SECTION 1. PURPOSE

This notice provides guidance on the new Build America Bonds under § 54AA of the Internal Revenue Code (“Code”) and the implementation plans for the re

fundable credit payment procedures for these bonds. This notice includes guidance on the modified Build America Bond program for Recovery Zone Economic Development Bonds under § 1400U–2 of the Code. This notice provides guidance on the initial refundable credit payment procedures, required elections, and information reporting. This notice solicits public comments on the refundable credit payment procedures for these bonds. This notice is intended to facilitate prompt implementation of the Build America Bond program and to enable state and local gov

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issuer ( i.e., the bond coupon interest payment) by 35 percent. See H. R. Conf. Rep. 111–16, 111 ^th Cong., 1 ^st Sess. (February 12, 2009) (“ARRA Conference Report”) at 594; see also id. at 593, n. 146 (original issue discount is not treated as a payment of interest for purposes of determining the credit).

Section 54AA(c)(1) provides that the credit allowed under § 54AA(a) for any taxable year shall not exceed the excess of (1) the sum of the regular tax liability (as defined in § 26(b)) plus the tax imposed by § 55, over (2) the sum of the credits allowable under part IV of subchapter A of chapter 1 (other than subpart C and subpart J). Section 54AA(c)(2) provides that if the credit allowable under § 54AA(a) exceeds the limitation imposed by § 54AA(c)(1) for such taxable year, such excess shall be carried to the succeeding taxable year and added to the credit allowable under § 54AA(a) for such taxable year (determined before the application of § 54AA(c)(1) for such succeeding taxable year). Unused credit may be carried forward to succeeding taxable years. See ARRA Conference Report at 593.

Section 54AA(d)(2)(A) provides that, for purposes of the restrictions against Federal guarantees of tax-exempt bonds under § 149(b), a Build America Bond is not treated as Federally guaranteed by reason of the credit under §§ 54AA(a) or § 6431.

Section 54AA(d)(2)(B) provides that, for purposes of applying the arbitrage restrictions under § 148, the yield on a Build America Bond shall be determined without regard to the credit allowed under § 54AA(a). Accordingly, issuers should calculate the yield on Build America Bonds (Tax Credit) for purposes of the arbitrage rules by applying the rules contained in § 148 and the regulations thereunder without an adjustment for the tax credit taken by bondholders. See ARRA Conference Report at 593.

Section 54AA(d)(2)(C) provides that a bond shall not be treated as a Build America Bond if the issue price has more than a de minimis amount (determined under rules similar to the rules of § 1273(a)(3)) of premium over the stated principal amount of the bond. See ARRA Conference Report at 593. This restriction applies to both Build America Bonds (Tax Credit)

ments, at their option, to issue two general types of Build America Bonds as taxable governmental bonds with Federal subsidies for a portion of their borrowing costs. The subsidies take the form of either tax credits provided to holders of the bonds or refundable tax credits paid to state and local governmental issuers of the bonds. Build America Bonds have different levels of Federal subsidies and program requirements depending on the particular type of bond.

The first type of Build America Bond provides a Federal subsidy through Federal tax credits to investors in the bonds in an amount equal to 35 percent of the total coupon interest payable by the issuer on taxable governmental bonds (net of the tax credit), which represents a Federal subsidy to the state or local governmental issuer equal to approximately 25 percent of the total return to the investor (including the coupon interest paid by the issuer and the tax credit). This type of Build America Bond will be referred to in this notice as “Build America Bonds (Tax Credit).”

The second type of Build America Bond provides a Federal subsidy through a refundable tax credit paid to state or local governmental issuers by the Treasury Department and the Internal Revenue Service (“IRS”) in an amount equal to 35 percent of the total coupon interest payable to investors in these taxable bonds. This type of Build America Bond will be referred to in this notice as “Build America Bonds (Direct Payment).” The level of the 35 percent Federal interest subsidy on Build America Bonds (Direct Payment) is deeper than the corresponding approximately 25 percent Federal interest subsidy on Build America Bonds (Tax Credit).

In addition, § 1401 of ARRA, which added § 1400U–2 of the Code, provides for a third type of Build America Bond (Direct Payment) known as “Recovery Zone Economic Development Bonds,” which provides for a deeper Federal subsidy through a refundable tax credit paid to state or local governmental issuers in an amount equal to 45 percent of the total coupon interest payable to investors in these taxable bonds. This type of Build America Bond will be referred to in this notice as “Recovery Zone Economic Development Bonds (Direct Payment).”

2.2 Build America Bonds (Tax Credit) .

Section 54AA(d) defines the term Build America Bond to mean any taxable state or local governmental bond (excluding a private activity bond under § 141) that meets the following requirements: (1) the interest on such bond would (but for § 54AA) be excludable from gross income under § 103; (2) the bond is issued before January 1, 2011; and (3) the issuer makes an irrevocable election to have § 54AA apply.

In general, Build America Bonds (Tax Credit) may be issued to finance any governmental purpose for which tax-exempt governmental bonds (excluding private activity bonds under § 141) could be issued under § 103 (“tax-exempt governmental bonds”) and must comply with all requirements applicable to the issuance of tax-exempt governmental bonds. Accordingly, Build America Bonds (Tax Credit) may be issued to finance the same kinds of expenditures ( e.g., capital expenditures and working capital expenditures) and may involve the same kinds of financings ( e.g., original new money financings, current refundings, and one advance refunding) as tax-exempt governmental bonds. Similarly, Build America Bonds (Tax Credit) may not be issued for any purposes for which tax-exempt governmental bonds could not be issued under § 103 ( e.g., prohibited second advance refunding issues or pension annuity issues).

Section 54AA(a) provides that if a taxpayer holds a Build America Bond on one or more interest payment dates of the bond during any taxable year, there shall be allowed as a credit against the tax imposed by chapter 1 for the taxable year an amount equal to the sum of the credits determined under § 54AA(b) with respect to such dates. Section 54AA(b) provides that the amount of the credit determined with respect to any interest payment date for a Build America Bond is 35 percent of the amount of interest payable by the issuer with respect to such date. Section 54AA(e) provides that the term “interest payment date” means any date on which the holder of record of the Build America Bond is entitled to a payment of interest under such bond. Accordingly, the tax credit that a taxpayer may claim with respect to a Build America Bond (Tax Credit) is determined by multiplying the interest payment that a bondholder is entitled to receive from the

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suer of such bond (or to any person who makes such interest payments on behalf of the issuer) 35 percent of the interest payable under such bond on such date. Section 6431(d) provides that the term “interest payment date” means each date on which interest is payable by the issuer under the terms of bonds. The ARRA Conference Report indicates that the payment by the Secretary is to be made either in advance or as reimbursement. ARRA Conference Report at 595.

The amount of refundable credit that a state or local governmental issuer may claim with respect to a Build America Bond (Direct Payment) is determined by multiplying the interest payment that is payable by the issuer on an interest payment date ( i.e., the bond coupon interest payment) by 35 percent (or 45 percent in the case of Recovery Zone Economic Development Bonds (Direct Payment)). See ARRA Conference Report at 594 and n. 148 (original issue discount is not treated as a payment of interest for purposes of calculating the refundable credit under this provision).

Section 6431(c) states that for purposes of the arbitrage investment restrictions under § 148, the yield on Build America Bonds (Direct Payment) is reduced by the credit allowed under this section. Accordingly, issuers should calculate the yield on Build America Bonds (Direct Payment) for purposes of the arbitrage rules by applying the rules contained in § 148 and the regulations thereunder, but by reducing the amount of interest paid on the bond by the amount of credit payments received pursuant to § 6431. See ARRA Conference Report at 595.

2.4 Recovery Zone Economic Development Bonds (Direct Payment) .

Section 1401 of ARRA added § 1400U–2 to the Code to authorize state and local governments to issue Recovery Zone Economic Development Bonds (Direct Payment). These bonds are treated as qualified bonds for purposes of § 6431 and they have a deeper refundable credit subsidy than Build America Bonds (Direct Payment) equal to 45 percent of the total coupon interest payable to investors in these taxable bonds.

In particular, § 1400U–2(b) defines the term “recovery zone economic develop

and Build America Bonds (Direct Payment).

Section 54AA(f)(1) provides that, for purposes of the Code, interest on any Build America Bond shall be includible in gross income. Under § 54AA(f)(2), rules similar to the rules of § 54A(f), (g), (h), and (i) shall apply for purposes of the credit allowed under § 54AA(a). Briefly, the referenced provisions under § 54A treat credits as interest includable in gross income, provide special rules for S corporations and partnerships, provide special rules for regulated investment companies and real estate investment trusts, and authorize the Department of the Treasury to promulgate regulations to allow for “stripping” (which is the separation of the ownership of these bonds and the associated tax credits under principles based on § 1286).

Section 54AA(h) grants to the Department of the Treasury broad regulatory authority to prescribe such regulations and other guidance as may be necessary or appropriate to carry out the provisions for Build America Bonds under § 54AA and the refundable credit provisions for these bonds under § 6431.

2.3 Build America Bonds (Direct Payment) .

Section 54AA(g) authorizes Build America Bonds (Direct Payment) that meet the definition of “qualified bonds” to receive a refundable credit under § 6431 in lieu of tax credits under § 54AA and imposes different program requirements. Section 54AA(g)(2) defines the term “qualified bond” to mean a bond that is issued as part of an issue that meets the following requirements: (1) the bond is a Build America Bond; (2) the bond is issued before January 1, 2011; (3) 100 percent of the excess of (i) the available project proceeds (as defined in § 54A to mean sale proceeds of such issue less not more than two percent of such proceeds used to pay issuance costs plus investment proceeds thereon), over (ii) the amounts in a reasonably required reserve fund (within the meaning of § 150(a)(3)) with respect to such issue, are to be used for capital expenditures; and (4) the issuer makes an irrevocable election to have this subsection apply.

In determining a reasonably required reserve fund for purposes of this provision,

the rules under § 148(d)(2) apply. Accordingly, a Build America Bond (Direct Payment) will be an arbitrage bond if the amount of the sale proceeds of such an issue that is part of any reserve or replacement fund exceeds 10 percent of the proceeds. As such, the interest on such bond would not be tax-exempt under § 103 and thus would not be a qualified bond for purposes of this provision. ARRA Conference Report at 596, n. 150.

The eligible uses of proceeds and types of financing for Build America Bonds (Direct Payment) are more limited than for Build America Bonds (Tax Credit). In general, Build America Bonds (Direct Payment) may be issued to finance governmental purposes for which tax-exempt governmental bonds (excluding private activity bonds under § 141) could be issued under § 103, but - pursuant to § 54AA(g)(2)(A) - the excess of available project proceeds over amounts in a reasonably required reserve fund may be used to finance only capital expenditures (as defined in Treas. Reg. § 1.150–1(b)), as contrasted with working capital expenditures. See ARRA Conference Report at 594, n. 147. For this purpose, an eligible financing of capital expenditures includes a reimbursement of capital expenditures under the reimbursement rules contained in Treas. Reg. § 1.150–2. By contrast, Build America Bonds (Direct Payment) generally may not be issued to refinance capital expenditures in “refunding issues” (as defined in Treas. Reg. § 1.150–1). Further, for this purpose, Build America Bonds (Direct Payment) may be used to reimburse otherwise-eligible capital expenditures under Treas. Reg. § 1.150–2 that were paid or incurred after the effective date of ARRA and that were financed originally with temporary short-term financing issued after the effective date of ARRA, and such reimbursement will not be treated as a refunding issue under Treas. Reg. §§ 1.150–1(d) or 1.150–2(g).

Section 6431(a) provides that, for Build America Bonds (Direct Payment) issued before January 1, 2011, the issuer of such bond shall be allowed a credit with respect to each interest payment under such bond which shall be payable by the Secretary. Section § 6431(b) provides that the Department of the Treasury shall pay (contemporaneously with each interest payment date under such bond) to the is

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3.2 Future Development and Refinement of Refundable Credit Payment Procedures .

The IRS and the Treasury Department plan to actively pursue refining the refundable credit payment procedures for Build America Bonds (Direct Payment) and Recovery Zone Economic Development Bonds (Direct Payment) for 2010 and thereafter to achieve as workable and efficient a system as possible that is consistent with all necessary and appropriate compliance safeguards. In this regard, the IRS and the Treasury Department plan to study the feasibility of moving these direct payment procedures to an electronic platform similar to that used by the Bureau of Public Debt to make recurring electronic payments on U.S. Treasury securities, such as U.S. Treasury Securities of the State and Local Government Series (“SLGs”) with which state and local governments are familiar. The IRS and the Treasury Department expect that any development or usage of an electronic platform for these direct payment procedures will include ongoing compliance safeguards that involve periodic information returns on these bonds at least annually.

3.3 Tax Character and Procedural Framework for the Refundable Credit .

In general, the refundable credits for Build America Bonds under § 6431 are payments that are treated as overpayments of tax. In this regard, § 1531(c)(5) of ARRA adds a reference to Build America Bond provisions under § 6431 as a conforming amendment to § 6401(b)(1) regarding amounts treated as overpayments. Similarly, § 1531(c)(4) of ARRA adds a reference to the provisions under § 6431 to § 6211(b)(4)(A) regarding treatment of erroneous payments of credits as negative amounts of tax or deficiencies. Accordingly, rules relating to overpayments of tax, such as credits against liabilities in respect of an internal revenue tax and offsets under § 6402, interest on overpayments of tax under § 6611, and limitations on credits or refunds of overpayments of tax under § 6511 also apply to credit payments with respect to Build America Bonds under § 6431. Pursuant to the broad legislative regulatory authority under § 54AA(h) to prescribe such regulations and other guidance as may be necessary or appropriate

ment bond” to mean a bond that is issued as part of an issue that meets the following requirements: (1) the bond is a Build America Bond; (2) the bond is issued before January 1, 2011; (3) 100 percent of the excess of (i) the available project proceeds (as defined in § 54A to mean sale proceeds of such issue less not more than two percent of such proceeds used to pay issuance costs plus investment proceeds thereon), over (ii) the amounts in a reasonably required reserve fund (within the meaning of § 150(a)(3)) with respect to such issue, are to be used for one or more “qualified economic development purposes” (as defined in § 1400U–2(c)); and (4) the issuer designates such bond for this purpose.

The Treasury Department and the IRS expect to issue separate guidance on Recovery Zone Economic Development Bonds (Direct Payment), including guidance on the allocation of the $10 billion national bond volume cap for these bonds under § 1400U–1.