Throughout the first six months of 2025, proponents of tax-exempt bond financing feared that Congress might eliminate the exemption of interest on such bonds from federal income taxation in its search for spending reductions and tax loophole closings. Fortunately for the proponents, H.R.1, also known as the One Big Beautiful Bill Act (OBBBA), not only preserves the exemption but even modestly expands it.
Tax-Exempt Bonds as a Target
A primary goal of the new President and the Republican majority in Congress has been the extension of the 2017 Tax Cuts and Jobs Act (TCJA), the bulk of which was scheduled to expire at the end of 2025. In late February, the House passed a spending bill (H. Con. Res. 119-4) to enable the extension, provided that Congress would also enact spending reductions. Cutting spending is always a challenge.
Another way to offset the cost of extending the TCJA was through the closure of tax “loopholes.” One such loophole under discussion was the exemption of interest on qualified state and local bonds from federal income taxation. The House Ways and Means Committee estimated that the elimination of the exemption would raise up to $250 billion in additional income tax revenue over the next 10 years.
However, Congress may have forgone the elimination of the exemption because it recognized that state and local governments are responsible for 90 percent of all public infrastructure spending and over 80 percent of that spending is financed with tax-exempt bonds, according to the Public Finance Network. In addition, non-profit organizations and multi-family housing providers rely on tax-exempt bond financing to finance the construction and renovation of essential and politically-popular facilities such as hospitals, schools and affordable housing developments.
What Congress Did
The OBBBA makes three salutary changes to the tax-exempt bond provisions of the Internal Revenue Code.
First, the OBBBA enacts the so-called “LIHTC Fix.” It alters the requirement for the 4 percent low-income housing tax credit (LIHTC) that at least 50 percent of the aggregate basis of the building and land be financed with tax-exempt bonds, subject to a state’s private activity bond (PAB) volume cap. The new requirement reduces the aggregate basis requirement from 50 to 25 percent. The LIHTC Fix has been discussed over the past several years as a way to reduce state volume cap pressures and expand LIHTC availability, which will, in turn, enhance the nation’s supply of affordable housing.
Second, the OBBBA authorizes tax-exempt PAB financing for spaceports. The term “spaceport” means a facility located at or in close proximity to a launch site or reentry site used for (i) manufacturing, assembling, or repairing spacecraft, space cargo, or other spaceport facilities or components, (ii) flight control operations, (iii) providing launch services and reentry services, or (iv) transferring crew, spaceflight participants, or space cargo to or from spacecraft. The OBBBA also provides spaceport bonds an exception from the federal guarantee prohibition.
Third, Congress made a minor change to the rules governing tax-exempt bonds as part of its effort to encourage domestic research and experimental expenditures (DREE). In addition to authorizing the full expensing of DREE, the OBBBA excludes DREE from the $10 million capital expenditure limitation for qualified small issue manufacturing bonds.
The Future
According to news reports, several Congressional “deficit hawks” were persuaded to vote for the OBBBA with the promise that there would be a second reconciliation bill in 2025. So tax-exempt bonds could again be on the chopping block this year. We will continue to monitor the deliberations.
