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CDFA Spotlight:
IRS Small Issue Bond Compliance Initiative
By Stan Provus |
Preview
This article presents the results of an IRS qualified small issue bond examination compliance initiative. This article rests on a summary of the compliance initiative written by Joe Grabowski of the IRS. Future Learning Corner articles will include a review of other areas of tax-exempt bond finance.
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This article is intended to provide accurate and authoritative information in regard to the subject matter covered. The author and CDFA are not herein engaged in rendering legal, accounting or other professional services, nor does it intend that the material included herein be relied upon to the exclusion of outside counsel.
The qualified small issue examination initiative was conducted to determine the level of compliance of a statistical sampling of qualified small issue bonds with the applicable provisions of the Internal Revenue Code and whether interest paid on the bonds examined should remain excludable from federal taxation. The examinations measured whether borrowers used bond proceeds appropriately and whether there were violations of major regulations such as the $10 million and $40 million capital expenditure limitations and the use of straight-line depreciation.
The IRS examined a statistical sampling of Forms 8038 of qualified small issue bonds filed in 1991-1992. 104 cases or bond issues were examined in this compliance initiative. 77 cases or 74% involved bond issues of less than $5,000,000. This compliance initiative was conducted in 1999.
The examination initiative of small issue bonds found a relatively high degree of noncompliance. As a consequence of the high degree of noncompliance, qualified small issue bonds were made a priority item in future IRS examination workplans. Important findings are highlighted below. 76.9% of the examinations resulted in no change, while 23.1% resulted in some type of change.
The 24 change cases were broken down as follows:
- Closing Agreements: 12
- Bonds declared taxable: 1
- Changes to other returns: 11
The changes to other returns are discrepancy adjustments made to the income tax returns of conduit borrowers for depreciation allowance. Small issue bond borrowers must use straight-line depreciation of assets financed with bond proceeds—they cannot use accelerated depreciation. This rule was violated more than any other.
The issues involved in closing agreements included: (1) the activity conducted was not manufacturing; (2) the 2% cost of issuance limitation was exceeded; (3) the $10 million capital expenditure limitation was exceeded; (4) and the $40 million nation-wide capital expenditure limitation was exceeded.
This initiative suggests that conduit issuers should underscore to their borrowers that they must use straight-line depreciation, even though this detracts from the competitiveness of tax-exempt financing relative to taxable or conventional financial. In addition, the closing agreement issues should be reviewed with conduit borrowers or they should be given information about these issues prepared by their bond counsels.
This article is intended to provide accurate and authoritative information in regard to the subject matter covered. The author and CDFA are not herein engaged in rendering legal, accounting or other professional services, nor does it intend that the material included herein be relied upon to the exclusion of outside counsel. CDFA is not responsible for the accuracy of the information provided in this fact sheet. The information provided has been collected from a variety of sources. Those seeking to conduct complex financial deals using the tools mentioned in this document are encouraged to seek the advice of a skilled legal/consulting professional.
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