With the Internal Revenue Service reportedly considering whether to strip Harvard University of its tax-exempt status, it's too soon to tell whether the move would render the university's $3.3 billion of tax-exempt bonds suddenly taxable or only restrict the university's future ability to issue tax-exempt debt.
"It's really about the date when they revoke it," said Adam Young, a partner at Fox Rothschild LLP, where he represents clients in federal, state and local tax controversies. "It's not clear from what the [Trump] administration has said whether they're going to revoke the tax-exempt status retroactively or whether they're going to do it on a go-forward basis," he said.
"It's less likely the revocation would be retroactive in a normal case but there's been a lot of upheaval at the IRS right now, so I can't say for sure if they would follow the same procedures that they otherwise would," said Young, who previously worked for the IRS Office of Chief Counsel.
The possibility the prominent issuer would lose its tax-exempt status seems to have spooked investors and
Amid an escalating standoff between Harvard and the Trump administration, the threat to its 501(c)(3) status became more real after President Donald Trump
"We'll see what IRS comes back with relative to Harvard," McMahon told CNN. "I certainly think, you know, in elitist schools, especially that have these incredibly large endowments, you know, we should probably have a look into that."
On CNBC, McMahon said, "We have not said that the tax exemption should be taken away, but I think it's worth having a look at. I think the president has put all the tools on the table and we should have the ability to utilize all of those particular tools." McMahon also said it's her "guess" that the IRS is looking at tax exempt statuses of other universities.
The political turmoil forced a "stickering" of the university's most recent borrowing of $750 million of taxable corporate CUSIPs on April 9. The updated information outlines a variety of federal actions that may impact "Harvard's standing in the higher education sector and its revenues, expenses and net assets," including possible adverse decisions affecting or elimination of its 501(c)(3) status.
Even if the IRS does move to strip the school of its status retroactively, and the interest on its outstanding tax-exempt bonds becomes taxable, it's unlikely that the bondholders would be the ones on the hook for repayments.
"When a bond loses its tax-exempt status, what we typically see is the IRS penalize the issuer in some way rather than penalize the bondholder," said Adam Stern, co-head of research at Boston-based Breckinridge Capital Advisors. "That makes sense, as it would be a black mark on the market that would lead to less liquidity."
Another possible scenario, Stern said, would follow the model of a hospital merger between a taxable and tax-exempt issuer when the outstanding tax-exempt paper is taken out, often through a tender offer.
"That could be another option," he said. "But the least likely outcome would be bondholders are compelled to pay taxes on their existing bonds."
Young agreed. "The IRS would most likely look to the issuer to pay whatever amount the IRS determines to be due," he said. "Often that gets resolved for some lesser amount, as the IRS looks at what the risks were and come to a settlement agreement with the issuer."
Losing its nonprofit status would cost Harvard an estimated $500 million annually, noted an April 21
They argue that the Trump administration may have a strong case, noting that the private Christian college Bob Jones University was successfully stripped of its status in a decision affirmed by the U.S. Supreme Court in 1983.
If the IRS revokes Harvard's tax exemption, Harvard would likely sue, and the legal wrangling could take years, said Barclays in its April 25 Municipal Weekly report.
"The downside risk to outstanding tax exempts remains," the firm said. Despite the risks, Barclays said it sees value in the tax-exempt bonds that have seen recent spread widening.
Harvard has $8.2 billion of municipal debt outstanding, including $3.3 billion of tax-exempt and $4.9 of taxable bonds, according to J.P. Morgan.
