Definition: What is a Tax Anticipation Note?
A tax anticipation note (TAN) is a short-term note that a state or local government issues and expects to repay with imminent tax receipts.
Tax Anticipation Note Example
Let's assume Town XYZ wants to purchase a new building to replace the old City Hall. The building costs $15 million. Town XYZ expects to pay $5 million cash for the building but needs to raise another $10 million by issuing new debt. 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 $10 million of tax anticipation notes that mature in May. (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 will pay buyers roughly 5% in annual interest. Remember, however, that the notes will be outstanding for less than one year.
Town XYZ is then able to purchase the building for $15 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 Does a Tax Anticipation Note (TAN) Matter?
Tax anticipation notes provide state and local governments with a way to stabilize cash inflows and outflows during the year. 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.
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