Why can volunteer firefighters borrow at low interest rates and tax-free?
IRS laws provide a significant advantage to volunteer fire departments. It offers the ability to borrow money at low interest rates and tax-free, just like your local government. But the IRS has certain rules to follow in exchange for granting this benefit and these rules must be followed in order for you to “qualify” as a tax-exempt borrower.
What rules must volunteer firefighters follow to comply with IRS rules?
- You must provide firefighting service to a political subdivision that is not protected by another fire department.
- You must provide this service under a written agreement.
- You have to use the borrowed money for a fire truck or a fire station.
- You must hold a public hearing to issue tax-exempt debt (which includes publishing legal notices in your local newspaper to announce the date, time and location of the public meeting to the public).
- The political subdivision must sign a document stating that they are aware that you are borrowing tax-exempt money and that they approve of its use to provide firefighting services under the written agreement.
- If you place the funds in escrow pending construction of the fire truck (which is very common), you must follow the rules governing the use and return of those funds.
- You must file an appropriate form (for example, IRS Form 8038G or 8038GC) with the IRS to notify the IRS that the transaction is tax-exempt.
- There are a number of other rules and regulations to follow such as you must use the fire truck for public benefit or purposes among others.
What bad things can happen if IRS rules aren’t followed?
Failure to follow these rules may result in your tax-exempt financing being “denied” by the IRS. If this happens, you may be required to pay significant penalties and taxes to the IRS. Additionally, your financing will likely revert to a taxable interest rate (usually around 3% higher) and you will be obligated to pay retroactive taxable interest. These can cost tens of thousands of dollars for the average fire truck.
First, the IRS will penalize you if you don’t follow the rules. The rules are set to ensure that only volunteer firefighters who are legally permitted to borrow against these special, low, tax-free interest rates receive this benefit. The rules are set to provide a system of checks and balances indicating that you are the fire department of the community, that you provide an essential government function for the community and that the local political subdivision and the community are aware of this you are doing.
Second, the bank’s contract will usually require you to certify that you will follow IRS rules, and if the IRS finds you unqualified, the interest rate will revert to the taxable interest rate. This means that you will pay a higher taxable interest rate in the future, but you will also be liable for additional taxable interest payments in the past – since the start of the loan.
The bank may offer you a low tax-free interest rate because the bank does not have to pay tax on the interest you pay to them. Since this significant cost (taxes) does not have to be paid, the bank can accept a much lower interest rate from a qualified volunteer fire department. So if your financing is denied, then the interest becomes taxable to the bank and the bank will pay approximately 33% of the interest earnings to the IRS for taxes on the now taxable interest. The bank cannot absorb this significant cost, so its contracts include provisions to compensate the bank if the loan turns out to be taxable. These provisions include the ability to charge you the extra interest to cover the income taxes they now owe.
So how can a volunteer fire department ensure they will follow all IRS rules?
First, it’s important to understand the rules if you want to take advantage of the low, tax-free interest rate available to you. Ask your legal or accounting professional for help to guide you through this complex and precise process if you don’t think you have a good understanding of all the requirements.
Second, make sure the bank you choose has the experience to help you with this type of transaction. Remember that even if the bank makes a mistake, the IRS will contact you and impose penalties on you as a borrower. The IRS considers you the beneficiary of the rules and therefore you will be penalized if the rules are not followed.
The good news is that there are several companies across the United States that specialize in financing volunteer fire departments. Ask the questions so that you feel comfortable that they can help you ensure that you fully comply with IRS rules.
This article is intended to provide general knowledge of IRS rules and help you formulate questions you think you need to answer to qualify for this benefit. This article is NOT intended as specific legal or accounting advice and is not a substitute for actual legal and/or accounting advice regarding your specific situation. Please seek professional help for the assistance you need in this specific type of transaction for your specific situation.