As the political landscape shifts with new administrations, discussions around the Internal Revenue Service (IRS) budget have become increasingly contentious. Historically a topic of fierce debate, the fluctuations in IRS funding levels directly correlate to the agency’s enforcement capabilities — a fact that has profound implications for municipal issuers. In particular, the relationship between the IRS budget and the frequency of audits is one that experts observe with keen interest.
Ed Oswald, a partner at Orrick, emphasizes that diminished funding can lead to fewer audits. “My general take is that if there is a curtailment in IRS funding, we will see a reduction in the frequency and duration of municipal bond audits,” he states. This relationship hints at a broader truth about budget allocations: the size of the IRS budget not only affects operational efficiency but also the agency’s ability to carry out its mandate comprehensively.
The IRS has, over the years, become something of a political football, passed between varying administrations with differing priorities. The Inflation Reduction Act in 2022 offered a significant boost to the agency’s budget—an $80 billion increase over ten years. However, this substantial allocation faced reductions during subsequent debt ceiling negotiations, highlighting the uncertainties surrounding government funding.
In 2023, significant cuts to the IRS budget were implemented through the Fiscal Responsibility Act, which slashed approximately $20 billion from the proposed increases. The variance in budget priorities leads to uncertainty that affects both the agency’s operability and its engagement with municipal issuers. IRS Commissioner Danny Werfel advocates for a restoration and extension of budget increases, arguing that such funding would not only fortify the agency but also generate substantial revenue—estimated at $341 billion.
Audits: A Byproduct of Budget Allocation
There is a clear consensus among municipal market experts: an increase in the IRS budget typically results in a corresponding rise in audits. As Rich Moore, another partner at Orrick, articulates, “A higher budget means more agents and more agents mean more examinations.” This dynamic creates a dual impact: not only do municipalities face increased scrutiny, but auditors are also better equipped to conduct thorough examinations, which may include site visits to projects financed by bonds.
As the IRS recently released its annual financial report, featuring self-assessments on its performance metrics, the numbers provided shed light on operational efficiency. While the agency reported a remarkable 95.8% score on the timeliness of delivering critical tax products, it is essential to recognize that such metrics do not directly correlate with audit performance. Oswald underscores this disparity, noting, “The communication between an IRS agent and the bond issuer can be protracted.” Hence, the impressive efficiency metrics may provide little reassurance to municipal issuers facing the prospect of an audit.
The political landscape, particularly with Republican leadership on the horizon, could signal a reevaluation of IRS funding and its implications for enforcement practices. As budget cuts disproportionately affect enforcement divisions, the resultant shift may lead to a decline in audit activities. Still, the current trend, as noted by experts, indicates a noticeable uptick in examinations, particularly in the years 2023 and 2024.
Moore’s observation paints a clear picture: “I have seen more audits in 2023 and 2024 than I have during any other two-year period since about the middle of the 2010s.” This upsurge, coupled with the previous increases in IRS funding, indicates a lingering tension between budgetary constraints and the enforcement capabilities of the agency.
The interaction between IRS funding and municipal bond audits exemplifies the complexities embedded within federal budget decisions. While optimistic figures regarding efficiency may provide comfort, the operational realities of audits reflect a different narrative—one where political maneuvering and budgetary strife shape the landscape. Municipal issuers must remain vigilant, as the uncertain terrain of IRS funding could influence not only the frequency of audits but also the overall health of municipal finance engagements in the years ahead. As such, stakeholders must engage proactively with developments in IRS policy and budget decisions, understanding that the financial environment is subject to rapid change.