WASHINGTON -- The Internal Revenue Service's controversial proposed redefinition of a political subdivision "would diminish the ability to issue future tax-exempt bonds" and weaken our country's infrastructure, a local finance group told tax regulators.

The Government Finance Officers Association urged the IRS and the Treasury Department to withdraw the proposed rule on political subdivisions that can issue tax-exempt bonds in a recent letter. The agencies proposed the rule in February 2016.

The proposed rule would “add extensive and additional federal requirements on top of the existing state power requirement,’’ GFOA said.

The controversial proposal has drawn a broad swathe of criticism from governmental groups and municipal bond industry organizations that have asked it to be withdrawn or substantially revised.

Under longstanding federal case law and rules, an entity is a political subdivision that’s able to issue tax-exempt bonds if it has at least two out of three sovereign powers – taxation, eminent domain or policing.

But the IRS became concerned about the rules because some community development districts in Florida that were political subdivisions and issued bonds were controlled by developers.

The IRS Office of Chief Counsel first proposed changing the definition of political subdivision in a technical advice memorandum in 2013 in connection with an examination of bonds issued in Florida by two community development districts that are part of The Villages development. But muni groups, particularly lawyers, protested and said the TAM was improperly trying to change the requirements through an enforcement case rather though rulemaking allowing for public comment.

The IRS subsequently proposed a rule adding the requirements that a political subdivision be governmentally controlled and serve a governmental purpose “with no more than incidental private benefit.’’

Many of GFOA’s 18,000 members are finance officers for governments and other political subdivisions that issue tax-exempt bonds.

“Together, special districts, agencies, and authorities in the U.S. encompass a wide variety of purposes such as economic development, public transportation, airports, corrections, highways, housing, roads, schools, water, sewer, parking and ports,'' said the letter, which was signed by Emily Brock, GFOA’s Federal Liaison Center director.

Emily Brock, director of GFOA's Federal Liaison Center
Emily Brock, director of GFOA's Federal Liaison Center

The GFOA letter pointed out that there were 38,572 special districts counted in the 2012 U.S. Census of Governments and that many of them “are intentionally designed to reach across multiple jurisdictions in order to create service delivery efficencies directly to citizens.’’

Special districts and state and local authorities issued $171 billion in bonds last year, a “substantial portion’’ of the $409 billion in total bonds issued during the year, the letter continued, citing statistics compiled by Thompson Reuters.

GFOA said it also is concerned that existing tax-exempt bonds also could be hurt if the new definition became law.

“This would adversely impact investors of those securities and may cause the political subdivisions to [have to take] remedial action that would be costly to the communities they serve and subject outstanding bonds to a taxable status after the proposed transition period expires,’’ said the letter.

The proposed rule was one of eight Treasury targeted as potentially creating undue financial burdens or complexity under an executive order by President Trump. Treasury Secretary Steve Mnuchin has until Sept. 18 to recommend “specific actions to mitigate the burden imposed by the regulations.’

Brock, who signed the GFOA letter, said in an email Friday that her organization hasn't gotten a response yet from the IRS or Treasury. "Because there was such resounding support of the proposed regulation’s withdrawal, both in 2016 and as a result of the executive order’s findings, it is our hope that Secretary Mnuchin might expedite his decision,'' she said.

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