¶ J-3106.4 REQUIRED COMPENSATION ARRANGEMENTS FOR..., FTC ¶ J-3106.4
FTC ¶ J-3106.4
Fed. Tax Coordinator ¶ J-3106.4 (2d.)
Federal Tax Coordinator, Second Edition
Current through the April 2015 update as provided by RIA.
Copyright (c) 2015 Thomson Reuters/Tax & Accounting
Chapter - J Income: Taxable and Exempt
J-3100 Private Activity Bonds and Industrial Development Bonds.
Private Business Use
¶ J-3106.4 REQUIRED COMPENSATION ARRANGEMENTS FOR MANAGEMENT CONTRACTS—PRIVATE
ACTIVITY BONDS.
Private activity bonds—i.e., state and local bonds, the proceeds of which are used for nongovernmental, private purposes—
aren’t tax-exempt (with specific exceptions), see J-3100 et For purposes of the “private business use test” for private activity
bonds, a management contract with respect to financed property may result in private business use of that property, see J3106 et But IRS has provided certain safe harbors, see J-3106.3.
For a management contract to qualify, the compensation arrangement must satisfy the following conditions:
1 It must provide for reasonable compensation for services rendered, not based in whole or in part on a share of net profits (J3106.5) from the operation of the facility. Reimbursement of the service provider (J-3106.6) for actual and direct expenses
paid by the service provider to unrelated parties isn’t by itself treated as compensation.4
2 The compensation arrangement must be one of the following:5
a 95% periodic fixed fee arrangement. At least 95% of the compensation for services for each annual period during the term
of the contract must be based on a periodic fixed fee (J-3106.9). The term of the contract, including all renewal options (J3106.11), can’t exceed the lesser of (i) 80% of the reasonably expected useful life of the financed property, or (ii) 15 years.6
“20 years” is substituted for “15 years” if all of the financed property subject to the contract is a facility or system of facilities
consisting of predominantly public utility property (as defined in IRC s 168(i)(10), see L-9302).7
b 80% periodic fixed fee arrangement. At least 80% of the compensation for services for each annual period during the
contract’s term must be based on a periodic fixed fee. The contract’s term, including all renewal options, can’t exceed the
lesser of (i) 80% of the reasonably expected useful life of the financed property and (ii) 10 years8 (20 years, for public utility
property described in (a), above).9
c 50% periodic fixed fee arrangements. Either (i) at least 50% of the compensation for services for each annual period during
the contract’s term must be based on a periodic fixed fee, or (ii) all of the compensation for services must be based on a
capitation fee (J-3106.8) or a combination of a capitation fee and a periodic fixed fee. The contract’s term, including all
renewal options, can’t exceed five years. The contract must be terminable by the qualified user (defined below) on reasonable
notice, without penalty or cause, at the end of the third year of the contract’s term.10
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¶ J-3106.4 REQUIRED COMPENSATION ARRANGEMENTS FOR..., FTC ¶ J-3106.4
d Per-unit fee arrangements in certain three-year contracts. All of the compensation for services must be based on a per-unit
fee or a combination of a per-unit fee and a periodic fixed fee. The contract’s term, including all renewal options, can’t
exceed three years. The contract must be terminable by the qualified user on reasonable notice, without penalty or cause, at
the end of the second year of the contract’s term.11
e Percentage of revenue or expense fee arrangements in certain two-year contracts. All the compensation for services must
be based on a percentage of fees charged or a combination of a per-unit fee and a percentage of revenue or expense fee. But
during the start-up period, compensation may be based on a percentage of either gross revenues, adjusted gross revenues
(defined below), or expenses of a facility. The contract’s term, including renewal options, can’t exceed two years. The
contract must be terminable by the qualified user on reasonable notice, without penalty or cause, at the end of the first year of
the contract’s term. This rule applies only to (i) contracts in which the service provider primarily provides services to third
parties, e.g., radiology services, or (ii) contracts involving a facility during an initial start-up period for which there have been
insufficient operations to estimate annual gross revenues and expenses reasonably, e.g., a contract for general management
services for the first year of operations.12
f Arrangements in certain 5-year contracts. All of the compensation for services is based on a stated amount; periodic fixed
fee; a capitation fee; a per-unit fee; or a combination of the preceding. The compensation for services also may include a
percentage of gross revenues, adjusted gross revenues, or expenses of the facility (but not both revenues and expenses). The
term of the contract, including all renewal options, doesn’t exceed five years. The contract need not be terminable by the
qualified user prior to the end of the term. For these purposes, a tiered productivity award (see J-3106.5) will be treated as a
stated amount or a periodic fixed fee, as appropriate.12.1
For purposes of (b)13 and (c),14 above, a fee doesn’t fail to qualify as a periodic fixed fee as a result of a one-time incentive
award during the contract’s term under which compensation automatically increases when a gross revenue or expense target
(but not both) is reached if that award’s equal to a single, stated dollar amount.
IRS added (f) above in anticipation that qualified users (J-3106.7) of hospitals and other health care facilities that are
financed with tax-exempt bonds may enter into management contracts with nongovernmental persons to provide health care
at qualified users’ facilities that will take into account the quality performance standards and Medicare fee-for-service
expenditures relevant to participation in the Medicare Shared Savings Program (MSSP) (see J-3104.2B.15
“Adjusted gross revenues” means gross revenues of all or a part of a facility, less allowances for bad debts and contractual
and similar allowances.15.1
If the compensation arrangements of a management contract are materially revised, then the above requirements must be
retested as of the date of the material revision. The management contract’s treated as one that was newly entered into as of
the date of the material revision.16
A management contract didn’t give rise to private business use where the compensation arrangement would have met the
guidelines of Rev Proc 97-13 (footnote 8), except that the manager was compensated for major capital improvements and the
costs of unforeseen events. The capital improvement category was disregarded because it didn’t relate to day-to-day
management and operations. The unforeseen event category involved only the pass-through of expenses, which doesn’t
create private business use.16.1
A manager’s compensation arrangement met the guidelines of Rev Proc 97-13 even though its fixed direct fee component
wasn’t a periodic fixed fee and was subject to poor performance reductions which weren’t specified, objective, and external.
IRS explained that potential reductions weren’t based on changes in net profits, and the fixed direct fee would remain a stated
amount for a particular annual period after the reduction. And while the incentive component was based on various
performance categories, none was based on gross revenues or net profits. Last, the reimbursement component was based on
actual direct expenditures, except for charges from affiliates applying a cost methodology that wasn’t based on net profits.16.2
2
¶ J-3106.4 REQUIRED COMPENSATION ARRANGEMENTS FOR..., FTC ¶ J-3106.4
For contracts entered into, materially modified, or extended (other than under a renewal option) before Jan. 22, 2015, the
rule at footnote 12.1 doesn’t apply. But, an issuer may apply the rule to contracts entered into before Jan. 22, 2015.16.3
For contracts entered into, materially modified, or extended (other than under a renewal option) before May 16, 1997, the
guidelines of Rev Proc 97-13 don’t apply. But an issuer may apply them to contracts entered into before May 16, 1997.17
Under guidelines in effect before Rev Proc 97-13, the compensation arrangement must be one of the following:
… at least 50% of the compensation for services for each annual period during the contract term must be based on a periodic
fixed fee;
… all of the compensation must be based on a capitation fee or a combination of a capitation fee and periodic fixed fee; or
… all of the compensation must be based on a percentage of fees charged.18
For contracts entered into before Mar. 16, 1993 (and not materially modified or extended, other than under a renewal
option, after Mar. 15, 1993, the guidelines of Rev Proc 97-13 don’t apply. But an issuer may apply them to such service
contracts involving facilities financed with proceeds of an issue to which Sec. 1301(e) of the Tax Reform Act of 1986 (PL
99-514) applies.19
Footnotes
4
Rev. Proc. 97-13, Sec. 5.02(1), 1997-1 CB 632.
5
Rev. Proc. 97-13, Sec. 5.03, 1997-1 CB 632.
6
Rev. Proc. 97-13, Sec. 5.03(1), 1997-1 CB 632.
7
Rev. Proc. 97-13, Sec. 5.03(3), 1997-1 CB 632.
8
Rev. Proc. 97-13, Sec. 5.03(2), 1997-1 CB 632.
9
Rev. Proc. 97-13, Sec. 5.03(3), 1997-1 CB 632.
10
Rev. Proc. 97-13, Sec. 5.03(4), 1997-1 CB 632.
11
Rev. Proc. 97-13, Sec. 5.03(5), 1997-1 CB 632.
12
Rev. Proc. 97-13, Sec. 5.03(6), 1997-1 CB 632.
12.1
Rev. Proc. 97-13, Sec. 5.03(7), 1997-1 CB 632 as amplified by Notice 2014-67’ s=’3.02(2), 2014-46 IRB.
13
Rev. Proc. 97-13, Sec. 5.03(1), 1997-1 CB 632.
14
Rev. Proc. 97-13, Sec. 5.03(2), 1997-1 CB 632.
15
Notice 2014-67’ s=’3.02, 2014-46 IRB.
15.1
Rev. Proc. 97-13, Sec. 3.01, 1997-1 CB 632.
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¶ J-3106.4 REQUIRED COMPENSATION ARRANGEMENTS FOR..., FTC ¶ J-3106.4
16
Rev. Proc. 97-13, Sec. 5.02(4), 1997-1 CB 632.
16.1
PLR 9823008.
16.2
PLR 201412011.
16.3
Notice 2014-67’ s=’5, 2014-46 IRB.
17
Rev. Proc. 97-13, Sec. 6, 1997-1 CB 632.
18
Rev. Proc. 93-19, Sec. 5.02, 1993-1 CB 526 before obsoleted by Rev. Proc. 97-13, 1997-1 CB 632.
19
Rev. Proc. 93-19, Sec. 7, 1993-1 CB 526 before obsoleted by Rev. Proc. 97-13, 1997-1 CB 632.
4