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IRS Backtracks on Auditing Up to Half of All BAB Deals

JUN 3, 2010 7:13pm ET
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WASHINGTON — Internal Revenue Service officials Thursday said that there are no plans to audit up to half of all Build America Bond deals, backing away from remarks they made last week.

In an apparent concession to issuers concerned that such an expansive enforcement program might discourage states and localities from selling the taxable BABs, the officials now are saying that it is far too premature to know how many of the transactions may be audited.

“Right now, to say exactly that we have the percentage or that we have a target in mind, I think that’s inaccurate,” Steven Miller, deputy commissioner for services and enforcement, said in an interview with The Bond Buyer. “It’s way too early.”

The IRS will determine its “audit footprint” after it sends a revised questionnaire to BAB issuers, the completed questionnaires are sent back, and agency officials have a chance to examine the results.

The whole process is likely to take until roughly the end of the fiscal year on Sept. 30, and may possibly not be complete until the end of calendar year, according to Miller.

He said there are about 10 BAB transactions currently under audit, out of a total of 789 BAB deals sold since last April.

IRS enforcement efforts towards BABs have been an issue of concern for issuers, especially in light of continuing debate over what steps issuers should take to track and determine issue price for the securities. The initial price is key to determining the interest rate, and the interest rate dictates the amount of the subsidy payment the IRS makes to BAB issuers. The American Recovery and Reinvestment Act set the BAB subsidy level at 35% of interest costs.

On a teleconference hosted by the National Association of Bond Lawyers last week, IRS officials urged issuers to track the primary market pricing of their BABs through the Municipal Securities Rulemaking Board’s EMMA site. They said they are concerned that some BABs are being sold to investors at prices that are higher than the initial pricing.

Bond prices and yields move in opposite directions: the lower the price, the higher the yield. If the interest rate is higher, the subsidy will cost the federal government more over the life of the bonds.

The subsidy is distributed by the IRS as a form of a tax refund. In addition, the tax law states that BABs cannot be sold at more than a de minimis amount of premium, with the implication that if the sales premiums were too high, issuers’ bonds would not qualify as BABs and then would not qualify to receive subsidy payments.

More significantly — and alarming for some issuers — was IRS officials indicating they plan to audit half of all BAB deals.

However, after last week’s teleconference, IRS officials clarified in an interview that they would audit only up to 50% of BABs, depending on the responses they get from issuers to the compliance-check questionnaire and their review of BAB trade data and prices on EMMA, as well as other information. The revised questionnaire the IRS plans to send at the end of the month will go to issuers who did not receive a similar one mailed in February.

“We’re going to be auditing up to potentially half of all transactions, but we haven’t decided on the exact amount,” Steve Chamberlin, manager of the IRS tax-exempt bond office’s compliance and program management section, said in an interview late last week.

The third iteration of the audit plans came in Miller’s remarks yesterday, as well as in written comments IRS officials sent to NABL this week in which they said that the actual number of examinations has not yet been determined.

Market participants yesterday said they remain skeptical that the IRS’ clarifications were sufficient to allay concerns of issuers and their attorneys.

One bond attorney, who asked not to be named, said Miller’s remarks were “helpful but leave open too many possibilities.”

“It sounds like they’re trying to carefully back off without foreclosing anything,” he said. “I don’t think it will calm people down enough.”

He also noted that IRS officials originally said the February compliance check was purely for informational purposes but later said it would be used for audits, leaving many issuers to lose trust in what the IRS was saying.

David Caprera, senior counsel at Kutak Rock LLP in Denver, said it is certainly within the IRS’ jurisdiction to audit a transaction, “but to say that they would audit a large number of transactions before they’ve audited a small number first to determine whether or not there is some perceived level of noncompliance would appear to be premature — 50% coming out of the box would be too large a number.”

Perry Israel, an attorney sole practitioner in Sacramento who moderated last week’s NABL teleconference, said it seemed unrealistic to think that the IRS had the manpower to audit 50% of BAB issues.

“So I’m not surprised that we’re hearing some changes there,” he said. “But because the program does result in the government writing a check, I’m still expecting more audits than we would see in the tax-exempt bond area, at least early on.”

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New York's budget leaves it at risk of becoming one of only five states that do not allow the use of design-build procurement to deliver public infrastructure projects.

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