WASHINGTON — The Fannin County Public Facility Corp. in Texas is negotiating with the Internal Revenue Service to settle a dispute over $30.78 million of revenue bonds it issued in 2008 to finance a jail.

The issuer anticipates finalizing a closing agreement under which it will make a payment to the IRS and issue taxable refunding bonds to redeem the series 2008 bonds, according to an event notice filed on the Municipal Securities Rulemaking Board’s EMMA system Friday.

As of Nov. 1, $29.2 million of the bonds remained outstanding. Hunton & Williams, LLP served as bond counsel  and Herbert J. Sims & Co., Inc. and Municipal Capital Markets Group, Inc. were underwriters, according to bond documents.

The IRS notified the issuer of the audit in December 2011. Starting in early 2012, the bond counsel had “significant conversations and negotiations” with the IRS. On Nov. 7, Hunton & Williams withdrew its representation of the county and the issuer. Norton Rose Fulbright was hired to represent the issuer before the IRS and has continued negotiations with the IRS. While the law firm believed a closing agreement had been “substantially finalized” around Nov. 13, senior IRS officials “significantly increased the settlement amount” causing  negotiations “to stall,” the event notice said. Talks have since resumed.

The issuer solicited consent from bondholders to allow a par call and mandatory tender of the bonds on and after Jan. 1. The indenture provided an optional redemption at a price of 105. But the issuer sought to amend the indenture to redeem the bonds at a price of 100. About 80% of the bondholders have consented to the amendment, according to the disclosures.

The settlement hasn’t been finalized, so the issuer will not be able to call the bonds on Jan. 1. However it expects to be able to issue taxable refunding bonds for the par call on or before July 1, the notice stated.

The document does not explain the dispute. However, the IRS has had concerns about the tax-exempt status of a number of jail bond issues. The IRS has suggested some jail bonds should be taxable private-activity bonds because the jails are managed under contract by private companies and/or because the jails house too many federal inmates, which are considered to be private parties.

Bonds are PABs if more than 10% of the proceeds are used by private parties and more than 10% of the debt service is paid by private parties. PABs are only tax-exempt if they fall within certain “qualified” categories, which don’t include jails. The Fannin County Jail is operated by Community Education Centers, Inc., a private, for-profit company. CEC’s webpage for the jail notes that both the Fannin County Sheriff’s Office and the U.S. Marshals Service are contracting agencies for the facility.

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