GFOA Asks IRS to Re-Examine Overpayment Procedures

The Government Finance Officers Association is urging the Internal Revenue Service to both pay interest on any arbitrage overpayments made by bond issuers and return the overpaid amounts more quickly.

The GFOA debt committee plans to discuss the issue at its winter meeting here Thursday, and also detailed its concerns in a Dec. 20 comment letter sent to the IRS by Susan Gaffney, director of GFOA’s federal liaison center.

The comments were sent in response to a set of modifications the IRS proposed to its arbitrage regulations in September.

The investment of an issuer’s tax-exempt debt generally is subject to the so-called arbitrage rules, with “arbitrage” referring to earnings on bond proceeds that materially exceed the yield on the bonds. The existing regulations provide detailed rules for determining and restricting the yields on the bond issue and investments, and for computing and paying arbitrage rebate to the federal government. If an issuer does not comply with the regulations, it risks the Internal Revenue Service declaring its bonds taxable.

An issuer that ends up with arbitrage generally can maintain its tax-exempt status if it rebates the arbitrage to the IRS, but GFOA’s criticisms arise when an issuer ends up overpaying the amount rebated. An overpayment typically occurs when the bonds are refunded, making the arbitrage payment, which normally is calculated under the assumption that the bonds will be outstanding for their full term, excessive. When an issuer overpays, the IRS will send the issuer a check for the amount overpaid, but will not pay interest.

GFOA maintains that the IRS should pay interest on these overpayments, noting in its letter that “an issuer must pay interest to the IRS on any underpayments, and the IRS pays interest on other types of overpayments.”

“At a minimum, an explanation of the rationale would be helpful,” GFOA told the agency.

In addition to paying interest, the IRS should try to send issuers the overpaid amounts sooner and with some explanation as to what the checks represent. GFOA said in its letter that some of its members have waited nearly 18 months for reimbursement checks, and when they did arrive, they did not come with an explanation from the agency.

“Some of our members have commented that their government will receive a check in the mail from the IRS without any information, thus making it difficult for the government, which could receive hundreds of checks a day, to know that this is related to the arbitrage repayment,” the group said in its letter.

Julia Cooper, deputy finance director for San Jose and vice chairwoman of GFOA’s committee on governmental debt management, said San Jose submitted paperwork requesting a rebate of $367,000 on an arbitrage overpayment in Jan. 2006, but didn’t even hear from the IRS until Aug. 2007 that a check would be forthcoming.

“If they paid timely, then [paying interest] wouldn’t maybe be as much of an issue, but 18 months is a long time to go without $367,000,” she said. “The IRS requires us to pay interest on underpayments, so it seems like it should go both ways.”

GFOA has not specifically discussed what type of an interest rate should be applied to the overpaid amounts, Cooper said.

A public hearing on this issue and other proposed changes to the arbitrage rules is slated for Jan. 30 at IRS headquarters in Washington.

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