The Internal Revenue Service has launched a compliance practice research team that will seek to identify red-flags indicating questionable municipal bond transactions.

“Particularly, the team is looking for initiatives that might suggest bid-rigging and price-fixing,” Cliff Gannett, director of the IRS’ tax-exempt bond office, who first envisioned the project, said at the Council of Infrastructure Financing Authorities’ federal policy conference here on Monday.

Carl Scott, technical advisor for field operations, and Isabel Guerra, senior tax law specialist, are leading the team.

“It doesn’t look like any of our other teams where six or eight people are working together on projects,” said Steve Chamberlin, manager of TEB compliance and program management.

The team, which officially got off the ground in February, is in its early stages of information gathering. Both Scott and Guerra are looking at internal IRS sources and interviewing TEB personnel for their experience and observations of problems in the muni market. They eventually will turn to external sources.

“What we’re going to come up with regarding scope is a bit premature,” Scott said. “We’re still trying to get our head around the charge Cliff has put to us. We don’t have any preconceived notion of what this thing needs to look like or what it should include or how we are going to do this.”

The IRS has been concerned with ongoing mispricing of investments and bonds in the muni market and wants to detect them and even prevent them from happening. 

“The concerns we have about this evasive practice has been identified and confessed by a number of major banks, like the yield burning back in the 1990s,” said Scott, referring to pricing of investments.

“These are things that the TEB has been keenly aware of and deeply involved with. To the extent that there is something that might come of this that would help folks avoid those situations, I think that’s probably something that Cliff would like to be able to provide to the industry.”

The TEB team’s goal is to put together a public resource product that would allow issuers to identify red flags as they track the life of a bond issue from the planning stages through the final redemption. It would outline the areas to which issuers should pay particular attention to make sure that they don’t wind up with problems, Chamberlin said.

He emphasized that the project would serve as a tool to prevent problems for issuers as opposed to providing a best-practices guide. It’s unclear at this early stage if it will yield a publication or an online interactive tool, Chamberlin said, adding that the IRS has dedicated a significant amount of time to the project.

There is no specific deadline for the project’s completion, which Chamberlin described as something that is evolving and could be long term. Scott and Guerra will spend the spring and summer gathering information and developing a proposal for what product could be developed.

The IRS has reached out to the Government Finance Officers Association’s debt committee and other muni market groups with the idea that the service may carry the project part way and have others join in on the effort. Depending on who participates will dictate what the ultimate product looks like, Chamberlin said.

“We receive a lot of questions from our members about issue price and other tax rules related to their bonds, and the debt committee has added a new compliance best practices to their 2012 work plan,” said Susan Gaffney, director of GFOA’s federal liaison center. “We appreciate talking with IRS officials and others to best understand their concerns and what may be an appropriate response from issuers.”

Separately, the IRS has sent out a 14-page, inaugural semiannual newsletter to advise state and other officials overseeing the issuance of tax-advantaged debt about the IRS’ agenda and provide information on key issues.

“We’ve been making a more deliberate effort to establish open lines of communication with key state officials in the bond area,” Chamberlin said.

Starting in the fall of 2010 and continuing through March 2011, TEB contacted state officials responsible for issuing and managing state debt in 52 jurisdictions, including the District of Columbia and New York City. TEB representatives met with state debt officials in nearly all of the jurisdictions during this period.

The goals of the meetings were threefold: introduce TEB to the primary state contacts, explain the functions of the TEB exam program and how it’s organized, and answer questions regarding the work of TEB.

The newsletter summarized IRS’ revisions to its form 8038-G for governmental bond issues, updates to its voluntary closing agreement program, and the basic concepts of reissuance of debt obligations. When bonds are modified, they may be considered reissued and have to meet the latest tax-law requirements and face other tax challenges.

The newsletter also described the recent memorandum of understanding with the Municipal Securities Rulemaking Board to look at trading data as part of a compliance effort to identify pricing irregularities and other potential compliance issues.

In addition, it outlined TEB’s fiscal 2012 work plan. The group will continue to focus on “identifying abusive tax-exempt bond transactions and their promoters,” the letter said. It will direct “substantial resources toward examining arbitrage motivated and-or abusive transactions with a continuing emphasis on addressing abuses involving swaps and other derivative contracts, or long investment periods or large investment amounts.”

IRS officials will continue its their arbitrage compliance programs, including focused examinations of bond issues determined to have a greater likelihood of arbitrage noncompliance, such as pool bonds and advance refunding bonds, as well as requests for recovery of overpayment of rebate.

For fiscal 2012, TEB will allocate resources to 11 examination areas including advance refunding bonds, governmental bonds, student loan bonds, tax promoter penalties and other specialty bonds and tax-credit bonds. TEB also expects to complete projects relating to working capital financings, small governmental lease financings, and various types of governmental and charitable financings involving management contracts, research agreements, naming rights, and other public-private partnership efforts. The IRS plans to send out a second newsletter to state officials in July or August.

Jennifer DePaul writes for The Bond Buyer.