Protecting the tax-exempt status of bonds

A tax-exempt not-for-profit organization needs to have processes in place to monitor its activities to ensure that the tax-exempt status of the organization's tax-exempt bonds is not lost. Typically, there is a great deal of effort and analysis done at the time tax-exempt bonds are issued. The bond attorneys make sure that the proceeds of the issue are going to be used for a tax-exempt purpose and plan around any private use of any facilities that may be financed with the tax-exempt bonds. However, once the construction project is completed, many organizations do not implement procedures to monitor the private use on an ongoing basis because, at least initially, the building is being used for the purpose for which it was built.

Over time, the use of such facilities may change, tax-exempt bonds may be refinanced, and staff may change diluting the memory as to the original use of the tax-exempt bonds. The governing board needs to provide oversight in this area to ensure the private use of facilities constructed with tax-exempt bonds does not exceed the allowable threshold. The greatest risk is that the bonds lose their tax-exempt status, causing the interest to become taxable to the bondholders. This can result in litigation, reputational risk, loss of key personnel and displacement of board members by the Attorney General.

What areas should be addressed to ensure compliance with private use rules?

To ensure compliance with the private use rules, the governing board and/or management should focus on the following areas:

Written procedures and guidelines

Are written procedures or guidelines maintained to ensure that bond financings remain in compliance with the following federal tax requirements after the bonds are issued:

  • Proper and timely use of bond proceeds?
  • Proper use of bond-financed property?
  • Arbitrage yield restriction and rebate?
  • Timely filing of tax returns and other general requirements?
Oversight of the process
  • Has a person (or persons) been identified who has primary responsibility for monitoring post-issuance compliance?
  • If several people are responsible, are there written guidelines to designate responsibility?
  • Is training provided to the responsible individual(s)?
Recordkeeping
  • Are the bond documents and analysis of the allocation of the original proceeds readily accessible?
  • Is documentation maintained for allocations of investments and investment earnings to the bond financings?
  • Are procedures in place to monitor instances where subsequent investments with respect to yield restricted accounts are required?
  • Is documentation maintained for allocations of bond-financing proceeds to expenditures?
  • Are the records updated on a regular basis?
Private Use
  • Are records maintained for all unrelated trade or business activities allocated to the bond-financed facilities?
  • Are records maintained for trade or business activities by third parties that are allocated to the bond-financed facilities?
  • Are service agreements, naming rights contracts, research contracts or other arrangements that are entered into with respect to the bond-financed property reviewed?

What should you do now?

Losing the tax-exempt status of your organization’s tax-exempt bonds can have significant repercussions. It is important that you review your policies and procedures to ensure compliance with the private use rules.