By CHRISTIE MARTIN and MAXWELL D. SOLET

After two sets of proposed regulations, Treasury and IRS have now released final regulations on the definition of “issue price” for purposes of arbitrage investment restrictions that apply to tax-advantaged bonds (the “Final Regulations”) and it appears that the third time’s the charm. Practitioners are particularly praising the addition of a special rule for determining issue price for competitive sales and clarification on determining issue price for private placements.  The Final Regulations were published in the Federal Register on December 9, 2016 and can be found here.

Several years ago, tax regulators became concerned that the longstanding practice of allowing an issue price to be calculated based on reasonable expectations could lead to abuse in that “reasonably expected” issue prices for bonds sometimes differed from the prices at which bonds were actually being sold to retail investors. A determination by the IRS that the “issue price” has been erroneously calculated can have ramifications for the calculation of arbitrage yield that could ultimately cause loss of tax-advantaged status.  A clear and predictable definition of issue price is therefore essential for the tax-advantaged bond community.

After the first set of proposed regulations, published in the Federal Register on September 16, 2013, caused an uproar in the bond counsel community as being largely unworkable, they were withdrawn and re-proposed on June 24, 2015 (the “2015 Proposed Regulations”). The 2015 Proposed Regulations were subject to a comment period followed by a public hearing.  These Final Regulations build on the 2015 Proposed Regulations with certain changes in response to the public comments.

The Final Regulations look to actual facts as the general rule for determining issue price. Generally, the issue price of bonds is the first price at which a substantial amount (at least 10%) of the bonds is sold to the public.  For bonds issued in a private placement to a single buyer, the Final Regulations clarify that the issue price of the bonds is the price paid by that buyer.

In recognition of the need in the tax-advantaged bond community for certainty as of the sale date (particularly in the case of advance refundings), the Final Regulations offer a special rule in the event a substantial amount of bonds has not been sold to the public as of the sale date. The special rule allows reliance on the initial offering price to the public if certain conditions are satisfied including evidence that the bonds were actually offered at the initial offering price and the written agreement of each underwriter that it will not offer or sell the bonds to any person at a price higher than the initial offering price during the period starting on the sale date and ending on the earlier of (i) the close of the 5th business day after the sale date, or (ii) the date on which the underwriters have sold at least 10% of the bonds to the public at a price that is no higher than the initial offering price.

Procedures for satisfying the conditions for use of this special rule will have to be developed but it is reasonable to expect that changes will need to be made to bond purchase agreements and underwriter selling agreements to comply with these requirements.

The special rule for competitive sales provides that in a competitive sale meeting certain requirements, an issuer may treat the reasonably expected initial offering price to the public as of the sale date as the issue price if the winning bidder certifies that its winning bid was based on this reasonably expected initial offering price as of the sale date. This special issue price rule for competitive sales has been repeatedly requested by practitioners and is a welcome improvement over the prior proposed regulations which treated both negotiated sales and competitive sales in the same manner.

The Final Regulations will be effective for obligations that are sold on or after June 7, 2017 and there is no option to rely upon the Final Regulations with respect to obligations that are sold prior to that date. This delayed effective date should allow bond counsel and underwriters time to develop effective and hopefully uniform procedures and documentation to implement the new regulations.

By MAXWELL SOLET and CHRISTIE MARTIN

Treasury and IRS today announced a decision to withdraw the much-criticized portion of the notice of proposed rulemaking published in the Federal Register on September 16, 2013 (the “2013 Proposed Regulations”) related to the definition of issue price for tax-advantaged obligations and to propose a revised definition of issue price in its place. A determination by the IRS that the “issue price” has been erroneously calculated can have ramifications, including for the calculation of arbitrage yield, that could ultimately cause loss of tax-exempt status in the case of tax-exempt bonds and loss of federal subsidy in the case of Build America Bonds (BABs), hence the importance to the tax-exempt bond community of a clear and predictable definition.

The new proposed regulations (the “2015 Proposed Regulations”) are scheduled to be published in the Federal Register on June 24, 2015 and can be found here. A 90-day comment period will be followed by a hearing on October 28, 2015.

The 2015 Proposed Regulations eliminate most of the troublesome features of the 2013 Proposed Regulations, including maintaining a 10% standard rather than the 2013 Proposed Regulations 25% standard for what constitutes a “substantial amount” of obligations sold to the public. However, the 2015 Proposed Regulations do not maintain the long-established “reasonable expectations” standard for establishing issue price. Instead, the 2015 Proposed Regulations look to actual facts as the general rule.

In recognition of the need in the tax-advantaged debt world for certainty as of the sale date (particularly in the case of advance refundings), the 2015 Proposed Regulations helpfully provide an alternative method in the event a substantial amount of bonds have not been sold to the public as of the sale date. The alternative method allows reliance on the initial offering price if certain conditions are satisfied.

Procedures for satisfying the conditions for use of this alternative method will have to be developed, and underwriters may conclude that compliance will be difficult. In particular, a preclusion of sales at prices above the initial offering price unless it can be demonstrated that the differential is based on market changes could be problematic.

The 2015 Proposed Regulations will be effective for obligations that are sold on or after 90 days after final regulations are published in the Federal Register. However, issuers may rely upon the 2015 Proposed Regulations with respect to obligations that are sold on or after June 24, 2015, the date the 2015 Proposed Regulations will be published in the Federal Register.

By LEN WEISER-VARON

Pi Day comes but once a century, on 3/14/15. The Internal Revenue Service receives praise approximately as frequently. But the IRS deserves applause for its Notice 2015-18, released March 10, 2015, giving the green light to states to proceed with the establishment of tax-free investment programs for the disabled under new Section 529A of the Internal Revenue Code.

Section 529A, which became effective January 1, 2015, grants tax-free treatment to the earnings in so-called ABLE accounts established for eligible disabled beneficiaries and used for qualified disability expenses. As is the case with Section 529 programs, which offer tax-free investment for higher education expenses, Section 529A programs must be established by state instrumentalities and must comply with a variety of statutory requirements. But unlike Section 529, which permits anyone to establish a Section 529 account (subject to the imposition of taxes and tax penalties on amounts withdrawn for purposes other than the account beneficiary’s higher education expenses), Section 529A imposes restrictions on the front end designed to ensure that the account beneficiary is disabled. (Section 529A likewise imposes taxes and tax penalties on amounts withdrawn for purposes other than the account beneficiary’s qualified disability expenses.)

Many families with children or other relatives who meet Section 529A’s disability definition and the statute’s requirement that the disability have occurred before age 26 are understandably eager to establish nest eggs that are not only tax-free but also, by statute, disregarded (up to a balance of $100,000) for purposes of determining the beneficiary’s financial eligibility for federal disability benefits. However, states seeking to make ABLE accounts available to their residents must work through a host of legal, contractual and investment option issues before launching these new programs.

By releasing Notice 2015-18, the Treasury Department and IRS have addressed, wisely and effectively, one factor that threatened to delay the launch of ABLE programs: uncertainty over how the Treasury Department and IRS will interpret certain provisions of Section 529A.

In particular, while Section 529A is clear that an ABLE account beneficiary’s disability qualification is determined by or through the federal government (through the beneficiary’s receipt of Social Security disability benefits or the beneficiary’s filing with the Treasury Department of a disability certification accompanied by a physician’s diagnosis), it is silent on whether the state program has some unspecified duty to obtain assurances or confirm that such actions, which don’t involve the state program, have occurred. Section 529A, which permits disability status to be established at any time during a tax year, also does not specify the treatment of account contributions made to or received by an ABLE account on a date in a tax year that precedes the date on which the beneficiary satisfies the disability status requirements for the applicable tax year. In addition, there is no statutory clarity on what a program is required to do to confirm compliance with Section 529A’s state residency restrictions.

The legislation pursuant to which Section 529A was enacted requires that the Treasury Department promulgate regulations under Section 529A by June 19, 2015 (six months from enactment.) It is unclear whether the Treasury Department will be able to meet this deadline. Even if the Treasury Department were to meet that deadline, some states might have concerns about structuring, much less launching, an ABLE program before there is regulatory guidance resolving some of the statutory ambiguities potentially affecting the program’s tax-exemption under Section 529A.

Notice 2015-18 straightforwardly acknowledges the tax uncertainty concerns and addresses them, asserting that “[t]he Treasury Department and the IRS do not want the lack of guidance to discourage states from enacting their enabling legislation and creating their ABLE programs, which could delay the ability of the families of disabled individuals or others to begin to fund ABLE accounts for those disabled individuals.” The Notice goes on to state that “the Treasury Department and the IRS are assuring states that enact legislation creating an ABLE program in accordance with section 529A, and those individuals establishing ABLE accounts in accordance with such legislation, that they will not fail to receive the benefits of section 529A merely because the legislation or the account documents do not fully comport with the guidance when it is issued.”

The Notice further states that “the Treasury Department and the IRS intend to provide transition relief with regard to necessary changes to ensure that the state programs and accounts meet the requirements in the guidance, including providing sufficient time after issuance of the guidance in order for changes to be implemented.”

This language represents a fairly extraordinary expression by the Treasury and the IRS of their intent to get out of the way as a potential obstacle to, or delaying factor in, the launching of ABLE programs. This approach is sympathetic to the cause and needs of families of disabled individuals, and deserves commendation. Although the Notice will not result in instantaneous availability of ABLE programs given the non-tax complexities of structuring the programs, it makes the states’ task in launching such programs appreciably less daunting.

Notice 2015-18 also includes an advance notice which acknowledges that, although Section 529A requires that the disabled beneficiary of an ABLE account be the account owner, someone other than the disabled beneficiary may have signature authority for the account. The advance notice, unsurprisingly, indicates that the regulatory guidance when issued will preclude any such person with signature authority who is not the account owner from acquiring a beneficial interest in the account, and will require such person to administer the account in the interests of the account owner/beneficiary.