The Voluntary Closing Agreement Program for Tax-Exempt Bonds
Has Been Implemented, but Its Impact on Voluntary Compliance Has Not Been
Determined
September 2004
Reference Number: 2004-10-175
This report has cleared the Treasury
Inspector General for Tax Administration disclosure review process and
information determined to be restricted from public release has been redacted
from this document.
September
22, 2004
MEMORANDUM FOR
COMMISSIONER, TAX EXEMPT AND GOVERNMENT ENTITIES DIVISION
FROM: Gordon C. Milbourn III /s/ Gordon C.
Milbourn III
Acting Deputy Inspector
General for Audit
SUBJECT: Final
Audit Report – The Voluntary Closing Agreement Program for Tax-Exempt Bonds Has
Been Implemented, but Its Impact on Voluntary Compliance Has Not Been
Determined (Audit # 200410005)
This
report presents the results of our review of the Office of Tax Exempt Bonds’
(TEB) Voluntary Closing Agreement Program (VCAP). The overall objectives of this review were to
determine whether the TEB office and Tax Exempt and Government Entities (TE/GE)
Division have taken appropriate actions to increase bond issuer participation
in the VCAP and whether the process established for VCAP cases ensures
settlement requests are processed timely, consistently, and effectively to meet
the goal of increasing voluntary compliance.
The VCAP was established to supplement the Examination Program and
provide a means for bond issuers to self-identify Internal Revenue Code
violations and report them to the Internal
Revenue Service (IRS). The VCAP also
allows a reduced settlement (sanction) amount of less than the amount the bond
issuer would be assessed if the violation was identified during an examination.
The
revenue impact of tax-exempt bonds to the Federal Government is
substantial. TEB office management
advised that the Department of the Treasury projects approximately $30 billion
in tax revenue would be gained in Fiscal Year 2004 if the tax-exempt bonds were
taxable.
In
summary, TEB office management has taken steps to develop and implement the
VCAP in accordance with “Voluntary Closing Agreement Program for Tax-Exempt
Bonds” (Internal Revenue Service Notice 2001-60, issued October 1, 2001), and
participation in the VCAP has increased over the first 2 years. In addition, the TEB office is continuing to
develop the Program to make the settlement process more effective, efficient,
and consistent. However, TEB office
management does not know the overall levels of voluntary compliance for
tax-exempt bonds and cannot determine the effect VCAP closures will have on
voluntary compliance. As a result, it is
difficult for TEB office management to determine the extent of value this
Program has had on the tax-exempt bond industry compliance levels.
We
also determined that TEB office management attempts to increase the impact of
the VCAP by performing education and outreach on noncompliance issues and is
working with the IRS Office of Chief Counsel and the Department of the Treasury
to make changes to the VCAP that should improve the timeliness and consistency
of case processing.
We
recommended the Director, TEB, TE/GE Division, identify the data needed to
adequately baseline tax-exempt bond noncompliance issues, coordinate with
Modernization and Information Technology Services organization management to
determine how these data could be tracked on current TEB office management
information systems, and establish a process to
collect and maintain these data.
Management’s Response: The
Commissioner, TE/GE Division, agreed with our recommendations and determined
that all line items on TEB returns should be transcribed to the Business Master
File. TEB management, in coordination with Information Technology Services, determined
that the data tracking process for risk
assessments and noncompliance issues identified through examinations and the VCAP
will be integrated into the TE/GE Reporting and
Electronic Examination System (TREES).
Also, the TEB office’s process of collecting and maintaining the data
will be integrated into the TREES. Management’s
complete response to the draft report is included as Appendix IV.
Copies
of this report are also being sent to the IRS managers affected by the report
recommendations. Please contact me at (202)
622-6510 if you have questions or Daniel R. Devlin, Assistant Inspector General for Audit
(Headquarters Operations and Exempt Organizations Programs), at (202) 622-8500.
The
Voluntary Closing Agreement Program’s Impact on Voluntary Compliance Is
Currently Limited
Appendix I – Detailed Objectives, Scope, and Methodology
Appendix II – Major Contributors to This Report
Appendix III – Report Distribution
List
Appendix IV – Management’s Response to the Draft Report
Tax-exempt bonds include governmental and qualified private activity certificates of debt issued by state and local governments or by organizations acting on their behalf, such as universities and nonprofit organizations. These bonds are considered tax-exempt because the bond issuers are tax-exempt entities and the bonds will be used for tax-exempt purposes, such as courthouses, hospitals, airport expansions, and highways. The bond issuers typically reinvest the bond proceeds, until they are needed to finance the tax-exempt project. If the tax-exempt bond issuers meet certain requirements under the Internal Revenue Code (I.R.C.), the interest income from the bond issuances can be excluded from gross income for tax purposes for both the bond issuer and the bond investors (i.e., bondholders). However, the bond issuers and investors can be held liable for paying sanctions if the I.R.C. requirements are not met.
The number of outstanding tax-exempt bonds and their total worth is not known. However, Internal Revenue Service (IRS) records show that more than 450,000 Information Returns for Tax-Exempt Private Activity Bond Issues (Form 8038) were filed with the IRS from 1985 through 2002. During the same period, the value of outstanding bonds grew from $650 billion to nearly $1.8 trillion.
The revenue impact of tax-exempt bonds to the Federal Government is substantial. The Office of Tax Exempt Bonds (TEB), Tax Exempt and Government Entities (TE/GE) Division, advised that the Department of the Treasury projects approximately $30 billion in tax revenue would be gained in Fiscal Year (FY) 2004 if the tax-exempt bonds were taxable.
The TEB office’s primary methods for ensuring compliance
with the I.R.C. are its examination and outreach and education programs. In an examination, TEB office examiners
review the books and records of the bond issuers to determine whether they are
complying with the I.R.C. In FY 2003, 53
field operations employees closed 349 bond examinations. This represents approximately 0.8 percent of
the estimated universe of bonds issued from 1985 through 2002. Sanctions in regard to these examinations
were negotiated in the amount of $18.3 million.
“Voluntary Closing Agreement Program for Tax-Exempt Bonds” (IRS Notice 2001-60) was issued on October 1, 2001, to establish the Voluntary Closing Agreement Program (VCAP) in the Outreach, Planning, and Review (OPR) function within the TEB office. The VCAP was intended to supplement the Examination Program and make better use of the TEB office’s scarce resources by having bond issuers self-identify violations with their bond issuances and report them to the IRS. To encourage bond issuers to voluntarily report I.R.C. violations, the VCAP allows for a reduced settlement (sanction) amount of less than the amount the bond issuer would be assessed if the violation was identified during an examination.
VCAP requests are worked by the OPR function, which is
separate from the Examination function.
The OPR function reviews the
settlement request, verifies the circumstances of the violation, and, based on
the severity of the violation, negotiates a sanction amount with the bond
issuer and issues a closing agreement.
The sanction is applied to the bond issuer due to the IRS policy of not
taxing investors for bond issuance violations of the I.R.C.
The VCAP had been in existence officially for 2 years at the time of our audit. The OPR function has increased the level of participation in the VCAP from 43 closures in FY 2002 to 50 closures in FY 2003. As a result of noncompliance issues resolved through the VCAP, bond issuers paid sanctions of $4.6 million in FY 2002 and $9.3 million in FY 2003.
This review was performed in the Office of the TEB, TE/GE
Division, in
The VCAP has been in existence officially for only 2 years, and the TEB office is continuing to develop the Program to make the settlement process more effective, efficient, and consistent. Although participation in the VCAP increased during the first 2 years of the Program, the 93 total VCAP closures represent only a small portion of total tax-exempt bonds outstanding. In addition, TEB office management does not have a process to determine what impact the VCAP has had on voluntary compliance. As a result, it is difficult for TEB office management to determine the extent of the value of this Program to the tax‑exempt bond industry.
The TEB office does not adequately track data on the tax‑exempt bond population and the results of VCAP closures and has not developed performance indicators to measure what impact the VCAP may have on voluntary compliance. For example, the TEB office does not know the overall levels of voluntary compliance (i.e., baselines) for tax‑exempt bonds and cannot determine the effect VCAP closures will have on voluntary compliance.
The Government Performance and Results Act of 1993 (GPRA) requires major functions of operations to specify in annual plans their general goals and objectives, including outcome-related goals; to determine the skills, technology, and human capital necessary to achieve these goals; and to determine the management information necessary to monitor whether they are achieving their goals.
Without adequate information to measure the population of outstanding bonds and indicators to measure the change in compliance levels, the TEB office faces the following challenges in measuring the VCAP’s impact on program goals:
· Complete data on tax-exempt bonds are not available on the TEB office’s computer systems. For example, the tax-exempt bond universe is not known because data from Forms 8038 were not captured on the Returns Information Computer System (RICS) until 1987 or processed on the IRS Business Master File (BMF) until FY 2001. Bonds issued prior to FY 2001 were entered on the BMF only if they were examined. In addition, the TEB office started capturing the results of tax‑exempt bond examination case information on the Audit Information Management System (AIMS) in FY 2003. Prior to then, tax-exempt bond examination information was maintained on the AIMS Non-Master File with some special reports on Microsoft Excel® spreadsheets. Furthermore, VCAP cases are not tracked on a computer system but maintained on a Microsoft Access® database. Because VCAP cases and the prior examinations were not added to the IRS computer system, comparisons of prior and current case information to measure the change in voluntary compliance cannot be achieved.
· The TEB office does not have meaningful outcome data from which to establish baselines of compliance levels and taxpayer burden reduction. OPR function management has established a method to measure the increase in customer participation in the VCAP by setting numeric goals for FYs 2003 and 2004. VCAP closures are tracked on internal reports and reviewed each month by the Director, TEB. While these are valid measures to help management determine whether resources are used properly, to gauge the activity or productivity (output) of the VCAP, and to aid in setting short-term goals for the program, they do not measure the impact on voluntary compliance.
TEB office
management advised us they would like to measure the impact of VCAP closures on
compliance but are having difficulty because they do not track the types of
data necessary to measure this. Another
difficulty in measuring the impact of VCAP closures is that requests for
closure under the VCAP are dependent on and directly related to the examination,
and outreach and education programs. For
example, an increase in examinations in a certain tax-exempt bond market
segment will result in an increase in requests for closure under the VCAP.
Because the effect of the VCAP on noncompliance cannot be adequately measured, TEB office management looks for general indicators of overall compliance levels through the Examination Program, research projects, and trend analyses of noncompliance in tax-exempt bond market segments. For example, one research project involves working with the Bureau of Public Debt to determine whether bond issuers involved in advance refunding are more likely in 2003, than they were in 1993, to participate in the acceptable practice of investing proceeds allocable to an advance refunding escrow in Department of the Treasury or State and Local Government Series (SLGS) securities, as opposed to open market securities. TEB office management believes this will be an indicator of a change in voluntary compliance.
Because the information about tax-exempt bond issuer compliance is limited to the relatively few examinations and VCAP cases worked and is not adequately tracked, a systematic analysis of noncompliance information is needed for TEB office management to make informed decisions about the use of their Examination function and VCAP resources. Until TEB office management can determine the impact the VCAP has on reducing taxpayer burden and increasing voluntary compliance, beyond the actual case closures each year, the real value of the VCAP cannot be determined.
The Director, TEB, TE/GE Division, should:
1. Identify the data needed to adequately baseline tax‑exempt bond noncompliance issues.
Management’s Response: The Director, TEB, TE/GE Division identified that, for the purpose of improving its process related to baselining tax-exempt bond noncompliance issues, all line items on TEB returns should be transcribed to the BMF. To meet this need, TEB coordinated with the TE/GE Division’s Customer Account Services staff to submit a request to Information Technology Services that all line items on the TEB returns be transcribed. This request was submitted in July 2004.
2. Coordinate with Modernization and Information Technology Services organization management to determine how these data could be tracked on current TEB office management information systems.
Management’s Response: The Director, TEB, TE/GE Division determined, in coordination with Information Technology Services, that the data tracking process for risk assessments and noncompliance issues identified through examinations and the VCAP will be integrated into the TE/GE Reporting and Electronic Examination System (TREES).
3. Establish a process to collect and maintain these data.
Management’s Response: The TEB office’s process of collecting and maintaining the data will be integrated into the TREES.
TEB office management has taken steps to develop and implement the VCAP in accordance with IRS Notice 2001-60. As implemented, the Program encourages bond issuers to comply with the I.R.C. and provides a vehicle for issuers to correct violations. Because of their publicity efforts, OPR management exceeded their VCAP participation goal (45 closures) for FY 2003. They have increased their goal to 50 VCAP closures for FY 2004. In addition, TEB office management has recommended changes to the Department of the Treasury regulations that should improve the efficiency of processing VCAP cases.
We also determined that TEB office management attempts to increase the impact of the VCAP by performing education and outreach on noncompliance issues to encourage other bond issuers to come in under the VCAP for these same noncompliance issues. Education and outreach efforts are important because bond issuers have demonstrated their willingness to come forward to report violations.
To publicize the VCAP and encourage participation, the TEB office has included information in IRS publications and on its Internet web site and made presentations at conferences, seminars, and other meetings attended by their customers. To determine whether the TEB Outreach and Education Program has been successful in making TEB office customers aware of the VCAP and determining their level of satisfaction with the process, we submitted questions to the Government Finance Officers Association (GFOA) and the National Association of Bond Lawyers (NABL). We requested information from their members about their knowledge and experiences related to the VCAP. They responded as follows:
· TEB office officials make presentations at GFOA and NABL meetings, and members have access to VCAP information through their respective Internet web sites, the TEB office web site, and newsletters.
· Both GFOA and NABL members generally agreed the VCAP case closure process was fair.
· There is a negative impression among some GFOA members that the VCAP is not as welcoming as it could be and that the process is slow and cumbersome. In addition, there is some concern that the IRS is using the VCAP to gather names of issuers who have inadvertently violated the I.R.C. and may refer them to the Examination function for enforcement.
Overall,
responses to the survey indicated TEB office efforts to publicize the VCAP were
successful. When we discussed the survey
responses with TEB office management, they agreed that, at times, the VCAP
process is time-consuming. TEB office
management also advised that the Program is not intended to be a “cure” for all
noncompliance issues. In the past, bond
issuers have submitted some inappropriate issues for closure under the VCAP,
and TEB office management has had to forward them to another program area for
consideration. For example, some bonds
involving fraudulent activities were submitted for closure under the VCAP and
were referred to the Criminal Investigation function for further investigation.
We reviewed the 35 FY 2003 VCAP cases closed with closing agreements to determine whether they were timely, consistently, and effectively processed. TEB office management has not established time standards for processing VCAP closures, so we could not determine whether there was a timeliness problem. However, we did note the amount of time to close VCAP cases varied tremendously. TEB office examiners required 21 to 801 days to close the 35 VCAP cases; 24 of the 35 cases required more than 90 days. On average, the 35 cases were closed within 163 days. TEB office examiners attempt to close simple cases that require no additional information within 90 days and all cases within 1 year. An example of a simple case is a request in which the bond issuer made an inadvertent error, the request package is complete, and no additional information is needed. Other requests can be extremely difficult and require technical opinions from the IRS Office of Chief Counsel. These cases can take up to a year or more to close. We did not determine which of the 35 cases should have been closed in 90 days and which required technical opinions.
IRS management recognized early on that the VCAP needed more detailed procedures. TEB office management has tried to increase the consistency and efficiency of closing VCAP cases through the development of standardized closing agreements. The use of standardized closing agreements and specified sanction amounts for similar violations could improve the efficiency and effectiveness of case closing by providing guidelines for working common types of I.R.C. violations and for negotiating sanctions. This should provide for greater consistency in working cases and determining sanctions and should reduce the time to close cases.
The Director, TEB, made an attempt to gain approval for standardized closing agreements. A request was submitted on May 29, 2003, to the IRS Chief Counsel to issue a revenue procedure that would implement a comprehensive voluntary resolution system. However, this request was not acted on. According to TEB office management, the IRS Chief Counsel has recently begun to consider implementation of such a system for the TEB office.
Of the 35 VCAP closures with settlement agreements in FY 2003, 33 cases (94 percent) contained the following 5 common issues:
·
Change In Use – Eleven (31 percent) of 35 cases involved an unapproved change in the
use of proceeds of state or local bonds after the date of issue. The sanction amounts ranged from $0 to almost
$1.5 million for the 11 cases.
·
Arbitrage/Excess Yield – Eight (23 percent) of 35 cases involved
investments that earned a yield materially higher than the yield on the bonds
of the issue. The sanction amounts
ranged from approximately $7,000 to $2.2 million for the 8 cases.
·
Guaranty – Five (14 percent) of 35 cases involved bonds that were
inappropriately guaranteed directly or indirectly by the Federal Government
with respect to the payment of principle or interest. The sanction amounts ranged from
approximately $2,000 to $21,000 for the 5 cases.
·
Announcement 2002-43 Hospital Refinancing Closing Agreement Program – Five (14 percent) of 35
cases involved bonds in connection with hospital affiliation transactions in
which 2 or more existing I.R.C. Section 501(c)(3) organizations agreed to
inappropriately merge their operations.
The sanction amounts ranged from $0 to approximately $500,000 for the 5
cases.
·
SLGS Arbitrage – Four (11 percent) of 35 cases involved the impermissible use of bond
proceeds by issuers to acquire a higher yielding investment or to replace funds
used to acquire higher yielding investments.
The sanction amounts ranged from approximately $4,000 to $143,000 for
the 4 cases.
The remaining 2 cases (6 percent) involved 2 different issues (Failure to Redeem Bonds and Failure to Pay). The sanction amounts for all 35 cases ranged from $0 to approximately $2.2 million.
The use of standardized closing agreements and specified sanction amounts for the similar violations listed above may have improved the efficiency and effectiveness of case closings for the common issues.
TEB office management uses an informal process in both the Examination function and the VCAP to decide what issues need to be addressed through education and outreach efforts. These efforts are designed to inform bond issuers of violations and to provide additional guidance for complying with the I.R.C. To determine whether the TEB office addressed the seven types of noncompliance issues worked in the VCAP in FY 2003, we reviewed IRS Publications, Private Letter Rulings, Field Service Advice, the TEB office Internet web site, and topics addressed during outreach speeches to bond issuer groups such as the GFOA and NABL. We determined the seven types of noncompliance issues were addressed through education and outreach activities. In a prior audit, we determined TEB office management adequately used the results of examinations to focus their taxpayer education and outreach program in an effort to reduce the number of similar errors in the future.
Appendix I
Detailed
Objectives, Scope, and Methodology
The overall objectives of this review were to
determine whether the Office of Tax Exempt Bonds (TEB) and Tax Exempt and
Government Entities Division have taken appropriate actions to increase bond
issuer participation in the Voluntary Closing Agreement Program (VCAP) and
whether the process established for VCAP cases ensures settlement requests are
processed timely, consistently, and effectively to meet the goal of increasing
voluntary compliance. To accomplish
these objectives, we:
I. Determined whether TEB office management’s education and outreach efforts provide complete guidance for bond issuers to submit a VCAP request.
A. Interviewed TEB office management and reviewed available documentation to identify the education and outreach efforts undertaken to inform customers of the VCAP and whether the customers were provided a listing of issues that would be considered for resolution under the VCAP.
B. Interviewed members of the National Association of Bond Lawyers and the Government Finance Officers Association to determine the organizations’ understanding of and participation in the VCAP.
II. Determined whether the TEB office’s education and outreach efforts were focused to help those bond markets/issuers that would benefit the most from the VCAP.
A.
Interviewed
TEB office management to determine how they focused their education and
outreach efforts based on the results of prior VCAP cases.
B.
Obtained a
listing of noncompliance issues from prior VCAP cases (from subobjective IV.
below) to determine how TEB office management focused their related education
and outreach efforts to provide guidance to the bond community.
III. Determined whether TEB office management has developed a method to measure the increase in participation and any change in voluntary compliance related to their efforts to increase closures under the VCAP.
A.
Interviewed TEB office management and reviewed other documentation
(Strategic Plan, TEB Work Plan, etc.) to identify goals established for the
VCAP and whether the goals had been met: goals for increasing voluntary compliance
overall and goals for increasing voluntary compliance attributable to the VCAP.
B.
Interviewed TEB office management and reviewed other documentation
(Strategic Plan, TEB Work Plan, etc.) to determine whether methodologies have
been developed to measure changes in voluntary compliance attributable to the
VCAP.
IV. Determined whether requests for closure under the VCAP were processed timely, consistently, and effectively.
A.
Interviewed TEB
office management to identify procedures for closing cases timely,
consistently, and effectively under the VCAP.
B.
Reviewed TEB
office management’s documented guidance to determine whether procedures have
been established to define time standards for case closure, guidance has been
provided to ensure consistency of case closure, and standardized closing
agreements have been developed.
C.
Reviewed all
closing agreements for VCAP cases closed in Fiscal Year 2003 and determined the
length of time it took to close the cases and whether cases with similar issues
were settled with similar sanction amounts.
D.
Interviewed TEB
office management to determine the cause of any discrepancies and resolved any
questions identified.
Appendix II
Major Contributors to This
Report
Daniel R. Devlin,
Assistant Inspector General for Audit (Headquarters
Operations and Exempt Organizations Programs)
Nancy A. Nakamura, Director
Gerald T. Hawkins,
Audit Manager
Barry G. Huff, Acting
Audit Manager
Jeffery A. Smith, Lead
Auditor
Kenneth C. Forbes,
Senior Auditor
Yolanda Brown, Auditor
Appendix III
Commissioner C
Office of the Commissioner – Attn: Chief of Staff C
Deputy Commissioner for Operations Support OS
Deputy Commissioner for Services and Enforcement SE
Associate Chief Information Officer, Information Technology Services OS:CIO:I
Director,
Government Entities, Tax Exempt and Government Entities Division SE:T:GE
Director, Tax
Exempt Bonds, Tax Exempt and Government Entities Division SE:T:GE:TEB
Chief Counsel CC
National Taxpayer Advocate TA
Director, Office of Legislative Affairs CL:LA
Director, Office of
Program Evaluation and Risk Analysis
RAS:O
Office of
Management Controls OS:CFO:AR:M
Audit
Liaison: Director, Communications and
Liaison, Tax Exempt and Government Entities
Division SE:T:CL
Appendix IV
Management’s
Response to the Draft Report
The response was removed due to its
size. To see the response, please go to
the Adobe PDF version of the report on the TIGTA Public Web Page.