We’ve previously reported that the Internal Revenue Service (IRS) has issued eight private letter rulings under Internal Revenue Code (Code) Section 54A(d)(2)(B)(iii) that grant an extension of the three-year expenditure period that applies to an issue of qualified tax credit bonds (QTCBs). An issuer of QTCBs must reasonably expect on the issuance date of the issue of QTCBs that it will spend all of the proceeds of the QTCBs within three years after the issuance date, and the issuer must in fact spend all of the proceeds or the issue loses its status as QTCBs (and the bonds are no longer eligible for a direct payment subsidy or a tax credit to the bondholders, as applicable). This three-year expenditure period can be extended if the issuer submits a ruling request to the IRS before the expiration of the three-year period and establishes both that the failure to spend all of the proceeds of the QTCBs was due to reasonable cause and that issuer will continue to proceed with due diligence to make expenditures of QTCB proceeds for qualified purposes. In other words, the issuer must demonstrate, among other things, that its issuance date expectation to spend all of the proceeds of the QTCBs was reasonable and that the failure to satisfy the three-year expenditure period resulted from events that could not have been reasonably anticipated as of the issuance date of the QTCBs. Each of these eight private letter rulings has dealt with qualified school construction bonds (QSCBs), a type of QTCB. The IRS recently released PLR 201514005 (pdf), the ninth such ruling granting an extension of the three-year expenditure that applies to QSCBs.
We’ve also previously reported that the IRS has asserted the position in recent audits of tax-exempt bonds that the issuer’s failure to spend at least 85% of the proceeds of the bond issue within three years after the issuance date means that the issuer could not have reasonably expected as of the issuance date to spend at least 85% of the proceeds within this three-year period. If an issuer of tax-exempt bonds does not reasonably expect as of the issuance date of the issue to spend at least 85% of the proceeds of the issue within three years after the issuance date, then, with some exceptions that we won’t delve into here, the issue consists of taxable hedge bonds and it does not satisfy the safe harbor to avoid characterization as an issue that overburdens the tax-exempt bond market by being issued too early. Stated another way, the IRS has taken the position in these audits that the best evidence of the reasonableness of the issuer’s issuance date expectations is the facts that exist at the end of the three-year expenditure period.
The incongruity between the position taken by the IRS in the QTCB/QSCB private letter rulings with respect to issuance date expectations as applied to QSCBs and the position taken by the IRS in audits of tax-exempt bonds is difficult to reconcile. There is no basis in authority or policy for the analysis of the issuer’s issuance date expectations to differ between QTCBs and tax-exempt bonds. The application of a stricter standard for tax-exempt bonds is especially punitive in an era in which many issuers saw their expenditure expectations shattered as a result of post-issuance events that resulted from the financial crises – events that these issuers neither could have anticipated nor controlled.
The nine favorable private letter rulings for QTCBs/QSCBs do, however, offer some hope to issuers of tax-exempt bonds who are facing questions on audit about the reasonableness of their issuance date expenditure expectations. The IRS has been quite accommodating in issuing these rulings, and the fact patterns covered by these rulings will be similar to many situations faced in these tax-exempt bond audits. Although private letter rulings are binding only between the IRS and the party (or parties) to which the ruling pertains, the courts have consistently held that private letter rulings reveal the IRS’s interpretations of the federal tax laws and aid in the interpretation of these laws. An issuer of tax-exempt bonds who faces questions on audit regarding the reasonableness of its issuance date expenditure expectations should therefore avail itself of the QTCB/QSCB private letter rulings and press the examining agent to distinguish the analyses in these rulings from the facts presented in the audit.
Now for a topic that is tangentially related, at best, to matters of public finance tax. The Big Ten Conference had great success in the 2015 Men’s Division I National Basketball Tournament. Michigan State and Wisconsin both advanced to the Final Four, and Wisconsin came very close to winning the national championship. The Big Ten outdid this basketball success in the recently concluded 2014 football season, where Ohio State (as a proud graduate of Miami University, I cannot bring myself to refer to OSU as “The” Ohio State University) and Michigan State each won their respective New Year’s Six bowl games and Ohio State won the national championship. Ohio State claimed the national championship in the first ever playoff for the Division I Football Bowl Subdivision, beating Alabama 42 – 35 (in a game that wasn’t as close as the score would indicate) in the national semifinal game and destroying Oregon, 42 – 20, in the national championship game.
These results call to mind (or at least call to my mind) an article published by the New York Times on October 5, 2014, titled, “As Big 10 Declines, Homegrown Talent Flees”. The article was written after the struggles that many members of the Big Ten had at the start of the 2014 football season. The article focuses on these early season missteps and on Jerome Baker, one of the top football prospects in Ohio (and in the country) and who played high school football at Benedictine High School in Cleveland. At the time the article was written, Mr. Baker had spurned Ohio State and committed to play football at the University of Florida. The Times reported these isolated data points as proof of a narrative. That narrative? The industrial Midwest is in inexorable decline, and its remaining inhabitants should abandon the Great Lakes (the world’s largest freshwater system) for the desiccated regions of this country, as all right-thinking people have done – just look at how the Big Ten is struggling and how Midwestern kids no longer want to play for the conference!
This is the same attenuated logic that leads some to conclude that a nation’s success, or lack thereof, at the Olympics demonstrates the virtue, or lack thereof, of that nation’s systems of governance and allocation of resources. Did the Times write an equally specious article claiming that the results of the 2014 college football season and 2015 college basketball season demonstrate that the Big Ten, and by extension the industrial Midwest, has regained its footing? No, and that’s a good thing – any such article would have, like the one published last October, lacked all journalistic integrity. If the Times had published such an article, however, it would have noted that Mr. Baker ultimately accepted a football scholarship from Ohio State this past February.