Issuer in Texas Settles With IRS Over Jail Bonds

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WASHINGTON — The Fannin County Public Facility Corp. in Texas has settled tax law violations with the Internal Revenue Service by agreeing to pay $1.75 million and redeem all of the outstanding bonds from the $30.78 million it issued in 2008 to finance a jail.

The settlement, which may represent a template for other jail bonds with tax issues, was disclosed in an event notice posted on the Municipal Securities Rulemaking Board's EMMA system on Wednesday.
The nonprofit, public corporation issued $31.39 million of taxable refunding bonds to redeem the $28.61 million that were outstanding and to pay the IRS. The refunding deal closed Wednesday.

The event notice does not specify the tax law violations.

However, the IRS has had concerns about the tax-exempt status of a number of jail bond issues, suggesting they should be taxable private-activity bonds. Jail bonds fall into this category when they are managed under contract by private companies and/or house too many federal inmates, which are considered to be private parties under federal tax law.

Bonds are PABs if more than 10% of the proceeds are used by private parties and more than 10% of the debt service is paid by private parties. PABs are only tax-exempt if they fall within certain "qualified" categories, which don't include jails.

The 2008 bonds were issued to finance a 432-bed detention center located in Bonham, Texas, which is northeast of Dallas. The jail and the county's 96-bed satellite jail facility are operated and managed by Community Education Centers, Inc., a private, for-profit company.

The detention center houses county inmates as well as inmates of the U.S. Marshals Service, which pays a per diem amount for each inmate, according to the official statement for the refunding bonds.

The IRS began auditing the corporation's bonds in December 2011. The issuer and the county began negotiating with the agency over the tax concerns in early 2012. In November 2013, the original bond counsel, Hunton & Williams LLP, withdrew its representation. The issuer then retained Norton Rose Fulbright to negotiate a settlement with the IRS.

Patrick Dertien, head of municipals for National Alliance Securities, which owned some of the 2008 bonds, said the issuer reduced its cost of capital by refunding the bonds because market interest rates and issuance are low and because the 2008 bonds were nonrated while the taxable bonds are BBB-rated by Standard and Poor's. He thinks other issuers of other tax-troubled jail bonds may also redeem them.

Herbert J. Sims & Co., Inc. and Municipal Capital Markets Group, Inc. were the underwriters of the 2008 bonds and Hunton & Williams LLP was bond counsel.

Aegis Capital Corp. and Municipal Capital Markets Group served as underwriter for the refunding bonds. Fulbright & Jaworski LLP, a member of Norton Rose Fulbright, was bond counsel.

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