The Internal Revenue Service has closed its audit of Rhode Island's $197 million tobacco settlement bonds, ruling that the bonds remained tax-exempt.

"We have made a determination that interest received by the beneficial owners of the bonds is excludable from gross income under Section 103 of the Internal Revenue Code," Allyson Belsome, an IRS manager of field operations for tax-exempt bonds, told state revenue director Rosemary Booth Gallogly.

Gallogly until this week also chaired the Rhode Island Tobacco Settlement Financing Corp., which has overseen the issuance of tobacco settlement-backed bond issues in 2002 and 2007. State budget officer Thomas Mullaney will succeed Gallogly as chairman of the tobacco board.

In July 2012, the IRS told state budget Director Richard Licht that it would audit the $197 million sale from 2007, which consisted of three series, for how the bonds were used.

The 2007 bonds, issued in three series, were structurally subordinate to the payment in full of $685 million of bonds sold in 2002.

The tobacco funds became available when 46 U.S. states and several territories settled with Philip Morris Inc., RJ Reynolds Tobacco Co., Brown & Williamson Corp. and Lorillard Tobacco Corp. in 1998 on payouts to cover costs of smoking-related illnesses.

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