An investor in a high income tax bracket is evaluating an Industrial Development Revenue Bond (IDB) issued by a municipality to construct a commercial facility leased to a private corporation. Which of the following statements accurately describes the credit backing and tax implications associated with this bond?
- The bond's debt service depends on lease payments made by the private corporation, and the interest income may be subject to the Alternative Minimum Tax (AMT).Answer
- BThe bond is backed by the full faith, credit, and ad valorem taxing power of the issuing municipality, rendering its interest fully tax-exempt for all investors.
- CThe bond carries zero credit risk because municipal issuer status provides an implicit U.S. government guarantee, protecting investors against default.
- DThe bond's interest is exempt from federal income tax for out-of-state residents, but municipal tax regulations prohibit taxing the corporation's lease payments.
Answer
The bond's debt service depends on lease payments made by the private corporation, and the interest income may be subject to the Alternative Minimum Tax (AMT).
Industrial Development Revenue Bonds (IDBs) are issued by municipalities to finance private commercial projects. The municipality does not guarantee the debt; principal and interest are paid solely from lease payments made by the corporate tenant. Because the proceeds directly benefit a private business, federal tax rules classify them as private activity bonds, making the interest income subject to the federal Alternative Minimum Tax (AMT) for applicable investors.
Step-by-Step Solution
Key Concept
Industrial Development Revenue Bonds (IDBs) credit risk and Alternative Minimum Tax (AMT) implications