What Is the QZAB Tax Credit and How Do You Claim It?

A Qualified Zone Academy Bond, or QZAB, was a type of tax-credit bond created by the Taxpayer Relief Act of 1997. Its purpose was to allow certain public schools in lower-income areas to borrow money for facility improvements and educational programs at a minimal cost. This was achieved by providing the entity that purchased the bond with a federal tax credit instead of a traditional cash interest payment. While the federal authorization to issue new QZABs has expired, the program’s structure remains relevant for those holding existing bonds and for understanding this unique financing mechanism.

School and Project Eligibility Requirements

For a school to be designated a “qualified zone academy,” it had to meet specific criteria. A primary requirement was its location; the school had to be situated within a federally designated Empowerment Zone or Enterprise Community. Alternatively, a school could qualify if it had a reasonable expectation that at least 35% of its students would be eligible for free or reduced-cost lunches under the National School Lunch Act.

A defining feature of the QZAB program was the mandatory partnership with the private sector. Before issuing the bonds, the school had to secure written commitments from a private entity for a “qualified contribution.” This contribution, which could be in the form of equipment, technical assistance, or student internships, needed to have a present value equal to at least 10% of the bond’s proceeds.

The funds generated from the sale of QZABs were restricted to specific uses. The proceeds could be used for rehabilitating or making repairs to the school building, but not for new construction. Other permissible uses included purchasing equipment, developing new course materials, and financing the training of teachers and other school personnel.

The Bondholder Tax Credit

Eligible holders of these bonds are typically financial institutions such as banks, insurance companies, or other corporations actively engaged in the business of lending money. Unlike conventional municipal bonds that pay tax-exempt interest to investors, QZABs provided the holder with a direct tax credit against their federal income tax liability. This unique arrangement effectively made the financing interest-free for the qualifying school district.

The value of the tax credit was determined by two factors: the face amount of the bond and a specific credit rate. This credit rate was set daily by the U.S. Department of the Treasury for the month in which the bond was issued. The rate was calculated to be sufficient to allow the school to issue the bond without a discount and without paying interest. The bondholder would then receive this credit annually for the term of the bond.

This tax credit mechanism was considered a more direct form of federal subsidy compared to traditional tax-exempt bonds. With tax-exempt bonds, a portion of the benefit is often captured by high-income investors who would have paid higher taxes on other investments.

Claiming the Credit

The holder must file IRS Form 8860, Qualified Zone Academy Bond Credit, with their annual income tax return. This form is the designated instrument for calculating and claiming the tax credit earned from holding the bond.

Completing Form 8860 requires specific information that was established at the time the bond was issued. The bondholder must report details such as the bond’s unique CUSIP number, its face amount, and the original credit rate assigned by the Treasury Department.

The calculated credit from Form 8860 is then carried to the filer’s main income tax form, such as Form 1120 for corporations. It is important to note that the amount of the credit must also be included in the bondholder’s gross income for the year. This inclusion effectively makes the credit itself taxable.