WASHINGTON – The Internal Revenue Service recently closed its audit of $45 million of first mortgage revenue bonds sold by Baker Correctional Development Corp. in Florida in 2008 after the bonds were converted to taxable bonds on July 11.
The closure of the audit, which followed the IRS’ claim in September 2016 that the bonds were taxable, is the latest example of IRS agents increasingly using relatively new case closing procedures.
The procedures allow IRS agents, in some cases, to close an audit of an issue of tax-exempt bonds without further action if the issuer or borrower converts all outstanding bonds from that issue into taxable bonds.
“I’ve been involved in a couple of situations where they’ve done this and they seeming to be doing it elsewhere,” said Tom Vander Molen, a partner at Dorsey & Whitney in Minneapolis who heads the National Association of Bond Lawyers’ tax law committee.
The new procedures stem from a memo that Rebecca Harrigal, former director of the IRS tax exempt bond office, wrote to TEB employees on Oct. 18, 2016.
“If, during an exam of a tax-exempt bond or tax-credit bond issue, an issuer redeems 100% of the outstanding principal amount of the bonds, the examiner and group manager should consider, under the circumstances, whether to close the exam without further TEB action,” wrote Harrigal in the memo. She left the IRS in late 2016 to join the law firm of Greenberg Traurig.
Harrigal suggested in the memo that bonds might warrant such procedures if the issuer or borrower took reasonable steps to ensure the bonds complied with the law or attempted to self-correct problems before the start of an audit.
But she warned bonds might not be suitable for these procedures if the transaction was abusive of if transaction participants were involved in aspects of the transaction that resulted in non-compliance. An example of this would be if the participants had a financial interest in the transaction, she said.
“It’s not automatic. It’s at the discretion of the IRS,” said Vander Molen.
In this latest case, the bonds had been used to help finance the development of the Baker County Detention Center near MacClenny, Fla., in Baker County, roughly 30 miles west of Jacksonville. The jail opened in September 2009,
The IRS found a private activity bond problem, much like it has with many jails across the country that have signed contracts with the federal government to take in federal prisoners. Typically the prisoners are from the U.S. Citizenship and Immigration Service or the U.S. Marshals Service.
At the time the IRS informally advised Baker Correctional Development Corp. that its 2008 bonds were taxable, the detention center had 480 inmates, of which roughly 350 were federal. The federal government is considered to be a private party under the federal tax code, while state and local governments are categorized as governments.
Under the tax code, bonds are private activity bonds if more than 10% of the proceeds are used for private use and more than 10% of debt service payments are from or secured by private parties. But for PABs to be tax-exempt they must fall into one of several specified categories, none of which include jails or correctional facilities.
The IRS found that the bonds failed to meet the private use and payment tests for PABs because of the large federal inmate population, according to Jeffrey Cox, finance director for the Baker County Sheriff’s Office, which operates the jail, and IRS correspondence with the office.
But on July 11 of this year, the BCDC converted all of the outstanding bonds -- about $36.3 million -- into taxable bonds.
As a result, Allyson Belsome, manager of tax exempt field operations for the IRS, sent Cox a letter dated July 18 in which she wrote: “We’re closing our audit of the debt issuance.”
