[Federal Register Volume 65, Number 187 (Tuesday, September 26, 2000)]
[Rules and Regulations]
[Pages 57732-57734]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 00-24588]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[TD 8903]
RIN 1545-AY01


Qualified Zone Academy Bonds; Obligations of States and Political 
Subdivisions

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations.

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SUMMARY: This document contains final regulations relating to the 
Federal income tax treatment of qualified zone academy bonds. These 
regulations provide guidance to State and local governments that issue 
qualified zone academy bonds and to banks, insurance companies and 
other taxpayers that hold those bonds. These regulations make final 
certain temporary regulations.

DATES: Effective Date: These regulations are effective September 26, 
2000.
    Applicability Date: For dates of applicability, see Sec. 1.1397E-
1(k).

FOR FURTHER INFORMATION CONTACT: Timothy L. Jones or Allan B. Seller at 
202-622-3980 (not a toll-free number).

SUPPLEMENTARY INFORMATION:

Background

    Section 226(a) of the Taxpayer Relief Act of 1997, Public Law 105-
34 (111 Stat. 788), amended the Internal Revenue Code (Code) by 
redesignating section 1397E as section 1397F and adding a new section 
1397E. Section 1397E authorizes a type of debt instrument known as a 
qualified zone academy bond.

Explanation of Provisions

In General

    A qualified zone academy bond is a taxable bond issued by a State 
or local government, the proceeds of which are used to enhance certain 
eligible public schools. In lieu of receiving periodic interest 
payments from the issuer, an eligible holder of a qualified zone 
academy bond is generally allowed annual federal income tax credits 
while the bond is outstanding. These credits compensate the holder for 
lending money to the issuer and function as payments of interest on the 
bond.
    Temporary regulations (REG-119449-97) interpreting section 1397E 
were published on January 7, 1998 (63 FR 671), and amended on July 1, 
1999 (64 FR 35573). The temporary regulations generally treat the 
allowance of the credit as if it were a payment of interest on the 
bond.
    Code section 1397E(e), as amended by section 509 of the Ticket to 
Work and Work Incentives Improvement Act of 1999, Public Law 106-170 
(113 Stat. 1860), imposes a national limitation on the amount of 
qualified zone academy bonds that can be issued. For each applicable 
year, the IRS publishes a revenue procedure allocating the national 
limitation among the States and the possessions.

Bonds Issued by a State or Local Government

    Section 1397E(d)(1)(B) requires that a qualified zone academy bond 
be issued by a State or local government within the jurisdiction of 
which a qualified zone academy (as defined in section 1397E(d)(4)) is 
located. Commentators requested clarification that, for these purposes, 
a State or local government means a State or political subdivision as 
defined for purposes of section 103(c). Commentators also requested 
that the final regulations include a provision for the issuance of 
qualified zone academy bonds on behalf of a State or local government 
in a manner similar to the issuance of obligations on behalf of a State 
or political subdivision under section 103.
    The final regulations provide that, for purposes of section 
1397E(d)(1)(B), the term State or local government means a State or 
political subdivision as defined for purposes of section 103(c). The 
final regulations also specify that a qualified zone academy bond may 
be issued on behalf of a State or local government under rules similar 
to those for determining whether a bond issued on behalf of a State or 
political subdivision constitutes an obligation of that State or 
political subdivision for purposes of section 103.

Private Business Contribution Requirement

    Section 1397E(d)(1)(C)(ii) requires the issuer of a qualified zone 
academy bond to certify that it has written assurances that the private 
business contribution requirement of section 1397E(d)(2) will be met 
with respect to the qualified zone academy. For these purposes, the 
private business contribution requirement is met if the eligible local 
education agency (as defined in section 1397E(d)(4)(B)) has written 
commitments from private entities to make qualified contributions 
having a present value as of the issue date of 10 percent or more of 
the proceeds of the issue.
    The Code does not define private entities for these purposes. 
Section 1397E(d)(2)(B) defines qualified contribution as any 
contribution (of a type and quality acceptable to the eligible local 
education agency) of (i) equipment for use in the qualified zone 
academy, (ii) technical assistance in developing curriculum or in 
training teachers in order to promote appropriate market driven 
technology in the classroom, (iii) services of employees as volunteer 
mentors, (iv) internships, field trips, or other educational 
opportunities outside the academy for students, or (v) any other 
property or service specified by the eligible local education agency.
    Commentators requested clarification of the meaning of private 
entities for these purposes. For example, commentators asked whether 
the term may include an organization described in section 501(c)(3) or 
a private individual.
    The final regulations provide that, for purposes of section 
1397E(d)(2)(A), the term private entities includes any person (as 
defined in section 7701(a)) other than the United States, a State or 
local government, or any agency or instrumentality thereof or related 
party with respect thereto.
    Commentators also sought clarification regarding the meaning of 
qualified contribution under section 1397E(d)(2)(B). The final 
regulations provide that cash received with respect to a qualified zone 
academy from a private entity constitutes a qualified contribution if 
it is to be used to purchase any property or service described in 
section 1397E(d)(2)(B)(i), (ii), (iii), (iv) or (v). The final 
regulations also indicate that services of employees of the eligible 
local education agency do not constitute qualified contributions.

[[Page 57733]]

Issuer Certifications

    Section 1397E(d)(1)(C) requires the issuer to certify (1) that it 
has written assurances that the private business contribution 
requirement will be met, and (2) that it has the written approval of 
the eligible local education agency for the bond issuance. The Treasury 
and the IRS intend that these certifications will be respected and may 
be relied on by taxpayers if the certifications are reasonably made.

95 Percent Test

    Section 1397E(d)(1)(A) requires that 95 percent or more of the 
proceeds of an issue of qualified zone academy bonds be used for a 
qualified purpose described in section 1397E(d)(5) with respect to a 
qualified zone academy. The Treasury and the IRS intend that the 
qualified purposes set forth in section 1397E(d)(5) are to be broadly 
interpreted. The Treasury and the IRS also intend that issuers may 
apply principles similar to the requirements of Sec. 1.142-2 (without 
regard to the requirement therein that the period between the issue 
date and the first call date not exceed 10\1/2\ years) to cure an 
unexpected failure to spend 95 percent or more of the proceeds of an 
issue for a qualified purpose. Further, the Treasury and the IRS intend 
that taxpayers may rely on an issuer's determination that a public 
school (or academic program within a public school) is a qualified zone 
academy for purposes of section 1397E(d)(4) if the determination has a 
reasonable basis.

Effective Dates

    The final regulations apply to bonds sold on or after September 26, 
2000. In addition, the final regulations permit elective, retroactive 
application to bonds sold before September 26, 2000 of either of the 
following sections of the regulations: Sec. 1.1397E-1(c) (private 
business contribution requirement) and Sec. 1.1397E-1(i) (State or 
local government).

Special Analyses

    It has been determined that this Treasury decision is not a 
significant regulatory action as defined in Executive Order 12866. 
Therefore, a regulatory assessment is not required. It has also been 
determined that section 553(b) of the Administrative Procedure Act (5 
U.S.C. chapter 5) does not apply. The Regulatory Flexibility Act (5 
U.S.C. chapter 6) does not apply because these regulations do not 
impose a collection of information on small entities. Pursuant to 
section 7805(f) of the Code, the notice of proposed rulemaking 
preceding these regulations was sent to the Chief Counsel for Advocacy 
of the Small Business Administration for comment on its impact on small 
businesses.

List of Subjects in 26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

Adoption of Amendments to the Regulations

    Accordingly, 26 CFR part 1 is amended as follows:

PART 1--INCOME TAXES

    Paragraph 1. The authority citation for part 1 is amended by 
removing the entry for Section 1.1397E-1T and adding a new entry in 
numerical order to read in part as follows:

    Authority: 26 U.S.C. 7805 * * * Section 1.1397E-1 also issued 
under 26 U.S.C. 1397E(b) and (d).


Sec. 1.1397E-1T  [Redesignated as 
Sec. 1.1397E-1]

    Par. 2. Section 1.1397E-1T is redesignated as Sec. 1.1397E-1.

    Par. 3. Newly designated Sec. 1.1397E-1 is amended as follows:
    1. The section heading is revised.
    2. Revising paragraphs (c), (f)(2), (i) and (j).
    3. Adding a new paragraph (k).
    The revisions and addition read as follows:


Sec. 1.1397E-1  Qualified zone academy bonds.

* * * * *
    (c) Private business contribution requirement--(1) Reasonable 
discount rate. To determine the present value (as of the issue date) of 
qualified contributions from private entities under section 
1397E(d)(2), the issuer must use a reasonable discount rate. The credit 
rate determined under paragraph (b) of this section is a reasonable 
discount rate.
    (2) Definition of private entities. For purposes of section 
1397E(d)(2)(A), the term private entities includes any person (as 
defined in section 7701(a)) other than the United States, a State or 
local government, or any agency or instrumentality thereof or related 
party with respect thereto. To determine whether a person is related to 
the United States or a State or local government under this paragraph 
(c)(2), rules similar to those for determining whether a person is a 
related party under Sec. 1.150-1(b) shall apply (treating the United 
States as a governmental unit for purposes of Sec. 1.150-1(b)).
    (3) Qualified contribution. For purposes of section 1397E(d)(2)(A), 
the term qualified contribution means any contribution (of a type and 
quality acceptable to the eligible local education agency) of any 
property or service described in section 1397E(d)(2)(B)(i), (ii), 
(iii), (iv) or (v). In addition, cash received with respect to a 
qualified zone academy from a private entity (other than cash received 
indirectly from a person that is not a private entity as part of a plan 
to avoid the requirements of section 1397E) constitutes a qualified 
contribution if it is to be used to purchase any property or service 
described in section 1397E(d)(2)(B)(i), (ii), (iii), (iv) or (v). 
Services of employees of the eligible local education agency do not 
constitute qualified contributions.
* * * * *
    (f) * * *
    (2) Adjustment if the holder cannot use the credit to offset a tax 
liability. If a holder holds a qualified zone academy bond on the 
credit allowance date but cannot use all or a portion of the credit to 
reduce its income tax liability (for example, because the holder is not 
an eligible taxpayer or because the limitation in section 1397E(c) 
applies), the holder is allowed a deduction for the taxable year that 
includes the credit allowance date (or, at the option of the holder, 
the next succeeding taxable year). The amount of the deduction is equal 
to the amount of the unused credit deemed paid on the credit allowance 
date.
* * * * *
    (i) State or local government--(1) In general. For purposes of 
section 1397E(d)(1)(B), the term State or local government means a 
State or political subdivision as defined for purposes of section 
103(c).
    (2) On behalf of issuer. A qualified zone academy bond may be 
issued on behalf of a State or local government under rules similar to 
those for determining whether a bond issued on behalf of a State or 
political subdivision constitutes an obligation of that State or 
political subdivision for purposes of section 103.
    (j) Cross-references. See section 171 and the regulations 
thereunder for rules relating to amortizable bond premium. See 
Sec. 1.61-7(d) for the seller's treatment of a bond sold between 
interest payment dates (credit allowance dates) and Sec. 1.61-7(c) for 
the buyer's treatment of a bond purchased between interest payment 
dates (credit allowance dates).
    (k) Effective dates. Except as provided in this paragraph (k), this 
section applies to bonds sold on or after September 26, 2000. Each of 
paragraphs (c) and (i) of this section may be applied

[[Page 57734]]

by issuers to bonds that are sold before September 26, 2000.

Bob Wenzel,
Deputy Commissioner of Internal Revenue.
    Approved: September 19, 2000.
Jonathan Talisman,
Acting Assistant Secretary of the Treasury.
[FR Doc. 00-24588 Filed 9-25-00; 8:45 am]
BILLING CODE 4830-01-P