News Column

Tiny mistake leads to big fine for Virginia Beach

July 21, 2014

By John Holland, The Virginian-Pilot



July 22--VIRGINIA BEACH -- OK, take a deep breath and slug back an extra cup of coffee before reading on. You'll need it.

Four years ago, the city made a mistake when issuing a $20 million water and sewer bond. A tiny mistake, by any standard: It miscalculated the eight-year maturity date by one day, the Internal Revenue Service ruled, giving the city an extra $4.20 more than it deserved each year -- a total of $33.59 over the eight years, with interest rate rounding.

The price for such a transgression? A $5,000 fine from the IRS and an expensive, four-year battle that brought in lawyers, bond experts and, briefly, a white flag of surrender from city officials.

"I said, 'You've got to be kidding me,' " Finance Director Patti Phillips said last week, recalling the October 2010IRS notification letter that started the skirmish. "First, I know we didn't make a mistake and that our calculations are right. But then, when you see the money they are talking, it's irrelevant."

An IRS spokesman Monday said the agency cannot discuss cases involving a specific client.

According to an IRS letter to the city, Virginia Beach was one day off when calculating part of the tax-exempt, municipal bond issuance. That changed the interest rate to 2.50 percent from 2.48. Because cities issuing tax-exempt bonds essentially get an IRS rebate, the miscalculation resulted in Virginia Beach receiving an extra $2.10 per reporting period.

At first, the city argued the IRS was wrong. That didn't work.

After consulting with outside bond attorneys, city officials decided it would be cheaper to pay the fine rather than risk a ruling that could cost much more down the road.

So it tried negotiating the price to $1,000, which the city still called outlandish but more reasonable, given the circumstances, according to Virginia Beach records. That didn't work either.

So it held its nose and wrote the $5,000 check. But Phillips kept up the argument.

"I'm just stubborn, I guess," she said. "It was just a matter of it being the right thing to do."

Phillips this time ran into a new IRS agent. Fresh eyes and what the city would call a dose of common sense led the IRS to issue a full $5,000 refund in late March, a virtually unheard of development, according to documents and industry newsletters.

The IRS has been cracking down in recent years on what it calls rampant fraud and manipulation in the municipal bond market. Price fixing, false statements by cities seeking money, and abuse of tax laws by corporate underwriters have led to tens of millions of dollars in fraud, according to the IRS and the Securities and Exchange Commission.

The IRS scrutiny has forced cities to spend more hours and dollars to comply with new reporting requirements. Virginia Beach, with a AAA bond rating, shouldn't be lumped with the others because all of its bonds are sold on the open market, creating competition that discourages the type of shenanigans seen in other regions, Phillips said.

She estimated the spat cost the city thousands of dollars in attorney's fees, and an untold number of staff hours. Still, she mostly laughed about the situation now that it's over.

"If there is a way to make something more complicated, the IRS will do it," she said.

"But at the end of the day, they didn't have to give the money back. We were fortunate to get an agent who worked with us, looked at all the information and made the right decision."

John Holland, 757-222-5047, john.holland@pilotonline.com

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(c)2014 The Virginian-Pilot (Norfolk, Va.)

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Source: Virginian-Pilot (Norfolk, VA)


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