Ch 6: Munis Part II (Taxes, Interest) Flashcards
(36 cards)
in almost every case, muni security…
is exempt from federal income tax
tax-exempt/tax free investments!!!
Bc of this, muni issuers are able to borrow at a lower interest cost; in fact, the interest is usually LOWER than US gov bond
Tax Reform Act of 1986
restricted fed income tax exemption of interest for muni bonds to PUBLIC PURPOSE BONDS (bonds issue do finance projects that benefit citizens rather than particulate private interests)
If a bond directs more than 10% of its proceeds to private parties, it’s considered a private activity bond and is not automatically granted tax exemption.
If investor lives in the issuer’s state, muni bond interests are…
free of state income tax as well
***tax-equivalent yield fo ra muni bond issued by an entity within a state with a state income tax will…
have a higher tax-equivalent yield to a resident of that state bc of the “double” tax exemption
***for the exam, note that you never recommend munis to investors unless…
they are in the HIGHER tax bracket
Original Issue Discount (OID) bonds
common to have a muni bond issued at discount on its IPO.
For other muni bonds: For tax, when a muni bond is bought in the 2nd market at a discount, that discount is accreted on a straight-line basis. That accretion is considered TAXABLE INCOME! Like any other muni bond, the coupon interest is tax-free.
For OID bond, the IRS considers the discount to be part of the issuers’ payment of interests. Therefore, that accretion on an OID bond is tax-free!
gains/losses of munis
munis are treated like nay other investment
AMT bonds
industrial rev bonds are issued for a corp’s benefit
Under Tax Reform aAct of 1986, the interest on these nonpublic purpose bonds (or private purpose bonds) may be taxable bc the act reserves tax exemption for PUBLIC PURPOSES. Bc these bonds are used for a nonpublic purpose, the interest income may be subject to Alternative Minimum Tax (AMT).
AMT was enacted to…
make sure that high income taxpayers do not escape paying taxes.
favorable tax treatment items (items that must be added back into taxable income for the AMT) include:
- tax-exempt interest on private purpose, nonessential gov service muni bonds
- certain costs associated with DPPs (research and development costs and excess intangible drilling costs)
- local taxes (ie. state income and property) and interest on investments that don’t generate income, and
- accelerated depreciation on investment property
***language o the Internal Rev Code (IRC) says that taxpayers are required to add the excess of the AMT over…
the regular tax to determine their total tax liability
Taxable Munis
some munis where interest is NOT tax-exempt.
Most commonly, it’s the Build America Bonds (BABs)
***BABs ?
Build America Bonds
created under Economic Recovery and Reinvestm Act of 2009 to assist in reducing costs to issuing munis and stimulating the economy
While bonds to fund muni projects have traditionally been tax-exempt, BABs are taxable!!! Bondh PAY TAX ON INTEREST RECEIVED FROM BABs.
However, tax credits are provided in lieu of the tax-exempt status usually afforded the interest on munis.
These bonds attracted investors who would normally NOT buy tax-exempt munis and expanded the pool of investors to include those in lower-income tax brackets, investors funding retirement accts where tax-free sec would normally not be suitable, public pension funds, and foreign investors.
2 types of BABs: tax credit BABs and direct payment BABs
***program could be reinstated in the future and the types of BABs offered could change as well; these expired in Dec of 2010
2 types of BABs
Tax Credit BABs - provides bondh with a federal income tax credit = to 35% of the interest paid on the bond in each tax yr
- if bondh lacks the tax liability to fully use that yr’s credit, the excess credit may be carried forward
Direct Payment BABs - provides NO CREDIT to bondh but instead provides muni issuer with payments from the US Treasury = to 35% of interest paid by the issuer
Section 529 Plans
tax-adv savings plan offering benefits to those saving for future education costs
2 types of 529 plans: prepaid tuition plans and college savings plans (both are funded with after-tax dollars) and earnings grow tax-deferred; withdrawals take for qualified edu expenses are generally tax-free
prepaid tuition plans
allow donors to lock in future tuition rates at today’s prices, thus offering inflation protection
college savings plan
allows the donor to invest a lump sum/periodic payments
- money typically invested into target-date funds; as target date approaches (the date the money is needed) the portfolio gets more conservative
Up to $10,000 per yr can be used for K-12 tuition purposes
contributions can be made int he form of periodic payments BUT they follow the tax rules for gifts. Thus, unless willing to pay a gift tax, contributions are limited to an indexed max amount per yr per donor ($15K as of now)
***BECAUSE 529s ARE STATE-SPONSORED, INDIVIDUAL STATES HAVE…
THEIR OWN VERSION OF THE PLAN
ABLE accounts
tax-adv savings accounts for individuals with disabilities and their families.
The ABLE act limits eligibility to individuals with significant disabilities where the age of onset of the disability occurred before turning 26.
LGIPs provide other gov entities (such as cities, counties, school districts, other state agencies) with…
Local gov investment pools
states establish LGIPs to provide other gov entities (cities, counties, school districts, state agencies) with a ST investm vehicle to invest funds.
generally formed as a trust in which munis can buy shares/units in the LGIP’s investment portfolio
While NOT a mm fund, most LGIPs operate similar to one. An LGIP may be permitted to maintain a fixed $1 NAV. Maintaining a stable NAV, similar to a mm mutual fund, facilities liquidity and min price volatility.
LGIPs are NOT required to register with SEC, so no prospectus. But LGIPs do have disclosure docs, which generally include info statem, investm policy and operating procedures.
MSRB
Sec Act Amend of 1975 established the MSRB as an INDEPENDENT SELF-REGULATORY ORG (SRO); governs the issuance and trading of munis securities. The rules require munis underwriters and dealers to protect investors’ interests, be ethical in offering advice, and be responsive to complains and disputes.
MSRB rules apply to all firms and individuals engaged int eh conduct of muni sec biz. The MSRB does not regulate issuers.
MSRB has no authority to enforce the rules it makes. They are specifically enforced by FINRA with SEC oversight.
For market participants, enforcement is in the hands of various banking agencies, including
- the Office of Comptroller of the Currency
- Fed Reserve Board
- Fed Deposit Insurance Corp (FDIC)
Records of Associated Persons (Rule G-7)
Recordkeeping for Muni Sec Firms
A muni securities dealer must obtain and keep on file specific info about its associated persons. The MSRB defines an associated person as anyone with a securities registration (including reps, principals, but NOT clerical help)
most of the required info (employm history, disciplinary actions, residence, and personal data) are on U4 and U5.
any material change must be UPDATED WITHIN 30 DAYS. these records must be kept for a min of 3 YEARS AFTER TERMINATION OF ASSOCIATED PERSONS.
Record maintenance requirements specify the length of time that various records must be kept. Records are categorized into these 3 maintenance periods:
- records kept fo the lifetime of the firm
- records kept for 6 yrs
- records kept for 4 yrs (all those not specifically designated as lifetime or 6-yr records)
***MSRB lists customer complaints as what type of record?
6 yr record; FINRA rules only require a 4-yr period
***MSRB Rule G-8 and G-9 require that…
Books and Recordkeeping requirements
G-8 lists the various records to be made and G-9 states the retention requirements.
G-8 (record maintenance requirements) specify that the length of time that various records must be kept. Generally, records are categorized into 3 maintenance periods:
- records kept for lifetime of firm
- records kept for 6 yrs
- records kept for 4 years (all those not specifically designated as lifetime or 6-yr records)
*** MSRB rules list customer complaints as 6-yr records (whereas FINRA only requires 4 years)
***MSRB rules require that designations of principals must be maintained for 6 yrs. ALL records must be readily available for 2 yrs.
*** a muni principal who’s appointed by a committee to manage the money for an LGIP must keep docs appointing him to this role for 6 yrs too
