WASHINGTON -- Issuers claiming that their bonds are being fully audited because they are seeking refunds of arbitrage payments can ask IRS officials in Washington to investigate whether the audits are warranted, an agency official said yesterday.
"If they find something like this that just doesn't make sense to them, the best thing for them to do is to call someone here in the national office, and we can look into it and find out if there is a problem," Lon Smith, chief of the Internal Revenue Service's tax-exempt bond branch, said in an interview.
Smith made the remarks in the wake and reports that some IRS field agents are initiating audits to determine if bond issues meet all the tax law requirements for tax-exempt status when state and local issuers request refunds of arbitrage payments.
"If apparently has happened to a number of people. I have talked to a few of them," Smith said. "Rumor says that it is very widespread, and I don't have any reason to doubt that."
Smith said he is aware of such audits in at least four different regions of the country, although it is not clear how many IRS field agents were involved in initiating the audits.
Bond lawyers are upset about the audits, which they say will discourage state and local issuers from requesting refunds. Most issuers would find the burden and cost of a full-scale audit not worth the refund, they said.
Smith cautioned state and local issuers not to get too upset if they get audit notices after requesting refunds. IRS field agents are just trying to do their jobs he said.
"This sort of thing is going to happen at first," he said, noting that this is the first time the IRS has offered such a refund program.
The IRS announced last June when it issued a simpler, consolidated set of arbitrage rules that issuer could retroactively apply the new rules and seek refunds if those rules were more favorable than the ones in effect when the bonds were issued.
Smith said, however, that state and local issuers should expect IRS field agents to investigate refund claims particularly when the claims involve large amounts of money.
"It's certainly fair enough for an agent to ask for [an issuer] to justify its claim," he said.
Agents might also initiate a full-scale audit if they see something suspicious or unusual about a bond issue for which a refund is being sought, Smith said.
"But overall, it's probably not worthwhile to routinely ask for a full-blown audit and for all of the documents unless the agent sees something or suspects something peculiar," he said.
Smith said it is not yet clear why some field agents are initiating full-scale audits of bond issues when refunds are requested.
Some bond lawyers suggest that the confusion may have occurred when the IRS, in embarking on its new bond enforcement program, held training sessions for field agents and gave them both refund claims to be processed and bond issues suspected of tax law violation to be audited.
In any case, Smith said, state or local issuers or bond lawyers concerned about being caught up in a full-scale audit over a refund request should contact him or Marcus Owens, the director of IRS' exempt organizations technical division, or other IRS officials in Washington, to look into the matter.
Perry Israel, a lawyer with Orrick, Herrington & Sutcliffe in San Francisco, said recently that Smith has been very helpful in looking into four separate cases of clients whose bonds were subjected to full-scale audits after they sought refunds.
Israel did not want to name the clients but said most of them were conduit borrowers who had sought refunds for different reasons, ranging from mathematical errors in arbitrage calculations to misunderstanding of tax law requirements.
A bond lawyer in the Midwest, who did not want to be identified, said an IRS field agent began a full-scale audit of a routine revenue bond issue sold by one of his clients after the client sought a refund.
The client, a local issuer the lawyer did not want to name, requested the refund after its interpretation of a tax law provision proved overly conservative when the provision was clarified in a more liberal fashion in the final arbitrage rules that were issued last June.
Soon after the refund claim was filed, the IRS agent notified the issuer than he was initiating an audit, the lawyer said. The agent asked for all ofthe bond documents and said he V
planned to determine whether the bonds meet all of the tax law requirements for tax-exempt bonds.
"At the completion of the examination, an explanation will be made of any proposed recommendation and how it affects the tax-exempt status of the bond issue[s]," the agent said in the letter.
The lawyer said yesterday that he would ask the IRS' Smith to look into the situation and to determine if the audit is warranted.