What Is Tax Code 150 for Tax-Exempt Bonds?

The Internal Revenue Code (IRC) serves as the comprehensive body of federal tax law in the United States. Within this extensive framework, Section 150 specifically addresses the regulations surrounding tax-exempt bonds. This section outlines various definitions and rules that govern whether the interest earned on certain bonds can be excluded from federal income tax for bondholders.

Purpose and Scope of Section 150

Section 150 of the Internal Revenue Code establishes the framework for determining which bonds issued by state and local governments can provide tax-exempt interest to investors. This enables public entities to borrow funds at lower interest rates, facilitating the financing of public projects. Investors accept a lower yield on these bonds due to the federal income tax exemption on the interest received.

Section 150 defines key terms like “bond,” “governmental unit,” and “net proceeds.” Understanding this section is important for both bond issuers and investors to ensure compliance and benefit from the tax exemption.

Classifications of Tax-Exempt Bonds

Section 150, alongside other IRC provisions, distinguishes between different types of bonds primarily based on the use of the bond proceeds. The two main classifications are “governmental bonds” and “private activity bonds.” Governmental bonds are generally issued to finance traditional public purposes, such as the construction of roads, schools, public buildings, and water systems. Interest on these bonds is typically tax-exempt if they do not meet the criteria for private activity bonds.

In contrast, private activity bonds are those where a significant portion of the bond proceeds, often exceeding 10%, is used by or for the benefit of a private business or entity, or if the debt service is secured by payments from a private business. While interest on governmental bonds is broadly tax-exempt, private activity bonds must meet specific additional requirements to retain their tax-exempt status, becoming “qualified private activity bonds.” Examples of qualified private activity bonds include those for airports, certain housing projects, and hospitals. These bonds are subject to strict limitations on their use and must serve a public benefit despite private involvement.

Ongoing Compliance for Tax-Exempt Bonds

Maintaining the tax-exempt status of bonds after issuance requires continuous adherence to federal tax rules, as outlined in Section 150 and related regulations. One important area of compliance involves “arbitrage restrictions,” which prevent issuers from profiting by investing bond proceeds at a materially higher yield than the bond’s yield. Issuers must calculate and, if necessary, rebate any such arbitrage profits to the U.S. Treasury.

Another aspect of ongoing compliance is managing “private business use limitations.” Governmental bonds must ensure that private use of bond-financed property remains below certain thresholds, generally 10%, to avoid reclassification as private activity bonds. If private use exceeds these limits, the tax-exempt status of the bonds could be jeopardized. For certain private activity bonds, public approval requirements must also be met before issuance. Issuers are required to maintain thorough records and submit information to the IRS to demonstrate ongoing compliance.