Tax Policy:

Tax-Exempt Status of Certain Bonds Merits Reconsideration, and Apparent Noncompliance with Issuance Cost Limitations Should Be Addressed

GAO-08-364: Published: Feb 15, 2008. Publicly Released: Mar 17, 2008.

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The outstanding amount of state and local government tax-exempt bonds has increased over the years. Congress is interested in whether the bonds are used for appropriate purposes since the federal government forgoes billions in tax revenues annually by excluding the bonds' interest from investors' federal gross income. Questions also exist over the bonds' borrowing costs as they can divert funds from the funded projects. This report (1) describes recent trends in tax exempt bonds, (2) provides information on the types of facilities financed with tax-exempt bonds, and (3) discusses borrowing costs considering the methods of selling bonds and compares issuance costs paid from bond proceeds for governmental and qualified private activity bonds. In addition to interviewing relevant officials, we analyzed IRS's Statistics of Income (SOI) data and data from Thomson Financial to address these objectives.

In recent years, the volume of tax-exempt bonds issued annually for both governmental and private activity bonds has reached historically high levels. Generally, the volume of new money bond issues has been greater than bonds issued for refunding purposes. The volume of tax-exempt bonds issued, particularly bonds issued for refunding, tends to be highest when interest rates decline. Because the interest earned by investors who purchase tax bonds is generally excluded from federal income taxes, the federal revenue losses amount to billions of dollars annually. Tax-exempt governmental and private activity bonds are used to finance a wide range of projects and activities, with bonds issued for "educational purposes" generally being the largest category of governmental bonds annually. Nonprofit organizations are the largest issuers of qualified private activity bonds. Previous legislation prohibited using qualified private activity bonds for certain facilities, including professional sports stadiums, hotels, and private golf courses. However, many of these types of facilities are still being financed with tax-exempt governmental bonds. Congress has held hearings on this issue primarily focusing on sports stadiums. Although the evidence is not definitive, studies have generally shown that interest costs are lower for bonds sold when competition between underwriters exists compared to when bond sales are negotiated with underwriters after controlling for other factors. About half of all issuers of qualified private activity bonds reported paying issuance costs from bond proceeds from 2002 to 2005. IRS's guidance does not indicate what to report when no issuance costs are paid from bond proceeds. Of those reporting issuance costs, some private activity bond issuers reported paying issuance costs from bond proceeds that exceed statutory limits.

Matter for Congressional Consideration

  1. Status: Open

    Comments: As of December 2013, no legislative changes have been taken to address this recommendation.

    Matter: As Congress considers whether tax-exempt governmental bonds should be used for professional sports stadiums that are generally privately used, it may also wish to consider whether other facilities, including hotels and golf courses, that are privately used should continue to be financed with tax-exempt governmental bonds.

Recommendations for Executive Action

  1. Status: Closed - Implemented

    Comments: In June 2010, IRS released revised instructions for Form 8038, "Information Return for Tax-Exempt Private Activity Bonds." In the revised instructions, IRS directed information return providers to clearly designate on the form instances when bond proceeds were not used to pay issuance costs by entering "0" in the location on the form where issuance costs paid from bond proceeds are to be reported. The revised instructions indicate that this section is not to be left blank.

    Recommendation: To better ensure that IRS can routinely and cost effectively determine whether issuers of qualified private activity bonds are complying with the statutory limits on using bond proceeds for issuance costs, the Commissioner of Internal Revenue should clarify IRS's forms and instructions for reporting issuance cost paid from bond proceeds to require that bond issuers clearly designate on the form instances when bond proceeds were not used to pay issuance costs.

    Agency Affected: Department of the Treasury: Internal Revenue Service

  2. Status: Closed - Implemented

    Comments: In response to our recommendation, IRS included an effort to determine the extent to which bond issuers were noncompliant with issuance cost requirements in its 2010 and 2011 tax-exempt bond work plans. IRS officials said that they sent advisory letters to bond issuers for bonds totaling $1.1 billion where issuance costs appeared to exceed legal limits based on standard information submitted by issuers. Although the issuers were not required to pay additional taxes or penalties on the bonds because IRS did not declare the bonds taxable, they were required to fix any errors (administrative, clerical, or otherwise) to ensure that issuance costs as a percentage of bond proceeds did not exceed legal limits. According to IRS officials, in fiscal year 2012 IRS intends to research return information on qualified private activity bond issues to identify bond issues with strong potential for noncompliance with applicable federal tax requirements, including continued research on issuance cost limitations.

    Recommendation: To better ensure that IRS can routinely and cost effectively determine whether issuers of qualified private activity bonds are complying with the statutory limits on using bond proceeds for issuance costs, the Commissioner of Internal Revenue should develop cost-effective methods to address apparent noncompliance with the statutory limits on using bond proceeds for issuance costs in such a manner that it would not preclude IRS from examining the bonds for more substantive compliance issues in the future.

    Agency Affected: Department of the Treasury: Internal Revenue Service

 

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