The Internal Revenue Service is auditing $63.2 million of Build America Bonds that a school district in Finney County, Kan., issued in mid-2009 to finance a new high school and an addition to an elementary school, according to the district’s chief financial officer.
The IRS notified Unified School District 457 of the audit in a Sept. 29 letter, stating, “We have no reason to believe that your debt issuance fails to comply with any of the applicable tax requirements.”
Meanwhile, Sioux Falls, S.D., disclosed in a material event notice filed with the Municipal Securities Rulemaking Board’s online EMMA system Tuesday that the IRS notified it that it has completed an audit of more than $55 million of health facilities revenue and refunding bonds issued in 2002 and 2006 without proposing any changes to the bonds’ tax-exempt status.
USD 457 did not disclose its audit through EMMA. The Garden City Telegram wrote about the audit after the USD 457 Board of Education met Monday night and decided to hire Ballard Spahr to represent it before the IRS.
Under the Securities and Exchange Commission’s existing Rule 15c2-12, as well as amendments scheduled to take effect on Dec. 1, issuers need only disclose the inception of an IRS audit if it is materially important.
At the meeting on Monday, USD 457 superintendent Rick Atha said, “We were randomly selected for the audit,” according to the paper. He said the district needed to hire a lawyer because, “When the IRS is involved, we need to be represented. As I understand it, the IRS just wants to verify we have spent the money in the way in which we said we would.”
Atha could not be reached for comment on Wednesday. Frederic Ballard, a partner at the firm, declined to comment other than to confirm Ballard Spahr has been hired by the school district.
But Kathleen Whitley, USD 457’s chief financial officer, said the school district hired Ballard Spahr to help it respond to the IRS at the recommendation of its bond counsel, Winton Hinkle at Hinkle Elkouri Law Firm LLC in Wichita, Kan.
In a letter to Whitley, Ballard agreed to charge the school district a discounted rate of $725 an hour and said he would not expect the costs to exceed $10,000.
The audit appears to be similar to other BAB audits the IRS is currently conducting. Clifford Gannett, director of the IRS’ tax-exempt bond office, said last month that the agency had 15 to 20 BAB audits underway.
In such audits, the IRS typically sends issuers four pages asking for bond documents and information including bond purchasers and prices. The IRS wants to know if any of the bonds were purchased in the primary or secondary market by or on behalf of the issuer or an affiliated entity, such as a pension plan.
The agency also has been concerned about the validity of the issue prices of BABs and whether issuers are complying with a tax law provision that prohibits them from being sold with more than a de minimis amount of premium.
Under current tax rules, the issue price is the first price at which a substantial amount of bonds are sold to the public. The rules suggest 10% is a substantial amount. Underwriters typically certify the issue price or initial offering price of the bonds.
But IRS officials are concerned that BABs are “trading up” after issuance, raising questions about whether the initial offering price was valid and whether the federal government is making the lowest subsidy payments possible to the issuer. BAB subsidy payments are equal to 35% of the interest costs. The higher the BAB price, the lower the yield. Lower interest rates would mean the IRS could make lower subsidy payments.
While bond documents show that $38.04 million of USD 457’s 25-year BABs were sold at 100, or par, during the underwriting period, EMMA trade reports show that 175,000 of the bonds were first sold to customers on a “when issued” basis at a premium of 104.6. Underwriter Piper Jaffray & Co. did not return calls for comment. But sources pointed out this was one of the first BAB deals, the issuer was small, and the bonds had a 10-year call provision.