IRS and Port of Port Arthur, Texas, settle tax status dispute

Bonds

The Internal Revenue Service has settled with the Port of Port Arthur Navigation District of Jefferson County, Texas regarding the tax-exempt status of a 2017 $55 million bond issuance.  

The issuer disclosed the recent settlement on EMMA Monday, concluding the matter after it was first disclosed months ago.

“As a result, there is no change to the tax-exempt status of the interest on the Series 2017A Bonds for federal income tax purposes,” the disclosure said.

“Typically, these audits are settled by redeeming or defeasing some amount of bonds and by making a payment to the IRS of “taxpayer exposure” on some portion of the bonds,” said Johnny Hutchinson, a partner at Nixon Peabody. “This payment is intended to compensate the federal government for lost tax revenue over some period of time on interest on the bonds.” 

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Judy Bettis, Port of Port Arthur’s chief financial officer, the Port’s general counsel, and the bond counsel all declined to comment on the terms of the settlement. 

“For whatever its reasons were, the issuer has determined it is better to settle the audit than to continue its battle with the IRS,” said Rich Moore, a tax partner with Orrick, Herrington & Sutcliffe.   

“Perhaps the cost of the settlement was small enough that it just financially made more sense to the issuer to settle than to continue to pay legal fees to pursue this matter.  Or maybe the issuer did recognize that there was an actual problem on the tax side and decided that prolonging this examination would be unlikely to change the result.” 

In late January the IRS notified the Port that the situation has escalated from a “Notice of Proposed Issue” to a “Proposed Adverse Determination.” The Port countered with notice that it believed it followed the regulations and intended to defend its position. 

The examination has been going on since last August and stemmed from an 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.” 

Section 149(g) was added to the tax code in 1989 as part of the Omnibus Budget Reconciliation Act. It’s designed to discourage municipalities from taking advantage of low interest rates for ill-defined uses while the excess debt remains shielded from taxes.   

The law can trip up issuers and their reasonable expectations about spending bond proceeds within a certain time frame. If expectations collide with reality the IRS can judge that hedging is involved and taxes are due. How much is due in the case is unclear. 

“Rumor has it that sometimes such matters are settled based on a formula that looks at the portion of the proceeds that, if actual facts were applied to the hedge bond test, were not spent in time to satisfy that test, and the amount of extra time that was needed to spend such proceeds,” said Moore. 

Other legal remedies may also be exercised. “Typically, these audits are settled by redeeming or defeasing some amount of bonds and by making a payment to the IRS of ‘taxpayer exposure’ on some portion of the bonds,” said Johnny Hutchinson, a partner at Nixon Peabody. “This payment is intended to compensate the federal government for lost tax revenue over some period of time on interest on the bonds.” 

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.

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