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Tax-Exempt Financing for Public Agencies
Frequently Asked Questions
There seems to be a greater
desire for public agencies to acquire equipment through financing. This may be
the result of better planning by the agencies, realizing at the beginning that
ownership is more cost effective than a long-term rental. Or it may be that
there is a better understanding of the benefits of this low-interest method of
financing that has gained over other methods of financing. Here's a quick
overview, incorporating the most often asked questions.
"What is a tax-exempt lease?"
This is a financing transaction also known as a conditional sales contract where
the interest earned by the lessor is not subject to federal taxes. The lessor,
since they do not pay federal taxes on the interest income can offer a lower
interest rate to the lessee. The exclusion from federal taxes is where the
"tax-exempt lease" name comes from.
"Who is eligible?"
The lessee must be a state or possession of the US, or a political subdivision
thereof. Political subdivisions include cities, towns, counties, as well as
other entities, which have sovereign powers that include taxation, eminent
domain, or police power. These entities include school districts, water
districts, hospitals and others.
"Who isn't eligible?"
Most charter schools, "not-for-profit" entities also known as 501(c) 3, federal
agencies, and public "affiliate" (not run by) entities.
Vendors may offer tax-exempt lease/purchase financing to qualified customers
even if financing is not part of the bid request. This can streamline the
documentation process. Often, municipal customers are already bidding the
financing separately. It varies from customer to customer. If you do choose this
type of financing, make sure to note that the appropriate documentation will be
necessary. A set of sample tax-exempt documents may be included with your bid
response, as you would be surprised how many purchasing agents still aren't
familiar with this type of financing.
"Is it always a Dollar ($1.00) Purchase Option?"
The IRS Code requires a nominal purchase option at the end of the lease term.
This small amount is typically one dollar, but can be slightly higher.
"OK, I'm getting there, just how cumbersome are municipal documents?"
The IRS Code requires a few very basic provisions be included to qualify the
lease as tax-exempt. This document has been standardized by the industry and
using the document from a financing source will have a favorable effect the
interest rate. These documents include but aren't limited to:
Master Lease/Purchase Agreement
This spells out the terms of the financing. This also includes a
"non-appropriations clause," which states the lessee can terminate the lease at
the end of the current fiscal year, and return the equipment if they are unable
to obtain sufficient funds to meet future lease payments.
Legal Opinion
This comes from the lessee's counsel, and states proper procedures were followed
in executing the documents.
Essential Use Certificate
The lessee states that the equipment is necessary and essential to the on-going
operations of the lessee. This is important in light of the "non-appropriations"
clause.
Insurance Certificate
8038-G or GC IRS Form
This is an IRS form and requires specific information to be filed. Failure to do
so may result in the transactions loss of its tax-exempt treatment.
Payment Schedule
Represents payments due under the lease and also breaks out the interest and
principle components of the lease payment, which is required by the IRS code.
Acceptance Certificate
Clearly specifies the lease start date
"Who is responsible for maintenance, property taxes,
insurance, and other operating expenses?"
A tax-exempt lease is a "net lease" and the lessee is responsible for all
operating expenses. The lessee may contract with a modular dealer/manufacturer
to provide such services as maintenance, but these are paid outside the scope of
the tax-exempt financing.
"Why would I enter into a tax-exempt lease?"
There are a few obvious benefits to this type of financing which include:
"Can they finance modular
equipment/furniture?"
Other equipment can be added to the tax-exempt financing in addition to the
equipment. This may include furniture and fixtures for new modular classrooms,
computers, or HVAC equipment. The list is almost endless. The important thing is
that this equipment must be "essential" to the operations of the lessee.
"How does credit approval work?"
Most lessors like to see three years of audited financial statements for credit
consideration. Obviously, the risk of a public entity going away is minimal, but
if they are having budget problems the lease needs to be priced accordingly.
There are financing sources for all types of credits and circumstances. If we
know the circumstances and have the information, the proper lease can be
tailored, with the proper rate.
"Who owns the equipment?"
In most cases the title, or MSO, is passed to the lessee, with the lessor
holding a security interest in the equipment.
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