Tax Administration

GAO found no evidence of any violations of recusal statements, federal conflict-of-interest law, regulations, or standards of conduct by Internal Revenue Service (IRS) officials in connection with the issuance of Revenue Ruling 90-27. The central question concerning this ruling, which involves financial instruments known as auction rate preferred stock, is whether such stock should have been characterized as debt or equity for tax purposes and whether it met the necessary holding period to qualify for the dividends-received deduction to the holder. GAO did find, however, that the ways in which the IRS Commissioner's and Chief Counsel's recusal statements were written could lead to some uncertainty as to the situations in which they applied. This situation exists because the recusal statements are written in such broad terms that they may lead to the impression that there is a violation when none has occurred. Finally, GAO did not find any instances in which IRS staff had failed to follow procedures in the Revenue Ruling Handbook. GAO is concerned, however, that IRS' reliance on individuals representing only one brokerage house--Shearson Lehman Hutton, Inc.--for consultations about auction rate preferred stock could be viewed as inappropriate, even though GAO found nothing improper about the actions Shearson's representatives had taken. Auction rate preferred stock, although now underwritten by many brokers, was originally marketed by Shearson, which, along with other brokers, issuers, and holders of such instruments, had a major stake in seeing that such stock was characterized as equity for tax purposes. GAO is troubled by Shearson's preeminent involvement.

GAO found that: (1) Revenue Ruling 90-27 stated that IRS would consider auction rate preferred stock (ARPS) to be an equity interest, rather than debt, for tax purposes and that the auction mechanism would not prevent the holders from claiming the dividends-received deduction for tax purposes; (2) there was no evidence of any violations of recusal statements, federal conflict-of-interest law, regulations, or standards of conduct on the part of the IRS Commissioner, Chief Counsel, or former Acting Chief Counsel in connection with the issuance of the ruling; (3) since recusal statements are written so broadly, the Commissioner's and Chief Counsel's statements could lead to the impression that there was a violation, when none occurred; (4) there were no instances in which IRS staff failed to follow established procedures; and (5) IRS primary reliance on one broker for consultations about ARPS and the ARPS market appeared to be ethical, even though that broker had a major interest in the characterization of ARPS as equity for tax purposes.

Recommendations

Our recommendations from this work are listed below with a Contact for more information. Status will change from "In process" to "Open," "Closed - implemented," or "Closed - not implemented" based on our follow up work.

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