Private Activity Bonds are a kind of bond that may be issued by or on behalf of a state or local government. Their primary function is to provide unique financial advantages to projects that meet certain criteria. The interest earned may not be subject to taxation if the bonds satisfy certain requirements. The finance is almost always for projects carried out by private user, and government does not typically put its credit on the line.

Understanding Private Activity Bonds

Public benefit projects that attract private investment are eligible for private activity bonds, municipal bonds issued by municipalities. However, strict laws control the types of projects that may qualify for private activity bonds. Eligible projects include, but are not limited to, airports, private colleges, hospitals, affordable rental housing, mortgage aid for first-time lower-income borrowers, etc. Additional Eligible Projects:

A private activity bond's profits may under no circumstances be used toward purchasing an aircraft, stadium, certain health club facilities, oil refinery, golf course, or liquor shop. The exemption from federal tax that comes with purchasing this kind of bond results in lower overall financing expenses.

By using private activity bonds, states and municipalities can borrow money for private businesses and nonprofit organizations, cutting the cost for organizations that would otherwise have to resort to bank loans or corporate bonds. Private activity bonds are issued to lure firms and workers to a particular area to provide public benefit, making the bond eligible for tax-exempt status. Unless expressly exempted by the federal government, the interest earned on these bonds is subject to taxation.

Special Considerations

Interest on private activity bonds is not eligible for deduction from gross income under Section 103(a) of the Internal Revenue Code unless the bond in question is a qualifying bond (IRC). Interest on private activity bonds, with the exception of interest on bonds issued by tax-exempt institutions like hospitals and universities, is subject to the Alternative Minimum Tax (AMT) as of the passing of the Tax Reform Act of 1986. Private activity bonds often provide higher returns than other bond kinds due to tax treatment.

A bond issuance is deemed a private activity bond under Section 141 of the Internal Revenue Code if more than 10% of the revenues are used for any privately owned business and if the principal and interest payable on more than 10% of the selling proceeds of issue are backed by private business property. Under IRC guidelines, more than 10% of the issue's selling proceeds must be collateralized by a private firm asset. A municipal bond qualifies as a private activity bond if at least $15 million, or 5% of the total proceeds, have been used to provide loans to borrowers who are not affiliated with the government.

Are Private Activity Bonds Tax Exempt?

According to the standard norm, interest from private activity bonds is subject to taxation. However, given that the bond does not qualify as a qualified PAB, it does not qualify as an arbitrage bond. It satisfies the criteria of section 149 of the Internal Revenue Code of the United States. Examining the Information Return for Tax-Exempt Private Activity Bond Issues (Form 8038) provided by the Internal Revenue Service is another way to determine whether or not the interest is in a qualifying municipal bond. Since this is the case, an alternative minimum tax must be paid on the interest received from PAB, with the exception of the income received from the hospital and non-profit college bonds.

What Exactly Is The Function Of Private Activity Bonds?

To provide deserving projects with specific financial incentives, a state or municipal government may issue PABs on its own or behalf of the government. If the bonds comply with the regulations, the interest generated may be free from taxation.

What Are Qualified Private Activity Bonds?

IRS defines a "qualifying bond" as any PAB that fulfills the volume limit criteria mentioned in Section 146 and the additional conditions indicated in Section 147. Additional restrictions may be found in Section 147 for certain types of bonds, such as qualified redevelopment bonds, qualified small issue bonds, qualified veterans' mortgage bonds, qualified 501(c)(3) bonds and qualified student loan bonds.