Tax Anticipation Note (TAN)
What it is:
How it works/Example:
Town XYZ wants to purchase a new building to replace the old City Hall. The building costs $10 million. Town XYZ expects to pay $5 million cash for the building but needs to raise another $5 million. It expects to receive at least that much next April after the annual income tax filing deadline has passed, but the real estate deal is scheduled to close six months before that date, in October.
Because of the timing, Town XYZ issues $5 million of tax anticipation notes that mature in May. (Note that tax anticipation notes are typically issued at a discount, meaning that the investors will pay, say, 95% of the face value of each bond; the actual discount depends on the market and the issuer’s creditworthiness.) The notes pay buyers 5% interest per year. Remember, however, that the notes will be outstanding for less than one year.
Town XYZ is then able to purchase the building for $10 million in October. When April arrives, Town XYZ has its income tax receipts and uses a portion of them to repay the TANs (which generally get first dibs on tax receipts). TAN maturities are usually not longer than one calendar year.
Why it matters:
Tax anticipation notes provide state and local governments with a way to stabilize cash inflows and outflows during the year. In turn, this allows governments to proceed with capital projects immediately rather than waiting to have the actual cash in hand.
Tax anticipation notes are a type of municipal bonds -- investors are generally able to obtain interest tax-free.