Proposed IRS Regulations Could Limit Tax-Exempt Bonds

The Internal Revenue Service (IRS) recently issued proposed regulations altering the definition of “political subdivision” for the purpose of issuing tax-exempt bonds and use of tax-exempt financed facilities. The proposed language could have troubling implications for certain wastewater and stormwater utilities seeking to finance projects using tax-exempt bonds and/or use facilities built with tax-exempt financing.
The National Association of Clean Water Agencies (NACWA) is currently analyzing the proposal to determine potential impacts on Association members and would appreciate any feedback from the members on this issue by the end of next week.

Under current IRS regulations, a “political subdivision” is “any division of any state or local governmental unit which is a municipal corporation or which has been delegated the right to exercise part of the sovereign power of the unit.” This has meant that a public entity able to exercise taxing, eminent domain, or police (regulatory) powers, is able to issue tax-exempt bonds and use tax-exempt financed facilities. However, the proposed new language imposes two additional requirements: 1) public purpose, and 2) governmental control.

The “public purpose” component requires that the entity be organized and continually operate for a public purpose, and that it operate in a way that “provides significant public benefit with no more than incidental benefit to private persons.” Without clarification, this language could impact stormwater utilities in particular. For example, in a watershed where some private properties may receive a disproportionate share of the benefits of a particular project, the ability of the utility to issue tax-exempt bonds could be called into question.

The governmental control requirement is also concerning for any regional utility controlled by multiple governmental entities, as the proposed language requires that a single state or local government exercise control through its power to: 1) both approve and remove a majority of the entity’s directors, 2) the power to elect a majority of the directors in periodic elections of reasonable frequency, or 3) the power to approve or direct the significant uses of funds or assets of the entity in advance. If a regional utility’s governing structure does not allow a single local or state government to exercise majority control, the proposed regulations could prohibit that utility from qualifying as a political subdivision for tax-exempt bond and financing purposes.

The public comment period for the proposed regulations closes on May 23, 2016. A hearing has also been scheduled by the IRS at 10 a.m. on June 6, 2016 at the IRS offices in Washington, D.C.

NACWA is reviewing the proposal and will engage in necessary advocacy efforts, including submitting comments on behalf of its members by the May 23 deadline, to ensure the regulations do not negatively impact clean water agencies.

Any NACWA members with additional thoughts or concerns about the regulations should contact Amanda Waters or Erica Spitzig by the end of this week. Concerned members should also submit their own comments to the IRS directly by the May 23 deadline.

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