WASHINGTON - The Federal Home Loan Bank of Chicago has asked top Treasury and InternalRevenue Service tax officials to put a halt to their practice of imposing what, ineffect, are monetary penalties on issuers of tax-exempt industrial revenue bonds thatare secured by standby letters of credit provided by federal home loan banks that theIRS has ruled constitute an illegal federal guarantee.
In a Nov. 13 letter sent to seven top officials, Eldridge Edgecombe, senior vicepresident of community investment for the Federal Home Loan Bank of Chicago, asked theIRS to stop its current practice of collecting payments from the issuers of such bondsuntil the practice is considered "by high levels" in the IRS and Treasury. In themeantime, he asked the IRS to cooperate with the issuers and conduit borrowers of thebonds.
Edgecombe added that to his knowledge, none of the 12 Federal Home Loan Banks has issueda letter of credit securing a tax-exempt non-housing bond since March 28, 2002, whentheir tax status became questionable.
The letter was sent about a week after the IRS opened four to five investigations intotransactions where tax-exempt bonds were backed by the standby letters of credit,according to Mark Scott, IRS director of tax-exempt bonds. "I think we have beenexceedingly cooperative and careful in these situations," Scott said this week inresponse to the letter's claims.
However, the Federal Home Loan Bank of Chicago sent the letter in response to the IRS'request this spring that issuers of the bonds voluntarily approach the agency to enterinto settlements based on a percentage of taxpayer exposure, according to a Federal HomeLoan Bank of Chicago spokesman.
The IRS is close to reaching settlements with a dozen issuers of the transactionsthrough the voluntary compliance agreement program, Scott said. The issuers have beenrequired to make a payment based on a formula in which a 29% tax is imposed on theinterest earned, with 30% of that amount then owed to the IRS during time letter ofcredit was outstanding, he said.
The payments ultimately impact the borrowers, said Edgecome in a statement yesterday."Obviously, requiring bond issuers to pay substantial penalties to resolve this issuewould disadvantage the low- and moderate-income individuals whom these bonds aredesigned to benefit," Edgecombe said. "All parties entered into these transactions ingood faith and in compliance with the law. All bonds issues received a clean opinionfrom bond counsel. We believe a settlement should reflect these facts."
Scott countered that the payment amounts are small and described them as "less than thecosts of a typical closing dinner."
The regional Federal Home Loan Banks are federally chartered but are owned by theirmembers, which are mostly commercial banks and savings and loan institutions. Some haveextended their practice of providing standby letters of credit that are used to backhousing bonds to other types of economic development bonds. All of the non-housing bondsbacked by the Federal Home Loan Bank of Chicago were designed to help low-incomecommunity development, according to the spokesman.
Last year, Scott's office determined that the issues backed by standby letters of creditprovided by the banks constitute an illegal federal guarantee. Under the tax code, anon-housing bond issue that carries a federal guarantee cannot also qualify for tax-exempt status.
The Federal Home Loan Banks have complained that the IRS has not issued guidance on thefederal guarantee rule since it was enacted by Congress in 1982. In 2002, the 12 banksasked the IRS for a private-letter ruling to address the standby letter of credit issue.However, they withdrew the request after the chief counsel's office appeared to be onthe verge of issuing an adverse ruling.
The Federal Home Loan Bank of Chicago has backed tax-exempt non-housing bonds totaling$62 million that the IRS has deemed to be taxable, said its spokesman.
Earlier this year, the IRS reached a settlement with the Illinois Development FinanceAuthority to close an audit that found that interest on $5.3 million of tax-exemptindustrial revenue bonds sold on behalf of Coburn Steel Products Inc. in 2000 wastaxable because of the deal's use of a standby letter of credit from the Federal HomeLoan Bank of Chicago. Under the settlement agreement, IDFA converted the bonds to ataxable investment and made a payment based on the same formula as the issuers who wentthrough the VCAP program.
It is the only issuer that has reached a settlement with the IRS through an audit. TheIRS closed another audit into a similar transaction earlier this year without penalty,Scott said.
Yesterday Scott encouraged other issuers of the bonds to voluntarily approach the IRSrather than wait to be audited. However, he said their settlement payments would beslightly higher. "People who choose to play `audit lottery' should know there is apotential for follow-up," Scott said. "We're going to do whatever we can to identifypeople that do not come in voluntarily."
The Federal Home Loan Bank of Chicago has not received a response from any of theletter's recipients, according to a spokesman.
In addition to Scott, the letter was distributed to IRS chief commissioner Mark Everson,Treasury assistant secretary for tax policy Pamela Olsen, IRS acting chief counsel anddeputy chief counsel for operations Emily Parker, IRS assistant commissioner for the taxexempt and government entities operating division Evelyn Petschek, IRS assistant chiefcounsel Sarah Hall Ingram, and IRS office of the district counsel-associate chiefcounsel Rebecca Harrigal.
