What Is “Tax Exempt” Municipal Leasing?
(A non-technical/non-legal overview)
You’ve probably heard the phrase “tax-exempt” in the context of municipal leases or their financial “first cousins,” municipal bonds. Both are very low cost methods of financing used by governments to acquire essential-use equipment. Including vehicles, hardware, software, police & fire stations, jails and maintenance facilities.
Tax-Exempt “Municipal” Leasing is an umbrella phrase that applies to state, county and municipal governments, special districts and authorities (very generally, entities funded with tax dollars).
The “Tax-Exempt” Designation is Sometimes Misunderstood
The I.R.S. created tax-exempt municipal leasing as an incentive to financial institutions to serve state, county & municipal entities (also referred to as state and political subdivisions) using the lowest possible rates. The I.R.S. accomplished this by exempting those financial institutions from certain income taxes on profits earned when lending to qualifying governments like yours. “Tax exempt” distinguishes between this unique type of financing higher-cost commercial loans and leases. This I.R.S. financial institution tax exemption is not related to sales, use or other taxes a government is otherwise be obligated to pay.
What’s the Difference Between a Municipal Lease and a Municipal Bond?
Both are types of multi-year financing. Both reflect the very attractive interest rates characteristic of their tax-exempt pricing structure. There are some VERY IMPORTANT DIFFERENCES for government borrowers.
Municipal bonds create debt and are structured around an unconditional “full faith and credit” pledge to pay by the municipal entity.
This pledge includes the obligation to levy taxes on every resident to pay bond debt, should funds be otherwise insufficient to meet the obligation. This is why most bonds require public consent in the form of complicated, time-consuming and expensive voter referendums.
Municipal leases are generally treated as expenses because they are subject to the annual appropriation of funds in most jurisdictions.
Should funds be insufficient (or are not appropriated for any legal reason) in any future budget year, the government body would have the legal prerogative to terminate the lease and in essence “walk away.” While the very low interest rates on municipal leasing programs compares directly with bonds, municipal lease issuance expenses are just a small fraction of the legal compliance costs incurred on a bond. Making bonds a much more expensive option for all but the very largest (7-8 figure/15-30 year) transactions.
Municipal Lease Interest Rates Are FIXED
Tax-exempt municipal leasing rates are low and locked-in up front for the full term of the lease. Bond rates FLOAT until the underwriter brings your issue “to market,” where your final (actual) rates are set by bond traders and the investing public. And you may or may not like the numbers–you may even find yourself back at “square one.”
1) This discussion above is intended as a non-technical/non-legal overview only.
2) First Capital Equipment Leasing Corp. (“FCELC”) acts for its own interest only. FCELC does not act as a municipal advisor, municipal financial consultant, fiduciary or agent to any person or entity pursuant to Section 15B of the Securities Exchange Act of 1934 and the municipal advisor rules of the SEC. FCELC is not recommending that you take an action with respect to the information contained on this page or this website. You should review and discuss anything presented herein with such independent financial, tax, legal and other advisors as you deem appropriate.