WASHINGTON -- The Internal Revenue Service's guidance on 501(c)(3) organizations exceeds the agency's jurisdiction and will increase costs and cause delays for nonprofit health-care groups that are seeking tax-exempt status and that want to issue bonds, several lawyers said yesterday.
In effect, they said, every bond issue by a group seeking 501(d)(3) status will have to be reviewed by the IRS. But two attorneys cautioned against overreacting and said the agency may prove reasonable and flexible in implementing this attempt to prevent abuses.
The IRS guidance to its field agents appeared in an article called "Tax-Exempt Bond Financing," part of a recently issued training document entitled "Exempt Organizations Continuing Professional Education Technical Instruction Program for Fiscal Year 1992."
The agents were given detailed procedures for scrutinizing the bonds of a health-care organization seeking 501(c)(3) status to ensure that the nonprofit group would be operated for public rather than private purposes and that bonds issued on its behalf would qualify for tax exemption.
They were told that the IRS's general policy is to withhold 501(c)(3) status until bond financings are reviewed. Agents must obtain bond documents and substantial amounts of other information about the applicant and its bond plans, the IRS said.
The guidance was issued more than a year after the IRS issued a notice warning that it planned to investigate potentially abusive 501(1)(3) health-care deals.
That notice was prompted by a series of widely publicized abusive deals in which developers set up 501(c)(3) organizations to issue bonds to finance the acquisition of their troubled nursing homes at inflated prices.
The authors of the recent guidance said it is intended to help reduce the default rate of 501(c)(3) bonds. But several lawyers described it as overkill that goes beyond that 1990 notice and IRS jurisdiction.
"It seems to me that this is a quantum leap from saying they're out to identify abusive transactions," said R. Todd Greenwalt, a lawyer with Vinson & Elkins in Houston who is chairman of an American Bar Association task force on qualified 501(c)(3) bonds. "You've got language instructing agents to review every transaction to make sure they comply with every single bond rule. That's more than checking for private benefit."
"Since when did the exempt organizations branch of the IRS get the notion that it should be taking over the Securities and Exchange Commission's duties to protect investors?" asked William Loafman, a lawyer with Washington, Christian and Laofman here.
"Its job is to make sure that charitable organizations have public purposes" and do not operate in a way that benefits private parties, he said, adding that its role is not supposed to be saving investors from developers.
Several lawyers said that the IRS's exempt organization branch also seems to be taking on the responsibilities of the tax-exempt bond branch, which normally is responsible for bonds.
They said they found errors in the guidance concerning the basics of bond deals and law. For example, the article's description of a negotiated sale was actually a private placement, and the authors did not seem to understand that delays could result in the loss of the interest rate that was needed to make the deal work, they said.
Several lawyers said that the guidance runs counter to the Bush administration's call for less government intrusion and the IRS's attempts to stop having to issue rulings providing comfort that transactions will not violate tax laws.
"Now you have the 501(c)3) branch getting into the business of issuing comfort letters because they don't want to use traditional enforcement measures like audits," said Amy Dunbar, director of governmental affairs for the National Association of Bond Lawyers.
Most lawyers warned that the guidance effectively requires IRS scrutiny of all bond issues by a would-be 501(c)(3) group.
"They're trying to provide a preclearance for all bonds of organizations seeking exemption," said Mr. Loafman. "I don't think they understand how many issues there are" or "how much grief their information requirements will put innocent people through," he said.
"They're forcing you to get a ruling," said Mr. Greenwalt.
Most of the lawyers said they understood that abuses have occurred and they need to be curbed, but the IRS is going beyond trying to curb abuse by issuing guidance that will adversely affect legitimate transactions.
"I'm very troubled. I believe it's such an overkill," said John Orr, with Fulbright & Jaworski in Texas, "Having to pre-approve everthing is sort of based on the assumption that everybody doing one of these deals is doing it incorrectly until provel otherwise," he said. "It's going to mean a significant use of resources both on the public side, for IRS, and the private side when it could be addressed differently."
"My concenr," said an East Coast lawyer who did not want to be identified, "is that we're going to see a lot of legitimate deals delayed or significantly delayed to the point where they may be killed."
But some lawyers were not as upset. "People should never overreact when the IRS is going about its normal business of providing guidance to its agents in the field. This should not be interpreted as signaling an attack on 501(c)(3) financings," said C. Willis Ritter, a partner with the local office of Arter Hadden Haynes & Miller.
"I frankly believe that we will need a few months working under this retime to determine if it will have a material impact on the ability to do a financing," said Fredric Weber, a lawyer with Fulbright & Jaworski and president of the National Association of Bond Lawyers.
Stressing that these were his person views, Mr. Weber said the guidance goes too far but that the IRS, in its practices, may prove to be more flexible. IRS officials, he said, have told lawyers in his firm that they will be able to review a bond transcript in two weeks.
Another lawyer in the Southeast, however, laughed at that idea. He said IRS officials told him that a request he submitted last February to obtain 501(c)(3) status for an organization, which did not even involve bond plans, will not be reviewed until November.