The relationship between the budget allocation for the Internal Revenue Service (IRS) and its auditing functions is a complex one that carries significant implications for municipal bond issuers. As the new administration settles in, existing legislative disputes concerning the IRS budget may directly influence how frequently audits are conducted on municipal bonds. Experts in the field have pointed out that the amount of funding allocated to the IRS correlates closely with the agency‘s capacity to enforce tax regulations, particularly in the realm of tax-exempt bonds.
The intricacies of IRS funding are often likened to a “political football,” subject to the whims of legislative negotiations and broader governmental priorities. Starting with an initial boost of $80 billion over ten years through the Inflation Reduction Act in 2022, the agency’s budget has already seen significant adjustments. The Fiscal Responsibility Act of 2023 resulted in a $20 billion cut, raising concerns among bond auditors about the future landscape of municipal bond audits. Ed Oswald, a partner at our own firm, has emphasized that reduced funding often leads to less frequent and shorter audits.
This assertion highlights a crucial consideration; the enforcement capabilities of the IRS hinge directly on its budget. Specifically, as Rich Moore, another partner at Orrick, points out, a larger budget is synonymous with an increased number of agents, which translates into more examinations and, importantly, enhanced resources for conducting these audits. Enhanced capabilities could include site visits to bond-financed projects, thereby ensuring that issuers comply with relevant regulations.
IRS Commissioner Danny Werfel’s push for an extension of the augmented budget—including a request to raise it to $104 billion over ten years—has been positioned as a necessary step to continue generating revenue for the government. He cites an expectation of generating an additional $341 billion over the same period as a rationale for his request. Despite the agency’s apparent emphasis on performance metrics, such as the positive grades reported for the timeliness of critical tax products, these figures do not necessarily reflect the realities faced by municipal bond issuers during audits.
Oswald contends that the interaction between an IRS agent and a bond issuer is markedly different from standard tax administration procedures. Municipal bond audits can be tedious, marked by prolonged communication that may not be adequately captured in general performance measures. The need for effective communication cannot be overstated; bond issues involve complex financial structures that require nuanced understanding on both sides of the auditing process.
As political dynamics shift within the administration, the scrutiny over IRS funding and its allocations is heightened. The cuts made in fiscal 2023 largely affected the enforcement branches of the IRS, where both Oswald and Moore have noticed a marked increase in audit activity. Moore’s observation that 2023 and 2024 are seeing more audits than any two-year period since the mid-2010s raises an important query: Is the IRS scaling down its operations while simultaneously ramping up enforcement?
This paradox illustrates a broader tension within tax administration practices, especially in the arena of municipal bonds, where compliance and regulatory diligence are critical. The recent trend towards more tax-exempt bond audits indicates that while budget cuts may signal less funding, the political will within the agency has been directed towards intensified enforcement measures.
The future of audits related to municipal bonds rests precariously on the evolving budgetary landscape of the IRS. As funding fluctuates due to political negotiations, so too will the face of enforcement. Experts like Oswald and Moore delineate a challenging environment for municipal issuers, punctuated by increased vigilance from the IRS. For the municipal bond market, this means that both current issuers and prospective investors must prepare for a landscape characterized by heightened scrutiny as the IRS modifies its audit strategies aligned with its fiscal resources.
As the situation develops, all stakeholders in the municipal bond market should stay vigilant. The current trajectory suggests that even as funding becomes more constrained, the IRS may be poised to exert more oversight as it attempts to fulfill its obligations in a politically charged environment.