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TEB VCAP Resolution Standards: Some Basic Concepts

Tax Exempt Bonds (TEB) focuses on providing participants in the municipal bond industry with quality service to assist issuers and conduit borrowers in understanding their tax responsibilities. As part of that service, TEB is providing the following basic information for issuers of tax-advantaged bonds with respect to the TEB Voluntary Closing Agreement Program (TEB VCAP) resolution standards. Issuers may use this basic information to identify situations when use of TEB VCAP resolution standards is appropriate.  However, issuers may not cite this basic information as an authoritative source.  TEB recommends that issuers review this basic information in consultation with their counsel.

Generally

The Tax Exempt Bonds Voluntary Closing Agreement Program (TEB VCAP) resolution standards in Internal Revenue Manual (IRM) section 7.2.3 provide transparency to issuers and other parties to tax-advantaged bond (tax-exempt, tax credit, or direct pay) transactions of TEB VCAP resolution methodologies. The resolution standards also encourage issuers to self-identify violations, utilize TEB VCAP, and adopt and undertake post-issuance due diligence practices.

The IRS originally developed TEB VCAP resolution standards (formerly section IRM section 7.2.3.3) in response to recommendations by the Advisory Committee on Tax Exempt and Government Entities (ACT) to expedite the closing agreement process for relatively straightforward violations. The August 2011 IRM update, relative to TEB VCAP resolution standards (IRM section 7.2.3.4), responded to additional recommendations of the ACT issued on June 9, 2010.  The update includes revisions and supplements to the former TEB VCAP resolution standards as well as new TEB VCAP resolution standards for closing agreements for tax-exempt bond violations. The update also includes new TEB VCAP resolution standards for violations affecting the status of direct pay build America bonds, recovery zone economic development bonds, and other direct pay bonds.

TEB VCAP Resolution Standards - Update Highlights

Written Procedures Encouraged. To encourage issuers to adopt written procedures and to exercise post-issuance due diligence, IRM section 7.2.3.4.4 generally provides that issuers that adopt and use such procedures to identify a violation will be allowed to treat the date of the discovery of the violation as the date of the violation. This adjustment will shorten the nonqualified period or credit adjustment period upon which the closing agreement payment is calculated and, consequently, will reduce the amount of the payment.

Customized Proposals. The resolution standards described in IRM section 7.2.3.4 apply only to specific tax-advantaged bonds referred to in that IRM section. However, the IRM recognizes that it is beneficial to the United States, and to issuers, if remedies to violations proposed in TEB VCAP take into account all facts and circumstances.  Therefore, the IRM allows issuers to propose, in their TEB VCAP requests, appropriate customized resolution terms.  Any such customized settlement is subject to the approval of the TEB Senior Management Team.  The terms of the proposal may be, but are not required to be, based in whole or in part on:

  • A resolution standard described in IRM section 7.2.3.4, regardless of whether the standard(s) directly apply to the tax-advantaged bonds described in the request;
  • A remedial action for tax-advantaged bonds described in the Internal Revenue Code or Income Tax Regulations (Regulations); and/or
  • Other specific facts and circumstances described in the request.

Standards for Tax-Exempt Bonds.  IRM section 7.2.3.4.2  describes the standardized methodologies for resolving noncompliance with tax matters that may impact the status of tax-exempt bond issues:

  • Excessive Nonqualified Use;
  • Ownership of Qualified 501(c)(3) Bond-Financed Property;
  • Failure to Provide Notice of Defeasance;
  • Failure to Call Defeased Bonds Within 10.5 Years of Issuance;
  • Alternative Minimum Tax Adjustment;
  • Capital Expenditure Limitation Failure;
  • Maturity Exceeding 120% of Economic Life;
  • Impermissible Advance Refunding;
  • Failure to Timely Reinvest Proceeds into 0% SLGS; and
  • Extinguishment/Merger.

Standards for Direct Pay Bonds.  IRM section 7.2.3.4.3 describes the standardized methodologies for resolving noncompliance with tax matters that may impact the status of certain direct pay bond issues:

• Private Activity;
• Impermissible Uses of Proceeds;
• De Minimis Premium; and
• Extinguishment/Merger.

Examples of the Application of Selected TEB VCAP Resolution Standards

The following example illustrates the application of certain TEB VCAP resolution standards to a generic set of facts.  It should not be referred to as an authoritative source. 

The City of Alpha (Alpha) issued the tax-advantaged bonds described below on 12/1/09 (the Bonds).  On the issue date, Alpha used all of the net proceeds of the Bonds to acquire land.  The Bonds principal is due on 12/1/12 and on 12/1 of each subsequent year to and including 12/1/39.  The Bonds are subject to an optional redemption at par plus accrued interest (without redemption premium) on 12/1/19 and on any date thereafter.  After the deliberate action/violation described in each example below, Alpha took none of the remedial actions provided under sections 1.141-12 or 1.142-2 of the Regulations that were applicable to the Bonds.  Alpha submits a TEB VCAP request utilizing the resolution standards under IRM section 7.2.3.4 on 3/1/12.  On 6/1/12, the IRS and Alpha execute a closing agreement.

 

 
  Example I - Tax-Exempt Bonds Example II - Build America Bonds Example III - Build America Bonds

Additional 
Facts

The Bonds are qualified 501(c)(3) bonds.  Beta, a 501(c)(3) organization  owns and uses the land on and after 12/1/09.  However, on 12/1/11, Beta sold a portion of the land to Gamma Company, a for-profit nongovernmental entity.  On 2/15/12, Alpha and Beta conclude that 30% of the Bonds are allocable to the ownership of the land by a person other than a 501(c)(3) organization or a governmental unit as of 12/1/11 and that 12/1/11 is the date of the deliberate action/violation.  Alpha stated that 30% of the Bonds are nonqualified bonds in the TEB VCAP request. The Bonds are direct pay build America bonds.  On the issue date, Alpha reasonably expected that the Bonds would meet neither the private business tests nor the private loan financing test for the entire term of the Bonds.  From and after the issue date, the land was owned by Alpha and leased to the Alpha Park District (APD), a subdivision of Alpha governed by a board whose members are appointed by Alpha’s city council.  On 12/1/11, APD subleased a portion of the land to Delta, a nongovernmental entity.  Alpha determined that the sublease caused the Bonds to meet the private business use test and the private security or payment test.  Alpha concluded that 30% of the Bonds are allocable to the sublease and 12/1/11 is the date of the deliberate action/violation.  Alpha stated that 30% of the Bonds are nonqualified bonds in the TEB VCAP request. Same facts as in Example II, except that on 2/15/12, Alpha’s finance department, as a result of conducting Alpha’s periodic review of the various uses of Alpha’s bond-financed assets pursuant to Alpha’s written procedures to ensure that the Bonds and other tax-advantaged bonds issued by Alpha remain in compliance with all post-issuance related federal tax requirements, discovered the sublease of the land to Delta.

Applicable
IRM
Sections

 

IRM section 7.2.3.4.2 - (5) Ownership of Qualified 501(c)(3) Bond-Financed Property.
IRM section 4.81.6.5.3.1 - Computation of Taxpayer Exposure
 
IRM section 7.2.3.4.3  - (4) Private Activity Violation 
IRM section 4.81.6.5.3.2  - Computation of Credit Maintenance Amount
 

IRM section 7.2.3.4.3 - (4) Private Activity Violation
IRM section 7.2.3.4.4  - Certain Modifications to Resolution Standards Based on Timing of Discovery of Violation
IRM section 4.81.6.5.3.2  - Computation of Credit Maintenance Amount
 

Result(s) Alpha (or Beta on behalf of Alpha) pays the greater of $1,000 or Taxpayer Exposure on 30% of the Bonds from 12/1/11 to 12/19/19 to the IRS on or before 6/1/12.  Also, on or before 6/1/12, Alpha or Beta establishes an escrow by no later than 6/1/12 that defeases the nonqualified bonds due after 12/1/19 to the first optional redemption date of 12/1/19.

Alpha pays the greater of $1,000 or the Credit Maintenance Amount to the IRS on or before 6/1/12 for 30% of the Bonds for the period beginning on 12/1/11 (the date of the violation) and ending on 12/1/39.

OR

Alpha pays the greater of $1,000 or the Credit Maintenance Amount to the IRS on or before 6/1/12 for 30% of the Bonds for the period beginning on 12/1/11 to a date prior to 12/1/39 (e.g., the date of the closing agreement (6/1/12), the next principal payment date (12/1/12), the first call date (12/1/19), or any other date prior to 12/1/39). The debt service schedule used to calculate credits for the remaining period that the Bonds are scheduled to be outstanding is permanently modified by subtracting the nonqualified bonds from the principal of the Bonds on a pro rata basis to reduce the refundable credits that the issuer may claim after 6/1/12.

Alpha pays the greater of $1,000 or the Credit Maintenance Amount to the IRS on or before 6/1/12 for 30% of the Bonds for the period beginning on 2/15/12 (the date of the discovery of the violation) and ending on 12/1/39.

OR

Alpha pays the greater of $1,000 or the Credit Maintenance Amount to the IRS on or before 6/1/12 for 30% of the Bonds for the period beginning on 2/15/12 to a date prior to 12/1/39 (e.g., the date of the closing agreement (6/1/12), the next principal payment date (12/1/12), the first call date (12/1/19), or any other date prior to 12/1/39). The debt service schedule used to calculate credits for the remaining period that the Bonds are scheduled to be outstanding is permanently modified by subtracting the nonqualified bonds from the principal of the Bonds on a pro rata basis to reduce the refundable credits that the issuer may claim after 6/1/12.

     
       
       
       
Page Last Reviewed or Updated: 08-Apr-2014