By Lorne Simmons
Tax reform could impact not-for-profits (NFPs)
The current version of the House Committee on Ways and Means draft of the tax reform bill (Bill) could have significant implications on the Municipal Bond Market in general, and on 501(c)3 organizations, in particular. The proposed changes would become effective December 31, 2017, and will affect 501(c)3s in a variety of ways. Most importantly, proposed provisions could alter both the way in which, and the rate at which, 501(c)3s borrow. Some of the key provisions and their possible effects are discussed below.
Provision: The Elimination of Private Activity Bonds (including 501(c)3 Public Bonds)
Effect: Increases Cost of Capital for 501(c)3 Borrowers
Private Activity Bonds (PABs), specifically Qualified 501(c)3 Bonds, are the mechanism through which 501(c)3s borrow at lower rates than their for‐profit peers via tax‐exempt debt, consisting mostly of tax‐exempt fixed rate bonds and tax‐exempt bank loans. The current House Bill proposes eliminating PABs, thereby shutting off access of 501(c)3s to financing at lower interest rates. This could eliminate the ability of NFP nursing homes and other long term care providers to issue tax‐exempt debt.
Any “draw‐down” tax‐exempt loans already issued would need to be fully drawn before January 1 to avoid jeopardizing the tax‐exempt status of the debt. Any 501(c)3 that currently has a draw down tax‐exempt loan that is not fully drawn down by the end of the year should arrange to have that loan fully funded by the end of the year. Also, any tax‐exempt bank loans that are already issued may become taxable when the loan is renegotiated on the reset date. If the current rate increases by more than 25 basis points, the loan would be considered a new issue. As a new issue, it would not qualify as a tax-exempt loan under the proposed bill. Therefore, if borrowers have existing bank loans with short reset dates, they should arrange before the end of the year to extend the reset date as long as possible.
Provision: Reduction in Corporate Tax Rate
Effect: Increases Rates on Existing and Future Tax‐Exempt Bank Obligations
Even if the above provision is eliminated from the Bill, the Bill has another provision to decrease corporate tax rates from their current levels, which will directly impact Directly Placed Tax‐Exempt Bank Bought Bonds (Tax‐Exempt Bank Loans), both existing and future. When banks make tax‐exempt loans, they are effectively passing the benefit of a tax‐rule on to the borrower in the form of a lower interest rate. The size of that tax benefit to the bank (and therefore to the borrower) is tied directly and proportionately to the prevailing corporate tax rate. If the corporate tax rate is reduced, the bank’s benefit is reduced. For Existing Tax‐Exempt Loans, the bank would now be left with a loan that is less profitable than originally anticipated. Banks are generally uncomfortable with this “tax risk,” and as a result pass that risk to borrowers in the form of “gross up provisions” in the legal documents, which allow the bank to change your interest rate (upward) on existing loans if the corporate tax rate falls. The rights of the bank to pass on the cost of the effects of the change of the corporate tax rate will depend on the particular language in your documents. For Future Tax‐Exempt Loans, rates will be higher to reflect the diminished benefit that the bank will receive as result of holding tax‐exempt obligations.
There are several actions you might consider pursuing to mitigate the effects of the proposed legislation.
- For existing tax‐exempt bank loans, determine the effects of any “gross up” language in the loan documents. For contemplated loans, consider negotiating the terms of the gross up language the banks will attempt to include. In addition, consider renegotiating the length of the bank commitment to a much longer date.
- For any contemplated financings, including advance refundings, consider the benefits and costs of accelerating those endeavors to close prior to year‐end.
- If you have recently issued any “draw‐down” tax‐exempt loans, consult your tax counsel regarding the need to fully draw on those obligations prior to year‐end.
As a reminder, these provisions are based only on the House bill language. At the time this article was written, the Senate language had just been released. However, their draft language did not address these provisions in the House bill. The final outcome of any tax reform law passed by the full Congress will be determined through the legislative conferencing process.
Workers’ comp insurance set for 2018
We reported in the last Pulse edition on the Office of Insurance Regulation (Office) requirement to review and approve or counter the National Council on Compensation Insurance (NCCI) proposal of a 9.6% reduction in workers’ compensation insurance rates for 2018. We are pleased to inform you that on November 9, 2017, the Florida Office of Insurance Regulation (OIR) issued a Final Order approving a rate level decrease of 9.5% for Florida workers’ compensation rates effective January 1, 2018. This is an average rate decrease which means most of the class codes will see a rate decrease; however, there are class codes that will experience an increase.
Lorne Simmons and Sandy Swindling are with Moore Stephens Lovelace, PA, FHCA’s CPA Consultant. Learn more about MSL at www.mslcpa.com.