IRS seeks to recover taxes lost to 'yield burning' Local governments that issued bonds are feeling the heat

July 28, 1996

WASHINGTON -- An IRS program to recover what could amount to billions of dollars of unpaid taxes from public bond issuers is sending tremors through local governments nationwide.

At issue is an obscure practice known as "yield burning" that enriches brokerage firms and cheats the federal government. Caught in the middle are municipalities, counties, states and other agencies that issue tax-exempt bonds and, potentially, the buyers of those bonds.

An Internal Revenue Service document issued July 19 is being interpreted as an attempt to coerce bond issuers into settling with the IRS or facing the potential of having their bonds declared taxable.

Using a process outlined in the document, issuers of bonds sold before July 19 have a year in which to seek a settlement from the IRS. Treasury Department officials say the program was set up to expedite settlements with issuers who know they face tax problems.

"This does not change the law. It's purely voluntary," said Calvin Mitchell, deputy assistant secretary.

But Amy Dunbar, director of government affairs for the National Association of Bond Lawyers, said the IRS document appeared retroactively to create a definition of yield burning that would cause problems for bond issuers who thought they were in the clear.

"Are you forcing people into a situation where they say, 'OK, I have to take your offer of a reduced penalty rather than take a higher penalty later for something that was not within my power'? " she said.

Treasury Secretary Robert E. Rubin sought at a meeting Wednesday to calm representatives of brokerage firms and bond-issuing agencies, assuring them that the department would consider their complaints.

Micah Green, executive vice president of the Public Securities -- Association, welcomed Rubin's commitment to work on the issue. Otherwise, he said, the IRS program could affect billions of dollars of outstanding bonds.

"The implications would have tainted the marketplace and a policy that taints everything is not the right approach," he said.

Yield burning, a form of price gouging, most often involves so-called advance refunding bonds. When interest rates fall, agencies sell those bonds to refinance older bonds previously issued at a higher interest rate.

The bond-issuing agency uses the proceeds of the new issue to buy U.S. Treasury securities, which temporarily are held in an escrow account. The Treasury securities are sold when the time comes to pay off the old high-rate tax-exempt bonds being refinanced.

If the municipal bond agency makes a profit by buying and selling Treasury securities with the proceeds from a tax-exempt issue, it must pay the profit to the IRS. It's a rule designed to prevent agencies from abusing their tax-exempt status.

Under yield burning, the brokerage firm handling the Treasury securities for the municipal bond agency uses fees and other devices to siphon off the profit that would otherwise go to the government.

Pub Date: 7/28/96

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