Tax exempt bonds typically carry a lower interest rate than a rate on commercial corporate bonds. Corporations and nonprofits can borrow money by issuing taxable bonds on their own in the commercial marketplace or they can work with public entities to issue bonds where those bonds can potentially become tax-exempt. These bonds are known as private activity bonds.
A private activity bond is one that primarily benefits or is used by a private entity. The federal tax code classifies state and local government bonds as either governmental bonds or private activity bonds. Governmental bonds have a tax-exempt status. Private Activity Bonds are any bonds where: (i) more than 10 percent of the proceeds is to be used in a trade or business of a person or persons other than a government entity; and (ii) which can be directly or indirectly repaid from, or secured by, revenues from a private trade or business. If a bond “fails” these two tests, it is a governmental bond and the interest on the bond is tax exempt. If a bond “meets” these two tests, it is a private activity bond and interest on the bond is taxable. Taxable bonds typically carry a higher interest rate.
- Publication date: April 2019