This article appeared as "Tax-Exempt Financing" in the Winter 2024 issue of Independent School.
When schools construct new facilities or undertake significant facility improvements, they often need to borrow funds for some or all the costs. Independent schools, as tax-exempt organizations, may be eligible for tax-exempt financing, or bond financing. I spoke to corporate attorney Jonathan Saben of Folger Levin about how this type of financing can benefit independent schools and how it’s different from other kinds of loans.
There are generally three core differences that distinguish tax-exempt financing, including some ways to save money when spending money.
1. Lower rates. This is the key reason independent schools should consider these loans for major capital projects. “In tax-exempt financing, the lender is not taxed on the interest payments,” Saben explains, “and therefore can charge a lower interest rate and still realize the same after-tax income they would receive on a standard commercial loan.” However, the proverbial strings here include a few more parties and steps.
2. More parties. Unlike a traditional commercial loan arrangement, which usually involves a borrower and a lender, bond financing adds, at a minimum, a third party: the government issuer, which is chosen by the school but is generally not heavily involved in the negotiation of the loan. There may be other parties, and each party is generally represented by counsel.
3. More steps. In tax-exempt financing, the lender lends the money first to the government issuer, which then immediately lends it to the school. While Saben clarifies that “there are multiple structures for tax-exempt financings with varying levels of complexity,” in its simplest form, this type of loan technically is two loans—one coming from the lender and the other coming from the government issuer. However, the issuer does not actually make any payments to the lender—the school pays the lender directly. This two-loan process is supported by three critical legal components:
- governmental approval (often referred to as the TEFRA, or Tax Equity and Fiscal Responsibility Act of 1982, approval);
- loan documentation; and
- a legal opinion, which is a letter from the school’s attorneys after they have conducted diligence regarding the school.
Because the TEFRA approval adds time to the process, Saben notes, the tax-exempt financing process can take several months from when the school receives a commitment letter from its lender to the date the loan closes. Timing and process may be drawbacks for some schools, but the benefit of lower interest rates should not be overlooked.