WASHINGTON -- An organization seeking 501(c)(3) status that is planning to issue health-care bond should be scrutinized to ensure that the nonprofit group will be operated for public rather than private purposes and that bonds issued on its behalf will qualify for tax exemption, the Internal Revenue Service has told its field agents in a recently published guidance.
Agents also were told to carefully investigate the health-care bond programs of existing 501(c)(3) organizations that are under audit.
Entitled "Tax-Exempt Bond Financing," the guidance appears in the IRS's Exempt Organizations Continuing Professional Education Technical Instruction Program for Fiscal 1992--a training document that was sent to field agents this week and made available to lawyers and other private practitioners.
IRS officials said yesterday that the article is an attempt to put in writing for the first time the policies and procedures that agent are to follow when an organization planning to issue health-care bonds is seeking 501(c)(3) status or has achieved such status and issued bonds but is under audit.
"We're going through what we think is the state of the law with regard to 501(c)(3) tax-exempt bonds. And we're also stating procedurally how we'll process 501(c)(3) status applications or examinations in which tax-exempt bonds are a factor," an agency official said.
The article is divided into five parts. The first provides background on the concerns about health-care financings. The second gives a hypothetical example of a bad bond deal. The third uses a question and answer format to detail the policies and procedures. It also recommends the language that should be used when letters granting 501(c)(3) status to organizations must be qualified. The last two provide existing technical rules and notices.
According to the article, the "general policy" of the IRS regarding an organization that is seeking 501(c)(3) nonprofit tax-exempt status and that is planning to issue health-care bonds, is to not grant such status until the bond financing plans are reviewed.
In such reviews, applicants should describe their bond financing plans and make bond documents available to the IRS, the article said.
If an applicant with plans to issue bonds "cannot describe its bond program" or "can [not] or will not produce bond documents," a "denial" of 501(c)(3) status is "appropriate" because the applicant has failed to establish its exempt status, the article said.
In some cases, the applicant may need 501(c)(3) status for reasons unrelated to the financing, the article said. In these situations, the IRS may issue a letter granting 501(c)(3) status on a qualified basis, with the following caveat: "...you have indicated that you plan to finance your activities with tax-exempt bonds in the near future. You have agreed to request a ruling as to the effect of bond financing on your exempt status" from the IRS "in a reasonable time prior to the bond issuance date."
In other cases, the applicant may not be planning to issue bonds now, but would like to do so in the future. The IRS would then likely issue a letter granting 501(c)(3) status with a caveat that reads, in part, "In the future, if you plan to finance your activities with tax-exempt bonds, you may request a ruling as to the effect of bond financing on your exempt status" from the IRS. It would also say that "the bond issuing authorities should be aware that this exemption was recognized without consideration of the effect of bond financing."
This language, the article said, should "alert the organization of its responsibility to request a ruling" on its 501(c)(3) status before the financing occurs.
"All bond cases should be screened initially to determine how close the organization is to the bond issuance date," the article says.
Some bond transactions may receive "expeditious treatment" based on the applicant's responses to more than 22 questions and requests for information in a "general information letter" of three and a half pages. This letter, to be sent to the applicant, will ask for numerous bond documents as well as the resumes of the applicant's directors and officers, organizational charts, details of how bond firms were chosen for the financing, detailed information about the facilities to be financed, and other data.
The authors, Debra Kawecki and Marvin Friedlander, suggested in the guidance that these policies and procedures were necessary because of the high default rate of bonds issued on behalf of 501(c)(3) organizations. During the 1980s, they said, more than $5 billion of private-activity bonds were issued for 501(c)(3) organizations. Of these, more than $1 billion are now in default according to the National Association of Attorneys General, they said.
Although the IRS is not required to rule on the tax-exempt status of these bonds before they are issued, "one effective means of controlling the situation is by controlling access to the bond market," the two IRS officials said. The IRS can block the issuance of 501(c)(3) bonds by issuing a letter refusing to grant 501(c)(3) status to the organization that would have benefited from the bonds. "It is just that simple: no letter -- no bonds," they said.
The article acknowledged that "not all bond financing is bad and not all bond cases need to be subject to endless scrutiny. But the authors said, "If we determine that the public interest is being served and that no private party, such as a developer or management company, can control the operations of the organization, there will be more assurance to the public and to the tax revenue that the bonds are being used for purposes" that are appropriate under the tax law and "the risk of default should be reduced."