With the onslaught of negative economic news related to the ongoing coronavirus crisis, many municipalities are scrambling to determine the impact of the pandemic on, among other things, their finances. Many may be staring down unbudgeted expenses related to this public health emergency, while at the same time anticipating substantial deficits due to drop-offs in real estate and income tax collections.

It is anticipated that federal emergency funds will be available to reimburse municipalities for certain eligible expenses under the major disaster declaration recently approved by President Trump for Pennsylvania on March 30, 2020. Additionally, the recently passed federal CARES Act, H.R. 748, provides $150 Billion of federal emergency funds to state, local and tribal governments for certain unbudgeted public health emergency expenditures related to COVID-19 that occur during the period beginning on March 1, 2020 and ending on December 30, 2020.

While these measures should help municipalities weather the storm, budgets are still expected to be strained due to declining tax collections during this period of uncertainty. Municipalities faced with tough choices may also be looking at the prospect of short-term borrowings to bridge the gap until tax revenues stabilize. This article addresses the tax and state law implications that municipalities face when considering undertaking such a borrowing.

The ability of municipalities to undertake such borrowings, commonly referred to as tax anticipation notes (TANS), is governed by the Local Government Unit Debt Act. Under the Act, TANS are defined as “notes issued in anticipation of taxes, in anticipation of revenues, or in anticipation of both as designated in the notes.”  The Act prescribes a number of limitations on the ability of a municipality to issue a TAN, including the following which are of particular interest:

• The total amount of TANS issued in a given year cannot exceed 85% of the amount of taxes levied for the current year.
• The municipality must certify to the Commonwealth as to the estimated amount of tax revenues to be received during the period when the TAN will be outstanding. This estimate must be based on collection experience and current economic conditions of the municipality, i.e., it must take into account the current economic downturn.
• The maximum term of a TAN may not extend beyond the last day of the fiscal year in which the TAN was issued.

It is this last requirement that may give municipalities pause when considering issuing a TAN. The TAN must mature by the end of the current fiscal year, which generally means December 31. A municipality considering a TAN is therefore making a bit of a gamble that tax revenues will bounce back enough by the end of this year to not only repay that TAN, but also avoid having to issue an additional TAN in the next fiscal year. In the event the TAN is not repaid at maturity, the unpaid balance is treated as non-electoral debt under the Act, and the municipality must include the repayment of it in its budget for the ensuing fiscal year.

There are also federal income tax implications that must be considered when undertaking a short-term borrowing to cover a coronavirus-related budget deficit. Such borrowings are working capital financings under federal income tax law, and Section 148 of the Internal Revenue Code and the regulations thereto restrict the ability of municipalities to undertake such financings (if they are to be on a tax-exempt basis). Working capital financings are subject to a special “proceeds spent last” accounting methodology; that is, unless an exception applies, they are not deemed to have been “spent” for tax purposes until all “available amounts” are first spent.

While it is likely that a deficit financing related to coronavirus would meet the “proceeds spent last” accounting requirement, an exception to the rule may apply. Section 1.148-6 of the Treasury Regulations provides that expenditures for “extraordinary items” are not subject to the general rule. “Extraordinary items” are defined as “nonrecurring items that are not customarily payable from current revenues, such as casualty losses or extraordinary legal judgments in amounts in excess of reasonable insurance coverage.” Expenditures related to a once-in-a-hundred years pandemic are not something a municipality will have included in its budget to pay from current revenues.