Cherokee County School System, Ga., says material event affects tax-exempt status of some bonds

By Susanna Moon

Chicago, Dec. 5 – Cherokee County School System, Ga., said there was a material event that affects the tax-exempt status of its series 2007A and series 2007B bonds.

The bonds affected by the notice are the $125 million Cherokee County School System general obligation bonds, series 2007A, and $41,915,000 Cherokee County School System G.O. bonds, series 2007B.

The bonds were issued in April 10, 2007.

On May 19, 2014, the Internal Revenue Service’s tax-exempt and governmental entities division randomly selected the bonds for a routine bond examination to determine compliance with federal tax requirements, according to a notice.

The series 2007B bonds were issued for the purpose of refunding a portion of the district’s outstanding G.O. bonds, series 2001, and G.O. bonds, series 2003.

Some of the escrow obligations were required to be rolled over at specific dates and used to purchase zero-coupon U.S. Department of Treasury – state and local government securities.

During the examination, the district determined that the rollover scheduled for Feb. 1, 2011 was not made timely due to the escrow agent’s failure to timely subscribe for the securities to provide for settlement on the correct rollover date.

When the error was discovered, the escrow agent subscribed for the securities and settled on Feb. 7, 2011. But from Feb. 1, 2011 through Feb. 7, 2011, the amount of $18,336,785 was held un-invested in the escrow fund.

In a letter addressed to the district dated Nov. 3, the IRS agent handling the examination asserted that it was necessary to impute a yield on the un-invested funds held in the escrow fund for the period from Feb. 1, 2011 through Feb. 7, 2011 and that the appropriate yield for the purposes was the yield on the bonds.

The IRS agent indicated that after imputing this yield its calculations showed that the yield on the escrow obligations was materially higher than the yield on the bonds, or greater than one-thousandth of one percent.

In the letter, the agent also said the IRS would consider resolution of the matter through a closing agreement requiring a rebate payment of $10,820.96 plus a 100% penalty. No closing agreement has been signed so far.

The district said it has made a counter proposal to the IRS for a closing agreement that would require the payment of $10,820.96 plus a 50% penalty, which is awaiting administrative approval by the IRS.

In the absence of a closing agreement, the IRS could take the position, as a result of the delayed reinvestment, that interest on the bonds must be included in gross income for federal income tax purposes, the notice said.

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