Chapter 2 Improvements Needed in IRS' Tax-Exempt IRS is responsible for overseeing a large and increasingly complex To carry out its overall oversight responsibilities, IRS has adopted a The Expanded Bond Audit Program can be improved in several respects to better promote voluntary compliance through enforcement efforts. To monitor compliance in the tax-exempt bond industry and to uncover potential cases of noncompliance, IRS has relied almost solely on others. For example, to monitor compliance, IRS relies primarily on the checks and balances provided by bond counsel's review of a bond at issuance. The Expanded Bond Audit Program also has concentrated almost exclusively on possible noncompliance cases for bonds that were issued 6 to 7 years ago and were referred to IRS through outside sources. Partially redirecting its existing efforts to proactively address current market activity could provide IRS a broader understanding of current compliance problems and may improve IRS' ability to determine if its enforcement presence is producing an acceptable deterrent effect. The Expanded Bond Audit Program is evolving and officials are working Improvements Needed in IRS' Tax-Exempt IRS Must Oversee a to investigate them. In addition, current staffing levels and locations as well as training, need to be reassessed in light of the evolving program. As IRS Completes work on its inventory of old cases, it needs to determine whether the current approach, which consists of training staff who work in dispersed locations and have little opportunity to apply that training, is effective. Another option, more centralized staffing, may help agents gain greater expertise and investigative skills. Although the Expanded Bond Audit Program is IRS' principal effort to The tax-exempt bond industry that IRS is responsible for overseeing has grown and become increasingly complex over the last 25 years. Both volume and uses of tax-exempt bonds have changed dramatically during that time. About 39,000 state and general purpose local governments can issue tax-exempt bonds, as can thousands of districts, authorities, and other entities specially authorized through state and local laws to do so. In 1990, issuers sold 11,500 issues and raised $162.3 billion. The bond counsels that IRS primarily relies on to monitor tax-exempt bond compliance with federal statutes are dispersed among more than 900 different firms. In addition, numerous other individual participants, such as underwriters, consultants, and trustees, are involved in the issuance of tax-exempt bonds. Moreover, since the late 1960s, as both financial markets in general and federal tax-exempt bond statutes became more complex, the financial community began to use intricate financing mechanisms for tax-exempt bonds that would produce the greatest financial benefits while attempting to remain within the confines of the law. These characteristics of the tax-exempt bond market create opportunities for noncompliance. For example, because tax-exempt bond law is so Improvements Needed in IRS' Tax-Exempt complex, complying with the law is burdensome, which provides an IRS' Heavy Reliance As with other taxes, IRS relies primarily on taxpayers-in this case bond issuers-to comply voluntarily with federal tax requirements. To monitor issuers' compliance, IRS relies to a large extent on the bond counsel's opinion that accompanies each tax-exempt bond. This opinion addresses compliance with federal laws at the time of bond issuance. Such an opinion is intended to give investors greater assurance that the bond's interest will be exempt from federal taxation. Reliance on counsel's opinion may provide IRS with some greater assurance of compliance up to the bond's issuance and involves individuals who should have knowledge of the complex IRC tax-exempt bond provisions. The purpose of the opinions is to enhance investors' confidence in the tax-exempt status of bond issuances. Bond counsels have an incentive to ensure that their opinions on compliance are accurate because if, contrary to their opinions, bonds turn out to be taxable, issuers will be reluctant to rely on their opinions in the future. However, reliance on bond counsels has limitations. Many tax-exempt bond provisions relate to the actual use of bond proceeds or other events that occur after the bond is issued. For example, bond counsel attests that the issue as structured would be compliant with restrictions on earning arbitrage at the time of issuance. However, bond proceeds actually are not invested and thus do not have the potential to earn arbitrage until after they are issued. Accordingly, even though bond counsel attests to Improvements Needed in IRS' Tax-Exempt compliance when the bond is issued, compliance also depends on subsequent actions taken by the issuer. Additionally, bond counsels generally are expected to give fair, accurate, and honest opinions. However, as for anyone, other circumstances, ranging from intentional misrepresentation to unintentional mistakes, can also affect the compliance of bond counsels. According to one bond counsel we spoke with, tax-exempt bond compliance relies on the capabilities, competence, and integrity of the parties involved; however, because these factors vary greatly across the range of bond deals, they can affect the degree of compliance. IRS' Expanded Bond IRS considers traditional enforcement activities as one key component of its overall attempts to encourage voluntary compliance with the tax laws. To the extent that it has engaged in enforcement activities for tax-exempt bonds, IRS historically has selected tax-exempt bond cases to pursue on the basis of sporadic tips from informants, tax-exempt bond issuers themselves, and other outside sources, as well as information from other federal agencies such as the Securities and Exchange Commission. According to IRS documents, IRS has relied heavily on such sources for leads on potentially abusive bond issues. For example, as of June 1992, IRS had reached approximately 70 closing agreements since 1981 with issuers on bonds it judged potentially taxable. About two-thirds of these closing agreements were reached over an 8-year period, as issuers voluntarily came to IRS. IRS did not independently identify these cases and did not obtain complete lists of bonds involving any common parties. Obtaining such lists potentially could have helped uncover additional similar abuses. The Expanded Bond Audit Program, currently IRS' primary tax-exempt bond oversight program, has taken steps to establish a more active enforcement presence. However, the program has not actively tested bond issuances, either randomly or selectively, for compliance. Instead, the program has concentrated on approximately 30 cases, mostly identified through external sources. The program primarily has focused on the surge in tax-exempt bond issuances that occurred before the provisions in the Tax Reform Act of 1986 became effective and the alleged abuses that occurred to avoid the act's restrictive arbitrage provisions. Although these potential abuses merit attention, only a few more recent cases have been included on the Expanded Bond Audit Program's active enforcement list. Accordingly, the program may not recognize whether, and if so, how, new compliance problems are developing. Improvements Needed in IRS' Tax-Exempt The possible benefits of a proactive enforcement approach are illustrated by recent Employee Plans and Exempt Organizations efforts. Employee Plans and Exempt Organizations recently began a coordinated examination program for tax-exempt organizations that have substantial income or assets; this program includes reviews of the organizations' tax-exempt bond financing. Preliminary work in this program has raised new concerns about whether some of these bonds satisfy IRC requirements. In another example, after several abusive nursing home deals were publicized widely, in 1991 Employee Plans and Exempt Organizations began emphasizing the review of tax-exempt bond financing plans for organizations applying for tax-exempt status under section 501(c)(3) of the IRC. In a February 1992 presentation, the Director of Exempt Organizations Technical Division said that about 10 percent of the 110 to 115 organizations applying in recent months either withdrew their applications in response to IRS' questions about the proposed bond deals or refused to answer them. Another 10 percent did not have enough information about proposed bond-related transactions for IRS to decide whether tax-exempt status should be granted. The Director interpreted these results as indicating that the special review appears to be stopping potentially abusive tax-exempt bond transactions that were unidentified and unsuspected before revelations on the abusive nursing home deals. Before the Expanded Bond Audit Program began, Examination tested issuers' and project managers' compliance with certain requirements for tax-exempt bonds used to finance low-income housing. According to its Manager, this one-time project began in 1988 as a result of a 1985 hearing before the Subcommittee on Oversight of the House Committee on Ways and Means and inquiries by the Subcommittee's Chairman about IRS' audit activities for tax-exempt bonds used to finance low-income housing.1 IRS has not released a formal report on the project's results. However, according to a summary provided at our request and statements made by the Assistant Commissioner of Examination on April 27, 1990, before the HUD/MOD Rehab Investigation Subcommittee of the Senate Committee on 'According to the project's Manager, IRS randomly selected 80 information returns filed for 1984 by issuers of multifamily housing bonds. Because 5 of the information returns could not be located, IRS reviewed 75 bonds. IRS revenue agents were directed to check for compliance with certain tax-exempt bond requirements such as whether issuers spent 90 percent of the bond proceeds within 3 years of the date of issuance and whether 20 percent of the project's units went to tenants certified to meet low-income criteria. We could not independently review the study's methodology or statistical validity or the strength of its findings because of a lack of documentation. Therefore, we do not know the extent to which IRS' results can be generalized to the universe of multifamily housing bonds. |