WASHINGTON -- Municipal market participants strongly support the Internal Revenue Service's new attempts to beef up its tax-exempt bond enforcement program, but worry it may not be effective, at least initially, in targeting and putting a halt to abusive transactions.
The new program was unveiled by the IRS on June 14 after the General Accounting Office concluded in a report that the prior enforcement program focused mostly on abuses that occurred years ago and lacked centralized management, overall objectives and adequate resources. The old program had been carried out by the examinations division, the main enforcement arm of the IRS.
The new program, which is to be centralized and given more resources, has been put under the purview of the exempt organizations branch of the agency's employee plans and exempt organizations division. The group, which oversees tax-exempt organizations and has its own enforcement program, recently began targeting tax-exempt bond abuses among nonprofit organizations.
A number of bond lawyers said, however, that they are concerned the exempt organizations branch does not have enough expertise in tax-exempt bond laws and rules to carry out an effective bond enforcement program.
"I'm concerned that these people may not have the experience" of the officials in the IRS' tax-exempt branch, said Richard Chirls, a lawyer with Orrick, Herrington & Sutcliffe in New York.
Chirls said he welcomes tougher bond enforcement but fears that due to a lack of experience "there may be a lot of false starts in auditing transactions that will delay the effectiveness of the [new] program."
R. Todd Greenwalt, a lawyer with Vinson & Elkins in Houston, who does a lot of work on bond financings for tax-exempt organizations, agreed.
The activities of the IRS' exempt organizations branch in the tax-exempt bond area, he said, have focused mostly on private-activity bond issues, and revolve around whether an impermissible amount of bond proceeds is being used for non-charitable purposes.
"They've not been auditing arbitrage questions" which are at the heart of the major abuses in the tax-exempt bond area, Greenwalt said.
He said exempt organizations branch officials will be "on a steep learning curve" and that it could take them "years to really get comfortable working with the code sections and rules" in the tax-exempt bond area.
Until then, Greenwalt said, "They're probably going to raise a lot of issues that shouldn't be raised, and they're probably going to be missing some issues that shouldn't be missed."
Robert Buck, a lawyer with Palmer & Dodge in Boston, said he hoped the exempt organizations branch would work closely with the tax-exempt bond branch in the financial institutions and products division.
"If the exempt organizations branch is going to be developing audit guidelines that are inconsistent with what [that division] has been working on, in terms of guidance, that's not going to be helpful," Buck said.
Dave Walton, a lawyer with Jones Hall Hill & White in San Francisco who formerly served at both the IRS and Treasury countered that the exempt organization branch is no more lacking in experience than the examinations division when it was doing bond enforcement.
Walton said he was more concerned that the new enforcement program would begin auditing issuers to determine if they have complied with all of the little detailed requirements rather than focusing on policing the market generally to catch the "very high-tech, sophisticated arbitrage motivated-transactions" that are the most costly to the government.
"What I'm concerned about is that there may be armies of agents going to school districts and other governmental offices and saying, ~I'd like to see your transcript for that $15 million issue you did last year."
Such audits might reveal "some minor technical problems" such as that the bond forms were not filled out completely correctly, Walton said, but "it's not the inadvertent failure to comply that's most important, it's the intentional very cleverly designed schemes to avoid compliance with arbitrage or rebate requirements."
Catherine Spain, director of the Government Finance Officers Association's federal liaison center, said she also was worried that the new program would result in increased audits of state and local governments. She said the IRS "needs to have a good educational program to make sure everyone knows what they're looking for, what issuers need to do to comply, and what the possible penalties are."
Most market participants are pleased that the exempt organizations branch is already asking Congress to allow the IRS to disclose some enforcement information and to levy lesser penalties than revoking the tax-exempt status of a bond issue.
But some lawyers are skeptical whether the new program will ever get off the ground. They note this is the second time in four years the IRS has announced a beefed up bond enforcement program.
"I'll believe it when I see it," said William Conner, a lawyer with Squire, Sanders & Dempsey in Cleveland. "A little enforcement would help all of the firms that live within the rules and that try to honor their spirit as well as their literal letter," he said.
But Conner said "it's very difficult to train agents" in tax-exempt bond law and rules and this kind of program is that first to go when budgets must be cut.
Most market participants said that only time will tell if the new program is going to be effective.
"I think it's a great idea. I'm happy they're doing something." said Henry S. Klaiman, a lawyer with Brown & Wood in New York. "We'll just have to wait and see if they do it effectively," Klaiman said. That may not be easy, however, because, "it takes so long to see an end-result" from IRS enforcement actions, he said.
