tax memo

Lucille is an avid boater living near Gotham city. Gotham has recently created a harbor improvement special assessment district to oversee renovations to the public boat docks and boardwalk area surrounding the city harbor. The special assessment district plans to issue bonds to fund a portion of the planned improvements. Lucille is considering an investment in these bonds, but is unsure whether the interest income she would earn qualifies for tax exemption. Prepare a written memorandum stating the research issue(s), your conclusions concerning the issues(s), and the specific statutory, regulatory, or judicial authority supporting your conclusions.

TAX FILE MEMORANDUM

Summary of Facts

Lucille is an avid boater living near Gotham City. Gotham has recently created a harbor improvement special assessment district to oversee renovations to the public boat docks and boardwalk area surrounding the city harbor. The special assessment district plans to issue bonds to fund a portion of the planned improvements. Lucille is considering an investment in these bonds, but is unsure whether the interest income she would earn qualifies for tax exemption.

Research Issue

Does interest earned on bonds issued by special assessment district of a city government qualify for tax exemption?

Law and Analysis

Internal Revenue Code (IRC) Section 103(a) provides that gross income does not include interest on any State or local bond. The term ‘State or local bond’ is defined in Section 103(f)(1) to mean an obligation of a State or its political subdivision. Thus, in order to exclude bond interest from taxation, the special assessment district of Gotham City must be considered a political subdivision of the state in which the city is located.

Treasury regulations under Section 103 expand on the definition of a political subdivision. Reg. Sec. 1.103-1(b) provides that obligations issued by or on behalf of a local governmental unit by authorities empowered to issue such obligations are considered obligations of the unit. Further, the term political subdivision may include special assessment districts, such as road, water, sewer, gas, light, school, harbor, port improvement, and similar districts and division of such governmental unit.

Conclusion

Gotham City’s special assessment district qualifies as a political subdivision of a State or local government. As a result, interest earned on bonds issued by the special assessment district in excluded from gross income under Section 103(a).