How to Cut Tax Exemption Municipal Bonds

by Wilhelm Schnotz

Although many people believe the only option state and local governments have at their disposal to raise revenue is through tax increases, many public projects are funded through investments in municipal bonds. When municipalities issue bonds to finance local projects, such as building or repairing transportation systems, airports, fire stations or hospitals, the Internal Revenue Service allows them to issue tax-exempt bonds whose interest payments to investors aren't subject to income taxes. This advantage allows municipalities to borrow money at very low rates while providing investors with competitive returns.

Determine the interest rate your municipal organization can afford to pay on its bonds. While low interest rates make borrowing more affordable, you'll attract more investors with higher rates. Remember, because interest on these bonds is tax free, you don't need to offer a rate that competes with commercial bonds. For example, a 5 percent tax-exempt bond pays the equivalent of a 6.67 percent taxable bond to investors in the 25-percent tax bracket.

Locate a bank to underwrite your bond. While this isn't necessary, it provides an added element of security against losses to default to make the bond more favorable to investors.

File Form 8038-G, the informational return, with the IRS to provide information on the amount of debt assumed by the bond, the type of issue, and the EIN of the issuer -- not the agency that will benefit from the bond in Lines 1 through 20. Disclose the final maturity date, issue price, yield and weighted maturity on Line 21.

Complete Lines 22 through 30 on Form 8038-G, indicating the amount of proceeds which will be used toward interest payments, credit enhancements and, if applicable, proceeds used to refund current or advance prior issues. Sign and return the form to the IRS by the 15th day of the second month following the quarter in which the bonds were issued.

About the Author

Wilhelm Schnotz has worked as a freelance writer since 1998, covering arts and entertainment, culture and financial stories for a variety of consumer publications. His work has appeared in dozens of print titles, including "TV Guide" and "The Dallas Observer." Schnotz holds a Bachelor of Arts in journalism from Colorado State University.

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