On November 2, U.S. House Republicans released a sweeping tax reform bill that could have a devastating effect on not-for-profit healthcare organizations, significantly increasing the cost of capital, hurting their financial health, and jeopardizing their ability to serve their communities.
The bill would eliminate the ability of 501(c)(3) hospitals and health systems to issue tax-exempt bonds beginning January 1, 2018. The proposed legislation would also eliminate the ability of municipal issuers to advance refund bonds issued after January 1, 2018.
These provisions are detrimental to the ability of 501(c)(3) hospitals to finance capital plans and exposes them to the risk of increased cost on some loans and bonds already outstanding.
Congress will begin considering this bill on Monday, November 6. We encourage you to contact your U.S. Representative immediately to urge opposition to the elimination of tax exemption for 501(c)(3) private-activity bonds and the ability to advance refund tax exempt bonds.
What Does the Draft Bill Say?
The House Ways and Means Committee released H.R. 1, titled the “Tax Cuts and Jobs Act.” This proposed legislation contains language pertaining to elimination of various types of Private Activity Bonds (PABs). The draft language specifically references qualified 501(c)(3) bonds. Separately, the proposed legislation would also eliminate the ability of municipal issuers to advance refund bonds issued after January 1, 2018.
Was This Expected?
A number of policy research papers were published following President Trump’s election in November 2016. Most raised the issue of the possible loss of tax-exempt status for municipal bonds, but dismissed the prospect of municipal bonds being included as far-fetched. The proposed language for qualified 501(c)(3) bonds is a surprise to the industry.
How Will Outstanding Instruments Be Affected?
Based on our understanding, the legislation would have the following implications for instruments currently held:
- Tax-Exempt Fixed Rate Bonds: Our understanding is that tax-exempt fixed rate bonds issued before December 31, 2017, would not be affected by the proposed legislation.
- Tax-Exempt Variable Rate Bonds and Loans: Kaufman Hall is not a law firm, nor do we provide tax advice. Our understanding of the proposed legislation, however, is that any reissuance for tax purposes would jeopardize the tax-exempt status of any variable rate loan or bond and significantly increase the cost of capital going forward. This is particularly relevant for tax-exempt direct purchase loans, put bonds, mandatory tender bonds, and commercial paper programs. The prospect of triggering a reissuance is further complicated by banking industry proposals to replace LIBOR with an alternative floating rate index not yet contemplated by the bond and/or loan documents already in place. Amending existing documents to provide for a LIBOR index replacement could alone trigger such a reissuance. Please consult your bond and/or tax counsel for more information.
- Synthetic Fixed Rate Structures: A synthetic fixed rate structure is a combination of two separate components. The first is a variable rate bond or loan, and the second is a derivative position with a swap counterparty. Careful review is required in each instance, but generally, the bond or loan may be affected by the proposed legislation. The derivative swap position, however, likely would not be affected.
What Happened in 1986 Is Worth Remembering
In 1985, Congress proposed certain changes to the tax code, which ultimately became law via the Tax Reform Act of 1986. The proposed legislation contemplated an elimination for 501(c)(3) hospitals and healthcare borrowers similar to the language currently being proposed. Early drafts of the 1986 Act were circulated in late 1985, but the 1986 Act was not ratified until October 1986. During the interim period (late 1985-October 1986), many U.S. bond counsel firms would not provide a clean tax opinion supporting the tax-exempt issuance of bonds. If the same were to hold true, borrowers may expect to see bond counsel firms refusing to issue opinions following the December 31, 2017 date as contemplated by the current draft of the Tax Cuts and Jobs Act. This would effectively put a moratorium into place beginning January 1, 2018 that prevents 501(c)(3) borrowers from issuing tax-exempt bonds until the issue is resolved.
What’s Next?
This is the beginning of a long and complicated process. Many different constituencies would be affected by the proposed tax reform legislation, and the political climate in Washington D.C. and across the country remains difficult to read. The Senate is due to release its version of a tax bill, which would likely need to go through reconciliation with the House version. For clients considering a borrowing, it is important to understand that disruption due to the legislative process is likely in the near term. For clients with bonds, loans, and/or synthetic fixed rate structures that may be affected by a tax reissuance at some point in the future, further examination is required. Until further clarity is available, borrowers should plan to budget for higher interest expense and some level of disruption related to issuing tax-exempt debt.
What Should You Do?
Kaufman Hall urges you to reach out to your U.S. Representatives and Senators, urging them to remove the relevant language from the proposed act. The proposed tax reform package is detrimental to your ability to finance capital plans, and exposes you to the risk of increased cost on some loans and bonds already outstanding.
If you have questions about current capital structure needs or plans to issue debt in the near future, please contact your Kaufman Hall financial advisor or email Eric Jordahl at ejordahl@kaufmanhall.com.