IRS pressing forward with taxable finding on $55 million of Port Arthur, Texas bonds

The Internal Revenue Service has informed the Port of Port Arthur Navigation District of Jefferson County, Texas that the tax-exempt status of a 2017 $55 million bond issuance remains unresolved, months after the district initially disclosed that the IRS was casting doubt on the tax-exempt status of the bonds.

The notice came via a notice on EMMA regarding the ongoing inquiry. In the nuanced language of the IRS, the situation has been escalated from a “Notice of Proposed Issue” to a “Proposed Adverse Determination.” 

Per the notice, “The Notice contains a proposed adverse determination that the Series 2017A Bonds are taxable hedge bonds due to alleged noncompliance with requirements of Section 149(g) of the Internal Revenue Code, which prescribes certain expectations for the timely expenditure of tax‐exempt bond proceeds.” 

The notice also acknowledges that “the Port believes it has complied with the applicable provisions of the federal Internal Revenue Code and intends to defend its position.” An appeal to the ruling seems likely. 

“Despite the similar names, these are two different documents for two separate stages in the audit process,” said Johnny Hutchinson, a partner at Nixon Peabody who is not involved in the proceeding.  “This means that the issuer sent its response to the Notice of Proposed Issue, but that they didn’t convince the IRS to change its mind.” 

Section 149(g) of the tax code remains a bedeviling requirement that was originally designed to discourage municipalities from taking advantage of low interest rates for ill-defined uses while excess debt remains shielded from taxes.   

Per the IRS, “Prior to 149(g), municipalities could issue bonds when interest rates were low, even though there was not an immediate need for financing. Congress viewed this practice as a drain on the federal treasury because the bonds were outstanding longer than necessary.” 

Perceived violations of the law are based on an issuer’s expectations to spend the proceeds of the bond within a certain time frame, generally defined as 85% of the proceeds within three years of the issue date. Some tax attorneys believe that the IRS can be overly aggressive enforcing a rule that relies primarily on expectations that can be dashed by unpredictable construction schedules. 

The Port of Port Arthur is located about 20 miles south of Beaumont, Texas on the Sabine-Neches Ship Channel. The port underwent a major expansion in 2000 enabling it to serve a variety of rail, shipping, barge, and roadway carriers.

What happens next with the IRS dispute remains open to conjecture. 

“If the issuer wants to keep going, as opposed to settling with the IRS by most likely making a payment to them and taking some or all of the bonds off the market, then the next step is to go to the IRS Appeals Office,” said Hutchinson. 

Attorneys believe the appeals process to be a fair and independent procedure, even though the system is run by the IRS, the same agency that’s logging the complaint.  

“On its face, it might look like a bad thing, but that is not always true,” said Rich Moore, a tax partner at Orrick, Herrington & Sutcliffe. “It can also be an opportunity for the issuer and its counsel to stop debating the matter with the same folks that determined there was a problem and may have become entrenched in their views.  The folks at appeals may view the case more favorably to the issuer.” 

Judy Bettis, Port of Port Arthur’s chief financial officer could not be reached for comment.