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IRS Conducts Random Audits on Outstanding Tax-Exempt Bonds for Arbitrage Compliance

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March 17, 2011

Recently one of our clients was randomly selected and received a letter from the Internal Revenue Service (IRS) notifying them that their debt service issuance has been selected for examination as part of a project initiative involving governmental bond issues. The IRS routinely examines tax exempt debt issuances to determine compliance with Federal Tax requirements applicable to arbitrage rebate under section 148 of the Internal Revenue Code.

Under the 1986 Tax Reform Act, the IRS required that all excess earnings (arbitrage) from investment proceeds be rebataed to the IRS. Arbitrage, for purposes of these regulations, is defined as the difference between the yield on the investment (earnings) and the yield on the obligations issued (interest paid).  If there are excess earnings, this amount may be required to be rebated to the IRS. The Regulations were issued in proposed form during 1989 and were subsequently revised. Final Regulations were issued during 1993 and 1994.

Recently the IRS has increased the number of examinations performed. With the improvements in computer software, it has become easier for the IRS to match the 8038-G at time of issuance with the 8038-T at time of arbitrage rebate submission. This effectively eliminates from the examination population those issuers that have complied and submitted the required rebate payments. The remaining population from which the IRS may select their examination either complied and did not owe arbitrage rebate or did not comply and will be subject to arbitrage rebate and applicable penalties. When an issue is audited by the IRS, it can be a time-consuming and expensive process. Penalty for failure to pay rebate can be substantial; however, it can be waived if the issuer provides an explanation to prove the failure was not due to willful neglect and the rebate is paid within 180 days of discovery without prior audit notification from the IRS. A waiver of penalty is not allowed if the issue is under examination by the IRS.

Lerch, Vinci & Higgins has an Arbitrage Department which performs arbitrage services for many clients. If you would like us to send you a proposal for financial advisory services in connection with the calculation of arbitrage rebate on your outstanding debt or if you would like to discuss the arbitrage requirements further, please contact Paul J. Lerch, CPA, Partner in Charge of Arbitrage Services, 201-791-7100.

Sincerely,

LERCH, VINCI & HIGGINS, LLP
Certified Public Accountants

17-17 ROUTE 208 FAIR LAWN NJ 07410 (201) 791-7100  FAX (201) 791-3035 dlerch@lvhcpa.com