IRS auditing entrepreneurial Texas jails that improperly used tax-exempt bonds

Finally, the IRS has begun to dig into shady Texas jail schemes where publicly backed bonds were used to enrich private companies, socializing risk while privatizing potential profits. Purchasers of those bonds may soon be on the hook for taxes on their earnings and counties could see their own bond ratings reduced. Turns out, the whole idea of filling entrepreneurial jails with federal inmates should never have qualified for issuance of tax-exempt bonds in the first place.

According to The Bond Buyer (Oct. 17, behind paywall, though you can sign up for a two week trial subscription), "Roughly $23 million of tax-exempt senior lien revenue bonds issued in 2003 to finance a jail may be taxable private activity bonds, an Internal Revenue Service agent has told the West Texas Detention Facility Corp." in Hudspeth County. And they're not the only one:

The jail bond deal is the latest of dozens under audit where the IRS has suggested that significant amounts of federal inmates paid for by the federal government and management contracts with private parties make the bonds taxable private-activity bonds.

Tax-exempt bonds are private-activity bonds 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. Under federal tax laws and rules, the federal government is considered a nongovernmental or private entity. PABs are only tax-exempt if they are issued for a “qualified” purpose, and a jail is not one of these.

For example, in August (8/23), The Bond Buyer reported that:

Bond counsel Jackson Walker LLP, based in Houston, has 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. The bonds were issued in 2003, but have been under scrutiny by the IRS since 2010 and in default since last year when the U.S. Marshal withdrew inmates because misconduct and security problems, forcing the facilities to close in May 2012 for repairs and improvements.

Their liability would have been greater if they'd succeeded in getting enough federal inmates to pay the bills.

The IRS’ concerns were two-fold, according to bond-related documents. First the IRS took issue with the management contract the city had with BRG, under which the net profits were split between the two. The IRS argued this compensation structure suggested “an equity interest in the operation of the bond-financed facility,” creating a private use and payments problem.

In addition, the IRS claimed the prison had too many federal inmates. Federal inmates are considered private, not public, parties under the tax law. The IRS contended that the economics of the prison would not work without substantial federal, and therefore private, use and payments. The federal government tends to pay more for incarceration of its inmates that state or local governments.

The only reason the Crystal City jail wasn't dinged harder was that the federal inmates never materialized. If they had, "Normally that would cause a problem, but since the bonds are in default, bondholders have not been receiving any tax-exempt interest that the IRS could declare taxable."

Another facility in Burnet County did find federal inmates to fill their extra beds, but as a result may now lose the bonds' tax-exempt status, The Bond Buyer reported Aug. 8:

This week, U.S. Bank N.A. filed event notices for two separate issuers that financed jails saying the IRS had indicated the tax-exempt bonds or COPs were not tax-exempt. The bank was trustee for both sets of bonds.

One notice said the Burnet County, Tex., Public Facility Corp. has received four letters from the IRS, the first on Dec. 12, 2011 and the most recent on April 12 of this year, seeking information about $35.38 million of project revenue bonds that were issued in 2008 to build a jail.

The bank said that, in the most recent IRS letter, the issuer was asked to provide information “regarding a preliminary conclusion by the IRS that the ... bonds ... violate certain Internal Revenue Code rules that cause [them] to be taxable.” The notice said the issuer is cooperating with the IRS and that “it is unknown at this time what the outcome of the IRS examination will be.”

Bill Neve, president of the Burnet County Public Facility Corp., said the county built the 586-bed jail to hold county prisoners but provided for some extra space so it wouldn’t have to expand the jail during the next 20 years or so. The IRS is concerned about the number of federal prisoners in the jail, many of whom were housed for less than 100 days, he said.

The PAB rules contain an exception for short-term private use and define that to be less than 100 days. But Neve and other sources indicated that if the IRS thinks there is a significant number of federal inmates, it does not take that exemption into account.

In yet another instance down in Willacy County, The Bond Buyer reported Aug. 28th that the bond terms actually contemplated the possibility that the tax-exemption would be disallowed, showing they knew up front this was a dicey deal:

Bonds issued for Willacy County, Texas’s $7 million jail in the town of Raymondville are among several being audited by the Internal Revenue Service to determine whether its bonds should lose their tax exemption, according to County Judge John F. Gonzales.

Gonzales disclosed the audit at a meeting of the Willacy County Commissioners Court earlier this month, according to the Valley Morning Star of Harlingen.

The south Texas county, which has invested heavily in the prison industry, has a large stake in the tax-exempt status of the prisons. The county seat of Raymondville has earned the nickname “Prisonville” because of its heavy concentration of private lockups, most housing federal inmates on immigration violations.

Refinancing the $3 million of outstanding bonds as taxable would cost the county about $200,000, Gonzales said. The jail was built using 2004 bonds bearing 7.5% coupons on maturities of 2029 with yields of 7.75%, according to the Municipal Securities Rulemaking Board’s Emma Web site.

The original $7.65 million of unrated bonds were issued in the name of the County Jail Public Facility Corp. of Willacy County. ...

According to the official statement for the 2004 deal, interest rates would rise to 140% of the original issue rate if the deal were found to be taxable, or the issuer could redeem the tax-exempt bonds at a price equal to 105% of principal, plus accrued interest.

For barely populated Willacy County, it should be noted, $200K is real money.

The facility in Jones County that the Legislature refused to bail out last spring was another example of a failed "public-private partnership" whose bonds would lose their tax exemption if it were filled with federal inmates. The Bond Buyer reported May 2: 

The prison was pitched as an economic stimulus measure that would provide 200 jobs and annual economic impact of $5 million.  County commissioners promised county taxpayers that the for-profit prison would rely on lease payments from the state and never require local tax support. ...

The bonds used to build the prison carried junk ratings of BB from Standard & Poor’s.  Original coupons ranged from 7.25% to 9%. That rating fell to D when the default occurred. ...

The bonds were issued by the Midwest Public Facility Corp., a conduit issuer overseen by the county commissioners.  The bonds were issued as tax-exempt debt.  The issuer failed to make its $2.23 million interest and principal payment due on Oct. 1, 2011.

Meanwhile, The Bond Buyer reported Aug. 16, "Zapata County, Texas, may pay a settlement or refund bonds after an audit of $9.97 million of its debt by the Internal Revenue Service."

Lots of Texas counties have entered into these sorts of entrepreneurial jail deals and many of them have gone bust because federal inmates they counted on to pay the bills never materialized. These stories, though, show these were ill-considered and likely illegal schemes from the get-go - even if they "worked" and federal inmates were found to cover costs. Many Texas counties, like McLennan (Waco), already have had to raise taxes to cover costs for empty, never-should-have-been-built lockups. Now, it's clear their problems won't subside even if those much-touted federal inmates ever do arrive.

Report: Deal cut to close two private prisons

Though Grits had heard that the decision over prison closures wouldn't be made until a 9 a.m. meeting of the budget conference committee on Monday, at which I was told to expect "fireworks," Mike Ward at the Austin Statesman reported today ("Deal reported on plan to close two private prison," May 10) that a deal has been struck. His story opened:

Senate and House negotiators have tentatively agreed on a plan to close two privately run state prisons, potentially resolving a political feud that threatened to derail the reauthorization of the state’s criminal justice agency.

Officials confirmed Friday that instead of specifying which two prisons should be shuttered, at a time when the state has more than 12,000 empty prison beds, lawmakers will let the prison system’s governing board decide which facilities to close.

But under new criteria that the Legislature has directed the prison board to use, a Mineral Wells prison that House members have been fighting to keep open will probably still be prime for closure. ...

Lawmakers said wording will be added to the budget bill specifying that two prisons must be closed — without naming them — while removing $97 million in funding, the cost of operating Mineral Wells and Dawson.

Leaders in both chambers said an agreement has been reached to close Dawson, but lawmakers who represent Mineral Wells are still fighting to keep their facility open. They argue that closing it would devastate the Mineral Wells economy.

If accurate, this is good news. The story doesn't mention the Jones County facility but if they're closing two units TDCJ likely won't be buying another one. Grits, of course, has been pressing for this course of action for some time.

Two years ago Texas closed a prison for the first time since the state first built one in the 1840s - a nearly century-old unit built to provide cheap labor to a now-defunct sugar plantation. This session it looks like we may close two more-recently built private units. If Sen. Whitmire succeeds in shutting down Dawson and Mineral Wells, or whichever two units end up being closed, Grits believes the goal should be to close four more when the next session rolls around in 2015. Indeed, with relatively modest policy alterations, it's not hard to envision closing more than that over the next few sessions. Incarceration rates have failed to decline with crime rates and over the last two decades, policy has been the main driver of incarceration levels, up or down, far more than crime rates. The Legislature could and should decide to spend less on prisons, starting with this biennium's budget.

Related:

• Texas House edging toward prison closures but doesn't want mentally ill in solitary confinement
• A plea to Texas budget conferees: Close two prisons and don't buy empty cells we don't need
• Budget conferees gather with opposing mandates on prison closures, purchases
• Texas House would buy new prison unit, rebuffs Senate suggestion for prison closures

A plea to Texas budget conferees: Close two prison units, don't buy empty cells we don't need

This is a plea to the ten conference committee members on the budget from both chambers of the Texas Legislature, who for the record are:

• House: Pitts, Crownover, Otto, S. Turner, Zerwas
• Senate: Williams, Duncan, Hinojosa, Nelson, Whitmire

Let's talk for a moment about prisons. First the House and Senate have both agreed in the base budget to fund 5% employee raises for correctional workers. Please don't start slashing at those wage hikes to pay for prison units you don't need. Including the extra money to bail out Jones County, the House decision to buy a prison instead of closing two will cost Texans an extra $116.8 million in incarceration costs over the biennium for those line items compared to the Senate budget. Close the privately-run Dawson State Jail and Mineral Wells pre-parole units as suggested by Senate-side budget writers and tell the folks in Jones County they're on their own, just like so many other counties that built speculative prisons and jails they now can't fill.

Also, know up front that you have likely underfunded prison healthcare by around $50 million or so and will need to come back and fund it with a supplemental on the back end like the Lege did this year. TDCJ/UTMB, et al., have told the Lege what it will cost to provide care to prisoners but even the more generous Senate version of the budget is $55 million shy of the requested amount. Why not just budget what the health care actually costs instead of paying tens of millions on the back end as though it's some big surprise or "emergency?" Incarcerating felons is a core function of state government. Budget what it costs.

Members on the House side, given that your chamber suggested paying for employee raises as well as three extra prison units, you could agree to prison closures, increase prison health care funding to the requested amount, and still call the result a "savings." That would be the truly "fiscal conservative" approach: Reduce spending where feasible but pay your bills in full.

To Senators, each of you has been around long enough to see TDCJ require "supplemental" funds for health care at the beginning of each session year after year. Why intentionally underfund that line item and perpetuate the cycle?

With the two chambers in disagreement on prison closures, it's your decision. Texas made history and received national attention for closing the Central Unit. Grits urges you to follow Chairman Whitmire's lead, double down on that success and close two more. The state doesn't need them and the money is better spent on employee raises, prisoner healthcare, and probation programming.

MORE: A couple of different sites are calling for people to contact conference committee members telling them to close two prisons and don't buy another one, see here and here.

AND MORE: From the Fort Worth Star-Telegram, "Texas shouldn't keep spending on unneeded prisons."

Budget conferees gather with opposing mandates on prison closures, purchases

Earlier this month, Grits had reported, the Texas House approved a budget that rebuffed the Senate's decision to close two private prison units, deciding to keep them and purchase another, empty unit in Jones County that the state doesn't need. On Friday they made it official as representatives of the two chambers head into the conference committee, reported the Statesman's Mike Ward:

The Texas House on Friday voted to buy an unused West Texas prison for $19.5 million, brushing aside growing criticism that the state has 12,000 empty prison beds and is wasting taxpayers’ money.

The decision to leave intact funding for the 1,100-bed Jones County lockup is expected to set up a showdown with Senate leaders, who have openly criticized the House as engaging in pork barrel politics.

The House approved the purchase in House Bill 1025, a supplemental appropriations measure, by a 129-9 vote.

“We’ll look forward to a discussion with the Senate,” said House Appropriations Committee Chairman Jim Pitts, R-Waxahachie. “This is just putting it out there for discussion. This is not the final version of the bill.”

From the story, it sounds like Rep. Sylvester Turner, who's on the conference committee, isn't a fan of the Jones County unit, and Chairman Pitts is open to omitting excess capacity from the "final version." If Senate conferees stick to their guns - and with John Whitmire among conferees, you'd expect them to - there's a decent, bettor's chance Texas may end up closing units this time instead of pointlessly expanding capacity, as the House has suggested. Here are the lists of House and Senate budget conferees, respectively:

• House: Pitts, Crownover, Otto, S. Turner, Zerwas
• Senate: Williams, Duncan, Hinojosa, Nelson, Whitmire

Surprising opposition has arisen in the House to closing the Dawson State Jail and the pre-parole facility in Mineral Wells, as the Senate has suggested. Besides the obvious, pork-barrel reasons (Corrections Corporation of America runs both facilities and its champions don't want them shuttered), it's been suggested that the Dawson State Jail in particular services women from the Dallas area disproportionately. That's true to a small extent, but the Hutchins State Jail takes even more inmates from Dallas, presently operates under capacity and could take the extra Dallas inmates and gender-specific programming, if so-directed. The relatively minor, bureaucratic adjustments that would be required to manage the inmate population if Dawson were closed pales in comparison to the extra expense of keeping it open. The Senate essentially paid for a 5% prison guard pay hike by eliminating two private-prison contracts the state doesn't need. If those units stay open, as the House envisions, and the state buys another empty unit, the question for conferees becomes, "How does the state pay for wage increases for corrections staff, or do those just go away?" Root for the senate conferees to stand firm on this one and hope for the House side to give into the imperatives of reason and math.

MORE: In another story by Mike Ward on related subjects, he quotes Sen. John Whitmire succinctly summing up the conflict on prisons between the upper and lower chambers. “The people in the House who are for buying a prison we don’t need, and are for keeping two existing prisons open that we don’t need, are the same tea party, fiscal conservatives who campaigned for less government and cutting wasteful spending,” he said. “Everyone wants to cut government waste, but it’s very hard to shut down anything.”

AND MORE (4/29): Patti Hart reported that John Whimire is "irate" over the House's decision to purchase the Jones County facility, and I can understand why. That said, if Chairman Whitmire were "irate" nearly as often as the MSM portray him that way the poor man would surely have suffered a coronary by now. Still, the starting position of the House on prisons in the budget is certainly insensible and frustrating. Where are all the small-government budget cutters when you need them?

Texas House would buy new prison unit, close none, rebuffs Senate suggestion for private prison closures

The House budget matched the Senate's inclusion of $105.2 million for TDCJ correctional officers salary increases of 5 percent, but failed to pay for them with prison closures the way they did on the Senate side..

While the Texas Senate budget suggested closing two prison units in the next biennium, saving $97.3 million, the House budget approved yesterday not only foresees no closure of adult prison units but anticipates spending $19.5 million to buy an  empty unit constructed by Jones County for which the county can find no prisoners. Locals in Jones County and Mineral Wells, where the Senate would close a private facility, have been lobbying for more units than the state needs, but Heaven knows why the House wants to keep open the ignominious Dawson State Jail. Including the extra money to bail out Jones County, the House decision to buy a prison instead of closing two will mean an extra $116.8 million in incarceration costs over the biennium for those line items compared to the Senate budget.

The House also lowered expenditures set by the Senate for prison healthcare by $14.3 million, but that's $55 million below what TDCJ said it needed for the line item, which took a nine-figure haircut in the last biennium. Unless the Legislature significantly reduces incarceration levels, you can bet prison healthcare will cost more than that.

The Texas Juvenile Justice Department would receive $15.7 million less under the House budget than the Senate budget.

The differences must be ironed out in conference committee.

Via HRO and summaries of the House and Senate budgets (all large pdfs).

Boo Hoo: Fewer prisoners bad news for speculative prisons, jails

Over the weekend, the Austin Statesman's Mike Ward  authored a story titled, "County, private lockups sit empty, drain money as Texas prisoners dwindle," (March 31), pointing out that 30,000 of the state's 93,000 county jail beds are sitting empty and private prisons built on spec can't find clients. "There's not a customer out there right now for these beds," said Jones County Judge Dale Spurgin, who wants the state to lease his county's facility even though no one thinks it's needed.

Grits sees no reason for the state to bail out counties or private companies that built extra lockup space hoping to profit from incarceration, a gambit your correspondent considers cynical and untoward. For several years this blog has been documenting examples of speculative prisons and jails going bust for lack of clients. As far as I'm concerned, they made their bed, let them lie in it.

House Appropriations criminal justice highlights

The Texas House Appropriations Committee yesterday adopted recommendations (pdf) from its subcommittee on Article V of the budget, which covers Public Safety and Criminal Justice. Obviously the Senate Finance Committee will have their say, too, and there's a long way to go before anything is final. But here are a few highlights from adopted committee recommendations on the House side that caught Grits' eye:

Private prison bubble bursting? Empty, speculative jails in Texas

Yesterday I'd written about the ugly finances underlying the all-but-empty Jack Harwell Detention Center in McLennan County, and it made me realize that right now there are quite a few jail and prison facilities out there - many owned by counties - that overbuilt banking on ever-growing inmate populations that haven't materialized and now appear unlikely.

Here's the list of private or public-private jails or prisons I could come up with off the top of my head in Texas that are currently sitting empty or partially empty for lack of customers, in most cases with taxpayer backed bonds which must be paid whether or not the beds are leased:

• Jack Harwell Detention Center, McLennan County Jail
• Lubbock County Jail
• Billy Clayton Detention Center in Littlefield
• Dickens County Correctional Center
• Johnson County Law Enforcement Center
• Jones County ISF
• Limestone County Detention Center
• Bell County Jail
• Former TYC facility in Eagle Lake
• Former TYC facility in Coke County
• North Texas Intermediate Sanctions Facility (recently closed)
• Garza County Jail*
• Jefferson County Jail*

*See update below.

If you're aware of others, please let me know in the comments.

Webb County is presently considering a similar entrepreneurial jail scheme. And in Cameron County, a speculatively built jail was successful in finding clients, so much so that they had no room for their own inmates and now get paid $36.35 per day to house federal inmates while paying $48 per day to house their own. These schemes never seem to wrok out the way their proponents hope, and taxpayers inevitably are left holding the bag.

Exacerbating matters, TDCJ last year canceled contracts with counties for 1,900 beds and doesn't plan rent beds from counties under the new budget, and the filed versions of Texas House and Senate budgets have suggested reducing the number of leased private prison beds by 3,519 and 2,119 beds respectively, further reducing the prospects for short-term demand. Each of the above-bulleted entities is hoping the feds will bail them out by leasing more immigration detention beds, but they won't bail out all of them and might not contract with any of them, given that there's lots of competition from other parts of the country. Corrections Corporation of America alone has around 12,500 empty beds nationwide.

All this to say, whereas just five years ago there was excess demand for private prison capacity, today there is a glut. What's more, quite a few Texas counties got roped into issuing taxpayer-backed debt to participate in this ill-conceived speculative bubble, which now appears to be bursting before our eyes.

UPDATE/MORE: I sent this post to administrators at the Texas Commission on Jail Standards and was advised by Assistant Director Brandon Wood via email that: "There is a former county jail in Jefferson that had been operated by a private that is now empty ... and the 96 bed juvenile facility at Garza was empty for quite some time, but they may be housing BOP in it now.  ... [T]he one in Littlefield was originally built as a contract juvenile facility and when that market did not materialize, it was converted to adult." Thanks Brandon! According to the latest TCJS population report (pdf), as of March 1 Garza County had 34 contract beds in its 96 bed jail.and remains 35% vacant.

Jones County pays for empty jail as detention bubble bursts

Using bonds approved by voters in 2005 for a new jail, officials in Jones County spent $25 million to construct a 1,127 bed detention facility on spec, hoping to house inmates on contract from the Texas Department of Criminal Justice. Now construction is complete, but TDCJ doesn't need the extra capacity and is under pressure to reduce spending instead of enter new contracts. So the facility sits empty while local taxpayers foot the bill for twenty times more jail than they need. Another Doomsday Deal gone predictably awry.

This is another instance where local officials thought they could build a jail for "free." The Abilene Reporter News said in August, "the original plan was to pay for the new county jail from revenue generated by the state facility." So now that that plan has fallen through, the county issued more debt to pay for the 96-bed county facility that was supposed to cost them nothing. As of November 1, the Jones County jail housed 24 total inmates, according to the Commission on Jail Standards.

County Judge Dale Spurgin implied that the county might default on the bonds if the state doesn't supply them with prisoners:

The facility was financed through the purchase of revenue bonds by investors, Spurgin said.

“They have bought those bonds knowing they are at risk,” Spurgin said.

One could also say the bonds were issued with the Commissioners Court knowing they were risking taxpayers' credit rating, as well. If the county were to default on the bonds, of course, it would harm the county's ability to incur indebtedness across the board for many years to come. That's not a realistic option. But what else is he going to say, except "We sold taxpayers a pig in a poke"?