Private Activity Bonds are defined in the Code as Bonds that benefit private entities and require the private entities to repay the Principal and Interest on the Bonds. Interest on Private Activity Bonds generally is taxable unless the private activities have been deemed by Congress to be worthy of federal subsidy. Unlike Private Activity Bonds, Governmental Bonds or Governmental Purpose Bonds are not defined in the Code but are terms commonly used to refer to municipal Bonds that are not Private Activity Bonds.

There are seven categories of “qualified” Private Activity Bonds that Congress has permitted to be issued as Tax-Exempt Bonds, including exempt facility Bonds, Qualified Mortgage Bonds, qualified veterans’ mortgage Bonds, Qualified Small Issue Bonds, qualified student loan Bonds, qualified redevelopment Bonds and Qualified 501(c)(3) Bonds.  Each of these types of Bonds has additional rules that must be met to qualify and continue to qualify as Tax-Exempt Bonds.

Section 141 of the Code defines a Private Activity Bond as any Bond that satisfies:

1. The private business use test and the private security or payment test (together, the “Private Business Tests”); or
2. The Private Loan Financing Test.

Therefore, if both Private Business Tests or the Private Loan Financing Test is met, the Bonds will be Private Activity Bonds. If at least one of the Private Business Tests and the Private Loan Financing Test are not satisfied, then the Bonds will not be Private Activity Bonds (i.e., they will be Governmental Bonds).

The Private Business Tests or Private Loan Financing Test are federal tax requirements that determine whether or not a Bond is considered a Private Activity Bond (PAB). If both Private Business Tests or the Private Loan Financing Test is met, the Bonds will be Private Activity Bonds. If at least one of the Private Business Tests and the Private Loan Financing Test are not satisfied, then the Bonds will not be Private Activity Bonds (i.e., they will be Governmental Bonds).

Qualified Private Activity Bond (PAB)

As mentioned above, there are certain categories of Private Activity Bonds that despite meeting the Private Business Tests or the Private Loan Financing Test still may be issued as Tax-Exempt Bonds.  These “qualified” Private Activity Bonds are subject to requirements specific to each category of qualified Private Activity Bonds, as well as some general requirements that apply to some or all of the various categories of Qualified Private Activity Bonds.

Common types of Qualified Private Activity Bonds (PABs):

Qualified 501(c)(3) Bonds

The term used in Section 145 of the code to refer to a type of tax-exempt bonds issued as private activity bonds for the benefit of a 501(c)(3) organization.

Exempt Facility Bonds

Type of private activity bond (PAB) permitted to be issued as a tax-exempt bond under Section 142 of the code for the purpose of funding many categories of exempt facilities.

Other Tax Considerations

Below are some additional tax related considerations and requirements applied to Qualified Private Activity Bonds (PABs):

TEFRA

The acronym for the Tax Equity and Fiscal Responsibility Act of 1982, which applies additional tax requirements and considerations to tax-advantaged bonds.

Cost of Issuance

Expenses paid by or on behalf of the Issuer or a conduit borrower which are directly related to the issuance and sale of the bonds.

120% Rule

Rule outlined in Section 147(b) of the code that states private activity bonds are not tax-exempt bonds if the weighted average maturity of the bond issue exceeds 120% of the average reasonably expected economic useful life of the facilities financed with the bond proceeds.  

Volume Cap

A requirement contained in Section 146 of the Code that private activity bonds (PAB) (with certain exceptions) issued as tax-exempt bonds obtain an allocation of volume cap from the state in which the project is located prior to the issuance of the bonds.

---

See Also

Conduit Financing

Financing in which the Issuer issues the bonds to finance a project to be used primarily by a third party.