This past summer, I wrote a blog post showing how the sequestration rate, which reduces federal subsidy payments to issuers of “Direct Pay Bonds” (defined below), has generally been decreasing since the spending cuts enacted by the Budget Control Act of 2011 (“BCA”) began on March 1, 2013. As a reminder, sequestration refers to the automatic, across-the-board spending cuts that apply to many of the federal government’s programs, projects and activities. Issuers of “Direct Pay Bonds” (i.e., Build America Bonds, Recovery Zone Economic Development Bonds and all qualified tax credit bonds that were issued on a direct payment rather than a tax credit basis), who are entitled to receive federal government subsidies tied to the interest paid on these bonds, have been negatively impacted by these spending cuts. The higher the sequestration rate, the lower the subsidy. Continue Reading
The IRS has given us new “remedial actions” for issuers of build America bonds and other direct pay bonds and for long-term leases of bond-financed property. These new rules are in Revenue Procedure 2018-26, and you can apply them immediately to cure the violations that the Revenue Procedure covers.
The beauty of the remedial action rules is that remedial actions are largely self-effectuating. Contrast them with the Voluntary Closing Agreement Program, which requires an application, IRS approval, negotiations, a closing agreement, etc. etc. Under the remedial action rules, you take the action described to cure the violation described, and you’re done, and you don’t have to ask the IRS’s permission.
BABs and Other Direct Pay Bonds. Before this Revenue Procedure, there were no remedial actions that applied to BABs and other tax-credit and direct pay bonds. The only means for solving a problem was to go through VCAP. This Revenue Procedure provides new options.
Long-term Leases. In addition, for issuers of all bonds, generally the only remedial action available for leases of bond-financed property that caused the bonds to violate the private business limits was to redeem an amount of bonds corresponding to the amount of leased property. If you couldn’t currently redeem the bonds, you had to fund a defeasance escrow with cash until the redemption date. In recent years, that has meant earning a pitifully low return. To add insult to injury, the lease does not generate any “disposition proceeds” that could be used to help fund the defeasance escrow, so issuers had to come up with their own funds, which couldn’t be generated by issuing additional tax-exempt bonds. In contrast, if the issuer sold the bond-financed property, the issuer would receive disposition proceeds, which it could instead redeploy for qualifying assets to remedy the excess private business use. For certain long-term leases, the new Revenue Procedure provides some limited relief (though it does not directly solve the problem of having cash up front) to this situation by allowing issuers to calculate an amount equal to the present value of the lease payments, and to redeploy that amount on qualifying uses.
As always, dangers, opportunities, and questions lurk in between the lines. We’ll have much more to say about those things in future posts.
The IRS recently issued Private Letter Ruling 201811009, which provides helpful insight into how the IRS construes the term “control” for purposes of determining whether two affiliated 501(c)(3) organizations are “related” for purposes of the definition of “refunding issue.”
The ruling involved a 501(c)(3) university (“Seller”) that sold its medical center to another 501(c)(3) organization (“Buyer”). The Buyer was operationally independent of the Seller, but the Seller could appoint 30% of the Buyer’s board and the Seller also had approval rights over certain major Buyer decisions, such as major transactions and changes to the mission of the Buyer. If the Buyer and the Seller were treated as related, the proposed bonds (“Proposed Bonds”) to be issued for the Buyer to finance the purchase of the Seller’s medical center would be treated as refunding bonds, and they therefore could not qualify as tax-exempt bonds. This was because the Seller had previously used part of the proceeds of prior bonds to finance the medical center, and those bonds had previously been advance refunded. As readers of this blog know, post-1985 qualified 501(c)(3) bonds could be advance refunded once and only once until tax-exempt advance refundings were repealed last year. Read below to see how the IRS tackled the analysis of control, which is still relevant even though tax-exempt advance refundings aren’t permitted anymore.
In January, the Supreme Court granted a writ of certiorari in the case of South Dakota v. Wayfair (discussed here). Wayfair, which will be argued before the Court on April 17, is a direct challenge to Quill Corp. v. North Dakota, in which the Supreme Court held that a vendor does not have to collect and remit the sales/use tax owed on sales made to customers who reside in a given state unless the vendor has a physical presence in that state (we have discussed this issue here and here).
On February 13, the Trump Administration released its proposal to finance improvements of the nation’s infrastructure. This proposal promotes the use of public-private partnership (“P3”) arrangements to fund these improvements by expanding exempt facility bonds (a type of tax-exempt private activity bond that can be used to finance a list of specific types of projects, such as airports, sewage facilities, etc.) so that tax-exempt bonds can be used more easily in conjunction with P3 arrangements. For example, many public infrastructure projects, such as convention centers, courthouses, and fiber optic networks, do not fit within the patchwork list of projects that qualify for private activity bond financing, and so they cannot be financed with tax-exempt bonds if the bonds would exceed the private activity limits.
The day after the Trump Administration released its proposal, House Ways and Means Chairman Kevin Brady made it clear that he does not support an expansion of tax-exempt private activity bonds($). If the scope of exempt facility bonds is not expanded to facilitate the more ready use of tax-exempt bonds in P3 financing structures, and Chairman Brady’s resistance could make this a likely outcome, P3 arrangements that wish to include tax-exempt bond financing will need to satisfy current law. One way to accomplish this objective is for the private party in the P3 arrangement not to be the owner or long-term lessee of the tax-exempt bond-financed property but instead to use this property under a management contract that complies with Revenue Procedure 2017-13 (which we have analyzed here, here, and here).
What if the P3 arrangement contemplates that the private party will hold attributes of ownership in the subject property that will result in excessive private business use of the bonds that would finance that property, so that the qualified management contract approach is not a solution? One technique, which is often used to allow the use of tax-exempt bonds to finance professional sports stadiums (which, since the Tax Reform Act of 1986, have not been among the list of projects that can be financed with exempt facility bonds), presents a potential alternative solution.
Last week’s NABL Tax and Securities Law Institute included a discussion featuring John Cross (Associate Tax Legislative Counsel – Treasury) and Vicky Tsilas (Chief Branch 5 — IRS General Counsel’s Office) of whether tax-exempt bonds can be issued to advance refund taxable bonds, including build America bonds (BABs) despite the prohibition of tax-exempt advance refundings by the 2017 tax legislation. The prohibition, set forth in Internal Revenue Code (Code) section 149(d)(1), states: “Nothing in section 103(a) or in any other provision of law shall be construed to provide an exemption from Federal income tax for interest on any bond issued to advance refund another bond.” The Code provides that “[t]he term ‘bond’ includes any obligation.” Code section 150(a)(1). Thus the question is whether a taxable bond is a “bond” as that term is used in the advance refunding prohibition. BABs are included in the question because interest on BABs is included in gross income under Code section §54AA(f)(1). So with this statutory backdrop, can tax-exempt bonds be issued to advance refund taxable bonds?
Notwithstanding all the doom and gloom around these parts about “the bill formerly known as the Tax Cuts and Jobs Act” (final name pending conclusion of sponsorship negotiations), the final legislation created a new tool for economic development in low-income communities, called the “Opportunity Zone” program. The program provides incentives for taxpayers to invest in low-income communities by allowing them to defer and potentially avoid gain on the sale of stock or other property if they reinvest their gains in a low-income community through an “Opportunity Fund.” But, state governors must act soon to designate eligible census tracts as Opportunity Zones, or they may lose the opportunity forever.
Our colleague Steve Mount has written a comprehensive analysis of the new program for BNA’s Tax Management Real Estate Journal; you should download it from the Squire Patton Boggs website by clicking here. Click through for a brief summary of the program here, and be sure to download Steve’s article for the full details on this new program.
Public finance tax lawyers have been acutely aware of the direct effects of the 2017 tax legislation, especially the elimination of tax-exempt advance refundings, but some of the indirect effects have begun to appear only recently. One of those is the triggering of bank rate adjustments resulting from the drop in the corporate tax rate. As frequently touted by the President, the legislation reduced the maximum corporate tax rate from 35% to 21%. The effect of this rate reduction on bond interest rates is more pronounced because of the popularity of bank placements of tax-exempt bonds in recent years. For a number of reasons, including to remain competitive, many banks have been willing to forego or reduce the interest rate increase to which they are entitled under the bank loan documents. This is obviously good news for bond obligors but the tax consequences – namely, a potential reissuance – must be kept in mind.
With the flurry of news regarding how tax-exempt bonds were affected by the Tax Cuts and Jobs Act (“TCJA”), some of you may have missed what else was included in the TCJA. Here are six things a 501(c)(3) organization should know (other than that TCJA did not eliminate tax-exempt qualified 501(c)(3) bonds):
- Fewer individuals will be claiming itemized deductions, so fewer people will get a tax benefit from making a charitable contribution, which could cause a decline in such contributions.
- The estate tax exclusion amount is raised through 2025 to $10 million, so fewer people will have an incentive to make charitable bequests. Because of inflation adjustments, the actual dollar amount of the exclusion in 2018 is expected to be about $11 million.
- There will no longer be a charitable deduction for college athletic seating rights. I suspect that Buckeye ticket sales will be unaffected.
- Unrelated business taxable income (“UBTI”) must now be calculated separately for each unrelated trade or business activity. Because losses from an unprofitable trade or business can’t be used to offset income from a profitable one, the result will be more UBTI. Also, organizations will need to determine which unrelated trade or business activities are separate trades or businesses.
- There is a 21% excise tax imposed on remuneration exceeding $1 million paid by tax-exempt employers to a “covered employee” or on “excess parachute payments.” Covered employees are generally individuals who are or were one of the five highest paid employees, and excess parachute payments are certain large severance payments.
- Colleges and universities with endowments exceeding $500,000 per student will generally owe an excise tax of 1.4% on their net investment income.
For more details, see this alert from our SPB colleagues.
A few months ago, I wrote a blog post about a hospital that had its Section 501(c)(3) status revoked by the IRS. In that case, the IRS found that the hospital had committed willful and egregious violations of the Patient Protection and Affordable Care Act (the “ACA”). For example, the hospital was not conducting a community health needs assessment every three years as required by the ACA, and was not shy about telling the IRS that the hospital had neither the financial wherewithal nor the employees to conduct a needed assessment every three years. Continue Reading