What Is a Tax Anticipation Note (TAN)?

Tax Anticipation Notes Explained In Less Than 5 Minutes

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Tax anticipation notes (TANs) are short-term securities issued by state, county, and local governments to finance infrastructure projects when funds are not immediately available. Local governments repay the securities using future tax revenue.

Learn about TANs, how they are issued, and how the notes function to fund government projects.

Definition and Examples of Tax Anticipation Notes

Tax anticipation notes (TANs) are municipal securities issued by state, county, or local governments to raise money for capital infrastructure projects. TANs are short-term notes, typically with a maturity rate of a year or less. They are used to finance immediate or near-term local capital project needs.

TANs are a boon for state and local governments that are experiencing a shortfall of funds. The short-term securities allow governments to smooth out the variances in the revenue cycle. The governments then pay down the TANs using tax revenues from the year after the note was issued.

  • Acronym: TANs

TANs raise a large amount of capital for municipalities since most projects cost millions of dollars.

Here’s an example: Assume your local government has an immediate need to replace the aging bridge spanning a local river. The cost to replace the bridge is $10 million, but the government only has $6 million currently available. It may choose to issue tax anticipation notes with a total face value of $4 million to make up the shortfall. The government may then levy taxes the following year so that it can pay back the note's principal as well as the accompanying interest.

How Tax Anticipation Notes Work

As the name implies, tax anticipation notes are issued in anticipation of future tax revenues. Capital projects are pricey, and governments rely on TANs to bridge the gap between available cash and the amount needed to fund projects. Governmental revenue streams are cyclical, and TANs are a tool that officials can use to help smooth the financial ups and downs.

A TAN is a short-term security that generally matures within one year, although it can have a longer term. Notes are interest-bearing securities; as such, noteholders are entitled to regular interest payments.

State and local governments can issue TANs in increments they see fit for their purposes. For example, Idaho typically issues TANS in increments of $5,000.

The entity issuing notes must therefore raise sufficient funds to repay both the principal of the note as well as the accompanying interest. To ensure this, most governments do not allow the TAN’s face value to be higher than the anticipated tax revenue so that it can cover the principal, interest, and associated costs. For example, Texas does not allow a municipality to issue a TAN with a face value that exceeds 75% of the taxes anticipated to be collected.

Interest rates on TANs might be on the low side, as the revenue generated from municipal securities is exempt from federal taxation.

Tax anticipation notes come attached with strict provisions. The maturity date of a TAN is generally fixed, which means the debt must be repaid by a specific date. In many states, such as Texas, the funds obtained through a TAN are earmarked and cannot be used for any purpose other than the specific project the TAN was designed to fund. Finally, the funds generated through tax revenues must first be used to repay the TAN holders before any surplus funds can be appropriated to fund other projects.

Alternatives to Tax Anticipation Notes

State and local governments can issue short-term anticipation notes in addition to TANs. These notes include revenue anticipation notes (RANs) and bond anticipation notes (BANs).

Revenue anticipation notes are notes issued similarly to TANs, but instead of using future tax revenues, they use other future revenue sources to justify borrowing money for specific purposes.

State laws vary for what a RAN can be used for. For example, In North Carolina, RANs can be used by local governments, nonprofits, or associations that are operating or leasing a public hospital. The notes cannot exceed 80% of the total anticipated revenues or funding of the organization (excluding taxes).

A bond is a security that can have a coupon (interest payment) or a face value paid upon maturity.

Local and state governments issue bonds called municipality bonds to fund projects. A BAN is used to raise funds before the bonds are issued to help fund and start a project.

Like TANs and RANs, BANs vary by state in how the funds can be used and how the debt can be paid back. For instance, the District of Columbia can issue them for a project that is going to be funded by general obligation bonds. The funds from the BAN can only be used for the project; the funding borrowed can be repaid using the funds raised from the sale of the actual bonds.

Key Takeaways

  • Tax Anticipation Notes (TANs) are short-term securities issued by municipal governments to finance capital projects.
  • They are paid down using future tax revenue, which can be collected via a levy.
  • TANs fund local infrastructure projects and generally mature within a year or less.
  • Interest rates on TANs are generally low since the interest revenue is exempt from federal taxes.
  • Maturity dates for TANs are fixed, and the funds cannot be diverted for other projects.