IRS Audits May Follow Surveys

WASHINGTON - The Internal Revenue Service's tax-exempt bond branch plans to send out about 200 surveys to governmental issuers on their post-issuance compliance practices next month. But unlike a similar questionnaire sent to charities earlier this year, the agency may follow up with audits in some cases.

The TEB branch's top officials discussed the survey yesterday along with the rest of their agenda for this fiscal year when they released their fiscal 2009 work plan.

Steve Chamberlin, the head of the IRS bond branch's office of compliance and program management, said the surveys were to be sent out in November, but TEB decided to delay them until January after market participants said filling out the information-rich document could be a burden during a period of market unrest. The agency could delay the surveys again if market conditions have not improved, he said.

To further accommodate issuers, the IRS plans to give them more time to respond to the surveys and will continue to be "fairly liberal" in granting further extensions if needed, said TEB director Cliff Gannett.

While IRS officials stressed earlier this year that they would not conduct follow-up audits on any of the bonds issued by 200 charitable organizations surveyed for post-issuance compliance practices, Chamberlin said the agency is changing its policy for the governmental surveys.

If the governmental survey responses give IRS officials reason to think that proper due diligence has not been undertaken, they could target some of the issuer's specific bond issues for follow-up examination, he said

Bond attorneys yesterday said they are not overly surprised by the policy change, and are grateful that the TEB office took into account their perspective by delaying the surveys.

"I'm not terribly shocked by the fact that they're leaving the possibility that they'll follow up [with audits]," said David Caprera, a partner at Kutak Rock LLP in Denver. "And the fact that they are delaying it demonstrates a sensitivity that one might not have expected in prior regimes."

"I think Cliff should be applauded for delaying it," said Michael Bailey, a partner at Foley & Lardner LLP in Chicago and member of the IRS' advisory committee on tax-exempt and government entities. "He's trying to be responsive."

Gannett added that TEB hopes to put together similar surveys for other areas of the municipal market in the future.

He also said the bond branch may impose sanctions against lawyers under IRS Circular 230 regulations if it believes they are deliberately delaying audit negotiations. Circular 230 governs the practice of tax attorneys that come before the agency. Sanctions for violating its provisions range from fines and suspensions to prohibiting the lawyers from practicing before the IRS.

"There are continuing signals ... that that is a problem we need to deal with," Gannett said.

Robert Henn, senior manager of TEB field operations, elaborated by saying that the agency has reason to believe that some attorneys are continuously responding to the IRS with small pieces of information as a stalling tactic, when they have more available. At the same time, issuers are redeeming the bonds in question in hopes that the statute of limitations will expire before any audit ruling can be made. Henn said TEB officials believe at least one attorney is currently engaging in this practice across several examinations, but would not identify him.

Noting the establishment this fall of a task force dedicated to identifying and notifying bondholders when the IRS has issued a proposed adverse determination letter warning their bonds may be taxable, Henn said it could help defeat that stalling tactic. The IRS can also request an extension of the statute of limitations in some cases, he said.

Among other things on the agenda for fiscal 2009, which began Oct. 1, Gannett said his office will continue to focus on taking enforcement action against abusive transactions. In fiscal 2008, $19 million of the $50 million TEB obtained in closing agreements stemmed from abusive transactions, he said, adding that he expects to see similar numbers for fiscal 2009.

The financial crisis "has kind of highlighted certain areas, and the IRS will be "redoubling efforts" in examining derivatives, Gannett said.

Henn said the field offices are entering into the second phase of TEB's initiative to examine qualified hedges. About 100 cases have been identified for examination - most of them swaps - and all of them have been initiated in recent months, he said.

Henn also said his office is planning to close out the remaining handful of cases from Phase 1 of the initiative, which included about 30 audits.

TEB agents plan to continue to look into the student loan bond sector for compliance issues, he added.

Separate from audit initiatives, Henn said agents are also beginning three research projects. Such projects differ from initiatives because they do not begin by opening examinations, although they could lead to audits if evidence of noncompliance is found.

Agents will be looking into charter school financings, particularly the issue of what happened to bond proceeds for failed schools. They also will be looking into tax-exempt financing for community development districts, as well as exploring projects involving tax increment financing.

"We want to explore what those are all about," Henn said.

In response to a recommendation from market participants that TEB find a way to streamline its voluntary closing agreement program, Chamberlin said yesterday that his office has updated the Internal Revenue Manual to identify eight common violations accompanied by the expected penalties. He said the unique facts and circumstances of each case could change the penalties, but that he hopes the guidelines will give issuers incentive to come forward voluntarily when they identify a problem with their bonds.

Some of the violations identified include excessive nonqualified use of bond proceeds, failure to provide notice of defeasance, impermissible advance refunding, and a failure to timely reinvest proceeds into 0% state and local government series securities.

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