WASHINGTON – For the second time in two months, the Internal Revenue Service has closed an audit of bonds used to finance the development of a jail facility after the bonds were converted to taxable.

The latest case involves $62.3 million in revenue bonds sold in 2007 by Otero County, N. M. to finance the development of a processing and detention facility in Chaparral, N.M.

The Otero County facility, located north of El Paso, Texas, is operated under a private management contract by Management and Training Corporation, which is based in Centerville, Utah.

The Internal Revenue Service has added two new deadlines for bond issuers to file claims for overpayment of arbitrage rebates.
The Internal Revenue Service has added two new deadlines for bond issuers to file claims for overpayment of arbitrage rebates.

The county authorized the project as an addition to a detention facility that served the U.S. Marshals Service's New Mexico District. The addition is used as a processing center for the U.S. Immigration and Customs Enforcement agency.

The IRS in recent years has been conducting audits of bonds issued across the nation for jail facilities that house inmates for the U.S. Marshals Service or ICE under contracts. Under the tax code the federal government is considered to be a private party.

It's a classic case of one arm of the federal government doing something that runs completely counter to the laws and rules governing another arm of the federal government. USMS and ICE officials have signed contracts with jail facilities all over the country, particularly in the Southwest, to house their detainees in state and local bond-financed correctional facilities, leading to tax disputes between the bond issuers and the IRS.

The tax code classifies a bond as a private activity bond if more than 10% of the proceeds are used for a private party and more than 10% of debt service payments are made or secured by private parties. PABs are tax exempt only if they fall into one of several categories, none of which include jails or correctional facilities.

Otero County officials did not respond to requests for information.

Allison McClain, a spokesperson for Nixon Peabody, the tax controversy counsel, said in an email Thursday "our attorneys cannot comment at this time.''

Bond counsel for the 2007 transaction was Brownstein Hyatt Farber Schreck of Albuquerque, N. M. The underwriters were Herbert J. Sims & Co. and Municipal Capital Markets Group, Inc.

Janet White of the Otero County Board of County Commissioners signed a notice published Wednesday in the Municipal Rulemaking Securities Board’s EMMA database that the remaining $44.28 million in bonds were converted to taxable on Aug. 1.

Otero County posted a notice last December announcing the IRS had begun an audit and had taken the position that the bonds should not be tax exempt. The county said it was cooperating with the IRS and considering refinancing the bonds.

In June the county announced the IRS issued a proposed adverse determination that the interest paid on the bonds was not exempt from income taxes.

But an Aug. 4 letter from the IRS Tax Exempt Bonds Field Operations Officer in Houston confirmed that the audit has been closed as a result of the bond conversion.

That’s becoming an increasing practice by the IRS when voluntary conversions are made and there’s no evidence of an abusive transaction.

The former director of the IRS tax exempt bond office, Rebecca Harrigal, recommended this practice in an Oct. 18, 2016 memo to employees prior to leaving the IRS for a job at the law firm Greenberg Traurig.

Last month the $36.3 million in outstanding first mortgage revenue bonds that were part of the $45 million sold in 2008 for Baker Correctional Development Corp. in Florida were converted to taxable.

The IRS advised Baker Correctional Development Corp. that its bonds were taxable because about 350 of its 480 inmates were federal. The federal government is considered to be a private party under the federal tax code, unlike state and local governments which are categorized as governments.

In the case of Baker Correctional, the bonds failed to meet the private use and payment tests for PABs because of the large federal inmate population, according to Jeffrey Cox, finance director for the county sheriff’s office. However, the IRS closed its audit after the bonds were converted to taxable.

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