Automatic Exemption Revocation for Non-Filing: Automatic Revocation May Cause Interest on Outstanding Tax-Exempt Bonds to Be Taxable
Could automatic revocation affect the tax exemption for interest on my organization's outstanding tax-exempt bonds?
Yes, it could if the tax-exempt status of the bonds is due to their qualification as qualified 501(c)(3) bonds under section 145 of the Code and the Issuer fails to take an appropriate remediation under sections 1.141-12 and 1.145-2 of the Income Tax Regulations. See TAM 200006049 and TAM 200107020, which indicate that section 7805(b) relief from retroactive revocation of bonds’ tax-exempt status is typically not granted in instances where remedial action is not timely taken. These regulations generally require redemption or defeasance of the bonds associated with the improper ownership or use of the financed property. The redemption must occur within 90 days of the action that resulted in the revocation (in this case, the failure to file the third year’s information return). In situations where immediate redemption of the bonds is restricted by the bond agreement, a defeasance of the bonds might be permitted. Publication 4077 contains additional information.
If the regulations do not provide a remedy, the governmental entity that issued the bonds may request a closing agreement addressing the tax status of the bonds under the Tax Exempt Bonds Voluntary Closing Agreement Program (TEB VCAP). A closing agreement addressing violation of the qualified ownership and use requirements for qualified 501(c)(3) bonds also will typically require a redemption or defeasance of the non-qualified bonds. For additional infomation, see Tax Exempt Bond Voluntary Compliance.
In Revenue Procedure 2014-11, the IRS provides a procedure for an organization to apply for reinstatement of its exempt status after automatic revocation. In some instances, the organization may be eligible for reinstatement retroactive to the date of revocation, in which case there will be no time during which the organization was not a 501(c)(3) organization, and qualified 501(c)(3) bonds will not be affected. In Announcement 2015-2, the IRS office of Tax Exempt Bonds announced a special TEB VCAP process to correct certain situations involving a revocation of exemption for an organization that is not retroactively reinstated. To be eligible for this streamlined process, which does not require redemption of bonds, certain requirements apply:
- the organization must have had its exempt status reinstated
- the organization must not have had its status previously revoked since the issue date of the bonds
- the issuer of the bonds must apply for the closing agreement within 12 months of the reinstatement
- the bonds must not be under examination