply to subsidy payments claimed by an issuer on any Form 8038-CP filed with the Service “which results in a payment to such issuer on or after March 1, 2013.”

Because many claims for subsidy payments with respect to interest payments due on March 1 and April 1 have already been filed and processed by the Service, bonds with interest payments due on May 1 are most likely to be the first ones affected by sequestration. Where the Secretary of the Treasury has already paid the full amount of the subsidy for interest payments that were due and payable “on or after March 1, 2013,” it remains to be seen whether the Service will attempt to offset the excess against future subsidy payments.

Maynard & Gale’s public finance attorneys have experience with direct-pay tax credit bonds and are familiar with the issues created by sequestration. Please contact us if we can provide advice or assistance with respect to the subject of this alert or with other public finance questions.