Best Practices

Managing Build America and other Direct Subsidy Bonds

Governments that issued BABs or other direct subsidy bonds should be acutely aware of their ongoing responsibilities associated with these bonds and be cognizant of Internal Revenue Service (IRS) actions related thereto.

In 2009 and 2010, Congress authorized or expanded several tax-advantaged alternatives for financing governmental infrastructure under the American Recovery and Reinvestment Act of 2009 (ARRA). The most popular ARRA financing program, Build America Bonds, was used as an alternative to traditional tax-exempt bonds for new money financings of governmental capital projects. BABs were taxable direct subsidy bonds and entitled the issuer to receive a payment from the federal government equal to thirty-five percent (35%) of the interest paid on the bonds (the “subsidy payment”) for the lifetime of the bond. In many cases, BABs provided the issuer with a lower net interest cost on the financing (65% of the taxable rate on the bonds) compared with conventional tax-exempt interest rates. The authority to issue new BABs expired at the end of 2010.

Another direct subsidy bond program created in ARRA, that is no longer available, was Recovery Zone Economic Development Bonds (RZEDBs), which provided a 45% subsidy rate for qualifying governmental purpose projects. Additionally, traditional tax credit bond programs - Qualified Zone Academy Bonds (QZABs), Qualified School Construction Bonds (QSCBs), Clean Renewable Energy Bonds (CREBs) and Qualified Energy Construction Bonds (QECBs) – were given federal allocation amounts (administered through each state) in 2009 and 2010, allowing these bonds to be issued as direct subsidy bonds, and receive various subsidy payments.

GFOA recommends that governments that issued BABs or other direct subsidy bonds, be acutely aware of their ongoing responsibilities associated with these bonds and be cognizant of Internal Revenue Service (IRS) actions related thereto. Additionally, if Congress reinstates direct subsidy bond programs in the future, the GFOA advises governments to exercise caution and have a full understanding of the differences between tax-exempt bonds and direct subsidy taxable bonds.

Post-Sale and Ongoing Responsibilities

  1. Governments should ensure that they have procedures and internal controls in place to ensure they are up to date on how to file as well as ensure the timely filing of IRS Form 8038-CP required for each interest payment date as a condition to receiving the subsidy payment due and to confirm receipt of the subsidy payments from the federal government.  If payment is not received in a timely manner, the issuer, or the trustee, if the trustee is authorized by the issuer on IRS Form 8038-CP, should contact the IRS directly.
  2. Governments should develop appropriate internal controls to ensure that the issuer calculated subsidy payment amount is the same amount that is received from the U.S. Department of the Treasury.  In the event that the subsidy payment is not the same amount, governments should contact the IRS and Department of the Treasury to learn why the payment changed.
  3. Issuers also should consider requesting that subsidy payments be made by electronic funds transfer (EFT) rather than paper checks via U.S. mail.
  4. A reduction in subsidy payments or “offset” can occur for tax liabilities or any other amount that may be owed to the federal government by the issuer (e.g., non-compliance with terms of grants or any federally funded program).  The federal law authorizing “offsets” is the “Debt Collection Improvement Act of 1996” and the Treasury Offset Program (“TOP”) describes the procedures for reducing subsidy payments which is currently linked to the issuer’s employer identification number (EIN).
  5. In order to effectively manage federal subsidy payments, governments may wish to consider the use of separate employee identification numbers (EIN) or multiple EINs.  The federal government can reduce the amount of the subsidy payment owed to a state and local government if the federal government plans to withhold money or money is owed by the state and local government to the federal government unrelated to the bond subsidy payment.  Therefore, to avoid the bond subsidy payment being reduced because of an unrelated payment (e.g., a federal grant program or payroll taxes), the government may wish to have a separate EIN solely for the bond subsidy payments.
  6. Issuers should know where to direct their direct subsidies.  If an issuer pledged their subsidy payment to bondholders, they should make sure that the subsidy payment is directed to the trustee for deposit in the debt service fund. If an issuer has not pledged the subsidy to bondholders, but intends to and/or budgets to use it to pay debt service the appropriate staff members should direct the subsidy payment to the correct governmental fund or account, in order to apply it as intended.
  7. The issuer should ensure that all accounting standards are adhered to in reporting subsidy payments.  According to Governmental Accounting Standards Board (GASB), the payment of interest on the qualifying bonds is reported gross, not netted with the federal reimbursement.
  8. The IRS has been sending direct subsidy bond issuers a tax compliance questionnaire.  An issuer’s failure to complete the questionnaire could trigger an IRS audit.  Governments are encouraged to discuss the questionnaire with their bond counsel and respond accordingly.
  9. Governments should develop written tax compliance procedures, including any procedures unique to direct subsidy bonds.  The IRS has stated consistently that issuers should have written tax compliance policies and procedures, and IRS Form 8038 asks governments if such policies and procedures are in place. Additionally, the IRS’s Voluntary Closing Agreement Program (VCAP), may have more beneficial terms for issuers that have written qualifying post- issuance compliance procedures.
  10. Within IRS audits on state and local government and authority bond issuances, the IRS looks at the issue price of bonds, including for direct subsidy bonds.  While issuers should always know the issue price of their bonds when issued and as part of their ongoing debt management practices, this information must be retained for IRS audit purposes (lifetime of the bonds + 3 years).
  11. Throughout the term of the bonds, issuers must be compliant with all tax laws related to direct subsidy bonds to ensure that they will continue to receive federal subsidy payments.  Issuers are encouraged to consult with their bond counsel if any questions arise about tax compliance, for instance if there is a change in the purpose of the project to one that does not qualify as a direct subsidy bond.
  12. Governments should look for alerts from GFOA and other organizations in the event that Congress acts to further reduce or eliminate the subsidy payments at any time during the years that the federal government will be making direct subsidy bond payments.
  13. Consider the risk that the federal government (through an act of Congress) could reduce or eliminate the subsidy payments at any time during the years that the direct subsidy bonds are outstanding and evaluate strategies or techniques to mitigate this risk (i.e., ten-year par call option or extraordinary call option).  The Budget Control Act of 2011 reduced payments to state and local issuers of direct subsidy bonds, including BABs, beginning March 1, 2013.  This reduction is referred to as sequestration.  Congress has repeatedly authorized the extension of the sequestration period through various legislative actions and during the COVID-19 pandemic temporarily deferred sequestration.  Issuers are encouraged to monitor Congressional actions and IRS guidance for any future changes to sequestration rates.
  14. Issuers need to be aware of the occurrence of delayed processing of payments from the IRS following the submission of Form 8038-CP.  In the event of a delayed payment, issuers are advised to develop contingency plans to ensure timely payment of debt service until the request is processed and payment is distributed.
  15. If considering the restructuring or refunding of debt obligations that utilize tax-advantaged alternatives, options should be discussed, including associated costs and risks, with your Municipal Advisor.  Depending on the timing of the settlement of the refunding, the issuer may be responsible for repayment of the direct subsidy if they were no longer eligible to receive it.  The issuer should consult with their bond or tax counsel to determine eligibility.

Future Considerations if Direct Subsidy Bonds Are Reauthorized by Congress

In the event that direct subsidy bond programs once again become a financing option for state and local governments, GFOA advises governments to exercise caution and, prior to issuing direct subsidy bonds in the future, have a full understanding of the differences between tax-exempt bonds and these taxable bond instruments.  If your government determines that issuing direct subsidy bonds is appropriate, the following items should be taken into consideration.

Direct Subsidy Bond Sale Planning Considerations

  1. Consult with an independent Municipal Advisor and analyze whether tax-exempt interest rates or taxable interest rates (net of the subsidy payment accounting for potential sequestration) results in a lower borrowing cost.
  2. An optimal bond structure may involve the issuance of both tax-exempt bonds (and taxable direct subsidy bonds.. When employing a competitive sale process, consider allowing bidders to determine which maturities will be tax-exempt and which will be taxable direct subsidy bonds.
  3. Evaluate permitted use of subsidy payments under the bond documents and determine what to do with those payments:
    • deposit into sinking fund and use to pay debt service - effectively reduces borrowing cost to the net interest rate; or
    • pledge subsidy payment as security for bonds – normally requires amendment of bond resolution or indenture; consult bond counsel; or
    • use subsidy payment for some other purpose - however, diverting subsidy payment is effectively borrowing for the other purpose;
  4. Other direct subsidy bond planning considerations include:
    • create a process for filing IRS Form 8038-CP to request the subsidy payment and for verifying that the subsidy payments are received;
    • evaluate/quantify potential reductions in bonding capacity, impact on rate covenant, additional bonds test, and debt ratios from issuing debt at potentially higher taxable interest rates. If the subsidy is not pledged to bondholders, the gross taxable interest rate may be used to calculate debt service;
    • evaluate the impact that the bonds’ gross debt service may have on funding requirements of reserves;
    • analyze/amend bond indentures/resolutions to incorporate direct subsidy payments;
    • quantify the total subsidy payments to be received over the term of the bonds to measure the monetary amount at risk of potential changes in the subsidy rate if retroactive changes are enacted;
    • if subsidy payment is to be used to pay debt service, consider modifying debt structure to achieve desired debt payment structure (i.e. level, ascending, descending) after applying subsidy payment;

Transaction Execution

For recommendations associated with executing transactions utilizing tax-advantaged alternatives, refer to GFOA Best Practice: Issuing Taxable Debt. Analysis for determining the most cost-effective method of sale, tax-exempt versus taxable direct subsidy bonds, should be updated immediately prior to sale to enable a modification, if market conditions warrant. Following the bond sale, issuers should prepare a post-sale analysis to evaluate the estimated savings from using the direct subsidy bond alternative and compare results to pre-sale estimates for future reference in evaluating the potential use of direct subsidy bonds for other financings.


  • GFOA Issuing Taxable Debt
  • GFOA Post-Issuance Compliance BP;
  • GFOA Developing and Implementing Procedures for Post-Issuance Tax Compliance for Issuers of Governmental Bonds Alert;
  • NABL Considerations for Developing Post-Issuance Tax Compliance Procedures
  • Board approval date: Friday, March 4, 2022