IRS AUDIT ISSUES AND SOLUTIONS

Transcription

1 IRS AUDIT ISSUES AND SOLUTIONS or What to do when the IRS comes knocking? David L. Richardson McGuireWoods LLP

2 Key Takeaway If you get a letter from the IRS telling you your bond issue is being audited and you have to ask yourself for the first time What do we do now, it s already too late!

3 The IRS The IRS does not like tax-exempt bonds. The IRS would rather look for problems after the fact in an audit setting than to provide clarity in advance through regulations, revenue rulings, private letter rulings or technical advice memoranda. Classic example is the Revenue Ruling safe harbors for management contracts.

4 The IRS (continued) Enforcement activity has increased dramatically over the past ten years. Serious upgrade in quality of IRS personnel and training. Keep in mind that the IRS treats the true borrower as the taxpayer and generally does not go after actual bondholders if the bonds become taxable.

5 Types of Audits Random Targeted Part of a Project Initiative (e.g. advance refundings). Part of a Third Party Initiative. Specific Bond Issue Problem.

6 Sample Random Audit Letter Issuer: Person to Contact: Badge No.: Contact Address: Contact Telephone Number Date: RE: [Name of bond issue] We have selected the debt issuance named above for examination. The IRS routinely examines municipal debt issuances to determine compliance with Federal tax requirements. Please review the enclosed Information Document Request and mail all requested documents to the address noted above. Other items may be requested as the examination proceeds. If you desire to appoint a representative to act on your behalf, a power of attorney must be filed with the Service in order for the Service to discuss or provide your representative with confidential information. A Form 2848, Power of Attorney and Declaration of Representative, or any other properly written power of attorney or authorization may be used for this purpose. Copies of Form 2848 may be obtained from any Internal Revenue Service Office. During the examination, the Internal Revenue Service may need to contact various third parties including, but not limited to, underwriters, financial advisors, bond counsel and various counsel to third parties, investment banks, conduit borrowers, trustees, credit enhancers, insurers, program administrators and any other parties having a transactional relationship to the bonds being examined. These contacts may be necessary to complete our determination of the status of the bonds under section 103 of the Internal Revenue Code. We are providing this notice to you in accordance with section 7602(c)(1) of the Internal Revenue Code. You are not required to take any action on account of this notice. Thank you for your cooperation in this matter. Please feel free to call or write if you have any questions or concerns about this matter or are unable to promptly respond to the Information Document Request.

7 Sample Targeted Audit Letter Issuer: RE: [Name of bond issue] Person to Contact: Badge No.: Contact Address: Contact Telephone Number Date: We have selected the debt issuance named above for examination. The IRS routinely examines municipal debt issuances to determine compliance with Federal tax requirements. Your debt issuance was selected for examination because of information we received from external sources or developed internally that causes a concern that the debt issuance may fail one or more provisions of sections 103, of the Internal Revenue Code. Please review the enclosed Information Document Request and mail all requested documents to the address noted above. Other items may be requested as the examination proceeds. If you desire to appoint a representative to act on your behalf, a power of attorney must be filed with the Service in order for the Service to discuss or provide your representative with confidential information. A Form 2848, Power of Attorney and Declaration of Representative, or any other properly written power of attorney or authorization may be used for this purpose. Copies of Form 2848 may be obtained from any Internal Revenue Service Office. During the examination, the Internal Revenue Service may need to contact various third parties including, but not limited to, underwriters, financial advisors, bond counsel and various counsel to third parties, investment banks, conduit borrowers, trustees, credit enhancers, insurers, program administrators and any other parties having a transactional relationship to the bonds being examined. These contacts may be necessary to complete our determination of the status of the bonds under section 103 of the Internal Revenue Code. We are providing this notice to you in accordance with section 7602(c)(1) of the Internal Revenue Code. You are not required to take any action on account of this notice. Thank you for your cooperation in this matter. Please feel free to call or write if you have any questions or concerns about this matter or are unable to promptly respond to the Information Document Request.

8 Audit Prevention Techniques Random audits are bad enough, so don t make yourself a target. Adopt a tax compliance policy you do not want to check the NO box on your 8038 or on Schedule K to your IRS Form 990.

9 Audit Prevention Techniques Be careful with your 8038 or 8038G. Advance or current refunding. Make sure use of proceeds is accurate (especially costs of issuance). Get yield correct if a fixed rate issue. CUSIP numbers. TEFRA approval dates and names of approving entities. Ensure accuracy of all exhibits.

10 Audit Prevention Techniques (continued) Take Schedule K to your IRS Form 990 very seriously. Your 990 is really a mini IRS audit. The IRS has stated publicly that Schedule K is used to determine audit targets. Schedule K is extremely complex and the instructions are even worse. Accounting firms are inconsistent in their understanding of Schedule K. Pay particular attention to how you present costs of issuance and private business use numbers. Make sure 8038 and Schedule K are consistent.

11 Audit Prevention Techniques (continued) Use open market securities in your advance refunding escrow only if the spread to SLGs is significant. Do business with lawyers, underwriters, bankers, financial advisors, feasibility consultants, accountants and verification agents you know and trust. IRS will ask for names of deal participants in an audit and will target any they have run across before.

12 Be Ready for the Audit Before It Happens Adopt a compliance policy (and actually follow it). Require annual compliance reports to an appropriate Board Committee. Good optics may help if you have a problem but can demonstrate that you really tried. Keep detailed records of exactly how you spent your bond proceeds. Keep detailed records of your investment earnings (and interest rates on any variable rate debt).

13 Be Ready for the Audit Before It Happens (continued) Keep detailed records of your private business use, updated annually. You will need that information for your Schedule K anyway, and private business use is measured over time, not as a snapshot. A contemporaneous spreadsheet is much more credible than one you prepare after the audit starts. Do your rebate calculations and file the appropriate forms on time.

14 Be Ready for the Audit Before It Happens (continued) Get Bond Counsel to check your work from time to time so you can make mid-course corrections if needed. Take the time to educate your own people about private use issues. In-house seminars for department heads, in-house counsel. Require internal written requests for debt funding to include a private use analysis. Require annual private use updates.

15 Be Ready for the Audit Before It Happens (continued) If you discover a problem that can t be fixed, consider VCAP (Voluntary Closing Agreement Program). One you get the audit letter, VCAP is not an option. The reality is that not everyone has the resources to hire a full or part time person to be responsible for compliance, but do the best you can.

16 You Got the Letter Now What? Check the response dates (often the letters go to the conduit issuer for 501(c)(3) Bonds and can take weeks to get to the real borrower). Call your Bond Counsel. Power of attorney for both you and the conduit issuer. Conflict considerations. Call your bond trustee. Call your rebate consultant.

17 You Got the Letter Now What? (continued) Organize your team internally to assign responsibility for each request -- spread the pain around if you can. Make sure the right people in your organization are made aware of the audit and that senior management emphasizes that responding in a timely and accurate fashion is a top priority. Meet the IRS deadlines if at all possible (perhaps a short extension on the first request, especially if you get it late).

18 The Response Designate someone as the primary person responsible for the response. Designate one person to speak to the IRS agent (usually Bond Counsel). Too many cooks can result in confusion. Ask the agent how they want the response submitted electronically, hard copy, both? If you can pull it off, offer to set up an e-room for them.

19 The Response (continued) Create a good first impression by producing a quality product. Use consistent font and spacing. Use tabs and a table of contents. Repeat each question as a cover sheet for each tab. If your response raises a potential problem, offer the solution right then and there, i.e. a management contract outside the safe harbors. Do not wait for them to come back and ask. TELL THE TRUTH, no matter what the consequences. Try to avoid a site visit if at all possible.

20 Preparing for the Site Visit Find out who from the IRS is coming and check them out in advance. Try to get the IRS to agree to an agenda in advance so you can control the process. See if you can get them to identify exactly what they are looking for. Typical concerns are arbitrage, private use and whether the projects were actually built. Involve high level people in the process, even if only briefly. Most importantly, conduct a training session for your participants a few weeks in advance.

21 The Visit Itself Start with the President, Board Chair, Chief Operating Officer or other high ranking dignitary, if at all possible. If you can, go to the safest places first. Avoid problematic projects, if possible. No gifts or expensive meals. Ask in advance what the ground rules are. Be responsive but do not volunteer information that hasn t been requested.

22 The IRS Auditor Discovers a Problem Now What? Before the IRS issues an adverse determination letter, you will generally have a chance to negotiate a deal. The deal usually involves taking some bonds off the market or making a payment based on tax exposure (how much would the IRS have collected if bonds were taxable plus interest). If you can t strike a deal, the IRS will issue an adverse determination letter and ultimately declare the bonds taxable. The IRS s starting point is usually 100% of taxable bonds and your challenge is to try to whittle that exposure down.

23 The IRS Auditor Discovers a Problem Now What? (continued) Try to limit the problem so that it impacts as small a portion of the bonds as possible. Amend any non-compliant management contracts. Do whatever you can to eliminate other private use problems so you can blend-down the bad use. Allocate, allocate, allocate! Be creative.

24 The IRS Auditor Discovers a Problem Now What? (continued) The audit is not necessarily limited to the specific bonds in question, and could be expanded to cover other bonds if the IRS determines that they have the same problem. If you and the IRS do not agree on a technical point during the audit, you can request a Technical Advice Memorandum from the IRS s General Counsel. Keep in mind that the IRS claims that it will take into account whether you have compliance procedures in place.

25 The IRS Auditor Discovers a Problem Now What? (continued) Your exposure is limited to the open years, which are the past three years before the audit was opened until the present, although this period can be increased to six years if the IRS determines you acted in bad faith in resolving the problem. Any closing agreement will require that conduit issuer s approval if you are a 501(c)(3). The appeals process.

26 Ultimate Goal Issuer: Person to Contact: Badge No.: Contact Address: Contact Telephone Number Date: RE: [Name of bond issue] We have recently completed our examination of the bond issue named above. We have decided to close the examination with no change to the position that interest received by bondholders is excludable from gross income under section 103 of the Internal Revenue Code. Please note that if the need to open another examination arises on this bond issue, any change resulting from that future examination may affect all open years of bondholders from the issue date of the bonds. Thank you for your cooperation in this matter. Sincerely,

27 Questions