How Do Qualified Tax Credit Bonds Work?
Government agencies have used bonds as instruments to finance everything from war efforts to school construction. These agencies solicit private investment with the promise of returns based on future tax revenue, with the borrower paying interest on the bond as with a conventional loan. Qualified tax credit bonds offer agencies the opportunity to solicit private investment --- though rather than receive interest on bond debt, investors receive a tax credit in return for the loan of their funds.
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Qualified Tax Credit Bond Mechanics
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Qualified tax credit bonds largely work like any other federal or municipal bond. The issuer, either the U.S. Treasury or a local agency, sets the rate of return on bonds on a daily basis, as well as the length until the bond reaches maturity. Investors receive interest payments in the form of tax credits that apply to their bottom-line tax bill each year until the bond reaches maturity. The credit is refundable, so investors receive an income tax refund if their total tax due is smaller than their tax credit. When the bond reaches maturity, the principal amount --- the bond purchase price --- returns to the investor.
Claiming Tax Credits
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Investors who purchase qualified tax credit bonds don't receive interest payments from the Department of the Treasury --- they claim their interest credit when they file their income taxes. Investors use the Internal Revenue Service's Form 8912 to claim the credit and must list the issuer's name and identification number, as well as return information. Taxpayers attach a completed Form 8912 to their Form 1040 and claim the amount determined on the 8912 worksheet on Line 53, checking Box "C." Indicate 8912 next to the box. The taxpayer's bottom-line tax due is reduced by this amount.
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Advantages for Investors
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Qualified tax credit bonds are attractive to certain investors because they feature a higher interest rate than other similar bonds. Although they don't pay cash returns, they function in essentially the same manner, providing their return as a tax credit. As with other municipal bonds, interest payments aren't subject to capital gains taxes, and investors may transfer the instrument to another party, who then receives the tax credit at a date before the bond reaches maturity.
Advantages for Issuers
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A handful of agencies may issue qualified tax credit bonds, including school districts using money to expand or upgrade facilities; projects developing renewable energy sources; public infrastructure projects as part of the American Recovery and Reinvestment Act; and energy-conservation programs. These agencies only need to return the bond principal to investors upon its maturity, and returns are applied as tax credits through the IRS; issuing agencies don't need to provide investors with interest payments. Because of this, issuing agencies may use qualified tax credit bonds as an interest-free loan.
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