Why IRS lowered the tax rate used to calculate taxpayer exposure in audits, VCAP

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WASHINGTON — The Internal Revenue Service has issued interim guidance that immediately lowers to 27.8% from 29% the tax rate used to calculate taxpayer exposure for violations uncovered in municipal bond audits and disclosed under the Voluntary Closing Agreement Program.

The 1.2-percentage point reduction will amount to $12,000 in saving on a $1 million tax settlement.

Bond attorneys greeted the new policy as good news but were surprised the rate reduction wasn’t more significant.

The 29% rate will continue to apply for tax years prior to 2018.

A revision had been expected because last year’s Tax Cuts and Jobs Act significantly reduced the top corporate rate to 21% from 35% and lowered individual tax rates as well.

IRS officials confirmed in late February at the National Association of Bond Lawyers' Tax and Securities Institute that a lower rate was under consideration.

The new rate was announced in a July 16 internal memo from Christie Jacobs, director of the IRS Indian Tribal Governments and Tax-Exempt Bonds Office that was sent to employees.

The memo stated it “provides direction to revenue agents and tax law specialists to resolve tax-exempt bond examination and Voluntary Closing Agreement Program cases.”

“This directive is not an official pronouncement of law, and cannot be used, cited, or relied on as such,” it said. “In addition, nothing in this directive should be construed as affecting the operation of any provision of the Internal Revenue Code, regulations, or guidance thereunder.”

Jacobs told employees that the guidance will be incorporated into the Internal Revenue Manual within two years of the memo.

Todd Cooper, a partner in the public finance group at Locke Lord in Cincinnati, who inquired about the possibility of lowering the rate in February, said Monday that “all of us in private practice appreciate the IRS’ willingness to consider the request” and “the timeliness with which they got it done, especially given the workload the new tax act has imposed on the IRS.”

Rich Moore of Orrick in San Francisco and treasurer of the National Association of Bond Lawyers agreed. “I am pleased with the relatively prompt action to reduce the rate,” he said.

A copy of the memo was published July 17 in the public finance blog of Squire Patton Boggs by one of the firm's partners, Johnny Hutchinson, who is vice chairman of NABL's tax law committee.

Hutchison said the reason for the new rate isn’t clear.

“Before there was no explanation why they chose the 29%,” Hutchinson said.

The new rate, Hutchinson said, uses two rates in a formula. One rate is 24% which is the backup withholding rate on interest payments and the other is 3.8% which is the net investment income tax that was a part of the Affordable Care Act.

“I guess I was surprised they didn’t drop the rate further,” said Tom Vander Molen, a partner at Dorsey & Whitney in Minneapolis who chairs NABL's tax law committee. “If it had been a 24% rate I’d have been delighted.”

Vander Molen theorized that the IRS appears to have data that justifies levying the additional 3.8%.

IRS officials didn’t respond Monday to a request from The Bond Buyer for an explanation and why the new policy was not publicly announced.

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