NABL Asks IRS to Upgrade Management Contract Rules

WASHINGTON — The National Association of Bond Lawyers is urging the Internal Revenue Service and the Treasury Department to update their rules and guidance on management contracts, which are key to making sure many governmental and 501(c)(3) bonds remain tax-exempt and are not private-activity bonds.

NABL made the request in a 14-page letter it sent to the two agencies Wednesday, after three years of deliberation.

The IRS’ rules and guidance on management contracts, some of which were issued 30 years ago, haven’t kept up with current business practices and as a result, bond lawyers are frequently requesting private-letter rulings from the IRS to determine whether certain contracts would comply with the guidance, said NABL president Kristin Franceschi.

“For us, this is a big deal because it is relates to many 501(c)(3)s and governmental bond-financed facilities,” she said, adding that it broadly affects the municipal bond market.

Most 501(c)(3) and governmental bond-financed facilities involve management contracts. For example, many hospitals have contracts with physician practice groups and governments may have contracts for the management of parking garages or cafeterias.

“We’re trying to provide some real-life examples where we see areas of guidance that are difficult to deal with,” Franceschi said. NABL wants to show that “there are ways to provide issuers and other borrowers with some flexibility and still hold true to the IRS’ principal of limiting private use.”

The concern is that if the IRS found a management contract resulted in a too much private use of a bond-financed facility, it might contend the bonds were private-activity bonds and taxable since they do not meet the requirements for PABs.

“The world has changed. These contracts have gotten so much more sophisticated,” Franceschi said. “The existing guidance is putting handcuffs on the ability of issuers and borrowers to negotiate management contracts.”

Franceschi cited as an example the new health care reforms, which are geared towards reducing patient readmissions to hospitals and may take readmission rates into account in determining compensation for doctors and other health care providers.

NABL made 15 different recommendations for how the IRS could update its rules and guidance to reflect current practices. One of the group’s major concerns is that the current guidance has three short-term contracts, each with their own criteria that provide safe harbors for tax law compliance. If issuers and borrowers meet the criteria, then their short-term contracts will not give rise to private use and jeopardize the tax-exempt status of their bonds.

“These are a complicated set of rules,” Franceschi said. “They are hard to explain and understand.”

Instead, NABL suggested that the IRS provide a single three-year, short-term contract safe harbor with one set of criteria that would give more flexibility to issuers in how they provide compensation. The contract could not be terminated on an optional basis.

Another area of concern involves contracts for “incidental services” such as janitorial work or hospital billing services that are not considered management contracts and do not give rise to private business use. However, NABL said in its letter, the IRS’ current examples of incidental services are “fairly limited and result … in ambiguity.”

“It’s hard to understand where the line ends for some of these things,” Franceschi said.

NABL suggested expanding the list to include services that weren’t thought about when the rules were first issued, such as an information technology help desk, lawn and landscaping services, or patient and resident nutrition services.

A third area of concern involves current IRS guidance that restricts “incentive compensation” to make sure private parties do not receive excessive compensation. Currently, incentive compensation is permitted only in extremely limited circumstances and usually provided when a service provider raises revenues or lowers expenses.

NABL recommends incentive compensation be broadened to cover other things such as improved customer satisfaction and limiting patient readmittances to hospitals.

The 22 members of NABL’s tax law committee played a key role in developing the recommendations.

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