[Federal Register Volume 73, Number 202 (Friday, October 17, 2008)]
[Proposed Rules]
[Pages 61757-61770]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: E8-24572]


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DEPARTMENT OF HOUSING AND URBAN DEVELOPMENT

24 CFR Part 570

[Docket No. FR-5181-P-01]
RIN 2506-AC22


State Community Development Block Grant Program: Administrative 
Rule Changes

AGENCY: Office of the Assistant Secretary for Community Planning and 
Development, HUD.

ACTION: Proposed rule.

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SUMMARY: This proposed rule would make changes to several sections of 
the regulations for the Community

[[Page 61758]]

Development Block Grant (CDBG) program for states (State CDBG). This 
proposed rule would streamline and update the regulations to reflect 
statutory changes, clarify the program income requirements, provide 
other clarifications to the State CDBG regulations, and make a 
conforming change to the regulations applicable to the CDBG Entitlement 
program. This proposed rule would also provide states additional 
flexibility in their administration of the program.

DATES: Comment Due Date: December 16, 2008.

ADDRESSES: Interested persons are invited to submit comments regarding 
this proposed rule to the Regulations Division, Office of General 
Counsel, Department of Housing and Urban Development, 451 Seventh 
Street, SW., Room 10276, Washington, DC 20410-0500. Communications must 
refer to the above docket number and title. There are two methods for 
submitting public comments. All submissions must refer to the above 
docket number and title.
    1. Submission of Comments by Mail. Comments may be submitted by 
mail to the Regulations Division, Office of General Counsel, Department 
of Housing and Urban Development, 451 Seventh Street, SW., Room 10276, 
Washington, DC 20410-0500.
    2. Electronic Submission of Comments. Interested persons may submit 
comments electronically through the Federal eRulemaking Portal at 
http://www.regulations.gov. HUD strongly encourages commenters to 
submit comments electronically. Electronic submission of comments 
allows the commenter maximum time to prepare and submit a comment, 
ensures timely receipt by HUD, and enables HUD to make them immediately 
available to the public. Comments submitted electronically through the 
http://www.regulations.gov Web site can be viewed by other commenters 
and interested members of the public. Commenters should follow the 
instructions provided on that site to submit comments electronically.

    Note: To receive consideration as public comments, comments must 
be submitted through one of the two methods specified above. Again, 
all submissions must refer to the docket number and title of the 
rule.

    No Facsimile Comments. Facsimile (FAX) comments are not acceptable.
    Public Inspection of Public Comments. All properly submitted 
comments and communications submitted to HUD will be available for 
public inspection and copying between 8 a.m. and 5 p.m. weekdays at the 
above address. Due to security measures at the HUD Headquarters 
building, an advance appointment to review the public comments must be 
scheduled by calling the Regulations Division at 202-708-3055 (this is 
not a toll-free number). Individuals with speech or hearing impairments 
may access this number via TTY by calling the Federal Information Relay 
Service at 800-877-8339. Copies of all comments submitted are available 
for inspection and downloading at http://www.regulations.gov.

FOR FURTHER INFORMATION CONTACT: Steven Higginbotham, Community 
Planning and Development Specialist, Office of Community Planning and 
Development, Department of Housing and Urban Development, 451 Seventh 
Street, SW., Room 7184, Washington, DC 20410; telephone number 202-708-
1322 (this number is not toll-free). Individuals with speech or hearing 
impairments may access this number through TTY by calling the toll-free 
Federal Information Relay Service at 800-877-8339. FAX inquiries (but 
not comments on this proposed rule) may be sent to Mr. Higginbotham at 
202-401-2044 (this is not a toll-free number).

SUPPLEMENTARY INFORMATION: 

I. Background

    This proposed rule would revise the regulations for the CDBG 
program for states (State CDBG) in 24 CFR part 570, subpart I, to 
respond to issues HUD has identified in the program, to conform the 
regulations to current statutory requirements concerning program 
income, and to provide additional flexibility to states in implementing 
their programs.
    Specifically, this proposed rule would revise requirements related 
to the following matters: (1) Interest on federal grant payments to 
states; (2) program income, including the situations in which income 
earned on grant funds must be remitted to the Department of the 
Treasury; (3) flexibility for a state to use up to 3 percent of its 
allocation, program income, and recaptured funds for state 
administrative expenses and technical assistance; (4) revolving funds; 
(5) the use of CDBG funds outside the jurisdiction of the recipient; 
(6) states' administrative flexibility to impose additional 
requirements on recipients; (7) allowability of costs incurred by 
states prior to execution of a grant agreement; (8) audits; (9) states' 
disbursement of grant funds to units of general local government only; 
(10) applicability of cost principles and the requirement for prior 
approval of certain costs by HUD; (11) fiscal controls and 
administrative procedures; (12) exclusion from program income of 
amounts generated by certain activities financed with section 108 loan 
guarantees; and (13) reporting. HUD is also requesting public comments 
on whether HUD should promulgate State CDBG regulations that mirror 
existing CDBG Entitlement program regulations (24 CFR part 570, subpart 
J) on lump-sum drawdowns and the use of escrow accounts for 
rehabilitation of residential properties.

II. This Proposed Rule

    Each of the proposed changes is described below.

A. Interest on Federal Grant Payments to States

    Section 570.489(c) of the current regulations describes the 
requirements concerning federal grant payments to states. Section 
570.489(c)(1) provides that states and units of general local 
government must minimize the elapsed time between receipt of federal 
funds from the state's line of credit and their disbursement for grant 
activities. Section 570.489(c)(2) provides that interest earned by 
units of general local government on funds held pending disbursement is 
not program income and must generally be returned to the Department of 
the Treasury. It further provides that states generally do not have to 
return interest earned during the time between receipt of funds and 
disbursement to local governments. These provisions of the State CDBG 
regulations were based in part on the Intergovernmental Cooperation Act 
(31 U.S.C. 6503) and pre-1993 implementing regulations at 31 CFR part 
205.
    The Cash Management Improvement Act of 1990 (CMIA) (31 U.S.C. 3335, 
6503), as amended in 1992, made several fundamental changes to the 
manner in which payments between federal and state governments are 
made. The Treasury Department's regulations implementing the CMIA are 
located in 31 CFR part 205. Under the current regulations, states and 
the Treasury Department enter into agreements covering all federal 
programs over a certain funding level. Through these agreements, states 
select payment techniques that are designed to prevent delays between 
drawdown and disbursement of funds, and the agreements provide for the 
calculation at stated interest rates of states' net interest 
liabilities to the federal government. For programs whose funding 
levels are below the applicable threshold or otherwise not subject to 
an agreement, states and federal agencies

[[Page 61759]]

must comply with subpart B of 31 CFR part 205, which provides 
requirements for minimizing the time between drawdown and disbursement 
of funds.
    The current requirements at 31 CFR part 205 render some aspects of 
Sec.  570.489(c) obsolete. Therefore, rather than repeat the 
requirements for states in the State CDBG regulations, this proposed 
rule would revise Sec.  570.489(c) by cross-referencing the 
requirements in 31 CFR part 205. This proposed rule would retain the 
existing requirement that units of general local government minimize 
the time between receipt of CDBG funds and their disbursement, and 
would clarify that the state is required to ensure that units of local 
government are in compliance with this requirement.

B. Program Income Requirements

    The proposed changes to the program income provisions that are 
described in this section respond to the amendments made by the Housing 
and Community Development Act of 1992 (the 1992 Act) (Pub. L. 102-550, 
approved October 28, 1992) and an opinion issued by the Comptroller 
General of the United States.
1. Implementation of 1992 Statutory Amendments
    The existing State CDBG regulations provide in Sec.  
570.489(e)(3)(ii)(B) that program income received by a unit of general 
local government after closeout of its grant from the state is 
generally not subject to the program income requirements in Sec.  
570.489(e). However, the 1992 Act amended section 104(j) (42 U.S.C. 
5304(j)) of the Housing and Community Development Act of 1974 (the Act) 
to provide that the use of program income is governed by CDBG program 
requirements for as long as program income remains.
    Several regulatory initiatives were reflected in the CDBG Program 
Economic Development Guidelines final rule, published on January 5, 
1995 (60 FR 1922). At that time, HUD noted that further regulatory 
changes were forthcoming to implement fully the 1992 Act. However, HUD 
recognized the need to provide guidance to grantees in the interim. On 
October 27, 2004, HUD published CPD Notice 04-11, ``Program Income 
Requirements in the State CDBG Program.'' The notice described the 
changes that occurred in 1992 and provided guidance to states on how to 
deal with their increased record-keeping responsibilities.
    A major challenge that states face in implementing the 1992 Act is 
that a unit of general local government may continue to generate and 
use program income long after the originally funded activities are 
completed and closed out. The statutory provision significantly 
extended states' responsibilities to track program income. To provide 
as much flexibility as possible within the constraints of the law, this 
proposed rule would revise Sec.  570.489(e)(3)(ii)(B) by allowing 
states to demonstrate compliance with this requirement in any of the 
following ways:
    (a) States may maintain contractual relationships with units of 
general local government for as long as there is program income to be 
tracked. Since, in some cases, receipts of program income by a local 
government may be sporadic, a state could craft its contractual 
agreements so that obligations would not be imposed once a local 
government has exhausted its program income and would arise again only 
upon receipt of new program income.
    (b) States may require, as a condition of closeout, that local 
governments agree to obtain advance state approval of a local plan to 
expend program income, or of individual expenditures of program income, 
in the absence of a continuing contractual relationship. This 
arrangement may be beneficial to states that presently use a 
``conditional closeout'' process, in which a grant recipient has 
program income on hand at the time of grant closeout or receives 
program income after closeout of the grant that generated the program 
income.
    (c) States may require, as a condition of closeout, that the unit 
of general local government agree to notify the state when new program 
income is received by the unit of general local government. This option 
may be especially useful when dealing with local revolving loan funds, 
or when states and units of local governments are not able to project 
future needs to be addressed with activities funded by program income.
    (d) States may seek HUD approval of an alternative method for 
demonstrating compliance. HUD intends that field offices, not 
Headquarters, would grant such approval.
    States may select different approaches for different types of grant 
recipients. For example, a state that distributes some of its funds on 
a formula basis and some on a competitive basis might select option 
(a), above, for those units of general local government that receive 
funding every year, and option (c) for other grant recipients. A state 
might also blend the first two options by requiring a plan for the use 
of program income by local governments as part of its contractual 
agreement with units of general local government.
    Program income is a significant resource in the State CDBG, and it 
constitutes a major multiplier of the benefits that the CDBG program 
provides to citizens and beneficiaries. For example, in Fiscal Year 
(FY) 2007, states cumulatively receipted $37.3 million in program 
income. The $37.3 million represents only that portion of program 
income that was returned to the states by units of general local 
government. Although HUD has issued guidance in the past on how to 
report on program income retained at the local level, many states have 
not complied with all of HUD's recommendations. This proposed rule 
would revise Sec.  570.490(a)(3) to require reporting of data that will 
include program income retained at the local level. Also, consistent 
with the 1992 Act's requirement to account for program income as long 
as the program income remains, this proposed rule would revise Sec.  
570.489(e)(4) to require the annual Performance and Evaluation Reports 
(PERs) of states to include the use of program income retained by local 
governments.
2. Uniform Treatment of Program Income
    Over the years, there has been a succession of regulatory changes 
to the State CDBG program income requirements. Program income received 
from grants made prior to December 9, 1992, was subject to the 
requirements in a final rule published in the Federal Register on 
November 9, 1992 (57 FR 53397). Program income generated from grants 
made by states with FY 1993 and later funds is subject to the 
requirements of the 1992 Act as well as the requirements of the 
November 9, 1992, final rule. Finally, the January 5, 1995, CDBG 
Program Economic Development Guidelines final rule included an expanded 
list of revenues that are not considered program income.
    States have reported that tracking different requirements as they 
apply to different funding years is complicated and time-consuming, 
especially for program income retained at the local level. Repayments 
of loans made from one grant to a given community may be subject to 
different requirements than repayments of loans made from a subsequent 
year's grant to the same community. This results in an increased 
record-keeping burden on both the state and local governments. The 
complexity and burden are compounded when program income is used to 
make additional loans, which, in turn, generate more program income. 
Some states have expressed confusion about whether program income is 
subject to

[[Page 61760]]

the requirements in effect at the time the state awarded the initial 
grant to the locality, or to the requirements in effect when the 
program income is received.
    This proposed rule would revise Sec.  570.489(e)(1) to apply the 
tracking requirements to all program income received and retained by 
localities, regardless of the fiscal year in which the state grant 
funds that generate the program income were appropriated. HUD does not 
believe that significant amounts of program income are likely to be 
generated by funds appropriated before FY 1993, since in most cases the 
funded activities ended years ago. Furthermore, this proposed rule 
would also clarify in Sec.  570.489(e)(2)(v) that proceeds received 
from the sale of real property acquired or improved in whole or part 
with CDBG funds would not be considered program income if the proceeds 
are received more than 5 years after expiration of the grant agreement. 
For these reasons, making all program income subject to post-FY 1992 
requirements should have little effect on grantees. However, HUD 
specifically requests comment from grantees that might be adversely 
affected.
    It is noted that for the purpose of determining the administrative 
expense, technical assistance, and public service caps, program income 
is counted in the year that it is received by the unit of general local 
government, or by the unit of general local government's subgrantee.
3. Miscellaneous Improvements and Updates
    States have requested several clarifications of the program income 
requirements, and HUD has discovered other requirements that call for 
clarification. In substantially updating the program income 
requirements contained in Sec.  570.489(e), this proposed rule would 
incorporate the following changes:
(a) Selling Off Loan Portfolios in Order To Expedite the Receipt of 
Program Income
    In order to maximize available financial resources, communities are 
increasingly selling portfolios of loans on the secondary market or 
selling obligations secured by loan portfolios. Several communities 
have requested HUD's approval to ``net out'' of the proceeds from such 
sales the various legal and other costs that are incurred when a 
grantee sells or securitizes a portfolio. Exclusion of such costs from 
program income would be analogous to the current provision under which 
costs incidental to the generation of program income from the rental or 
use of CDBG-assisted real or personal property may be netted out of the 
gross income received. Therefore, this proposed rule would amend Sec.  
570.489(e)(1)(vi) and (vii) to allow legal and other costs associated 
with the sale or securitization of CDBG-funded loans to be netted out 
before the amount of program income is determined. This provision does 
not allow to be netted out those costs that are eligible as general 
administrative costs of either the state or the unit of general local 
government.
(b) Annual Threshold for Program Income
    Section 104(j) of the Act allows HUD to promulgate regulations 
excluding from the program income requirements amounts that are so 
small that tracking them would pose an unreasonable administrative 
burden on the unit of general local government. In the CDBG Program 
Economic Development Guidelines final rule published on January 5, 
1995, HUD raised the threshold in Sec.  570.489(e)(2)(i) from $10,000 
to $25,000 per year per unit of general local government. Income that 
would otherwise be considered program income, but which totals less 
than the current $25,000 threshold, is excluded from the definition of 
program income and is therefore not subject to CDBG requirements. If 
the total income that would otherwise be considered program income 
exceeds the threshold, then none of it is excluded from CDBG 
requirements. In order to account for inflation, this proposed rule 
would raise the threshold to $35,000 per year per unit of general local 
government.
    In addition, this proposed rule would revise Sec.  570.489(e)(2)(i) 
to match the language found in the Entitlement CDBG regulations at 
Sec.  570.500(a)(4)(i). The Entitlement CDBG regulations exclude income 
that ``does not exceed'' the applicable threshold, while the State CDBG 
regulations exempt income ``which is less than'' the applicable 
threshold. This proposed rule would revise the State CDBG regulations 
so that total income that ``does not exceed'' the applicable threshold 
would be excluded from the definition of program income. The 
Entitlement threshold of $25,000 is not being proposed for change at 
this time.
    This proposed rule would also revise Sec.  570.489(e)(2)(i) to 
clarify that the exclusion of total income that does not exceed the 
threshold applies only to program income retained by a unit of general 
local government and its subgrantees, and that the threshold applies 
separately to each unit of general local government. As with the 
current regulation, the exclusion would not apply to program income 
that a unit of general local government earns but returns to the state. 
It is HUD's policy, communicated to states in the past, that the 
exclusion does not apply to program income received into local 
revolving loan funds (RLFs). The proposed rule would codify this 
policy. Income received into an RLF is always included in program 
income and subject to CDBG requirements.
    This proposed rule would also codify HUD's policy that income 
received into an RLF is not added to ``regular'' program income 
received by the local government in applying the threshold, which this 
proposed rule would increase to $35,000. For example, assume that the 
proposed threshold increase becomes effective, and a unit of general 
local government maintains an RLF that receives $10,000 in one program 
year. In that same program year, it receives $30,000 in non-RLF income 
that, if not for the exclusion in Sec.  570.489(e)(2)(i), would be 
considered program income. In this example, the $30,000 in non-RLF 
income would be excluded from program income (and, as a result, CDBG 
requirements would not apply to it), even though the total amount of 
program income under control by the local government is $40,000. The 
$10,000 that the RLF received would be considered program income. In 
another example, the unit of general local government maintains the 
same $10,000 in its RLF, but receives $35,001 in non-RLF program 
income. In this example, neither the RLF nor non-RLF program income 
would be exempted from CDBG requirements.
(c) Remission of Interest
    This proposed rule would add Sec.  570.489(e)(2)(iv), listing three 
types of interest income that are not considered program income and 
must be remitted to the Treasury Department. The first type, which 
would be defined in Sec.  570.489(e)(2)(iv)(A), would respond to an 
opinion of the Comptroller General of the United States that income 
generated by an ineligible CDBG-assisted activity must be remitted to 
the U.S. Treasury. According to the Comptroller General opinion, 
eligibility includes meeting a national objective. Therefore, interest 
generated from CDBG-funded loans could be kept by the grantee only when 
the assisted activities meet the national objective requirements.
    A second type of interest that is excluded from program income 
would be defined at Sec.  570.489(e)(2)(iv)(B). Interest income on 
funds reimbursed to a state's CDBG program account prior to the state's 
disbursement of the funds for

[[Page 61761]]

eligible purposes would have to be returned to the Treasury Department.
    A third type of interest that is excluded from program income and 
must be remitted to the U.S. Treasury would be defined at Sec.  
570.489(e)(2)(iv)(C). All interest in excess of $100 earned by units of 
general local government on grant advances prior to disbursement of the 
funds for activities must be returned to the Treasury Department under 
the current provision at Sec.  570.489(c)(2). Consistent with the 
proposed revision of Sec.  570.489(c), described above, this proposed 
rule would move the requirement to Sec.  570.489(e)(2)(iv), in order to 
complete the listing of what is not program income.
    HUD issued comparable provisions in a final rule for the 
Entitlement CDBG program, published on November 9, 1995 (60 FR 56892). 
In responding to public comments in that rulemaking, HUD provided 
guidance on the extent and applicability of those provisions. Readers 
with a particular interest in those provisions may wish to read the 
preamble to the November 9, 1995, final rule (60 FR 56892).
(d) Program Income Generated by Loans to State Grant Recipients
    This proposed rule would add a provision in Sec.  
570.489(e)(2)(iii) to prevent double-counting of program income 
received by a subgrantee and subsequently used to make payments on a 
loan from a unit of general local government. To the extent that the 
funds used by a subgrantee to make principal or interest payments on a 
CDBG loan it received from a unit of general local government consist 
solely of program income received by the subgrantee, no amount of those 
payments represents ``new income'' to the unit of general local 
government's CDBG program as a whole. Since revenue is already counted 
as program income at the time it is received by the subgrantee, this 
provision would prevent double-counting of program income. To the 
extent, however, that the subgrantee uses non-CDBG funds to make the 
principal or interest payments, those payments to the local government 
are new program income to the CDBG program. This proposed rule would 
not affect the treatment of such payments under existing practice. HUD 
added a similar provision to the Entitlement program regulations in the 
November 9, 1995, final rule (60 FR 56893).
    For example, if Apple Borough provided funds to the Apple 
Development Authority as a subgrantee to run its economic development 
loan program, and the Apple Development Authority provided a $50,000 
loan to Apple Dairies for a business expansion, Apple Dairies' 
repayment of the $50,000 to the Apple Development Authority would be 
program income. The Apple Development Authority's repayment of the 
$50,000 to Apple Borough would not be program income, since it would be 
the same $50,000 transferred from Apple Dairies to the Apple 
Development Authority and such program income should not be counted 
twice.
(e) Program Income Retained at the Local Level
    Section 104(j) of the Act allows a state to require that a unit of 
general local government return any program income that it collects to 
the state, to be used by the state to fund additional eligible 
community development activities. However, the state must waive this 
requirement ``to the extent such income is applied to continue the 
activity from which such income was derived.''
    HUD gives states flexibility to determine whether program income 
received by a unit of general local government is being ``applied to 
continue the activity from which such income was derived.'' HUD is 
aware of situations in which states found that a unit of general local 
government failed to use program income in accordance with other 
program requirements or was not making sufficient efforts to expend its 
program income to continue the activity. HUD does not believe that the 
statutory language prohibits states from requiring a unit of general 
local government to return program income if it is expending the 
program income in violation of other CDBG requirements or delays 
expenditure for an unreasonable period of time. Inasmuch as local 
retention of program income is required only ``to the extent such 
income is applied to continue the activity from which such income was 
derived,'' HUD believes the statute necessarily contemplates that the 
funds will be used for eligible activities in a timely manner and in 
compliance with applicable requirements. This proposed rule would 
revise Sec.  570.489(e)(3)(ii)(A) to provide that a state's 
determination of whether program income is being ``applied to continue 
the activity from which such income was derived'' can include 
consideration of whether the program income is not being used (or is 
unlikely to be used) within a reasonable time and in accordance with 
program requirements to continue the activity.
    In some situations, a state may determine that a unit of general 
local government will apply program income to continue the activity 
from which the income is derived, but that the amount of program income 
on hand exceeds projected cash needs for the reasonably near future. 
For example, a community has a demand for two housing rehabilitation 
loans per month, but has enough program income on hand to fund 25 
loans. A state could require the unit of general local government to 
return some or all of the program income to the state's CDBG program 
income account until such time as it is needed by the unit of general 
local government. The state could disburse these funds to other units 
of general local government in the meantime rather than drawing funds 
from its line of credit. When the local government needs its program 
income, the state could disburse the funds from the program income 
account or, as necessary, draw an equivalent amount from the state's 
line of credit for disbursement to the local government.
    In other situations, a state may determine that a unit of local 
government is not likely to apply any significant amount of program 
income to continue the activity within any reasonable amount of time, 
or that it will not apply the program income in accordance with 
applicable requirements. In such cases, a state could require the unit 
of general local government to return all of the program income to the 
state's CDBG program income account for disbursement to other units of 
local government.
    This proposed rule would increase the effective ``buying power'' of 
a state's CDBG funds, by making otherwise idle CDBG funds available to 
support current needs elsewhere in the state. Reduced interest costs to 
the Treasury Department from prematurely drawn funds would be another 
benefit, because states would need to draw funds from their line of 
credit somewhat less frequently. States would have the flexibility to 
define the time period over which cash needs for program income would 
be projected and the appropriate level of program income that could be 
retained in the local government's own program account. If a state 
plans to manage program income in this manner, its approach must be 
described in the state's action plan submitted in accordance with Sec.  
91.320 of this title.
(f) New Entitlement Grantees
    This rule would clarify requirements for new Entitlement grantees 
that possess program income that they received when they were 
participating in the State CDBG program. Any such program income would 
continue to be treated as State CDBG program income, unless the state 
approves the transfer of

[[Page 61762]]

the program income to the Entitlement program. States and units of 
local government may prefer to transfer such State CDBG program income 
to the Entitlement program, since doing so would reduce states' 
monitoring burdens and require new Entitlement grantees to comply with 
only one set of program income requirements.
    Conversely, on rare occasions a state may be faced with the return 
to the State CDBG program of a grantee that has recently lost or 
relinquished its Entitlement status. This proposed rule would provide 
that, in such a case, the unit of general local government may elect to 
transfer the program income to the State CDBG program. Program income 
that is not transferred would continue to be subject to Entitlement 
program requirements, and closeout of the community's Entitlement 
grants with HUD could be delayed. While guidance has been given to 
individual grantees on these issues in the past, HUD recognizes the 
need to provide for these options through regulations.
    This proposed rule would add at Sec.  570.489(e)(3)(iii) a list of 
conditions that must be met by a new Entitlement grantee before the 
state may approve the transfer of the State CDBG grant-generated 
program income to the locality's new Entitlement program. The grantee 
would have to elect to participate in the Entitlement program, agree to 
use the program in accordance with Entitlement program requirements, 
set up access to HUD's Integrated Disbursement and Information System 
(IDIS), and agree to enter the transferred program income into IDIS. 
The proposed rule would also add at Sec.  570.489(e)(3)(iv) the options 
for a former Entitlement community's handling of program income when 
joining the State CDBG program. The proposed rule would also make a 
conforming change to the Entitlement program regulations by adding the 
same language at Sec.  570.504(e).
(g) Administering the State CDBG Program
    Section 106(d)(2)(A) of the Act (42 U.S.C. 5306(d)(2)(A)) provides 
that a state may elect to distribute State CDBG funds to its non-
entitlement areas and also provides that any such election is permanent 
and final. Forty-nine states and the Commonwealth of Puerto Rico have 
elected to administer the State CDBG program, and only Hawaii's non-
entitlement program is administered by HUD. The proposed rule would 
revise Sec.  570.480(a) to clarify that, consistent with the Act, the 
requirements of subpart I of part 570 are applicable to states that 
have permanently elected to distribute funds to their non-entitlement 
areas. Revised Sec.  570.480(a) would also cross-reference requirements 
outside of part 570, subpart I, that apply to the State CDBG program.

C. Flexibility for States To Allocate Funds for Administrative Expenses 
and Technical Assistance

    This proposed rule would revise Sec.  570.489(a)(1) to reflect a 
statutory amendment that provides states flexibility to allocate an 
increased portion of CDBG funds between state administrative expenses 
and costs of providing technical assistance to units of local 
governments and nonprofit program recipients. The 2004 Consolidated 
Appropriations Act amended section 106(d) of the Act to allow states to 
use up to 3 percent of their allocations on administrative expenses, 
technical assistance, or a combination thereof, in addition to the 
$100,000 base amount that states may use for administrative expenses. A 
maximum of 50 percent of administrative expenses in excess of $100,000 
may be paid for with CDBG funds, and the remainder must be paid for 
with states' own funds. Prior to the amendment, states could allocate 
up to 2 percent of CDBG funds (in addition to the $100,000 base amount) 
for state administrative expenses, and up to one percent for technical 
assistance. This proposed rule would revise the corresponding 
regulation to reflect states' increased flexibility to allocate up to 3 
percent of CDBG funds between administrative expenses and technical 
assistance according to the states' preferences.
    For instance, a state could increase the percentage of CDBG funds 
for state administrative expenses to $100,000, plus 2.5 percent of its 
total allocation, in which case it would have only 0.5 percent 
available to use for technical assistance activities. Or the state 
could spend 2 percent of its allocation on technical assistance 
activities, leaving only $100,000 plus one percent of its total 
allocation to spend on state administrative expenses. In either case, 
the state will still have to match, dollar-for-dollar, any CDBG funds 
used for administrative expenses in excess of $100,000.
    Under the current regulations, a state is allowed to add amounts 
reallocated by HUD to the state, as well as program income received by 
units of general local government, to the amount of the state's annual 
grant in calculating its state administrative expense cap. This 
proposed rule would provide in Sec.  570.489(a)(1)(ii) that a state may 
make the same additions to the amount of the state's annual grant in 
calculating the technical assistance cap. This proposed rule would also 
add clarifying provisions at Sec.  570.489(a)(1)(iv) to reflect that 
increased amounts of CDBG funds for state administrative costs are 
available only for periods following the enactment of the statutory 
amendment.

D. Determining Compliance With Administrative Expense Cap

    This proposed rule would revise Sec.  570.489(a)(1)(v)(A), which 
describes the cumulative accounting method to determine compliance with 
the administrative expense cap. The revisions would ensure that terms 
are used in a manner consistent with section 106(d) of the Act, as 
amended, and with Sec.  570.489(a)(1)(v). This rule would also correct 
the description of the matching requirement to clarify that the amount 
the state must contribute is logically a minimum, rather than a 
maximum, amount. This proposed rule would also clarify that if a grant 
for any year during the Consolidated Planning period considered has 
been closed out, then aggregate amounts will be reduced by amounts 
attributable to the closed-out grant in order to make the required 
comparisons.
    This proposed rule would also revise Sec.  570.489(a)(1)(v)(B) to 
clarify the year-to-year accounting method for determining compliance 
with the administrative expense cap, which is an alternative to the 
cumulative approach for determining compliance. The current regulation 
refers to ``an accounting process developed and implemented by the 
state which provides sufficient information to demonstrate that the 
requirements of this subsection are met.'' This proposed rule would 
replace the current provision with a defined alternative to the 
cumulative approach. It would specifically describe the process for 
tracking administrative costs on a yearly basis, and permit a state to 
draw down funds for administrative expenses (after the expenditure of 
the initial $100,000 for state administrative expenses) only upon 
expending an equal or greater amount of its own funds for 
administrative expenses. HUD does not anticipate that this change will 
have any material effect on state CDBG grantees.

E. State Revolving Funds

    Revolving funds are typically established and administered in the 
following manner: A loan is made by a unit of general local government 
with CDBG funds (e.g., to a business to expand). Payments on the loan 
(i.e., principal, interest, or both) are accounted for as CDBG program 
income

[[Page 61763]]

on the local government's books and held in a separate account 
independent of other program accounts. The program income in that 
account, including interest earned on the funds while on deposit 
pending their reuse, becomes the source of financing for additional 
loans of the same type. Hence, the term ``revolving fund'' has been 
used to describe such a fund. Revolving funds are used most frequently 
in connection with housing rehabilitation and economic development 
projects that involve loans.
    A number of states have found regional revolving loan funds to be 
an efficient means of collecting and redistributing program income held 
at the local level. Such loan funds are often operated by a non- or 
quasi-governmental organization that administers programs as a 
subgrantee of several units of general local government to which the 
state awarded the grants. (Since these subgrantees are usually not 
units of general local government, they may not directly receive CDBG 
funding.) Any program income the subgrantee administers belongs to the 
unit of general local government whose grant generated the program 
income, and successive reuses of program income must be traceable back 
to an individual locality's grant. This presents an obstacle for 
regional loan fund operators that wish to use program income to fund 
activities anywhere in their service area, regardless of which 
community the program income belongs to. While a unit of general local 
government may use CDBG funds for activities outside its jurisdictional 
boundaries, it must first determine that doing so will meet its 
community development needs. It may be difficult for community A to 
reasonably conclude that its citizens benefit by having its program 
income used for an activity in community B, 60 miles away.
    To address these obstacles, HUD supports efforts to establish 
regional state revolving funds (SRFs). Economies of scale can often be 
achieved in the administration of such programs. Regional economic 
development efforts may be more cognizant of the regional nature of 
rural economies and be better positioned to act accordingly. Assessing 
the benefits of individual economic development projects may also make 
sense from a regional perspective, because employees of businesses in 
rural communities frequently commute from residences in other 
communities that are a significant distance away from their jobs.
    To provide administrative flexibility, the Act and current State 
CDBG regulations in Sec.  570.489(f) offer three options regarding 
revolving funds. First, section 106(d)(4) of the Act provides that 
states may make awards to combinations of governments. Under such an 
arrangement, program income can be reused within the jurisdiction of 
any of the participating local governments. Second, if both the 
activities and the regional entity that carries out the activities 
qualify under section 105(a)(15) of the Act (42 U.S.C. 5305(a)(15)) 
(assistance to a neighborhood-based nonprofit organization), repayments 
generated from these activities are not within the definition of 
``program income'' at Sec.  570.489(e)(2)(ii) and thus are not subject 
to program requirements. Third, a state may operate a statewide 
revolving fund to redistribute program income returned to the state, in 
the form of grants to units of general local government, as provided at 
570.489(f)(2).
    This proposed rule would expand upon this third option by 
clarifying in Sec.  570.489(f)(2) that a state may operate one or more 
revolving funds on a regional or statewide basis. Provided that the 
state determines that the program income will not be used to continue 
the activity that generated it, section 104(j) permits a state to 
require program income generated from grant-funded activities to be 
returned to the state, regardless of whether the amount falls below the 
$25,000 threshold (which this proposed rule would increase to $35,000). 
With the proposed change, a state could designate a regional revolving 
fund as an SRF and require units of general local government to pay 
their program income directly to it. The state could then contract with 
a regional entity to administer the fund (including the distribution of 
program income to local governments) on behalf of the state. Because 
the program income belongs to the state, the regional entity could 
distribute it to any other eligible unit of general local government 
covered by the regional SRF on behalf of the state and in accordance 
with the state's method of distribution. The community whose initial 
grant generated the program income would have no further responsibility 
for the program income, once the program income is paid into the 
regional SRF. Payments of program income to the regional SRF would 
belong to the state, rather than to a unit of general local government, 
and the regional SRF entity could award the funds, on behalf of the 
state, to units of general local government anywhere within the region. 
While this arrangement is similar to a revolving loan fund, it is 
important to note that the regional entity administering the SRF, as an 
agent of the state, could make grants only to units of general local 
government. Any state choosing this approach would be required to 
describe its process in the method of distribution contained in its 
action plan.

F. Spending Funds Outside the Jurisdiction of the Recipient

    This proposed rule would revise Sec.  570.486(b) and add a new 
Sec.  570.486(c) to place conditions on CDBG-funded projects that 
benefit residents outside the recipient's jurisdiction. Under the 
existing regulations, CDBG-funded activities may serve beneficiaries 
living outside the jurisdiction of the unit of general local government 
that receives the grant, so long as the jurisdiction determines that 
the activity meets its community's needs, in accordance with section 
106(d)(2)(D) of the Act. HUD has identified two emerging trends that 
require further regulation. In both situations, funds do not always 
benefit the community that received the grant.
    First, states and units of general local government are 
increasingly using regional organizations to administer revolving loan 
funds on behalf of local governments. These regional entities, which 
may administer grants from multiple localities, often seek the 
flexibility to use program income generated from these grants anywhere 
within their service area, regardless of which community's grant 
generated the program income. As discussed above in section II.E, this 
presents a challenge for units of general local government, which are 
responsible for ensuring that program income generated from their grant 
is used to meet the community's needs. HUD has concluded that the 
current regulations should be revised to clarify the extent to which 
funded activities must benefit residents of the jurisdiction whose 
grant generated the program income.
    Second, HUD is aware of a number of situations in which states 
awarded a grant to one community, but the benefits of the activities 
occurred in a different community or throughout a much larger area. In 
some cases, one small community would receive a grant for an activity 
that would be carried out on a regional or even statewide basis. In 
other cases, suburban communities would receive funding for projects 
that principally benefitted a nearby Entitlement community. HUD does 
not believe it is appropriate for one community to serve as a primary 
grant recipient when the funded activity will not provide a significant 
benefit to

[[Page 61764]]

residents of that jurisdiction. In such situations, the more 
appropriate approach is for a state to make a grant to a ``combination 
of governments,'' as is specifically provided for in the Act.
    This proposed rule would add to Sec.  570.486(b) the requirement 
that all State CDBG-funded activities must significantly benefit 
residents of the grant recipient's jurisdiction. HUD is aware that some 
projects (e.g., one that provides assistance to a business that will 
provide 200 jobs in a locality with a population of 500) will provide 
benefits to residents of surrounding jurisdictions. Because the project 
significantly benefits residents of the grant recipient's jurisdiction, 
the project would meet this proposed requirement of the proposed rule. 
(Another proposed requirement, described below in this section, would 
permit the expenditure of CDBG funds in this example only if it 
provides no more than an incidental benefit to any surrounding 
Entitlement jurisdictions.)
    In making a determination that a project will ``significantly 
benefit'' residents of the recipient's jurisdiction, the community must 
determine that the benefits to its residents will be sufficient to 
justify the amount of CDBG funds it will expend on the project. HUD 
would not challenge the determination (or the state's acceptance 
thereof) unless it is clearly unreasonable. This proposed rule would 
not limit the amount or percentage of funds that may assist an activity 
in non-entitlement jurisdictions, so long as the magnitude of the 
benefit to recipient jurisdiction residents is not unreasonably 
outweighed by the recipient jurisdiction's expenditure of CDBG funds. 
HUD does not anticipate that this proposed rule would inhibit joint 
efforts by cities and counties to benefit their residents.
    This proposed rule would also add a new requirement at Sec.  
570.486(c) that residents of Entitlement jurisdictions may not receive 
more than an incidental benefit from the state grantee's expenditure of 
funds. In situations involving activities located in or benefiting 
residents of Entitlement communities, HUD believes it is appropriate 
for Entitlement communities to participate in funding such projects at 
levels commensurate with the benefits their citizens receive, since 
Entitlement communities receive a separate source of funding. HUD 
realizes that addressing the community development and housing needs of 
nonentitlement area residents may necessarily involve serving residents 
of Entitlement communities. In some cases, the most feasible or 
practical location for an activity may be within the boundaries of an 
Entitlement community (such as for reasons of public transportation 
accessibility, maximizing accessibility to the greatest number of 
beneficiaries, operational cost-effectiveness, land/building 
availability, or engineering considerations). Also, state or local law 
may prohibit a nonentitlement county from limiting the benefits of an 
activity to residents of the nonentitlement area of the county. In such 
cases, the prohibition against using State CDBG funds to provide more 
than an incidental benefit to Entitlement area residents would apply. 
However, if the Entitlement community is participating financially in 
proportion to the share of expected benefits its residents will 
receive, it would be appropriate for the state to conclude that the 
Entitlement community residents are receiving no benefit, or only an 
incidental benefit, from the State CDBG funds contributed to the 
activity. The recipient would be responsible for determining the 
magnitude of the benefits in such cases and the appropriate financial 
contribution by the entitlement community. Comparable language is 
contained in the CDBG Entitlement program regulations at Sec.  570.309.

G. Program Income Exclusion for Activities Financed by Section 108 Loan 
Guarantees in Areas That Meet Empowerment Zone Eligibility Requirements

    This proposed rule would remove Sec.  570.489(e)(2)(iii). This 
paragraph excludes from the definition of program income revenue 
generated from Section 108 loan guarantees that meet one or more of the 
public benefit standards of Sec.  570.482(f)(3)(v) or that are 
implemented in conjunction with an Economic Development Initiative 
grant under Section 108(q) of the 1974 Act, as amended, and which are 
located in an area that meets the Empowerment Zone eligibility 
requirement from the definition of program income. It is HUD's belief 
that this paragraph has been of limited use by grantees.

H. State Authority To Impose Additional Provisions

    This proposed rule would add a new provision at Sec.  570.480(f) to 
expand states' administrative flexibility. This new provision would 
authorize states to impose on participating units of general local 
government additional requirements or requirements that are more 
restrictive than those established by HUD. Such authority is implied in 
the states' authority to administer the CDBG program, but HUD has never 
expressly provided for it in the regulations. States would not be 
authorized to impose requirements that would be inconsistent with the 
Act or with other statutory or regulatory provisions that apply to the 
State CDBG program. HUD proposes this provision to clarify states' 
responsibilities and authorities.

I. Pre-Agreement Costs

    This proposed rule would revise Sec.  570.489(b) to clarify that 
states may charge to the grant certain pre-agreement costs that they 
incur, to the extent that the activities that generate the costs are 
eligible. Such activities would have to be in conformance with the 
environmental review provisions of part 58 and the citizen 
participation requirements of part 91, as is the case for other costs 
incurred by a state. The current regulation provides that states may 
permit units of general local government to charge certain pre-
agreement costs to the grant, but does not expressly state that states 
may also charge to the grant certain pre-agreement costs that they 
incur. As discussed below in section L, this proposed rule would also 
require states and their recipients of CDBG funds to comply with 
applicable cost principles. However, it would permit certain costs, 
including pre-agreement costs, to be charged to the grant without the 
prior approval by HUD that would otherwise be required under Appendix B 
of 2 CFR part 225.

J. Audits

    This proposed rule would correct an outdated regulatory citation 
within Sec.  570.489(m). Currently, the paragraph states that audits of 
the state and units of general local government must be conducted in 
accordance with 24 CFR part 44, which used to implement the Single 
Audit Act. However, the Single Audit Act requirements applicable to 
states and local governments are now at Sec.  85.26. Although part 85 
as a whole only applies to states that adopt it, this proposed rule 
would require states to adhere to one specific provision within that 
part. This proposed rule would revise Sec.  570.489(m) to require that 
audits be conducted in accordance with Sec.  85.26(a), which in turn 
incorporates by reference the provisions of OMB Circular A-133.

K. Grant-Making

    This proposed rule would add a new paragraph at Sec.  570.480(g) to 
clarify the long-standing statutory requirement, found at section 
106(d)(2)(A) of the Act, that states must distribute CDBG funds in the 
form of grants only to units of general local government. Another

[[Page 61765]]

statutory provision, found at section 106(d)(3)(A) and (6) of the Act, 
permits states to deduct and expend limited amounts of CDBG funds for 
administrative expenses and technical assistance to local governments 
and nonprofit program recipients. States may find it necessary to 
procure such administrative services and technical assistance from 
third parties and, accordingly, to make payments to them. This proposed 
rule would clarify that the requirement for a state to disburse CDBG 
funds to units of general local government does not prohibit it from 
making payments to other entities to procure goods and services to 
support the state's administrative and technical assistance activities.

L. Cost Principles and Prior Approval of Certain Costs by HUD

    This proposed rule would add a new paragraph (n)(1) to Sec.  
570.489 to require that State CDBG funds must be expended in compliance 
with applicable cost principles that are now codified in title 2 of the 
CFR. (Prior to codification, these cost principles were referred to by 
the name of the OMB circular through which they were issued.) The cost 
principles that apply depend on whether a given cost is incurred by a 
government entity, nonprofit organization, or educational institution. 
Application of the cost principles to expenditures would ensure that 
HUD bears its fair share of costs in a consistent manner across all 
states, thereby ensuring a level playing field.
    The cost principles that apply to state, local, and Indian tribal 
governments are codified at 2 CFR part 225. Appendix B of part 225 
provides that a number of cost items are allowable only if approved by 
the cognizant federal agency. For example, section 31 of Appendix B of 
part 225 requires prior approval of pre-agreement costs, which are 
further discussed in section I of this preamble. HUD's regulations for 
the Entitlement program provide at Sec.  570.200(a)(5) that HUD's prior 
approval is not required to the extent that cost items otherwise comply 
with the cost principles and other requirements. This proposed rule 
would add a similar provision at Sec.  570.489(n)(2) for the State CDBG 
program. Cost items that require federal agency approval under Appendix 
B of part 225 would be allowable without HUD's prior approval, so long 
as they otherwise comply with 2 CFR part 225 and subpart I of 24 CFR 
570. Approval on a case-by-case basis would still be required under 
cost principles that are applicable to educational institutions and 
nonprofit organizations.

M. Fiscal Controls and Administrative Procedures

    This proposed rule would also provide clarification at Sec.  
570.489(d)(2)(iii) for states that opt to apply part 85 in order to 
comply with the requirement at 570.489(d)(1) for fiscal controls and 
administrative procedures. Such states would be required to comply with 
all of the provisions of part 85, and would also be required to ensure 
that recipients of their State CDBG funds comply with part 84, 
``Uniform Administrative Requirements for Grants and Agreements with 
Institutions of Higher Education, Hospitals, and Other Non-profit 
Organizations,'' as applicable. This requirement would ensure that 
there will be no inconsistencies or accountability gaps between the 
practices of those states that adopt HUD's administrative standards and 
the practices of their recipients.

N. Reporting

    This proposed rule would add a new paragraph at Sec.  570.490(a)(3) 
that would require states to make entries into the Integrated 
Disbursement Information System (IDIS) in a form prescribed by HUD, to 
accurately capture the state's accomplishment and funding data during 
each program year. It is recommended that the data be entered on a 
quarterly basis, and states would be required to enter the data at 
least annually. This change would better enable HUD and grantees to 
report accomplishments to community development stakeholders.

III. Request for Public Comments on Whether Other Changes Are Needed

    HUD requests public comments on whether regulations are needed on 
the matters described below. Any such regulations would be published 
under a separate proposed rule.

A. Lump Sum Drawdowns

    Section 104(h) of the Act allows units of general local government 
to make lump-sum drawdowns of CDBG funds to establish revolving loan 
funds for property rehabilitation activities. It also provides for HUD 
to establish standards governing lump-sum drawdowns. Such standards 
exist in the CDBG Entitlement program regulations in Sec.  570.513, but 
HUD has not promulgated comparable regulations for the State CDBG 
program. HUD is inviting public comments on whether separate 
regulations are needed to address situations not covered by the 
Entitlement regulations.

B. Use of Escrow Accounts for Rehabilitation

    Section 570.511 of the Entitlement program regulations allows 
Entitlement communities to establish escrow accounts for funding loans 
and grants for the rehabilitation of privately owned residential 
property. HUD has never created comparable regulations for the State 
CDBG program. HUD is inviting public comments on whether separate 
regulations are needed to address situations not covered by the 
Entitlement regulations.

IV. Findings and Certifications

Paperwork Reduction Act

    The information collection requirements contained in this proposed 
rule have been submitted to the Office of Management and Budget (OMB) 
under the Paperwork Reduction Act of 1995 (44 U.S.C. 3501-3520). In 
accordance with the Paperwork Reduction Act, an agency may not conduct 
or sponsor, and a person is not required to respond to, a collection of 
information, unless the collection displays a currently valid OMB 
control number.
    The burden of the information collections in this proposed rule is 
estimated as follows:
    Reporting and Recordkeeping Burden:

----------------------------------------------------------------------------------------------------------------
                                                                                     Estimated
                                                                                   average time      Estimated
          Section reference               Number of     Number of responses per         for        annual burden
                                         respondents           respondent           requirement     (in hours)
                                                                                    (in hours)
----------------------------------------------------------------------------------------------------------------
Sec.   570.489(e)(4).................             550  Ongoing..................              27          15,000
Sec.   570.490(a)(3).................              50  10.......................               2           1,000
                                      --------------------------------------------------------------------------
    Totals...........................             600  NA.......................              29          16,000
----------------------------------------------------------------------------------------------------------------


[[Page 61766]]

    In accordance with 5 CFR 1320.8(d)(1), HUD is soliciting comments 
from members of the public and affected agencies concerning this 
collection of information to:
    (1) Evaluate whether the proposed collection of information is 
necessary for the proper performance of the functions of the agency, 
including whether the information will have practical utility;
    (2) Evaluate the accuracy of the agency's estimate of the burden of 
the proposed collection of information;
    (3) Enhance the quality, utility, and clarity of the information to 
be collected; and
    (4) Minimize the burden of the collection of information on those 
who are to respond, including through the use of appropriate automated 
collection techniques or other forms of information technology, e.g., 
permitting electronic submission of responses.
    Interested persons are invited to submit comments regarding the 
information collection requirements in this rule. Comments must refer 
to the proposal by name and docket number (FR-5181-P-01) and must be 
sent to:

HUD Desk Officer, Office of Management and Budget, New Executive Office 
Building, Washington, DC 20503, Fax number: (202) 395-6947; and
Laruth Harper, Reports Liaison Officer, Office of Community Planning 
and Development, Department of Housing and Urban Development, 451 
Seventh Street, SW., Room 7233, Washington, DC 20410.

Environmental Impact

    A Finding of No Significant Impact with respect to the environment 
has been made in accordance with HUD regulations in 24 CFR part 50 that 
implement section 102(2)(C) of the National Environmental Policy Act of 
1969 (42 U.S.C. 4332(2)(C)). The Finding is available for public 
inspection during regular business hours in the Regulations Division, 
Office of General Counsel, Department of Housing and Urban Development, 
451 Seventh Street, SW., Room 10276, Washington, DC 20410-0500. Due to 
security measures at the HUD Headquarters building, please schedule an 
appointment to review the Finding by calling the Regulations Division 
at 202-402-3055 (this is not a toll-free number). Individuals with 
speech or hearing impairments may access this number via TTY by calling 
the Federal Information Relay Service at 800-877-8339.

Executive Order 13132, Federalism

    Executive Order 13132 (entitled ``Federalism'') prohibits an agency 
from publishing any rule that has federalism implications if the rule 
either imposes substantial direct compliance costs on state and local 
governments and is not required by statute, or the rule preempts state 
law, unless the agency meets the consultation and funding requirements 
of section 6 of the Order. This proposed rule does not have federalism 
implications and would not impose substantial direct compliance costs 
on state and local governments nor preempt state law within the meaning 
of the Order.

Unfunded Mandates Reform Act

    Title II of the Unfunded Mandates Reform Act of 1995 establishes 
requirements for federal agencies to assess the effects of their 
regulatory actions on state, local, and tribal governments and the 
private sector. This final rule does not impose a federal mandate on 
any state, local, or tribal government, or the private sector within 
the meaning of the Unfunded Mandates Reform Act of 1995.

Regulatory Flexibility Act

    The Regulatory Flexibility Act (RFA) (5 U.S.C. 601 et seq.) 
generally requires an agency to conduct a regulatory flexibility 
analysis of any rule subject to notice and comment rulemaking 
requirements, unless the agency certifies that the rule will not have a 
significant economic impact on a substantial number of small entities. 
This rule would revise certain requirements that apply to the 
management of CDBG funds, program income, and other administrative 
matters by state governments. In many instances, the changes would 
codify existing HUD policy, update obsolete provisions, or revise 
regulations to reflect statutory language. Therefore, the undersigned 
certifies that this rule will not have a significant impact on a 
substantial number of small entities.
    Notwithstanding HUD's view that this rule will not have a 
significant effect on a substantial number of small entities, HUD 
specifically invites comments regarding any less burdensome 
alternatives to this rule that will meet HUD's objectives, as described 
in this preamble.

Catalog of Federal Domestic Assistance

    The Catalog of Federal Domestic Assistance (CFDA) program number 
for the State CDBG program is 14.228 and the CFDA program number for 
the Entitlement program is 14.218.

List of Subjects in 24 CFR Part 570

    Administrative practice and procedure, American Samoa, Community 
Development Block Grants, Grant programs--education, Grant programs--
housing and community development, Guam, Indians, Loan programs--
housing and community development, Low and moderate income housing, 
Northern Mariana Islands, Pacific Islands Trust Territory, Puerto Rico, 
Reporting and recordkeeping requirements, Student aid, Virgin Islands.

    Accordingly, for the reasons described in the preamble, HUD 
proposes to amend 24 CFR part 570 as follows:

PART 570--COMMUNITY DEVELOPMENT BLOCK GRANTS

    1. The authority citation for 24 part 570 continues to read as 
follows:

    Authority: 42 U.S.C. 5300-5320.

    2. In Sec.  570.480, revise paragraph (a) and add paragraphs (f) 
and (g), to read as follows:


Sec.  570.480  General.

    (a) This subpart describes policies and procedures applicable to 
states that have permanently elected to receive Community Development 
Block Grant funds for distribution to units of general local government 
in the state's nonentitlement areas under the Housing and Community 
Development Act of 1974, as amended (the Act). Other subparts of part 
570 are not applicable to the State CDBG program, except as expressly 
provided otherwise. Regulations of part 570 outside of this subpart 
that apply to the State CDBG program include Sec. Sec.  570.200(j) and 
570.606.
* * * * *
    (f) In administering the CDBG program, a state may impose 
additional or more restrictive provisions on units of general local 
government participating in the state's program, provided that such 
provisions are not inconsistent with the Act or other statutory or 
regulatory provisions that are applicable to the State CDBG program.
    (g) States shall make CDBG grants only to units of general local 
government. This restriction does not limit a state's authority to make 
payments to other parties for state administrative expenses and 
technical assistance activities authorized in section 106(d) of the 
Act.
    3. In Sec.  570.486, revise paragraph (b) and add paragraph (c), to 
read as follows:

[[Page 61767]]

Sec.  570.486  Local government requirements.

* * * * *
    (b) Activities serving beneficiaries outside the jurisdiction of 
the unit of general local government. Any activity carried out by a 
recipient of State CDBG funds must significantly benefit residents of 
the jurisdiction of the grant recipient, and the unit of general local 
government must determine that the activity is meeting its needs in 
accordance with section 106(d)(2)(D) of the Act. For an activity to 
significantly benefit residents of the recipient jurisdiction, the CDBG 
funds expended by the unit of general local government must not be 
unreasonably disproportionate to the benefits to its residents.
    (c) Activities located in Entitlement jurisdictions. State grant 
recipients may not expend State CDBG funds for activities located in or 
serving Entitlement jurisdictions, unless Entitlement residents receive 
only an incidental benefit from State CDBG expenditures for the 
activity.
    4. Amend Sec.  570.489 as follows:
    a. Revise paragraphs (a)(1), (b), (c), (e)(1), (2), and (3)(i) and 
(ii), and (m);
    b. Add paragraphs (d)(2)(iii)(A) and (B), (e)(3)(iii), (iv), and 
(4), and (n); and
    c. Revise the first sentence of paragraph (f)(2), to read as 
follows:


Sec.  570.489  Program administrative requirements.

    (a) Administrative and planning costs--(1) State administrative and 
technical assistance costs. (i) The state is responsible for the 
administration of all CDBG funds. The state shall pay from its own 
resources all administrative expenses incurred by the state in carrying 
out its responsibilities under this subpart, except as provided in this 
paragraph (a)(1)(i) of this section, which is subject to the time 
limitations in paragraph (a)(1)(iv) of this section. To pay 
administrative expenses, the state may use CDBG funds not to exceed 
$100,000, plus 50 percent of administrative expenses incurred in excess 
of $100,000. Amounts of CDBG funds used to pay administrative expenses 
in excess of $100,000 shall not, subject to paragraph (a)(1)(iii) of 
this section, exceed 3 percent of the sum of the state's annual grant, 
program income received by units of general local government during 
each program year (whether retained by units of general local 
government or paid to the state), and of funds reallocated by HUD to 
the state.
    (ii) To pay the costs of providing technical assistance to local 
governments and nonprofit program recipients, a state may, subject to 
paragraph (a)(1)(iii) of this section, use CDBG funds received on or 
after January 23, 2004, in an amount not to exceed 3 percent of the sum 
of its annual grant, program income received by units of general local 
government during each program year (whether retained by units of 
general local government or paid to the state), and funds reallocated 
by HUD to the state during each program year.
    (iii) The amount of CDBG funds used to pay the sum of 
administrative costs in excess of $100,000 paid pursuant to paragraph 
(a)(1)(i) of this section and technical assistance costs paid pursuant 
to paragraph (a)(1)(ii) of this section must not exceed 3 percent of 
the sum of a state's annual grant, program income received by units of 
general local government during each program year (whether retained by 
the unit of general local government or paid to the state), and funds 
reallocated by HUD to the state.
    (iv) In calculating the amount of CDBG funds that may be used to 
pay state administrative expenses prior to January 23, 2004, the state 
may include in the calculation the following elements only to the 
extent they are within the following time limitations:
    (A) $100,000 per annual grant beginning with FY 1984 allocations;
    (B) Two percent of the sum of a state's annual grant and funds 
reallocated by HUD to the state within a program year, without 
limitation based on when such amounts were received;
    (C) Two percent of program income returned by units of general 
local government to states after August 21, 1985; and
    (D) Two percent of program income received and retained by units of 
general local government after February 11, 1991.
    (v) In regard to its administrative costs, the state has the option 
of selecting its approach for demonstrating compliance with the 
requirements of this paragraph (a)(1) of this section. Any state whose 
matching costs contributions toward state administrative expense 
matching requirements are in arrears must bring matching cost 
contributions up to the level of CDBG funds expended for such costs. A 
state grant may not be closed out if the state's matching cost 
contribution is not at least equal to the amount of CDBG funds in 
excess of $100,000 expended for administration. Funds from any year's 
grant may be used to pay administrative costs associated with any other 
year's grant. The two approaches for demonstrating compliance with this 
paragraph (a)(1) of this section are:
    (A) Cumulative accounting of administrative costs incurred by the 
state since its assumption of the CDBG program. Under this approach, 
the state will identify, for each grant it has received, the CDBG funds 
eligible to be used for state administrative expenses, as well as the 
minimum amount of matching funds that the state is required to 
contribute. The amounts will then be aggregated for all grants 
received. The state must keep records demonstrating the actual amount 
of CDBG funds from each grant received that were used for state 
administrative expenses, as well as matching amounts that were 
contributed by the state. The state will be considered to be in 
compliance with the applicable requirements if the aggregate of actual 
amounts of CDBG funds spent on state administrative expenses does not 
exceed the aggregate maximum allowable amount and if the aggregate 
amount of matching funds that the state has expended is equal to or 
greater than the aggregate amount of CDBG funds in excess of $100,000 
(for each annual grant within the subject period) spent on 
administrative expenses during its 3-to 5-year Consolidated Planning 
period. If the state grant for any grant year within the 3-to 5-year 
period has been closed out, the aggregate amount of CDBG funds spent on 
state administrative expenses, the aggregate maximum allowable amount, 
the aggregate matching funds expended, and the aggregate amount of CDBG 
funds in excess of $100,000 (for each annual grant within the subject 
period) will be reduced by amounts attributable to the grant year for 
which the state grant has been closed out.
    (B) Year-to-year tracking and limitation on drawdown of funds. For 
each grant year, the state will calculate the maximum allowable amount 
of CDBG funds that may be used for state administrative expenses, and 
will draw down amounts of those funds only upon its own expenditure of 
an equal or greater amount of matching funds from its own resources 
after the expenditure of the initial $100,000 for state administrative 
expenses. The state will be considered to be in compliance with the 
applicable requirements if the actual amount of CDBG funds spent on 
state administrative expenses does not exceed the maximum allowable 
amount, and if the amount of matching funds that the state has expended 
for that grant year is equal to or greater than the amount of CDBG 
funds in excess of $100,000 spent during that same grant year. Under 
this approach, the state must demonstrate that it has paid from its own 
funds at least 50 percent of its

[[Page 61768]]

administrative expenses in excess of $100,000 by the end of each grant 
year.
    (b) Reimbursement of pre-agreement costs. The state may permit, in 
accordance with such procedures as the state may establish, a unit of 
general local government to incur costs for CDBG activities before the 
establishment of a formal grant relationship between the state and the 
unit of general local government and to charge these pre-agreement 
costs to the grant, provided that the activities are eligible and 
undertaken in accordance with the requirements of this part and 24 CFR 
part 58. A state may incur costs prior to entering into a grant 
agreement with HUD and charge those pre-agreement costs to the grant, 
provided that the activities are eligible and are undertaken in 
accordance with the requirements of this part, part 58 of this title, 
and the citizen participation requirements of part 91 of this title.
    (c) Federal grant payments. The state's requests for payment, and 
the Federal Government's payments upon such requests, must comply with 
31 CFR part 205. The state must use procedures to minimize the time 
elapsing between the transfer of grant funds and disbursement of funds 
by the state to units of general local government. States must also 
have procedures in place and units of general local government must use 
these procedures to minimize the time elapsing between the transfer of 
funds by the state and disbursement for CDBG activities.
    (d) * * *
    (2) * * *
    (iii) * * *
    (A) A state that opts to satisfy this requirement for fiscal 
controls and administrative procedures by applying the provisions of 
part 85 must comply with the requirements therein.
    (B) A state that opts to satisfy this requirement for fiscal 
controls and administrative procedures by applying the provisions of 
part 85 of this title must also ensure that recipients of the state's 
CDBG funds comply with part 84 of this title, ``Uniform Administrative 
Requirements for Grants and Agreements with Institutions of Higher 
Education, Hospitals, and Other Non-Profit Organizations,'' as 
applicable.
    (e) Program income. (1) For the purposes of this subpart, ``program 
income'' is defined as gross income received by a state, a unit of 
general local government, or subgrantee of the unit of general local 
government that was generated from the use of CDBG funds, regardless of 
when the CDBG funds were appropriated and whether the activity has been 
closed out, except as provided in paragraph (e)(2) of this section. 
When income is generated by an activity that is only partially assisted 
with CDBG funds, the income must be prorated to reflect the percentage 
of CDBG funds used (e.g., a single loan supported by CDBG funds and 
other funds; a single parcel of land purchased with CDBG funds and 
other funds). Program income includes, but is not limited to, the 
following:
    (i) Proceeds from the disposition by sale or long-term lease of 
real property purchased or improved with CDBG funds, except as provided 
in paragraph (e)(2)(v) of this section;
    (ii) Proceeds from the disposition of equipment purchased with CDBG 
funds;
    (iii) Gross income from the use or rental of real or personal 
property acquired by the unit of general local government or subgrantee 
of the unit of general local government with CDBG funds, less the costs 
incidental to the generation of the income;
    (iv) Gross income from the use or rental of real property, owned by 
the unit of general local government or other entity carrying out a 
CDBG activity that was constructed or improved with CDBG funds, less 
the costs incidental to the generation of the income;
    (v) Payments of principal and interest on loans made using CDBG 
funds, except as provided in paragraph (e)(2)(iii) of this section;
    (vi) Proceeds from the sale of loans made with CDBG funds, less 
reasonable legal and other costs incurred in the course of such sale 
that are not otherwise eligible costs under sections 105(a)(13) or 
106(d)(3)(A) of the Act;
    (vii) Proceeds from the sale of obligations secured by loans made 
with CDBG funds, less reasonable legal and other costs incurred in the 
course of such sale that are not otherwise eligible costs under 
sections 105(a)(13) or 106(d)(3)(A) of the Act;
    (viii) Interest earned on funds held in a revolving fund account;
    (ix) Interest earned on program income pending disposition of the 
income;
    (x) Funds collected through special assessments made against non-
residential properties and properties owned and occupied by households 
not of low and moderate income, if the special assessments are used to 
recover all or part of the CDBG portion of a public improvement; and
    (xi) Gross income paid to a unit of general local government or 
subgrantee of the unit of general local government from the ownership 
interest in a for-profit entity acquired in return for the provision of 
CDBG assistance.
    (2) ``Program income'' does not include the following:
    (i) The total amount of funds, which does not exceed $35,000 
received in a single year from activities, other than revolving loan 
funds that is retained by a unit of general local government and its 
subgrantees (all funds received from revolving loan funds are 
considered program income, regardless of amount);
    (ii) Amounts generated by activities eligible under section 
105(a)(15) of the Act and carried out by an entity under the authority 
of section 105(a)(15) of the Act;
    (iii) Payments of principal and interest made by a subgrantee 
carrying out a CDBG activity for a unit of general local government, 
toward a loan from the local government to the subgrantee, to the 
extent that program income received by the subgrantee is used for such 
payments;
    (iv) The following classes of interest, which must be remitted to 
HUD for transmittal to the Department of the Treasury, and will not be 
reallocated under section 106(c) or (d) of the Act:
    (A) Interest income from loans or other forms of assistance 
provided with CDBG funds that are used for activities determined by HUD 
to be not eligible under Sec.  570.482 or section 105(a) of the Act, to 
fail to meet a national objective in accordance with the requirements 
of Sec.  570.483, or to fail substantially to meet any other 
requirement of this subpart or the Act;
    (B) Interest income from deposits of amounts reimbursed to a 
state's CDBG program account prior to the state's disbursement of the 
reimbursed funds for eligible purposes; and
    (C) Interest income received by units of general local government 
on deposits of grant funds before disbursement of the funds for 
activities, except that the unit of general local government may keep 
interest payments of up to $100 per year for administrative expenses 
otherwise permitted to be paid with CDBG funds.
    (v) Proceeds from the sale of real property purchased or improved 
with CDBG funds, if the proceeds are received more than 5 years after 
expiration of the grant agreement.
    (3) * * *
    (i) Program income paid to the state. Except as described in 
paragraph (e)(3)(ii)(A) of this section, the state may require the unit 
of general local government that receives or will receive program 
income to return the program income to the state. Program income that 
is paid to the state is treated as additional CDBG funds subject to the 
requirements of this subpart. Except for program income retained and 
used by

[[Page 61769]]

the state for administrative costs or technical assistance under 
paragraph (a) of this section, program income paid to the state must be 
distributed to units of general local government in accordance with the 
method of distribution in the action plan under Sec.  91.320(k)(1)(i) 
of this title that is in effect at the time the program income is 
distributed. To the maximum extent feasible, the state must distribute 
program income before it makes additional withdrawals from the 
Department of the Treasury, except as provided in paragraph (f) of this 
section.
    (ii) Program income retained by a unit of general local government. 
A state may permit a unit of general local government that receives or 
will receive program income to retain the program income. 
Alternatively, subject to the exception in paragraph (e)(3)(ii)(A) of 
this section, a state may require that the unit of general local 
government pay any such income to the state.
    (A) A state must permit the unit of general local government to 
retain the program income to the extent that the program income is 
applied to continue the activity from which it was derived. A state 
will determine whether a unit of general local government is likely to 
apply funds to continue the activity from which the funds were derived, 
and HUD will give maximum feasible deference to a state's 
determination, in accordance with Sec.  570.480(c). In making such a 
determination, a state may consider whether the unit of general local 
government is or will be unable to comply with the requirements of 
paragraph (e)(3)(ii)(B) of this section or other requirements of this 
part, and the extent to which the program income is unlikely to be 
applied to continue the activity within the reasonably near future. 
When a state determines that the program income will be applied to 
continue the activity from which it was derived, but that the amount of 
program income held by the unit of general local government exceeds 
projected cash needs for the reasonably near future, the state may 
require the local government to return all or part of the program 
income to the state until such time as the program income is needed by 
the unit of general local government. When a state determines that a 
unit of local government is not likely to apply any significant amount 
of program income to continue the activity within a reasonable amount 
of time, or that it will not likely apply the program income in 
accordance with applicable requirements, the state may require the unit 
of general local government to return all of the program income to the 
state for disbursement to other units of local government. A state that 
intends to require units of general local government to return program 
income in accordance with this paragraph (e)(3)(ii)(A) of this section 
must describe its approach in the state's action plan required under 
Sec.  91.320 of this title.
    (B) Program income that is received and retained by the unit of 
general local government is treated as additional CDBG funds and is 
subject to all applicable requirements of this subpart, regardless of 
whether the activity that generated the program income has been closed 
out. If the grant that generated the program income is still open when 
the program income is generated, program income permitted to be 
retained will be considered part of the unit of general local 
government's grant that generated the program income. If the grant is 
closed, program income permitted to be retained will be considered to 
be part of the unit of general local government's most recently awarded 
open grant. If the unit of general local government has no open grants, 
the program income retained by the unit of general local government 
will be counted as part of the state's grant year in which the program 
income was generated. A state must employ one or more of the following 
methods to ensure that units of general local government comply with 
applicable program income requirements:
    (1) Maintaining contractual relationships with units of general 
local government for the duration of the existence of the program 
income;
    (2) Closing out the underlying activity, but requiring as a 
condition of closeout that the unit of general local government obtain 
advance state approval of either a unit of general local government's 
plan for the use of program income, or of each use of program income by 
grant recipients via regularly occurring reports and requests for 
approval;
    (3) Closing out the underlying activity, but requiring as a 
condition of closeout that the unit of general local government notify 
the state when new program income is received; or
    (4) With prior HUD approval, other approaches that demonstrate that 
the state will ensure compliance with the requirements of this subpart 
by units of general local government.
    (C) The state must require units of general local government, to 
the maximum extent feasible, to disburse program income that is subject 
to the requirements of this subpart before requesting additional funds 
from the state for activities, except as provided in paragraph (f) of 
this section.
    (iii) Transfer of program income to Entitlement program. A unit of 
general local government that becomes eligible to be an Entitlement 
grantee may request the state's approval to transfer State CDBG grant-
generated program income to the unit of general local government's 
Entitlement program. A state may approve the transfer, provided the 
unit of general local government:
    (A) Has officially elected to participate in the Entitlement grant 
program;
    (B) Agrees to use such program income in accordance with 
Entitlement program requirements; and
    (C) Has set up Integrated Disbursement Information System (IDIS) 
access and agrees to enter receipt of program income into IDIS.
    (iv) Transfer of program income of grantees losing Entitlement 
status. Upon entry into the State CDBG program, a unit of general local 
government that has lost or relinquished its Entitlement status must, 
with respect to program income that a unit of general local government 
would otherwise be permitted to retain, either:
    (A) Retain program income generated under Entitlement grants and 
continue to comply with Entitlement program requirements for program 
income; or
    (B) Retain the program income and transfer it to the State CDBG 
program, in which case the unit of general local government must comply 
with the state's rules for program income and the requirements of this 
paragraph (e).
    (4) The state must report on the receipt and use of all program 
income (whether retained by units of general local government or paid 
to the state) in its annual performance and evaluation report.
    (f) * * *
    (1) * * *
    (2) The state may establish one or more state revolving funds to 
distribute grants to units of general local government throughout a 
state or a region of the state to carry out specific, identified 
activities. * * *
* * * * *
    (m) Audits. Notwithstanding any other provision of this title, 
audits of a state and units of general local government shall be 
conducted in accordance with Sec.  85.26 of this title, which 
implements the Single Audit Act (31 U.S.C. 7501-07) and incorporates 
OMB Circular A-133. States shall develop and administer an audits 
management system to ensure that audits of units of general local 
government are conducted in accordance with OMB Circular A-133, if 
applicable.
    (n) Cost principles and prior approval. (1) A state must ensure 
that costs

[[Page 61770]]

incurred by the state and by its recipients are in conformance with the 
following cost principles, as applicable:
    (i) ``Cost Principles for State, Local, and Indian Tribal 
Governments (OMB Circular A-87),'' which is codified at 2 CFR part 225;
    (ii) ``Cost Principles for Non-Profit Organizations (OMB Circular 
A-122),'' which is codified at 2 CFR part 230; and
    (iii) ``Cost Principles for Educational Institutions (OMB Circular 
A-21),'' which is codified at 2 CFR part 220.
    (2) All cost items described in Appendix B of 2 CFR part 225 that 
require federal agency approval are allowable without prior approval of 
HUD to the extent they otherwise comply with the requirements of 2 CFR 
part 225 and are otherwise eligible under this subpart I, except for 
the following:
    (i) Depreciation methods for fixed assets shall not be changed 
without the express approval of HUD or, if charged through a cost 
allocation plan, the cognizant federal agency.
    (ii) Fines and penalties (including punitive damages) are 
unallowable costs to the CDBG program.
    5. Add Sec.  570.490(a)(3) to read as follows:


Sec.  570.490   Recordkeeping requirements.

    (a) * * *
    (3) Integrated Disbursement and Information System (IDIS). The 
state shall make entries into IDIS in a form prescribed by HUD to 
accurately capture the state's accomplishment and funding data, 
including program income, for each program year. It is recommended that 
the state enter IDIS data on a quarterly basis and it is required to be 
entered annually.
* * * * *
    6. Add Sec.  570.504(e) to read as follows:


Sec.  570.504   Program income.

* * * * *
    (e)(1) Transfer of program income to Entitlement program. A unit of 
general local government that becomes eligible to be an Entitlement 
grantee may request the state's approval to transfer State CDBG grant-
generated program income to the unit of general local government's 
Entitlement program. A state may approve the transfer, provided the 
unit of general local government:
    (i) Has officially elected to participate in the Entitlement grant 
program;
    (ii) Agrees to use such program income in accordance with 
Entitlement program requirements;
    (iii) Has set up Integrated Disbursement and Information System 
(IDIS) access and agrees to enter receipt of program income into IDIS.
    (2) Transfer of program income of grantees losing Entitlement 
status. Upon entry into the State CDBG program, a unit of general local 
government that has lost or relinquished its Entitlement status must, 
with respect to program income that a unit of general local government 
would otherwise be permitted to retain, either:
    (1) Retain the program income generated under Entitlement grants 
and continue to comply with Entitlement program requirements for 
program income; or
    (2) Retain the program income and transfer it to the State CDBG 
program, in which case the unit of general local government must comply 
with the state's rules for program income and the requirements of Sec.  
570.489(e).

    Dated: September 23, 2008.
Susan D. Peppler,
Assistant Secretary for Community Planning and Development.
 [FR Doc. E8-24572 Filed 10-16-08; 8:45 am]
BILLING CODE 4210-67-P