[Code of Federal Regulations]
[Title 26, Volume 11]
[Revised as of April 1, 2004]
From the U.S. Government Printing Office via GPO Access
[CITE: 26CFR1.1397E-1]

[Page 809-810]
 
                       TITLE 26--INTERNAL REVENUE
 
    CHAPTER I--INTERNAL REVENUE SERVICE, DEPARTMENT OF THE TREASURY 
                               (CONTINUED)
 
PART 1_INCOME TAXES--Table of Contents
 
Sec. 1.1397E-1  Qualified zone academy bonds.

    (a) Overview. In general, a qualified zone academy bond is a taxable 
bond issued by a state or local government the proceeds of which are 
used to improve certain eligible public schools. An eligible taxpayer 
that holds a qualified zone academy bond generally is allowed annual 
Federal income tax credits in lieu of periodic interest payments. These 
credits compensate the eligible taxpayer for lending money to the issuer 
and function as payments of interest on the bond. Accordingly, this 
section generally treats the allowance of a credit as if it were a 
payment of interest on the bond. In addition, this section provides 
rules to determine the credit rate, the present value of qualified 
contributions from private entities, and the maximum term of a qualified 
zone academy bond.
    (b) Credit rate. The Secretary shall determine monthly (or more 
often as deemed necessary by the Secretary) the credit rate the 
Secretary estimates will generally permit the issuance of a qualified 
zone academy bond without discount and without interest cost to the 
issuer. The manner for ascertaining the credit rate for a qualified zone 
academy bond as determined by the Secretary shall be set forth in 
procedures, notices, forms, or instructions prescribed by the 
Commissioner.
    (c) Private business contribution requirement--(1) Reasonable 
discount rate. To determine the present value (as of the issue date) of 
qualified contributions from private entities under section 1397E(d)(2), 
the issuer must use a reasonable discount rate. The credit rate 
determined under paragraph (b) of this section is a reasonable discount 
rate.
    (2) Definition of private entities. For purposes of section 
1397E(d)(2)(A), the term private entities includes any person (as 
defined in section 7701(a)) other than the United States, a State or 
local government, or any agency or instrumentality thereof or related 
party with respect thereto. To determine whether a person is related to 
the United States or a State or local government under this paragraph 
(c)(2), rules similar to those for determining whether a person is a 
related party under Sec. 1.150-1(b) shall apply (treating the United 
States as a governmental unit for purposes of Sec. 1.150-1(b)).
    (3) Qualified contribution. For purposes of section 1397E(d)(2)(A), 
the term qualified contribution means any contribution (of a type and 
quality acceptable to the eligible local education agency) of any 
property or service described in section 1397E(d)(2)(B)(i), (ii), (iii), 
(iv) or (v). In addition, cash received with respect to a qualified zone 
academy from a private entity (other than cash received indirectly from 
a person that is not a private entity as part of a plan to avoid the 
requirements of section 1397E) constitutes a qualified contribution if 
it is to be used to purchase any property or service described in 
section 1397E(d)(2)(B)(i), (ii), (iii), (iv) or (v). Services of 
employees of the eligible local education agency do not constitute 
qualified contributions.
    (d) Maximum term. The maximum term for a qualified zone academy bond 
is determined under section 1397E(d)(3) by using a discount rate equal 
to 110

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percent of the long-term adjusted AFR, compounded semi-annually, for the 
month in which the bond is issued. The Internal Revenue Service 
publishes this figure each month in a revenue ruling that is published 
in the Internal Revenue Bulletin. See Sec. 601.601(d)(2)(ii)(b) of this 
chapter.
    (e) Tax credit--(1) Eligible taxpayer. An eligible taxpayer (within 
the meaning of section 1397E(d)(6)) that holds a qualified zone academy 
bond on a credit allowance date is allowed a tax credit against the 
Federal income tax imposed on the taxpayer for the taxable year that 
includes the credit allowance date. The amount of the credit is equal to 
the product of the credit rate and the outstanding principal amount of 
the bond on the credit allowance date. The credit is subject to a 
limitation based on the eligible taxpayer's income tax liability. See 
section 1397E(c).
    (2) Ineligible taxpayer. A taxpayer that is not an eligible taxpayer 
is not allowed a credit.
    (f) Treatment of the allowance of the credit as a payment of 
interest--(1) General rule. The holder of a qualified zone academy bond 
must treat the bond as if it pays qualified stated interest (within the 
meaning of Sec. 1.1273-1(c)) on each credit allowance date. The amount 
of the deemed payment of interest on each credit allowance date is equal 
to the product of the credit rate and the outstanding principal amount 
of the bond on that date. Thus, for example, if the holder uses an 
accrual method of accounting, the holder must accrue as interest income 
the amount of the credit over the one-year accrual period that ends on 
the credit allowance date.
    (2) Adjustment if the holder cannot use the credit to offset a tax 
liability. If a holder holds a qualified zone academy bond on the credit 
allowance date but cannot use all or a portion of the credit to reduce 
its income tax liability (for example, because the holder is not an 
eligible taxpayer or because the limitation in section 1397E(c) 
applies), the holder is allowed a deduction for the taxable year that 
includes the credit allowance date (or, at the option of the holder, the 
next succeeding taxable year). The amount of the deduction is equal to 
the amount of the unused credit deemed paid on the credit allowance 
date.
    (g) Not a tax-exempt obligation. A qualified zone academy bond is 
not an obligation the interest on which is excluded from gross income 
under section 103(a).
    (h) Reimbursement. An expenditure for a qualified purpose may be 
reimbursed with proceeds of a qualified zone academy bond. For this 
purpose, rules similar to those in Sec. 1.150-2 shall apply.
    (i) State or local government--(1) In general. For purposes of 
section 1397E(d)(1)(B), the term State or local government means a State 
or political subdivision as defined for purposes of section 103(c).
    (2) On behalf of issuer. A qualified zone academy bond may be issued 
on behalf of a State or local government under rules similar to those 
for determining whether a bond issued on behalf of a State or political 
subdivision constitutes an obligation of that State or political 
subdivision for purposes of section 103.
    (j) Cross-references. See section 171 and the regulations thereunder 
for rules relating to amortizable bond premium. See Sec. 1.61-7(d) for 
the seller's treatment of a bond sold between interest payment dates 
(credit allowance dates) and Sec. 1.61-7(c) for the buyer's treatment 
of a bond purchased between interest payment dates (credit allowance 
dates).
    (k) Effective dates. Except as provided in this paragraph (k), this 
section applies to bonds sold on or after September 26, 2000. Each of 
paragraphs (c) and (i) of this section may be applied by issuers to 
bonds that are sold before September 26, 2000.

[T.D. 8755, 63 FR 673, Jan. 7, 1998; 63 FR 8528, Feb. 19, 1998, as 
amended by T.D. 8826, 64 FR 35574, July 1, 1999. Redesignated and 
amended by T.D. 8903, 65 FR 57733, Sept. 26, 2000]

              Rules Relating to Individuals' Title 11 Cases

    Source: Sections 1.1398-1 and 1.1398-2 appear at T.D. 8537, 59 FR 
24937, May 13, 1994, unless otherwise noted.

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