Pattern of IRS Puerto Rico audits grows

WASHINGTON — The Puerto Rico Electric Power Authority reported Tuesday that the Internal Revenue Service is auditing $355.7 million of Build America Bonds it issued in 2010, the fourth examination of tax-advantaged bonds in the commonwealth announced over the last two months.

The IRS notified PREPA last month that it is examining a Form 8038-CP related to its Power Revenue Bonds Series EEE, the power authority disclosed via EMMA. Coming hot on the heels of three other Puerto Rico audits issued over just the past several weeks, the latest disclosure seems to confirm growing suspicions that the IRS has launched an enforcement initiative involving the island territory.

Kristin Franceschi, a partner at the law firm of DLA Piper who is representing Puerto Rico in all four audits, said the inquiries are still at an early stage and the IRS’ intentions are not yet clear. Franceschi said earlier this month, however, that the rapid-fire audits seemed to point to an enforcement initiative.

“PREPA intends to respond to all correspondence from the IRS and intends to continue to cooperate with the IRS in connection with the examinations,” according to the notice posted on EMMA.

The direct-pay BABs include $60.9 million maturing in 2030 at a 5.95% coupon rate, $217.3 million maturing in 2032 at a 6.05% coupon rate, and $77.5 million maturing in 2040 with a coupon of 6.25%.

The other audits in the apparent pattern of IRS activity include examinations of $59 million in 2005 Series B Refunding Bonds issued by the Puerto Rico Municipal Finance Agency, $320.2 million of Series YY Build America Bonds also issued by PREPA in 2010, and $877.9 million in school bonds the Puerto Rico Public Buildings Authority issued in 2011. That audit includes $121.5 million of Series 2011 T direct-pay qualified zone academy bonds and Series 2011 R taxable school construction bonds that totaled $756.4 million.

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%.

The federal tax issue that is at stake with the BABs audit involves the federal payments for the direct-pay subsidy, which is what Form 8038-CP deals with reporting.

None of the three Puerto Rico audits involve the IRS audit priorities for the current 2019 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 from 480 in the 2018 fiscal year that ended Sept. 30.