What Is a Tax Anticipation Note (TAN)?

A Tax Anticipation Note (TAN) is a short-term debt security issued by a municipal government to finance an immediate project that will be repaid with future tax collections. State and local governments use tax anticipation notes to borrow money, typically for one year or less and at a low-interest rate, in order to finance a capital expenditure such as the construction of a road or repairs of a building.

Key Takeaways

  • A Tax Anticipation Note (TAN) is a short-term note that state and local government issues with the intent to repay once tax payments are collected.
  • TANs are often issued when state and local governments want to move forward with capital projects but don't have the money on hand.
  • The short-term notes are typically issued with maturity dates of less than a year and usually expire around or after the time yearly taxes are due.
  • TANs are usually offered at a discount to the buyer; when the note matures, the buyer would then earn interest.

Understanding the Tax Anticipation Note (TAN)

A note is a debt instrument issued by a borrowing entity to raise funds in the short-term. Notes are interest-bearing securities, promising periodic interest payments to lenders for the duration of the bond’s life and the principal repayment at the end of the security’s term life. These payments are usually made from a defined revenue source. Notes usually mature in one year or less, although notes of longer maturities are also issued. One form of a note that is issued by a governmental body to fund its short-term need is a tax anticipation note.

A Tax Anticipation Note (TAN) is a type of municipal bond issued to finance a current operation or project before the issuer receives tax revenues. In effect, the issuing government uses the following year's tax revenue to repay the TANs. The government does not have to wait to have cash in hand before embarking on a capital project as it could issue these short-term notes in the interim. The interest income earned from TANs is generally tax-exempt for investors on a state and federal level. Due to this tax exemption, tax anticipation notes carry relatively low-interest rates.

A TAN is a type of municipal bond, a debt security issued by local governments to help finance projects.

TAN Example

For example, assume the government would like the development of a public park to start in June 2020. The total budget for financing this endeavor is $5 million, however, the city can only afford to pay $2 million currently. In anticipation of the tax revenues that will be received in April 2021 after the deadline for filing taxes, the city may issue tax anticipation notes with a face value of $3 million to mature in May 2021. After it collects taxes from individuals and businesses in 2021, the city would retire the TANs and repay any other expenses associated with building the park.

Special Considerations

Tax anticipation note financing helps governments smooth out the ups and downs in their revenue cycles if 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. Also, 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).