20 July 2018 IRS modifies computation of resolution amount for closing agreements for tax-exempt bonds In a memo to IRS exempt bond employees (TE/GE-04-0718–0017, "the Memo"), the IRS has announced an update to the tax rate used in calculating taxpayer exposure for purposes of determining resolution amounts for closing agreements for tax-exempt bonds. Internal Revenue Manual (IRM) 4.81.6 includes guidance on closing agreements executed between tax-exempt bond issuers and the IRS to resolve tax issues relating to tax-exempt bonds. Within this section, IRM 4.81.6.5.3 specifies procedures that apply to corresponding resolution amounts — i.e., amounts to be paid along with the execution of the closing agreement to resolve the issue that arose either during a tax examination or within the Voluntary Closing Agreement Program (VCAP). In general, closing agreement resolution amounts are based on the "taxpayer exposure" of the bond issue, as computed in IRM 4.81.6.5.3.1. Taxpayer exposure is the estimated amount of tax liability that the US would collect from the bondholders if the bondholders were taxed on the interest they realized from the bonds during the years covered under the closing agreement. The current IRM specifies that a 29% tax rate should generally be used to calculate taxpayer exposure (unless a more accurate measure is available in the particular case). The 29% rate has remained unchanged since a 2003 revision of the IRM, despite changes in income tax rates over the following years. The Memo includes interim guidance for IRS revenue agents and tax law specialists to resolve tax-exempt bond examination and VCAP cases. Specifically, the guidance updates the tax rate used in calculating taxpayer exposure for resolution amounts for closing agreements for tax-exempt bonds. The Memo states that the guidance will be incorporated into the IRM within two years. Under the new guidance, the 29% tax rate will continue to be used in calculating taxpayer exposure for tax years before 2018 (unless specifically instructed otherwise or a more accurate measure of a particular holder's tax rate is available). For tax years after 2017, the tax rate to be used will be the sum of: (1) the backup withholding rate on interest payments under Section 3406(a)(1); and (2) the net investment income tax rate specified in Section 1411(a)(1), in effect on the closing agreement execution date. As an example, the Memo notes that, for a closing agreement executed on May 15, 2018, taxpayer exposure for 2018 and later years would be computed based on a tax rate of 27.8% (24% plus 3.8%). The Treasury Department's decision to modify the calculation of taxpayer exposure for closing agreements from a flat rate of 29% to a fluctuating rate based on the sum of the backup withholding rate on interest payments plus the net investment income tax rate will potentially lower taxpayer exposure for tax years after 2017. The rate could vary, however, depending on changes to the backup withholding rate or net investment tax rate. Taxpayers should be advised to review the rates applicable to their unique set of facts to determine their tax exposure. This new guidance also serves as a reminder to issuers and conduit borrowers of tax-exempt bonds that they are liable to the extent of the investor's tax savings from investing in municipal bonds if the bond issue becomes "taxable." Tax-exempt bonds can become "taxable" for certain violations of federal tax laws applicable to tax-exempt bonds, including meeting the private security or private payment tests and arbitrage rebate noncompliance. These penalties apply to closing agreements, whether voluntary (under the VCAP) or initiated by the IRS. Issuers and conduit borrowers should exercise due diligence in complying with all federal tax laws by monitoring the proceeds of tax-exempt bonds, including establishing internal written procedures to ensure that all outstanding bond issues are monitored, and that violations of federal tax requirements are timely identified and corrected through the VCAP or other available means. — For more information about EY's Exempt Organization Tax Services group, visit us at www.ey.com/ExemptOrg.
Document ID: 2018-1462 | |||||||||||||||||
