Private Activity Bonds
The Tax Reform Act of 1986 placed severe restrictions on qualifying for tax exempt financing. According to the act, the government could no longer subsidize activities that did not provide a significant benefit to the general public. Taxable municipal bonds were created to fund private activities that would no longer qualify for exemption from federal taxes. These are known as private activity bonds. Besides supporting nonpublic functions, private activity bonds may also be issued to refund debt or bolster underfunded pension funds.
The IRS provides several tests to determine whether or not a bond is considered a private activity bond. If the bond meets both of the private business tests, or if it passes the private loan financing test, then it is a private activity bond.
The two private business tests are the private business use test and the private security or payment test.
- • Private business use test—greater than 10% of bond proceeds are used to fund a nongovernmental entity
- • Private security or payment test—greater than 10% of the debt service for a bond is paid for or secured by a property used by a private business
If both of these tw