Alert: Post-Issuance Compliance by 501(c)(3) Borrowers of Tax-Exempt Bond Proceeds

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March 7, 2012

Following the issuance of tax-exempt qualified 501(c)(3) bonds, a 501(c)(3) organization that is the borrower of such bond proceeds must continue to take certain actions with respect to the bonds in order to retain its tax-exempt status. In particular, the borrower must ensure that the project financed with the bonds continues to be used for its charitable purposes, and also that the proceeds of the bonds are applied in a manner that complies with the arbitrage rules of the Internal Revenue Code of 1986, as amended ("the Code"), and its related regulations. Over the last couple of years, the IRS has increased its scrutiny of tax-exempt qualified 501(c)(3) bonds and has strongly expressed an expectation that 501(c)(3) borrowers of tax-exempt bond proceeds have written procedures in place to ensure compliance with these rules.

Revisions to Form 8038
In 2011, the IRS released a new Form 8038, which is the form that issuers file with the IRS upon the issuance of each tax-exempt qualified 501(c)(3) bond issue. The new version of the form specifically asks the issuer to check a box stating that it has established written procedures "to ensure that all nonqualified bonds of this issue are remediated according to the requirements under the Code and Regulations." There also is a second box asking if the issuer has written procedures "to monitor the requirements of Section 148," which is the Code section governing arbitrage. As a result, many issuers now are requiring that a 501(c)(3) borrower have such written procedures in place prior to closing on the bonds in order that the issuer may affirmatively answer these questions on the Form 8038.

Revisions to Schedule K
The IRS also has revised Schedule K to the 2011 Form 990, which is the annual information return filed by tax-exempt organizations with gross receipts over $200,000 and/or total assets over $500,000. Schedule K must be filed with respect to any tax-exempt bond issued after December 31, 2002 (including refunding bonds) with an outstanding principal amount of more than $100,000 as of the last day of the organization’s tax year. Part III, Line 7 of Schedule K asks if the organization has “adopted management practices and procedures to ensure the post-issuance compliance of its tax-exempt bond liabilities.” Additionally, a new Part V of Schedule K asks if the organization “has established written procedures to ensure that violations of federal tax requirements are timely identified and corrected through the voluntary closing agreement program if self-remediation is not available under applicable regulations.”

What Does This Mean for Your Organization?
There is no statutory or rule requirement that a 501(c)(3) organization have such written procedures.  However, by including these questions on Form 8038 and Schedule K of Form 990,  the IRS is strongly emphasizing its view on the importance of having such procedures in place. The IRS has also informally indicated that having such procedures in place may result in a lower penalty in the event of any audit or voluntary compliance agreement related to a 501(c)(3) organization's bonds. As such, the Briggs and Morgan Nonprofit Practice Group is strongly recommending that any 501(c)(3) organization that has outstanding tax-exempt bonds or that is contemplating borrowing tax-exempt bond proceeds, adopt written post-issuance compliance policies and procedures.

Our group is knowledgeable about and experienced with the concerns and expectations expressed by the IRS regarding what should be included in such written post-issuance compliance policies and procedures, and we can assist in the preparation of these documents. We recognize that organizations, along with their advisors, are already doing many of the tasks that would be set forth in an actual written document. The written procedures will simply demonstrate that your organization is, in fact, taking the appropriate actions to ensure that your bonds remain tax-exempt.

Please feel free to contact our Nonprofit Practice Group if you have any further questions or if you would like assistance in the preparation of post-issuance compliance policies and procedures.