Vulnerabilities at the Internal Revenue Service could allow for improper or fraudulent claims for bond tax credits, according to a new government report.

A heavily redacted report on the vulnerabilities was publicly released Thursday by the Treasury Inspector General for Tax Administration. It noted that nearly $5 billion in tax credit bonds were issued in calendar years 2009 and 2010, resulting in millions of dollars of bond tax credits claimed each year. TIGTA noted that without effective IRS oversight, improper or fraudulent credits may be claimed, thereby reducing federal government revenue.

This review was initiated as part of TIGTA’s fiscal year 2013 annual audit plan and addresses the major management challenge of tax compliance initiatives.  The overall objective was to evaluate the IRS’s progress in identifying and addressing bond tax credit noncompliance.

TIGTA conducted an analysis of corporate and individual returns and determined that more than $700 million in bond tax credits were claimed in tax years 2010 and 2011.

Changes to the law in calendar year 2008 allowed bond tax credits to be stripped, or separated, from the bonds and sold to other investors who could use the credits to reduce their tax liability.

These changes increased the risk for improper or fraudulent claims for bond tax credits because the population of taxpayers holding the credits became more diverse and there were no requirements for third-party reporting of information on the stripping and transfer of these credits.

In the first quarter of calendar year 2013, the IRS began collecting information via the new information return, Form 1097-BTC, Bond Tax Credit, to begin addressing the vulnerabilities in this area. The research indicated that compliance increases when taxpayers know that the IRS receives data from third parties.

TIGTA’s recommendations were redacted from the report, but IRS management agreed with TIGTA and plans to analyze the population of bond tax credits and determine whether changes to the compliance strategy are needed to address and prevent the improper or fraudulent claiming of bond tax credits.

“As noted in the report, legislative changes and the economic downturn have contributed to the diversification of the population of taxpayers claiming benefits associated with Bond Tax credit (BTC),” wrote Peggy Bogadi, commissioner of the IRS’s Wage and Investment Division, in response to the report. “Consequently, those changes have commensurately increased the complexity associated with the administration of BTC attributes. … We will evaluate the compliance risks associated with BTC and determine strategies that may be implemented to mitigate those risks.”

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