Minnesota pays $500K fine to IRS over accidental state bond purchase

Minnesota budget officials quietly paid a $537,000 penalty to the Internal Revenue Service in September of last year, after the board that handles state investments accidentally purchased the state's own debt and then resold it.

Under federal tax rules, the state is prohibited from buying its own bonds, which generally is low-interest debt sold to investors to pay for roads, bridges and state buildings. The two violations occurred in 2010 and 2011, disqualifying the state from its tax-exempt status on nearly $16 million in bonds that the State Board of Investment accidentally bought.

Budget officials noticed the transactions in 2012 and reported them to federal tax authorities. The penalty was the result of a settlement, finalized in September of last year.

"I'm not happy about it," said Minnesota Management and Budget Commissioner Myron Frans, who took the helm of the agency in January 2015. "I'm not happy that it happened, and I'll do everything I can to make sure it won't happen again."

After the discovery of the improper bond purchases, the state enacted new procedures to avoid similar violations in the future, satisfying the IRS, said a spokeswoman for the state budget office.

State and local governments must follow myriad complex rules to ensure that their bonds qualify for tax-free status, which can be a big advantage for investors and governments selling the debt. "It's very important you follow those so you get the benefit of reduced interest," Frans said.

The infractions occurred during the tenure of former investment board director Howard Bicker, who retired in 2013 after 32 years in that job. A phone message left for him Monday was not immediately returned.

The investment board's new executive director, Mansco Perry III, said that staff members have now been instructed on the new compliance guidelines.

"I'm certain the bonds would not have been purchased" under the new procedures, Perry said in an interview.

Perry, who became executive director in late 2013, said the amount of bonds in question is a tiny fraction of the board's investment portfolio, which includes about $10 billion in bonds. The state investment board is responsible for managing various pensions and trust funds, overseeing nearly $77 billion in assets for the state.

Nonetheless, "it's something we take very seriously, and we endeavor with the resources we have to do the best we can," Perry said. "Fortunately, these things don't happen very much."

The final settlement amount could have been larger, according to an IRS spokeswoman. The spokeswoman said federal law prohibited the agency from commenting on specific cases, including Minnesota's.

An IRS policy says penalties are generally lower for organizations that report the problems before they are discovered by a federal audit or review.

Legislative leaders say they were not told about the bond buying slip-up or the penalty, which first appeared deep in a budget spreadsheet released earlier in December. A review of the investment board's meeting minutes for the last few years found no mention of the improper investments or the IRS settlement.

House Capital Investment chairman Paul Torkelson, R-Hanska, said the fine should have been disclosed to legislators sooner.

"These are public dollars, and as citizens of Minnesota, we deserve to know when these public dollars are being spent on IRS fines instead of important issues," Torkelson said. He added that although the transactions appeared to be inadvertent, state budget officials should have been more forthcoming.

"If you accidentally break your mother's best china, you don't hide it in the closet," he said.

Janelle Tummel, a budget office spokeswoman, said there was nothing secretive about the fine.

"The payment is reflected in budget forecast documents provided to the media, posted online, and publicly available," she said. "We are providing additional materials to legislators, and will provide any additional information requested."

Senate Finance Committee chairman Dick Cohen, DFL-St. Paul, said Monday that he, too, was surprised to learn of the settlement.

"I did not catch that," Cohen said. "Usually, I try to stay on top of it."

Cohen declined to comment further without first learning more details about the bond purchases.

House Taxes Committee Chairman Greg Davids, R-Preston, said the state should already have had procedures in place to avoid the infractions.

"Not knowing the law is not an excuse," Davids said. "You can have an 'oops' when it's 10 bucks, but when it's a half-million dollars, that's a pretty big 'oops.' "

Torkelson and other legislators are expected to assemble a hefty bill to fund capital improvement projects around the state, money for colleges, universities and local municipalities.

Torkelson said that while the amount of the IRS fine is a negligible slice out of the state's $42 billion budget, every dollar counts. "This means we'll have a little less available," he said.

Ricardo Lopez • 651-925-5044