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The 501(c)(3) Opinion in Qualified 501(c)(3) Bond Transactions The 501(c)(3) Opinion In Qualified 501(c)(3) Bond Transactions Background, Opinion Formulations.

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Presentation on theme: "The 501(c)(3) Opinion in Qualified 501(c)(3) Bond Transactions The 501(c)(3) Opinion In Qualified 501(c)(3) Bond Transactions Background, Opinion Formulations."— Presentation transcript:

1 The 501(c)(3) Opinion in Qualified 501(c)(3) Bond Transactions The 501(c)(3) Opinion In Qualified 501(c)(3) Bond Transactions Background, Opinion Formulations and Due Diligence

2 The 501(c)(3) Opinion in Qualified 501(c)(3) Bond Transactions E. Tyler Smith Haynsworth Sinkler Boyd, P.A. Greenville, South Carolina (864) Antonio D. Martini Edwards Wildman Palmer LLP Boston, Massachusetts (617)

3 The 501(c)(3) Opinion in Qualified 501(c)(3) Bond Transactions Notice The following is provided to further legal education and research and is not intended to provide legal advice or counsel as to any particular situation. The National Association of Bond Lawyers takes no responsibility for the completeness or accuracy of this material. You are encouraged to conduct independent research of original sources of authority. If you discover any errors or omissions, please direct those and any other comments to the President of NABL. National Association of Bond Lawyers 601 Thirteenth Street, NW, Suite 800 South Washington, D.C Phone (202) Copyright © 2014 National Association of Bond Lawyers

4 The 501(c)(3) Opinion in Qualified 501(c)(3) Bond Transactions Introduction Topic – Legal opinions rendered in qualified 501(c)(3) bond transactions as to 501(c)(3) status of borrower Purpose of report – Educational resource Not model form language – Fill a void in published commentary

5 The 501(c)(3) Opinion in Qualified 501(c)(3) Bond Transactions Introduction Overview of presentation – Background of qualified 501(c)(3) transactions – Requirements for 501(c)(3) organizations in general – Purpose and common formulations of 501(c)(3) opinion – Due diligence By counsel rendering the 501(c)(3) opinion – Typically “borrower’s counsel” By counsel relying upon the 501(c)(3) opinion – Typically “bond counsel” – Bond counsel’s reliance on borrower’s counsel opinion

6 The 501(c)(3) Opinion in Qualified 501(c)(3) Bond Transactions Qualified 501(c)(3) bond transactions In general – Section 145 of Internal Revenue Code – Bonds are issued by governmental issuer (the “issuer” or “conduit issuer”) for benefit of a 501(c)(3) organization (the “borrower” or (“conduit borrower”)

7 The 501(c)(3) Opinion in Qualified 501(c)(3) Bond Transactions Legal opinions generally Typical division of opinion responsibilities – Bond counsel’s opinion Validity and tax exempt status – The Bonds are validly issued and enforceable – Interest on the Bonds is excludable from gross income for federal income tax purposes » Involves evaluating the 501(c)(3) status of the borrower – Borrower’s counsel’s opinion 501(c)(3) status (among other matters) – Bond counsel typically relies upon borrower counsel’s 501(c)(3) opinion – Borrower’s counsel likely to have closest relationship with the borrower to render the opinion

8 The 501(c)(3) Opinion in Qualified 501(c)(3) Bond Transactions Legal opinions generally Alternative divisions of opinion responsibilities – Borrower’s counsel and bond counsel are the same May render express 501(c)(3) opinion May subsume 501(c)(3) status opinion in the general tax opinion – Bond counsel doesn’t rely upon borrower’s counsel’s opinion May render express 501(c)(3) opinion May subsume 501(c)(3) status opinion in the general tax opinion – Special 501(c)(3) counsel Allocation of responsibilities – Counsel should allocate responsibilities early in the transaction Avoidance of confusion Planning and undertaking of due diligence as to 501(c)(3) status

9 The 501(c)(3) Opinion in Qualified 501(c)(3) Bond Transactions Legal opinions generally Absence of uniform 501(c)(3) opinion standard – Phrasings and interpretation vary From lawyer to lawyer / firm to firm From region to region The NABL report provides commentary and guidance – Not intended as adopting a uniform standard

10 The 501(c)(3) Opinion in Qualified 501(c)(3) Bond Transactions 501(c)(3) organizations Benefits include – Exemption from federal income tax – Ability to receive tax-deductible contributions – Ability to borrow on a tax-exempt basis – Other benefits

11 The 501(c)(3) Opinion in Qualified 501(c)(3) Bond Transactions 501(c)(3) organizations Requirements to be a 501(c)(3) organization – Must be organized and operated exclusively for certain specified exempt purposes – No part of net earnings may inure to the benefit of a private shareholder or individual – No political campaigning and no substantial part of activities may consist of attempts to influence legislation – Information reporting requirements IRS Form 990

12 The 501(c)(3) Opinion in Qualified 501(c)(3) Bond Transactions 501(c)(3) organizations Organizational test – Must be organized exclusively for exempt purposes Limitations must be stated in articles of organization Exempt purposes include, among others: – Religious – Charitable purposes which include, among others: » Relief of the poor » Promotion of health » Lessening the burdens of government – Scientific – Educational – Must not be organized to substantially benefit private interests – Must permanently dedicate is assets to exempt purposes Articles of organization will provide that, on dissolution, assets to be distributed to one or more exempt purposes or to a governmental entity – In some states this may be satisfied “outside” the articles by operation of state law applicable to nonprofit corporations

13 The 501(c)(3) Opinion in Qualified 501(c)(3) Bond Transactions 501(c)(3) organizations Operational test – Prohibition on “private inurement” No part of net earnings may inure to private shareholders or individuals – Officers, directors and employees and others may receive benefits so long as reasonable and in exchange for fair value – Private inurement can be basis for revocation of 501(c)(3) status “Intermediate sanctions” rules are an alternative to revocation – The rules impose excise taxes on “disqualified persons” and “organization managers” who benefit from or approve “excess benefit transactions” Political campaigning and legislative activities – Prohibition on participating or intervening in any political campaign on behalf of, or in opposition to, any candidate for public office – Prohibition on advocating on adoption or rejection of legislation …unless such activities are not more than an insubstantial part of activities

14 The 501(c)(3) Opinion in Qualified 501(c)(3) Bond Transactions 501(c)(3) organizations Annual Information and Reporting – Most organizations must file Form 990 annually – If there is any unrelated business taxable income, Form 990-T Along with any taxes due – Automatic revocation if organization fails to file Form 990 for three consecutive years – IRS may revoke 501(c)(3) status of organization that, without reasonable cause, does not file complete and accurate Forms 990 Changes in operations – Changes in character, purposes or operations must be disclosed to the IRS Disclosure may be accomplished on Form 990

15 The 501(c)(3) Opinion in Qualified 501(c)(3) Bond Transactions 501(c)(3) organizations Recent legislative changes for hospitals – Patient Protection and Affordable Care Act Added Section 501(r) to the Internal Revenue Code – Organizations operating hospital facilities must: Establish written financial assistance / emergency care policies Limit amounts charged for emergency or other care to individuals eligible for assistance under the financial assistance policy Make reasonable efforts to determine whether an individual is eligible for assistance before engaging in extraordinary collections actions Conduct a community health needs assessment and adopt implementation strategy at least once every three years

16 The 501(c)(3) Opinion in Qualified 501(c)(3) Bond Transactions Application for 501(c)(3) status IRS Form 1023 – “Application for Recognition of Exemption Under Section 501(c)(3) of the Internal Revenue Code” Exemption for churches IRS issues ruling or determination letter on 501(c)(3) status – Typically effective as of date of organization’s formation – IRS includes name of organization in online listing “Exempt Organizations Select Check” – Formerly “IRS Publication 78” – Group exemptions

17 The 501(c)(3) Opinion in Qualified 501(c)(3) Bond Transactions The 501(c)(3) Opinion Qualified 501(c)(3) bonds – To be tax-exempt, the bonds must finance property owned by a 501(c)(3) organization (or a state or local governmental unit) Thus the 501(c)(3) status of the borrower is fundamental to the tax-exempt status of the bonds – The borrower must qualify as a 501(c)(3) organization on the issue date and for so long as the bonds are outstanding – Substantially all of the uses of the bond-financed property must be for the 501(c)(3) organization’s approved exempt purposes Latest IRS determination may be dated – At the time of issue of the bonds, the most recent determination or examination confirming the borrower’s 501(c)(3) status may be dated – Thus a 501(c)(3) opinion should address two points...

18 The 501(c)(3) Opinion in Qualified 501(c)(3) Bond Transactions The 501(c)(3) Opinion The 501(c)(3) opinion should address two points – The first point: Whether the borrower has been determined to be a 501(c)(3) organization by the IRS as of the date of the 501(c)(3) opinion – The second point: Whether, since that determination, the borrower has continued to be organized and operated in a manner to qualify as a 501(c)(3) organization through the date of the 501(c)(3) opinion

19 The 501(c)(3) Opinion in Qualified 501(c)(3) Bond Transactions The 501(c)(3) Opinion Simplest formulation – “The Borrower is an organization described in Section 501(c)(3) of the Code” This should be interpreted as addressing the first point: A borrower would not be a 501(c)(3) organization without having been determined to be such by the IRS, and such determination has not been revoked The wording suggests coverage of the second point by stating that the borrower “is” a 501(c)(3) organization as of the date of the opinion – However, the description of the due diligence undertaken by borrower’s counsel generally should be reviewed as well. » Does the opinion state that borrower’s counsel has examined such facts and law as are necessary to enable the opinion to be rendered? » Does the opinion state that borrower’s counsel has relied solely upon the IRS determination letter or a certificate from an officer of the borrower?

20 The 501(c)(3) Opinion in Qualified 501(c)(3) Bond Transactions The 501(c)(3) Opinion “Has been determined” limited formulation – “The Borrower has been determined by the Internal Revenue Service to be an organization described in Section 501(c)(3) of the Code” This would be generally interpreted as addressing the first point But this wording fails to address the second point – When taken alone, this formulation should be considered inadequate – Referred to in the NABL report as the “limited formulation”

21 The 501(c)(3) Opinion in Qualified 501(c)(3) Bond Transactions The 501(c)(3) Opinion Limited formulation coupled with negative assurance – No standard formulation – Provides assurance that the opinion giver has no knowledge, based upon due diligence, of circumstances that would cause the organization to fail to meet the requirements for 501(c)(3) status

22 The 501(c)(3) Opinion in Qualified 501(c)(3) Bond Transactions The 501(c)(3) Opinion Examples of “negative assurance” language – “Based on a certificate of the Chief Financial Officer of the Borrower, our examination of certain records of the Borrower, discussions with the above-referenced officer of the Borrower and factual representations made by other senior officers of the Borrower (in each instance as to those issues that would, in our experience, most likely affect the Borrower’s status as an organization described in Section 501(c)(3) of the Code), nothing has come to our attention that would cause us to believe that the Borrower (1) has not conducted its operations in a manner necessary to maintain its status as such an exempt organization, (2) has not made all filings necessary to maintain its status as such an exempt organization, or (3) has done anything known to it to impair its status as such an exempt organization.” – “To our knowledge, based on our review of the Exempt Status Documents and any Exempt Status Discussions, the Borrower has not failed to file a return with the IRS which is required to be filed to maintain its status as an exempt organization described in Section 501(c)(3) of the Code or engaged in conduct inconsistent with its status as an exempt organization described in Section 501(c)(3) of the Code.” – “To our knowledge, after due inquiry, the Borrower has conducted its operations and has made all necessary filings so as to maintain its status as an exempt organization described in Section 501(c)(3) of the Code and has done nothing to impair its status as an exempt organization. To our knowledge, after due inquiry, the Borrower has not received notice or any other communication from the Internal Revenue Service questioning, directly or indirectly, its status as an exempt organization under Section 501(c)(3) of the Code.”

23 The 501(c)(3) Opinion in Qualified 501(c)(3) Bond Transactions The 501(c)(3) Opinion Question – Does the limited formulation, even with negative assurance, fall short of the full coverage of the second point discussed above? That is, has the borrower continued to be organized and operated in a manner to qualify as a 501(c)(3) organization through the date of the 501(c)(3) opinion? If not, is bond counsel at least partially responsible for the ultimate conclusion on this point? – Under these circumstances bond counsel may consider increasing the amount of 501(c)(3) due diligence it might otherwise perform

24 The 501(c)(3) Opinion in Qualified 501(c)(3) Bond Transactions The 501(c)(3) Opinion Additional potential opinions – The Section 513 opinion That the bond-financed project is not, or will not be, used in an unrelated trade or business – Use of qualified 501(c)(3) bond financed property in an unrelated trade or business results in private business use – The “private foundation” opinion That the borrower is not a “private foundation” as defined in Section 509(a) of the federal tax code – Not a critical element for purposes of issuing qualified 501(c)(3) bonds – The Section 7701 opinion When a limited liability company “inherits” the 501(c)(3) status of its parent company with which it is disregarded for federal income tax purposes – Group exemptions If the borrower relies upon a group exemption letter through its parent for its 501(c)(3) status, an opinion that the parent is a 501(c)(3) organization and has taken steps to include the borrower under the group exemption

25 The 501(c)(3) Opinion in Qualified 501(c)(3) Bond Transactions Due Diligence 501(c)(3) issues reviewed in general – Organizational Test Review organizational documents for charitable purpose and provision for proper dissolution of assets – IRS Determination IRS determination letter and listing on IRS “Exempt Organizations Select Check” website – Operational Test Has the organization operated in furtherance of the exempt purpose for which it was granted tax-exempt status? – Private Inurement Impermissible levels of private inurement?

26 The 501(c)(3) Opinion in Qualified 501(c)(3) Bond Transactions Due Diligence 501(c)(3) issues reviewed in general – Lobbying / Political Campaigns Has the organization engaged in prohibited political campaigning or excessive lobbying? – Unrelated Business Activity Has the organization received excessive unrelated business income or otherwise been involved in excessive unrelated business activity? – Reporting Obligations Including annual filings of Forms 990 and 990-T

27 The 501(c)(3) Opinion in Qualified 501(c)(3) Bond Transactions Due Diligence Basic documents for 501(c)(3) review – Organizational documents – Bylaws and other governing documents – Application to IRS for 501(c)(3) status (Form 1023) – 501(c)(3) determination letter and any IRS updating or confirming letters – IRS Forms 990 – IRS Forms 990-T – Operational minutes – Conflicts of interest policies – Compensation materials

28 The 501(c)(3) Opinion in Qualified 501(c)(3) Bond Transactions Due Diligence Further diligence – Due diligence telephone conferences – Formal due diligence sessions – Project/site visits – Publicly available resources – Institutional knowledge – Transaction documentation

29 The 501(c)(3) Opinion in Qualified 501(c)(3) Bond Transactions Particular Types of Borrowers What follows is a list of examples of the types of due diligence counsel may perform for certain types of borrowers. The list provides examples but is not intended to be exhaustive of the types of due diligence that counsel may perform.

30 The 501(c)(3) Opinion in Qualified 501(c)(3) Bond Transactions Particular Types of Borrowers Hospitals and Healthcare Systems – Community benefit standard under IRS Revenue Ruling Full time emergency room? Care for all persons in the community? Extent of charity care? Ways in which the hospital directs surplus moneys? Makeup of the governing board? Extending of privileges to all qualified physicians? Serve a sufficiently large portion of the community? Educational and research activities? – New requirements under the Affordable Care Act (discussed above) Written financial assistance and emergency medical care procedures? Does the facility limit amounts charged for emergency services to individuals eligible for assistance? Does the facility make efforts to determine whether individuals are eligible for financial assistance before engaging in extraordinary collection efforts? Does the facility conduct a community health needs assessment and adopt implementation strategy at least every three years? – Schedule H to IRS Form 990

31 The 501(c)(3) Opinion in Qualified 501(c)(3) Bond Transactions Particular Types of Borrowers Educational Institutions – Anti-discrimination policies IRS Revenue Ruling – Maintain an anti-discriminatory admissions policy? – Publicize the policy? Schedule E to IRS Form 990 Continuing care facilities – IRS Revenue Ruling Provide care and housing to the aged otherwise unable to provide for themselves? Services rendered to residents at below actual cost? Services minister to the needs and relief of hardships of the aged? – IRS Revenue Ruling Does the facility satisfy the need for housing? Satisfy the need for healthcare? Address the need for financial security?

32 The 501(c)(3) Opinion in Qualified 501(c)(3) Bond Transactions Particular Types of Borrowers Residential rental facilities – Does the project accomplish the borrower’s charitable purposes? Applicable safe harbors based on occupancy and income levels Childcare facilities – Does the facility further “educational purposes”? This includes providing care of children away from their homes if substantially all care is for enabling persons to be gainfully employed and services are available to the general public. Religious organizations – Considerations regarding Establishment Clause of U.S. Constitution E.g., an organization teaching of religious as truth in public schools Generally not a 501(c)(3) tax status issue, but may affect validity/enforceability of governmental bonds issued for conduit borrower’s benefit Lessing the burdens of government – Would a governmental unit consider the organization’s activities alleviating a governmental burden? – Do the activities actually lessen such burden?

33 The 501(c)(3) Opinion in Qualified 501(c)(3) Bond Transactions Bond Counsel Due Diligence Prevailing practice of relying on borrower counsel’s opinion Bond counsel’s opinion standard – “Unqualified in nature” Is bond counsel “firmly convinced” (a “high degree of confidence”) that the highest court of the jurisdiction would reach the same legal conclusions? – For bond counsel’s tax opinion, the highest court is the U.S. Supreme Court – Bond counsel will typically expressly state reliance on borrower counsel’s opinion

34 The 501(c)(3) Opinion in Qualified 501(c)(3) Bond Transactions Reliance on Borrower’s Counsel’s Opinion Is reliance on the borrower’s counsel opinion reasonable? – Reputation of borrower’s counsel for competence in the applicable matter? – Does the opinion respond to the needs of the bond counsel opinion? IRS Circular 230 – Reliance is not considered reasonable when bond counsel knows or reasonably should know: That borrower’s counsel opinion should not be relied upon That borrower’s counsel is not competent or lacks necessary qualifications That borrower’s counsel has a conflict of interest – Bond counsel will typically expressly state reliance on borrower counsel’s opinion

35 The 501(c)(3) Opinion in Qualified 501(c)(3) Bond Transactions Reliance on Borrower’s Counsel’s Opinion Should bond counsel “look behind” borrower’ counsel’s opinion? – Considerations Expertise of borrower’s counsel in 501(c)(3) matters Historical relationship between borrower’s counsel and bond counsel Historical relationship between borrower’s counsel and the borrower The scope of the 501(c)(3) opinion that borrower’s counsel is willing to render – Bond counsel may: Deem itself comfortable to rely on borrower’s counsel 501(c)(3) opinion without doing more Perform limited due diligence – Review organizational documents, IRS determination letter, review recent Forms 990, inquire as to audits and discuss with borrower’s counsel the extent of borrower’s counsel’s diligence Perform additional due diligence – Particularly when the scope of the borrower’s counsel opinion is limited » E.g., the “limited formulation” discussed above) » When borrower’s counsel relies solely on the borrower’s determination letter of limited borrower certifications

36 The 501(c)(3) Opinion in Qualified 501(c)(3) Bond Transactions Reliance on Borrower’s Counsel’s Opinion Should bond counsel “look behind” borrower counsel – Considerations Expertise of borrower’s counsel in 501(c)() matters Historical relationship between borrower’s counsel and bond counsel Historical relationship between borrower’s counsel and the borrower The scope of the 501(c)(3) opinion that borrower’s counsel is willing to render – Bond counsel may: Choose to rely on borrower’s counsel 501(c)(3) opinion without doing more Perform limited due diligence – Review organizational documents, IRS determination letter, review recent Forms 990, inquire as to audits and discuss with borrower’s counsel the extent of borrower’s counsel’s diligence Perform additional due diligence – Particularly when the scope of the borrower’s counsel opinion is limited » E.g., the “limited formulation” discussed above » When borrower’s counsel relies solely on the borrower’s determination letter of limited borrower certifications

37 The 501(c)(3) Opinion in Qualified 501(c)(3) Bond Transactions Conclusion To ensure that the 501(c)(3) status of the borrower is appropriately evaluated, it is important that, as early as possible during the course of a qualified 501(c)(3) bond transaction, bond counsel, borrower’s counsel and other applicable counsel (e.g., underwriter’s counsel in a publicly offered bond issue, purchaser’s counsel in a privately placed bond issue) allocate responsibilities for conducting due diligence and opining (either expressly or impliedly) on the 501(c)(3) status of the borrower. Counsel opining on the 501(c)(3) status of the borrower will need to consider the due diligence it needs to perform in rendering such an opinion. When relying on the 501(c)(3) opinion of borrower’s counsel, bond counsel also will need to consider the due diligence, if any, it needs to perform.

38 The 501(c)(3) Opinion in Qualified 501(c)(3) Bond Transactions The 501(c)(3) Opinion In Qualified 501(c)(3) Bond Transactions Background, Opinion Formulations and Due Diligence


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