Port of Port Authur: $55 Million Municipal Bonds Ruled Taxable by IRS

In 2017, the Port of Port Authur issued $55M of its Texas Unlimited Tax Port Improvement Bonds, Series 2017A Bonds to finance construct and improve or develop wharves, docks, warehouses, other storage facilities, terminal facilities and aids to navigation at the port.  An annual ad valorem tax, without legal limit as to rate or amount, levied against all taxable property located within the port's jurisdictional boundaries provided security for the payment of principal of and interest on the bonds.

This issue of Bonds was the second installment of $89,950,000 of authorized but unissued bonds approved by the voters of the District at an election held May 7, 2016. The District had previously issued its Unlimited Tax Port Improvement Bonds, Series 2017 which utilized $29,800,000 of the voter authorization tax held at an election on May 7, 2016.

By a letter dated August 7, 2023 to the Port, the Internal Revenue Service issued a Notice of Proposed Issue (Form 5701‐B, including Form 886‐A Explanation of Items) (collectively, the “Notice”) relating to the Port's Unlimited Tax Port Improvement Bonds, Series 2017A (the “Series 2017A Bonds”).  The Notice contains a proposed notice of adverse determination that the Series 2017A Bonds are taxable hedge bonds due to the port's alleged failure to comply the reqquirements of Section 149(g) of the Internal Revenue Code, which provides certain expectations for the timely expenditure of tax‐exempt bond proceeds.

“How long do I have to spend tax-exempt bond proceeds?”

"As soon as possible," says Eric LaFleur, bond counsel at LaFleur & Laborde. "By their nature, tax exempt bonds allow issuersto borrow money at lower rate of interest as the purchaser of those bonds pays no income tax on the interest earned from those bonds.  The lower interest rate paid for those borrowed funds provides a savings to the issuer and reduction in the overall costs of the project." 

"At the same time, however, the tax exempt bonds deprives the U.S. Treasury of tax revenue. Genewr

Regularly discussed with issuers of tax exempt bonds On August 23, 2023, the Internal Revenue Service issued a notice of proposed adverse determination to the Port of Port Arthur Navigation District of Jefferson County, Texas, indicating that a 2017 $55 million bond issuance will be considered taxable.  According to the notice posted on EMMA, the infraction is related 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.  In the same notice, which is not a final determination, the port says it "believes it has complied with the applicable provisions of the federal Internal Revenue Code and intends to defend its position." Issuers have 30 days to make a request for an administrative appeal of its case. 

Section 149(g) was added to the tax code by the Omnibus Budget Reconciliation Act of 1989 and is designed to discourage municipalities from taking advantage of low interest rate for ill-defined uses while the excess debt remains shielded from taxes.    According to 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." Expectations and reality can be complicated by the reasons behind spending delays which can include supply chain issues, labor disruptions, litigation about the project and the inability to get approvals. 

The rule has a complicated history among tax attorneys who believe that in the past the IRS was sometimes over aggressive when analyzing the issue by applying 20/20 hindsight to the reasonableness of the issuer's expectations. Debate about cases can come down to judgment calls about whether the issuer had the correct reasonable expectations at closing.   In July the Government Finance Officers Association awarded the port with a Certificate of Achievement for Excellence in Financial Reporting.