Alerts and Updates
IRS to Initiate Tax-Exempt Bond Audit Program
June 14, 2006
For almost two years, senior officials in the Tax-Exempt Bond Audit and Enforcement Group at the IRS have made public statements about their intention to conduct an audit program focused on compliance with the tax law requirements that apply to "qualified 501(c)(3) bonds." Beginning in August of this year, the IRS will send letters to some 20 or 30 issuers of qualified 501(c)(3) bonds notifying them that their bond issues have been selected for audit. The bond issues involved will be selected from bonds that were issued between May 1997 and December 1998. It is expected that two-thirds of the audits will involve hospital bonds (with the remainder involving economic development and affordable housing).
The audit program will emphasize compliance with the limitations imposed on private business use of bond-financed facilities under the so-called "95/5" test (requiring that throughout the term of the bond issue at least 95 percent of the use of the facilities financed with the proceeds of the tax-exempt bonds be used by the qualifying section 501(c)(3) borrower exclusively in furtherance of its exempt purposes). Thus, the examinations will analyze whether any "unrelated business" use of the facilities by the borrowers has occurred. Other issues to be reviewed are whether there are leases of portions of the bond-financed facilities to private businesses (e.g., private physician practices or joint ventures with private physicians) and/or management or research contracts with private businesses that fail to satisfy the safe harbor requirements identified in Revenue Procedures 97-13 and 97-14.
The audits will likely highlight the importance of keeping adequate records to demonstrate compliance with the 95/5 test, including proper allocation of the bond proceeds to the facilities that were financed, and careful recordkeeping concerning the use of those facilities from the date of issuance of the bonds. The IRS reportedly decided to delay its original intention to mail the notification letters to issuers at the end of June until the month of August in order to give potentially affected bond issuers and borrowers time to review their records and, in the event any problems are discovered, to begin a voluntary correction process with respect to any identified problems under the IRS' Tax-Exempt Bond Voluntary Closing Agreement Program ("VCAP"). Once an audit begins, proceeding under the VCAP will no longer be an option.
Needless to say, the tax consequences of noncompliance with the private business use limitations are very undesirable. Although by the time the audit notification letters are mailed in August it may be too late for the issuers and borrowers whose bond issues have been selected for audit to take any remedial action, this program should stand as a warning to all other recent issuers and borrowers of qualified 501(c)(3) bonds and qualified hospital bonds that they should carefully review their recordkeeping with respect to the use of the facilities financed with the proceeds of those bonds. It seems likely that this new audit program will be only the first in a series of tax-exempt bond audits likely to be conducted by the IRS, especially if this project results in findings of significant noncompliance.
For Further Information
For more information or if you have a question about this Alert, please contact one of the attorneys of our Health Law Practice Group or the attorney in the firm with whom you are regularly in contact.
As required by United States Treasury Regulations, you should be aware that this communication is not intended by the sender to be used, and it cannot be used, for the purpose of avoiding penalties under United States federal tax laws.
Disclaimer: This Alert has been prepared and published for informational purposes only and is not offered, nor should be construed, as legal advice. For more information, please see the firm's full disclaimer.
