The following post is written by Kirk Dryer, a law student at the University of Missouri.  Kirk is also the first Green Building Law Update intern.  His assistance researching the Destiny USA matter was priceless.  Below, Kirk explains the tax implications of an adverse ruling in the Destiny USA dispute.  If you want to read more on the Destiny USA dispute, please read my short e-book on the subject.  

While Destiny USA stands to lose $122 million in financing costs if the IRS strips the project of it’s green bond tax exemption, an adverse ruling will also result in a significant investment income loss for individual bondholders.  In total, these bondholders purchased $228,085,000 in green bonds for Destiny USA and would owe taxes they were not expecting to pay which would significantly cut into their investment gains.  The tax exemption itself and not green building promises is the means through which the developer was able to offer an interest rate lower than the market rate and remain a competitive investment. Most (if not all) of the individual investors would have chosen an investment with a higher return if the gain had been taxable.  

It is easy to assume that most individual investors with enough income to hold a significant sized investment in the Destiny USA bonds would be in one of the two highest federal income tax brackets which means that any additional income for 2010 would be taxed at either 33% or 35% depending on the investor’s taxable income.  This means that if the IRS takes away Destiny USA’s green bond tax exemption, any gain collected on a bondholder’s investment would be taxed and would cut his/her investment gain by at least a third.

For example: We’ll say an investor, Bob, had an adjusted gross income of $250,000 for 2010 and he held a $50,000 bond in Destiny USA.  The Destiny USA Green Bond interest rate is 4.420% meaning that Bob would have a gain on his bond investment of $2,210.  With the tax exemption, he would not have to pay any income tax on that bond income.  However, if the tax exemption is stripped from the Destiny USA project, Bob would owe 33% of that gain or $729.30 in federal income tax.   If Bob bought his bond at issuance in 2006 he would owe a total of $3,646 in back taxes for his investment gain for the five years (2006-2010) he took the tax exemption.  He would then no longer have the exemption for the next 25 years until the bond matures on January 1, 2036.  Over the life of the bond Bob would pay $21,879 in income taxes he would not have owed if Destiny USA fulfilled its obligations for the Green Bond program.

Ultimately, bondholders like Bob would have legal recourse, but the filing of a lawsuit to recover the money lost on a bond investment is sure to create a domino effect of filings resulting in lengthy legal battles.  If the tax exemption is revoked due to Destiny USA’s noncompliance with IRS Green Bond requirements, the bondholders can sue the Syracuse Industrial Development Agency and Citigroup as the bond issuers.  The bond issuers may then recover their losses from their bond insurer who may then recover its losses from the Destiny USA.  

Overall, Bob is simply an example of a bondholder who purchased one $50,000 bond out of the $228 million.  For simplicity’s sake, if all bondholders were in the same tax bracket as Bob, the bondholders would pay $99,805,434.30 in income taxes over the 30 years of the bond. While the bondholders may ultimately recover their losses, the IRS ruling nonetheless has a large impact on the financial gains of their investment.