This post was originally published in the Washington Business Journal’s WBJBizBeat Blog. | Washington Business Journal
On June 14, the D.C. Council approved the $10.8 billion fiscal 2012 Budget Support Act, which included a contentious tax on non-D.C. municipal bonds. The new provision effectively institutes an 8.5 percent tax on tax-free municipal bond interest generated by non-D.C.-issued bonds.
On a 7-6 vote, the council voted to not grandfather the tax, meaning all non-D.C. bond holdings (regardless of when purchased) are subject to the tax. The tax will be retroactive to 1/1/2011. The Council did not include any provisions to remove the tax if collected tax revenues exceed expectations.
The budget is expected to be approved by Congress.
There are several arguments both for and against the tax:
- D.C. needs the money. Prior efforts to implement this tax in 2002 and 2004 were defeated. Given the difficult economic environment, the tax gained support as a revenue source mostly funded by the wealthiest taxpayers.
- Since the tax will not be grandfathered, it is anticipated the tax will generate approximately $13 million annually.
- The tax may be an alternative to raising the income tax rate on top earning taxpayers.
- All other states in the U.S. now tax out-of-state municipal interest. This year Indiana approved a tax on out-of-state municipal interest beginning in 2012.
- The original reason for offering exemption on non-D.C. interest was due to the limited availability of D.C. bonds. This has not changed. D.C. still issues less debt than Rhode Island, the smallest state.
- The tax will create hardship for retirees living on a fixed income generated by municipal bond portfolios or funds.
- Many investors have concern about how they will build diversified portfolios if their purchases are concentrated in one socio-economic/geographic area. States offer more bonds with greater diversity.
- Not grandfathering previous bond purchases is considered by many to be an unfair to investors who acted in good faith.
Councilwoman Mary Cheh argued: “The unfairness of that has been made plain to everyone because people have already purchased these and relied on these and we would be going back in time”. When Indiana approved the tax which begins in 2012, they grandfathered all purchases made prior to Jan. 1, 2012.
This action necessitates careful planning and consideration by D.C. residents who own and buy tax-exempt bonds.
Read more: Watch out for new retroactive tax in D.C.