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IRS and SEC Bond Initiatives Aimed at Tax-Exempt Hospitals and Other 501(c)(3) Organizations

11.20.12

The IRS plans to begin recurring market segment examination of tax-exempt bonds, including the hospital market, according to statements made by Bob Griffo, Supervisory Tax Law Specialist with the Internal Revenue Service (IRS), at a recent National Association of Bond Lawyers conference. For the first year of the program, the IRS plans to examine between 20 to 40 tax-exempt hospitals. In addition, another 100 section 501(c)(3) organizations outside of the hospital industry will be chosen at random for examination. This announcement follows on the heels of increases in the number of examinations conducted by the IRS’s Tax-Exempt Bond Division (TEB) and an increase in municipal bond disclosure from the Securities and Exchange Commission (SEC).

IRS Examinations

Since 2005, the TEB office more than doubled the examinations performed each year and found significant non-compliance in excess of 30% of the issues examined. Assessments ranged from an average of approximately $873,000 in 2006 to in excess of $359,000 in 2010. While the increases in the number of audits performed is sufficient to increase anxiety, the IRS also has launched new initiatives designed to encourage borrowers to self-report violations by essentially requiring issuers to adopt policies and procedures to self-monitor compliance with the tax-exempt bond rules and to self-report if any violations are found. To accomplish the self-policing of the borrowers, the IRS started the practice of sending out questionnaires to a large body of issuers and asking whether the issuers have adopted policies and procedures to ensure compliance with the tax-exempt bond rules. If an issuer answers that it has failed to adopt a set of policies and procedures or fails to produce evidence that clearly demonstrates that it has taken steps to monitor compliance with the tax-exempt bond rules, the IRS has stated that under either of those circumstances, it will use such failure as justification for a full audit.

SEC Disclosure

The increased scrutiny by the IRS in the tax-exempt bond arena is matched by the SEC’s increased drive to bring additional and more timely disclosure in the municipal bond arena. In its Report on the Municipal Securities Market released on July 31, 2012, the SEC unanimously recommended changes in legislation, government and self-regulatory regulations and industry practices to encourage greater and more timely disclosure. The SEC has also launched initiatives to bring greater transparency in the market activity. Taken as a whole, the proposals are designed to drive change through the municipal marketplace and will result in significantly higher cost of compliance for all issuers. 

Take Away

The initiatives brought by the IRS and the SEC are likely to present increased concern for tax-exempt and governmental hospitals with bond financing this year and well into 2013 and beyond. Such organizations are well advised to review their procedures for compliance, with a particular focus on private use and arbitrage. Any issuer of tax-exempt bonds would be well served to adopt policies and procedures to monitor compliance with the bond rules and to go further by being able to demonstrate through documentation or other extrinsic evidence of the steps taken to monitor compliance.

If you have any questions on establishing appropriate procedures or monitoring compliance in this area, please contact Alex Buchanan or Don Stuart at 800-487-6380.