Why IRS is considering lowering the rate it uses to determine penalties for violations

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WASHINGTON -- The Internal Revenue Service is considering lowering the 29% tax exposure rate it uses to determine penalties for tax violations of issuers and borrowers found in audits or admitted to under the Voluntary Closing Agreement Program.

The 29% rate, which dates back to 1997, is up for a readjustment because the new tax law enacted in December lowered the corporate tax rate to 21% from 35% and also lowered individual tax rates.

The tax exposure rate is a blended estimated rate of what bondholders would pay in taxes if the interest on their bonds had been taxable during the period of the violation. The period would typically range from three years before the violation (because of the IRS' three-year statute of limitations) through the time it takes to remedy the violation.

IRS officials said the rate was under review during a "tax hot topics" panel at the National Association of Bond Lawyers' Tax and Securities Law Institute in Phoenix last week. But they offered no estimate when it might be changed.

The IRS officials talked about the rate after Todd Cooper, a partner in the public finance group at Locke Lord in Cincinnati who moderated the panel, inquired about the possibility of lowering the 29% rate since the new tax law slashed the corporate tax rates and lowered individual rates.

Cooper also chairs the American Bar Association’s taxation committee section on tax-exempt financing.

“I think where the 29% was written somewhere in the books of Greek mythology,” joked Rich Moore, a NABL board member and partner at Orrick Herrington & Sutcliffe in San Francisco. “It only makes sense when tax rates go down, that the number should go down.”

The rate change for audits and VCAP would occur in the Internal Revenue Manual and would not necessitate other changes in audit procedures, bond attorneys said.

Bond attorneys could ask for a lower percentage during an audit in anticipation of the change, Cooper suggested. “I think people will ask, but I’m not sure that they will get as far as they would like with it,” he added.

The IRS closed 577 audits in the tax exempt bond office in the 2018 fiscal year that ended Sept. 30. That’s down from the 717 closed in fiscal 2017 but slightly higher than the 570 concluded in fiscal 2016 and the 569 in fiscal 2015, according to the IRS.

There were 44 VCAP cases closed in 2017, the most recent year for which data is available, down from 67 in 2016 and 122 in 2015, the IRS said.

Cooper said the number of VCAP cases has declined because the success of the program after a couple of decades of use. “There aren’t as many flaws out there anymore, so there isn’t as much need to ask for a solution to a problem,” Cooper said. “There aren’t as many problems. People are more educated and aware.”

VCAP is still needed when a bond-financed building is found to be obsolete and sold to a private buyer, Cooper said.

“Maybe they built a 10 floor county administration building and due to advances in technology they don’t need as many people and their records are digitized,” Cooper said, explaining that the county might want to rent out a floor or two to lawyers.

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