WASHINGTON - IRS field agents should be prohibited from auditing the bonds of issuers that are seeking refunds of arbitrage payments, Richard Chirls, a lawyer with Orrick, Herrington & Sutcliffe, said at a conference here Friday.

But Marcus Owens, one of the Internal Revenue Service officials speaking at the conference, said IRS officials in Washington are not permitted to tell IRS field agents what audits they can or cannot conduct. Agency officials may, however, be able to address the audit issue in forthcoming guidelines advising agents how to process refund claims, Owens indicated.

Owens, the director of the IRS' exempt organizations' technical division who heads up the bond enforcement program, was noncommittal about Chirls' recommendation to advise agents against expanding refund reviews into full-fledged audits, saying only that he would "take note of" it.

Owens said the IRS has 153 bond issue under audit. While a number of those involve refund claims, the bulk of them have been targeted because of concerns outlined in the bond enforcement program's action plan issued earlier this year, he said.

The exchange between Chirls and Owens took place at a meeting of the American Bar Association's exempt organization committee.

Chirls told Owens, who was speaking on a panel, that "it's not appropriate" for IRS agents to expand reviews of refund claims into audits.

The arbitrage rules permit issuers to seek refunds when they have made mathematical errors in their arbitrage calculations or when they are able to reduce their arbitrage liability by retroactively applying the final arbitrage rules that were issued last year, Chirls said.

Lawyers at Orrick Herrington and other firms have reported in recent weeks that their state and local issuer-clients are being subjected to audits when they seek refunds of arbitrage payments. The audits have a chilling effect on all issuers and prevent many from seeking refunds because no issuer wants to risk an audit by seeking a refund, Chirls and others have said.

Chirls told Owens that the IRS appears to be treating state and local bond issuers more harshly than other taxpayers, who are not routinely audited when they seek refunds.

"I'm wondering why municipalities would be treated worse than other taxpayers," he said.

Chirls said it is not proper for IRS field agents to decide whether state and local issuers should be audited in such cases.

But Owens said that, since the 1950s, officials in Washington have been prohibited from telling field agents what audits to conduct. The prohibition stemmed from concerns that IRS officials in Washington might try to exert political influence over such decisions, he said "That decision would be difficult, if not impossible, to change."

IRS officials in Washington can provide guidance to field agents, but the ultimate decision about whether to audit rests with them, Owens said.

He told Chirls that the IRS is also concerned about such audits and whether they are an effective use of agency resources. Owens said his office may try to address the issue in the forthcoming guidelines for field agents that will recommend how they process claims for refunds of arbitrage payments.

The guidelines would carry some weight with the field agents, Owens told a reporter later, because the agents' annual evaluations would take into account the extent to which they have been complying with the guidelines.

Owens said that the IRS also expects to issue two other sets of guidelines for field agents. One set of guidelines would govern the coordination of closing agreements, which allow municipal bond issuers to avoid a loss of tax-exempt status for bonds. In such settlement agreements, the issuer typically makes a payment to the IRS to compensate for lost arbitrage profits or taxes, and the IRS, return, agrees not to tax the bondholders.

These guidelines, Owens said, will probably be issued before the guidelines on processing refund claims.

The IRS this summer also expects to issue guidelines governing how field agents should locate bondholders when the tax-exempt status of their bonds is revoked.

The IRS would prefer to settle tax disputes through closing agreements, Owens said, but there will be cases where such agreements are inappropriate and the IRS will have to revoke the tax-exempt status of the bonds. Owens said an issuer is more likely to be given the option of a closing agreement if it is cooperative with the IRS and anxious to correct the tax law violation.

Subscribe Now

Access to authoritative analysis and perspective and our data-driven report series.

14-Day Free Trial

No credit card required. Complete access to articles, breaking news and industry data.