Exemption of Bonds in States

May 24, 2013

Reciprocal State Tax Exemption:

See Kentucky v. Davis for a discussion of whether it was unconstitutional for the Commonwealth of Kentucky to exempt its own bonds but not automatically exempt bonds issued by other states. The Supreme Court determined that each state may make its own determination of whether or not to exempt other states’ bonds. The Justice writing the court’s opinion had the following to say in his introduction: “For the better part of two centuries States and their political subdivisions have issued bonds for public purposes, and for nearly half that time some States have exempted interest on their own bonds from their state income taxes, which are imposed on bond interest from other States. The question here is whether Kentucky’s version of this differential tax scheme offends the Commerce Clause. We hold that it does not.”  What this means is that there is no automatic exemption of one state’s bonds in another state. Exemption of one state’s bonds in another state would depend on that other state’s statutes.

Enterprise Zone Facility Bonds

May 23, 2013

Issuance of Enterprise Zone Facility Bonds

May Enterprise Zone Facility Bonds (I.R.C. 1394) still be issued as new money bonds?  Yes, so long as there is a valid enterprise community or empowerment zone.  See I.R.C. 1391, as amended in 2013 by H.R. 8, regarding term of such zones.

Refunding of Enterprise Zone Facility Bonds

May Enterprise Zone Facility Bonds be refunded? Yes, see Treas. Reg. 1.1394-1(o).

Empowerment Zones

The IRS has issued guidance in Notice 2013-38 on how a state or local government may amend the nomination of an empowerment zone to provide for a new termination date.


See http://www.rurdev.usda.gov/rbs/ezec/Invest/taxes.html for helpful (but somewhat outdated) background information.

Notiz 20130101

Accountable Care Organizations: Exempt Purpose and Private Business Use

May 16, 2013


The Patient Protection and Affordable Care Act, Pub. L. 111-148, 124 Stat. 119 (the “Affordable Care Act”) (signed into law on March 23, 2010) provides for the creation of Accountable Care Organizations (ACOs).  ACOs are intended to include participants such as governmental entities, section 501(c)(3) organizations and others.  The purpose of ACOs is to facilitate the coordination of providing Medicare services.  Several exempt organization and tax-exempt bond issues arise with respect to ACOs, certain of which are summarized or referenced in this post.

acasignedExempt Organization Concerns:

There are concerns that (1) the participation by a section 501(c)(3) organization in an ACO is not an exempt purpose under the operation rules in Treas. Reg. 1.501(c)(3)-1(c)(1), (2) such participation could give rise to prohibited private inurement to insiders or exceed the limit on private benefits to others and/or (3) give rise to difficulties in applying the unrelated trade or business rules.  See IRS Notice 2011-20 (March 31, 2011) for a good description of the issue and preliminary guidance.

Tax-Exempt Bond Concerns:

Apart from the concerns described above regarding the basic eligibility of a borrower for qualification under section 501(c)(3) of the Code, ACOs also give rise to problems under the private business use rules.   Specifically, one question is whether use of bond-financed facilities by an ACO gives rise to a “comparable arrangement” covered by the private business use rules in Treas. Reg. 1.141-3(b).  See the National Association of Bond Lawyers’ April 1, 2013 submission to the Treasury Department and Internal Revenue Service for a good description of the issue.

Related Person, Related Party

May 10, 2013

Related Party:

“Related party” is defined in Treas. Reg. 1.150-1(b).  The definition is a “way finder” – it does not directly define the term but tells the reader whether the applicable definition is found in one section or another, depending on the situation being addressed.  In reference to a governmental unit or a 501(c)(3) organization, “related party” means any member of the same “controlled group.”  In reference to any other type of person, “related party” actually means “related person” as defined in I.R.C. 144(a)(3).  Therefore, when a section of 103 and 141-150 states a rule concerning related parties and governmental units or 501(c)(3) organizations, think “controlled group” – the definition of which is in Treas. Reg. 1.150-1(e).

Controlled Group:

A controlled group, within the meaning of Treas. Reg. 1.150-1(e), is a group of organizations that is controlled by the same entity or group of entities, either directly or indirectly.  The regulations describe what it means to have direct control and indirect control.

An organization is controlled directly by another if the facts and circumstances so indicate.  Relevant considerations to determine control are:

  • Does the controlling organization the right to approve and remove the members of the governing body of the other entity?
  • Does the controlling organization have the effective power to make such approvals and removals?
  • Does the controlling organization have the right to require the use of funds or assets of the controlled organization for any purposes of the controlling entity?
  • Does the controlling organization have the power to require such use of funds or assets?

Indirect control of an organization can arise from a chain of control relationships.  The “parent” organization is considered to be indirectly controlling any entities that are directly or indirectly controlled by an organization the parent controls directly.

Related Person:

I.R.C. 144(a)(3) explains that a person is a related person to another person (and that such persons are “related persons”) if:

  1. the relationship between the persons would result in a disallowance of losses under I.R.C. 267 or I.R.C. 707(b); or
  2. such persons are members of the same controlled group of corporations (defined in I.R.C. 1563(a), except that “more than 50 percent” is used instead of “at least 80 percent” each place in such section).

I.R.C. 267 describes when losses and other tax attributes in transactions between related taxpayers are disallowed.  Generally, such attributes are disallowed (or suspended) when the persons have any of the following relationships:

  1. Members of a family;
  2. An individual and a corporation more than 50 percent in value of the outstanding stock of which is owned, directly or indirectly, by or for such individual;
  3. Two corporations that are members of the same controlled group (I.R.C. 1563(a), which the exceptions shown above);
  4. Certain grantors, fiduciaries and beneficiaries of trusts;
  5. A person and a 501 organization that is controlled directly or indirectly by such person or (if such person is an individual) by members of the family of such individual;
  6. A corporation and a partnership, if the same persons own (A) more than 50 percent in value of the outstanding stock of the corporation, and (B) more than 50 percent of the capital interest or profits interest in the partnership;
  7. An S corporation and another S corporation if the same persons own more than 50 percent in value of the outstanding stock of each corporation;
  8. An S corporation and a C corporation, if the same persons own more than 50 percent in value of the outstanding stock of each corporation; or
  9. Certain executors and beneficiaries of estates.

I.R.C. 707(b) describes certain disallowed attributes for controlled partnerships.  Such controlled partnerships include:

  1. A partnership and a person owning, directly or indirectly, more than 50 percent of the capital interest, or the profits interest, in such partnership; or
  2. Two partnerships in which the same persons own, directly or indirectly, more than 50 percent of the capital interests or profits interests.

I.R.C. 1563(a) describes what a controlled group of corporations is.  The section describes parent-subsidy controlled groups, brother-sister controlled groups, combined groups and certain insurance companies:

  1. Parent-subsidy controlled groups are one or more chains of corporations connected through stock ownership with a common parent if: 80 percent vote or value of stock is owned by one or more of the other corporations in the chain;
  2. Brother-sister controlled group is a group of two or more corporations if 5 or fewer persons who are individuals, estates or trusts own stock possessing more than 50 percent of the total combined vote or value of the stock of each corporation.

Note that I.R.C. 147(a) has a slightly different definition of “related person” for purposes of the substantial user limitation (where a bond is not a qualified bond if it is held by a person who is a substantial user of the facilities or a “related person” to such a substantial user).  For purposes of I.R.C. 147(a), “related person” has the same basic meaning, but is expanded to also include (1) a partnership and each of its partners (and their spouses and minor children), and (2) an S corporation and each of its shareholders (and their spouses and minor children).


Substantial User Requirement (I.R.C. § 147(a))

May 9, 2013

In General:

Interest on private activity bonds is not excludible from gross income for federal income tax purposes for any period during which such bond is held by a person who is a “substantial user” of the facilities or by a “related person” of such a substantial user.  These rules do not apply to any qualified mortgage bond, qualified veterans’ mortgage bond, qualified student loan bond or qualified 501(c)(3) bonds.

Substantial User:

A substantial user is generally one that derives gross revenues from the financed facility in excess of five percent of the total derived by all users, or one who occupies more than five percent of the usable area of the facility (5% revenue/space test).  See Treas. Reg. 1.103-11.

Other evidence of substantial use includes:

  • having specifically constructed property;
  • having contractual or preemptive usage rights to the exclusive use of property or a portion of property;
  • the existence of a lease or sublease of all or any portion of the facility; and
  • having a license that provides for the regular use of the facility in a matter that is not merely a casual, infrequent or sporadic use.

Employees of a substantial user are generally not substantial users.

If a partnership is the user of all or a portion of the facility, all partners are “substantial users.”  There is no threshold partnership interest percentage under which a partner may escape treatment as a substantial user.

Special Reimbursement Matters:

See Treas. Reg. 1.103-8(a)(5) regarding rules concerning the interaction between the reimbursement rules and the substantial user limitation.  The following is example language that might be included in exempt facility tax documents:

No “substantial user” of the project within the meaning of I.R.C. 147(a) (or a “related person” thereto, within the meaning of I.R.C. 147(a)), during the five-year period preceding the date of issue of the bonds who will receive, directly or indirectly, five percent or more of the proceeds of the loan, will be a substantial user or a related person thereto (within the meaning of I.R.C. 147(a)) during the five-year period following the date of issuance of the bonds unless the requirements of Treas. Reg. 1.150-2 are satisfied and, for an acquisition, no person that is a substantial user or related person after the acquisition date was also a substantial user more than 60 days before __________ __, 2005, the date on which the issuer first declared its official intent to issue to the bonds.


Members of a CPA society may purchase bonds issued to finance CPA headquarters because the members do not receive significant economic or commercial benefits.  See PLR 8003059.

Each member of a cooperative who purchases IDBs to finance the construction of a slaughterhouse and marketing facility to be leased to the cooperative to slaughter their own cattle is a substantial user, even if none meets the 5% revenue/space test.  See Rev. Rul. 76-406.


PLR 8612045:  Forge IDB ruling.  Addresses substantial user determination in connection with a temporary lease for storage of seller’s equipment, acquisition of existing facilities