WASHINGTON - The Internal Revenue Service has established a standardized voluntary closing agreement program for issuers whose 501(c)(3) bonds benefited organizations that had their tax-exempt statuses prospectively reinstated after being revoked due to the failure to file returns for three consecutive years.
The IRS announced the VCAP in Announcement 2015-2, which will appear in the Internal Revenue Bulletin dated Jan. 19. The announcement provides a simplified process for issuers to request settlements for this type of tax-law violation and a closing agreement form that issuers can use.
In order to settle tax issues under the VCAP and preserve the tax-exempt status of their bonds, issuers will have to fill out the form and pay a penalty. The settlement amount for each bond issue covered in an agreement will be equal to $500 for each month or partial month in the period beginning with the month that includes the revocation date and ending with the month that includes the effective date of reinstatement, the IRS said.
501(c)(3) bonds are used to finance projects for nonprofits such as hospitals and universities. They are generally issued by conduit issuers who loan the proceeds to 501(c)(3) organizations.
Under federal tax law, 501(c)(3) bonds can become taxable if the organization that they were issued for loses its 501(c)(3) status at any point while the bonds are outstanding. This is because all property financed with the proceeds of 501(c)(3) bonds have to owned by a 501(c)(3) organization or a state or local government, and property financed with 501(c)(3) bond proceeds have to be used almost exclusively by 501(c)(3) organizations and state and local governments.
Organizations' 501(c)(3) statuses are automatically revoked if they fail to file an annual return or notice for three consecutive years. The revocations are effective on the date for filing the third annual return or notice.
Organizations can seek reinstatement of their 501(c)(3) status following revocation. In some cases, the IRS will reinstate the organization's tax-exempt status retroactively to the revocation date. However, sometimes, the IRS will reinstate the organization's 501(c)(3) status prospectively, or with an effective date that is later than the revocation date. This leaves the organization with a period of time when it was not a 501(c)(3) organization.
Issuers of 501(c)(3) bonds can apply for a settlement under the VCAP if they meet certain criteria, the IRS said. The organization that is the beneficiary of the bonds has to have had its 501(c)(3) status prospectively reinstated, and the IRS can't be auditing the bonds. The organization can only have had its tax-exempt status revoked and reinstated once since the bonds were issued, or in the case of refunding bonds, since the bonds that were refunded were issued. The VCAP request has to be submitted within 12 months of the date of the reinstatement letter, or within 12 months of Dec. 30, 2014 if the reinstatement letter was dated before that date.
If one organization's revocation and prospective reinstatement affected more than one of an issuer's bond issues, the issuer can submit one closing agreement that covers all of the affected bond issues. If an issuer has problems with its bonds because more than one conduit borrower of its bond proceeds had its tax-exempt status revoked and prospectively reinstated, the issuer has to submit a separate closing agreement for each organization.
Issuers will have to send IRS three copies of their closing agreements as well as the reinstatement letter. They will also have to pay the necessary settlement amount, the IRS said.
Bond lawyers said that the VCAP will be helpful for nonprofits that had their 501(c)(3) status revoked.
"This procedure is very straightforward and could involve, little, if any, need for legal assistance, which will be particularly beneficial for the smaller, single purpose 501(c)(3) organizations," said Linda Schakel, a partner at Ballard Spahr in Washington.
The director of the IRS' tax-exempt bonds office, Rebecca Harrigal, has made standardizing the settlement process one of her priorities. Matthias Edrich, a shareholder at Greenberg Traurig, said that the new program furthers the goal of "making compliance more efficient."
Bond lawyers said they found the settlement amount under the VCAP to be reasonable.
"The amount is larger the longer the lapse but is never that much," said Chas Cardall, a partner at Orrick, Herrington and Sutcliffe in San Francisco.
Tom Vander Molen, a partner at Dorsey and Whitney in Minneapolis, said that a few items in the closing agreement form were notable.
Both the issuer and the nonprofit have to sign the closing agreement, which Vander Molen said "makes sense." Also, in the agreement, the IRS said it has "a basis to conclude" that the bonds are taxable, which is preferable to the IRS saying that the bonds were taxable, as the IRS has said in other closing agreements, he said.
But there was one part of the closing agreement form that Vander Molen found to be "troubling." The issuer and the nonprofit have to represent that they are aware of no reason besides the revocation of 501(c)(3) status that the bonds could be taxable. This representation is not currently standard and could require the issuer or the borrower to disclose something that they do not think is problematic but that the IRS might have an issue with, he said.
