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Does Your Organization Issue Tax-Exempt Bonds? How to Manage Your Arbitrage Compliance Responsibilities

By Gail Robertson


If your organization issues tax-exempt municipal bonds, you’re probably familiar with the term “arbitrage” — the earnings that result from investing tax-exempt proceeds in higher yielding taxable securities. These earnings are by no means a free-for-all; the arbitrage provisions of the Internal Revenue Code limit an issuers’ ability to earn and keep arbitrage profits. 

Between 2008 and 2016, generating arbitrage wasn’t a concern for most issuers of tax-exempt bonds. But now, with interest rates on the rise, it’s much more probable, particularly for bonds that were issued at a very low yield. In response, the Internal Revenue Service (IRS) recently hired a significant number of employees in a bid to expand its monitoring of arbitrage compliance.    

To avoid violations, organizations must carefully manage their arbitrage compliance responsibilities. But this can be a tall order: the federal arbitrage provisions are notoriously complex, and the rising interest rates can make it difficult to determine how they apply to your organization. 

Here’s how an arbitrage advisor can help.

1.    Minimize or eliminate your organization’s arbitrage liability. 
With knowledge of the tax rules and exceptions, an arbitrage advisor can help you minimize or even eliminate your organization’s arbitrage liability, just like a tax advisor does for your personal income taxes. Several exemptions to the arbitrage regulations are contingent on the timely expenditure of bond proceeds and the management of fund balances. For best results, consult with an arbitrage advisor prior to the issuance of tax-exempt bonds and well before arbitrage deadlines. Doing so will better enable your organization to take advantage of the many arbitrage exceptions on the books.  

2.    Maximize what you can do under the current arbitrage regulations.  
You don’t want to be in a situation in which your organization makes poor investment decisions simply to avoid generating an arbitrage liability. With expertise in the arbitrage laws, an arbitrage advisor can tell you whether or not you’re investing your organization’s tax-exempt proceeds at the optimal level.    

3.    Avoid the consequences of noncompliance.  
Any arbitrage liability must be remitted to the IRS within 60 days of applicable tax deadlines. Failure to comply—even inadvertently—can lead to steep penalties including fines, the forced redemption of bonds and the loss of tax-exempt status. An arbitrage advisor can help ensure your organization steers clear of these potentially debilitating consequences. 

4.    Simplify and streamline the arbitrage compliance process. 
From compiling financial information and bond documentation to keeping track of tax deadlines, managing the arbitrage compliance process can be a daunting task. Many finance directors aren’t sure where to start and don’t have the time to research next steps. An arbitrage advisor can provide you with a brief tutorial, so you’re not left trying to figure it out on your own.  

To the extent Abdo, Eick & Meyers is serving as your organization’s government auditor, our arbitrage group can further streamline the compliance process by referencing information already on file.  

Make arbitrage compliance a non-issue for your organization in 2019. 

Given the rising interest rates and the IRS’ new hires, it’s likely that issuers of tax-exempt debt will face a greater number of arbitrage-related challenges in 2019.  If your organization issues tax-exempt bonds, consider working with an arbitrage advisor as soon as possible. With the right expertise, you’ll be poised to navigate arbitrage matters with ease. If you have any questions about arbitrage or how the current investment and regulatory environment may impact your situation, please give us a call today, or learn more, here.