Wanted: A Method to the Motive

The motive is excellent, but the method is flawed.

The Internal Revenue Service's new move to try preventing private firms from setting up shell 501(c)(3) organizations so they can issue tax-exempt debt to finance what are really private, profit-making health-care facilities is a major step in the right direction.

But the procedures the IRS has outlined to prevent abusive tax-exempt deals appear to be so cumbersome and time consuming that they may needlessly delay or deter legitimate deals.

Under guidance issued by the IRS recently, field agents have been told they should scrutinize any organization seeking 501(c)(3) status that is planning to issue tax-exempt health-care bonds. They have been urged to make sure the nonprofit group will be operated for public rather than private purposes and that bonds issued on its behalf qualify for tax exemption. And the IRS has said it will withhold 501(c)(3) status from such groups until agents have reviewed their bond financing plans.

That's generally a good move that should be supported by every responsible member of the municipal bond community because it will go a long way toward deterring more abusive deals similar to the widely publicized ones in Iowa and Missouri in which developers set up 501(c)(3) organizations to issue tax-exempt bonds to finance the purchase of their troubled nursing homes at grossly inflated prices.

But bond lawyers raised an excellent point last week when they charged that the IRS may be engaging in "overkill" by asking agents to collect what could add up to boxes and boxes of documents on the organization seeking nonprofit status, the people behind it, and the proposed bond financing.

What the IRS appears to have come up with is a laundry list of items that is far more expansive than the items it would look at in a routine audit of a bond issue. Not only is it looking for far more information than it needs, but it doesn't have enough personnel to sift through all the documents it is requesting without creating even greater delays than now are common for applicants seeking 501(c)(3) status.

What the agency really needs to do is narrow the focus of its investigation to zero in on key documents that usually show whether a bond financing is legitimate. Those items include feasibility studies; property appraisals; management of the proposed nonprofit group and its relationship to the developer of the facility; and, most importantly, whether the bond financing involves the acquisition of an existing and financially troubled facility -- the area where most abuses have occurred.

If the IRS can review 501(c)(3) applicants quickly enough so it does not inhibit legitimate bond deals, yet prevents abuses, the municipal market will be much better off.

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