Is interest from a Build America Bond issued by Kansas or a Kansas political subdivision subject to Kansas individual income tax?

Plain-English summary

An investor asked whether interest from Build America Bonds issued by Kansas should be taxed by Kansas, because the bonds were described as federally “taxable” while Kansas instructions exempted interest on Kansas bonds issued after 1987.

The Department said Kansas does not tax the interest when the Build America Bond was issued by Kansas or one of its political subdivisions. Kansas begins its income-tax calculation with federal adjusted gross income, but K.S.A. 79-32,117(b)(i) specifically excludes interest on Kansas and Kansas-political-subdivision obligations issued after December 31, 1987, “whether or not included in federal adjusted gross income.”

Build America Bonds were created by the American Recovery and Reinvestment Act of 2009 as taxable municipal bonds with a federal subsidy. A Direct Payment BAB gave the issuer a federal subsidy equal to 35% of interest paid; a Tax Credit BAB gave the bondholder a refundable federal credit. Those federal features did not change the Kansas result: a Kansas-issued BAB was treated like any other obligation issued by Kansas or its political subdivisions.

The Department also noted that the Build America Bond program expired on December 31, 2010.

What this means for you

Kansas bondholders

For a Build America Bond issued by Kansas or a Kansas political subdivision, this letter says the interest is excluded from Kansas adjusted gross income even if it is included in federal adjusted gross income.

Tax preparers

Do not assume “federally taxable” means “Kansas taxable.” The controlling Kansas modification in the letter is K.S.A. 79-32,117(b)(i), which specifically addresses interest on Kansas state and political-subdivision obligations.

Holders of bonds issued outside Kansas

This opinion answers only the treatment of Build America Bonds issued by Kansas or its political subdivisions. It does not say that interest from another state's bonds receives the same Kansas subtraction.

Common questions

Q: Were Build America Bonds tax-exempt municipal bonds for federal purposes?
A: No. The letter describes them as taxable municipal bonds carrying federal subsidies or tax credits.

Q: Why was the interest nevertheless exempt from Kansas income tax?
A: K.S.A. 79-32,117(b)(i) excludes interest on Kansas and Kansas-political-subdivision obligations issued after December 31, 1987, whether or not federal adjusted gross income includes it.

Q: Did the answer depend on whether the bond was a Direct Payment BAB or Tax Credit BAB?
A: No distinction was made. The Department said Kansas-issued Build America Bonds should be treated like other bonds issued by Kansas or its political subdivisions.

Q: Is the Build America Bond program still open for new bonds?
A: Not under the program discussed in this letter; the Department said it expired December 31, 2010.

Citations and references

• K.S.A. 79-32,117(b)(i) — excludes interest on post-1987 Kansas and Kansas-political-subdivision obligations from Kansas adjusted gross income
• American Recovery and Reinvestment Act of 2009, Division B, Title I, § 1531 — created Build America Bonds

Source

• Landing page: Kansas Department of Revenue Policy Information Library
• Original document: O-2011-015

Original ruling text

Opinion Letter

Body:

Office of Policy & Research

February 11, 2011

XXXXX
XXXXX
XXXXX
XXXXX

Re: Kansas Income Tax

Dear XXXXX:

Your correspondence of February 9, 2011 has been referred to me for response. Thank you for your inquiry.

Your e-mail requests our advice regarding Build America Bonds issued by Kansas. You note that in 2009, when Build America Bonds were conceived literature from the Internal Revenue Service called them “taxable”. You also note that the Kansas individual income tax instructions talk about an exemption for “any bond interest on bonds issued by Kansas since 12/31/1987.” By your e-mail you ask how these bonds should be treated for Kansas income tax purposes.

It is our understanding that Build America Bonds are taxable municipal bonds that carry special tax credits and federal subsidies for either the bond issuer or the bond holder. Build America Bonds were created under Section 1531 of Title I of Division B of the American Recovery and Reinvestment Act which was signed into law on February 17, 2009. The program expired December 31, 2010.

Build America Bonds (BABs) are either “Direct Payment BABs” or “Tax Credit BABs”. Direct Payment BABs provide a federal subsidy to the issuer of 35% of the interest paid on the bonds. Tax Credit BABs provide a federal subsidy in the form of a refundable tax credit directly to the bond holders.

As you are aware, Kansas law requires the use of federal adjusted gross income as the starting point for computing the Kansas income tax. In the absence of a specific modification, items that are subject to federal tax will be subject to Kansas tax. Similarly, those items that are exempt from federal tax will be exempt from Kansas tax.

Addition modifications are found in K.S.A. 79-32,117(b). Clause (i) of subsection (b), which is an addition modification, also contains language which acts as a subtraction modification. The clause states:

(i) Interest income less any related expenses directly incurred in the purchase of state or political subdivision obligations, to the extent that the same is not included in federal adjusted gross income, on obligations of any state or political subdivision thereof, but to the extent that interest income on obligations of this state or a political subdivision thereof issued prior to January 1, 1988, is specifically exempt from income tax under the laws of this state authorizing the issuance of such obligations, it shall be excluded from computation of Kansas adjusted gross income whether or not included in federal adjusted gross income. Interest income on obligations of this state or a political subdivision thereof issued after December 31, 1987, shall be excluded from computation of Kansas adjusted gross income whether or not included in federal adjusted gross income. (Emphasis added).

While the financing cost of bonds issued as Build America Bonds is subsidized in one form or another by the federal government, the bonds are issued by state and local governments. As a result, we believe that when these bonds are issued by the state of Kansas or its political subdivisions they should be treated as any other bonds issued by the state of Kansas or its political subdivisions. Therefore, in accordance with K.S.A. 79-32,117(b)(i), interest income from Build America Bonds is not subject to Kansas income tax.

I trust this information is of assistance. If I can be of further service, please feel free to contact me.

Sincerely,

Jim Weisgerber
Attorney
Tax Specialist

JW:jw

NOTE: This opinion letter is based solely on the facts provided in your request for advice. If material facts or information were not disclosed this letter is null and void. This letter will be revoked without further action by the Department if the statutes, administrative regulations, published revenue rulings, or court decisions that materially affect this opinion are changed.

Date Composed: 04/18/2013 Date Modified: 04/18/2013

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