by David M. Reutter

The Internal Revenue Service (IRS) is auditing dozens of tax-exempt bond-financed jail deals. The audits are looking into whether the bonds are no longer tax-exempt and are taxable private-activity bonds.

In recent years, many local governments have made investments into the prison industry. Typically, such deals involve a promise to taxpayers that their taxes will not raise when a needed renovation of a jail or the building of a new one is approved. The promise is made on the premise of issuing tax-exempt bonds that will be paid by revenue received from housing federal prisoners.

Counties who venture into the industry have built extra cells onto their jails, and they count on contracts with the U.S. Marshall’s Service or Federal Immigration officials to fill those cells. The federal government pays more to house tis prisoners than states or local governments.

Texas’ Willacy County built a $7 million jail in 2004 by issuing bonds bearing 7.5% coupons on maturities of 2029 that yields 7.75%, says the Municipal Securities Rulemaking Board’s Emma website. With its heavy concentration of private jails and prisons, Willacy County’s seat, Raymondville has garnered the nickname “Prisonville.”

Most of those lockups house federal prisoners. If the IRS decides the $3million in remaining bonds issued by the County Jail Public Facility Corp. of Willacy County are taxable, refinancing them will cost taxpayers $200,000 which is real money in that tiny community.

Jones County, Texas, also promised its taxpayers a free jail that would provide 200 jobs and a $5 million annual economic impact. Payments on the tax-exempt bond issuance were to come from lease payments from a private entity that would manage the facility as it filled with federal prisoners. The prisoners never materialized and the bonds went into fault, but the premises of tax-exemption were flawed from the start.

Federal tax laws and rules that apply to private-activity bonds (PAB) consider state and local governments to be governments, but they provide that federal government is a nongovernmental or private entity. Also, if more than 10% of the proceeds are for private use and more than 10% of the payments for debt service are from private parties, then tax-exempt bonds are PABs. Moreover, a jail is not considered a “qualified” purpose to make a PAB tax-exempt.

While the PAB rule contains an exception for short-term use of less than 100 days, the IRS does not take that exemption into account if a facility houses a significant number of federal prisoners. As the facilities under audit were built under the premise of housing federal prisoners, the bonds were not tax-exempt from the start.

The IRS is just now catching up to these ill-conceived and illegal entrepreneurial schemes to cash in on the prison industry. At least one bond attorney has agreed to pay an IRS settlement.

Houston based bond counsel Jackson Walker LLP “tentatively agreed to pay $400,000 to settle a tax dispute between Crystal City Public Facility Corp in Texas and the Internal Revenue Service over $13.94 million of revenue bonds issued to finance prison facilities,” reported The Bond Buyer.

That IRS investigation of bonds issued in 2003 began after Crystal River defaulted on the bonds in 2010. The default came after the U.S. Marshal withdrew prisoners due to misconduct and security problems. The facility closed in 2012.

Also under scrutiny is a 592-bed facility in Louisiana’s Village of Epps. It issued $13.65 million in bonds in 2003 to purchase the detention center to house U.S. Marshals Service prisoners.

The schemes by local governments to profit off of the prison industry are now set to cost taxpayers money. This has already occurred in Texas’ McLennan County. The lesson here is one slavers learned long ago: prosperity off from the misery of others is short-lived and costly in the end.

Sources: The Bond Buyer, gritsforbreakfast.blogspot.com

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