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Qualified, experienced BKD client service professionals write the contents of these articles. We urge you to carefully consider all of the facts and circumstances of your situation before applying specific information in our articles. Consult your BKD advisor before acting on any matter covered in these articles.
May 2010

Will Indirect Arbitrage Have an Impact on Tax-Exempt Bonds?

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Cheryl Schluterman
Beginning May 15, 2010, calendar year filers are required to file Form 990’s Schedule K, Supplemental Information on Tax-Exempt Bonds. Schedule K reports detailed information about certain tax-exempt bond issues. The disclosure requirements include various arbitrage questions. Direct arbitrage, i.e., using the proceeds of tax-exempt securities sales to buy higher-yield securities, is prohibited by law.

A recent release by the Congressional Budget Office (CBO) reported colleges and universities can engage in what it called an "indirect" form of arbitrage by issuing tax-exempt debt. The law allows colleges and universities to use tax-exempt financing for projects such as new buildings and equipment even while they own other higher-return investments, such as securities, land or other buildings. This can be a substantial benefit for the institution.

However, if legislators were to expand the definition of direct arbitrage and eliminate some of the benefits of tax-exempt financing, nonprofit institutions would probably issue less tax-exempt debt. The resulting reduction in tax-exempt bonds would thereby increase tax revenues for the federal government. According to the CBO, “nearly all” the bonds issued by 251 higher education institutions in 2003 would have been considered to have earned profits from tax arbitrage. Because of the federal government’s need to increase tax revenues and the increased scrutiny of tax-exempt organizations, more discussion on laws governing tax-exempt bond issues is likely.

Schedule K will provide a database of information for these discussions. If you haven’t already, now is the time to gather the information necessary to complete Schedule K.

If you have any questions, please contact your BKD advisor.