Yes, you will need to file either IRS Form 8038-G or 8038-GC in order to extend a tax-exempt loan to the municipality. Additionally, there are other Illinois and IRS requirements that must be met before you may extend such a loan.

The IRS has issued guidance on tax-exempt government “bonds,” a term that it uses to refer to loans and other financing arrangements entered into by state and local governments. Regarding necessary forms, the IRS guidance states that all issuers of governmental bonds must file an information return using either IRS Form 8038-G or 8038-GC, depending on whether the bond’s price is $100,000 or greater, for Form 8038-G, or less than $100,000, for Form 8038-GC.

While we do not believe any specific language or wording needs to be included in the loan documents when extending a tax-exempt loan to a municipality, there are other Illinois and IRS requirements that must be met before a bank can extend such a loan. For example, the Illinois Municipal Code authorizes municipalities to borrow money from banks, subject to the municipality’s debt limits and provided that the loan is payable within ten years. The indebtedness must be authorized in an ordinance passed by the municipality’s corporate authorities and evidenced by a promissory note (or similar debt instrument) executed by the municipality’s mayor or president. The payments must be a “lawful direct general obligation of the municipality payable from the general funds of the municipality and such other sources of payment as are otherwise lawfully available.” Your bank also should check with the municipality about any other requirements or limitations that it has imposed on its lending activities.

Additionally, as explained in the IRS’s “Tax-Exempt Governmental Bonds” publication, tax-exempt bonds must meet the private activity bond tests and other requirements in order to qualify for a tax exemption. The application of these tests and requirements is relatively complex and requires a full understanding of the loan. Consequently, we recommend consulting with accounting professionals to confirm the tax-exempt status of any loan to a municipality or other governmental entity.

For resources related to our guidance, please see:

• IRS, Publication 4079, Tax-Exempt Governmental Bonds, page 2 (“State and local governments receive direct and indirect tax benefits under the IRC that lower borrowing costs on their valid debt obligations. Because interest paid to bondholders on these obligations is not includable in their gross income for federal income tax purposes, bondholders are willing to accept a lower interest rate than they would accept if the interest was taxable. These benefits apply to many different types of municipal debt financing arrangements including bonds, notes, loans, lease purchase contracts, lines of credit and commercial paper (collectively referred to as ‘bonds’ in this publication).

  To receive these benefits, issuers must ensure that the requirements under the IRC are met, generally for as long as the bonds remain outstanding. These requirements include, but are not limited to, information filing and other requirements related to issuance, the proper and timely use of bond-financed property, and limitations on how bond proceeds (funds derived from the sale of bonds) may be invested. This publication describes these rules as they relate to governmental bonds.”)

• IRS, Publication 4079, Tax-Exempt Governmental Bonds, page 7 (“Form 8038-G, Information Return for Tax-Exempt Governmental Bonds, for a governmental bond issue with an issue price of $100,000 or greater. . . . Form 8038-GC, Information Return for Small Tax-Exempt Governmental Bond Issues, Leases, and Installment Sales, for a governmental bond issue with an issue price of less than $100,000. May be filed for a single issue or on a consolidated basis for all ‘small’ issues in a calendar year.”)

• IRS, Form 8038-G

• IRS, Form 8038-GC

• Illinois Municipal Code, 65 ILCS 5/8-1-3.1 (“The corporate authorities may also borrow money from any bank or other financial institution provided such money shall be repaid within 10 years from the time the money is borrowed. The mayor or president of the municipality, as the case may be, shall execute a promissory note or similar debt instrument, but not a bond, to evidence the indebtedness incurred by the borrowing. The obligation to make the payments due under the promissory note or other debt instrument shall be a lawful direct general obligation of the municipality payable from the general funds of the municipality and such other sources of payment as are otherwise lawfully available. The promissory note or other debt instrument shall be authorized by an ordinance passed by the corporate authorities and shall be valid whether or not an appropriation with respect to that ordinance is included in any annual or supplemental appropriation adopted by the corporate authorities. The indebtedness incurred under this Section, when aggregated with the existing indebtedness of the municipality, may not exceed the debt limitation provided in Section 8-5-1 of this Code. . . .”)

• Illinois Municipal Code, 65 ILCS 5/1-1-2 (“(1) ‘Municipal’ or ‘municipality’ means a city, village, or incorporated town in the State of Illinois.”)

• Illinois Municipal Code, 65 ILCS 5/1-1-2 (“(2) ‘Corporate authorities’ means (a) the mayor and alderpersons or similar body when the reference is to cities, (b) the president and trustees or similar body when the reference is to villages or incorporated towns, and (c) the council when the reference is to municipalities under the commission form of municipal government.”)

• Illinois Municipal Code, 65 ILCS 5/1-1-2 (“(8) Wherever the words ‘city council’, ‘alderpersons’, ‘commissioners’, or ‘mayor’ occur, the provisions containing these words shall apply to the board of trustees, trustees, and president, respectively, of villages and incorporated towns and councilmen in cities, so far as those provisions are applicable to them.”)

• IRS, Publication 4079, Tax-Exempt Governmental Bonds, page 3 (“Testing for Governmental Bonds: The Private Activity Bond Tests. IRC Section 141 sets forth tests to determine if a bond is a private activity bond. These tests identify arrangements that actually, or are reasonably expected to, transfer benefits of tax- exempt financing to a nongovernmental person. . . . A state or local bond will be a private activity bond if, as of the issue date of the bonds or at any time while the bonds are outstanding, the bond issue exceeds the limits set forth in either:
   
  • the private business tests of Section 141(b), which consist of the private use test and the   private security and payment test, and certain special private business rules (see Special Private Business Test Rules and Special Rules for Certain Utility Financings, below), or
     
  • the private loan financing test of Section 141(c).”)