WASHINGTON -- The IRS recently told field agents to avoid raising red flags during audits of 501(c)(3) organizations if they discover bond reserve funds or escrow accounts that could potentially violate rules on unrelated business income, an agency official said this week.

The directive comes as Internal Revenue Service officials are struggling to find a way to reconcile an apparent conflict between Section 514 of the IRS code, which governs unrelated business income of 501(c)(3) organizations, and tax rules that permit issuers to invest bond reserve funds and escrow accounts in taxable securities.

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