Options to Enhance Voluntary Compliance Recent Simplification Both the legislative and executive branches have been working to simplify tax-exempt bond requirements. Several bills were introduced during the 102nd Congress that included provisions intended to simplify these requirements. Treasury and IRS officials have shown a willingness to take on the major problem areas, and IRS has been working at simplifying related regulations. In its Strategic Business Plan, IRS has described an organizational goal to reduce the burden on taxpayers and enhance voluntary compliance by making it easier for taxpayers to comply with the law. During the 102nd Congress, bills were considered that would make changes intended to simplify some of the tax-exempt bond requirements, especially those related to arbitrage rebate. For example, proposals were made to decrease the number of issuers that would be subject to arbitrage rebate requirements by increasing the applicable dollar thresholds for exceptions and to eliminate more complex arbitrage restrictions that achieve purposes similar to those achieved by less complex provisions. Treasury and IRS have been working to simplify tax-exempt bond arbitrage regulations, including the temporary arbitrage rules issued in May 1989. In May 1992, Treasury issued the 1989 temporary rules, with interim amendments, as final regulations. At the same time, IRS and Treasury announced a commitment to simplify and clarify those regulations by revising and finalizing them by June 1993. In November 1992, Treasury issued 177 pages of proposed regulations on arbitrage restrictions to replace approximately 400 pages of existing rules on arbitrage. Generally viewed as a major simplification, the proposed regulations would provide greater coordination of the rules on yield restriction and rebate, more unified definitions, general antiabuse rules in lieu of numerous special rules, clarifications of ambiguous areas, and new guidance on many previously reserved topics. As an example, the proposed regulations would provide a one-time yield computation for a fixed yield issue, which generally would eliminate the requirement to recalculate the yield on a fixed-yield issue except in narrow circumstances. A representative of the National Association of Bond Lawyers referred to the proposed regulations as an important move toward simplification because of their smaller size as well as the guidance they provided in areas such as rebate exception. Conclusions Although the extent is unknown, IRS has found some noncompliance in the tax-exempt bond area. However, IRS' ability to effectively address Options to Enhance Voluntary Compliance noncompliance and promote overall market compliance could be enhanced if the law provided further incentives to deter noncompliance. IRS could more appropriately penalize noncompliance in the tax-exempt bond industry, and thereby promote compliance, if it had a choice of penalties beyond the basic sanction of taxing the interest earned by bondholders. Taxing the interest on bonds is administratively complex, penalizes investors rather than directly punishing the parties most likely responsible for the abusive transactions, and is a severe sanction to levy for minor infractions such as filing Forms 8038 late. Until recently, IRS avoided taxing bondholders largely for these reasons. Instead, they entered into closing agreements. Yet officials have judged this reliance on closing agreements to be inadequate in promoting compliance and have had to resort to pursuing the taxation of bondholders; effective alternative penalties are not available for the cases they have targeted. IRS can use the penalty for promoting abusive tax shelters contained in IRC section 6700 to direct penalties to those responsible for tax-exempt bond abuses. However, IRS has not had a good opportunity to apply it because the noncompliance cases it is pursuing predate the January 1, 1990, effective date of legislative language that more clearly makes the resulting penalty worth the effort. Because this penalty would be targeted to those responsible for noncompliance, we believe IRS should test it for tax-exempt bond abuses that have occurred after the effective date of the clarifying legislative language to determine whether it can be used to effectively enhance tax-exempt bond compliance. Even if the section 6700 penalty can be successfully used by IRS to target responsible parties in abuses that amount to promoting abusive tax shelters, the nature and seriousness of potential tax-exempt bond abuses vary widely. For many potential abuses, the taxation of bondholders' interest is not commensurate with the severity of the violation, in addition to being a sanction that is not directed at the responsible party. Additional alternative penalties, including narrower penalties for specific kinds of noncompliance, such as failure to file tax-exempt bond returns, would assist IRS in promoting compliance. Several disclosure options could provide additional incentives to promote compliance with tax-exempt bond requirements. If information about tax-exempt bond enforcement actions could be released, the market forces created by the motivation of tax-exempt bond market participants to protect their reputations and financial interests could better assist IRS in Options to Enhance Voluntary Compliance ensuring compliance. One important component of an efficient market that would be strengthened by disclosure is the free exchange of information with which market participants can make reasoned judgments about compliance risks. Removal of the current prohibition on disclosure, even in a limited sense, however, must be carefully considered. The concerns related to disclosing information either do not apply as strongly for tax-exempt bonds as for other protected information or may be alleviated through a carefully designed disclosure provision. Because the disclosure prohibitions currently are contained in law and very inclusive, arguably prohibiting even a very general report on IRS enforcement activities, Treasury cannot effect this change on its own. Therefore, we believe Congress should consider options allowing some disclosure of IRS' tax-exempt bond enforcement efforts. Simplifying tax-exempt bond requirements, as Congress and the executive Recommendation Matters for We recommend that the Commissioner of Internal Revenue test the use of Congress may want to consider several options to enhance tax-exempt bond voluntary compliance. The penalty structure for tax-exempt bond abuses needs to be improved. Congress may want to consider adopting other penalties for specific kinds of noncompliance. Also, if after testing IRS finds that the section 6700 penalty is not effective in encouraging Options to Enhance Voluntary Compliance Agency Comments and Our Evaluation compliance in the tax-exempt bond market, Congress may want to In oral comments on a draft of this report, IRS officials generally agreed with our recommendation. IRS agreed that the emphasis of tax-exempt bond enforcement activities should be on the promoters and not on the investors. However, they said that the application of the section 6700 penalty to tax-exempt bond abuses is difficult in that it is hard to prove and applies only to cases after 1989. We agree that this penalty could be difficult to apply in a tax-exempt bond case because intent is difficult to prove and, as we said in our report, IRS must prove that those parties considered responsible in the case intentionally promoted a bond through which investors could improperly shelter income and avoid paying taxes. It is for this reason that we believe IRS should test the use of the penalty to determine whether it is an effective tool for encouraging tax-exempt bond voluntary compliance. It is also another reason that Congress may want to consider alternatives. In that regard, IRS officials also agreed that permitting the disclosure of some tax-exempt bond information is an issue for Congress to decide. Appendix I Tax-Exempt Bond Requirements in the Tables I.1 through I.11 provide summary explanations of the major Table I.1 covers the overall tax exemption (section 103). ⚫ Tables I.2 and 1.3 cover the sections of the IRC that apply to all • Tables I.4 through I.7 cover the sections of the IRC that generally apply to • Tables I.8 through I.11 cover the sections of the IRC that apply to specific qualified private activity bonds (sections 142, 143, 144, and 145). 'These tables are based on the table entitled "Summary of Tax-Exempt Bond Provisions" included in Tax Policy: Internal Revenue Code Provisions Related to Tax-Exempt Bonds (GAO/GGD-91-124FS, Sept. 27, 1991). The sections, subsections, and explanations included in these tables are updated through the enactment of the Tax Extension Act of 1991. The tables do not (1) detail all of the technical intricacies of the tax laws, (2) include references to the Department of the Treasury's authority to prescribe regulations and certain definitions, or (3) represent a legal interpretation of the various tax-exempt bond provisions. Consequently, the IRC should be consulted for details on the full legal requirements associated with the use of tax-exempt bonds. Additionally, these tables do not detail the myriad of other laws and regulations that may apply, such as applicable Treasury regulations, antifraud and securities law, and state and local laws. |