Tax Anticipation Note (TAN): Meaning, Benefits, Examples

What Is a Tax Anticipation Note (TAN)?

A Tax Anticipation Note (TAN) is a short-term debt security issued by a state or local government to raise money for a public project. The debt is repaid with future tax collections.

Municipal governments use tax anticipation notes to borrow money, typically for one year or less and at a lower interest rate than would be available from other lenders. The money finances capital expenditures such as the construction of a road or repairs to a building.

Understanding a Tax Anticipation Note (TAN)

In general, a note is a debt instrument similar to a bond. It is issued by a borrowing entity to raise funds in the short term.

Like bonds, notes are interest-bearing securities that are sold with the promise of periodic interest payments to the investor for the duration of the bond’s life. The principal is repaid when the note reaches its maturity date. Notes usually mature in one year or less, although notes of longer maturities are occasionally issued.

The payments are usually made from a defined revenue source.

In the case of the tax anticipation note, the defined revenue source is the following year's tax revenues.

Benefits of a TAN to Investors and Governments

Issuing a TAN allows the government to immediately move forward on a public project without waiting to have the cash in hand. The interest cost is low compared to the costs of financing from other sources such as a commercial bank.

For investors, a TAN is a relatively safe choice with a relatively low rate of return.

However, the interest income earned from a TAN is generally tax-exempt at both the state and federal levels, adding something back to the return on investment.

TAN Example

For example, assume the government would like to start the development of a public park in June 2022. The total budget for the endeavor is $5 million.

The city only has $2 million in spare cash. So, anticipating tax revenues that will be received in April 2023 after the deadline for filing taxes, the city may issue tax anticipation notes with a face value of $3 million to mature in May 2023.

Once it collects taxes from individuals and businesses in 2023, the city will retire the TANs and repay the costs of building the park.

Special Considerations

Financing with tax anticipation notes helps governments smooth out the ups and downs in their revenue cycles when the timing of their receipts does not match the timing of their expenditures.

The maturity dates on the notes are fixed and cannot be altered. In addition, the proceeds received from the notes cannot be diverted for other projects or expenses other than the one stated in the indenture.

The revenue received from taxes must be used to first repay the TAN holders before any excess can be used for other projects. For example, the indenture may state that the security of an issued note is based on the income tax proceeds they expect to get in 10 months.

TANs are one of several types of anticipation notes that state and local governments can use to fund a short-term need. Others include revenue anticipation notes (RANs) and bond anticipation notes (BANs).