CHICAGO -- The Internal Revenue Service plans to launch its random audit program for tax-exempt bonds before the end of the year, an agency official told bond lawyers here on Thursday.

IRS officials will begin the program by sending survey letters to issuers of one or two categories of bonds issued in 1986 and 1987, Debra Kawecki said at a tax enforcement session and interview at the National Association of Bond Lawyers annual workshop. Kawecki is an assistant branch chief with the IRS' exempt organizations division.

The survey letters will contain about a dozen questions aimed at .determining such things as whether the bond proceeds were spent for their intended purpose, she said. ff an issuer's answers are fairly routine and do not raise any questions, the IRS probably will not investigate the bond issue any further, she said. But if the answers are troubling or raise questions, the IRS will probably send the issuer a second round of questions and begin a full-blown audit of the issue, she said.

Kawecki said it is not yet clear how many bond issues will be initially surveyed under the random audit program. The number will depend on what is necessary for it to fall within a reasonable statistical margin of error for determining compliance levels for the various categories of bonds, she said. IRS officials also have not yet made final decisions on the categories of bonds to be surveyed, she said. Michael Bailey, the IRS' senior technician reviewer for tax-exempt bonds, told the lawyers that the IRS decided to do the audits according to categories of bonds because many of the tax law issues that are key to multifamily housing bonds, for example, are different from those that are important for advance refunding bonds.

The timing of the start of the random audit program took many of the bond lawyers by surprise. They had thought that it would take the IRS a year or two to develop a statistical base for the program.

But Kawecki said that IRS bond enforcement officials have obtained permission to tap into the massive computer system that is run by the agency officials responsible for computing tax return information. The system contains the tax-exempt bond forms that state and local governments are required to file for bond issues.

The bond lawyers attending the tax enforcement session raised several questions and concerns about the plans to survey issuers.

One of the biggest concerns raised was whether the survey letter should be regarded as the start of an official audit, which would immediately raise securities law issues about whether the issuer would have to disclose that its bonds were being audited.

One lawyer said she thought the bonds should not be under audit unless the IRS decides to pursue its investigation of the bond issue after the initial survey.

But Kawecki said, "I'm thinking of it as an audit from the get-go."

Kawecki and Bailey said they had discussed the disclosure concerns with Securities and Exchange Commission officials and that those officials had indicated there is no easy, "bright line" answer and that it would be a "facts and circumstances test" as to whether or when an issuer would have to disclose its bonds were being audited.

Kawecki said SEC officials indicated they would be willing to talk to any bond market participants who needed help with this question.

Another more basic concern raised by the bond lawyers was who the IRS would be contacting for the survey. Kawecki said she thought the agency would rely on the names and addresses listed on the Form 8038 bond information forms. But several of the lawyers worried that the state and local officials listed on those forms may no longer be with the issuer or that the addresses may be incorrect.

The lawyers wanted to know whether the issuers, who are not taxpayers, would be granted any of the procedures or rights that taxpayers are typically given in nonbond tax disputes.

Kawecki said that an issuer who wants to dispute an IRS field agent's claim of a tax law violation can appeal the matter to the IRS' national office in Washington by seeking a technical advice memorandum.

The lawyers also wanted to know whether the IRS, in an audit of a conduit bond issue, would deal with the issuer or the borrower. Kawecki said that the IRS would primarily deal with the issuer, but that the issuer could bring the-borrower into the proceedings.

One lawyer at the meeting who is involved in a current enforcement action with the IRS said issuers may want to consider being represented by independent counsel in tax disputes so they can preserve their right to bring a claim against the bond counsel at some point if it is justified.

Kawecki said that the IRS plans soon to issue guidance advising field agents how to conduct these random audits. The guidance, she said, will be a refinement of draft audit procedures that were outlined in a training document that was sent to the field agents earlier this month.

At the same time, she said, the IRS is going to have to get some experience with the audit program to begin to have a full understanding of what the problems will be and how they can best be addressed.

The random audits are one of four different kinds of audits that IRS agents throughout the country are, or will be, conducting under the agency's beefed-up bond enforcement program, Kawecki said.

In addition to the random audits, agents will be auditing bond issues the IRS has targeted as giving rise to possible abuse and bonds that market participants have told the IRS might be abusive, she said.

The targeted audits will focus on bond issues with back-loaded debt service payments that may be arbitrage driven; guaranteed investment contracts that may have been purchased at greater than fair market value; advance refundings in which escrowed securities may have been purchased at greater than fair market value; and small-issue industrial development bonds for which capital expenditures may have exceeded the tax law's $10 million limit.

In addition, IRS agents are conducting limited audits of issuer requests of refunds of arbitrage payments to verify that the refunds are appropriate, Kawecki said.

However, she said, the IRS plans to issue guidance in the next week or two that says the field agents must contact agency officials in the IRS' national office before turning any of these limited audits of refund claims into fullblown audits.

The guidance is intended in part to respond to market participants who worry that IRS field agents might be subjecting every issuer that filed an arbitrage rebate refund request to a fullblown audit and that this would have a chilling effect on issuers that want to request refunds.

The draft audit procedures and guidance that the IRS issued earlier this month urges field agents to conduct their audits of bond issues as efficiently and as quickly as possible because of a three-year statute of limitations that prevents the IRS from collecting back taxes for more than three years after the taxes were to have been reported. The draft guidance says that agents should try to settle tax disputes whenever possible. However, all proposed settlements should be submitted to IRS officials in Washington for review, it says.

If a tax dispute cannot be settled and the agent believes it is necessary to tax bondholders, the agent must first forward the case to the district counsel to make sure he or she would be willing to defend it if it ends up in court. The agent must also send the case to IRS officials in Washington for technical advice.

In addition to the draft audit procedures and guidance, the IRS also sent agents step-by-step procedures for investigating the bond issues that have been targeted as potentially abusive under the new bond enforcement program.

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