The IRS recently issued PLR 201519015 which concluded that payments made by private persons that have “little connection” to the bond-financed property are not “private payments” that count against the private payment limit.  The IRS concluded that there was little connection between fares paid by bus riders and a bond-financed highway where the fares were unrelated to the degree to which the bus would traverse the bond-financed portion of the highway.

Private Business Tests

The PLR, dated February 3 but not publicly released until May 8, applies the ever-confusing private payment test (Treas. Reg. 1.141-4….good luck) to payments made for the use of two bond-financed highway lanes.  The private payment test is one of two private business tests that limit the use of proceeds from various types of tax-advantaged bonds.[1]

The private payment test is implicated when debt service on an issue of tax-exempt bonds is derived (directly or indirectly) from payments made by nongovernmental persons. The other, much more familiar, test is the private business use test which looks to how tax-advantaged bond proceeds and the facilities financed with such proceeds are actually used.  Tax-advantaged governmental bonds can lose their favorable tax status if more than 10 percent of the proceeds of an issue are used for (a) any private business use and (b) more than 10 percent of the debt service on the same issue is derived from payments in respect of property used in the private business use.[2] Both limits must be exceeded before an issue of tax-advantaged bonds can lose its favorable tax status.

Certain facilities that are exclusively used by private parties (e.g., sports stadiums) may nonetheless be financed with proceeds from tax-exempt bonds because the private user’s payments are not used to pay debt service on the issue (e.g., the limit on private payments is not exceeded). This straightforward application of the private payment test has drawn considerable attention for many years from those critical of public financing of professional stadiums and arenas.

The PLR in Detail

The issuer that requested the ruling intended to use proceeds of tax-advantaged bonds to construct two highways (the “Managed Lanes”) running in opposite directions.  The Managed Lanes would be operated by a private party pursuant to a management contract that results in private business use of the bonds issued to finance the Managed Lanes; therefore, ensuring that the private payment limit is not exceeded is critical.  The facts are a little unclear, but the fact that the lanes are operated by a private party suggests that the Managed Lanes may be used primarily by high occupancy vehicles – the carpool lanes or HOV lanes.  In all likelihood, the HOV lanes are owned by a governmental entity who contracts with a vendor who installs and operates the EZ Pass or similar system, which can go by many names, and bills the HOV lane users. That vendor would be the private user of the HOV lanes.

The issuer operates bus routes throughout the area, including certain routes that may use the highway (including the Managed Lanes) to varying degrees.  To ride the bus lines, members of the general public pay the issuer certain published fares (“Fare Revenues”).  Some riders pay a per-ride fare while others pay for bus access during a particular period of time (e.g., per-month, per-year).  The amount of the fare varies based on whether the bus travels on local, express, or regional routes.

Certain of the regional and express routes will include transportation on the Managed Lanes.  The time that each bus spends on Managed Lanes varies based on the particular route.  The fares paid by bus riders are unrelated to the degree to which a bus will travel on the Managed Lanes.   Put another way, bus riders will not pay a premium to travel on the Managed Lanes.

In concluding that the Fare Revenues were not private payments (under Section 141(b)(2)(B) of the Code and Treas. Reg. 1.141-4) in respect of the Managed Lanes, the IRS said that the Fare Revenues have “little connection” to the Managed Lanes.  In reaching this conclusion, the IRS relied on the uniform fee schedule, which did not vary based on whether a bus route traveled on Managed Lanes as well as the minimal amount of bus usage of the Managed Lanes relative to the entire system of bus routes.

The IRS gave little explanation for the “little connection” rationale.  These words do not appear in the Code or the Regulations.  Interestingly, there were several options in the Code and the Treasury Regulations that the IRS could have utilized, although the IRS can only work with the facts presented and perhaps there was a reason why other facts were not presented.  Had these facts been presented, the IRS could have chosen to incorporate the private payment exception for operating expenses in Treas. Reg. 1.141-4(c)(2)(C) which excludes from the definition of private payment, those payments that are “properly allocable to the payment of ordinary and necessary expenses (as defined under Section 162) directly attributable to the operation and maintenance of the financed property used by that person.”  Fare Revenues in the public transit sector are rarely, in fact probably never, sufficient to cover all of the operating expenses of a bus line (the rest are typically subsidized by the local, state, and federal governments); therefore, the exception likely applied.

Alternatively, the IRS could have treated the Fare Revenues as private payments and still determined that the amount of private payments actually attributable to the Managed Lanes was well within permitted limits.  The PLR makes clear that the Managed Lanes are only a fraction of the total routes used by buses.  The IRS could have, for example, quantified the payments by multiplying the total Fare Revenues collected by a fraction the numerator of which was the mileage of the Managed Lanes, and the denominator of which was the total mileage in the bus system (i.e., the total mileage to which Fare Revenues relate).

In my opinion, the second approach would be more consistent with the definition of private payments in the Treasury Regulations.  It’s difficult to conclude that there is “little connection” between the Fare Revenues and the Managed Lanes when, in fact, the Fare Revenues are paid for the use of the bus routes, which includes the Managed Lanes.  In that respect, the bus fares directly relate to use of the Managed Lanes, albeit in small proportion to the rest of the traffic lanes for which fares are paid.  The IRS’s analysis seems to create a new de minimis exception for private payments rather than a relational exception.

While the reasoning may be a bit unconventional, the PLR continues the IRS’s recent trends towards permitting a wider variety of contracts and financial arrangements between beneficiaries of tax-exempt bond proceeds and private parties.

[1]               Certain tax-advantaged bonds, such as Section 142 exempt facility bonds, are not subject to the private business tests.

[2]               I am blatantly and intentionally ignoring the private security test. Section 141 of the Code provides that an issue with more than 10 percent private business use will lose its tax-advantaged status if either the private payments test or the private security test is met.  Because the PLR does not reference the private security test, I am ignoring the private security test as well.