IRS begins second audit of federally subsidized Puerto Rico bonds

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WASHINGTON — The Internal Revenue Service has begun auditing a second issuer of direct-pay bonds in Puerto Rico less than a month after the start of the first examination.

The federal tax issue that is at stake in both audits involve the federal payments for the direct-pay subsidy. One involves Build America Bonds and the other involves qualified zone academy bonds. Both programs were authorized under the 2009 American Recovery and Reinvestment Act enacted during the Obama administration.

The Puerto Rico Electric Power Authority filed a public event notice Thursday that the Internal Revenue Service is auditing the Form 3038-CP it filed in connection with its Series YY Build America Bonds.

Six days earlier the Puerto Rico Fiscal Agency and Financial Advisory Authority also filed an event notice about an IRS audit on the Municipal Securities Rulemaking Board's EMMA website on behalf of the Public Buildings Authority.

The Puerto Rico Public Buildings Authority audit includes $121.5 million in Series 2011 T direct-pay qualified zone academy bonds and four Series 2011 R taxable of school construction bonds that totaled $756.4 million.

The newer audit of PREPA involves $320.2 million in 30-year BABs issued in April 2010 with a coupon rate of 6.125%.

Both PREPA and the building authority are in default as the territory undergoes its historic debt restructuring. PREPA is attempting to negotiate new terms on more than $8 billion of bonds.

BABs receive a 35% federal subsidy on their interest payments, although that subsidy is subject to a federal budget sequestration reduction which varies each year. In the current 2019 federal fiscal year the cut is 6.2% of the 35% subsidy. That shaves 2.17 percentage points off the subsidy, reducing it to 32.83%.

Kristin Franceschi, an attorney for PREPA who is a partner at DLA Piper, also represents the Puerto Rico Public Buildings Authority.

She repeated the statement she issued a week ago about the earlier audit. “The audits have just begun,” Franceschi said. “At this juncture, it is too early in the process to make any comments.”

Asked whether there’s any connection between the two audits, both of which involve IRS Forms 8038-CP, Franceschi said, “At this point, it would be speculation to say this audit is tied to the recently announced PBA audits but, on the face of it, there is a certain commonality.”

“PREPA intends to respond to all correspondence from the IRS and intends to continue to cooperate with the IRS in connection with the examinations,” the new event notice said. “PREPA has not undertaken to provide any further information regarding these examinations except to the extent that it may be obligated to give notice of any future adverse tax opinions or other events affecting the tax-exempt status of the Series YY Bonds in accordance with the applicable continuing disclosure agreement.”

Neither of the Puerto Rico audits involve the IRS audit priorities for the current fiscal year.

The IRS has said its auditors plan to focus on excessive cost of issuance for private activity bonds, defeasance, and public safety or jail bonds.

The IRS expects to close 500 audits in its Tax Exempt Bonds office in the current fiscal year, up slightly from 480 in the 2018 fiscal year that ended Sept. 30.

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Direct-pay bonds Government finance Government payments Build America Bonds IRS Puerto Rico Public Buildings Authority Puerto Rico Electric Power Authority Washington DC Puerto Rico