City pays penalty to IRS
Aspen Times Staff Writer
Aspen has paid $35,859 in penalties and interest to the Internal Revenue Service for failing to comply with federal arbitrage regulations.
The city was accepted into a voluntary program administered by the federal agency last spring and received confirmation last week that the IRS considers the violations rectified and the matter closed.
About $12,000 of the city’s payment was the penalty for failing to rebate interest earnings on past bond issues in accordance with arbitrage requirements. The remainder was interest due the IRS, according to Paul Menter, city finance director.
The arbitrage law was enacted in 1986. It prohibits entities that can issue tax-exempt bonds, such as cities, from earning more money through reinvestment of the bond proceeds than they’re paying in interest to bondholders.
The regulations came in response to what was once a common practice for some governments – take advantage of their ability to borrow money at low rates by issuing bonds with no real plans to spend the proceeds. Instead, they would reinvest the money at a higher yield to generate revenue, City Manager Steve Barwick explained.
The arbitrage rules generally require cities to spend the money they borrow within three years or pay a penalty and rebate to the IRS any excess interest earnings. If the city borrows the money at 5 percent interest, for example, and earns 6 percent by investing it until it is spent, it must pay the 1 percent difference to the feds.
Arbitrage laws require meticulous recordkeeping so the city can calculate any rebate owed to the IRS. The city must document its spending of borrowed money and investment earnings on the bonds but doesn’t have to file a return to the IRS unless it owes a rebate. The calculations don’t have to be done until five years after the money is borrowed.
When Menter joined the city finance office in August 2002, he checked to see if the city was in compliance.
“Here, the reports had not been done,” he said. It appeared the city had been handling its bond issues appropriately, but it didn’t have documentation to show to the IRS in the event of a random audit.
“It’s one of those situations when the IRS comes in and says, `Prove it. Demonstrate to me that you don’t owe money,'” Menter said.
“We approached this issue with a pretty high level of urgency,” he said.
Initially, city officials feared the city could be facing a substantial payment to the IRS.
“I was afraid it was going to be over $1 million because we couldn’t prove that we spent the bond proceeds appropriately,” Menter said. “We didn’t have daily records that prove it implicitly. I was very concerned that we wouldn’t be able to reconstruct the records.”
The city paid Arbitrage Compliance Specialists about $130,000 to prepare reports on its bond issues after the finance office researched and supplied the raw data.
That’s what the city might have paid had it hired experts to assist in preparing the reports when they should have been done, according to Barwick.
Eighteen bond issues between 1986 and 1999, some of which were refinancings, had to be examined. The kind of daily accounting records the IRS wants existed for money borrowed after 1994, when the city began using a new computerized financial system.
Compiling the data for earlier bond issues required what Menter called “forensic accounting work.”
Tony Petrocco, general ledger accountant in the finance office, was assigned the daunting task of poring over hard-copy records archived on rolls of microfiche that were still stored in boxes in the finance office.
“It was an extremely laborious process,” Menter said.
Ultimately, the city concluded it didn’t have precise records to track interest earnings on five bond issues but was able to satisfy the IRS that no rebate was owed for three of them.
For two others – the 1987 borrowing of $525,000 to build the city’s Maroon Creek hydroelectric facility and a 1989 bond issue for $4.6 million to finance construction of the Truscott Place housing – the city and the IRS concluded the city should have paid rebates to the IRS.
“We earned interest at a higher rate than we were allowed to. Then, because we were delinquent, we owed interest and penalties, as well,” Menter said.
Aspen is not alone in its past failure to keep the kind of accounting records necessary to meet arbitrage requirements, according to Barwick.
“[The IRS] has found 40 percent of municipalities haven’t done the work they needed to do,” he said.
When the city discovered it didn’t keep adequate records, it decided to contact the IRS, admit its mistake and ask permission to address it through the IRS Voluntary Closing Agreement Program, Barwick said.
Janet Urquhart’s e-mail address is firstname.lastname@example.org
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