1.4.2. By Taxable Status
Public Purpose Bonds. Also known as governmental bonds, these are municipal bonds that enjoy the full extent of the federal tax-exempt status typically associated with munis. They finance projects that serve the local population, without private entities benefiting excessively.
Private Activity Bonds (PABs). These are municipal bonds that channel more than 10% of their proceeds into private hands or otherwise meet a complex set of criteria under the Internal Revenue Code. The distinction between PABs and public purpose bonds was created by the Tax Reform Act of 1986, which attempted to ensure that the federal government would no longer subsidize activities that did not provide a significant benefit to the general public. Under the Tax Reform Act, most PABs completely lost their exemption from federal taxes. These are called non-qualified PABs.
Alternative Minimum Tax (AMT) Bonds. Also called qualified PABs, these bonds are partial exceptions to the general rule that PABs enjoy no federal tax exemption. Typically, this is because the private activity supported by the bond is viewed as especially valuable or essential, such as financing airports, docks, hazardous waste disposal, water and sewer service, or residential property. Qualified PABs picked up the name “AMT bonds” because they are exempt from regular federal income tax but not from the alternative minimum tax (AMT). The AMT is a provision in the Internal Revenue Code imposing a minimum income tax on high-income individuals who receive significant savings from the use of certain tax deductions, credits, and exclusions. The AMT is discussed in greater detail later. AMT bonds tend to pay somewhat higher yields than public purpose bonds, but typically not enough to completely make up the difference for those who end up paying the AMT.
Bank Qualified (BQ) Bonds. The Tax Reform Act further distinguished public purpose bonds from PABs by giving banks a financial incenti