Tax law changes allowing the tax credits of tax-credit bonds to be stripped and sold separately to investors have increased the risk for improper or fraudulent tax credit claims, the Treasury Inspector General for Tax Administration said in a June 26 report.
More Internal Revenue Service oversight is required, TIGTA concluded in the partially redacted report.
Nearly $5 billion in tax credit bonds were issued in calendar years 2009 and 2010, resulting in millions of dollars of bond tax credits claimed each year, the report said. "Without effective IRS oversight, improper or fraudulent credits may be claimed, thereby reducing federal government revenue," the report said.
The report was initiated as part of TIGTA's fiscal year 2013 annual audit plan and addresses challenges of bond tax credit noncompliance. In the first quarter of 2013, the IRS began collecting information through Form 1097-Bond Tax Credit, to begin assessing the vulnerabilities in this area.
In calendar year 2008, bond tax credits were allowed to be stripped or separated from the bonds and sold to other investors who could use the credits to reduce their tax liability. Risk for improper or fraudulent claims increased because the population of taxpayers holding the credits became more diverse and there were no requirements for third-party reporting or information on the stripping and transfer of these credits.
TIGTA recommends the IRS analyze bond tax credits and determine whether changes to the compliance strategy are needed in order to address and ultimately prevent improper or fraudulent bond tax credit claims.
The IRS agreed with TIGTA's recommendation and said it begin performing an analysis of bond tax credits. "The findings will be considered in determining any changes needed to enhance the compliance strategy for detecting improper or fraudulent claims for bonds tax credits," the report said.
As part of the 1997 Taxpayer Relief Act, tax credit bonds were first introduced. They were first available in 1998 and provided a credit that could be used on the investor's federal tax return to reduce the tax liability in lieu of receiving interest.
Tax credit bonds were initially privately placed with large financial institutions, but were later sold on the open market. Financial institutions purchased the bonds to use the credits to reduce their tax liabilities. But with the economic downturn, many investors had reduced income and therefore could not use the bond tax credits to reduce their tax liability. Mutual funds also began investing in tax credit bonds and passing the credits on to their investors.
As a result, the owners of tax credit bonds and the stripped tax credits became more diverse. Institutional investors, such as mutual funds could pass the credits on to their investors.
In 2010, the Treasury Department expressed concern that multiple taxpayers could improperly or fraudulently claim the same bond tax credit, thereby reducing the amount of taxes paid to the federal government.
