Tax Credit Bonds Offer Tax Credit Choice

December 24, 2011 by  Filed under: Taxes 

Tax Credit Bonds (TCBs) are a type of financial security that gives the holder a federal tax credit instead of earning interest. Each type has a specific target and market in which it functions and is a very valuable way for financing a variety of governmental programs that are deemed worthy. There are four types of TCBs:

  1. Qualified Zone Academy Bonds (QZABs)
  2. Clean Renewable Energy Bonds (CREBs)
  3. Gulf Tax Credit Bonds (GTCBs)
  4. Forestry Conservation Bonds (FCBs)

TCBs have been around since 1998, and have an economic and sometimes political purpose that federal policy makers wish to establish. For instance, issuers of QZABs are required to use the proceeds from selling these bonds to finance public school partnership programs in economically distressed areas. CREBs are designated for clean renewable energy projects. GTCB proceeds are for the refinancing of outstanding government debt in Gulf Coast regions affected by Hurricane Katrina, and FCBs are intended to help non-profits or government entities purchase then conserve forest land.

Not to be confused with two other types of securities, regular corporate bonds (CBs) and municipal bonds (MBs). For tax purposes, MBs are tax exempt while CBs are not. However, municipal bonds have a lower yield rate. Typically, the difference between the average high-grade taxable corporate bond rate and the average high-grade municipal bond rate is around one percent. Obviously, municipal bond issuers can issue these bonds at a lower rate because of the tax exemption status. On the other hand, TCBs allow the holder to claim a federal tax credit equal to a percentage of the bond’s par value (face value) for a limited number of years. This tax credit percentage is set at the current yield on taxable corporate bonds. Therefore, tax credit bonds send a greater federal subsidy to the issuer than do municipal bonds. The government entity selling the bond is obligated to repay only the principal of the bond. The federal government makes payments to the bondholder through the tax credits.

Tax Credit Bonds are taxable, so the interest rate earned is greater than municipal bonds and are usually competitive with corporate bonds’ after-tax rate of similar maturity and risk. TCBs perform an important function by allowing investors a chance to contribute to programs that they feel have social and even environmental value. Funds from investors pay for school renovation, help local utilities construct alternative energy facilities, help conserve America’s forests, and have help states affected by hurricane Katrina refinance debt owed.

News in Local and World Environmental Economics.

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