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Proposal Would Reduce BAB Subsidies for VCAP Users

WASHINGTON — Build America Bond issuers that inadvertently violate tax law requirements and voluntarily seek to correct them would have their federal subsidy payments reduced, rather than eliminated, if the Internal Revenue Service adopts recommendations an advisory committee presented to it yesterday.

“We wanted the IRS to provide issuers with assurance that, if they issue Build America Bonds now and there is some inadvertent violation or foot fault, they’ll be able to resolve it on a reasonable and proportionate basis,” said Michael Bailey, a partner at Foley & Lardner LLP in Chicago who yesterday became chairman of the Advisory Committee on Tax-Exempt and Government Entities. The committee is known as ACT.

Bailey made recommendations for improving the IRS’ voluntary closing agreement program, known as VCAP, along with David Cholst, a partner at Chapman and Cutler LLP in ­Chicago, and George Magnatta, a partner at Saul Ewing LLP in Philadelphia.

The three members of ACT presented their report and recommendations for improving the VCAP to IRS officials. They recommended the IRS modify the VCAP to apply to direct-pay bonds, like Build America Bonds.

Municipal issuers have been worried that if they violated the tax law requirements for BABs they would lose their subsidy payments from the federal government. The payments currently equal 35% of their interest costs.

But the advisory committee recommended that if issuers inadvertently exceed the de minimis premium restriction on pricing bonds or fail to spend 100% of proceeds on capital improvements — two tax law requirements that specifically apply to BABs, but not other tax-exempt bond issues — they could instead receive reduced payments proportionate to the violation by turning themselves in using the VCAP.

BAB issuers also could use the VCAP for other inadvertent violations. Most of the tax-exempt bond rules apply to BABs, even though BABs are taxable bonds.

The VCAP currently generally permits an issuer of tax-exempt bonds that discovers a tax law violation affecting 3% of its bonds to make a payment equal to 3% of the bonds’ tax exposure and to redeem 3% of the bonds.

But Bailey said it would not make sense for the IRS to require the issuer to redeem BABs. ACT’s report contains a suggested form for direct payment reductions that would include information about the issuer, the bonds, the reason for the reduced payment, the reduction requested, and the effective date of the reduction.

Officials in the IRS’ tax-exempt bond office were receptive to the idea of ACT’s making recommendations along this line, Bailey said. He and Cholst said Moises C. Medina, director of the IRS’ government entities section who was at the meeting with the members of ACT yesterday, made clear that the IRS will consider the recommendations.

Cliff Gannett, the head of the IRS’ TEB, told issuers about the BAB-related recommendations yesterday during a panel session at the Government Finance Officers Association meeting in Atlanta.

ACT also urged the IRS to make several overall improvements to the VCAP.

The report suggested the IRS: provide clear assurances that the VCAP and a streamlined version of the program will be more favorable to issuers than closing agreements when used to resolve examinations; relax eligibility requirements that seem unnecessary and could discourage issuers from using the programs; permit issuers to correct certain violations with only minimal action from the IRS; and allow for special procedures in the case of de minimis violations.

“Taken together, these changes should serve to promote the use of VCAP and SVCAP while making the programs more administratively efficient,” the three lawyers said in the ACT report. SVCAP is the Streamlined Voluntary Closing Agreement Program.

Bailey said the IRS could adopt the recommended changes to the VCAP program quickly by incorporating them into the Internal Revenue Manual that is used by agency officials and agents.

“They could give immediate comfort to the market by amending the Internal Revenue Manual to include these recommendations,” Bailey said. Ultimately, the recommended changes could be adopted through new rules or a revenue procedure, but this would take time, he said.

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