June 12, 2023

The Impact of Staffing Shortages on Tax-Exempt Bonds

By Mary Antonetti, Partner, Tax & Business Services

The Impact of Staffing Shortages on Tax-Exempt Bonds Clinical Services

The Great Resignation that took place over the last few years, has created staffing shortages for many organizations. My clients often tell me they are having difficulty hiring qualified employees. While it does seem like there are fewer people working, there is also a growing number of gig workers. Sometimes, the answer to a worker shortage is in outsourcing certain services or departments or simply hiring temporary help.

If your organization uses tax-exempt bond funds for any of your facilities, have you considered how hiring temporary help could impact your private business use calculation? For example, if you use contracted nurses in an assisted living facility built with tax-exempt bond financing, have you considered if this creates a private business use? Or, if your CFO retires and your organization contracts with a person or company to provide short-term help, does this create private business use?

Issuing tax-exempt debt can provide a tax-exempt organization with financial benefits, but it comes with compliance obligations to establish and maintain the tax-exempt status of the interest payable on the debt. If your organization has tax-exempt debt, you should have post-issuance bond compliance monitoring policies. You should also have procedures in place to make those policies are followed.

Section 141(b)(6) defines the term “private business use” as “use (directly or indirectly) in a trade or business carried on by any person other than a governmental unit.” Generally, facilities built or refinanced with tax-exempt bond proceeds must be used for the exempt function of the organization. If a person or business financially benefits from the bond-financed space, that may create private business use. For example, say a school allows someone to use a room to teach driver’s ed. In this case, the instructor privately benefits because they make money by teaching in a building built with tax-exempt bond proceeds.

Similarly, if a hairdresser uses space in a bond-financed building to cut hair, the hairdresser privately benefits from using tax-exempt, bond-financed space. In both cases, the organization did not collect the money, but the individual made money in the bond-financed space. Many organizations have some level of private business use, but if the use grows beyond certain thresholds, it could jeopardize the tax-exempt nature of the bond.

The rules around private business use are complex. Different activities can generate private business use, such as leases, research arrangements, unrelated business income activities, and management or service contracts. Many types of contracts could fall under the management or service contract umbrella. A contract could be as extensive as managing a cafeteria or department or as simple as janitorial assistance or an elevator service contract. IRS Regulation Section 1.141-3 defines private business use. Rev. Proc. 2017-13 was issued to provide “new guidelines” on meeting certain safe harbors related to management and service contracts.

It is essential that your organization maintains a list of all your management and service contracts and evaluates them against IRS rules and regulations. Your organization should inventory different types of contacts, including but not limited to temporary staffing, agency nurses, an outsourced CFO, outsourced food service, outsourced janitorial help, doctors’ practices operating in your facility, elevator maintenance contracts, and landscaping services. Your policies should require you to evaluate these contracts regularly. In addition, there are reporting requirements on your Form 990, Schedule K.

Thankfully, many of these contracts meet a safe harbor for private business use. For example, IRS Regulation 1.141-3 (b)(4)(iii) provides some guidance on arrangements that are generally not treated as management contracts. One exception under IRS Regulations 1.141-3(b)(iii)(A) is “Contracts for services that are solely incidental to the primary governmental function or functions of a financed facility (for example, contracts for janitorial, office equipment repair, hospital billing, or similar services).”

Many of your contracts may fit into the incidental use safe harbor. However, you cannot assume they meet the requirements without evaluating the contract. Your organization should inventory all your management and service contracts and definitively decide if they meet the safe harbor. If audited by the IRS, your organization must show a list of your service contracts and whether they generate private business use or meet a safe harbor. If there is private business use, the IRS will need to see the impact over the life of the bond. The rules around post-issuance bond compliance and private business use are extraordinarily complex, and management contracts are just one aspect. I suggest you consult your tax advisor or bond counsel to help you evaluate your specific activities.