The Internal Revenue Service has stepped up its efforts to investigate possible misconduct in the municipal bond sector, more than doubling the number of examinations it conducts per year.

A new report by the Treasury Inspector General for Tax Administration found that the IRS’s Tax Exempt Bonds Office’s enforcement activities examination program has dramatically increased its coverage of the municipal bond sector by conducting more examinations from fiscal year 2005 to fiscal year 2010. However, the IRS’s TEB office has minimal information to select municipal bonds for examination and continues to use its limited resources examining compliant bonds.

State and local governments have outstanding debt of more than $3.7 trillion in municipal bonds, and hundreds of millions of dollars in new municipal bonds are issued each year. The TEB office’s primary method to ensure bonds are in compliance with tax laws is through its examination program. The Congressional Research Service estimates that $309.9 billion in federal tax will not have to be paid for fiscal years 2012 through 2016 because interest income from municipal bonds is exempt from federal income taxes.

TIGTA’s overall objective was to review statistical data for the TEB office’s enforcement activities from October 2004 through September 2010 to assess the office’s efforts in identifying noncompliant bonds. TIGTA auditors found that the TEB office more than doubled the number of examinations conducted per year since TIGTA last reviewed enforcement activities from fiscal years 2002 through 2004.

Assessments based on these examinations conducted from fiscal years 2005 through 2010 total more than $84 million. The TEB office accomplished these results while significantly decreasing the amount of time it spends examining municipal bonds from more than 100 staff days per examination in FY 2002 to approximately eight staff days in FY 2010.

However, the TEB office still spends a substantial amount of time examining compliant bonds, TIGTA found. As in a prior audit, TIGTA determined that more than half of the examinations conducted by the TEB office do not uncover noncompliance. Finally, TIGTA found that the time expended on misconduct investigations was not always tracked.

During the audit, TIGTA recommended that the TEB office provide guidance to its employees to ensure time captured relative to misconduct investigations is complete. The TEB office took appropriate action prior to the issuance of this report.

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