The IRS is placing increased scrutiny on the use of tax exempt bonds by 501(c)(3) organizations. Since interest earned on the revenue bonds issued by state and local governmental organizations is exempt from federal income taxation, bonds are subject to compliance with federal tax law requirements.
One important requirement under the Internal Revenue Code is that not more than 5% (or 10% in the case of a governmental unit) of the net proceeds of the bonds, before issuance costs, may be used for private business use.
Private business use means the use of the bond financed facility, both actual or beneficial use, by a person other than a 501(c)(3) organization or a state or local government or by a 501(c)(3) in an activity that is an unrelated trade or business.
If the property is used both for a related purpose and an unrelated purpose, the property is still considered used in a private use, but the private business use may be allocated. If the organization fails the private use test, then the interest on the bonds can become taxable.
It is common for private business use to arise in connection with management and rental contracts at colleges and universities with management of cafeterias, concession stands, bookstores, retail facilities, parking garages, summer camps, other rental activities, or research contracts. If you have contracts with these types of activities, it is recommended that you review the contracts and make sure they meet an exclusion or the safe harbor requirements under the Code based on your facts and circumstances. The Code does provide for exceptions to private business use, such as use by the general public, incidental use, and short term use, but you must meet the requirements under each exception.
If you would like more information on private business use or help with review of your current or potential contracts, please contact your Dean Dorton advisor or Allison Carter at alcarter@deandorton.com.
