Income investors are snatching up a new form of pseudo municipal bonds known as Build America Bonds (BAB).

The so-called “Build America Bonds” can reduce overall borrowing costs by letting issuers collect a tax credit of up to 35 percent of total interest payments.

BAB, which is part of President Obama’s stimulus package, functions in 2 ways:

A state or agency can elect to pay a higher rate to bondholders, while 35% of the interest it pays will be rebated back to the issuer by the Federal government. Or the issuer can pay a lower rate in which 35% of the interest received by investors will be tax-free. While issuers have so far mostly gone with choice number one, either way, the bonds are taxable, an important difference from traditional municipal bonds, according to Marc Lichtenfeld,a senior analyst at Smart Profits Report.

The Illinois State Toll Highway Authority is the latest governmental unit to issue Build America Bonds which are worth $500-million and is priced at a net interest cost of less than 4 percent, the company said.

The state of Illinois and Cook County are among other potential issuers.

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