The Internal Revenue Service introduced a Voluntary Closing Agreement Program that will help financial firms avoid harsh penalties for violating federal tax laws on arbitrage investment restrictions for municipal bonds.

The program is available to municipal bond issuers so they can correct any violations of non-fair-market value purchases of forward-float investment agreements. The IRS noted that purchasing a forward-float agreement at a yield below market value could result in a violation of the applicable arbitrage yield restrictions.

The resolution terms in the voluntary program are only available until March 1, 2008. The IRS warned that failure to correct a violation could result in a bond issue being labeled "arbitrage bonds," which means it would lose its tax-exempt status.

The illegal practice of yield burning by securities brokerage firms first came to the attention of the IRS in the mid-1990s. With yield burning, brokerage firms charge inflated prices for escrow securities to artificially comply with yield restrictions. The IRS said the underpayment of earnings on a float agreement creates a similar diversion of arbitrage.

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