WASHINGTON, Aug 1 (Reuters) - Tax-credit municipal bonds present large risks for fraud, according to a heavily redacted report from the federal government on Thursday that gave few hints on how banks and other investors may use the debt to cheat on taxes.
The bonds, which give buyers tax credits in lieu of payments, could create a “significant loss of revenue for the federal government,” the Treasury Inspector General for Tax Administration said, adding that the Internal Revenue Service “cannot easily detect errors or potential fraud.”
Issuers have mostly shunned tax-credit bonds. In 2009 and 2010, state and local governments issued only $4.8 billion of them, according to the report. But many federal leaders, including Senator Ron Wyden, the Oregon Democrat poised to head the Finance Committee, promote them as an alternative to tax-exempt bonds, which they say create outsized tax breaks for the highest earners.
Parts of the report were hidden from the public because the information could be used to circumvent regulations or statutes, according to a TIGTA spokesman. Still, it revealed that the credits are claimed by a group of taxpayers that is hard to define, and for amounts that can reach into the millions of dollars.
“While the number of tax returns filed claiming bond tax credits is small, the dollar value of bond tax credits claimed per return can be significant and ranged from $1 to approximately $244,000 for individual returns and up to approximately $83 million for corporate returns,” the report said.
In tax year 2011 there were 212 corporate returns filed claiming a total of $334.9 million in bond tax credits, after 192 returns filed in tax year 2010 claimed $366.8 million in credits, according to the report.
Also in tax year 2011, 1,153 individual returns claimed $3.1 million of credits, and in tax year 2010, 1,118 individual returns claimed $2.2 million of credits.
The Treasury Department is concerned “multiple taxpayers could improperly or fraudulently claim the same bond tax credit, thereby reducing the amount of taxes paid.”
Since creating the tax-credit form of debt in 1997, Congress has authorized different programs to sell the bonds for specific purposes such as school construction. With each authorization, it tweaked the debt’s structure, and the many changes “made the population of owners of these credits more diverse.” That, in turn, made it harder for the IRS to trace the credits.
Initially, the bonds were privately placed with financial institutions. Then they were sold on the open market. A legal change allowed mutual funds to pass the credits on to their investors.
Then, the 2009 economic stimulus plan allowed the credits to be stripped and sold separately. But the financial crisis dampened financial institutions’ appetite for the debt as their taxable income fell.
The inspector general made one recommendation on preventing fraud or addressing the problems, but it was redacted from the report.
It did, however, provide an IRS response to the suggestion: “IRS management agreed with this recommendation and plans to perform an analysis of the population of bond tax credits. The findings will be considered in determining any changes needed to enhance the compliance strategy for detecting improper or fraudulent claims for bond tax credits.”