Glossary of Municipal Securities Terms

ARBITRAGE BONDS

Bonds  initially issued on a tax-exempt or other federally tax-advantaged basis that are formally deemed by the Internal Revenue Service to violate federal arbitrage regulations. If the Internal Revenue Service finds that tax-exempt bonds are “arbitrage bonds,” the interest becomes retroactively taxable and therefore is included in each bondholder’s gross income for federal income tax purposes. However, the issuer and/or related parties may make payments to the IRS in return for the IRS not declaring the bonds taxable. Similarly, certain federal tax benefits are lost if other types of federally tax-advantaged bonds are found by the Internal Revenue Service to be “arbitrage bonds.” See: ARBITRAGE. Compare: DIRECT PAY SUBSIDY BONDS; TAXABLE MUNICIPAL SECURITY; TAX CREDIT BONDS; TAX-EXEMPT BOND.

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