Internal Revenue Service officials reversed themselves on Friday and took pains to assure lawyers meeting in New York City that the loss of a charitable organization's tax-exempt status will not necessarily cause its municipal bonds to become taxable.

"I think its going to be fairly rare that there is going to be a situation where bonds are going to lose their tax-exempt status," Marcus Owens, director of the technical section of the IRS' exempt organizations branch, said at a meeting of the American Bar Association's exempt organizations committee.

Owens' branch took over the tax-exempt bond enforcement program in June.

He and Debra Kawecki, assistant branch chief, warned earlier this year that a few of the 28 hospitals and health care groups currently undergoing audits in a special program probably will lose their tax-exempt status because of tax law violations. Most of these organizations have used tax-exempt financing. Although the organization's loss of tax-exemption may have nothing to do with the bonds, it would nevertheless cause the bonds to lose their tax-exempt status, Owens and Kawicki said.

But at the meeting on Friday, Owens and Marvin Friedlander, another IRS exempt organizations official, backed away from those statements.

"I think it's premature to say that any hospital's going to lose its exemption. There's long road with a lot of appeal rights and conferences and that sort of thing before an organization loses its exemption, especially a hospital," Friedlander told the lawyers.

Friedlander said also "it's unlikely" that the IRS would revoke the tax-exempt status of bonds for technical violations of the tax law.

"It's more likely that we would enter into closing agreements," he said.

In a closing agreement, the IRS would refrain from taxing bondholders in return for the organization's paying its back taxes and taking corrective action.

Owens told the lawyers that "tax-exempt bond issues really lend themselves to closing agreements."

It may be possible for a charity to bring itself into compliance with tax laws quickly to re-obtain nonprofit status soon after losing it, he said.

Owens said he could not say that tax-exempt bonds would never be taxed. But the IRS is always going to be concerned about the injustice of taxing bondholders who had nothing to do with the abuses caused by the organization that used the bonds, he said.

On another issue, Owens seemed to back away from Kawecki's statement at a meeting 10 days ago that the IRS tries to encourage nonprofit organizations, in closing agreements, to disclose they were the subject of enforcement action.

Owens said that while the IRS may encourage disclosure of abuses that it wants exempt organizations to be aware of, "we do not have a general policy that every closing agreement will have some sort of disclosure.

"There may very well be issues and agreements where there isn't any clear voluntary compliance benefit," he said.

Bond lawyers breathed a sigh of relief after Owens and Friedlander said hospital bonds will not necessarily lose their tax-exempt status because of enforcement action against hospitals under audit.

"I was pleased to see that representatives of the exempt organization branch seem to have a real good understanding or the sensitivity of the bond market," said William Loafman, a partner with the law firm of Whitman and Ransom in New York.

When IRS officials talk about taxing hospital bonds, that affects the trading of the bonds, Loafman said,

But Loafman and other bond lawyers at the meeting were concerned at Friedlander's examples of potential bond abuses that are being raised in the hospital audits.

In one case, Friedlander said, IRS auditors are questioning whether bond-financed housing for hospital employees constitutes the private use of bond proceeds. Under the tax law, bond issues are private activity bonds and possibly taxable if more than 10% of the proceeds are used in a private trade or business and more than 10% of the debt service is paid with money from private sources.

But most bond counsel would not view this as a private use problem because the hospital employees are not using the housing to engage in a private trade or business, Loafman and others said after the meeting.

Friedlander cited another case in which auditors are questioning whether hospital bonds used to finance a research facility would fall within the tax law's $150 million cap on the amount of nonhospital bonds that a nonprofit organization can have outstanding at any one time.

R. Todd Greenwalt, a lawyer with Vinson & Elkins in Houston, and Lauren K. McNulty, a lawyer with Gardner, Carton & Douglas in Chicago, both pointed out after the meeting that previously issued IRs private letter rulings suggest it might be possible to issue such bonds outside the cap if the research facility is integrated with the hospital and does not impinge on the hospital's primary mission of caring for its patients.

McNulty said Friedlander's examples show how much the exempt organizations branch still has to learn about tax-exempt bonds.

"Right now they seem to be jumping on things that the bond community hasn't been concerned about. They just need to tread carefully," McNulty said.

Friedlander tried to assure the lawyers that exempt organization branch officials and auditors will work closely with the IRS' tax-exempt bond branch on bond issues that arise from the new municipal bond enforcement program.

He also talked about the agency's new procedural rules for organizations that are planning tax-exempt financings and seeking tax-exempt status, calling them "an 18-month experiment." The rules, which were issued late last year, require the organizations to provide the IRS with information about their bond plans in order to obtain tax-exempt status. The IRS plans to seek comments on the rules after they have been in place for 18 months.

Friedlander said the rules are not meant to put the IRS in the business of qualifying bonds, but instead are aimed at preventing abusive situations.

Most organizations that already have been granted tax-exempt status need not come back to the IRS for a reconfirmation if they plan a new bond financing, unless they have changed their mission, he said.

However, Friedlander said, a tax-exempt evangelistic organization should come back for a ruling if its mission changes unexpectedly from running revival meetings to operating health care facilities.

Friedlander also said the IRS expects to stop issuing "group rulings" for related organizations that are seeking tax-exempt status if the groups' primary activities are low-income housing or elderly or health care facilities. Such organizations that already have obtained tax-exempt status need not have it confirmed if they have not changed their mission, he said.

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