With little fanfare, the Internal Revenue Service has begun requiring issuers of traditional tax credit bonds to file information forms to the recipients of the tax credits and IRS, adding costs and other burdens to cash-strapped school districts and other small issuers, market sources said this week.
Up until this year, issuers were permitted to voluntarily file Form 1097-BTC for tax-credit bonds.
But late last year, the IRS updated the form instructions to mandate the filing of the forms to tax-credit recipients quarterly and to the IRS annually.
Bond lawyers think the IRS made the filings mandatory because of suspected abuses in the tax credit market. Numerous attempts to reach IRS officials were unsuccessful.
IRS officials have talked about the potential for fraud with any type of tax credit for several years, in Notice 2010-28 on the stripping of tax credits from tax credit bonds, and in speeches, said Linda Schakel, partner with Ballard Spahr.
Form 1097-BTC is one check the IRS will now have as it processes tax returns claiming credits, she said.
The new requirement has resulted in market-wide confusion for issuers and bond counsel alike.
"Confusion would be putting it mildly," said Edward McLiney, chairman at Missouri-based McLiney & Co, who has worked on over 400 qualified zone academy bond deals (QZABs) in 35 states. "The IRS did not notify issuers of tax credit bonds, but only updated the form instructions."
McLiney said his average client bond issue is $1.5 million, but can be as small as $30,000.
"On the deals that we've done, I don't see how there would be abuse," McLiney said. "You're burdening small school districts because of something big cities and states may or may not have done. Maybe it's worthwhile on big deals but we've never done an issue that has traded hands or been stripped."
Schakel further added that the new instructions are extremely confusing.
"People thought this might have been only for issuers who stripped the credit," Schakel said. "The instructions now say if you strip the credit or not the issuer needs to file this."
Issuers of QZABs along with clean renewable energy bonds (CREBs), New CREBs, qualified energy conservation bonds (QECBs), qualified school construction bonds (QSCBs), and Build America Bonds sold as traditional tax credit bonds, are required to file Form 1097-BTC.
QZABs are taxable tax-credit bonds that can only be issued by a state or local government within the jurisdiction of a qualified zone academy. A qualified zone academy is any public school or program established and run by an eligible local education agency to educate and train teachers and other educational personnel. Under Section 54E of the Internal Revenue Code, QZABs can be issued to rehabilitate or repair public school facilities, purchase equipment, develop course materials, as well as to train teachers and other school personnel. They cannot be used for new construction.
"I don't think there was a lot of attention paid to the form," said Brent Feller, partner with Chapman and Cutler LLP in Chicago. "Overtime maybe people knew about the form in its draft stages but they did not know that it is now active and needs to be filed."
The confusion surrounding the new form requirements could be quite costly for tax credit issuers if they have multiple maturities and multiple bondholders, Feller said. For serial bonds, each bond must be reported separately on the Form 1097-BTC.
Penalty fees apply if an issuer fails to file on a timely basis, if there is missing information, or if the information on the form is incorrect, according to the IRS instruction sheet. Form 1097-BTC was due on Feb. 28 and April 1, if filed electronically, for all outstanding tax credit bonds for the 2012 calendar year.
There is a $30 fine per information return if the issuer correctly files within 30 days of the due date, with a maximum of $250,000 of fines per issuer per year or $75,000 for small businesses, according to the IRS' 2013 general instructions for the form. There is a $60 fine per information return if the issuer correctly files more than 30 days after the due date but before Aug. 1, with a maximum penalty of $500,000 per issuer per year and $200,000 for small businesses.
Finally, there is a $100 fine per information return if an issuer files after Aug. 1 or if no information return is filed at all with a maximum penalty of $1.5 million per issuer per year or $500,000 for small businesses.
Bond lawyers worry issuers do not understand the need to file the forms quarterly for each bondholder and once annually to the IRS.
"We are hearing concerns that there needs to be further outreach and [information about] what the objectives are so they can better appreciate and understand what the requirements are and why they need to commit limited local resources," said Lars Etzkorn, program director for the National League of Cities' center for federal relations.
The Municipal Securities Rulemaking Board does a lot of outreach and follow up and would be a great model for other agencies, Etzkorn said.
Etzkorn added that the IRS has not made much of a public case for the new requirements.
Another predicament issuers face is that they typically don't know the identities of their bondholders.
Up until now, most issuers have been notified by bond counsel about the new filing requirements.
"There does seem to be a problem communicating with issuers about their filing responsibilities," Feller said. "There are a lot of issuers out there that just don't know about the form and that they are subject to penalties."
Feller suggested that the more that is done to publicize the filing form requirements from the IRS the better off it would be for the market. "That would go a long way to educating bond counsel and then bond counsel can in turn notify their clients," he said.