Municipal issuers and their advisors continue to navigate a changing landscape when it comes to arbitrage rebate and yield restriction compliance. As federal regulations evolve and market dynamics shift, staying informed about trends in these areas is more crucial than ever. In this blog post, we’ll break down what’s happening now—and what’s on the horizon.
A Quick Refresher: What Is Arbitrage Rebate and Yield Restriction?
Arbitrage rebate is a requirement under the Internal Revenue Code that mandates issuers of tax-exempt bonds to rebate to the U.S. Treasury any excess earnings from investing tax-exempt bond proceeds above the permitted “bond yield”.
Yield restriction, on the other hand, pre-dates the arbitrage rebate regulations and is a rule that limits how much issuers can earn on invested bond proceeds—especially for certain types of funds (most commonly construction funds)—to prevent issuers from earning a profit after certain “temporary periods” (generally three years after the issue date of the bond).
Both concepts are designed to ensure that the federal government isn’t subsidizing profit-generating investments with tax-exempt municipal bonds.
Trend # 1: Low Interest Rate Hangover
Rates crept higher in 2024 and started to decline slightly at the end of 2024 and beginning of 2025, but the multi-year low-interest rate environment that dominated the early part of this decade and the decade prior has ended. For years, issuers were less concerned with arbitrage rebate because investment returns didn’t exceed bond yields. Now, with the rate environment normalizing, rebate liabilities are relevant again. Most “new money” bonds issued in between 2023 and 2025 are accruing positive arbitrage that may have to be remitted to the Federal government in the future.
Takeaway: Don’t assume your bond issues are exempt from rebate liabilities just because rates were low at issuance. Rising returns on investments may trigger rebate or yield restriction requirements, especially if construction funds were not spent within three years after the issuance date.
Trend #2: Focus on Investment Strategy and Cash Flow Timing
With yield restriction and arbitrage rebate limits in mind, issuers are becoming more strategic in how they time and structure the investment of bond proceeds. Instead of simply “parking” funds, many are exploring laddered investment structures, demand deposit SLGS, sweep accounts, and short-duration instruments that align more closely with spending timelines.
Takeaway: Remitting excess rebate or yield restriction earnings is not a penalty; it is merely returning excess investment earnings. Maximizing investment returns instead of trying to “avoid” rebate payments should be considered. Strategic investment planning doesn’t just support arbitrage compliance — it can also enhance project cash flow efficiency while maximizing investment returns.
Trend #3: More Frequent Use of Spending Exceptions
The IRS provides several exceptions to arbitrage rebate, including the 6-month, 18-month, and 2-year spending exceptions. More issuers are designing their capital programs to take advantage of these exceptions. That said, the IRS has been more rigorous in reviewing whether issuers met these requirements, so careful tracking and documentation along with consultations with arbitrage rebate consulting firms are essential. ACS recommends having discussions with your arbitrage consultant regarding the spending exceptions at the onset of (or even prior to) bond issuance.
Takeaway: Spending exceptions are valuable tools—but only if properly documented and substantiated.
Trend #4: Monitoring for Yield Restriction is Also Crucial
One of the most significant developments in recent years has not been arbitrage rebate payments to the IRS, but rather, yield restriction payments. Most commonly, when construction and capital projects slowed in 2020 – 2021 due to COVID and other contributing factors, issuers faced difficulties in spending bond proceeds in a timely manner. These construction delays, combined with the spike in investment rates at the end of 2022, have created scenarios in which bonds issued in 2019 and 2020 do not trigger an arbitrage rebate payment but instead result in a yield restriction payment. These payments are either currently (or may become) due in 2025.
These factors place more pressure on issuers to maintain thorough documentation and monitoring of the spending of bond proceeds.
Takeaway: If you’re not already on a regular compliance schedule, now’s the time to establish one and conduct regular “due diligence” checks for arbitrage rebate and yield restriction.
Final Thoughts
Arbitrage rebate and yield restriction rules aren’t going anywhere, and non-compliance can be costly—not just in dollars, but in the risk of losing your bond’s tax-exempt status and the desirability amongst investors this confers. As trends point toward regulatory attention and evolving market conditions, proactive compliance is the best defense. Through third-party consultants and in-house policies to address compliance, staying ahead of the curve is not just smart — it’s essential.