Tax-Exempt Bonds: What Your Nonprofit Should Know

Person holding a brown leather wallet containing dollar bills.

As your organization grows in size and expands in staff, office space, and programs offered, you may be wondering how you’re going to pay for all this growth. Whether you’re looking at acquiring land or equipment, or simply renovating an existing building to fit your new needs, growth brings its own set of financial difficulties. While it would be wonderful to find a generous donor to fulfill those needs, that’s not always the most practical route. One common option to finance your expansion is to take out a loan directly from the bank. But if a traditional loan isn’t the best choice, you may want to look into tax-exempt bonds.

Acquiring a tax-exempt bond may sound like a daunting process - and it can certainly be more complicated and time-intensive than a loan - but bonds could save your organization thousands of dollars in interest compared to a traditional loan. There are many different types of bonds, but in general, the process goes something like this:

A nonprofit organization in need of financing will look to an issuer in order to acquire a tax-exempt bond. Nonprofits cannot issue tax-exempt bonds, so they must turn to a government or government agency who then becomes the issuer. The issuer can be a local city, county, municipality, district or state-wide agency. The issuer is merely a conduit for the bond and takes no risk of repayment. The issuer will acquire the loan from a commercial bank and will use the asset (land, building, equipment, etc) as collateral. Once the loan has been granted to the issuer, they will turn around and grant the bond to the nonprofit organization. The lender (bank) will gain tax-free interest on the loan, the issuer will charge an administrative fee for acquiring the loan and providing the nonprofit a bond, and the nonprofit will have lower interest debt. In this way, tax-exempt bonds provide benefits to all parties involved.

Bonds can be a great alternative to traditional loans, but they aren’t right for every organization or situation. There are restrictions on what the bond amount can be used for, and only organizations described by the IRS code section 501(c)(3) and exempt from tax pursuant to IRS code section 501(a) can be borrowers of these bonds. There are also higher initial costs and on-going administrative costs to consider. Before your organization decides to pursue a tax-exempt bond, it’s always wise to do the math and compare the short-term and long-term debt load to that of a traditional loan.