A tax-exempt municipal lease, also known as a lease-purchase agreement, is a contract that enables government entities to acquire essential-use assets, including fire and public safety equipment, modular buildings, vehicles, computer hardware and software, real property and much more.
In a tax-exempt municipal lease, the government entity has a ”non-appropriation of funds” clause in the agreement. This allows the lessee to terminate the lease at the end of its fiscal year if funds have not been appropriated for the coming year’s payment without the lessee being in default under the lease terms and conditions. This clause serves as the basis for a municipal lease not violating the public debt limitations that typically require voter approval for a municipality to enter into a long-term debt obligation.
Equipment leasing is a lower cost alternative to traditional bond financing. In addition the tax-exempt municipal lease offers government entities a wide range of benefits in procuring essential assets:
Low, tax-exempt interest rates that are fixed for the term of the lease.
Increasing equity with every payment, resulting in complete ownership and clear title to the equipment at the end of the term.
Lease payments that are considered an operating expense, not long-term debt, thereby providing an avenue to ownership that does not create a debt obligation.
An alternative to the high issuance cost bond market and the time and complexity of obtaining voter approval for a bond issue.
An option to prepay the contract throughout the term for a predetermined purchase price. Payments structured to meet the lessee’s cash flow and budgetary requirements on a monthly, quarterly, semiannual or annual basis.
A master lease program that allows for simple add-on schedules.
Desirability of matching costs and benefits over time.
Prevention of technological obsolescence.
Fixed monthly payments.
Who qualifies for tax-exempt municipal leasing?
Section 103 of the Internal Revenue Code allows certain municipal entities to obtain financing at lower interest rates than what is available to commercial and industrial businesses. That is because the interest earned by the Lessor is exempt from federal income taxes. The following entities qualify for tax-exempt financing:
State and City Governments
State Universities
Community Colleges
Public Authorities
Public School Districts
Municipal Hospitals
Some not-for-profit corporations [501 (c)(3)’s] may qualify for tax-exempt financing if a public authority or local government (Sponsor) supports the issuance of the debt. This is sometimes called a conduit. These 501 (c)(3)’s are:
Hospitals
Private Schools
Churches
Public Housing Authorities may also issue tax-exempt debt if they have a sponsor.
Who is tax- exempt?
In order for a lease to be tax-exempt for federal (and possibly state) income taxes, the following are required:
The lessee must be viewed as a “municipality” and have one of the following powers:
1) taxation 2) eminent domain 3) police
The interest rate or component must be itemized in some form (most lessors want an amortization schedule breaking out the actual dollars of interest in each payment, as opposed to simply providing the interest percentage rate.
The lessee must obtain an equity interest in the property being financed during the lease term. This is usually shown by a nominal purchase option of $1.00 or a small amount in relation to the actual value at the end of the lease.
The useful life of the equipment must be equal to or longer than the lease term.
The lessee must file an IRS 8038-G or 8038-GC form within a set time frame after the lease commences, as opposed to the usual process in which the lessor files these forms.
The property must meet the private-public use rules, in which no more than 5% (but in some cases, up to 10%) can be used for private purposes.
If any one of the above requirements is not met, the lease cannot be completed on a tax-exempt basis. If the lessee does not want “ownership” of the property, a municipal taxable lease is more appropriate.
