The Hampton County School District in Varnville, South Carolina has received a notice of proposed adjustment via Internal Revenue Service Form 5701-B, a sign the tax-exempt status of its $14 million Series 2010 general obligation bonds is being called into question.
“They received a notice from the IRS and they're responding to it,” said Ryan Gentry, a partner at Burr Forman, which is bond counsel to the Hampton County School District. Gentry said he wasn’t at liberty to discuss the proceeding any further than what was
According to Johnny Hutchinson, a securities lawyer who was most recently a partner with Squire Patton Boggs, the notice is often referred to as the “30 day letter,” as issuers typically have 30 days to respond.
When the IRS begins to audit bond issues, they typically look at a particular segment of the market and then spend a couple of years conducting audits, which is fairly routine.
“For most bond counsel, the view is that that kind of random audit is not something that would require disclosure to the market and it’s usually not covered by most continuing disclosure undertakings that issuers agreed to in connection with their bonds,” Hutchinson said.
“It’s only when you get to this stage in the audit, that a lot of times a continuing disclosure agreement will mention this exact form, 5701-B, as a point at which things have gotten sufficiently serious and that it’s time to make a disclosure to the market.”
The audit will typically present the issuer with a basic questionnaire in a first round, asking about the use of proceeds, whether it was new money or refunding, what was built with the money, and so on.
Most bond issuers will respond and that’ll be the end of it. But if there are problems that the IRS sees, the agency will follow up with another round of questions but will never explicitly express a particular view or tell the issuer what the possible problem is.
“When you get that second round of questions, the funnel is narrowed a little bit and you can kind of see what the IRS is focusing on,” Hutchinson said. “But a lot of times you won’t really find out what their real issues are until they give you a call and send you this 5701-B.”
The IRS Form 5701-B is then the moment the issuer knows that the IRS has a problem with the tax-exempt status of the bonds, setting out facts not unlike a formal legal opinion, Hutchinson said.
“The 5701-B is the point where you’re going to have to actually fight with the IRS, you’re going to have to convince them that their position is incorrect,” Hutchinson said, which is where this issuer is now.
