General Rules for Qualified Non-Profits
- Project Owned by Non-Profit. 100% of the project financed must be owned by a Section 501(c)(3) organization or the government.
- Exempt Purpose Use. The bond proceeds must be used for activities related to a 501(c)(3) organization’s exempt purpose.
- Private Business Restrictions. No more than 5% of the net proceeds may be used in private trade or business.
- Donor Restrictions. Tax-Exempt Bonds can’t replace donations earmarked for a capital project.
- 2% Limit on Issuance Costs – Issuance costs are limited to 2% of the Sales Proceeds (amount of bonds issued)
- 95% Use Test Rule – 95% or more of the “net proceeds” (sales proceeds minus reserve fund) of the bond issue must be used to finance the qualified purpose for which the bonds were issued.
- Qualified Use Allocation – allocation of proceeds among the various project expenditures in a manner demonstrating compliance with the qualified use.
- Subject to Arbitrage and Rebate Rules
- Substantial User Prohibition – no person who is a substantial user of a facility financed with qualified private activity bonds, or any person related to such a user, can receive tax-exempt interest income as a holder of those bonds.
- No direct or indirect federal guarantees except governmental entities administering federal insurance programs for home mortgages and student loans and the investment of bond proceeds in U.S. Treasury securities.
- No prohibited facilities (skybox, gambling, liquor, etc.)
- Weight average maturity of Bonds may not exceed 120% of useful life of asset financed. (ignore land; life of working capital equals zero.)
Management Contract Rules under Revenue Procedure 97-13
- For-profit manager can be paid expenses and reasonable fee for services.
- No part of manager’s fee may be based on net revenues.
- Formulaic approach to permitted duration—15 years if 95% of fee is fixed; 10 years if 80% of fee is fixed; 5 years if 50% of fee is fixed. With 50% fixed fee, contract must be terminable by the 501(c)(3) at year 3 without penalty.
Signs it may not be an Eligible Project
IRS field agents’ manual highlights 7 “red flags” that suggest possible violations:
- Board scattered with no connection to project/community.
- Created and controlled by a for-profit.
- Organizational/start-up costs of the IRC Section 501(c)(3) organization paid by (loan from) for-profit.
- For-profit seller of project recently acquired it at significantly lower price.
- For-profit seller is buying subordinated debt.
- Letter of credit bank or guarantor has control over IRC Section 501(c)(3) organization’s budget/finances.
- Management contract violates Rev. Proc. 97-13.