THE SHORT ANSWER
The minor portion exception is the federal arbitrage allowance under 26 U.S.C. 148(e) and Treasury Regulation 1.148-2(g) that lets an issuer invest gross proceeds up to the lesser of 5 percent of an issue's sale proceeds or $100,000 in higher yielding investments without making the bonds arbitrage bonds. It is an exception to yield restriction only, so the rebate rules may still require the earnings to be paid to the U.S. Treasury.
The minor portion exception is the federal arbitrage allowance under 26 U.S.C. 148(e) and Treasury Regulation §1.148-2(g) that lets an issuer invest a limited slice of an issue's gross proceeds in higher yielding investments without making the bonds arbitrage bonds.
The slice is capped at the lesser of 5 percent of the issue's sale proceeds or $100,000, and it is an exception to the yield restriction rules only, not to the rebate rules.
The allowance is one of the narrow windows in the federal arbitrage rules for bond proceeds, restrictions that trace to 1969 legislation limiting the arbitrage profits state and local governments can earn on bond proceeds, the same legislation behind the SLGS securities program, established in 1972.
What is the lesser-of-5%-or-$100,000 test?
The test sets the size of the allowance: gross proceeds up to the lesser of 5 percent of the sale proceeds of the issue or $100,000 may be invested in higher yielding investments without making the bonds arbitrage bonds, under 26 U.S.C. 148(e) and Treasury Regulation §1.148-2(g).
The regulation states the operative result: a bond is not an arbitrage bond solely because of the investment of gross proceeds up to that amount in higher yielding investments.
The stakes sit one definition away: 26 U.S.C. 148(a) makes a bond an arbitrage bond when any portion of an issue's proceeds is reasonably expected, at the time of issuance, to be used to acquire higher yielding investments or to replace funds used to acquire them, and intentional use of proceeds in that way produces the same result.
That classification carries a direct tax consequence: section 103(a) excludes interest on state and local bonds from gross income, and section 103(b)(2) provides that the exclusion does not apply to any arbitrage bond.
"Higher yielding investments" is a defined term as well: under 26 U.S.C. 148(b), it means investment property that produces a yield over the term of the issue materially higher than the yield on the issue, and investment property includes any security, any obligation, any annuity contract and any investment-type property.
Under 26 U.S.C. 148(b)(3), tax-exempt bonds are generally not investment property, except that specified private activity (AMT) bonds count as investment property for most issues.
Whether a particular investment is permitted for the fund under the indenture or under state law is a separate question from federal tax law, covered for the general case in the guide to permitted investments.
How do the 5 percent and $100,000 limits interact?
The two figures work as a genuine lesser-of comparison, so the binding number depends on how large the issue is.
The statute and the regulation state the percentage base in slightly different terms: 26 U.S.C. 148(e) says 5 percent of the proceeds of the issue, while Treasury Regulation §1.148-2(g) says 5 percent of the sale proceeds.
The allowance itself is stated in gross proceeds, which Treasury Regulation §1.148-1(b) defines as all proceeds plus all replacement proceeds of an issue, with proceeds meaning sale proceeds, investment proceeds and transferred proceeds.
The $100,000 figure is a fixed statutory amount and is not indexed for inflation.
Measured the other way, the minor portion also drops out of net sale proceeds: Treasury Regulation §1.148-1(b) defines net sale proceeds as sale proceeds less the portion of those proceeds invested in a reasonably required reserve or replacement fund under section 148(d) and as part of a minor portion under section 148(e).
Any arbitrage test built on net sale proceeds therefore excludes the minor portion by construction.
What are the practical uses of the minor portion?
The exception's practical uses are mechanical: it adds an allowance on top of the temporary periods and the reserve fund allowance, it is carved out of net sale proceeds, and it is the only one of the three allowances covered by Treasury Regulation §1.148-2(h) that an issuer can waive after the issue date.
Treasury Regulation §1.148-2(g) states this allowance in addition to the temporary periods and the reasonably required reserve or replacement fund under section 148(d), which the guides to the temporary periods and the reasonably required reserve fund cover in full.
| Allowance | What it covers | Waiver under Treas. Reg. §1.148-2(h) |
|---|---|---|
| Temporary period | Higher yielding investment during any temporary period | On or before the issue date |
| Reasonably required reserve fund | Higher yielding investment in a reasonably required reserve fund under section 148(d) | On or before the issue date |
| Minor portion | Gross proceeds up to the lesser of 5% of sale proceeds or $100,000 | At any time |
Waivers run on a different clock for this allowance: under Treasury Regulation §1.148-2(h), an issuer may elect on or before the issue date to waive the right to invest in higher yielding investments during a temporary period or in a reasonably required reserve fund, and it may waive the right to invest as part of a minor portion at any time.
Whether a waiver serves an issue is a determination for bond counsel.
How does the minor portion interact with rebate?
The minor portion is an exception to the yield restriction rules, not to the rebate rules.
The two regimes are independent: an issue is tested under both the yield restriction rules of section 148(a) and the rebate rules of section 148(f), and IRS Publication 5271, the IRS overview of the arbitrage requirements (which states on its face that it is not formal guidance), is explicit that "If the bonds are arbitrage bonds under either set of rules, they are arbitrage bonds even if they are not arbitrage bonds under the other set."
For an exception like the minor portion, the practical consequence is the one Publication 5271 states: "The yield restriction rules may allow the issuer to earn the arbitrage, but the rebate rules may not allow the issuer to keep the arbitrage."
What becomes of earnings produced under the minor portion is therefore a rebate question, governed by the rebate rules and by the exceptions under which an issue is treated as meeting the rebate requirement, such as the spending exceptions, on their own terms.
What does the minor portion mean for investing the fund?
For the investment itself, the minor portion is an amount allowance: the cap is the lesser of 5 percent of the issue's sale proceeds and $100,000, so the allowance's size moves with the size of the issue until the fixed ceiling binds.
Because the allowance is stated in gross proceeds, it reaches more than unspent sale proceeds alone, since investment earnings and replacement proceeds are also gross proceeds under Treasury Regulation §1.148-1(b).
Where a fund's actual balances sit relative to its allowances is a factual question, and an independent review can check your proceeds against the rules.
mGIC, an independent municipal advisor and Bidding Agent, provides that kind of review as a free, no-obligation reinvestment review or conversation about how a fund is invested.
Final determinations about whether the minor portion applies to an issue, and about how the rebate rules treat the earnings, belong to bond counsel and tax counsel.
Frequently asked questions
Is the minor portion's $100,000 limit indexed for inflation?
No. The $100,000 ceiling is a fixed statutory figure under 26 U.S.C. 148(e), so once an issue's sale proceeds exceed $2 million, the $100,000 ceiling, not the 5 percent test, is the binding limit, and the allowance covers only amounts up to that cap.
Can an issuer waive the minor portion?
Yes. Treasury Regulation 1.148-2(h) lets an issuer waive the right to invest in higher yielding investments as part of a minor portion at any time, while waivers of the temporary period and reserve fund rights may be elected on or before the issue date. Whether a waiver fits an issue is a question for bond counsel.
Does the minor portion reduce net sale proceeds?
It is excluded from them. Treasury Regulation 1.148-1(b) defines net sale proceeds as sale proceeds less the amounts invested in a reasonably required reserve or replacement fund and as part of a minor portion, so an arbitrage test built on net sale proceeds does not count the minor portion.
If an issue invests more than the minor portion at a higher yield, are the bonds arbitrage bonds?
The exception covers only amounts within the minor portion itself, and the issue is tested under both the yield restriction rules of section 148(a) and the rebate rules of section 148(f). If the bonds are arbitrage bonds under either set, section 103(b)(2) denies their interest the gross income exclusion. Whether a particular issue fails is a determination for tax counsel.
Sources
This page is general educational information about municipal finance and federal and state rules as of the date shown. It is not legal, tax or investment advice, and it is not a recommendation about any particular investment. Product availability, legality and suitability depend on the issuer, jurisdiction, governing documents and transaction-specific facts. Final legal and tax determinations remain with the issuer's bond counsel, tax counsel and other advisors.
