SAN ANTONIO — Build America Bond issuers could potentially go years without subsidy payments under the examination process the Internal Revenue Service is currently considering for them, bond attorneys meeting here warned last week.

IRS officials are putting the finishing touches on a revenue procedure that will outline how BABs will be audited, as the agency kicks off an initial round of about 28 audits of the bonds.

That document is expected to state that the IRS will stop BAB payments immediately if it discovers evidence of fraud and will suspend payments after issuing an adverse-determination letter that proposes bonds have violated the tax requirements.

But lawyers gathered at the National Association of Bond Lawyers’ Bond Attorneys Workshop noted that if the issuer decides to challenge that adverse determination, it could face years without potentially receiving multimillion-dollar payments as the parties work through the process.

“We’re talking about potentially years of suspension here,” said Bradley Waterman, a tax controversy attorney who chaired a panel discussion on IRS enforcement.

“When you’re talking about suspending the direct payment upon the issuance of a proposed adverse determination, you’re talking about a suspension that’s going to last a very long time.”

That means the IRS could have significant leverage when it comes to negotiating closing agreements with BAB issuers, he said.

With the prospect of going without subsidy payments for years, the issuer is “going to be under enormous pressure to capitulate,” Waterman said.

But if the IRS takes too heavy-handed an approach with muni issuers, they might urge Congress to set up a different process through legislation, he added.

Carl Scott, the IRS group manager handling BAB payments, said that if the agency resolves any problems it has with an issuer’s bonds, any payments suspended would be paid with interest.

Speaking on the same panel, Clifford Gannett, the head of the IRS tax-exempt bond office, said his agents have not yet had to deal with assessing penalties or negotiating a closing agreement with a BAB issuer found to be violating tax ­requirements.

But when the IRS reaches that point, he hopes to retain an arrangement that is similar to how it handles tax-exempt bonds — issuers who come forward voluntarily to settle tax disputes will get a better deal than issuers whose problems are found in an audit.

“The interest on our part is to be fair with respect to any of those closing agreements, but certainly we want to have a regime where if you come in voluntarily, you’re going to have a more favorable settlement than if we catch you through the examination process,” he said.

IRS officials also discussed the question on the information document request they are sending to BAB issuers under audit, asking them about any potentially related parties that have purchased their BABs, including pension funds.

The IRS posted a copy of the document on its website last week.

Scott said the IRS is looking into whether some BABs might be considered extinguished after being purchased by a related party.

“We have some concern that issue may be present in the industry, and I think this will help us better identify whether it is, the extent to which it is, and how to better focus in on those types of things,” he said.

Gannett emphasized that the question is the beginning of a “long process” and the bond branch has not decided on any course of action on it yet.

“We want to try to figure out whether it’s a credible issue and then if it is a credible issue … we’re going to have this dialogue and try to decide what we’re going to do about it,” he said.

Some bond attorneys have expressed surprise at the question, saying it is the first time the issue of related parties buying BABs had been broached by the IRS.

“It’s like the question dropped out of the sky,” Waterman said.

But Michael Bailey, a partner at Foley & Lardner LLP, said he sees merit in the query.

“This is a question that’s so obvious no one thought of it,” Bailey said. “In retrospect, it seems like an obvious issue.”

The issue of related parties buying up municipal debt traditionally has not been a significant issue, since tax-exempt entities achieve none of the benefits that come with buying tax-exempt debt — namely, tax-exempt interest payments.

But with the emergence of BABs and other direct pay taxable bonds, muni entities now have a reason to invest in muni debt.

Bailey, who is chairman of the Advisory Committee on Taxation, which advises the IRS on issues, said it was good the IRS posted the document online because it allows the community to discuss it.

“I think there’s danger in the community to overreact, because I think a lot of this is in the spirit for them of, 'Let’s be as transparent as we can,’ ” he said.

The IRS’ concern about pension fund purchases of BABs from related issuers has troubled some attorneys.

One lawyer in the audience at a panel during the conference, who did not want to be identified, asked what happens to a BAB if a pension fund buys it, the IRS considers the debt extinguished because it views that fund as related to the issuer, and then, as part of its regular portfolio management, the fund resells those BABs back into the secondary market after the program has sunset.

The answer seems to be if the debt is considered extinguished and the bonds are resold after the BAB program has expired, then the bonds are considered new debt for tax purposes, meaning they cannot not be BABs, he said.

James Polfer, chief of the IRS’ tax-exempt bond branch in the associate chief counsel’s office, said the area is “muddy” and cautioned attorneys to not draw conclusions based simply on a question asked by the IRS.

“Legal implications are not to be drawn simply from the questions in these” information document requests, he said.

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