The Internal Revenue Service has agreed to work more closely with the Securities and Exchange Commission to regulate the U.S. municipal bond market, the IRS said on Tuesday, adding the two federal agencies had signed memorandum of understanding.

This memorandum reflects the commitment both agencies have in using all means possible to ensure the municipal bond market operates in accordance with all the laws that govern it, said IRS Commissioner Doug Shulman in a statement.

Under the agreement, the two agencies will identify issues and trends in the municipal securities industry and enhance performance in regulating the $2.8 trillion market.

SEC Chairman Mary Schapiro has repeatedly said that she would like to create more investor protections in the municipal bond market, which is uniquely regulated.

Because of a part of securities law known as the Tower Amendment, the U.S. government cannot regulate how states and public entities sell their debt. Instead, it can only directly regulate the market's broker-dealers and underwriters.

The Municipal Securities Rulemaking Board, a self-regulatory organization made up primarily of employees of banks and securities firms, writes rules for the brokers that the SEC enforces. In recent years the SEC has entrusted the MSRB to create and operate a clearinghouse of information on trades and new issues.

The IRS has the power to take away bonds' tax exemption if they are used to commit fraud or generate arbitrage.

Under Schapiro, the SEC has also created a new enforcement division that focuses on misconduct in the municipal securities market and in connection with public pension funds.

(Reporting by Lisa Lambert, additional reporting by Dan Margolies; Editing by Kenneth Barry)