WASHINGTON — Pecos City, Texas has discovered tax law issues relating to the tax-exempt status of $5.6 million of 2001 certificates of participation and plans to enter into a voluntary closing agreement with the Internal Revenue Service.

The information was disclosed in an event notice the city filed with the Municipal Securities Rulemaking Board’s EMMA system on Monday.

City officials confirmed they will be entering into an agreement under the voluntary closing agreement program but declined to specify the potential settlement amount or tax law violations.

The city “expects to contact the IRS to resolve these issues in a timely manner. Possibly resolutions could include a payment from the city to the IRS and/or the refunding of all or a portion of the COPs with taxable obligations,” the notice said.

COPs are lease financing agreements in the form of securities that can be marketed to investors in a manner similar to tax exempt debt. Legally, however, COPs are not considered debt and can therefore be issued without a vote. The investor purchases a share of the lease revenues from a particular project.

The $5.6 million of COPs were used to build a municipal jail facility, the Criminal Justice Center, that could house 96 inmates of the city and of the U.S. Marshals Service, bond documents said. The jail is located on property owned by the city.

Last week Bob Henn, acting director of the IRS tax-exempt bond office, said at the American Bar Association’s tax-exempt financing committee meeting that the IRS will ramp up it’s focus on public safety bonds, which include jail bonds and prisons.

Meanwhile, Moody’s Investors Services downgraded and assigned a rating of A2 from A1 last week to the Pecos’ $15 million in combination tax and revenue certificates of obligation due to the town’s elevated debt burdens. The current $15 million certificates of obligation issuance “significantly” increases the town’s total general obligation debt to $19.9 million, of which $13.6 million is supported by the utility system.

At the same time, Moody’s downgraded the city’s $15.3 million in outstanding general obligation limited tax parity debt from A2 to A1. The rating downgrade and assignment of A2 rating reflects the town’s elevated debt burdens that increase sustainability with the current issuance, limited and concentrated tax base, as well as adequate financial reserves, Moody’s said.

The rating also incorporates the town’s socioeconomic profile, measured by per capita income and median family income, that trends well below state and national medians, the agency said.

The GMS Group, LLC and Unicapital Securities Corp. were co-underwriters on the COPs transaction. Dorsey & Whitney LLP served as special tax counsel to the underwriters. Scott W. Johnson was counsel to Pecos, the lessee.

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