WASHINGTON -- Numerous bond industry officials blasted the Internal Revenue Service yesterday for taxing the interest earnings from a 1984 escrow bond deal and expressed fear the action would cause investors to lose confidence in the municipal market.
The criticism came in the wake of news that the IRS slapped the estate of a deceased investor, Dr. Joseph Jarabak, with a bill for $6,232 in taxes on the interest earned from about $300,000 of tax-exempt bonds he purchased in 1985.
The bonds were part of a $34 million issue that had been sold for the Industrial Development Board of Sevier County, Tenn., in late 1984 to finance the expansion and rehabilitation of the historic Mountain View Hotel in Gatlinburg, Tenn. The issue was underwritten by Donaldson, Lufkin & Jenrette Securities Corp., Matthews & Wright Inc., and Cumberland Securities Co. But the projects never went forward and the bonds were redeemed in late Dec. 1987.
An IRS revenue agent, however, wrote a letter on Monday to James S. Bosik, the lawyer for Dr. Jarabak's estate and also an investor in the same bond issue, telling him that the issue was not tax-exempt. But the agent gabe no reason for the determination.
Mr. Bozik said yesterday that he has no intention of paying the tax. He said he would dispute the IRS claim in the U.S. tax court, if necessary, and that he would urge other investors to join him in any such court action.
Several industry officials said yesterday that they were upset at the IRS for going after the investors of the Sevier County authority's bonds.
"I am philosophically upset with the IRS' approach here," David M. Thompson, chairman of the Public Securities Association's municipal securities division, said yesterday.
"They're picking on the most vulnerable target," he said. "They're penalizing the one party of a transaction who has knowledge" of any tax law violations that may have occurred, he added, saying, "I think it's sort of a cheap shot on the IRS' part."
"The issuer and the issuer's team are better able to defend themselves," said Mr. Thompson. "They're the ones that should be contacted" if the IRS has a legitimate tax law violation claim, he said.
An IRS official, however, said in an interview what "when it comes to the enforcement of a tax law, we deal with taxpayers. They are the only ones that we can deal with" and "the only party that we have any relationship with at all." The official stressed that he could not discuss any specific bond issue or enforcement action, only the IRS procedures and authorities in general.
The IRS has "no obligation to notify anybody" about a tax law problem with a bond issue other than the taxpayer, the official said. "The taxpayer is the one holding the bonds and claiming the benefit on the tax forms," he said.
But many industry officials agreed with Mr. Thompson. They said the investor, when compared to the participants in a bond deal, is least equipped with either the money or the expertise to defend himself against IRS claims.
"They cannot fight back," said one New York lawyer.
Several industry officials worried about the impact of the IRS action on the municipal market.
"My reaction to this is obviously very negative," said Ralph Horn, chairman of the Public Securities Association. "I certainly don't think this is the right way to do it. It can be very damaging to the market, there's no question about that."
"The timing of all of this is worrisome, because it's all bad news right now," said Catherine Spain, director of the federal liaison center of the Government Finance Officers Association. "What are people reading about bonds?" she asked, answering, "They're reading about fiscal conditions, defaults, emergencies, and now they're reading about bonds being taxed."
Other industry officials were hopeful the dispute would lead to a reassessment of the IRS enforcement authorities for municipal bonds.
"This may prove to be the first real test of how well the current tax law system works," said Richard Chirls, president of the National Association of Bond Lawyers. "I think it will prove to be a real mess," he said in a telephone interview from Anchorage, Alaska, where the association's board was meeting.
Mr. Chirls predicted that, "The issuer and other parties to the transaction will have no choice now but to arm themselves with lawyers and slug it out with the IRS and among themselves."