TAX NEWS - June 2010

IRS To Review Build America Bond Program Advisory Report

The Internal Revenue Service (IRS) and U.S. Treasury Department will review a report from an IRS advisory committee that recommends penalties for any violations under the popular Build America Bond program, Clifford J. Gannett, director of the Tax Exempt Bond Office at the tax agency, said Wednesday.

Gannett was speaking at a panel at the Government Finance Officers Association conference in Atlanta.

The report, released Wednesday by the IRS' Advisory Committee on Tax Exempt and Government Entities, recommends that if a Build America Bond, or BAB, is in violation of the program's rules, the government's subsidy on interest costs should be reduced, he said. There might also be a penalty imposed on some BAB issuers depending on the extent and timing of the violation, said Gannett.

"We'll start to work toward rules on remediation in this area," after the report has been reviewed, Gannett said. He couldn't provide a time frame but said after the panel, "I would expect that it would be a high priority this year" for the Treasury Department and IRS chief counsel.

The focus of the BABs-related portion of the 405-page report was on suggested improvements to programs meant to encourage issuers to report violations to the IRS on their own.

The report says "specific guidance is needed" regarding how to fix possible violations related to bonds like BABs and "lack of such guidance may be a deterrent to the issuance of these bonds." The report is available on the IRS website.

BABs are taxable municipal bonds that give issuers a 35% subsidy on interest costs under the U.S. government's stimulus program. The program has been popular since its start in April 2009, accounting for roughly a third of municipal bonds that have been sold.

But the IRS has said it is concerned that BABs may be being priced incorrectly, which would be among the ways an issuer could violate the program's rules. The tax agency has said it is worried some BABs may be being sold in the marketplace at prices that are higher than the initial pricing. There are anecdotal reports of some BAB issues trading immediately after issuance at prices much above the initial offering price, which could indicate the initial interest rate, and thus the subsidy amount the government pays to the issuer, may be too high.

Recent statements from the IRS on BABs have raised concerns among some in the $2.8 trillion municipal-bond market that interest-rate subsidies that municipalities receive for the debt may be reduced or even eliminated.

The IRS has started sending questionnaires to every agency that has sold a BAB and Friday confirmed that it has opened audits into fewer than 10 sales.

At the panel, Gannett said that all BAB issuers have received a questionnaire, but several issuers in the audience said they have not. Earlier Wednesday, Frank Hoadley, Wisconsin's capital finance director, said his office hasn't received one.

Gannett told audience members that the response rate from the questionnaire was 77%, which is a "little low."

He said that the IRS's approach has been "methodical," and that it's "premature" for officials to know "what will happen on the examination side."

His remarks echo recent IRS statements that sought to allay concerns after another official suggested last month that up to half of all BAB issues--almost 800 so far--could expect a formal audit. The agency later backpedaled, saying that was an outside estimate and it was too early to say how many audits there ultimately might be.

The IRS is looking for "outliers," such as price-fixing cases, Gannett said. "We need to make sure that the system is as clean as we can make it."

The agency had earlier reduced subsidy payments to a handful of municipal borrowers because they may owe money to the federal government.