2015 MSBO ANNUAL CONFERENCE. Miller, Canfield, Paddock & Stone, P.L.C. Random IRS Audits: What Do They Look For?

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1 2015 MSBO ANNUAL CONFERENCE Presenter: Jeffrey McHugh Miller, Canfield, Paddck & Stne, P.L.C. Randm IRS Audits: What D They Lk Fr? Intrductin: The IRS has added new auditrs in the tax-exempt bnd enfrcement divisin and they are busy! Learn hw t keep the tax man at bay and be well-psitined fr an audit.

2 Why des the Internal Revenue Service (the IRS ) audit tax-exempt bnds? IRS audits tax-exempt bnds t ensure that the issuer cntinues t meet Internal Revenue Cde (the Cde ) requirements frm date f issue until bnds mature. Fr purpses f an audit, the issuer is treated as the taxpayer. If the issuer fails t meet the Cde requirements, then the bndhlders lse the federal incme tax-exemptin n interest earned n the bnds. Bndhlders will then lk t the issuer t recup lsses. Fr this reasn, the IRS will nrmally negtiate an agreement with the issuer s that bndhlders d nt lse their tax exemptin. In exchange fr the cntinued tax-exemptin, the clsing agreement will likely require that issuer pay a settlement amunt and redeem at least a prtin f the ffending bnds. What is the current scpe f IRS enfrcement? IRS annual examinatin cverage (ttal returns examined per ttal returns prcessed) has increased by ver 120% in the past 10 years. At the same time, the number f staff at the IRS has als increased. In the early 2000s, the IRS fcused n prblems at the date f issuance. Nw, the IRS lks mre clsely at the entire life f the bnds. Primary fcuses f enfrcement: Cmpliance with yield-restrictin and rebate rules; Including specific issues such as: Reimbursement f expenditures incurred prir t brrwing Treatment f unspent prceeds Cmpliance with the private use rules. Hw des the IRS chse which bnds it will audit? Audit letter itself will nrmally reveal why the IRS chse t audit a particular bnd. General Prgram Examinatin Letter 2

3 Randmly selected cases Prject/Initiative Examinatin Letter Cases selected as part f an IRS initiative fr the year Recent IRS cmpliance initiatives that may affect schls: Cash flw r deficit funding; Advance refundings; New mney deals Referral Examinatin Letter Cases where the IRS determines a prblem is likely based n internal research r an external tip. Identified Nn-Cmpliance Letter Cases where the IRS has identified a specific cncern with respect t the particular bnd issue. IRS will nt audit bnds that are ging thrugh the Vluntary Cmpliance Agreement Prcess, an alternative dispute mechanism available t issuers and the IRS. What shuld an issuer d upn receipt f an audit letter? Audit letter will typically request infrmatin abut the bnd in questin. This is knwn as an Infrmatin Dcument Request ( IDR ). Issuer will have t respnd t the IDR fairly quickly. IDR may request dcuments which d nt exist r may use the wrng names fr certain dcuments. Issuer shuld immediately cnsider whether it shuld hire an attrney. Can hire its bnd cunsel but shuld first ensure that it has a tax specialist. If hiring bnd cunsel, then will need a cnflict waiver and pwer f attrney. IDR can be fairly general r fcus n a few questins. A fcused IDR will ften ask questins related t arbitrage rebate nly. E.g. Yield calculatins, SLGs subscriptins, rebate calculatins 3

4 Mst IDRs will inquire hw the bnd prceeds have been r will be spent and the investment f bnd prceeds prir t expenditure. An IDR might als inquire abut private use f bnd-financed facilities. E.g. Management cntracts, leases, research agreements, etc. Hw des a typical audit prceed? Issuer must quickly respnd t the IDR and typically sends bnd transcript t IRS. Agent will review respnse/bnd transcript and identify any prblems. Issuer may receive a secnd r several mre IDRs. If the agent des nt identify any prblems, then the audit will be dismissed. If the agent des find a prblem, then he r she is required t disclse the prblem and wrk with the issuer t reslve it. Upn reslutin, the parties enter int a clsing agreement. If nt reslved thrugh clsing agreement, then the issuer may receive an adverse determinatin that is subject t appeal. Hw des the clsing agreement prcess wrk? IRS r the issuer can initiate a clsing agreement at any time during an audit. Almst all audits in which the agent finds prblems end in clsing agreements because it avids the interest n the bnds becming taxable t the bndhlders. Clsing agreement is narrwly drafted ONLY t cver prblems that arse in the audit. Agent will prepare agreement terms and higher level fficials will review. Certain factrs that may affect the terms f the agreement: Facts and circumstances surrunding the cmpliance failure; Gd faith and due diligence f the parties t the riginal transactin; Whether the issuer cperated with the IRS during the audit; Whether the cmpliance prblem was intentinal r inadvertent; Whether the issuer implemented pst-issuance cmpliance prcedures; Ecnmic benefit t the issuer when entering int the prblematic transactin. Clsing agreement is final and cnclusive with respect t the prblem it addresses ONLY 4

5 Hw lng des an issuer have t keep its recrds related t pst-issuance cmpliance? The IRS has nt yet issued definitive recrd-keeping standards; hwever, material recrds generally shuld be kept fr at least 3 years after the final redemptin date. An issuer shuld remember that state law may require a lnger retentin perid. The length f time the bnds are utstanding and the amunt f capital prjects a single bnd may finance creates a large recrd-keeping burden. Electrnic strage f recrds is permissible. What shuld an issuer d if its pst-issuance prgram reveals a vilatin f the tax rules? If it is a private use prblem, then certain remedial actin rules are available. If an issuer fllws the remediatin prcedures, then it cures the prceeds that cause the private use tests t be met. Imprtant t identify the prblem early, because there are timing cnditins t remediatin and the issuer may be required t redeem the prblematic bnds. If requirements fr remedial actin are nt met, then the Vluntary Cmpliance Agreement Prgram ( VCAP ) may be a pssibility. VCAP is an alternative dispute mechanism where the issuer vluntarily identifies a prblem t the IRS and wrks with the IRS t negtiate a slutin t its particular prblem. MORE QUESTIONS? Thank yu fr the pprtunity t present at the MSBO Annual Cnference. If yu have any further questins, please feel free t cntact us. Jeffrey M. McHugh, Esq. Miller, Canfield, Paddck, and Stne, P.L.C. Direct Line: (313) mchughj@millercanfield.cm Katrina Piligian Desmnd, Esq. Miller, Canfield, Paddck and Stne, P.L.C. Direct Line: (313) desmnd@millercanfield.cm 5