Cape school board learns it must pay IRS $500,000

The Cape Girardeau School Board got a lesson in bond financing and something called arbitrage after being informed at Monday's meeting that the district had to pay $500,000 to the Internal Revenue Service.

The payment was necessary because of interest the district earned on $18 million of bonds issued in 2000 to pay for the new Central High School.

Before Monday night, board members were unsure why the district had to pay the hefty IRS fee. Some were concerned the arbitrage fee might come out of the operating budget, teacher salaries or classroom expenses.

Arbitrage occurs when loans, such as bonds, are bought and sold at differing rates, resulting in a profit. Just as an individual investor must pay taxes on money earned from interest on a savings account, schools also must pay an arbitrage rebate on bond profits.

School districts pay lower borrowing rates because school bonds are tax-exempt, and the IRS places limits on arbitrage profits, said Michael McRobbie, a lawyer with Gilmore and Bell, the district's bond attorney. The law firm figured out how much the arbitrage rebate would cost the district and helped file the paperwork.

Just like when an individual taxpayer files his or her tax returns, the school district is responsible for calculating its taxes and then sending the paperwork and a check to the IRS.

By selling the bonds at one rate and refinancing them at another rate, the district earned almost $2 million in interest, board president Steve Trautwein said. Because of IRS rules, the district could only spend $1.5 million of the profit. The other $500,000 was set aside to pay for the arbitrage rebate.

Not the first time

This is not the first time Cape Girardeau School District has paid an arbitrage rebate to the IRS. The district paid about $250,000 for interest it earned on a 1997 bond issue, said Rob Huff, assistant superintendent.

Huff said he knew the tax on the 2000 bond was coming, but he did not know for how much until the paperwork came in from the IRS.

The payment came as a surprise to Trautwein and other board members.

"I was not aware that the bond in 1997 had an arbitrage rebate," Trautwein said.

The only way the board could have avoided paying the arbitrage rebate would have been to meet certain spending levels after the bonds were sold and within a certain time frame.

Less than 10 percent of school districts would be able to qualify for that exemption because of the nature of construction spending and schedules, McRobbie said.

After Monday's meeting, Trautwein said he feels much more knowledgeable about arbitrage rebates.

"When there is turnover not only in board members, but in employees, the corporate memory of these events remains lodged only in the records. And if individual board members don't know to ask about these things, then they get surprised only because it's something that they've not heard about," Trautwein said.

ameyer@semissourian.com

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