7661 / What are Build America Bonds and how are they taxed?

ARRA 2009 created the Build America Bond program (under IRC Section 54AA), which authorized state and local governments to issue Build America Bonds as taxable governmental bonds in 2009 and 2010 to finance any governmental purpose for which tax-exempt governmental bonds could be issued. The 2017 tax reform legislation repealed Section 54AA, which governed Build America Bonds for 2009 and 2010. State and local governments could, at their option, issue two general types of Build America Bonds and receive federal subsidies for a portion of their borrowing costs. The subsidies took the form of either tax credits provided to holders of the bonds (tax credit type) or refundable tax credits paid to state and local governmental issuers of the bonds (direct payment type).¹

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

In general, Build America Bonds (tax credit type) could be issued to finance any governmental purpose for which tax-exempt governmental bonds (excluding private activity bonds) could be issued and must have complied with all requirements applicable to the issuance of tax-exempt governmental bonds.³

If a taxpayer holds a Build America Bond on one or more interest payment dates of the bond during any taxable year, a credit is allowed against the regular income tax liability in an amount equal to the sum of the credits determined under IRC Section 54AA(b) with respect to those dates.⁴ The amount of the credit determined under IRC Section 54AA(b) with respect to any “interest payment date” for a Build America Bond is 35 percent of the interest payable by the issuer with respect to such date.⁵ “Interest payment date” means any date on which the holder of record of the Build America Bond is entitled to a payment of interest from such bond.⁶ 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 the bondholder is entitled to receive from the issuer (i.e., the bond coupon interest payment) by 35 percent.⁷

The credit allowed under IRC Section 54AA(a) for any taxable year cannot exceed the excess of (1) the sum of the regular tax liability plus the alternative minimum tax liability, over (2) the sum of the credits generally allowable against the regular income tax (excluding the refundable credits and the Build America Bond tax credit).⁸ Any excess is carried over to the succeeding taxable year and added to the credit allowable under IRC Section 54AA(a) for the taxable year.⁹ Unused credit may be carried forward to succeeding taxable years.¹⁰

Original issue discount (OID) is not treated as a payment of interest for purposes of determining the credit.¹¹

Interest on any Build America Bond is includable in gross income.¹²