Pursuant to the requirements of Securities and Exchange Commission Rule 15c2-12 (the Rule), the University of Rhode Island (the University), on behalf of itself and the Rhode Island Health and Educational Building Corporation (RIHEBC), provided a notice of material event (the Disclosure) with respect to two series of bonds issued in 2018 by RIHEBC (the Bonds). Specifically, the University indicated that the IRS sent a notice (the Notice) containing a preliminary determination that the Bonds are taxable hedge bonds due to alleged noncompliance with requirements of section 149(g) of the Internal Revenue Code (the Code).

Section 149(g) was added to the Code to limit issuers from issuing tax-exempt bonds without expecting to use the proceeds in a timely manner, so-called “hedge bonds.” In other words, section 149(g) was enacted so that issuers will issue tax-exempt bonds only when they have an expectation to use the proceeds of such tax-exempt bonds.

In general, a bond is not a hedge bond, and thus eligible for tax-exempt status, if an issuer reasonably expects that:

• 85% of the spendable proceeds of the issue will be used to carry out the governmental purposes of the issue within the 3-year period beginning on the date the bonds are issued; and
• not more than 50% of the proceeds of the issue are invested in nonpurpose investments (as defined in section 148(f)(6)(A)) having a substantially guaranteed yield for 4 years or more.

It is important to note that section 149(g) does not require bond proceeds to be spent in a specific timeframe but instead relates the reasonable expectations of the issuer at the time of issuance. In general, issuers will confirm these reasonable expectations in a tax certificate signed at issuance, and the hedge bond rules in section 149(g) are considered satisfied at that point. Upon examination, however, the IRS may challenge that an issuer either did not have these expectations, or that the expectations were not reasonable.

In either case, the challenge is based on a subjective assertion, and the issuer will bear the burden to show that its expectations were reasonable and satisfactory at issuance. To avoid any doubt, issuers should adequately document the basis for their expectations about the expenditure of proceeds at issuance. Such documentation may include signed contracts for projects expected to be financed with the tax-exempt bonds or other objective manifestations that show the expectations satisfying section 149(g) are reasonable.

If, after issuance, circumstances change to where the proceeds of a tax-exempt bond will not be spent according to the expectations at issuance, issuers may document why the circumstances have changed and why the changes were outside of the issuer’s control. This subsequent documentation will be valuable in the event of an examination.

With regard to the University, the Notice is a preliminary determination, and the University may still show its expectations at issuance were reasonable.

All issues subject to the Rule are required to provide similar notice to the Disclosure upon the communication by the IRS of a proposed or final determinations of taxability, Notices of Proposed Issue (IRS Form 5701-TEB), or other material notices or determinations with respect to the tax status of an issue, or other material events affecting the tax status of the issue.

To discuss any concerns regarding the timely expenditure of tax-exempt bond proceeds, or disclosure requirements with respect to tax-exempt bonds, please contact any member of the Taft Public Finance team.