Tax




IRS EO Update: e-News for Charities & Nonprofits.

1. Register for IRS webinar: Introduction to tax-exempt status

Thursday, Nov. 20 at 2 p.m. ET

You will learn how to:

Register for this event.

2. Register for EO workshops

Register for our upcoming workshops for small and medium-sized 501(c)(3) organizations on:

Dec. 9 – Austin, TX
Hosted by Austin Community College

Jan. 9 – Salt Lake City, UT
Hosted by University of Utah & the Utah Nonprofits Association

3. PTIN renewal season underway

The renewal fee is $63. The fee for a new PTIN application is $64.25.

The easiest way to renew is online. It takes about 15 minutes. There is a new October 2014 version of the paper Form W-12 available on IRS.gov for those who prefer to use it. However, it takes 4-6 weeks to process.

4. In 2015, various tax benefits increase due to inflation adjustments

For tax year 2015, the IRS announced recently annual inflation adjustments for more than 40 tax provisions, including the tax rate schedules, and other tax changes. Revenue Procedure 2014-61 provides details about these annual adjustments.

Inflation adjusted items of interest to exempt organizations affect the:

Read news release.

5. IRS announces tax guidance related to Ebola outbreak in Guinea, Liberia and Sierra Leone

The IRS recently issued two items of guidance in response to the need for charitable and other relief due to the Ebola outbreak in Guinea, Liberia and Sierra Leone. One provides special relief intended to support leave-based donation programs to aid victims who have suffered from the Ebola outbreak in those countries. The other designates the Ebola outbreak in those countries as a qualified disaster for federal tax purposes.

Read news release.

6. Notice 2014-67 issued

Notice 2014-67 provides guidance for determining whether a state or local government entity or a 501(c)(3) organization will be considered to have private business use of its tax-exempt bond-financed facilities due to its participation in an “accountable care organization” and guidance regarding certain management contracts that do not result in private business use.

Notice 2014-67 appeared in IRB 2014-46 dated Nov. 10, 2014.



Texas Court Rules Natural Gas Destined For Interstate Commerce Properly Subject To Local Property Tax.

The Texas First Court of Appeals has ruled that the owner of natural gas stored in a Texas reservoir was properly assessed local property tax, regardless of whether the gas was sold in interstate commerce.1 Rejecting the taxpayer’s contention that the “dormant” U.S. Constitution Commerce Clause rendered the assessment unconstitutional, the Court concluded that the tax did not fail any of the four prongs of the substantial nexus test established in Complete Auto.2

Background

ETC Marketing, Ltd. (ETC) is a marketer of natural gas with offices and employees in Texas. ETC buys, sells, and markets natural gas to customers located outside Texas, but is not in any way restricted from selling to Texas customers. Its affiliate, Houston Pipeline Company (Houston Pipeline), operates an intrastate natural gas pipeline and a reservoir for the storage of natural gas in Texas.

ETC buys natural gas destined for sale to interstate purchasers from multiple sellers, and “immediately entrusts” the product to Houston Pipeline for storage. ETC’s storage agreement with Houston Pipeline allows it to purchase gas and “time the market” by holding the gas for delivery at a later date in order to maximize the sale price.3 Because natural gas is considered to be fungible, the points of transfer from ETC to Houston Pipeline and ultimately to ETC’s customers do not necessarily relate to a physical location associated with the seller’s gas, as gas owned by various marketers is physically commingled in the pipeline system which includes both intrastate and interstate pipeline. Distinct volumes of gas are segregated by paper allocation, but due to the fungible nature of the product, cannot be separately identified and tracked by the owners.

Since the reservoir where ETC stores its natural gas is located in Harris County, Texas, the Harris County Appraisal District (HCAD) appraised the value of approximately 33 billion cubic feet of natural gas owned by ETC and stored in the reservoir for calendar year 2010, and assessed related ad valorem taxes. While ETC conceded that it was the owner of the natural gas, it contended that all of the gas stored in the reservoir was exempt from property tax under the Commerce Clause of the U.S. Constitution because the gas was destined to be sold in interstate commerce. HCAD countered that the sale of gas was not in interstate commerce, but even if the sale were considered to be in interstate commerce, it would still be subject to tax under the Complete Auto test. The 127th District Court rejected ETC’s summary judgment motion and rendered final judgment for HCAD, holding that the stored gas was subject to ad valorem taxation as the gas was not in interstate commerce.4 ETC appealed the decision to the Court of Appeals.

Application of Complete Auto to Ad Valorem Tax

Texas law provides that all tangible personal property is subject to property tax if it is located in a taxing unit for longer than a temporary period, unless forbidden by law.5 In addition, property exempt from ad valorem taxation by federal law is exempt from taxation.6 Noting that the federal exemption applies only to activities related to interstate commerce, the Court accepted that the natural gas at issue was in the stream of interstate commerce. To decide whether an applicable exemption was available under federal law, the Court focused its attention on whether the application of property tax to the natural gas failed any of the prongs of the dormant Commerce Clause test established in Complete Auto. The Court considered each of the four factors necessary to allow a local government to tax goods in interstate commerce: (i) substantial nexus to the taxing state; (ii) fair apportionment; (iii) no discrimination against interstate commerce; and (iv) a fair relation to state-provided services.7 Importantly, the Court noted that the burden of proof is on the taxpayer to show that the tax fails to meet at least one of the prongs.8

Substantial Nexus

First, to survive constitutional scrutiny, a tax must apply to an activity that has a substantial nexus with the taxing state. ETC argued that physical presence alone does not satisfy the substantial nexus prong in ad valorem cases. The Court disagreed, referencing both federal and Texas cases in which physical presence was found to be sufficient to meet this part of the test.9 The Court focused on ETC’s physical presence in Harris County and other parts of Texas, including its offices, employees and stored natural gas, in finding a substantial nexus between the activity being taxed and Texas.

Fair Apportionment

The second prong of the Complete Auto test is whether the tax is fairly apportioned (i.e., each state taxes only its fair share of an interstate transaction). In order for the requirements of this prong to be met, a tax must be both internally and externally consistent.10

A tax is considered to be internally consistent when it is structured so that if every state were to impose an identical tax, multiple taxation would not result.11 The Court quickly dismissed this requirement, noting that because ETC was not attempting to store gas in two states at the same time, there was no risk of multiple taxation.

The external consistency test examines whether the state has taxed only the portion of revenue from the interstate activity which reasonably reflects the in-state component of the activity being taxed.12 ETC argued that the ad valorem tax at issue was externally inconsistent because it would be impossible to determine, at any given time, the actual physical location of each molecule of its owned natural gas. However, because ETC had conceded its ownership of 33 billion cubic feet of natural gas stored in the reservoir located in Harris County, the Court rejected this contention. Accordingly, the Court found the ad valorem tax to be fairly apportioned.

Discrimination Against Interstate Commerce

The Court subsequently considered whether the ad valorem tax discriminated against interstate commerce. Noting that the U.S. Supreme Court had previously determined that “ad valorem tax of general application … is of necessity non-discriminatory,”13 the Court concluded that this particular tax was valid.

Fair Relation to State-Provided Services

The final prong of the Complete Auto test considers whether the tax is fairly related to services provided by the state. The Court noted that no detailed accounting of the services provided to a taxpayer was necessary to prove this fact, but instead “police and fair protection, along with the usual and usually forgotten advantages conferred by the State’s maintenance of a civilized society, are justifications enough.”14

ETC argued that this prong was not satisfied because the gas was entrusted to Houston Pipeline, which pays property taxes on the reservoir and related equipment. Also, ETC argued that Houston Pipeline had complete and exclusive control over the activity being taxed, which was storage of gas in the reservoir. Finding that ETC had not met its burden of proof on this issue, the Court noted that ETC retained control over the disposition of the gas in the reservoir, as indicated in the evidence provided during the district court’s decision. While the gas is stored in the reservoir, the Court found that ETC “enjoys the benefit of public services which facilitate gas storage, which in turn allows it to accomplish its business objective of buying natural gas and holding it for sale at some later point in time.” Thus, the Court concluded that the ad valorem tax was fairly related to the services provided by Texas.

In ruling against ETC, the Court reiterated that it was not necessary to resolve the dispute between ETC and the HCAD regarding whether the natural gas was sold in interstate commerce to evaluate the validity of the tax. The ad valorem tax was properly imposed because ETC stored the gas in Texas for the business purpose of selling the gas at a higher price at a later time.

Commentary

The interstate commerce exemption is especially significant for taxpayers engaged in the oil and gas industry in Texas because it is one of the few exemptions potentially applicable to ad valorem taxes on oil and natural gas. Three general exemptions from Texas ad valorem taxes are available for tangible personal property: (i) the freeport exemption; (ii) the goods-in-transit exemption; and (iii) the interstate commerce exemption. The freeport exemption applies when certain types of property are transported outside Texas within 175 days,15 but is not available for oil, natural gas or other petroleum products. Similarly, the goods-in-transit exemption does not apply to oil, natural gas, or petroleum products.16 Thus, businesses in the oil and gas industry generally must rely solely on the interstate commerce exemption for relief from Texas property taxation.

This decision is distinguishable from two recent Texas appellate court decisions that were favorable to the taxpayer and addressed the same constitutional concerns.17 Both cases involved petroleum products being stored in Texas that were later to be transported out of state. In Peoples Gas, the Sixth District Court of Appeals, which sits in Texarkana, held that the natural gas could not be taxed locally because there was insufficient nexus.18 In BP America, the Eleventh District Court of Appeals, which sits in Eastland, held that an ad valorem tax could not be imposed on crude oil stored in a tank farm that is an integral part of an interstate pipeline system.19 The Texas Supreme Court has yet to rule in either of these cases. It is interesting to note that the dissenting opinion in ETC cited Peoples Gas as indistinguishable on the substantial nexus issue.20

The issue of whether property tax properly applies to stored oil and natural gas has been highly litigated in recent years, both in Texas and in other states. For example, both the Oklahoma and Kansas State Supreme Courts found against taxpayers in recent decisions, finding that property tax was validly assessed.21 The United States Supreme Court has refused to hear both the Oklahoma and the Kansas cases,22 despite the fact that the Solicitor General of the United States was requested to file a brief expressing the views of the federal government on this issue.23

The Court’s insightful analysis reflects the far-reaching effect of the Complete Auto precedent.24 In practice, Complete Auto’s four-prong test continues to lessen the practical effect of the Dormant Commerce Clause, and defenses based upon the concept, with respect to interstate commerce (in contrast to foreign commerce).

Finally, it is important to note that ETC is an appellate court decision that is binding in the area of the court’s jurisdiction,25 but is not binding in other parts of Texas. The taxpayer will still have an opportunity to appeal to the Texas Supreme Court.26

Footnotes

1 ETC Marketing, Ltd. v. Harris County Appraisal District, Texas Court of Appeals, First District, No. 01-12-00264-CV, Oct. 2, 2014.

2 Complete Auto Transit, Inc. v. Brady, 430 U.S. 274 (1977). The test addresses whether the entity has substantial nexus under the Commerce Clause, thereby allowing a state to impose a tax.

3 ETC has historically stored gas in the reservoir for several months at a time, buying it during warmer months and selling it to northern markets in the winter months. The length of time the gas is stored depends on the volume, time of year, and demand for natural gas.

4 Harris County Appraisal District v. ETC Marketing, Ltd., 127th District Court, No. 2010-71360.

5 TEX. TAX CODE ANN. § 11.01.

6 TEX. TAX CODE ANN. § 11.12.

7 Barclays Bank PLC v. Franchise Tax Board, 512 U.S. 298, 310-11 (1994).

8 Vinmar, Inc. v. Harris County Appraisal District, 947 S.W.2d 554, 555 (Tex. 1997).

9 Relying upon Quill Corp. v. North Dakota, 50 U.S. 298 (1992), which reaffirmed that physical presence satisfies the first prong of the Complete Auto test for sales and use tax purposes. Several Texas cases reached the same conclusion with respect to ad valorem taxes. See, for example, Rylander v. 3 Beall Bros. 3, Inc., 2 S.W.3d 562, 570 (Tex. Ct. App. 1999), cert. denied, 538 U.S. 1013 (2003) and Peoples Gas, Light, and Coke Co. v. Harrison Central Appraisal District, 270 S.W.3d 208 (Tex. Ct. App. 2008), cert. denied, 131 S. Ct. 2097 (2011).

10 Goldberg v. Sweet, 488 U.S. 252 (1989).

11 Id.

12 Id.

13 Japan Line, Ltd. v. Los Angeles County, 441 U.S. 434, 445 (1979).

14 Okla. Tax Comm’n v. Jefferson Lines, Inc., 514 U.S. 175, 200 (1995).

15 TEX. CONST. art. VIII, §1-j.

16 TEX. TAX CODE ANN. §11.253(a)(2)(D).

17 See Peoples Gas, Light & Coke v. Harrison Central Appraisal District, 270 S.W.3d 208 (Tex. Ct. App. 2008), in which the Court held that a tax assessment on stored natural gas was invalid because of a lack of substantial nexus; Midland Central Appraisal District v. BP America Production Co., 282 S.W.3d 215 (Tex. Ct. App. 2009), in which ad valorem tax was found to be improperly assessed on oil passing in interstate commerce through an interstate pipeline, but temporarily held in Texas.

18 The majority in ETC distinguishes Peoples Gas by saying the natural gas marketer’s “only connection to Texas was through the ‘structure and location’ of the separately owned pipeline which made the decision about where to store the gas and paid its own ad valorem taxes on the facility and equipment used for storage of natural gas in Texas. In contrast, ETC Marketing had a physical presence in Harris County including employees, offices, and – most significantly – natural gas that it had specifically contracted to store with Houston Pipeline. Unlike the pipeline at issue in Peoples Gas, Houston Pipeline’s facilities are located entirely within Texas, including the Bammel reservoir in Harris County. There was no evidence that the gas was already bound for another state when it was committed to Houston Pipeline.”

19 The majority distinguishes BP from ETC because the oil in the BP case “was not held in the tank farm for storage purposes or for any business purpose of the owner other than its transmission through the pipeline.”

20 ETC Marketing, No. 01-12-00264-CV (Keyes – dissenting) pg. 9.

21 In re Assessment of Personal Property Taxes, 234 P.3d 938 (Okla. 2008); In the Matter of the Appeals of Various Applicants from a Decision of the Division of Property Valuation of the State of Kansas for Tax Year 2009 Pursuant to K.S.A. 74-2438, 313 P.3d 789 (Kan. 2013).

22 Certiorari was denied for the Kansas case on Oct. 6, 2014, while certiorari in the Oklahoma case was denied on Mar. 1, 2010.

23 In her brief to the Court, the Solicitor General argued that the Oklahoma Supreme Court had correctly rejected the dormant Commerce Clause challenge.

24 In comparison, this is the precedential effect some commentators thought, and some tax practitioners wished, the U.S. Supreme Court decision in the Quill case (Quill Corp. v. North Dakota, 504 U.S. 298, 309 (1992)) had. The precedential effect of Quill has, however, been relied upon sparingly by the courts.

25 Counties served by the First Court of Appeals are Austin, Brazoria, Chambers, Colorado, Fort Bend, Galveston, Grimes, Harris, Waller and Washington.

26 The taxpayer filed a motion for rehearing with the Court of Appeals on October 20. If the Court refuses to rehear the case, the taxpayer will have 45 days from that refusal to file a petition for review with the Texas Supreme Court. Indeed, there might be increased incentive for the Texas Supreme Court to take this case (if appealed) to resolve a perceived split in the Courts of Appeals between ETC on one side, and BP America and Peoples Gas on the other.

Last Updated: November 6 2014

Article by John LaBorde, P.J. Olzen, Don Lippert Jr., Pat McCown, Terry Gaul, Jamie C. Yesnowitz and Lori Stolly

Grant Thornton LLP



Firm Forwards Amicus Brief on Hospital Community Benefit Reporting.

Catherine Livingston of Jones Day, on behalf of the American Hospital Association, has provided Treasury with a copy of an amicus brief the firm filed with the Supreme Court in Perez v. Mortgage Bankers Association, describing how the IRS changed its position retroactively on hospital community benefit reporting without notice or explanation.

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October 17, 2014

Ms. Emily McMahon
Deputy Assistant Secretary (Tax Policy)
Department of the Treasury
Room 3120
1500 Pennsylvania Avenue, N.W.
Washington, DC 20220

Dear Emily:

I am writing on behalf of our client, the American Hospital Association (“AHA”) to provide you with a copy of the brief we have filed with the Supreme Court of the United States as amici curiae in Perez v. Mortgage Bankers Association, describing how the IRS changed its position retroactively on the reporting of hospital community benefit without notice or explanation. You will recall that AHA and other stakeholders were deeply concerned by the change to the Schedule H form instructions made abruptly last December, not only because the substantive position was problematic but also because the process that was followed was so flawed.

The rules for reporting community benefit expenditures are contained exclusively in the instructions for Form 990 Schedule H (Hospital). Notwithstanding their status as form instructions, they function as rules given the penalties that can apply for failure to file a complete and accurate return and given the lack of any other guidance on measuring community benefit through expenditures. From 2008 when the instructions were first issued through 2012, the instructions for Schedule H consistently treated all hospital expenditures for research funded by the government or another tax-exempt entity as community benefit expenditures that were to be included in computing the hospital’s net community benefit percentage. In December of 2013, the IRS issued draft instructions reversing that position and excluding research expenditures for projects specifically funded by grants from government or tax-exempt entities from net community benefit expenditures. The IRS finalized these instructions eleven days later, never explaining the change. AHA and others submitted comments in December of 2013 objecting to the change as it had the nonsensical effect of treating most medical research as something other than a community benefit activity. AHA also met with Ms. Tamera Ripperda, Director of Exempt Organizations, and other IRS representatives on June 9, 2014 to express its concerns. The IRS has never issued a public explanation for the change.

As explained in the brief, the lack of transparency and explanation is entirely counter to the open process that was followed in developing Schedule H and its instructions. The community benefit standard was created in revenue rulings, and there is no published guidance whatsoever on measuring community benefit through expenditures. The process for developing Schedule H and its instructions respected those facts and provided notice and comment. Moreover, the substantive position adopted in the draft instructions is illogical and contrary to the considered position on the same issue that was adopted in 2008 after notice and comment.

The substantial majority of medical research funding in this country comes from the federal government. It does not have the infrastructure or talent to perform all the medical research the public is seeking. Therefore, the federal government funds research performed in hospitals and universities all over the country that invest in the infrastructure and recruit and support the scientists needed to perform the research. The Schedule H instructions appear to take the position that hospitals are not providing a community benefit when they conduct research projects to find new ways to delay and prevent type 1 diabetes or to find new therapies for Alzheimer’s disease because the instructions treat most of the dollars spent on these activities as not being net community benefit expenditures. That makes no sense. The hospital’s research infrastructure and scientific personnel are critical to converting the grant dollars into research activities. The research is a public good, not a service to a particular patient where it may be relevant whether the hospital or a third party payor is covering the cost. The relevant consideration for exemption is the amount of community benefit generated by the hospital. The change to the Schedule H instructions was certainly not propelled by changes to the law as section 501(c)(3) has not changed since 2008, and the enactment of section 501(r) does not change the community benefit standard or the treatment of medical research as an activity that promotes the health of the community as a whole.

The IRS issued draft instructions for the 2014 Schedule H last month and retained the language used in the 2013 Schedule H instructions with respect to the reporting of research expenditures for purposes of determining net community benefit expenditures. On behalf of AHA, I would like to reiterate the concerns with this language and the continuing lack of sound rationale or explanation for the change and ask that the language adopted after the 2008 notice and comment process be reinstated.

Sincerely,

Catherine E. Livingston
Jones Day
Washington, DC

Enclosure



Group Seeks Removal of New Community Benefit Reporting Rule.

Edward Goodman of VHA Inc. has expressed concerns about a policy change that was made by the IRS without adequate notice or public comment in the 2013 instructions to Schedule H (Form 990), “Hospitals,” urging the IRS to remove a new rule treating restricted grants as “direct offsetting revenue” for community benefit reporting purposes.

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October 21, 2014

The Honorable John A. Koskinen
Commissioner
Internal Revenue Service
1111 Constitution Ave, N.W.
Washington, DC 20224

Dear Commissioner Koskinen:

On behalf of VHA Inc. (“VHA”), we are writing to express our concern about a policy change that was made by the IRS without adequate notice or public comment in the 2013 Instructions to Schedule H of the Form 990. As described in a recently-filed amicus curiae brief submitted by the American Hospital Association (AHA) to the United States Supreme Court,1 this ill-considered change appears likely to have serious tax consequences for a wide array of tax-exempt hospitals and represents a significant departure from longstanding IRS rulings that were recently reaffirmed by Congress when it enacted new Code section 501(r).

VHA is a national health care network that serves more than 1,500 not-for-profit hospitals nationwide. VHA is dedicated to the success of nonprofit community-based health care. VHA has participated for many years with the Catholic Health Association of the United States (CHA) in developing resources to help community hospitals fulfill their mission and maintain their tax-exempt status.

AHA’s amicus brief, a copy of which is enclosed for ease of reference, recounts how the IRS first developed reporting rules for measuring community benefit in consultation with the hospital community, and then precipitously altered a significant aspect of the rules retroactively with only 10 days’ notice and no meaningful opportunity for comment. The amicus brief also discusses the negative impact that the rule change is likely to have on the tax status of medical research hospitals.

VHA shares AHA’s concerns about the flawed administrative process by which this key rule was changed (i.e., lack of public notice and comment) as well as its adverse impacts on academic medical centers. Further, VHA believes the following factors should be considered:

In light of these significant procedural and substantive deficiencies, VHA urges the Commissioner to immediately withdraw the new rule and revert to the well-reasoned former rule, which excluded both restricted and unrestricted grants from the definition of “direct offsetting revenue.”

The New Rule Announced in IRS Form Instructions

The new rule, imposed by a change in IRS Form Instructions first announced on December 9, 2013 and finalized on December 20, 2013, treats “restricted grants” as “direct offsetting revenue” for community benefit reporting purposes. As such, it would prevent tax-exempt hospitals that rely on grant funding to extend their reach into the communities they serve from being able to fully and accurately report their community benefit expenditures.

From the inception of the new Schedule H in 2008 through the first 11 months of 2013, the Instructions for Schedule H provided as follows:

“Direct offsetting revenue” means revenue from the activity during the year that offsets the total community benefit expense of that activity, as calculated on the worksheets for each line item. “Direct offsetting revenue” includes any revenue generated by the activity or program, such as payment or reimbursement for services provided to program patients. Direct offsetting revenue does not include restricted or unrestricted grants or contributions that the organization uses to provide a community benefit.

However, in the final 2013 Instructions released on December 20, 2013, the IRS included a sentence that states the opposite, specifically that “[d]irect offsetting revenue also includes restricted grants or contributions that the organization uses to provide a community benefit, such as a restricted grant to provide financial assistance or fund research.” The same sentence is included in the recently released 2014 Draft Schedule H Instructions along with a statement advising hospitals that “Organizations may describe any inconsistencies from reporting in prior years in Part VI.”

Negative Impacts of IRS Rule Reversal

The new reporting regime imposed by the IRS form will artificially depress many hospitals’ community benefit expenditure percentages — in particular, those community hospitals and academic medical centers that rely on foundation and government grants to help fund their community benefit expenditures (including research, community health improvement initiatives, and charity care).

VHA is particularly concerned about the new rule’s adverse impact on financially struggling community hospitals that pro-actively extend their community benefit reach by partnering with community organizations and foundations. While the IRS in its new community health needs assessment rules encourages hospitals to partner with other hospitals, community health organizations and local, state and federal health agencies, the new Schedule H reporting rule will unfairly penalize hospitals funding community benefit expenditures with grant funds derived from most charitable or government grants. Although the reporting rule would allow full credit for expenditures made with “unrestricted” grants, the reality of institutional grant-making is that the majority of grants made to hospitals (whether for research or community health programs) are “restricted” grants.

Inconsistency of New Rule with HFMA Charity Care Valuation Principles

According to guidelines developed by the HFMA on calculating charity care and community benefit, the concept of subtracting out “direct offsetting revenue” was intended to make sure that hospitals did not inflate the value of charity care by including “any patient-related revenue” in the amount counted as charity care. The subtraction of “direct offsetting revenue” was not intended to create disincentives for charitable hospitals to use grants to fund community benefit initiatives. For that reason, Statement 15 of the HFMA Principles & Practices (P&P) Board Statement on Valuation of Charity Care by Health Care Providers ( ” Statement 15 ” ) (issued Dec. 2006) only stipulates that health care providers subtract out patient-related revenue in determining the net cost of charity care. Further, Section 7.1 of Statement 15 explains the accounting principle as follows: “The goal of charity care disclosure is to identify the net cost related to charity care, as determined by the total cost of charity care services less any patient-related revenue due to sliding scale payments or other patient-specific sources.” HFMA recognized that charity care is frequently funded by external sources (such as grants, contributions and special taxes) as well as by hospital surplus revenues.

The IRS’s rule reversal deviates from these common-sense principles. It would allow hospitals funding charity care or other community benefit with their own surplus operating revenues to fully report such community benefit expenditures, while discounting the community benefit expenditures of those financially struggling or low-margin hospitals that solicit and receive grants to help fully fund their programs. Consequently, the IRS’s proposed treatment of most hospital grants as “Direct Offsetting Revenue” will result in reporting distortions and the creation of perverse incentives.

Inconsistency of the New Rule with IRS Rulings Recently Affirmed By Congress

When it passed the Affordable Care Act (ACA), Congress imposed new requirements on tax-exempt hospitals, including the following:

The new ACA requirements are entitled, “Additional Requirements for Section 501(c)(3) Hospitals,” and the legislative history of the ACA makes it clear that the new requirements are in addition to, and not in lieu of, the requirements otherwise applicable to 501(c)(3) organizations.2 In fact, the legislative history of the ACA describes in great detail the prevailing IRS standard for tax-exemption as follows:

Since 1969, the IRS has applied a “community benefit” standard for determining whether a hospital is charitable. According to Revenue Ruling 69-545, community benefit can include, for example: maintaining an emergency room open to all persons regardless of ability to pay; having an independent board of trustees composed of representatives of the community; operating with an open medical staff policy, with privileges available to all qualifying physicians; providing charity care; and utilizing surplus funds to improve the quality of patient care, expand facilities, and advance medical training, education and research.3

As emphasized by the AHA amicus brief, this longstanding IRS community standard has never required hospitals to discount their community benefit expenditures by the amount of restricted grants they receive.

Conclusion

In 2008, the IRS, in consultation with the Treasury Department and the hospital community, promulgated a definitional rule that made sense. In 2013, the IRS unilaterally and retroactively replaced the rule with one that is inconsistent with recognized accounting practices, published revenue rulings and the intent of Congress. In view of these inconsistencies and the negative impact of the rule on both research and community hospitals, the IRS should immediately withdraw the new rule and replace it with the former rule.

If you have any questions about VHA’s comments or have further questions, please contact VHA’s Senior Director, Governmental Relations, Cidette Perrin at (202) 354-2608 or at [email protected].

Sincerely,

Edward N. Goodman
Vice President, Public Policy
VHA, Inc.
901 New York Avenue, N.W.
Washington, D.C. 20001

cc:
Chairman Dave Camp and Ranking Member Sander S. Levin,
Committee on Ways and Means, United States House of Representatives

Assistant Secretary (Tax Policy) Mark J. Mazur,
United States Treasury Department

Kathleen M. Nilles, Holland & Knight LLP

 

FOOTNOTES

1 The amicus brief was filed in Perez v. Mortgage Bankers Association, Nos. 13-1041, 13-1052. See Brief for the American Hospital Association, Association of American Medical Colleges, and Healthcare Financial Management Association as Amici Curiae Supporting Respondent, 2014 WL 5299417 (2014).

2 See S. Rep. No. 111-89, at 346-348 (2009). See also Staff of the Joint Committee on Taxation, 111th Cong., Technical Explanation of the Revenue Provisions of the “Reconciliation Act of 2010,” as amended, in combination with the “Patient Protection and Affordable Care Act” (“Technical Explanation), at 78 (J. Comm. Print. 2010) (citing Rev. Rul. 69-545, 1969-2 C.B. 117).

3 S. Rep. No. 111-89 at 346.



IRS LTR: Extension Granted to Elect Period for Low-Income Housing Credit.

The IRS granted a property owner an extension to elect when to start the credit period for its qualified low-income building.

Citations: LTR 201444013

Third Party Communication: None
Date of Communication: Not Applicable
Person To Contact: * * *, ID No. * * *
Telephone Number: * * *

Index Number: 9100.01-00, 42.00-00
Release Date: 10/31/2014
Date: July 29, 2014

Refer Reply To: CC:PSI:B5 – PLR-108988-14

LEGEND:

Taxpayer = * * *
Address = * * *
BIN = * * *
Agency = * * *
Accounting Firm = * * *
Year 1 = * * *
Year 2 = * * *

Dear * * *:

This letter responds to a letter dated February 26, 2014, submitted on behalf of Taxpayer by Taxpayer’s authorized representative requesting an extension of time to make an election under § 42(f)(1) of the Internal Revenue Code pursuant to § 301.9100-3 of the Procedure and Administration Regulations.

According to the information submitted, Taxpayer owns and operates a low-income housing building located at Address and identified by BIN. The building was placed in service in Year 1. In Year 2, Taxpayer received a Form 8609 for the building from the Agency, and provided the form to Accounting Firm to complete Part II of the form. Taxpayer intended to start the credit period for the building in Year 2, the year following the year the building was placed in service. However, Accounting Firm inadvertently checked the “No” box on line 10a of the Form 8609 for the building indicating that the credit period for the building was to begin in Year 1, the year the building was placed in service. Consistent with its intent, Taxpayer seeks an extension of time to make the election under § 42(f)(1) to start the credit period for the building in Year 2.

Section 42(f)(1) defines “credit period” to mean, with respect to any building, the period of 10 taxable years beginning with the taxable year in which the building is placed in service, or at the election of the taxpayer, the succeeding taxable year, but in either case only if the building is a qualified low-income building as of the close of the first year of such period. The election, once made, is irrevocable.

Section 301.9100-8(b) provides that the election under § 42(f)(1) generally must be made for the taxable year in which the building is placed in service, or the succeeding taxable year if the § 42(f)(1) election is made to defer the start of the credit period, and must be made in the certification required to be filed pursuant to § 42(l)(1) and (2). Section 301.9100-8(a)(4)(i) provides that the election under § 42(f)(1) is irrevocable.

Section 1.42-1(h) provides, in part, that unless otherwise provided in forms or instructions, a completed Form 8609 (or any successor form) must be filed by the building owner with the IRS. The requirements for completing the Form 8609 are provided in the instructions to the form.

Sections 301.9100-1(b) through 301.9100-3 provide the standards the Commissioner will use to determine whether to grant an extension of time to make an election.

Section 301.9100-1(b) defines the term “regulatory election” as including an election whose due date is prescribed by a regulation published in the Federal Register, or a revenue ruling, revenue procedure, notice, or announcement published in the Internal Revenue Bulletin.

Under § 301.9100-1(c), the Commissioner has discretion to grant a reasonable extension of time under the rules set forth in §§ 301.9100-2 and 301.9100-3 to make a regulatory election, or a statutory election (but no more than six months except in the case of a taxpayer who is abroad), under all subtitles of the Code, except E, G, H, and I.

Section 301.9100-2 provides automatic extensions of time for making certain elections. Section 301.9100-3 provides extensions of time for making elections that do not meet the requirements of § 301.9100-2.

Requests for relief under § 301.9100-3(a) will be granted when the taxpayer provides evidence (including affidavits described in § 301.9100-3(e)) to establish that the taxpayer acted reasonably and in good faith, and that granting relief will not prejudice the interests of the government.

In the instant case, based solely on the facts submitted and the representations made, we conclude that the requirements of §§ 301.9100-1 and 301.9100-3 have been met. Accordingly, Taxpayer is granted an extension of time to make the § 42(f)(1) election on Form 8609 to treat the credit period for the building located at Address and identified by BIN, as beginning in Year 2. The election must be made by filing within 120 days from the date of this letter an amended Form 8609 that includes this intended election. The amended Form 8609 (along with a copy of this letter) is to be sent to the following address:

Department of the Treasury
Internal Revenue Service Center
Philadelphia, PA 19255-0549

A copy of this letter is enclosed for this purpose.

No opinion is expressed or implied regarding the application of any other provisions of the Code or regulations. Specifically, we express no opinion on whether the building located at Address and identified by BIN otherwise qualifies for credit under § 42.

This ruling is directed only to the taxpayer requesting it. Section 6110(k)(3) provides that it may not be used or cited as precedent.

The ruling contained in this letter is based upon information and representations submitted by Taxpayer and accompanied by a penalty of perjury statement executed by an appropriate party. While this office has not verified any of the material submitted in support of the request for rulings, it is subject to verification on examination.

In accordance with the Power of Attorney on file with this office, a copy of this letter is being sent to your authorized representative.

Sincerely,

Associate Chief Counsel
(Passthroughs & Special Industries)

By: Christopher J. Wilson
Senior Counsel, Branch 5
Office of Associate Chief Counsel
(Passthroughs & Special Industries)

Enclosures (2):
Copy of this letter
Copy for § 6110 purposes



Foley: IRS Releases Favorable Private Business Use Rules For Facilities Financed With Tax-Exempt Bonds.

On October 24, 2014, the IRS released Notice 2014-67, which establishes more favorable safe harbors for types of service contracts and other arrangements using property financed with tax-exempt bonds. The Notice also provides helpful guidance of more limited scope regarding the treatment of Accountable Care Organizations under the Medicare Shared Savings Program.

The more favorable rules generally can be applied retroactively, and are of immediate practical importance.

Notice 2014-67 is available here.

Highlights of the New Rules

Highlights of New Rules for Certain Accountable Care Organizations

Practical Consequences of the New Rules

The following is a list of certain of the most important consequences of the new IRS rules. Because the rules may be applied to outstanding bond issues and contracts, many of these consequences may apply immediately.

Further Discussion

Tax-exempt bonds that benefit State and local governments and section 501(c)(3) organizations are subject to “private business tests” under sections 141 and 145 of the Internal Revenue Code that restrict the use of bond-financed facilities. These rules include restrictions on the “private business use” of bond-financed facilities.

The main impetus for publication of the Notice appears to have been to provide helpful guidance for certain accountable care organizations. In practice, however, the new rules in the Notice for service contracts are a more significant development that has widespread significance for issuers and borrowers of tax-exempt bonds, and also service providers to those issuers and borrowers. The Notice is the most significant IRS guidance on the treatment of service contracts involving facilities financed with tax-exempt bonds since the publication of IRS Rev. Proc. 97-13 in 1997.

For the most part, the new safe harbor for 5-year contracts displaces the existing Rev. Proc. 97-13 safe harbors for 2-year, 3-year and 5-year contracts. Each of those safe harbors requires that the qualified user (generally, the issuer or borrower) have the right to terminate the contract without penalty or cause after a 1-year, 2-year or 3-year period, respectively. The new 5-year safe harbor does not require any such termination provision. The types of compensation arrangements permitted by the new 5-year safe harbor are broad, but do not include all types of compensation arrangements. It is possible that, in some cases, issuers and borrowers may seek to continue to use an existing 2-year, 3-year or 5-year safe harbor; the existing safe harbors are not affected, and may still be relied upon.

The new rules set forth safe harbors, not requirements. The IRS has issued many private letter rulings providing that certain service contracts that do not technically meet all of the requirements of a Rev. Proc. 97-13 safe harbor, but are nonetheless sufficiently consistent with the principles of a published safe harbor, may still be favorably treated as not giving rise to private business use. Accordingly, it can be expected that many interpretive questions will arise regarding whether contracts that do not exactly meet all of the requirements of the new safe harbor for 5-year contracts, but are consistent with the spirit of the new safe harbor, may receive similar favorable treatment.

Use of the new 5-year safe harbor for service contracts may heighten the need to consider and review the general requirements of Rev. Proc. 97-13, as amended, and other federal tax and regulatory requirements for service contracts. For example, the safe harbors of Rev. Proc. 97-13, and the rules under section 501(c)(3) of the Internal Revenue Code, generally require that all such service contracts be entered into at fair market value. The longer term contracts permitted under the new rules may heighten the need to consider how to best establish and document that a contract is entered into a fair market value. As another example, the regulations continue to provide that a service contract generally results in private business use if the contract provides for compensation based, in whole or in part, on a share of net profits from operation of the facility. The new 5-year safe harbor may heighten the need to consider and review whether the compensation arrangement meets this requirement.

The new rules may be applied immediately, but are not required to be applied until on or after January 22, 2015. The Notice states that the provisions relating to ACOs under the Medicare Shared Savings Program apply to bonds sold on or after January 22, 2015, but may be applied to bonds sold before that date. The Notice states that the provisions relating to service contracts apply to contracts entered into, or materially modified or extended (other than pursuant to a renewal option) on or after January 22, 2015, but may be applied to contracts entered into, modified or extended before or after that date.

The favorable treatment for ACOs entered into under the Medicare Shared Savings Program is similar to the approach taken in IRS Notice 2011-20, which provided similar favorable treatment for purposes of section 501(c)(3) of the Internal Revenue Code. Guidance regarding the treatment of the many other types of ACOs is not provided in this Notice, although nonprofit organizations and their counsel may look to Notice 2014-67 for helpful benchmarks for the analysis of treatment of other ACO arrangements. In other words, particularly because participation in the Medicare Shared Savings Program is limited, the portion of Notice 2014-67 that concerns ACOs represents only a helpful “toe in the water” towards providing broader needed guidance on the treatment of ACOs.

The Notice concerns only “short-end” safe harbors for service contracts (that is, contracts having a term not longer than 5 years). The existing Rev. Proc. 97-13 also sets forth safe harbors for longer term contracts (10-year, 15-year and 20-year), which are not directly affected by the Notice. In general, the safe harbors for the “short-end” have more significance in certain sectors (particularly including health care) than others. Public comments have also been submitted to the IRS for additional safe harbors on the “long-end”. For example, more flexible long-term safe harbors could be particularly helpful for governmental utility systems, convention centers, and similar facilities financed with tax-exempt bonds. It is possible that the release of the favorable guidance for the “short-end” increases the possibility of future favorable guidance on the “long-end” as well.

Last Updated: October 29 2014

Article by Michael G. Bailey, David Y. Bannard, Chauncey W. Lever, Richard F. Riley, Jr. and Mark T. Schieble

Foley & Lardner

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.



Philadelphia 2010 Water Bonds’ Tax-Exemption Under IRS Scrutiny.

Philadelphia water and wastewater revenue bonds sold in 2010 are being audited by the Internal Revenue Service to verify they meet tax-exempt requirements, the city said in a filing.

The city received a notice from the agency around Oct. 8 that the $396 million issue is being examined because of “concern that the debt issuance may fail one or more provisions” of the code regarding tax-free securities, according to a posting on the Municipal Securities Rulemaking Board’s website.

Proceeds from the debt went toward refinancing 2003 securities and funding a $48.8 million payment to terminate a swap agreement, bond documents show.

Philadelphia reviewed the IRS matter and will provide the information requested, Treasurer Nancy Winkler said by telephone.

“We don’t see anything that should cause a problem,” she said. “We have not identified anything that would lead us to believe that the bonds fail to meet the applicable requirements.”

Winkler said the city has undergone five audits on debt issues in the past four years without any action taken.

Ubon Mendie, an IRS spokesman in Washington, declined to comment on the Philadelphia case.

Bloomberg

By Romy Varghese Oct 27, 2014 7:56 AM PT

To contact the reporter on this story: Romy Varghese in Philadelphia at [email protected]

To contact the editors responsible for this story: Stephen Merelman at [email protected] Mark Tannenbaum, Stacie Sherman



IRS Rules on Tax Consequences of Plan Contributions, Transfers.

The IRS ruled that some employer contributions, including picked-up contributions, to a city’s defined contribution plan aren’t includable in the employee’s gross income until distributed and that trustee-to-trustee transfers from a participant’s account in the plan to purchase service credit will not be included in their gross income.

Citations: LTR 201443035

Uniform Issue List: 414.00-00, 414.09-00

Date: July 28, 2014

Refer Reply To: T:EP:RA:T3

LEGEND:

City A = * * *
State B = * * *
Plan C = * * *
Plan D = * * *
Plan E = * * *
Board F = * * *
Class G Employees = * * *
Class H Employees = * * *

Dear * * *:

This letter is in response to correspondence dated April 22, 2005, as supplemented by correspondence dated February 29, 2008, January 28, 2009, February 3, 2009, August 17, 2009, August 31, 2009, April 15, 2013, May 7, 2013, November 22, 2013, March 6, 2014, March 25, 2014, and May 15, 2014, submitted on behalf of City A by its authorized representatives, in which a request for a letter ruling was submitted with respect to the federal tax consequences of certain contributions to, and trustee-to-trustee transfers from, Plan C, as established effective December 20, 2004, and as most recently amended and restated as of January 1, 2014.

The following facts and representations are submitted under penalties of perjury in support of your request:

City A is a municipal corporation and a political subdivision of State B. Pursuant to a certain ordinance enacted effective December 20, 2004, City A established Plan C, a defined contribution retirement plan for eligible employees of City A. Plan C is intended to be a tax-qualified retirement plan under section 401(a) of the Internal Revenue Code (“Code”), and is represented to be a governmental plan under section 414(d) of the Code. Plan C has been amended from time to time and, on December 19, 2013, Plan C was amended and restated in its entirety, effective January 1, 2014. A First Amendment to Plan C, as amended and restated effective January 1, 2014, was adopted by City A on March 14, 2014 (such Amendment hereinafter referred to as the “First Amendment”). In addition, City A proposes to adopt a Second Amendment, also effective January 1, 2014 (such Amendment hereinafter referred to as the “Second Amendment”),

Two categories of employees eligible to participate in Plan C are Class G Employees and Class H Employees. Other categories of City A employees are eligible to participate in Plan C as determined by City A’s Personnel Department.

Effective March 1, 2014, section 1.1 of Plan C defines the term “Accumulated Leave Time Value” as the value of an employee’s accumulated sick leave at retirement determined by multiplying the applicable percentage, based on the collective bargaining agreement or City A policy to which the employee is subject, by the amount of Plan-eligible accumulated sick leave available for conversion under such collective bargaining agreement or City A policy.

Section 1.1 of Plan C defines the term “Supplemental Contributions” as mandatory contributions made pursuant to section 3.1(d) of Plan C.

Pursuant to the Second Amendment, section 3.1(a)(2) of Plan C provides that, on and after April 1, 2014, City A shall automatically make an “Accumulated Leave Contribution” to Plan C on behalf of a Class G Employee equal to his or her Accumulated Leave Time Value at retirement. Section 3.1(a)(2) of Plan C, as set forth in the Second Amendment, further provides that no Class G Employee eligible for such an Accumulated Leave Contribution may receive any portion of his or her Accumulated Leave Time Value in cash.

Under the Second Amendment, section 3.1(a)(4) of Plan C provides that, on and after April 1, 2014, City A shall automatically make an Accumulated Leave Contribution to Plan C on behalf of a Class H Employee equal to his or her Accumulated Leave Time Value at retirement. Section 3.1(a)(4) of Plan C, as set forth in the Second Amendment, further provides that no Class H Employee eligible for such an Accumulated Leave Contribution may receive any portion of his or her Accumulated Leave Time Value in cash.

Section 3.1(b)(1) of Plan C provides that certain “Nonelective Employer Contribution Amounts” shall be contributed by City A to Plan C. Different classifications of eligible employees under Plan C are entitled to different Nonelective Employer Contribution Amounts in accordance with a specified Appendix of Plan C. Section 3.1(b)(1) of Plan C further states that no employee may elect to receive any portion of such Nonelective Employer Contribution Amounts in cash.

Pursuant to the Second Amendment, section 3.1(d)(1)(A) of Plan C provides that certain eligible classifications of City A employees hired on or after January 1, 2014, may make an election to have “Supplemental Contributions” made to Plan C. Under section 3.1(d)(1)(A), eligible employees may irrevocably elect salary reduction in the amount of a designated percentage (from among the available percentages set forth in a specified Appendix of Plan C, as amended from time to time) of the compensation otherwise payable to him or her on or after January 1, 2014 to be paid by City A into Plan C. Section 3.1(d)(1)(A) of Plan C further provides that such payment by City A into Plan C shall be a “pick up contribution” pursuant to section 414(h)(2) of the Code. Under section 3.1(d)(1)(A) of Plan C, such election must be made no later than the eligible employee’s first becoming eligible under any plan or arrangement of City A. Furthermore, section 3.1(d)(1)(A) says that, pursuant to such election, City A will pick up and pay the elected amount directly to Plan C, and the eligible employee will not have the option of choosing to receive the elected amount directly instead of having it paid by City A to Plan C. Section 3.1(d)(1)(A) also provides that no employee eligible for such a “pick up contribution” shall be permitted to make contributions of any portion of his or her compensation directly to Plan C.

Section 3.1(d)(1)(C) of Plan C provides that an eligible employee described in section 3.1(d)(1)(A) of Plan C who fails to make the election specified in that section shall be deemed to have irrevocably elected to have 0% of the compensation otherwise payable to him or her contributed to Plan C. Section 3.1(d)(1)(D) provides that the election made by an eligible employee to make (or not make) Supplemental Contributions is irrevocable and remains in place in the event the employee transfers to a position under the same or different employee classification (or terminates employment with City A and is subsequently reemployed under the same or different employee classification).

City A also established and maintains Plan D, which is represented to be a governmental plan within the meaning of section 414(d) of the Code, and is intended to be a qualified plan under section 401(a) of the Code. Plan D is a defined benefit plan. Plan D will accept transfers from Plan C for the purchase of service credit. Plan D contains distribution restrictions on any transferred amounts it receives that are at least as restrictive as the distribution restrictions of Plan C.

State B established and maintains Plan E, which is represented to be a governmental plan within the meaning of section 414(d) of the Code, and is intended to be a qualified plan under section 401(a) of the Code. Plan E is a defined benefit plan. Plan E will accept transfers from Plan C for the purchase of service credit. Plan E contains distribution restrictions on any transferred amounts it receives that are at least as restrictive as the distribution restrictions of Plan C.

Section 6.3 of Plan C provides that, if authorized by Board F (or its designee), and to the extent permitted by applicable law, Plan C shall allow participants to make voluntary plan-to-plan transfers directly to Plan D or Plan E, or another qualified defined benefit plan from which the participant is entitled to a benefit and which allows for such transfers (hereinafter “transferee plan”), for the purchase of service credit under such transferee plan. Under section 6.3 of Plan C, a participant may not request a transfer of an amount that exceeds 100% of the actuarial cost of the service credit being purchased, as determined by the transferee plan. Further, a participant must request a transfer to purchase service credit under section 6.3 of Plan C before his or her termination of employment with City A or retirement.

Based on the above facts and representations, you request the following rulings:

1. The employer contributions of Accumulated Leave Time Value made to Plan C on and after January 1, 2014, for Class G Employees in accordance with section 3.1(a)(2), and for Class H Employees in accordance with section 3.1(a)(4), are not contributions under a cash or deferred arrangement and are not includible in the gross income of the employee, because these mandatory, non-elective leave contributions are employer contributions to a qualified plan, subject to the limits on annual additions to a qualified plan,

2. The Nonelective Employer Contributions made to Plan C for eligible employees in accordance with section 3.1(b) are not includible in the gross income of the employee because these contributions are employer contributions to a qualified plan, subject to the limits on annual additions to a qualified plan.

3. The Supplemental Contributions made to Plan C for eligible employees in accordance with section 3.1(d) and which are (i) made pursuant to an irrevocable election of each eligible employee hired on or after January 1, 2014, upon first becoming eligible under any plan or arrangement of City A, and (ii) picked up by City A pursuant to section 414(h)(2) of the Code, are not includible in the gross income of each such employee, subject to the limits on annual additions to a qualified plan.

4. Trustee-to-trustee transfers made pursuant section 6.3 of Plan C from a participant’s account in Plan C to Plan D for the purchase of service credit will not be included in the gross income of the participant under section 402 of the Code and are not subject to withholding under section 3405 of the Code or tax reporting under section 6047 of the Code. Furthermore, such transferred amounts are not annual additions under section 415(c) of the Code, and the benefit attributable to the transferred amounts is not subject to the limitation on benefits under section 415(b) of the Code. In addition, section 415(n) of the Code is not applicable to the transferred amounts and the transferred amounts are not subject to limitation under section 415 of the Code at the time of transfer.

With respect to your first two requested rulings, section 401(a) of the Code provides that a trust created or organized in the United States and forming a part of a qualified stock bonus, pension, or profit sharing plan of an employer constitutes a qualified trust only if the various requirements set out in section 401(a) of the Code are met.

Section 401(k)(1) of the Code provides that a profit sharing or stock bonus plan, pre-ERISA money purchase pension plan, or a rural cooperative plan shall not be considered as not satisfying the requirements of section 401(a) of the Code merely because the plan includes a qualified cash or deferred arrangement as defined in section 401(k)(2) of the Code.

Section 401(k)(4)(B)(ii) of the Code provides that “a cash or deferred arrangement shall not be treated as a qualified cash or deferred arrangement if it is part of a plan maintained by a State or local government or political subdivision thereof, or any agency or instrumentality thereof.” Section 1116(f)(2)(B)(i) of the Tax Reform Act of 1986, P.L. 99-514, provides a transition rule pursuant to which the prohibition of section 401(k)(4)(B)(ii) of the Code does not apply to any cash or deferred arrangement adopted by a State or local government (or political subdivision thereof) before May 6, 1986. Thus, if a governmental employer maintains a qualified defined contribution plan, the plan cannot generally include a qualified cash or deferred arrangement within the meaning of section 401(k), unless the cash or deferred arrangement was adopted before May 6, 1986.

Section 1.401(k)-1(a)(2) of the Income Tax Regulations (“Regulations”) provides that, subject to certain exceptions, which are inapplicable in this case, a cash or deferred arrangement is an arrangement under which an eligible employee may make a cash or deferred election with respect to contributions to, or accruals or other benefits under, a plan that is intended to satisfy the requirements of section 401(a) of the Code.

Section 1.401(k)-1(a)(3) of the Regulations generally defines a cash or deferred election as any direct or indirect election (or modification of an earlier election) by an employee to have the employer either: (1) provide an amount to the employee in the form of cash (or some other taxable benefit) that is not currently available, or (2) contribute an amount to a trust, or provide an accrual or other benefit under, a plan deferring the receipt of compensation.

Section 402(a) of the Code generally provides that any amount actually distributed to any recipient by any employees’ trust described in section 401(a) of the Code, which is exempt from tax under section 501(a) of the Code, shall be taxable to the recipient, in the taxable year of the distribution, under section 72 of the Code (relating to annuities).

Section 1.402(a)-1(a)(1)(i) of the Regulations provides that if an employer makes a contribution for the benefit of an employee to a trust described in section 401(a) of the Code for the taxable year of the employer which ends within or with a taxable year of the trust for which the trust is exempt under section 501(a) of the Code, the employee is not required to include such contribution in his or her income except for the year or years in which such contribution is distributed or made available to him or her.

Section 415(a)(1)(B) of the Code provides that a defined contribution plan is not a qualified plan if contributions and other additions made to the plan with respect to any participant in a taxable year exceed the limitation of section 415(c) of the Code.

In the present case, pursuant to section 3.1(a)(2) and section 3.1(a)(4) of Plan C, on and after January 1, 2014, City A automatically contributes an amount equal to an eligible employee’s Accumulated Leave Time Value to Plan C on behalf of the employee at the time of the employee’s retirement. Under the terms of Plan C, no such eligible employee may receive any portion of his or her Accumulated Leave Time Value in cash.

Accordingly, no eligible employee is permitted a cash or deferred election with respect to his or her Accumulated Leave Time Value, as the employee cannot elect to receive any portion of such amount in the form of cash (or some other taxable benefit) rather than to have such amount contributed by City A to Plan C on the employee’s behalf pursuant to section 3.1(a)(2) or section 3.1(a)(4) of Plan C. Therefore, contributions under section 3.1(a)(2) and section 3.1(a)(4) of Plan C are treated as employer contributions for purposes of section 1.402(a)-1(a(1))(i) of the Regulations, and not as contributions made pursuant to a cash or deferred arrangement within the meaning of section 1.401(k)-1(a)(2) of the Regulations.

Similarly, no employee is allowed a cash or deferred election with respect to contributions made by City A to Plan C of Nonelective Employer Contribution Amounts pursuant to section 3.1(b) of Plan C. Section 3.1(b) of Plan C explicitly states that no employee may elect to receive any portion of such Nonelective Employer Contribution Amounts in cash rather than having such amounts contributed to Plan C.

Pursuant to section 415(a)(1)(B) of the Code, the contributions made on behalf of an eligible employee under section 3.1(a)(2), section 3.1(a)(4), and section 3.1(b) of Plan C, and any other contributions and additions made to Plan C with respect to any participant, are subject to the limitation of section 415(c) of the Code. Additionally, in accordance with section 1 402(a)-1(a)(1)(i) of the Regulations, employer contributions made by City A to Plan C on behalf of an employee pursuant to section 3.1(a)(2), section 3.1(a)(4), and section 3.1(b) of Plan C are not required to be included in the taxable income of the employee until such time as such amounts are distributed or made available to him or her.

Therefore, with respect to ruling request 1, we conclude that the employer contributions of Accumulated Leave Time Value made to Plan C on and after January 1, 2014, for Class G Employees in accordance with section 3.1(a)(2), and for Class H Employees in accordance with section 3.1(a)(4), are not contributions under a cash or deferred arrangement and are not includible in the gross income of the employee until such time as such amounts are distributed to the employee, because these mandatory, non-elective leave contributions are employer contributions to a qualified plan, subject to the limits on annual additions to a qualified plan.

With respect to ruling request 2, we also conclude that the Nonelective Employer Contributions made to Plan C for eligible employees in accordance with section 3.1(b) of Plan C are not includible in the gross income of the employee until such time as such amounts are distributed to the employee because these contributions are employer contributions to a qualified plan, subject to the limits on annual additions to a qualified plan.

With respect to your third requested ruling, section 1.401(k)-1(a)(3)(v) of the Regulations provides that a cash or deferred arrangement does not include certain one-time irrevocable elections. Under section 1.401(k)-1(a)(3)(v), such an election must be made no later than the employee’s first becoming eligible under the plan or any other plan or arrangement of the employer. The election must be to have contributions equal to a specified amount or percentage of the employee’s compensation made by the employer on the employee’s behalf to the plan and a specified amount or percentage divided among all other plans or arrangements of the employer. Furthermore, pursuant to section 1.401(k)-1(a)(3)(v), such an election must be for the duration of the employee’s employment with the employer.

Section 414(h)(1) of the Code provides that any amount contributed to an employees’ trust described in section 401(a) of the Code shall not be treated as having been made by the employer if it is designated as an employee contribution.

Section 414(h)(2) of the Code provides that, for purposes of section 414(h)(1), in the case of any plan established by the government of any State or political subdivision thereof, or by any agency or instrumentality of any of the foregoing, or a governmental plan described in the last sentence of section 414(d) (relating to plans of Indian tribal governments), where the contributions of employing units are designated as employee contributions but where any employing unit picks up the contributions, the contributions so picked up shall be treated as employer contributions.

The federal income tax treatment to be afforded contributions that are picked up by the employer within the meaning of section 414(h)(2) of the Code has been developed in a series of revenue rulings. In Revenue Ruling 77-462, 1977-2 C.B. 358, the employer school district agreed to assume and pay the amounts employees were required by state law to contribute to a state pension plan. Revenue Ruling 77-462 concluded that the school district’s picked-up contributions to the plan were excluded from the employees’ gross income until such time as they were distributed to the employees. The revenue ruling further held that, under the provisions of section 3401(a)(12)(A) of the Code, the school district’s contributions to the plan were excluded from wages for purposes of the collection of income tax at the source on wages. Therefore, no withholding was required for federal income tax purposes from the employees’ salaries with respect to such picked-up contributions.

Revenue Ruling 81-35, 1981-1 C.B. 255, and Revenue Ruling 81-36, 1981-1 C.B. 255, established that the following two criteria must be met: (1) the employer must specify that the contributions, although designated as employee contributions, are being paid by the employer in lieu of contributions by the employee; and (2) the employee must not be given the option of choosing to receive the contributed amounts directly instead of having them paid by the employer to the pension plan.

Revenue Ruling 87-10, 1987-1 C.B. 136, provides that the required specification of designated employee contributions must be completed before the period to which such contributions relate. If not, the designated employee contributions paid by the employer are actually employee contributions paid by the employee and recharacterized at a later date. The retroactive specification of designated employee contributions as paid by the employing unit (i.e., the retroactive pick-up of designated employee contributions by a governmental employer), is not permitted under section 414(h)(2) of the Code. Thus, employees may not exclude from current gross income designated employee contributions to a qualified plan that relate to compensation earned for services rendered prior to the date of the last governmental action necessary to effect the pick-up.

Revenue Ruling 2006-43, 2006-35 I.R.B. 329, amplifying and modifying Revenue Ruling 81-35, Revenue Ruling 81-36, and Revenue Ruling 87-10, describes the actions required for a state or political subdivision of a state, or an agency or instrumentality of either, to pick-up employee contributions to a plan qualified under section 401(a) of the Code so that the contributions are treated as employer contributions pursuant to section 414(h)(2). Specifically, Revenue Ruling 2006-43 provides that a contribution to a qualified plan established by an eligible employer (i.e., a governmental employer) will be treated as picked-up by the employing unit under section 414(h)(2) of the Code if two conditions are satisfied:

1. First, the employing unit must specify that the contributions, although designated as employee contributions, are being paid by the employer. For this purpose, the employing unit must take formal action to provide that the contributions on behalf of a specific class of employees of the employing unit, although designated as employee contributions, will be paid by the employing unit in lieu of employee contributions. A person duly authorized to take such action with respect to the employing unit must take such action. The action must apply only prospectively and be evidenced by a contemporaneous written document (e.g., minutes of a meeting, a resolution, or ordinance).

2. Second, the pick-up arrangement must not permit a participating employee from on and after the effective date of the pick-up to have a cash or deferred election right within the meaning of section 1.401(k)-1(a)(3) of the Regulations with respect to designated employee contributions. Thus, for example, no participating employee may be given the right to opt out of the pick-up arrangement described in section 414(h)(2) of the Code, or to receive the contributed amounts directly instead of having them paid by the employing unit to the plan.

Revenue Ruling 2006-43 states that the pick-up rules expressed in Revenue Ruling 81-35 and Revenue Ruling 81-36 apply even if the employer picks up contributions through a reduction in salary or through an offset against future salary increases.

In this case, the Supplemental Contributions made under section 3.1(d) of Plan C on behalf of certain eligible classifications of City A employees hired on or after January 1, 2014, are made pursuant to “one-time irrevocable elections” within the meaning of section 1.401(k)-1(a)(3)(v) of the Regulations. Each eligible employee’s election to have salary reduction contributions made under section 3.1(d) by City A to Plan C on the employee’s behalf in the amount of a designated percentage of the compensation otherwise payable to the employee, must be irrevocable and for the duration of the employee’s employment with the employer, and must be made no later than the employee’s first becoming eligible under Plan C or any other plan or arrangement of the employer. Consequently, pursuant to section 1.401(k)-1(a)(3)(v), the one-time irrevocable election offered under section 3.1(d) with respect to Supplemental Contributions does not constitute a cash or deferred arrangement within the meaning of section 1.401(k)-1(a)(2) of the Regulations. Since such a one-time irrevocable election is not a cash or deferred arrangement, it follows that it is also not a cash or deferred election within the meaning of section 1.401(k)-1(a)(3) of the Regulations.

Furthermore, consistent with the requirements stated in Revenue Ruling 81-36, Revenue Ruling 81-36, and Revenue Ruling 2006-43, with respect to a valid pick-up arrangement under section 414(h)(2) of the Code, Plan C, as formally adopted by City A, explicitly states that the Supplemental Contributions under section 3.1(d) described immediately above, although designated as elective, employee contributions, shall be paid by City A into Plan C. Section 3.1(d)(A) of Plan C provides that such payments by City A to Plan C shall be pick-up contributions pursuant to section 414(h)(2) of the Code. In further satisfaction of the requirements of Revenue Ruling 81-35, Revenue Ruling 81-36, and Revenue Ruling 2006-43, section 3.1(d)(A) of Plan C provides that no employee eligible for such a pick-up contribution has the option of choosing to receive the elected amount directly instead of having it paid by City A to Plan C. Moreover, since City A’s formal commitment to pick up the Supplemental Contributions on behalf of an employee exists under Plan C before the employee earns any compensation for Plan C purposes, there can be no retroactive pick-up of designated employee contributions by City A in contravention of Revenue Ruling 87-10 Additionally, as mandated by Revenue Ruling 2006-43, and for the reasons stated earlier, we find that section 3.1(d) of Plan C does not permit a participating employee from on and after the effective date of the pick-up of Supplemental Contributions by City A to have a cash or deferred election right within the meaning of section 1.401(k)-1(a)(3) of the Regulations with respect to designated employee contributions.

Accordingly, with respect to ruling request 3, we conclude that the Supplemental Contributions made to Plan C for eligible employees in accordance with section 3.1(d), and which are made pursuant to an irrevocable election of each eligible employee hired on or after January 1, 2014, upon first becoming eligible under any plan or arrangement of City A, shall be treated for federal income tax purposes as employer contributions pursuant to section 414(h)(2) of the Code. Therefore, in accordance with Revenue Ruling 77-462, we further conclude that, subject to the limits on annual additions to a qualified plan of section 415(c) of the Code, such picked-up contributions to Plan C are not includible in the gross income of each such employee until such time as such amounts are distributed to the employee.

With respect to your fourth requested ruling, section 415(a)(1)(A) of the Code provides that a defined benefit plan is not a qualified plan if the plan provides for the payment of benefits with respect to a participant which exceed the limitation of section 415(b) of the Code.

Section 1.415(b)-1(b)(1)(ii) of the Regulations provides that an annual benefit, for purposes of determining the section 415(b) limitation, does not include the annual benefit attributable to either employee contributions or rollover contributions (as described in sections 401(a)(31), 402(c)(1), 403(a)(4), 403(b)(8), 408(d)(3), and 457(e)(16) of the Code), determined pursuant to the rules of section 1.415(b)-1(b)(2) of the Regulations. Section 1.415(b)-1(b)(1)(ii) further provides that the treatment of transferred benefits is determined under the rules of section 1.415(b)-1(b)(3) of the Regulations.

Section 1.415(b)-1(b)(2)(iii) of the Regulations provides that, in the case of mandatory employee contributions, as defined in section 411(c)(2)(C) of the Code and section 1.411(c)-1(c)(4) of the Regulations (or contributions that would be mandatory employee contributions if section 411 applied to the plan), the annual benefit attributable to those contributions is determined by applying the factors applicable to mandatory employee contributions, as described in sections 411(c)(2)(B) and (C) of the Code and regulations promulgated under section 411, to those contributions to determine the amount of a straight life annuity commencing at the annuity starting date, regardless of whether the requirements of sections 411 and 417 of the Code apply to that plan,

Section 1.415(b)-1(b)(2)(v) of the Regulations provides that the annual benefit attributable to rollover contributions from an eligible retirement plan, as defined in section 402(c)(8)(B) of the Code (for example, a contribution received pursuant to a direct rollover under section 401(a)(31)(A) of the Code), is determined in the same manner as the annual benefit attributable to mandatory employee contributions if the plan provides for a benefit derived from the rollover contribution (other than a benefit derived from a separate account to be maintained with respect to the rollover contribution and actual earnings and losses thereon). Thus, in the case of rollover contributions from a defined contribution plan to a defined benefit plan to provide an annuity distribution, the annual benefit attributable to those rollover contributions for purposes of section 415(b) is determined by applying the rules of section 411(c) as described in section 1.415(b)-1(b)(2)(iii) of the Regulations, regardless of the assumptions used to compute the annuity distribution under the plan and regardless of whether the plan is subject to the requirements of sections 411 and 417 of the Code. Accordingly, in such a case, if the plan uses more favorable factors than those specified in section 411(c) to determine the amount of annuity payments arising from rollover contributions, the annual benefit under the plan would reflect the excess of those annuity payments over the amounts that would be payable using the factors specified in section 411(c).

Section 1.415(b)-1(b)(3)(ii) of the Regulations provides that if there is an elective transfer of a distributable benefit to a defined benefit plan from either a defined contribution plan or a defined benefit plan, the amount transferred is treated as a benefit paid from the transferor plan, and the annual benefit provided by the transferee defined benefit plan does not include the annual benefit attributable to the amount transferred (determined as if the transferred amount were a rollover contribution subject to the rules of section 1.415(b)-1(b)(2)(v) of the Regulations). Section 1.415(b)-1(b)(3)(ii) further states that the rule described in the preceding sentence applies regardless of whether the requirements of section 411 of the Code apply to the plan and, in the case of a transfer from a defined contribution plan that is not subject to the requirements of section 411 (such as a governmental plan) to a defined benefit plan, the rule applies even if the participant’s benefits are not distributable from the defined contribution plan at the time of the transfer.

Section 415(n) of the Code generally provides that if a participant makes one or more contributions to a defined benefit governmental plan (within the meaning of section 414(d) of the Code) to purchase permissive service credit under such plan, then the requirements of section 415 of the Code shall be treated as met only if —

1. The requirements of section 415(b) of the Code are met, determined by treating the accrued benefit derived from all such contributions as an annual benefit for purposes of section 415(b); or

2. The requirements of section 415(c) of the Code are met, determined by treating all such contributions as annual additions for purposes of section 415(c).

Section 415(n)(3) defines “permissive service credit” as service credit —

1. recognized by the governmental plan for purposes of calculating a participant’s benefit under the plan,

2. which such participant has not received under such governmental plan, and

3. which such participant may receive only by making a voluntary additional contribution, in an amount determined under such governmental plan, which does not exceed the amount necessary to fund the benefit attributable to such service credit.

Revenue Ruling 67-213, 1967-2 C.B. 149, involves the transfer of funds attributable to employer contributions directly from the trust forming a part of a qualified pension plan to the trust forming part of a qualified stock bonus plan. The revenue ruling provides, in part, that if funds are transferred from one qualified plan to another, without being made available to the participants, no taxable income will be recognized by the participants by reason of such a transfer. The revenue ruling further provides that since the funds are not considered as having been made available to the participants, they continue to be funds derived from employer contributions and do not constitute employee contributions even though they are fully vested.

In this case, section 6.3 of Plan C provides that, if authorized by Board F (or its designee), and to the extent permitted by applicable law, Plan C shall allow participants to make voluntary plan-to-plan transfers directly to Plan D (or another qualified defined benefit plan from which the participant is entitled to a benefit and which allows for such transfers) for the purchase of service credit under such transferee plan. Pursuant to Revenue Ruling 67-213, the plan-to-plan transfers from Plan C to Plan D will not be treated as a distribution from Plan C followed by an employee contribution to Plan D. Therefore, the trustee-to-trustee transfers made pursuant to section 6.3 of Plan C from a participant’s account in Plan C to Plan D for the purchase of service credit will not be included in the gross income of the participant at the time of such transfer under section 402 of the Code.

As discussed above, section 415(n) of the Code provides that, in order to meet the requirements of section 415 of the Code, if a participant makes voluntary additional contributions to a defined benefit plan for the purchase of permissive service credit, the plan must either: (1) treat the accrued benefit derived from all such contributions as an annual benefit for purposes of section 415(b); or (2) all such contributions must be treated as annual additions for purposes of section 415(c).

In the present case, the voluntary plan-to-plan transfers from Plan C to Plan D, in accordance with section 6.3 of the Plan, do not constitute voluntary additional contributions made by a participant to Plan D. Since section 415(n) of the Code applies to voluntary additional contributions made by a participant to purchase permissive service credit, and the transferred amounts are not voluntary additional contributions made by a participant, we find that section 415(n) does not apply to the transferred amounts.

As stated earlier, section 1.415(b)-1(b)(3)(ii) of the Regulations provides that if an elective transfer of a benefit is made from a governmental defined contribution plan to a defined benefit plan, the amount transferred is treated, for purposes of applying the section 415 limitations, as a benefit paid from the transferor plan. Section 1.415(b)-1(b)(3)(ii) further states that, for purposes of section 415, the annual benefit provided by the defined benefit plan does not include the annual benefit attributable to the amount transferred (determined as if the transferred amount were a rollover contribution subject to the rules of section 1.415(b)-1(b)(2)(v) of the Regulations).

In the present case, in accordance with section 1.415(b)-1(b)(2)(v) of the Regulations, the annual benefit attributable to the plan-to-plan transfers from Plan C to Plan D, for purposes of section 415(b), is determined by applying the rules of section 411(c) as described in section 1.415(b)-1(b)(2)(iii) of the Regulations. Therefore, if Plan D uses the factors specified in section 411(c) of the Code to calculate the annual benefit under the plan, then, for purposes of the limitation of section 415(b), as provided in section 1.415(b)-1(b)(3)(ii) of the Regulations, the annual benefit provided under Plan D does not include the annual benefit attributable to the amounts transferred from Plan C for the purchase of service credit. However, pursuant to section 1.415(b)-1(b)(2)(v) of the Regulations, if Plan D uses more favorable factors than those specified in section 411(c) of the Code to determine the amount of annuity payments arising from the transferred amounts, the annual benefit under Plan D, for purposes of the limitation of section 415(b), would reflect the excess of those annuity payments over the amounts that would be payable using the factors specified in section 411(c).

Based on the foregoing, with respect to ruling request 4, we conclude that trustee-to-trustee transfers made pursuant to section 6.3 of Plan C from a participant’s account in Plan C to Plan D for the purchase of service credit will not be included in the gross income of the participant under section 402 of the Code. We further conclude, with respect to ruling request 4, that such transferred amounts are not annual additions under section 415(c) of the Code, and the benefit attributable to the transferred amount is not subject to the limitation on benefits under section 415(b) of the Code; provided, however, if Plan D uses more favorable factors than those specified in section 411(c) of the Code to determine the amount of annuity payments arising from the transferred amounts, the annual benefit under Plan D would reflect the excess of those annuity payments over the amounts that would be payable using the factors specified in section 411(c). In addition, with respect to ruling request 4, we conclude that section 415(n) of the Code is not applicable to the transferred amounts and the transferred amounts are not subject to limitation under section 415 of the Code at the time of transfer.

No opinion is expressed as to the federal tax consequences of the transactions described above under any other provisions of the Code.

This ruling is based on the assumption that Plan C, Plan D, and Plan E satisfy the qualification requirements set forth in section 401(a) of the Code, and constitute governmental plans within the meaning of section 414(d) of the Code, at all relevant times.

This ruling is directed only to the specific taxpayers that requested it. Section 6110(k)(3) of the Code provides that it may not be used or cited by others as precedent.

Pursuant to a power of attorney on file with this office, a copy of this letter ruling is being sent to your authorized representatives.

Should you have any questions or concerns regarding this ruling, please contact * * * (I.D. Number * * * at * * *. Please address all correspondence to SE:T:EP:RA:T3.

Sincerely yours,

Laura B. Warshawsky, Manager
Employee Plans Technical Group 3
Enclosures:
Deleted copy of this letter
Notice of Intention to Disclose

cc:
* * *



IRS Issues Guidance on Facilities Financed With Tax-Exempt Bonds.

The IRS has provided guidance (Notice 2014-67) for determining whether a state or local government entity or an exempt organization that benefits from tax-exempt bond financing will be considered to make private business use of its bond-financed facilities as a result of participating in the Medicare shared savings program through an accountable care organization (ACO).

Section 103 provides that gross income generally does not include interest on any state or local bond, but the exclusion does not apply to any private activity bond that is not a qualified bond. A private activity bond is defined in section 141(a) as any bond issued as part of an issue (1) that meets the private business use test and private security or payment test, or (2) that meets the private loan financing test. A bond issue meets the private business use test if more than 10 percent of the proceeds of the issue are to be used for any private business use.

An ACO is a legal entity established by two or more healthcare providers or suppliers to coordinate and improve care for some Medicare beneficiaries and reduce costs. Under the Medicare shared savings program, an ACO that meets quality performance standards and satisfies specified cost savings benchmarks is eligible to receive payment of a portion of the total savings generated. Both for-profit entities and organizations exempt from tax under section 501(c)(3) may participate in an ACO. Notice 2014-67 is in part a response to governmental entities and tax-exempt hospitals that asked whether participating in an ACO with a for-profit entity will result in private business use of facilities financed with tax-exempt bonds.

According to Notice 2014-67, participation by a user of a healthcare facility financed with tax-exempt bonds in the shared savings program through an ACO that includes participants that are nongovernmental persons must be structured to not result in private business use of the facility. Also, any section 501(c)(3) organization using a facility financed with tax-exempt bonds must structure its participation in an ACO so that it neither jeopardizes its exempt status nor causes it to be engaged in an unrelated trade or business under section 513(a). Notice 2014-67 specifies six conditions under which the participation of a qualified user in the shared savings program through an ACO in itself will not result in private business use of the bond-financed facility.

Similarly, Notice 2014-67 provides that management contracts between qualified users of hospitals or other healthcare facilities that are financed with tax-exempt bonds and nongovernmental persons to provide healthcare services at the facilities must be structured to avoid private business use. Notice 2014-67 amplifies the permitted productivity rewards and the types of permissible arrangements described in Rev. Proc. 97-13 that do not result in private business use, provided all other requirements of the revenue procedure are met. The notice also solicits public comments on further guidance needed to facilitate participation in the shared savings program.

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Notice 2014-67; 2014-46 IRB 1

Private business use of tax-exempt bond financed facilities

Part III — Administrative, Procedural, and Miscellaneous

SECTION 1. INTRODUCTION

The Internal Revenue Service (IRS) is considering the application of the provisions of the Internal Revenue Code (Code) governing tax-exempt bonds to arrangements entered into by hospitals or other health care organizations participating in the Medicare Shared Savings Program (Shared Savings Program) described in §§ 3022 and 10307 of the Patient Protection and Affordable Care Act, Pub. L. 111-148, 124 Stat. 119 (Affordable Care Act), enacted March 23, 2010. This notice provides interim guidance for determining whether a State or local government entity or an organization described in § 501(c)(3) of the Code that benefits from tax-exempt bond financing will be considered to have private business use of its bond-financed facilities under § 141 or § 145(a)(2)(B) of the Code as a result of its participation in the Share Savings Program through an “accountable care organization” (ACO). In addition, this notice amplifies Rev. Proc. 97-13, 1997-1 C.B. 632, as amended by Rev. Proc. 2001-39, 2001-2 C.B. 38 (cited herein as “Rev. Proc. 97-13”), regarding certain management contracts that do not result in private business use. This notice also solicits public comments on this interim guidance and on further guidance needed to facilitate participation in the Shared Savings Program.

SECTION 2. BACKGROUND

ACOs and the Shared Savings Program

Section 3022 of the Affordable Care Act amended Title XVIII of the Social Security Act (SSA) (42 U.S.C. 1395 et seq.) by adding a new § 1899, which directs the Secretary of the Department of Health and Human Services (HHS) to establish a Medicare shared savings program that promotes accountability for care of Medicare beneficiaries, improves the coordination of Medicare fee-for-service items and services, and encourages investment in infrastructure and redesigned care processes for high quality and efficient service delivery. Under § 1899(b)(1) of the SSA, groups of health care service providers and suppliers that have established a mechanism for shared governance and that meet criteria specified by HHS are eligible to participate as ACOs under the program.

Section 1899(b)(1) of the SSA provides examples of groups of service providers and suppliers that may form an ACO, including (i) physicians and other health care practitioners (ACO professionals) in a group practice, (ii) a network of individual practices, (iii) a partnership or joint venture arrangement between hospitals and ACO professionals, and (iv) a hospital employing ACO professionals. ACOs eligible to participate in the Shared Savings Program will manage and coordinate care for their assigned Medicare fee-for-service beneficiaries. Health care service providers and suppliers participating in an ACO will continue to receive Medicare fee-for-service payments in the same manner as such payments would otherwise be made. In addition, an ACO that meets quality performance standards established by HHS and demonstrates that it has achieved savings against an appropriate benchmark of expected average per capita Medicare fee-for-service expenditures will be eligible to receive payments for Medicare shared savings (Shared Savings Program payments) under § 1899(d)(2) of the SSA. Section 1899(i) of the SSA also authorizes the use of other payment models that the HHS Secretary determines will improve the quality and efficiency of items and services for Medicare.

Section 1899(b)(2) of the SSA establishes the following requirements for an ACO to participate in the Shared Savings Program:

(1) The ACO shall be willing to become accountable for the quality, cost, and overall care of the Medicare fee-for-service beneficiaries assigned to it.

(2) The ACO shall enter into an agreement with the HHS Secretary to participate in the Shared Savings Program for not less than a 3-year period.

(3) The ACO shall have a formal legal structure that would allow the organization to receive and distribute Shared Savings Program payments to participating providers of services and suppliers.

(4) The ACO shall include primary care ACO professionals that are sufficient for the number of Medicare fee-for-service beneficiaries assigned to the ACO under § 1899(c). At a minimum, the ACO shall have at least 5,000 such beneficiaries assigned to it under § 1899(c) to be eligible to participate in the Shared Savings Program.

(5) The ACO shall provide the HHS Secretary with such information regarding ACO professionals participating in the ACO as the Secretary determines necessary to support the assignment of Medicare fee-for-service beneficiaries to an ACO, the implementation of quality and the other reporting requirements under § 1899(b)(3), and the determination of Shared Savings Program payments.

(6) The ACO shall have in place a leadership and management structure that includes clinical and administrative systems.

(7) The ACO shall define processes to promote evidence-based medicine and patient engagement, report on quality and cost measures, and coordinate care, such as through the use of telehealth, remote patient monitoring, and other such enabling technologies.

(8) The ACO shall demonstrate to the HHS Secretary that it meets patient-centeredness criteria specified by the Secretary, such as the use of patient and caregiver assessments or the use of individualized care plans.

On November 2, 2011, the Centers for Medicare & Medicaid Services (CMS), the agency within HHS that administers the Medicare program, published final regulations addressing § 1899 of the SSA (76 FR 67802). The regulations contain specific eligibility criteria for entities to qualify as ACOs under the Shared Savings Program and describe quality measures, reporting requirements, and monitoring by CMS. The regulations require the ACO to be a legal entity formed under applicable State, Federal, or Tribal law, identified by a taxpayer identification number, and authorized in each State in which it operates for purposes of (1) receiving and distributing shared savings; (2) repaying shared losses or other monies determined to be owed to CMS; (3) establishing, reporting, and ensuring provider compliance with health care quality criteria, including quality performance standards; and (4) fulfilling other ACO functions identified in the regulations. The regulations require an ACO to provide for meaningful participation in the composition and control of the ACO’s governing body by ACO participants (or their designated representatives). In addition, the regulations generally require that the ACO’s governing body include a Medicare beneficiary representative(s) served by the ACO who does not have a conflict of interest with the ACO.

The regulations require an ACO seeking to participate in the Shared Savings Program to submit a written application to CMS describing how the ACO plans to use and distribute any Shared Savings Program payments and how that plan would contribute to achieving the specific goals of the Shared Savings Program and the general aims of better care for individuals, better health for populations, and lower growth in expenditures.

Finally, consistent with the authorization in § 1899(i) of the SSA of alternative payment models, the regulations provide a “two-sided model” under which participating ACOs not only would be eligible to share in cost savings at higher rates but also would be required to repay losses resulting from spending that exceeds a benchmark of expected average per capita Medicare fee-for-service expenditures (Shared Savings Program losses).

Private Business Use of Tax-Exempt Bonds

Section 103(a) of the Code provides that, except as provided in § 103(b) of the Code, gross income does not include interest on any State or local bond. Section 103(b)(1) of the Code provides that § 103(a) of the Code shall not apply to any private activity bond that is not a qualified bond (within the meaning of section 141 of the Code).

Section 141(a) of the Code provides that the term “private activity bond” means any bond issued as part of an issue (1) that meets the private business use test and private security or payment test, or (2) that meets the private loan financing test.

Section 141(b)(1) of the Code provides generally that an issue meets the private business use test if more than 10 percent of the proceeds of the issue are to be used for any private business use. Section 141(b)(6) of the Code defines “private business use” as use (directly or indirectly) in a trade or business carried on by any person other than a governmental unit. For this purpose, any activity carried on by a person other than a natural person must be treated as a trade or business use.

Section 1.141-3(a) of the Income Tax Regulations provides, in part, that the 10 percent private business use test of § 141(b)(1) of the Code is met if more than 10 percent of the proceeds of an issue is used in a trade or business of a nongovernmental person. For this purpose, the use of financed property is treated as the direct use of proceeds. Section 1.141-1(b) defines a nongovernmental person as a person other than a governmental person. Pursuant to § 1.141-1(b), a governmental person means a State, territory, a possession of the United States, the District of Columbia, or any political subdivision thereof, or any instrumentality of the foregoing. The United States and any agencies and instrumentalities thereof are not governmental persons.

Section 1.141-3(b)(1) provides that both actual and beneficial use by a nongovernmental person may be treated as private business use. In most cases, the private business use test is met only if a nongovernmental person has special legal entitlements to use the financed property under an arrangement with the issuer. In general, a nongovernmental person is treated as a private business user as a result of ownership; actual or beneficial use of property pursuant to a lease, a management contract, or an incentive payment contract; or certain other arrangements such as a take or pay or other output-type contract. Section 1.141-3(b)(7) provides that any other arrangement that conveys special legal entitlements for beneficial use of bond proceeds or of financed property that are comparable to the special legal entitlements described above results in private business use.

Section 1.141-3(b)(4)(i) provides generally that a management contract with respect to financed property may result in private business use of that property, based on all of the facts and circumstances. A management contract with respect to financed property generally results in private business use of that property if the contract provides for compensation for services rendered with compensation based, in whole or in part, on a share of net profits from the operations of the facility.

Section 1.141-3(b)(4)(ii) defines “management contract” as a management, service, or incentive payment contract between a governmental person and a service provider under which the service provider provides services involving all, a portion, or any function, of a facility. For example, a contract for the provision of management services for an entire hospital, a contract for management services for a specific department of a hospital, and an incentive payment contract for physician services to patients of a hospital are each treated as a management contract.

Section 1.141-3(b)(4)(iii) provides that certain arrangements described therein generally are not treated as management contracts that give rise to private business use. The described arrangements include (A) contracts for services that are solely incidental to the primary governmental function or functions of a financed facility (for example, contracts for janitorial, office equipment repair, hospital billing, or similar services); and (B) the mere granting of admitting privileges by a hospital to a doctor, even if those privileges are conditioned on the provision of de minimis services if those privileges are available to all qualified physicians in the area, consistent with the size and nature of the hospital’s facilities.

Section 141(e) of the Code provides, in part, that the term “qualified bond” includes a qualified 501(c)(3) bond if certain requirements stated therein are met.

Section 145(a) of the Code provides generally that the term “qualified 501(c)(3) bond” means any private activity bond issued as part of an issue if (1) all property that is to be provided by the net proceeds of the issue is to be owned by a 501(c)(3) organization or a governmental unit, and (2) such bond would not be a private activity bond if (A) 501(c)(3) organizations were treated as governmental units with respect to their activities that do not constitute unrelated trades or businesses, determined by applying § 513(a) of the Code, and (B) §§ 141(b)(1) and (2) of the Code were applied by substituting “5 percent” for “10 percent” each place it appears and by substituting “net proceeds” for “proceeds” each place it appears. Section 150(a)(4) of the Code defines the term “501(c)(3) organization” to mean any organization described in § 501(c)(3) and exempt from tax under § 501(a) of the Code.

Section 1.145-2 provides that, with certain exceptions and modifications, §§ 1.141-0 through 1.141-15 apply to § 145(a) of the Code. Section 1.145-2(b) provides that, in applying §§ 1.141-0 through 1.141-15 to § 145(a), (1) references to governmental persons include 501(c)(3) organizations with respect to their activities that do not constitute unrelated trades or businesses under § 513(a) of the Code; (2) references to “10 percent” and “proceeds” in the context of the private business use test and the private security or payment test mean “5 percent” and “net proceeds”, respectively; and (3) references to the private business use test in §§ 1.141-2 and 1.141-12 include the ownership test of § 145(a)(1) of the Code.

Rev. Proc. 97-13 sets forth conditions under which a management contract between a qualified user and a service provider does not result in private business use under § 141(b) of the Code. Rev. Proc. 97-13 also applies to determinations of the effect of such a management contract on whether a bond meets the test in § 145(a)(2)(B) of the Code. Section 3.07 of Rev. Proc. 97-13 defines “qualified user” as any State or local governmental unit as defined in § 1.103-1 or any instrumentality thereof. The term also includes a 501(c)(3) organization if the financed property is not used in an unrelated trade or business under § 513(a) of the Code. The term does not include the United States or any agency or instrumentality thereof.

Section 5.01 of Rev. Proc. 97-13 provides that if the requirements of section 5 of Rev. Proc. 97-13 are satisfied a management contract does not itself result in private business use. In addition, the use of financed property, pursuant to a management contract meeting these requirements, is not private business use if that use is functionally related and subordinate to that management contract and that use is not, in substance, a separate contractual agreement (for example, a separate lease of a portion of the financed property).

Under section 5.02(1) of Rev. Proc. 97-13, the management contract must provide for reasonable compensation for services rendered with no compensation based, in whole or in part, on a share of net profits from the operation of the facility.

Section 5.02(2) of Rev. Proc. 97-13 provides, for purposes of § 1.141-3(b)(4)(i) and Rev. Proc. 97-13, that compensation based on (a) a percentage of gross revenues (or adjusted gross revenues) of a facility or a percentage of expenses from a facility, but not both; (b) a capitation fee; or (c) a per-unit fee is generally not considered to be based on a share of net profits.

Section 5.02(3) of Rev. Proc. 97-13 provides, for purposes of § 1.141-3(b)(4)(i) and Rev. Proc. 97-13, that a productivity reward equal to a stated dollar amount based on increases or decreases in gross revenues (or adjusted gross revenues), or reductions in total expenses (but not both increases in gross revenues (or adjusted gross revenues) and reductions in total expenses) in any annual period during the term of the contract, generally does not cause the compensation to be based on a share of net profits.

Section 5.03 of Rev. Proc. 97-13 provides that the management contract must be described in section 5.03(1), (2), (3), (4), (5), or (6). Section 5.03(4) describes periodic fixed fee and capitation fee arrangements in certain 5-year contracts. Section 5.03(5) describes per-unit fee arrangements in certain 3-year contracts. Section 5.03(6) describes percentage of revenue or expense fee arrangements in certain 2-year contracts.

SECTION 3. INTERIM GUIDANCE

01. Participation by Governmental Persons or Section 501(c)(3) Organizations in the Shared Savings Program through ACOs

The IRS understands that governmental persons (as defined in § 1.141-1(b)) and 501(c)(3) organizations typically will be participating in the Shared Savings Program through ACOs with nongovernmental persons. The IRS further understands that this participation may take a variety of forms, including membership in a nonprofit membership corporation, ownership of shares in a corporation, ownership of a partnership interest in a partnership, and ownership of a membership interest in an LLC.

Under the private business use test described above, participation by a user of a health care facility financed with tax-exempt bonds in the Shared Savings Program through an ACO that includes participants that are nongovernmental persons must be structured so as not to result in private business use of the facility. In addition, any 501(c)(3) organization using a facility financed with tax-exempt bonds must structure its participation in an ACO so that its participation neither jeopardizes its 501(c)(3) status nor causes it to be engaged in an unrelated trade or business under § 513(a) of the Code.

The participation of a qualified user (as defined in section 3.07 of Rev. Proc. 97-13) in the Shared Savings Program through an ACO in itself will not result in private business use of the tax-exempt bond financed facility if all of the following conditions are met:

The terms of the qualified user’s participation in the Shared Savings Program through the ACO (including its share of Shared Savings Program payments or losses and expenses) are set forth in advance in a written agreement negotiated at arm’s length.

CMS has accepted the ACO into, and has not terminated the ACO from, the Shared Savings Program.

The qualified user’s share of economic benefits derived from the ACO (including its share of Shared Savings Program payments) is proportional to the benefits or contributions the qualified user provides to the ACO. If the qualified user receives an ownership interest in the ACO, the ownership interest received is proportional and equal in value to its capital contributions to the ACO and all ACO returns of capital, allocations, and distributions are made in proportion to ownership interests.

The qualified user’s share of the ACO’s losses (including its share of Shared Savings Program losses) does not exceed the share of ACO economic benefits to which the qualified user is entitled.

All contracts and transactions entered into by the qualified user with the ACO and the ACO’s participants, and by the ACO with the ACO’s participants and any other parties, are at fair market value.

The qualified user does not contribute or otherwise transfer the property financed with tax-exempt bonds to the ACO unless the ACO is an entity that is a governmental person, or in the case of qualified 501(c)(3) bonds, either a governmental person or a 501(c)(3) organization.

.02 Management Contracts

It is anticipated, further, that qualified users of hospitals or other health care facilities that are financed with tax-exempt bonds will enter into management contracts (as defined in § 1.141-3(b)(4)(ii)) with nongovernmental persons to provide health care services at the qualified users’ facilities that will take into account the quality performance standards and Medicare fee-for-service expenditures relevant to participation in the Shared Savings Program. Under the private business use test described above, a qualified user must structure its management contracts with respect to those facilities to avoid private business use.

This notice amplifies the permitted productivity rewards and the types of permissible arrangements described in Rev. Proc. 97-13 that do not result in private business use, provided all other requirements of section 5 of Rev. Proc. 97-13 are met.

(1) Section 5.02(3) of Rev. Proc. 97-13 is amplified to add the following text at the end:

A productivity reward for services in any annual period during the term of the contract generally also does not cause the compensation to be based on a share of net profits of the financed facility if:

The eligibility for the productivity award is based on the quality of the services provided under the management contract (for example, the achievement of Medicare Shared Savings Program quality performance standards or meeting data reporting requirements), rather than increases in revenues or decreases in expenses of the facility; and

The amount of the productivity award is a stated dollar amount, a periodic fixed fee, or a tiered system of stated dollar amounts or periodic fixed fees based solely on the level of performance achieved with respect to the applicable measure.

(2) Section 5.03 of Rev. Proc. 97-13 is amplified to revise the first sentence and add new section 5.03(7) at the end as follows:

.03 Permissible Arrangements. The management contract must be described in section 5.03(1), (2), (3), (4), (5), (6), or (7).
* * * * *

(7) Arrangements in certain 5-year contracts. All of the compensation for services is based on a stated amount; periodic fixed fee; a capitation fee; a per-unit fee; or a combination of the preceding. The compensation for services also may include a percentage of gross revenues, adjusted gross revenues, or expenses of the facility (but not both revenues and expenses). The term of the contract, including all renewal options, does not exceed five years. Such contract need not be terminable by the qualified user prior to the end of the term. For purposes of this section 5.03(7), a tiered productivity award as described in section 5.02(3) will be treated as a stated amount or a periodic fixed fee, as appropriate.

SECTION 4. REQUEST FOR PUBLIC COMMENTS

The IRS expects to issue guidance concerning management contracts for purposes of §§ 141 and 145(a)(2)(B) of the Code. That guidance may address issues relevant to participation in the Shared Savings Program. To help inform that guidance, the Treasury Department and the IRS solicit comments on the guidance that is described in section 3 of this notice and on further guidance needed to facilitate participation in the Shared Savings Program by qualified users of tax-exempt bond financed facilities through ACOs.

Public comments should be submitted in writing on or before January 22, 2015. Comments should be sent to the following address:

Internal Revenue Service
CC:PA:LPD:PR (Notice 2014-67)
P.O. Box 7604
Ben Franklin Station
Washington, DC 20044
Comments may be hand delivered to:

CC:PA:LPD:PR (Notice 2014-67)
Courier’s Desk
Internal Revenue Service
1111 Constitution Avenue, NW
Washington, DC 20224

Comments may also be sent electronically to [email protected]. Please include “Notice 2014-67” in the subject line.
All comments will be available for public inspection.

SECTION 5. APPLICABILITY DATES

Section 3.01 of this notice applies to bonds subject to § 141 or § 145(a)(2)(B) of the Code sold on or after January 22, 2015. Section 3.01 may be applied to bonds sold before January 22, 2015 that are subject to § 141 or § 145(a)(2)(B) of the Code.

Section 3.02 of this notice applies to contracts entered into, materially modified, or extended (other than pursuant to a renewal option) on or after January 22, 2015. Section 3.02 may be applied to contracts entered into before January 22, 2015.

SECTION 6. EFFECT ON OTHER DOCUMENTS

Rev. Proc. 97-13 is amplified by this notice.

SECTION 7. DRAFTING INFORMATION

The principal author of this notice is Johanna Som de Cerff of the Office of Associate Chief Counsel (Financial Institutions & Products). For further information regarding this notice contact Johanna Som de Cerff on (202) 317-6980 (not a toll-free call).



IRS Issues Guidance on Facilities Financed With Tax-Exempt Bonds.

The IRS has provided guidance for determining whether a state or local government entity or an exempt organization that benefits from tax-exempt bond financing will be considered to have private business use of its bond-financed facilities as a result of participating in the Medicare Shared Savings Program through an accountable care organization.



IRS Issues Guidance on ACOs.

The Internal Revenue Service today released Notice 2014-67, which provides guidance for determining whether a State or local government entity or a 501(c)(3) organization will be considered to have private business use of its tax-exempt bond-financed facilities due to its participation in an “accountable care organization” and guidance regarding certain management contracts that do not result in private business use.

IRS Notice 2014-67 on Private Business Use of Tax-Exempt Bond Financed Facilities can be seen here.



IRS LTR: Income Exempt as Exercise of Essential Government Function.

The IRS ruled that the income of an authority that was formed by a county and a state political subdivision and that receives revenues from the sale of electrical energy is derived from the exercise of an essential governmental function and that the authority is a constituted authority under reg. section 1.103-1(b).

Citations: LTR 201442037

Third Party Communication: None
Date of Communication: Not Applicable
Person To Contact: * * *, ID No. * * *
Telephone Number: * * *

Index Number: 115.00-00, 103.02-02
Release Date: 10/17/2014
Date: July 11, 2014

Refer Reply To: CC:FIP:05 – PLR-146092-13

LEGEND:

Act = * * *
Agreement = * * *
Authority = * * *
State = * * *
County = * * *
Agency = * * *
Project = * * *
Statutes = * * *
x = * * *

Dear * * *:

This letter is in response to your request for rulings that (1) the Authority’s income is derived from the exercise of an essential governmental function and will accrue to the State or a political subdivision thereof for purposes of § 115(1) of the Internal Revenue Code; and (2) the Authority is a constituted authority within the meaning of § 1.103-1(b) of the Income Tax Regulations.

FACTS AND REPRESENTATIONS

The County is a political subdivision of the State. The Agency was created by the Act as a body politic and corporate. The Agency is empowered by the Act to undertake any lawful act necessary to ensure sufficient water for the present and future beneficial use of the land and inhabitants within County. The Authority represents that Agency is a political subdivision of the State.

The Agency owns the Project, which consists of hydroelectric power plants, dams, tunnels, and public recreational facilities. The Agency operates the Project pursuant to a license issued by the Federal Energy Regulatory Commission (FERC).

Pursuant to the Statutes, the County and the Agency entered into the Agreement creating the Authority. The Agreement authorizes the Authority to exercise the powers of each of the County and the Agency. The purpose of the Authority is to provide financing for costs required by the FERC licensing process, to approve electrical energy and related services contracts, and to distribute revenues from those contracts. Among the powers the Authority can exercise in furtherance of these purposes are the powers to acquire, to lease, and to sell property. The Agreement and the Statutes authorize the Authority to issue bonds.

The County and the Agency are the sole members of the Authority. The Authority is governed by a x member board of directors. Half of those directors are members of the County’s board of directors, and half are members of the Agency’s board of directors.

The Agreement provides that the Authority receives all revenues from the sale of electrical energy produced by the Project. The Agreement also establishes priorities for the expenditure and distribution of those revenues. Under the Agreement, revenues must first be spent on basic operation and maintenance of the Project, compliance with contractual and regulatory requirements, maintenance of operating reserves, and repayment of debt. After those costs are paid, revenues must then be spent on additions and betterments, such as major improvements, emergency reserves, and sinking funds for replacements. Finally, any remaining revenues may be distributed equally to the County and the Agency. Upon dissolution, the Authority’s property will be divided between the County and the Agency.

LAW AND ANALYSIS

Income under § 115

Section 115(1) provides that gross income does not include income derived from any public utility or the exercise of any essential governmental function and accruing to a state or any political subdivision thereof.

In Revenue Ruling 77-261, 1977-2 C.B. 45, income from an investment fund, established by a state under a written declaration of trust for the temporary investment of cash balances of the state and its participating political subdivisions, was excludable from gross income for federal income tax purposes under § 115(1). The ruling explains that the statutory exclusion was intended to extend not to the income of a state or municipality resulting from its own participation in activities, but rather to the income of a corporation or other entity engaged in the operation of a public utility or the performance of some governmental function that accrues to either a state or municipality. The ruling points out that it may be assumed that Congress did not desire in any way to restrict a state’s participation in enterprises that might be useful in carrying out projects that are desirable from the standpoint of a state government and which are within the ambit of a sovereign properly to conduct.

In Revenue Ruling 90-74, 1990-2 C.B. 34, the income of an organization formed, funded, and operated by political subdivisions to pool various risks arising from their obligations regarding public liability, workers’ compensation, or employees’ health was excludable from gross income under § 115. In this ruling, private interests did not participate in the organization, nor did they benefit more than incidentally from the organization.

The Authority reviews and approves contracts for the sale of electrical energy generated by the Project, distributes revenues from those contracts, and provides financing for costs required by the FERC licensing process. Engaging in such activities on behalf of the County and the Agency constitutes the performance of essential governmental functions. See Rev. Rul. 90-74 and Rev. Rul. 77-261.

All of the Authority’s income accrues to the County and the Agency, which are political subdivisions of the State. Revenues exceeding amounts necessary for the operation, maintenance, and support of the Project and for additions and betterments to the Project are distributed to the County and the Agency. Upon the Authority’s dissolution, all of its property will be divided between the County and the Agency. No private interests participate in, or benefit more than incidentally from, the operation of the Authority, other than as providers of goods or services or purchasers of electrical energy. See Rev. Rul. 90-74. We conclude, therefore, that the Authority’s income is derived from the exercise of an essential governmental function and will accrue to the State or a political subdivision thereof for purposes of § 115(1).

Constituted Authority

Section 103(a) provides that gross income does not include interest on any state or local bond. Treas. Reg. § 1.103-1(a) provides in part that interest upon obligations of a state, territory, possession of the United States, the District of Columbia, or any political subdivision thereof is not includable in gross income. Treas. Reg. § 1.103-1(b) provides in part that obligations issued by or on behalf of any such governmental unit by a constituted authority empowered to issue such an obligation are the obligations of such a unit.

Revenue Ruling 57-187, 1957-1 C.B. 65, holds that bonds issued by an entity are considered issued on behalf of a political subdivision of the state under the following conditions: (1) the issuance of bonds is authorized by a specific state statute; (2) the bond issuance has a public purpose; (3) the governing body of the entity is controlled by the political subdivision; (4) the entity has the power to acquire, lease, and sell property and issue bonds in furtherance of its purposes; (5) earnings do not inure to the benefit of private persons; and (6) upon dissolution, title to all bond-financed property reverts to the political subdivision.

The Agreement and the Statutes authorize the Authority to issue bonds, and its issuances are for the public purpose of financing costs required by the FERC licensing process. The County and the Agency, which are political subdivisions, control the Authority’s governing board. The Agreement empowers the Authority to acquire, lease, and sell property and to issue bonds in furtherance of its public purposes. Earnings of the Authority inure solely to the benefit of the County and the Agency. Upon the Authority’s dissolution, all of its property reverts to the County and the Agency. We conclude, therefore, that the Authority is a constituted authority within the meaning of Treas. Reg. § 1.103-1(b).

CONCLUSION

Based on the information submitted and representations made, we conclude that (1) the Authority’s income is derived from the exercise of an essential governmental function and will accrue to the State or a political subdivision thereof for purposes of § 115(1); and (2) the Authority is a constituted authority within the meaning of Treas. Reg. § 1.103-1(b).

Except as expressly provided herein, no opinion is expressed or implied concerning the tax consequences of any aspect of any transaction or item discussed or referenced in this letter.

This ruling is directed only to the taxpayer requesting it. Section 6110(k)(3) of the Code provides that it may not be used or cited as precedent.

In accordance with the Power of Attorney on file with this office, a copy of this letter is being sent to your authorized representative.

The rulings contained in this letter are based upon information and representations submitted by the taxpayer and accompanied by a penalty of perjury statement executed by an appropriate party. While this office has not verified any of the material submitted in support of the request for rulings, it is subject to verification on examination.

Sincerely,

James A. Polfer
Branch Chief
(Financial Institutions & Products)



IRS LTR: Historic Preservation Charity's Agreement Won't Jeopardize Exemption.

The IRS ruled an historic preservation charity’s tax-exempt status won’t be adversely affected as a result of its preservation agreement with a section 501(c)(7) organization for the restoration of a building.

Citations: LTR 201442066

Contact Person: * * *
Identification Number: * * *
Telephone Number: * * *

UIL: 501.03-00
Release Date: 10/17/2014
Date: July 24, 2014

Employer Identification Number: * * *

LEGEND:

Club = * * *
Building = * * *

Dear * * *:

This is in response to your letter dated December 6, 2013 in which you requested certain rulings with respect to I.R.C. § 501(c)(3).

BACKGROUND

You have been recognized as a publicly supported charitable organization exempt under § 501(c)(3) of the Code and classified within the meaning of §§ 509(a)(1) and 170(b)(1)(A)(vi). Your Articles of Incorporation list your specific charitable and educational purposes as dedicated to preserving and memorializing the history and architecture of the city in which you are located; to research, restore and insure the preservation of buildings, land, homes or other articles which may relate to the history and architecture of the city.

The Club is a private social club that has been recognized as an organization exempt under § 501(c)(7). The Club currently owns and occupies the Building, which is located within the city, which has been recognized as a historic building, and which has been listed on the National Register of historic buildings and landmarks. The Building is over 150 years old and occupies one square block. You executed a written Preservation Agreement with the Club, under which you raised public funds to be used for the restoration of the Building in accordance with the Secretary of the interior’s Standards for the Treatment of Historic Properties and the Secretary of the Interior’s Guidelines for Preserving, Rehabilitating, Restoring and Restructuring Historic Buildings (hereinafter, “The Secretary of the Interior’s Standards and Guidelines.”). Any restoration or projects using your funds on the Building would require your prior approval before such projects could be started.

You represent that currently the interior of the Building, including the Designated Interior Historic Spaces, are primarily accessible only to Club members, with the Building primarily used by the Club. Scholars and other educational or architectural groups interested in the Building’s historic character have access to the interior portions of the Building only when sponsored by a Club member or holders of privilege cards (spouses and widows/widowers of deceased members). However, persons who attend seminars, meetings, receptions and cultural events in the Building, which are scheduled pursuant to approval by the Club, have access to the interior portions of the Building during these events.

You represent that the Preservation Agreement would increase public access to the Designated Interior Historic Spaces. Specifically, the Amended Agreement as modified by your submission provides for increased public access in the following manner:

The general public will be given the opportunity to tour the Designated Historic Spaces on a given day twice every month throughout the year

Organizations of architects, engineers, historians or others whose professional or academic pursuits are concerned with the creation, preservation or restoration of historic buildings may arrange to tour the Designated Historic Spaces at a time mutually agreed to by the Club and the organizations.

No member sponsorship will be required to participate in the tours described above. The Club will accept reservations for such tours by telephone or on the Internet.

In addition, the Club agrees to make virtual tours available through the Internet via video and photographs. These tours will consist of interactive tours, whereby viewers will have full control of the viewing of a majority of the rooms and the rooms will contain a voice over tour to accompany the images.

This availability of these viewings will be displayed prominently on your web site, along with the ability for the public to make reservations for tours either via your web site or via telephone. Also in your submission, you make it clear that there will be an unlimited number of tours for professional groups interested in historic preservation and restoration.

Finally, your Agreement with Club constitutes a Covenant on this property that will run with the land for any future purchasers of the Building. You have recorded this Covenant in the local property Register.

RULING REQUESTED

Your agreement to the terms of the Preservation Agreement, your performance of those terms, and the Club’s acceptance of contributions to be utilized to defray the costs of the preservation and restoration in a manner consistent with the Preservation Agreement will not adversely affect your tax exemption under § 501(c)(3).

LAW

I.R.C. § 501(c)(3) provides, in part, for the exemption from Federal income tax of organizations that are organized and operated exclusively for charitable purposes, provided no part of the net earnings of the organization inures to the benefit of any private individual or shareholder.

Treas. Reg. § 1.501(c)(3)-1(c)(1) provides, in part, that an organization will be regarded as operated exclusively for one or more exempt purposes only if it engages primarily in activities that accomplish one or more of such purposes described in § 501(c)(3), but will not be so regarded if more than an insubstantial part of its activities is not in furtherance of an exempt purpose.

Treas. Reg. § 1.501(c)(3)-1(d)(1)(ii) provides, in part, that an organization is not operated exclusively for exempt purposes “unless it serves a public, rather than a private, interest,” Thus, it is necessary for an organization to establish that “it is not operated for the benefit of private interests such as designated individuals, the creator or his family, shareholders of the organization, or persons controlled, directly or indirectly, by such private interests.”

Treas. Reg. § 1.501(c)(3)-1(d)(2) provides that the term charity includes, but is not limited to, “erection or maintenance of public buildings, monuments or works.”

Rev. Rul. 75-470, 1975-2 C.B. 207, describes a nonprofit organization that was formed to promote an appreciation of history through the acquisition, restoration, and preservation of buildings having special historical or architectural significance. After restoration was completed, the buildings were open to the general public for viewing. The organization was financed with admission fees to the restored buildings. The Service held that “[t]he organization is carrying on activities similar to those of a museum and is educational and charitable within the meaning of § 501(c)(3).”

Rev. Rul. 86-49, 1986-14 I.R.B. 7, describes an organization that was formed for the purpose of preserving the historical and/or architectural character of a community through the acquisition, restoration, and subsequent sale of historically and/or architecturally significant properties, subject to restrictive covenants. The Service held that the organization would qualify as an organization that is organized and operated exclusively for charitable or educational purposes under § 501(c)(3). The organization sold the properties to private parties in arms-length transactions subject to restrictive covenants designed to ensure public access to the properties; thereby, preserving the properties for the public’s benefit. Where the properties were not visible from the public right of way “the organization provides in the restrictive covenants that visual access to the property will be made available to the public on a regular basis and the terms of the restrictive covenants contain prescribed conditions for such access, under the requirements set forth in Treas. Reg. § 1.170A-14(d)(5)(iv).”

In Better Business Bureau v. United States, 326 U.S. 279, 66 S.Ct. 112, (1945), the Supreme Court ruled that an organization that is tax-exempt as an educational institution must be devoted to educational purposes exclusively, and the presence of a single noneducational purpose, if substantial in nature, will destroy the exemption regardless of the number or importance of truly educational purposes.

In Columbia Park and Recreation Association v. Commissioner, 88 T.C. 1 (1987), an organization that was organized to develop and operate utilities, systems, services and facilities for the common good and the social welfare of the homeowner’s association within the planned community, sought tax-exempt status under § 501(c)(3) of the Code. The Tax Court found that the majority of services and facilities the organization provided were only offered to association members, with only a small fraction of those services actually offered to the general public, with the public paying higher rates than association members for the same services. The Tax Court held that the organization was not organized or operated as charitable within the meaning of § 501(c)(3).

ANALYSIS

You intend to engage in the activities outlined in your Preservation Agreement and expend public funds for the repair, restoration and preservation of certain interior spaces of the Club’s Building that have been labeled as “Designated Historic Interior Spaces.” The issue therefore arises whether the public is given substantial access to the Designated Interior Historic Spaces to justify your expenditures of public monies to restore these spaces, which are currently owned and utilized by a private social club, so as not to violate your tax-exempt status under § 501(c)(3) of the Code. If the public does not have substantial access to these areas for viewing, then you would have expended public funds for the private benefit of the Club and its members, in violation of your tax-exempt status under § 501(c)(3).

Under § 501(c)(3), an organization that is exempt from Federal income tax must be both organized and operated exclusively for charitable or educational purposes, and must provide that no part of the net earnings of the organization inures to the benefit of any private shareholder or individual. The term charity includes, but is not limited to, “erection or maintenance of public buildings, monuments or works.” Section 1.501(c)(3)-1(d)(2).

An organization is not organized and operated exclusively for charity “unless it serves a public rather than a private interest” Section 1.501(c)(3)-1(d)(1)(ii). The presence of private benefit, if substantial in nature, will destroy the organization’s tax-exempt status regardless of whether the organization has other charitable purposes or activities; however, where private benefit is incidental to the accomplishment of an organization’s charitable or educational purposes, it will not prevent the organization from being described in § 501(c)(3) of the Code. See Section 1.501(c)(3)-1(c)(1); Better Business Bureau, 326 U.S. 279.

Several court cases and revenue rulings have focused on the issue of whether the public’s access to an organization’s facilities is substantial. In Columbia Park and Recreation, 88 T.C. 1, the Tax Court denied an organization’s 501(c)(3) status on the grounds that the public’s access to the organization’s facilities were not substantial. The Court found that only a small percentage of the organization’s total assets, and a rather limited percentage of the organization’s total budget, were actually spent on facilities and services that were open to the public, with the remainder of the organization’s assets and budget spent on facilities only open to the organization’s members. This is contrasted with Rev. Rul. 75-470, supra, in which the organization’s facilities were deemed to be substantially open to the public. In Rev. Rul. 75-470, an organization qualified for tax-exemption under § 501(c)(3) for its activities of acquiring and restoring buildings having historical and/or architectural significance. After restoration was completed, the buildings were open to the public for viewing. The Service found that the public’s access to the interiors of the buildings was substantial because the organization was operating the buildings as museum exhibits, which were open regularly for public viewing. Furthermore, in Rev. Rul. 86-49, supra, the Service held that an organization that was formed for the purpose of restoring historical and/or architecturally significant buildings and subsequently selling the same buildings was sufficient to qualify the organization under § 501(c)(3) because the buildings were sold with restrictive covenants that permitted substantial public access to the buildings.

In Rev. Rul. 86-49, supra, the charitable organization sold properties subject to restrictive covenants designed exclusively to preserve and to allow for public viewing of the historical and/or architecturally significant properties. Where the properties were not visible from the public right of way “the organization provides in the restrictive covenants that visual access to the property will be made available to the public on a regular basis and the terms of the restrictive covenants contain prescribed conditions for such access, under the requirements set forth in section 1.170A-14(d)(5)(iv).” Id. Specifically, § 1.170A-14(d)(5)(iv) provides the following:

Where the historic land area or certified historic structure which is the subject of the donation is not visible from a public way (e.g., the structure is hidden from view by a wall or shrubbery, the structure is too far from the public way, or interior characteristics and features of the structure are the subject of the easement), the terms of the easement must be such that the general public is given the opportunity on a regular basis to view the characteristics and features of the property which are preserved by the easement to the extent consistent with the nature and condition of the property.

Factors to be considered in determining the type and amount of public access required under paragraph (d)(5)(iv)(A) of this section include the historical significance of the donated property, the nature of the features that are the subject of the easement, the remoteness or accessibility of the site of the donated property, the possibility of physical hazards to the public visiting the property (for example, an unoccupied structure in a dilapidated condition), the extent to which public access would be an unreasonable intrusion on any privacy interests of individuals living on the property, the degree to which public access would impair the preservation interests which are the subject of the donation, and the availability of opportunities for the public to view the property by means other than visits to the site.

As a result of these restrictive covenants, the Service held in Rev. Rul. 86-46, supra, that the public was ensured substantial access to the historical and/or architecturally significant buildings, resulting in the organization’s purpose qualifying for tax-exemption under § 501(c)(3).

Rev. Rul. 86-49, supra, references § 1.170A-14(d)(5)(iv) to determine whether the public’s access to the property is substantial, given the nature and condition of the property. Although § 1.170A-14(d)(5)(iv) pertains to the issue of public benefit from the standpoint of whether the donor of a constructive easement in a historic and/or architecturally significant building has permitted substantial public access to the building to allow the donor a charitable deduction, these same factors, according to Rev. Rul. 86-49, are germane to the evaluation of public benefit from the standpoint of a tax-exempt organization that receives the donated conservation easement and is required to expend public funds to repair, restore, and maintain the historical and/or architecturally significant buildings comprising the conservation easement. In Rev. Rul. 86-49, the buildings were sold to private owners with restrictive covenants, consistent with § 1.170A-14(d)(5)(iv), to guarantee substantial public access. Absent these restrictive covenants guaranteeing public access, it would be difficult for the organization to claim that it was fulfilling a charitable purpose if public funds were used to restore historical and/or architecturally significant buildings primarily for the private benefit of the property owners.

Section 1.170A-14(d)(5)(iv) references Example (1) as an example of what facts constitute substantial public access to the exterior and interior facade of a building. Example (1) describes a donation by A of an easement to the exterior and interior of his Victorian period home that he and his family live in. The view of A’s home is obscured by a high stone wall. The easement provides that the house may be opened to the general public from 10:00 a.m. to 4:00 p.m. on one Sunday in May and one Sunday in November each year for house and garden tours. The donee organization is given the right to photograph the exterior and interior of the house for use in publications and to permit persons affiliated with educational organizations, professional architectural associations, and historical societies to make appointments to study the property. In this example, the regulations concluded that the two opportunities for public visits per year, when combined with both the ability of the general public to view the subject of the easement through photography and the opportunity for scholarly study of the property on a reasonable basis, coupled with the fact that the house is used as a family residence, enabled the donation to satisfy the requirement of public access.

The transaction you wish to engage in pursuant to the Preservation Agreement is similar to Example (1) in § 1.170A-14(d)(5)(iv). The subject of your Preservation Agreement is the “Designated Interior Historic Spaces” of the Building. As in Example (1), your Preservation Agreement provides that persons affiliated with educational organizations, professional architectural associations, and historical societies have unlimited opportunities to make appointments to study the Building’s interior. Furthermore, as in Example (1), your Preservation Agreement provides the public the opportunity to view images of the Building’s interior via a virtual tour available on the Club’s internet website. However, in several respects, your Preservation Agreement goes beyond the public access described in Example (1). Expanding on Example (1), which provided public access to the historic building twice a year as part of house and gardens tours, your Preservation Agreement provides the public with the opportunity to view the interior of the Building twice a month throughout the year. Furthermore, your Preservation Agreement establishes both a telephone and an internet reservation system, expediting the public’s ability to schedule visits to gain access to the interior of the Building. Furthermore, as in Rev. Rul. 86-49, supra, you also provide that the provision of funds by you is subject to a restrictive covenant that will be recorded in the local registry. As such, these conditions create sufficient public access to the Designated Interior Historic Spaces of the Building, with any private benefit to the Club and its members being incidental.

RULING

Your agreement to the terms of the Preservation Agreement, your performance of those terms, and the Club’s acceptance of contributions to be utilized to defray the costs of the preservation and restoration in a manner consistent with the Preservation Agreement will not adversely affect your tax exemption under § 501(c)(3).

This ruling will be made available for public inspection under section 6110 of the Code after certain deletions of identifying information are made. For details, see enclosed Notice 437, Notice of Intention to Disclose. A copy of this ruling with deletions that we intend to make available for public inspection is attached to Notice 437. If you disagree with our proposed deletions, you should follow the instructions in Notice 437.

This ruling is directed only to the organization that requested it. Section 6110(k)(3) of the Code provides that it may not be used or cited by others as precedent.

This ruling is based on the facts as they were presented and on the understanding that there will be no material changes in these facts. This ruling does not address the applicability of any section of the Code or regulations to the facts submitted other than with respect to the sections described. Specifically, this ruling does not reach any conclusion as to the qualifying distribution status of your proposed transfer under § 4942(g)(3). Because it could help resolve questions concerning your federal income tax status, this ruling should be kept in your permanent records.

If you have any questions about this ruling, please contact the person whose name and telephone number are shown in the heading of this letter.

In accordance with the Power of Attorney currently on file with the Internal Revenue Service, we are sending a copy of this letter to your authorized representative.

Sincerely,

Michael Seto
Manager, Exempt Organizations

Technical
Enclosure
Notice 437



IRS LTR: Nonprofit Corporation's Retirement Plan Is a Church Plan.

The IRS ruled that a retirement plan established by a tax-exempt nonprofit corporation that maintains a residential center for girls as a ministry of a religious order is a church plan under section 414(e).

Citations: LTR 201442072

U.I.L 414.08-00

Date: July 21, 2014

Refer Reply To: SE:T:EP:RA:T3

Attention: * * *

LEGEND:

Religious Order A = * * *
Leader B = * * *
Church C = * * *
Board D = * * *
Entity E = * * *
State F = * * *
Plan X = * * *
Directory Z = * * *

Dear * * *:

This is in response to your request dated September 30, 2013, as supplemented by correspondence dated February 4, 2014, April 14, 2014, and May 7, 2014, submitted on behalf of Entity E by its authorized representative, concerning whether Plan X qualifies as a church plan under section 414(e) of the Internal Revenue Code (Code).

The following facts and representations have been submitted under penalty of perjury in support of the ruling requested:

Entity E is a non-profit corporation organized under the laws of State F. Entity E is a ministry of Religious Order A and maintains a residential center for girls. Religious Order A is a pontifical/apostolic order directly under the jurisdiction of the highest levels of authority of Church C. Religious Order A’s constitution is filed with the highest level of authority of Church C, and the organization serves in a diocese at the pleasure of the local bishop of Church C. The primary apostolate of Religious Order A is to work with women in need. As such, its ministries include providing shelter to victims of domestic abuse; counseling for troubled teenaged girls; day care for children and adults; nursing and rehabilitative care for the ill, elderly, and people with AIDS. It also provides teaching and religious education in English and Spanish-speaking parishes.

Entity E is exempt from federal income tax under section 501(a) of the Code as an organization described in section 501(c)(3). Entity E is listed in Directory Z, the directory for Church C.

Entity E was founded by Religious Order A. Under its Articles of Incorporation, the sole member of Entity E is Leader B, a top official of Religious Order A. Entity E has a two-tier management structure. It’s board of directors is elected by Religious Order A, and consists only of members of Religious Order A. Entity E also has a local board of trustees which oversees Entity E’s daily operations. Entity E’s board of trustees, Board D, is either appointed or approved by Leader B, with any vacancies filled by the board itself from a pool of potential trustees approved by Leader B. Leader B also has the authority to remove members of Board D. Leader B has the authority to adopt the bylaws of Entity E, and to establish and change the purposes, mission statement and other values statements of Entity E. Leader B also has the authority to approve various types of corporate actions, including the budget, expenditures over a certain amount, and the purchase, sale, lease, or encumbrance of real estate.

Effective November 1, 1987, Board D of Entity E established Plan X, a retirement plan. Plan X has been amended and restated from time to time thereafter. All benefit accruals under the Plan were frozen effective February 1, 2005. Entity E is the only participating employer and it is the administrator of Plan X. You represented that Entity E currently funds Plan X but Religious Order A may also fund if necessary.

You represented that no election has been made at any time under Section 410(d) of the Code. You also represented that none of the employees of Entity E are or can be considered employed in connection with one or more unrelated trades or businesses within the meaning of Section 513 of the Code.

On April 2, 2014, Board D established a Pension Committee to administer Plan X and to serve as trustee of the plan. The Pension Committee is appointed by Board D, and consists primarily of members of Religious Order A. The Pension Committee’s principal purpose is the administration of Plan X.

In accordance with Revenue Procedure 2011-44, 2011-39 I.R.B. 446, notice to Plan participants and other interested persons with reference to Plan X was provided on July 26, 2013. This notice explained to participants of Plan X and other interested persons the consequences of church plan status.

Based on the above facts and representations, you request a ruling that Plan X qualifies as a church plan under section 414(e) of the Code.

Section 414(e)(1) of the Code generally defines a church plan as a plan established and maintained for its employees (or their beneficiaries) by a church or a convention or association of churches which is exempt from taxation under section 501 of the Code.

Section 414(e)(2) of the Code provides, in part, that the term “church plan” does not include a plan that is established and maintained primarily for the benefit of employees (or their beneficiaries) of such church or convention or association of churches who are employed in connection with one or more unrelated trades or businesses (within the meaning of section 513); or if less than substantially all of the individuals included in the plan are individuals described in section 414(e)(1) or section 414(e)(3)(B) (or their beneficiaries).

Section 414(e)(3)(A) of the Code provides that a plan established and maintained for its employees (or their beneficiaries) by a church or a convention or association of churches includes a plan maintained by an organization, whether a civil law corporation or otherwise, the principal purpose or function of which is the administration or funding of a plan or program for the provision of retirement benefits or welfare benefits, or both, for the employees of a church or a convention or association churches, if such organization is controlled by or associated with a church or a convention or association of churches.

Section 414(e)(3)(B) of the Code generally defines “employee” of a church or a convention or association of churches to include a duly ordained, commissioned, or licensed minister of a church in the exercise of his or her ministry, regardless of the source of his or her compensation, and an employee of an organization, whether a civil law corporation or otherwise, which is exempt from tax under section 501, and which is controlled by or associated with a church or a convention or association of churches.

Section 414(e)(3)(C) of the Code provides that a church or a convention or association of churches which is exempt from tax under section 501 shall be deemed the employer of any individual included as an employee under subparagraph (B).

Section 414(e)(3)(D) of the Code provides that an organization, whether a civil law corporation or otherwise, is associated with a church or a convention or association of churches if it shares common religious bonds and convictions with that church or convention or association of churches.

Section 414(e)(4)(A) of the Code provides that if a plan, intended to be a church plan, fails to meet one or more of the church plan requirements and corrects its failure within the correction period, then that plan shall be deemed to meet the requirements of this subsection for the year in which the correction was made and for all prior years. Section 414(e)(4(C)(i) of the Code provides, in pertinent part, that the term “correction period” means the period ending 270 days after the date of mailing by the Secretary of a notice of default with respect to the plan’s failure to meet one or more of the church plan requirements.

Revenue Procedure 2011-44, 2011-39 I.R.S. 446, supplements the procedures for requesting a letter ruling under section 414(e) of the Code relating to church plans. The revenue procedure requires that plan participants and other interested persons receive a notice in connection with a letter ruling request under section 414(e) for a qualified plan, requires that a copy of the notice be submitted to the Internal Revenue Service (IRS) as part of the ruling request, and provides procedures for the IRS to receive and consider comments relating to the ruling request from interested persons.

In order for an organization that is not itself a church or convention or association of churches to have a qualified church plan, it must establish that its employees are employees or deemed employees of a church or convention or association of churches under section 414(e)(3)(B) of the Code by virtue of the organization’s control by or association with the church or convention or association of churches. Employees of any organization maintaining a plan are considered to be church employees if the organization: 1) is exempt from tax under section 501 of the Code; 2) is controlled by or associated with a church or convention or association of churches; and 3) provides for administration or funding (or both) of the plan by an organization described in section 414(e)(3)(A) of the Code. To be described in section 414(e)(3)(A) of the Code, an organization must have as its principal purpose the administration or funding of the plan and must also be controlled by or associated with a church or convention or association of churches.

Entity E is a section 501(c)(3) organization established by Religious Order A. Religious Order A is a religious order directly under the jurisdiction of the highest level of authority of Church C. Religious Order A’s constitution is filed with the highest levels of authority of Church C, and it serves in a diocese at the pleasure of the local bishop of Church C.

The leader of Religious Order A (Leader B) is the sole member of Entity E. The board of directors of Entity E is elected by Religious Order A, and the members of such board are all members of Religious Order A. Leader B retains control of Entity E’s purposes and mission statement. The members of Board D, which oversees Entity E’s daily operations, are either appointed or approved by Leader B, and Leader B must approve certain actions by Entity E, including its budget and expenditures over a certain amount. Entity E is a sponsored ministry of Religious Order A, and is committed to accepting and implementing the teachings of Church C. Entity E’s staff and board members must conform to Church C’s standards of ethics. Entity E is listed in Directory Z, the directory of Church C.

We therefore conclude that Entity E shares common religious bonds and convictions with Church C, and is thus associated with Church C. Entity E’s employees are thus deemed to be employees of Church C for purposes of section 414(e).

Plan X is administered by a Pension Committee, which consists primarily of members of Religious Order A. The Pension Committee’s principal purpose and function is the administration of Plan X. The members of the Pension Committee are appointed by Board D, whose members are either appointed or approved by Leader B, the head of Religious Order A. Religious Order A is a pontifical/apostolic order directly under the jurisdiction of the highest levels of authority of Church C, and which serves in the relevant diocese at the pleasure of the local bishop of Church C. Board D reports annually to Leader B and Leader B has the power to remove the members of Board D.

We therefore conclude that the Pension Committee is an organization associated with Church C, whose principal purpose or function is the administration of Plan X for the provision of retirement benefits for the deemed employees of a church or convention or association of churches. The Pension Committee thus constitutes an organization described in section 414(e)(3)(A) of the Code.

The Pension Committee was formally established on April 2, 2014. As provided under section 414(e)(4)(A) of the Code, where a plan fails to meet one or more of the church plan requirements and corrects its failure within the correction period, then that plan shall be deemed to meet the requirements of section 414(e) of the Code for the year in which the correction is made and for all prior years. The formal establishment of the Pension Committee to administer the Plan on April 2, 2014 was within the correction period of Plan X.

Therefore, with respect to your ruling request, we conclude that Plan X, is maintained by an Entity described in section 414(e)(3)(A) for the deemed employees of a church or convention or association of churches. Plan X thus qualifies as a church plan pursuant to section 414(e) of the Code.

No opinion is expressed as to the tax treatment of the transaction described herein under the provisions of any other section of either the Code or regulations which may he applicable thereto.

This letter is directed only to the taxpayer who requested it. Section 6110(k)(3) of the Code provides that it may not be used or cited as precedent.

Pursuant to a power of attorney on file with this office, a copy of this letter ruling is being sent to your authorized representative. If you have any questions regarding this letter, please contact * * *, SE:T:EP:RA:T3, at * * *.

Sincerely yours,

Laura B. Warshawsky, Manager
Employee Plans Technical Group 3

Enclosures:
Deleted copy of ruling letter
Notice of Intention to Disclose



Proposed Regs Remove 36-Month Nonpayment Testing Period Rule.

The IRS has published proposed regulations (REG-136676-13) removing a rule under section 6050P that provides that the 36-month nonpayment testing period is an identifiable event requiring information reporting for discharge of indebtedness by some financial institutions and governmental entities.

Section 6050P generally requires an applicable entity to issue an information return if $600 or more of indebtedness is discharged during a calendar year. The applicable regulation lists eight identifiable events that trigger a reporting obligation, including the expiration of a 36-month nonpayment testing period. Under the 36-month rule, a rebuttable presumption arises that an identifiable event has occurred if a creditor does not receive a payment within the 36-month testing period.

Treasury and the IRS have expressed concerns that the rule creates confusion for taxpayers and doesn’t increase tax compliance by debtors or give the IRS valuable third-party information that may be used to ensure taxpayer compliance. In November 2012 the IRS requested comments (Notice 2012-65) on whether to remove or modify the 36-month rule as an identifiable event for purposes of information reporting under section 6050P. All comments suggested removing or revising the 36-month rule. Several commentators expressed concern that the expiration of a 36-month nonpayment testing period doesn’t necessarily coincide with an actual discharge of the indebtedness, which may confuse the debtor and, in some cases, create uncertainty for the creditor regarding whether it may lawfully continue to pursue the debt. Other commentators noted that the IRS’s ability to collect tax on discharge of indebtedness income may be undermined if the actual discharge occurs in a different year from the year of information reporting.

In the preamble to the proposed regs, Treasury and the IRS said they agree that information reporting under section 6050P should generally coincide with the actual discharge of a debt and described the potential problems with reporting under the 36-month rule. Accordingly, the proposed regs remove the 36-month rule. The IRS declined to adopt suggested changes to the rule, explaining that they don’t alleviate problems caused by the rule to debtors, creditors, and the IRS. The rule is proposed to be removed when final regs are published in the Federal Register. Comments and public hearing requests are due by January 13, 2015.

*********

Removal of the 36-month Non-payment Testing Period Rule

[4830-01-p]

DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 1

RIN 1545-BM01

AGENCY: Internal Revenue Service (IRS), Treasury.
ACTION: Notice of proposed rulemaking.

SUMMARY: This document contains proposed regulations that will remove a rule that a deemed discharge of indebtedness for which a Form 1099-C, “Cancellation of Debt,” must be filed occurs at the expiration of a 36-month non-payment testing period. The Department of the Treasury and the IRS are concerned that the rule creates confusion for taxpayers and does not increase tax compliance by debtors or provide the IRS with valuable third-party information that may be used to ensure taxpayer compliance. The proposed regulations will affect certain financial institutions and governmental entities.

DATES: Comments and requests for a public hearing must be received by January 13, 2015. ADDRESSES: Send submissions to: CC:PA:LPD:PR (REG-136676-13), room 5203, Internal Revenue Service, P.O. Box 7604, Ben Franklin Station, Washington, DC 20044. Submissions may be hand-delivered Monday through Friday between the hours of 8:00 a.m. and 4:00 p.m. to CC:PA:LPD:PR (REG-136676-13), Courier’s Desk, Internal Revenue Service, 1111 Constitution Avenue, NW., Washington, DC 20224. Alternatively, taxpayers may submit comments electronically via the Federal eRulemaking Portal at www.regulations.gov (IRS REG-136676-13).

FOR FURTHER INFORMATION CONTACT: Concerning the proposed regulations, Hollie Marx, (202) 317-6844; concerning the submission of comments and requests for a public hearing, Oluwafunmilayo Taylor, (202) 317-6901 (not toll-free calls).

SUPPLEMENTARY INFORMATION:

Background

This document contains proposed regulations to amend certain Income Tax Regulations (26 CFR Part 1) issued under section 6050P of the Internal Revenue Code (Code), which provide that the 36-month non-payment testing period is an identifiable event triggering an information reporting obligation for discharge of indebtedness by certain entities. The proposed regulations would remove the 36-month non-payment testing period as an identifiable event.

Statutory Provisions

Section 61(a)(12) provides that income from discharge of indebtedness is includible in gross income. Section 6050P was added to the Code by section 13252 of the Omnibus Budget Reconciliation Act of 1993, Public Law 103-66 (107 Stat. 312, 531-532 (1993)). Section 6050P was enacted in part “to encourage taxpayer compliance with respect to discharged indebtedness” and to “enhance the ability of the IRS to enforce the discharge of indebtedness rules.” H.R. Rep. No. 103-111, at 758 (1993). As originally enacted, section 6050P generally required applicable financial entities (generally financial institutions, credit unions, and Federal executive agencies) that discharge (in whole or in part) indebtedness of $600 or more during a calendar year to file information returns with the IRS and to furnish information statements to the persons whose debt is discharged. In addition to other information prescribed by regulations, an applicable financial entity is required to include on the information return the debtor’s name, taxpayer identification number, the date of the discharge, and the amount discharged. See 26 U.S.C. 6050P(a) (1994).

The Debt Collection Improvement Act of 1996 (1996 Act), Public Law 104-134 (110 Stat. 1321, 1321-368 through 1321-369 (1996)) was enacted on April 26, 1996. Section 31001(m)(2)(B)(i) and (ii) of the 1996 Act amended section 6050P to expand the reporting requirement to cover “applicable entities,” which includes any executive, judicial, or legislative agency, not just federal executive agencies, and any previously covered applicable financial entity. Effective for discharges of indebtedness occurring after December 31, 1999, section 533(a) of the Ticket to Work and Work Incentives Improvement Act of 1999 (1999 Act), Public Law 106-170 (113 Stat. 1860, 1931 (1999)), added subparagraph (c)(2)(D) to section 6050P, to further expand entities covered by the reporting requirements to include any organization the “significant trade or business of which is the lending of money.”

On April 4, 2000, the IRS released Notice 2000-22 (2000-1 CB 902) to provide penalty relief to organizations that were newly made subject to section 6050P by the 1999 Act (organizations with a significant trade or business of lending money and agencies other than Federal executive agencies). The relief applied to penalties for failure to file information returns or furnish payee statements for discharges of indebtedness occurring before January 1, 2001. On December 26, 2000, the IRS released Notice 2001-8 (2001-1 CB 374) to extend the penalty relief for organizations described in Notice 2000-22 for discharges of indebtedness that occurred prior to the first calendar year beginning at least two months after the date that appropriate guidance is issued.

Regulatory History

On December 27, 1993, temporary regulations under section 6050P relating to the reporting of discharge of indebtedness were published in the Federal Register (TD 8506) (58 FR 68301). The temporary regulations provided that an applicable financial entity must report a discharge of indebtedness upon the occurrence of an identifiable event that, considering all the facts and circumstances, indicated the debt would never have to be repaid. The temporary regulations provided a non-exhaustive list of three identifiable events that would give rise to the reporting requirement under section 6050P: (1) a discharge of indebtedness under title 11 of the United States Code (Bankruptcy Code); (2) an agreement between the applicable financial entity and the debtor to discharge the indebtedness, provided that the last event to effectuate the agreement has occurred; and (3) a cancellation or extinguishment of the indebtedness by operation of law. These regulations were effective for discharges of indebtedness occurring after December 31, 1993.

A concurrently published notice of proposed rulemaking (IA-63-93) (58 FR 68337) proposed to adopt those and other rules in the temporary regulations. Written comments were received in response to the notice of proposed rulemaking, and testimony was given at a public hearing held on March 30, 1994. In response to the comments and testimony, the IRS provided, in Notice 94-73 (1994-2 CB 553), interim relief from penalties for failure to comply with certain of the reporting requirements of the temporary regulations for discharges of indebtedness occurring before the later of January 1, 1995, or the effective date of final regulations under section 6050P.

On January 4, 1996, prior to the amendments made by the 1996 Act, final regulations relating to the information reporting requirements of applicable financial entities for discharges of indebtedness were published in the Federal Register (TD 8654) (61 FR 262) (1996 final regulations). The final regulations were generally effective for discharges of indebtedness occurring after December 21, 1996, although applicable financial entities at their discretion could apply the final regulations to any discharge of indebtedness occurring on or after January 1, 1996, and before December 22, 1996. Further, the preamble to these regulations provided that the temporary regulations and the interim relief provided in Notice 94-73 remained in effect until December 21, 1996. Finally, the 36-month non-payment testing period identifiable event would not occur prior to December 31, 1997. See § 1.6050P-1(b)(2)(iv)(C) of the 1996 final regulations.

In response to objections by commenters, the 1996 final regulations did not adopt the facts and circumstances test to determine whether a discharge of indebtedness had occurred and information reporting was required. Instead, the 1996 final regulations provided that a debt is deemed to be discharged for information reporting purposes only upon the occurrence of an identifiable event specified in an exhaustive list under § 1.6050P-1(b)(2), whether or not an actual discharge has occurred on or before the date of the identifiable event. See § 1.6050P-1(a)(1).

Section 1.6050P-1(b)(2) of the 1996 final regulations listed eight identifiable events that trigger information reporting obligations on the part of an applicable financial entity: (1) a discharge of indebtedness under the Bankrutpcy Code; (2) a cancellation or extinguishment of an indebtedness that renders the debt unenforceable in a receivership, foreclosure, or similar proceeding in a federal or state court, as described in section 368(a)(3)(A)(ii) (other than a discharge under the Bankruptcy Code); (3) a cancellation or extinguishment of an indebtedness upon the expiration of the statute of limitations for collection (but only if, and only when, the debtor’s statute of limitations affirmative defense has been upheld in a final judgment or decision in a judicial proceeding, and the period for appealing it has expired) or upon the expiration of a statutory period for filing a claim or commencing a deficiency judgment proceeding; (4) a cancellation or extinguishment of an indebtedness pursuant to an election of foreclosure remedies by a creditor that statutorily extinguishes or bars the creditor’s right to pursue collection of the indebtedness; (5) a cancellation or extinguishment of an indebtedness that renders a debt unenforceable pursuant to a probate or similar proceeding; (6) a discharge of indebtedness pursuant to an agreement between an applicable entity and a debtor to discharge indebtedness at less than full consideration; (7) a discharge of indebtedness pursuant to a decision by the creditor, or the application of a defined policy of the creditor, to discontinue collection activity and discharge debt; (8) the expiration of a 36-month non-payment testing period.

The first seven identifiable events are specific occurrences that typically result from an actual discharge of indebtedness. The eighth identifiable event, the expiration of a 36-month non-payment testing period, may not result from an actual discharge of indebtedness. The 36-month non-payment testing period was added to the final regulations in 1996 as an additional identifiable event in response to concerns of creditors that the facts and circumstances approach taken in the temporary and proposed regulations was unclear regarding the effect of continuing collection activity. Creditors proposed (among other things) that the final regulations require reporting after a fixed time period during which there had been no collection efforts.

Section 1.6050P-1(b)(2)(iv) of the 1996 regulations sets forth the 36-month non-payment testing period rule (the 36-month rule). Under that rule, a rebuttable presumption arises that an identifiable event has occurred if a creditor does not receive a payment within a 36-month testing period. The creditor may rebut the presumption if the creditor engaged in significant bona fide collection activity at any time within the 12-month period ending at the close of the calendar year or if the facts and circumstances existing as of January 31 of the calendar year following the expiration of the non-payment testing period indicate that the indebtedness has not been discharged. A creditor’s decision not to rebut the presumption that an identifiable event has occurred pursuant to the 36-month rule is not an indication that it has discharged the debt. Concluding that the debts have, in fact, been discharged, some taxpayers may include in income the amounts reported on Forms 1099-C even though creditors may continue to attempt to collect the debt after issuing a Form 1099-C as required by the 36-month rule. See § 1.6050P-1(a)(1) and (b)(iv).

On October 25, 2004, final regulations reflecting the amendments to section 6050P(c) were published in the Federal Register (TD 9160) (69 FR 62181). These regulations describe circumstances in which an organization has a significant trade or business of lending money and provide three safe harbors under which organizations will not be considered to have a significant trade or business of lending money.

On November 10, 2008, final and temporary regulations were published in the Federal Register (TD 9430) (73 FR 66539) (2008 regulations) to amend the regulations under section 6050P to exempt from the 36-month rule entities that were not within the scope of section 6050P as originally enacted (organizations with a significant trade or business of lending money and agencies other than Federal executive agencies). The changes made by the 2008 regulations reduced the burden on these entities and protected debtors from receiving information returns that reported discharges of indebtedness from these entities before a discharge had occurred. The 2008 regulations also added § 1.6050P-1(b)(2)(v), which provided that, for organizations with a significant trade or business of lending money and agencies other than federal executive agencies that were required to file information returns pursuant to the 36-month rule in a tax year prior to 2008 and failed to file them, the date of discharge would be the first identifiable event, if any, described in § 1.6050P-1(b)(2)(i)(A) through (G) that occurs after 2007. On September 17, 2009, final regulations were published in the Federal Register (TD 9461) (74 FR 47728-01) adopting the 2008 regulations without change.

Notice 2012-65

Even after the amendments to the regulations in 2008 and 2009, concerns continued to arise about the 36-month rule, and taxpayers remained confused regarding whether the receipt of a Form 1099-C represents cancellation of debt that must be included in gross income. To address those concerns, in Notice 2012-65 (2012-52 IRB 773 (Dec. 27, 2012)), the Treasury Department and the IRS requested comments from the public regarding whether to remove or modify the 36-month rule as an identifiable event for purposes of information reporting under section 6050P. Ten comments were received, all recommending removal or revision of the 36-month rule. Several commenters generally expressed concerns that the expiration of a 36-month non-payment testing period does not necessarily coincide with an actual discharge of the indebtedness, leading to confusion on the part of the debtor and, in some instances, uncertainty on the part of the creditor regarding whether it may lawfully continue to pursue the debt. Additionally, commenters noted that the IRS’s ability to collect tax on discharge of indebtedness income may be undermined if the actual discharge occurs in a different year than the year of information reporting.

Explanation of Provisions

The Treasury Department and the IRS agree that information reporting under section 6050P should generally coincide with the actual discharge of a debt. Because reporting under the 36-month rule may not reflect a discharge of indebtedness, a debtor may conclude that the debtor has taxable income even though the creditor has not discharged the debt and continues to pursue collection. Issuing a Form 1099-C before a debt has been discharged may also cause the IRS to initiate compliance actions even though a discharge has not occurred. Additionally, § 1.6050P-1(e)(9) provides that no additional reporting is required if a subsequent identifiable event occurs. Therefore, in cases in which the Form 1099-C is issued because of the 36-month rule but before the debt is discharged, the IRS does not subsequently receive third-party reporting when the debt is discharged. The IRS’s ability to enforce collection of tax for discharge of indebtedness income may, thus, be diminished when the information reporting does not reflect an actual cancellation of indebtedness. After considering the public comments and the effects on tax administration, the Treasury Department and the IRS propose to remove the 36-month rule.

In addition to the comments recommending removal of the 36-month rule, commenters made other suggestions to change this rule, which were not adopted. One commenter suggested that the rule should be revised to require information reporting after 24 months of non-payment, without regard to the creditor’s collection efforts. The commenter suggested that most debts are not collectible after 24 months of non-payment and that requiring information reporting after 24 months would allow the IRS time to assess. This commenter also suggested that the Form 1099-C should be revised to clarify that the issuance of a Form 1099-C does not mean that the debt is discharged, and that creditors should be required to issue corrected Forms 1099-C if they receive payments after the first Form 1099-C is issued.

The revisions proposed by the commenter do not alleviate the problems to debtors, creditors, and the IRS caused by the 36-month rule. There is no indication that merely shortening the time before a Form 1099-C is required to be issued more closely comports with the actual discharge of indebtedness. For example, even if the debt has actually been discharged, the amount reported on the Form 1099-C may not be the same as the amount that the taxpayer is required to report as income because, for instance, the taxpayer may be entitled to claim an exclusion or an exemption. In addition, the Instructions for Debtor on Form 1099-C already explain that the issuance of a Form 1099-C does not necessarily mean that the debtor must include the cancellation of debt in gross income. As a result, such revisions would fail to address the fact that issuance of a Form 1099-C pursuant to the 36-month rule does not necessarily coincide with a discharge of indebtedness. Also, the commenter’s suggestion that creditors be required to issue a corrected Form 1099-C if they later receive a payment from the debtor would not reduce the debtor’s confusion about what receipt of a Form 1099-C issued pursuant to the 36-month rule means. The issuance of a corrected Form 1099-C after the debtor has already reported discharge of indebtedness income with respect to the discharge that is reported on the corrected Form 1099-C could require the debtor to file amended returns to report the reduced amount of cancellation indebtedness and the debtor may be entitled to a refund. Issuance of a corrected Form 1099-C would increase, not decrease, the debtor’s confusion regarding how to proceed.

One commenter suggested that the rule should be retained because it eliminates the possibility of a “permanent deferral” of information reporting of a discharged debt. This commenter noted two recent Tax Court cases, Kleber v. Commissioner, T.C. Memo. 2011-233, and Stewart v. Commissioner, T.C. Sum. Op. 2012-46, in which the court used the 36-month rule to determine the year in which a debt was discharged. In both cases, the court determined that the statute of limitations for assessment had expired before a Form 1099-C was issued. The commenter stated that confusion could result if the 36-month rule is eliminated for information reporting purposes, but the court continues to use it to determine whether there has been an actual discharge. The commenter viewed this as a reason to retain the rule in a modified form. The commenter suggested that the Treasury Department and the IRS modify the 36-month rule and § 1.6050P-1(b)(2)(i)(G) by: (1) treating a creditor’s decision to discontinue collection activities as an identifiable event, whether or not that decision coincides with an actual discharge; (2) placing a 36-month time limit on a creditor’s defined policy for discharging a debt under § 1.6050P-1(b)(2)(i)(G); (3) prohibiting creditors from issuing Forms 1099-C while collection activities are ongoing or while the creditor is considering selling the debt; and (4) requiring creditors to issue corrected Forms 1099-C if they engage in subsequent collection activities or receive a payment on the debt.

Because the revisions suggested by this commenter would not require information reporting only upon an actual discharge of indebtedness, the revisions would not eliminate the problems associated with issuance of Forms 1099-C under the 36-month rule. Adopting these changes could increase, not decrease, confusion, because they would modify another identifiable event, § 1.6050P-1(b)(2)(i)(G), to require that a debtor’s policy for discharging debt incorporate a 36-month discharge rule. Additionally, as explained in this preamble, requiring creditors to issue corrected Forms 1099-C would neither improve tax compliance nor reduce debtors’ confusion. Eliminating the 36-month rule for information reporting purposes, moreover, is likely to lead courts to cease using it as an identifiable event for purposes of determining when an actual discharge occurs, thereby eliminating the issue of the IRS being precluded from assessing tax on discharge of indebtedness before the information return has been issued.

Effective Date

Sections 1.6050P-1(b)(2)(i)(H), 1.6050P-1(b)(2)(iv), and 1.6050P-1(b)(2)(v) would be removed on the date these regulations are published as final regulations in the Federal Register. Conforming amendments to § 1.6050P-1(h)(1) necessary as a result of the removal of the above-referenced sections would be effective on the same date.

Special Analyses

It has been determined that this notice of proposed rulemaking is not a significant regulatory action as defined in Executive Order 12866, as supplemented by Executive Order 13563. Therefore, a regulatory assessment is not required. It also has been determined that section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5) does not apply to these regulations. Because the regulations do not impose a collection of information on small entities, the Regulatory Flexibility Act (5 U.S.C. chapter 6) does not apply. Pursuant to section 7805(f) of the Code, this notice of proposed rulemaking has been submitted to the Chief Counsel for Advocacy of the Small Business Administration for comment on its impact on small business.

Comments and Requests for a Public Hearing

Before these proposed regulations are adopted as final regulations, consideration will be given to any comments that are submitted timely to the IRS as prescribed in this preamble under the “Addresses” heading. The Treasury Department and the IRS request comments on all aspects of the proposed rules. All comments will be available at www.regulations.gov or upon request.

A public hearing will be scheduled if requested by any person who timely submits comments. If a public hearing is scheduled, notice of the date, time, and place for the hearing will be published in the Federal Register.

Drafting Information

The principal author of these proposed regulations is Hollie Marx of the Office of Associate Chief Counsel (Procedure and Administration).

List of Subjects in 26 CFR Part 1

Income taxes, Reporting and recordkeeping requirements.

Proposed Amendments to the Regulations

Accordingly, 26 CFR part 1 is proposed to be amended as follows:

PART 1 — INCOME TAXES

Paragraph 1. The authority citation for part 1 continues to read in part as follows:

Authority: 26 U.S.C. 7805 * * *

Par. 2. Section 1.6050P-1 is amended by:

a. Removing paragraphs (b)(2)(i)(H), (b)(2)(iv), and (b)(2)(v).

b. Revising paragraph (h).

The revision reads as follows:

§ 1.6050P-1 Information reporting for discharge of indebtedness by certain entities.

* * * * *

(h) Effective/applicability date. The rules in this section apply to discharges of indebtedness after December 21, 1996, except paragraphs (e)(1) and (3) of this section, which apply to discharges of indebtedness after December 31, 1994, and except paragraph (e)(5) of this section, which applies to discharges of indebtedness occurring after December 31, 2004.

John Dalrymple,
Deputy Commissioner for Services
and Enforcement.

[FR Doc. 2014-24392 Filed 10/14/2014 at 8:45 am; Publication Date: 10/15/2014]



IRS LTR: Plan Is a Qualified Governmental Excess Benefit Arrangement.

The IRS ruled that an excess benefit plan is a qualified governmental excess benefit arrangement under section 415(m) and the benefits payable under the plan will be includable in gross income for the tax year in which they are paid or otherwise made available to a participant or participant’s beneficiary in accordance with the terms of the plan.

Citations: LTR 201441034

Uniform Issue List: 415.00-00
Date: July 17, 2014

Refer Reply To: SE:T:EP:RA:T3

Attention: * * *

LEGEND:

System X = * * *
State S = * * *
Plan X = * * *
Excess Plan X = * * *
Board B = * * *

Dear * * *:

This is in response to correspondence dated September 24, 2009, as supplemented by correspondence dated September 10, 2010, January 3, 2011, February 27, 2013, and June 24, 2014, submitted on behalf of System X by its authorized representatives, in which a request for a letter ruling was submitted with respect to the applicability of section 415(m) of the Internal Revenue Code (Code) to an excess benefit plan (Excess Plan X) and the tax consequences related thereto.

The following facts and representations have been submitted under penalty of perjury in support of the rulings requested.

State S has established Plan X on behalf of its eligible employees, who are members of the General Assembly of State S. Your authorized representatives have represented that Plan X is a defined benefit plan and a governmental plan as described in section 414(d) of the Code, and is intended to meet the qualification requirements of section 401(a) of the Code.

System X, an instrumentality of State S, is the administrator of Plan X. Board B, a board comprised of officials of State S, is the Trustee of Plan X.

Contributions to Plan X are mandatory for participating employees and are equal to a fixed percentage of each participant’s compensation. Plan X allows participants to make pre-tax elective contributions to Plan X to buy years of service credit in Plan X for eligible prior service in other specified public employment. These purchases of years of service credit may also be made by after-tax contributions, rollovers, or trustee-to-trustee transfers.

State S statutes provide for the establishment of qualified excess benefit arrangements within the meaning of section 415(m) of the Code. Pursuant to this authority, on September 23, 2009, Board B adopted and is planning to implement Excess Plan X for the benefit of employees of State S who participate in Plan X. Excess Plan X will operate in accordance with section 415(m) of the Code as a qualified governmental excess benefit arrangement. Employees who participate in Plan X will become eligible for benefits from Excess Plan X if their benefits calculated under the benefit formula are limited by section 415(b) of the Code as that section applies to government plans. Participation in Excess Plan X is mandatory and automatic for all participants in Plan X whose retirement benefits from Plan X are limited by section 415 of the Code.

Section 4.01 of Excess Plan X provides that a participant will receive a benefit equal to the amount of retirement income that would have been payable to, or with respect to, a Participant that could not be paid by Plan X because of the application of the limitations on his retirement income under section 415(b) of the Code. An excess benefit under Excess Plan X will be paid only if and to the extent the participant is receiving retirement benefits from Plan X. Section 4.01 of Excess Plan X will be amended to provide that no portion of benefits in excess of the Code section 415(b) limit paid to a participant can be attributable to service credit purchases made with picked-up employer contributions.

Excess Plan X will be administered by System X. Board B has established a separate trust fund for segregation of the assets related to Excess Plan X. The trust fund was established solely for the purpose of holding employer contributions intended to pay excess benefits to affected Excess Plan X participants. The trustees of this separate trust fund will be members of Board B. Your authorized representatives have represented in the correspondence dated February 27, 2013 that the trust fund is designed to constitute a grantor trust under state law and for federal income tax purposes. Under the represented facts, Excess Plan X participants will receive no property right or interest in the trust assets, and the trust assets are subject to the claims of State S’s general creditors in the event of insolvency.

Excess Plan X will be funded on a pay as you go basis. Board B will determine the amount necessary to pay the excess benefits under Excess Plan X for each plan year. The required contribution will be the aggregate of the excess benefits payable to all affected participants for such plan year in an amount determined by Board B to be a necessary and reasonable expense of administering Excess Plan X. The amount so determined will be paid by State S and deposited into the trust fund. Any contributions not used to pay the excess benefits for a current year, together with any income accruing to the trust fund, will be used to pay the administrative expenses of Excess Plan X for the plan year. Any contributions not so used that remain after the payment of administrative expenses will be used to fund administrative expenses or excess benefits of participants in future years.

Benefits under Excess Plan X will be paid only if and to the extent the participant is receiving benefits from Plan X. Participation in Excess Plan X will cease for any Plan Year in which the participant’s benefit under Plan X does not exceed the requisite limitations of section 415(b) of the Code, or if all benefit obligations under Excess Plan X to the member, retiree or beneficiary have been satisfied. The form of the benefits paid to a participant from Excess Plan X will be the same form as the participant’s retirement benefit under Plan X. A participant in Excess Plan X will be paid the amount of the benefit that would otherwise have been payable to the participant under Plan X except for the limitations of section 415(b) of the Code. The excess benefit to which a participant is entitled under Excess Plan X will be paid commencing during or with the month in which all monthly payments of retirement benefits under Plan X are paid. Under no circumstances will the participant be given any election to defer compensation under Excess Plan X, either directly or indirectly. In addition, under the represented facts, there will be no employee contributions to Excess Plan X.

Although Excess Plan X is a part of Plan X, no assets of Plan X will be used to pay any benefits under Excess Plan X. Excess Plan X is intended to grant a participant no more than a mere contractual right to payment of benefits under Excess Plan X. Employer contributions to Excess Plan X’s related trust may not be commingled with assets of Plan X’s related trust, nor may Excess Plan X receive any transfers from Plan X. Under no circumstances will employer contributions to fund the excess benefits under Excess Plan X be credited to Plan X.

Based upon the facts and representations stated above, the following rulings are requested:

1. Excess Plan X is a qualified governmental excess benefit arrangement within the meaning of section 415(m) of the Code.

2. The benefits payable under Excess Plan X will be includible in gross income for the taxable year or years in which such benefits are paid or otherwise made available to a participant or a participant’s beneficiary in accordance with the terms of Excess Plan X.

3. Income accruing to Excess Plan X is exempt from federal income tax under sections 115 and 415(m)(1) of the Code as income derived from the exercise of an essential governmental function.

Section 415(b) of the Code and section 1.415(b)-1 of the Income Tax Regulations (“Regulations”) set forth the limitations on annual benefits for participants in defined benefit plans.

Section 415(m)(1) of the Code provides that, in determining whether a governmental plan (as defined in section 414(d) of the Code) meets the benefit limitations of section 415 of the Code, benefits provided under a qualified governmental excess benefit arrangement shall not be taken into account. Section 415(m)(1) of the Code also states that income accruing to a governmental plan (or to a trust that is maintained solely for the purpose of providing benefits under a qualified governmental excess benefit arrangement) shall constitute income derived from the exercise of an essential governmental function upon which such governmental plan (or trust) shall be exempt from tax under section 115 of the Code.

Section 415(m)(2) of the Code describes the tax treatment of benefits payable under a qualified governmental excess benefit arrangement. Under section 415(m)(2) of the Code, the taxable year or years for which amounts in respect of a qualified excess benefit arrangement are includable in gross income by a participant, and the treatment of such amounts when so includible by the participant, are determined as if such qualified governmental excess benefit arrangement were treated as a plan for the deferral of compensation that is maintained by a corporation not exempt from tax and which does not meet the requirements for qualification under section 401 of the Code.

Section 415(m)(3) of the Code defines a qualified governmental excess benefit arrangement as a portion of a governmental plan that meets the following three requirements:

(A) Such portion is maintained solely for the purpose of providing to participants in the plan that part of the participant’s annual benefit otherwise payable under the terms of the plan that exceeds the limitations on benefits imposed by section 415 (“excess benefits”);

(B) Under such portion no election is provided at any time to the participant (directly or indirectly) to defer compensation; and

(C) Excess benefits are not paid from a trust forming a part of such governmental plan unless such trust is maintained solely for the purpose of providing such benefits.

With respect to your first requested ruling, Excess Plan X was adopted by Board B as a part of Plan X. It has been represented that Plan X is a governmental plan as described in section 414(d) of the Code. It has also been represented that the only purpose of Excess Plan X is to provide affected employees who are participants in Plan X that portion of their benefits that would otherwise be payable under the terms of Plan X except for the limitations on benefits imposed by section 415(b) of the Code, as applicable to governmental plans. The terms of Excess Plan X limit participation to participants in Plan X for whom benefits would exceed the limits of section 415 of the Code. Therefore, we have determined that Excess Plan X is a portion of a governmental plan which is maintained solely for the purpose of providing to State S employees who participate in Plan X that part of the participants’ benefits otherwise payable under the terms of Plan X that exceed the section 415 limits, and, as such, meets the requirements of section 415(m)(3)(A) of the Code.

Your authorized representatives have stated that participation in Excess Plan X is mandatory and automatic, and that there are no employee contributions to Excess Plan X. Your representatives also assert that no direct or indirect election to defer compensation is provided to any participant in Excess Plan X. Thus, we have determined that no direct or indirect election is provided at any time to participants to defer compensation, and accordingly, the requirements of section 415(m)(3)(B) of the Code are met.

Section 415(m)(3)(C) of the Code requires that the trust from which the excess benefits are paid must not form a part of the governmental plan which contains the excess benefit arrangement, unless such trust is maintained solely for the purpose of providing such benefits. In this case, Excess Plan X will be funded on a pay-as-you-go basis. Board B established a trust fund for the segregation of assets related to Excess Plan X which is maintained separately from Plan X. This trust fund was established solely for the purpose of holding employer contributions intended to pay excess benefits to affected Plan X participants. Contributions to the trust fund will consist only of the amounts required to pay the excess benefits and administrative expenses for the plan year. Any contributions not used to pay the excess benefits for a current plan year, together with any income accruing to the trust fund, will be used to pay the administrative expenses of Excess Plan X for the plan year. Any contributions not so used that remain after the payment of administrative expenses will be used to fund excess benefits of participants or pay administrative expenses in future years. Therefore, we have determined that the requirements of section 415(m)(3)(C) of the Code are met.

Since Excess Plan X satisfies all of the requirements of section 415(m)(3) of the Code, we conclude, with respect to your first ruling request, that Excess plan X is a qualified governmental excess benefit arrangement within the meaning of section 415(m) of the Code.

Your second ruling request asks whether the benefits payable under Excess Plan X will be includible in gross income for the taxable year or years in which such benefits are paid or otherwise made available to a participant or a participant’s beneficiary in accordance with the terms of Excess Plan X. In response to your first ruling request, we determined that Excess Plan X meets the legal requirements of section 415(m) of the Code and, therefore, constitutes a qualified governmental excess benefit arrangement. Accordingly, under section 415(m)(2) of the Code, the tax treatment of the amounts distributed under Excess Plan X to the participants is determined as if such qualified governmental excess benefit arrangement were a plan for the deferral of compensation which is maintained by a corporation not exempt from tax and which does not meet the requirements for qualification under section 401 of the Code.

Section 83(a) of the Code provides that the excess (if any) of the fair market value of property transferred in connection with the performance of services over the amount paid (if any) for the property is includible in the gross income of the person who performed the services for the first taxable year in which the property becomes transferable or is not subject to a substantial risk of forfeiture.

Section 1.83-3(e) of the Regulations provides that for purposes of Code section 83, the term “property” includes real and personal property other than money or an unfunded and unsecured promise to pay money or property in the future. Property also includes a beneficial interest in assets (including money) transferred or set aside from claims of the transferor’s creditors, for example, in a trust or escrow account.

Section 402(b) of the Code provides that contributions made by an employer to an employee’s trust that is not exempt from tax under section 501(a) are included in the employee’s gross income in accordance with section 83, except that the value of the employee’s interest in the trust will be substituted for the fair market value of the property in applying section 83. Under section 1.402(b)-1(a)(1) of the Regulations, an employer’s contributions to a nonexempt employee’s trust are included as compensation in the employee’s gross income for the taxable year in which the contribution is made, but only to the extent that the employee’s interest in such contribution is substantially vested, as defined in the Regulations under section 83 of the Code.

Section 451(a) of the Code and section 1.451-1(a) of the Regulations provide that an item of gross income is includible in gross income for the taxable year in which actually or constructively received by a taxpayer using the cash receipts and disbursements method of accounting. Under section 1.451-2(a) of the Regulations, income is constructively received in the taxable year during which it is credited to a taxpayer’s account, set apart, or otherwise made available so that the taxpayer may draw on it at any time. However, income is not constructively received if the taxpayer’s control of its receipt is subject to substantial limitations or restrictions.

Various revenue rulings have considered the tax consequences of nonqualified deferred compensation arrangements. Rev. Rul. 60-31, Situations 1-3, 1960-1 C.B. 174, holds that a mere promise to pay, not represented by notes or secured in any way, does not constitute receipt of income within the meaning of the cash receipts and disbursements method of accounting. See also Rev. Rul. 69-650, 1969-2 C.B. 106, and Rev. Rul. 69-649, 1969-2 C.B. 106.

Under the economic benefit doctrine, an employee has currently includible income from an economic or financial benefit received as compensation, though not in cash form. Economic benefit applies when assets are unconditionally and irrevocably paid into a fund or trust to be used for the employee’s sole benefit. Sproull v. Commissioner, 16 T.C. 244 (1951), aff’d per curiam, 194 F.2d 541 (6th Cir. 1952), Rev. Rul. 60-31, Situation 4. Rev. Rul. 72-25, 1972-1 C.B. 127, and Rev. Rul. 68-99,1968-1 C. B. 193, holds that an employee does not receive income as a result of the employer’s purchase of an insurance contract to provide a source of funds for deferred compensation because the insurance contract is the employer’s asset, subject to claims of the employer’s creditors.

Based on the foregoing, with respect to the second ruling request, we conclude that the benefits payable under Excess Plan X will be includible in gross income for the taxable year or years in which such benefits are paid or otherwise made available to a participant or a participant’s beneficiary in accordance with the terms of Excess Plan X.

With respect to your third requested ruling, section 415(m)(1) of the Code provides that income accruing to a governmental plan (or to a trust that is maintained solely for the purpose of providing benefits under a qualified governmental excess benefit arrangement) in respect of a qualified governmental excess benefit arrangement will constitute income derived from the exercise of an essential governmental function upon which such governmental plan (or trust) will be exempt from tax under section 115 of the Code. We have determined, in connection with your first ruling request, that Excess Plan X meets the legal requirements of section 415(m) of the Code for qualified governmental excess benefit arrangements. Therefore, under section 415(m)(1) of the Code, with respect to your third requested ruling, we conclude that income accruing to Excess Plan X is exempt from federal income tax under sections 115 and 415(m)(1) of the Code as income derived from the exercise of an essential governmental function.

No opinion is expressed as to the tax treatment of the transactions described herein under the provisions of any other section of either the Code or regulations which may be applicable thereto.

No opinion is expressed as to whether the trust fund established for the purpose of holding employer contributions intended to pay excess benefits to affected Excess Plan X participants constitutes a grantor trust under Rev. Proc. 92-64, 1992-33 I.R.B. 11. No opinion is expressed as to the tax treatment of the transactions described herein with respect to the trust holding the contributions under the provisions of any other section of either the Code or regulations which may be applicable thereto.

This letter assumes that Plan X is and was a governmental plan as described in section 414(d) of the Code, is and was qualified under section 401 of the Code, and its related trust is and was exempt from tax under section 501(a) of the Code at all relevant times thereto.

This ruling is contingent upon the adoption of the amendments to Article III and Section 4.01 of Excess Plan X, as stated in the correspondence dated September 10, 2010 and June 24, 2014.

This letter is directed only to the taxpayer who requested it. Section 6110(k)(3) of the Code provides that it may not be used or cited as precedent.

Pursuant to a power of attorney on file with this office, a copy of this ruling letter is being sent to your authorized representatives.

If you wish to inquire about this ruling, please contact * * * at * * *. Please address all correspondence to SE:T:EP:RA:T3.

Sincerely yours,

Laura B. Warshawsky, Manager
Employee Plans Technical Group 3

Enclosures:
Deleted copy of letter ruling
Notice of Intention to Disclose

cc
* * *



IRS LTR: Plan Is a Qualified Governmental Excess Benefit Arrangement.

The IRS ruled that an excess benefit plan is a qualified governmental excess benefit arrangement under section 415(m) and the benefits payable under the plan will be includable in gross income for the tax year in which they are paid or otherwise made available to a participant or participant’s beneficiary in accordance with the terms of the plan.

Citations: LTR 201441033

Uniform Issue List: 415.00-00
Date: July 17, 2014

Refer Reply To: T:EP:RA:UK

Attention: * * *

LEGEND:

System X = * * *
State S = * * *
Plan X = * * *
Excess Plan X = * * *
Board B = * * *

Dear * * *:

This is in response to correspondence dated September 24, 2009, as supplemented by correspondence dated September 10, 2010, January 3, 2011, February 27, 2013, and June 24, 2014, submitted on behalf of System X by its authorized representatives, in which a request for a letter ruling was submitted with respect to the applicability of section 415(m) of the Internal Revenue Code (Code) to an excess benefit plan (Excess Plan X) and the tax consequences related thereto.

The following facts and representations have been submitted under penalty of perjury in support of the rulings requested.

State S has established Plan X on behalf of its eligible employees, who are certain police officers, firefighters, peace officers or certain state agencies, probate judges, magistrates and coroners of State S. Your authorized representatives have represented that Plan X is a defined benefit plan, a governmental plan as described in section 414(d) of the Code, and is intended to meet the qualification requirements of section 401(a) of the Code.

System X, an instrumentality of State S, is the administrator of Plan X. Board B, a board comprised of officials of State S, is the Trustee of Plan X.

Contributions to Plan X are mandatory for participating employees and are equal to a fixed percentage of each participant’s compensation. Plan X allows participants to make pre-tax elective contributions to Plan X to buy years of service credit in Plan X for eligible prior service in other specified public employment. These purchases of years of service credit may also be made by after-tax contributions, rollovers, or trustee-to-trustee transfers.

State S statutes provide for the establishment of qualified excess benefit arrangements within the meaning of section 415(m) of the Code. Pursuant to this authority, on September 23, 2009, Board B adopted and is planning to implement Excess Plan X for the benefit of employees of State S who participate in Plan X. Excess Plan X will operate in accordance with section 415(m) of the Code as a qualified governmental excess benefit arrangement. Employees who participate in Plan X will become eligible for benefits from Excess Plan X if their benefits calculated under the benefit formula are limited by section 415(b) of the Code as that section applies to government plans. Participation in Excess Plan X is mandatory and automatic for all participants in Plan X whose retirement benefits from Plan X are limited by Code section 415 of the Code.

Section 4.01 of Excess Plan X provides that a participant will receive a benefit equal to the amount of retirement income that would have been payable to, or with respect to, a Participant that could not be paid by Plan X because of the application of the limitations on his retirement income under section 415(b) of the Code. An excess benefit under Excess Plan X will be paid only if and to the extent the participant is receiving retirement benefits from Plan X. Section 4.01 of Excess Plan X will be amended to provide that no portion of benefits in excess of the Code section 415(b) limit paid to a participant can be attributable to service credit purchases made with picked-up employer contributions.

Excess Plan X will be administered by System X. Board B has established a separate trust fund for segregation of the assets related to Excess Plan X. The trust fund was established solely for the purpose of holding employer contributions intended to pay excess benefits to affected Excess Plan X participants. The trustees of this separate trust fund will be members of Board B. Your authorized representatives have represented in the correspondence dated February 27, 2013 that the trust fund is designed to constitute a grantor trust under state law and for federal income tax purposes. Under the represented facts, Excess Plan X participants will receive no property right or interest in the trust assets, and the trust assets are subject to the claims of State S’s general creditors in the event of insolvency.

Excess Plan X will be funded on a pay as you go basis. Board B will determine the amount necessary to pay the excess benefits under Excess Plan X for each plan year. The required contribution will be the aggregate of the excess benefits payable to all affected participants for such plan year in an amount determined by Board B to be a necessary and reasonable expense of administering Excess Plan X. The amount so determined will be paid by State S and deposited into the trust fund. Any contributions not used to pay the excess benefits for a current year, together with any income accruing to the trust fund, will be used to pay the administrative expenses of Excess Plan X for the plan year. Any contributions not so used that remain after the payment of administrative expenses will be used to fund administrative expenses or excess benefits of participants in future years.

Benefits under Excess Plan X will be paid only if and to the extent the participant is receiving benefits from Plan X. Participation in Excess Plan X will cease for any Plan Year in which the participant’s benefit under Plan X does not exceed the requisite limitations of section 415(b) of the Code, or if all benefit obligations under Excess Plan X to the member, retiree or beneficiary have been satisfied. The form of the benefits paid to a participant from Excess Plan X will be the same form as the participant’s retirement benefit under Plan X. A participant in Excess Plan X will be paid the amount of the benefit that would otherwise have been payable to the participant under Plan X except for the limitations of section 415(b) of the Code. The excess benefit to which a participant is entitled under Excess Plan X will be paid commencing during or with the month in which all monthly payments of retirement benefits under Plan X are paid. Under no circumstances will the participant be given any election to defer compensation under Excess Plan X, either directly or indirectly. In addition, under the represented facts, there will be no employee contributions to Excess Plan X.

Although Excess Plan X is a part of Plan X, no assets of Plan X will be used to pay any benefits under Excess Plan X. Excess Plan X is intended to grant a participant no more than a mere contractual right to payment of benefits under Excess Plan X. Employer contributions to Excess Plan X’s related trust may not be commingled with assets of Plan X’s related trust, nor may Excess Plan X receive any transfers from Plan X. Under no circumstances will employer contributions to fund the excess benefits under Excess Plan X be credited to Plan X.

Based upon the facts and representations stated above, the following rulings are requested:

1. Excess Plan X is a qualified governmental excess benefit arrangement within the meaning of section 415(m) of the Code.

2. The benefits payable under Excess Plan X will be includible in gross income for the taxable year or years in which such benefits are paid or otherwise made available to a participant or a participant’s beneficiary in accordance with the terms of Excess Plan X.

3. Income accruing to Excess Plan X is exempt from federal income tax under sections 115 and 415(m)(1) of the Code as income derived from the exercise of an essential governmental function.

Section 415(b) of the Code and section 1.415(b)-1 of the Income Tax Regulations (“Regulations”) set forth the limitations on annual benefits for participants in defined benefit plans.

Section 415(m)(1) of the Code provides that, in determining whether a governmental plan (as defined in section 414(d) of the Code) meets the benefit limitations of section 415 of the Code, benefits provided under a qualified governmental excess benefit arrangement shall not be taken into account. Section 415(m)(1) also states that income accruing to a governmental plan (or to a trust that is maintained solely for the purpose of providing benefits under a qualified governmental excess benefit arrangement) shall constitute income derived from the exercise of an essential governmental function upon which such governmental plan (or trust) shall be exempt from tax under section 115 of the Code.

Section 415(m)(2) of the Code describes the tax treatment of benefits payable under a qualified governmental excess benefit arrangement. Under section 415(m)(2) of the Code, the taxable year or years for which amounts in respect of a qualified excess benefit arrangement are includable in gross income by a participant, and the treatment of such amounts when so includible by the participant, are determined as if such qualified governmental excess benefit arrangement were treated as a plan for the deferral of compensation that is maintained by a corporation not exempt from tax and which does not meet the requirements for qualification under section 401 of the Code.

Section 415(m)(3) of the Code defines a qualified governmental excess benefit arrangement as a portion of a governmental plan that meets the following three requirements:

(A) Such portion is maintained solely for the purpose of providing to participants in the plan that part of the participant’s annual benefit otherwise payable under the terms of the plan that exceeds the limitations on benefits imposed by section 415 (“excess benefits”);

(B) Under such portion no election is provided at any time to the participant (directly or indirectly) to defer compensation; and

(C) Excess benefits are not paid from a trust forming a part of such governmental plan unless such trust is maintained solely for the purpose of providing such benefits.

With respect to your first requested ruling, Excess Plan X was adopted by Board B as a part of Plan X. It has been represented that Plan X is a governmental plan as described in section 414(d) of the Code. It has also been represented that the only purpose of Excess Plan X is to provide affected employees who are participants in Plan X that portion of their benefits that would otherwise be payable under the terms of Plan X except for the limitations on benefits imposed by section 415(b) of the Code, as applicable to governmental plans. The terms of Excess Plan X limit participation to participants in Plan X for whom benefits would exceed the limits of section 415 of the Code. Therefore, we have determined that Excess Plan X is a portion of a governmental plan which is maintained solely for the purpose of providing to State S employees who participate in Plan X that part of the participants’ benefits otherwise payable under the terms of Plan X that exceed the section 415 limits, and, as such, meets the requirements of section 415(m)(3)(A).

Your authorized representatives have stated that participation in Excess Plan X is mandatory and automatic, and that there are no employee contributions to Excess Plan X. Your representatives also assert that no direct or indirect election to defer compensation is provided to any participant in Excess Plan X. Thus, we have determined that no direct or indirect election is provided at any time to participants to defer compensation, and accordingly, the requirements of section 415(m)(3)(B) are met.

Section 415(m)(3)(C) of the Code requires that the trust from which the excess benefits are paid must not form a part of the governmental plan which contains the excess benefit arrangement, unless such trust is maintained solely for the purpose of providing such benefits. In this case, Excess Plan X will be funded on a pay-as-you-go basis. Board B established a trust fund for the segregation of assets related to Excess Plan X which is maintained separately from Plan X. This trust fund was established solely for the purpose of holding employer contributions intended to pay excess benefits to affected Plan X participants. Contributions to the trust fund will consist only of the amounts required to pay the excess benefits and administrative expenses for the plan year. Any contributions not used to pay the excess benefits for a current plan year, together with any income accruing to the trust fund, will be used to pay the administrative expenses of Excess Plan X for the plan year. Any contributions not so used that remain after the payment of administrative expenses will be used to fund excess benefits of participants or pay administrative expenses in future years. Therefore, we have determined that the requirements of section 415(m)(3)(C) of the Code are met.

Since Excess Plan X satisfies all of the requirements of section 415(m)(3) of the Code, we conclude, with respect to your first ruling request, that Excess plan X is a qualified governmental excess benefit arrangement within the meaning of section 415(m) of the Code.

Your second ruling request asks whether the benefits payable under Excess Plan X will be includible in gross income for the taxable year or years in which such benefits are paid or otherwise made available to a participant or a participant’s beneficiary in accordance with the terms of Excess Plan X. In response to your first ruling request, we determined that Excess Plan X meets the legal requirements of section 415(m) of the Code and, therefore, constitutes a qualified governmental excess benefit arrangement. Accordingly, under section 415(m)(2) of the Code, the tax treatment of the amounts distributed under Excess Plan X to the participants is determined as if such qualified governmental excess benefit arrangement were a plan for the deferral of compensation which is maintained by a corporation not exempt from tax and which does not meet the requirements for qualification under section 401 of the Code.

Section 83(a) of the Code provides that the excess (if any) of the fair market value of property transferred in connection with the performance of services over the amount paid (if any) for the property is includible in the gross income of the person who performed the services for the first taxable year in which the property becomes transferable or is not subject to a substantial risk of forfeiture.

Section 1.83-3(e) of the Regulations provides that for purposes of Code section 83, the term “property” includes real and personal property other than money or an unfunded and unsecured promise to pay money or property in the future. Property also includes a beneficial interest in assets (including money) transferred or set aside from claims of the transferor’s creditors, for example, in a trust or escrow account.

Section 402(b) of the Code provides that contributions made by an employer to an employee’s trust that is not exempt from tax under section 501(a) are included in the employee’s gross income in accordance with section 83, except that the value of the employee’s interest in the trust will be substituted for the fair market value of the property in applying section 83. Under section 1.402(b)-1(a)(1) of the Regulations, an employer’s contributions to a nonexempt employee’s trust are included as compensation in the employee’s gross income for the taxable year in which the contribution is made, but only to the extent that the employee’s interest in such contribution is substantially vested, as defined in the Regulations under section 83 of the Code.

Section 451(a) of the Code and section 1.451-1(a) of the Regulations provide that an item of gross income is includible in gross income for the taxable year in which actually or constructively received by a taxpayer using the cash receipts and disbursements method of accounting. Under section 1.451-2(a) of the Regulations, income is constructively received in the taxable year during which it is credited to a taxpayer’s account, set apart, or otherwise made available so that the taxpayer may draw on it at any time. However, income is not constructively received if the taxpayer’s control of its receipt is subject to substantial limitations or restrictions.

Various revenue rulings have considered the tax consequences of nonqualified deferred compensation arrangements. Rev. Rul. 60-31, Situations 1-3, 1960-1 C.B. 174, holds that a mere promise to pay, not represented by notes or secured in any way, does not constitute receipt of income within the meaning of the cash receipts and disbursements method of accounting. See also Rev. Rul. 69-650, 1969-2 C.B. 106, and Rev. Rul. 69-649, 1969-2 C.B. 106.

Under the economic benefit doctrine, an employee has currently includible income from an economic or financial benefit received as compensation, though not in cash form. Economic benefit applies when assets are unconditionally and irrevocably paid into a fund or trust to be used for the employee’s sole benefit. Sproull v. Commissioner, 16 T.C. 244 (1951), aff’d per curiam, 194 F.2d 541 (6th Cir. 1952), Rev. Rul. 60-31, Situation 4. Rev. Rul. 72-25, 1972-1 C.B. 127, and Rev. Rul. 68-99,1968-1 C.B. 193, holds that an employee does not receive income as a result of the employer’s purchase of an insurance contract to provide a source of funds for deferred compensation because the insurance contract is the employer’s asset, subject to claims of the employer’s creditors.

Based on the foregoing, with respect to the second ruling request, we conclude that the benefits payable under Excess Plan X will be includible in gross income for the taxable year or years in which such benefits are paid or otherwise made available to a participant or a participant’s beneficiary in accordance with the terms of Excess Plan X.

With respect to your third requested ruling, section 415(m)(1) of the Code provides that income accruing to a governmental plan (or to a trust that is maintained solely for the purpose of providing benefits under a qualified governmental excess benefit arrangement) in respect of a qualified governmental excess benefit arrangement will constitute income derived from the exercise of an essential governmental function upon which such governmental plan (or trust) will be exempt from tax under section 115 of the Code. We have determined, in connection with your first ruling request, that Excess Plan X meets the legal requirements of section 415(m) of the Code for qualified governmental excess benefit arrangements. Therefore, under section 415(m)(1) of the Code, with respect to your third requested ruling, we conclude that income accruing to Excess Plan X is exempt from federal income tax under sections 115 and 415(m)(1) of the Code as income derived from the exercise of an essential governmental function.

No opinion is expressed as to the tax treatment of the transactions described herein under the provisions of any other section of either the Code or regulations which may be applicable thereto.

No opinion is expressed as to whether the trust fund established for the purpose of holding employer contributions intended to pay excess benefits to affected Excess Plan X participants constitutes a grantor trust under Rev. Proc. 92-64, 1992-33 I.R.B. 11. No opinion is expressed as to the tax treatment of the transactions described herein with respect to the trust holding the contributions under the provisions of any other section of either the Code or regulations which may be applicable thereto.

This letter assumes that Plan X is and was a governmental plan as described in section 414(d) of the Code, is and was qualified under section 401, and its related trust is and was exempt from tax under section 501(a) at all relevant times thereto.

This ruling is contingent upon the adoption of the amendments to Article III and Section 4.01 of Excess Plan X, as stated in the correspondence dated September 10, 2010 and June 24, 2014.

This letter is directed only to the taxpayer who requested it. Section 6110(k)(3) of the Code provides that it may not be used or cited as precedent.

Pursuant to a power of attorney on file with this office, a copy of this ruling letter is being sent to your authorized representatives.

If you wish to inquire about this ruling, please contact * * * at * * *. Please address all correspondence to SE:T:EP:RA:T3.

Sincerely yours,

Laura B. Warshawsky, Manager
Employee Plans Technical Group 3

Enclosures:
Deleted copy of letter ruling
Notice of Intention to Disclose



IRS LTR: Plan Is a Qualified Governmental Excess Benefit Arrangement.

The IRS ruled that an excess benefit plan is a qualified governmental excess benefit arrangement under section 415(m) and the benefits payable under the plan will be includable in gross income for the tax year in which they are paid or otherwise made available to a participant or participant’s beneficiary in accordance with the terms of the plan.

Citations: LTR 201441032

Uniform Issue List: 415.00-00
Date: July 17, 2014

Refer Reply To: T:EP:RA:T3

Attention: * * *

LEGEND:

System X = * * *
State S = * * *
Plan X = * * *
Excess Plan X = * * *
Board B = * * *

Dear * * *:

This is in response to correspondence dated September 24, 2009, as supplemented by correspondence dated September 10, 2010, January 3, 2011, February 27, 2013, and June 24, 2014 submitted on behalf of System X by its authorized representatives, in which a request for a letter ruling was submitted with respect to the applicability of section 415(m) of the Internal Revenue Code (Code) to an excess benefit plan (Excess Plan X) and the tax consequences related thereto.

The following facts and representations have been submitted under penalty of perjury in support of the rulings requested.

State S has established Plan X on behalf of its eligible employees, who are certain state employees, public school employees, public higher education institution personnel, and employees of participating cities, counties and other local subdivisions of government. Your authorized representatives have represented that Plan X is a defined benefit plan, a governmental plan as described in section 414(d) of the Code, and is intended to meet the qualification requirements of section 401(a) of the Code.

System X, an instrumentality of State S, is the administrator of Plan X. Board B, a board comprised of officials of State S, is the Trustee of Plan X.

Contributions to Plan X are mandatory for participating employees and are equal to a fixed percentage of each participant’s compensation. Plan X allows participants to make pre-tax elective contributions to Plan X to buy years of service credit in Plan X for eligible prior service in other specified public employment. These purchases of years of service credit may also be made by after-tax contributions, rollovers, or trustee-to-trustee transfers.

State S statutes provide for the establishment of qualified excess benefit arrangements within the meaning of section 415(m) of the Code. Pursuant to this authority, on September 23, 2009, Board B adopted and is planning to implement Excess Plan X for the benefit of employees of State S who participate in Plan X. Excess Plan X will operate in accordance with section 415(m) of the Code as a qualified governmental excess benefit arrangement. Employees who participate in Plan X will become eligible for benefits from Excess Plan X if their benefits calculated under the benefit formula are limited by section 415(b) of the Code as that section applies to government plans. Participation in Excess Plan X is mandatory and automatic for all participants in Plan X whose retirement benefits from Plan X are limited by section 415 of the Code.

Section 4.01 of Excess Plan X provides that a participant will receive a benefit equal to the amount of retirement income that would have been payable to, or with respect to, a Participant that could not be paid by Plan X because of the application of the limitations on his retirement income under section 415(b) of the Code. An excess benefit under Excess Plan X will be paid only if and to the extent the participant is receiving retirement benefits from Plan X. Section 4.01 of Excess Plan X will be amended to provide that no portion of benefits in excess of the Code section 415(b) limit paid to a participant can be attributable to service credit purchases made with picked-up employer contributions.

Excess Plan X will be administered by System X. Board B has established a separate trust fund for segregation of the assets related to Excess Plan X. The trust fund was established solely for the purpose of holding employer contributions intended to pay excess benefits to affected Excess Plan X participants. The trustees of this separate trust fund will be members of Board B.

Your authorized representatives have represented in the correspondence dated February 27, 2013 that the trust fund is designed to constitute a grantor trust under state law and for federal income tax purposes. Under the represented facts, Excess Plan X participants will receive no property right or interest in the trust assets, and the trust assets are subject to the claims of State S’s general creditors in the event of insolvency.

Excess Plan X will be funded on a pay as you go basis. Board B will determine the amount necessary to pay the excess benefits under Excess Plan X for each plan year. The required contribution will be the aggregate of the excess benefits payable to all affected participants for such plan year in an amount determined by Board B to be a necessary and reasonable expense of administering Excess Plan X. The amount so determined will be paid by State S and deposited into the trust fund. Any contributions not used to pay the excess benefits for a current year, together with any income accruing to the trust fund, will be used to pay the administrative expenses of Excess Plan X for the plan year. Any contributions not so used that remain after the payment of administrative expenses will be used to fund administrative expenses or excess benefits of participants in future years.

Benefits under Excess Plan X will be paid only if and to the extent the participant is receiving benefits from Plan X. Participation in Excess Plan X will cease for any Plan Year in which the participant’s benefit under Plan X does not exceed the requisite limitations of section 415(b) of the Code, or if all benefit obligations under Excess Plan X to the member, retiree or beneficiary have been satisfied. The form of the benefits paid to a participant from Excess Plan X will be the same form as the participant’s retirement benefit under Plan X. A participant in Excess Plan X will be paid the amount of the benefit that would otherwise have been payable to the participant under Plan X except for the limitations of section 415(b) of the Code. The excess benefit to which a participant is entitled under Excess Plan X will be paid commencing during or with the month in which all monthly payments of retirement benefits under Plan X are paid. Under no circumstances will the participant be given any election to defer compensation under Excess Plan X, either directly or indirectly. In addition, under the represented facts, there will be no employee contributions to Excess Plan X.

Although Excess Plan X is a part of Plan X, no assets of Plan X will be used to pay any benefits under Excess Plan X. Excess Plan X is intended to grant a participant no more than a mere contractual right to payment of benefits under Excess Plan X. Employer contributions to Excess Plan X’s related trust may not be commingled with assets of Plan X’s related trust, nor may Excess Plan X receive any transfers from Plan X. Under no circumstances will employer contributions to fund the excess benefits under Excess Plan X be credited to Plan X.

Based upon the facts and representations stated above, the following rulings are requested:

1. Excess Plan X is a qualified governmental excess benefit arrangement within the meaning of section 415(m) of the Code.

2. The benefits payable under Excess Plan X will be includible in gross income for the taxable year or years in which such benefits are paid or otherwise made available to a participant or a participant’s beneficiary in accordance with the terms of Excess Plan X.

3. Income accruing to Excess Plan X is exempt from federal income tax under sections 115 and 415(m)(1) of the Code as income derived from the exercise of an essential governmental function.

Section 415(b) of the Code and section 1.415(b)-1 of the Income Tax Regulations (“Regulations”) set forth the limitations on annual benefits for participants in defined benefit plans.

Section 415(m)(1) of the Code provides that, in determining whether a governmental plan (as defined in section 414(d) of the Code) meets the benefit limitations of section 415 of the Code, benefits provided under a qualified governmental excess benefit arrangement shall not be taken into account. Section 415(m)(1) also states that income accruing to a governmental plan (or to a trust that is maintained solely for the purpose of providing benefits under a qualified governmental excess benefit arrangement) shall constitute income derived from the exercise of an essential governmental function upon which such governmental plan (or trust) shall be exempt from tax under section 115 of the Code.

Section 415(m)(2) of the Code describes the tax treatment of benefits payable under a qualified governmental excess benefit arrangement. Under section 415(m)(2) of the Code, the taxable year or years for which amounts in respect of a qualified excess benefit arrangement are includable in gross income by a participant, and the treatment of such amounts when so includible by the participant, are determined as if such qualified governmental excess benefit arrangement were treated as a plan for the deferral of compensation that is maintained by a corporation not exempt from tax and which does not meet the requirements for qualification under section 401 of the Code.

Section 415(m)(3) of the Code defines a qualified governmental excess benefit arrangement as a portion of a governmental plan that meets the following three requirements:

(A) Such portion is maintained solely for the purpose of providing to participants in the plan that part of the participant’s annual benefit otherwise payable under the terms of the plan that exceeds the limitations on benefits imposed by section 415 (“excess benefits”);

(B) Under such portion no election is provided at any time to the participant (directly or indirectly) to defer compensation; and

(C) Excess benefits are not paid from a trust forming a part of such governmental plan unless such trust is maintained solely for the purpose of providing such benefits.

With respect to your first requested ruling, Excess Plan X was adopted by Board B as a part of Plan X. It has been represented that Plan X is a governmental plan as described in section 414(d) of the Code. It has also been represented that the only purpose of Excess Plan X is to provide affected employees who are participants in Plan X that portion of their benefits that would otherwise be payable under the terms of Plan X except for the limitations on benefits imposed by section 415(b) of the Code, as applicable to governmental plans. The terms of Excess Plan X limit participation to participants in Plan X for whom benefits would exceed the limits of section 415 of the Code. Therefore, we have determined that Excess Plan X is a portion of a governmental plan which is maintained solely for the purpose of providing to State S employees who participate in Plan X that part of the participants’ benefits otherwise payable under the terms of Plan X that exceed the section 415 limits, and, as such, meets the requirements of section 415(m)(3)(A).

Your authorized representatives have stated that participation in Excess Plan X is mandatory and automatic, and that there are no employee contributions to Excess Plan X. Your representatives also assert that no direct or indirect election to defer compensation is provided to any participant in Excess Plan X. Thus, we have determined that no direct or indirect election is provided at any time to participants to defer compensation, and accordingly, the requirements of section 415(m)(3)(B) are met.

Section 415(m)(3)(C) of the Code requires that the trust from which the excess benefits are paid must not form a part of the governmental plan which contains the excess benefit arrangement, unless such trust is maintained solely for the purpose of providing such benefits. In this case, Excess Plan X will be funded on a pay-as-you-go basis. Board B established a trust fund for the segregation of assets related to Excess Plan X which is maintained separately from Plan X. This trust fund was established solely for the purpose of holding employer contributions intended to pay excess benefits to affected Plan X participants. Contributions to the trust fund will consist only of the amounts required to pay the excess benefits and administrative expenses for the plan year. Any contributions not used to pay the excess benefits for a current plan year, together with any income accruing to the trust fund, will be used to pay the administrative expenses of Excess Plan X for the plan year. Any contributions not so used that remain after the payment of administrative expenses will be used to fund excess benefits of participants or pay administrative expenses in future years. Therefore, we have determined that the requirements of section 415(m)(3)(C) of the Code are met.

Since Excess Plan X satisfies all of the requirements of section 415(m)(3) of the Code, we conclude, with respect to your first ruling request, that Excess Plan X is a qualified governmental excess benefit arrangement within the meaning of section 415(m) of the Code.

Your second ruling request asks whether the benefits payable under Excess Plan X will be includible in gross income for the taxable year or years in which such benefits are paid or otherwise made available to a participant or a participant’s beneficiary in accordance with the terms of Excess Plan X. In response to your first ruling request, we determined that Excess Plan X meets the legal requirements of section 415(m) of the Code and, therefore, constitutes a qualified governmental excess benefit arrangement. Accordingly, under section 415(m)(2) of the Code, the tax treatment of the amounts distributed under Excess Plan X to the participants is determined as if such qualified governmental excess benefit arrangement were a plan for the deferral of compensation which is maintained by a corporation not exempt from tax and which does not meet the requirements for qualification under section 401 of the Code.

Section 83(a) of the Code provides that the excess (if any) of the fair market value of property transferred in connection with the performance of services over the amount paid (if any) for the property is includible in the gross income of the person who performed the services for the first taxable year in which the property becomes transferable or is not subject to a substantial risk of forfeiture.

Section 1.83-3(e) of the Regulations provides that for purposes of Code section 83, the term “property” includes real and personal property other than money or an unfunded and unsecured promise to pay money or property in the future. Property also includes a beneficial interest in assets (including money) transferred or set aside from claims of the transferor’s creditors, for example, in a trust or escrow account.

Section 402(b) of the Code provides that contributions made by an employer to an employee’s trust that is not exempt from tax under section 501(a) are included in the employee’s gross income in accordance with section 83, except that the value of the employee’s interest in the trust will be substituted for the fair market value of the property in applying section 83. Under section 1.402(b)-1(a)(1) of the Regulations, an employer’s contributions to a nonexempt employee’s trust are included as compensation in the employee’s gross income for the taxable year in which the contribution is made, but only to the extent that the employee’s interest in such contribution is substantially vested, as defined in the Regulations under section 83 of the Code.

Section 451(a) of the Code and section 1.451-1(a) of the Regulations provide that an item of gross income is includible in gross income for the taxable year in which actually or constructively received by a taxpayer using the cash receipts and disbursements method of accounting. Under section 1.451-2(a) of the Regulations, income is constructively received in the taxable year during which it is credited to a taxpayer’s account, set apart, or otherwise made available so that the taxpayer may draw on it at any time. However, income is not constructively received if the taxpayer’s control of its receipt is subject to substantial limitations or restrictions.

Various revenue rulings have considered the tax consequences of nonqualified deferred compensation arrangements. Rev. Rul. 60-31, Situations 1-3, 1960-1 C.B. 174, holds that a mere promise to pay, not represented by notes or secured in any way, does not constitute receipt of income within the meaning of the cash receipts and disbursements method of accounting. See also Rev. Rul. 69-650, 1969-2 C.B. 106, and Rev. Rul. 69-649, 1969-2 C.B. 106.

Under the economic benefit doctrine, an employee has currently includible income from an economic or financial benefit received as compensation, though not in cash form. Economic benefit applies when assets are unconditionally and irrevocably paid into a fund or trust to be used for the employee’s sole benefit. Sproull v. Commissioner, 16 T.C. 244 (1951), aff’d per curiam, 194 F.2d 541 (6th Cir. 1952), Rev. Rul. 60-31, Situation 4. Rev. Rul. 72-25, 1972-1 C.B. 127, and Rev. Rul. 68-99, 1968-1 C.B. 193, holds that an employee does not receive income as a result of the employer’s purchase of an insurance contract to provide a source of funds for deferred compensation because the insurance contract is the employer’s asset, subject to claims of the employer’s creditors.

Based on the foregoing, with respect to the second ruling request, we conclude that the benefits payable under Excess Plan X will be includible in gross income for the taxable year or years in which such benefits are paid or otherwise made available to a participant or a participant’s beneficiary in accordance with the terms of Excess Plan X.

With respect to your third requested ruling, section 415(m)(1) of the Code provides that income accruing to a governmental plan (or to a trust that is maintained solely for the purpose of providing benefits under a qualified governmental excess benefit arrangement) in respect of a qualified governmental excess benefit arrangement will constitute income derived from the exercise of an essential governmental function upon which such governmental plan (or trust) will be exempt from tax under section 115 of the Code. We have determined, in connection with your first ruling request, that Excess Plan X meets the legal requirements of section 415(m) of the Code for qualified governmental excess benefit arrangements. Therefore, under section 415(m)(1) of the Code, with respect to your third requested ruling, we conclude that income accruing to Excess Plan X is exempt from federal income tax under sections 115 and 415(m)(1) of the Code as income derived from the exercise of an essential governmental function.

No opinion is expressed as to the tax treatment of the transactions described herein under the provisions of any other section of either the Code or regulations which may be applicable thereto.

No opinion is expressed as to whether the trust fund established for the purpose of holding employer contributions intended to pay excess benefits to affected Excess Plan X participants constitutes a grantor trust under Rev. Proc. 92-64, 1992-33 I.R.B. 11. No opinion is expressed as to the tax treatment of the transactions described herein with respect to the trust holding the contributions under the provisions of any other section of either the Code or regulations which may be applicable thereto.

This letter assumes that Plan X is and was a governmental plan as described in section 414(d) of the Code, is and was qualified under section 401, and its related trust is and was exempt from tax under section 501(a) at all relevant times thereto.

This ruling is contingent upon the adoption of the amendments to Article III and Section 4.01 of Excess Plan X, as stated in the correspondence dated September 10, 2010 and June 24, 2014.

This letter is directed only to the taxpayer who requested it. Section 6110(k)(3) of the Code provides that it may not be used or cited as precedent.

Pursuant to a power of attorney on file with this office, a copy of this ruling letter is being sent to your authorized representatives.

If you wish to inquire about this ruling, please contact * * * at * * *. Please address all correspondence to SE:T:EP:RA:T3.

Sincerely yours,

Laura B. Warshawsky, Manager
Employee Plans Technical Group 3

Enclosures:
Deleted copy of letter ruling
Notice of Intention to Disclose



IRS LTR: Extension Granted to Make Low-Income Housing Election.

The IRS granted an entity an extension to make an election under section 42(g)(3)(D) to treat all buildings in a low-income housing project as part of a single, multiple-building project.

Citations: LTR 201441002

Third Party Communication: None
Date of Communication: Not Applicable
Person To Contact: * * *, ID No. * * *
Telephone Number: * * *

Index Number: 42.00-00, 9100.00-00
Release Date: 10/10/2014
Date: June 5, 2014

Refer Reply To: CC:PSI:B5 – PLR-103340-14

LEGEND:

Taxpayer = * * *
Project = * * *
BINs = * * *
N = * * *
Agency = * * *

Dear * * *:

This letter responds to Taxpayer’s authorized representative’s letter dated January 1, 2014, and subsequent correspondence, requesting an extension of time pursuant to § 301.9100-1 of the Procedure and Administration Regulations to elect to treat all of the buildings in Project identified by BINs as part of a single, multiple-building project under § 42(g)(3)(D) of the Internal Revenue Code on Taxpayer’s IRS Forms 8609, Low-Income Housing Credit Allocation and Certification.

According to information submitted, Taxpayer intended that Project consist of N buildings identified by BINs. Taxpayer, through inadvertence, failed to elect to treat all N buildings in Project identified by BINs for which Forms 8609 were issued by Agency as part of a single, multiple-building project under § 42(g)(3)(D).

Section 42(g)(3)(D) provides that a project will consist of only one building unless, prior to the end of the first calendar year in the project period (as defined in § 42(h)(1)(F)(ii)), each building that will comprise the project is identified in the form and the manner that the Secretary provides.

Section 42(l)(1) sets forth the certifications for the first year of the credit period regarding any qualified low-income building that a taxpayer must certify to the Secretary (at such time and in such manner as the Secretary prescribes). Section 1.42-1(h) of the Income Tax Regulations requires that a building owner (i.e., taxpayer) must file a completed Form 8609 with the Service in accordance with the form instructions. The election to treat under § 42(g)(3)(D) a building as part of a multiple-building project is made on Part II of Form 8609 and requires the inclusion of an accompanying informational statement.

Sections 301.9100-1 through 301.9100-3 provide the standards the Commissioner will use to determine whether to grant an extension of time to make an election. Section 301.9100-1(b) defines the term “regulatory election” as including an election whose due date is prescribed by regulation published in the Federal Register, or a revenue ruling, revenue procedure, notice, or announcement published in the Internal Revenue Bulletin.

Under § 301.9100-1(c), the Commissioner has discretion to grant a reasonable extension of time under the rules set forth in §§ 301.9100-2 and 301.9100-3 to make a regulatory election, or a statutory election (but no more than six months except in the case of a taxpayer who is abroad), under all subtitles of the Code, except E, G, H, and I. Section 301.9100-2 provides automatic extensions of time for making certain elections. Section 301.9100-3 provides extensions of time for making elections that do not meet the requirements of § 301.9100-2.

Requests for relief under § 301.9100-3(a) will be granted when the taxpayer provides evidence to establish that the taxpayer acted reasonably and in good faith and that granting relief will not prejudice the interests of the government.

In the instant case, based solely on Taxpayer’s facts submitted and its representations made, we conclude that the requirements of §§ 301.9100-1 and 301.9100-3 have been met. Accordingly, Taxpayer is granted an extension of time to elect to treat under § 42(g)(3)(D) all N buildings in Project identified by BINs as part of a single, multiple-building project by filing within 120 days from the date of this letter amended Forms 8609, and accompanying information statement(s), that include this intended election. The amended Forms 8609 and statement(s) (along with a copy of this letter) are to be filed with the Philadelphia Service Center at the address provided for the Service Center in that form. A copy of this letter is enclosed for this purpose.

No opinion is expressed or implied regarding the application of any other provisions of the Code or regulations. Specifically, we express no opinion on whether the Forms 8609 for the N buildings in Project identified by BINs were timely or correctly filed, the effect of Taxpayer’s election to treat under § 42(g)(3)(D) the N buildings as a single, multiple-building project for any closed year, or whether the N buildings in Project otherwise qualify for low-income housing tax credits under § 42.

This ruling is directed only to the taxpayer requesting it. Section 6110(k)(3) of the Code provides that it may not be used or cited as precedent.

In accordance with the Power of Attorney on file with this office, a copy of this letter is being sent to your authorized representatives.

Sincerely,

Associate Chief Counsel
(Passthroughs & Special Industries)

By: Christopher J. Wilson
Senior Counsel, Branch 5
Office of Associate Chief Counsel
(Passthroughs & Special Industries)

Enclosure (2):
Copy of this letter
Copy for section 6110 purposes



IRS Requests Comments on Tax-Exempt Bond Arbitrage Regs.

The IRS has requested public comment on information collections under final regulations (T.D. 8801) on arbitrage restrictions that apply to tax-exempt bonds issued by state and local governments. Comments are due by December 8, 2014.

Read the Request.



The E-Mail Caveat Is Dead! Long Live the E-Mail Caveat!

Kip Dellinger discusses recent revisions to Circular 230 that removed the covered opinion provisions promulgated in 2004 that led to the “you can’t rely on this advice” statements so common in the e-mails of law and accounting firms. He also comments on protective engagement letter language regarding tax advice.

* * * * *

On June 12 tax professionals were finally required — not merely allowed — to dump the Circular 230 e-mail caveat.1 One would think everyone would be quite pleased. After all, slogging through a string of e-mail tax advice disclaimers embedded in a conversation can be an aggravating task (we stopped reading them ages ago). This is particularly true when the e-mail is simply coordinating a lunch or planning a trip to the ballpark.

No sooner had the e-mail removal directive arrived than many practitioners decided they loved their e-mail caveats and related disclaimers — presumably, if not primarily, because it allowed them to avoid any responsibility to the recipients of less-than-formal written advice (as in protection from malpractice claims). Many in tax practice upper management positions also surely believe that the caveats insulate them from responsibility under the supervisory provisions of Circular 230 for any “wrong” e-mail or similar advice provided by lower-level tax personnel. CPAs and accounting firms across the country sought guidance in this area from their errors and omissions insurance carriers.

Never Required on E-Mail Communications

The original e-mail caveat was never a requirement for tax practitioners. It was a defense mechanism to opt out regarding two of six specific types of tax opinions2 described in section 10.35 of Circular 230 — a reliance opinion and a marketed opinion — which labeled them as covered opinions.3 If written advice of any type (formal, informal, e-mail, text, or crayon on a napkin) was actually furnished4 regarding any of the other four types of opinion, technically, the requirements of section 10.35 would apply, and the opt-out would be useless.

Those four types of opinions concerned (1) a listed transaction; (2) a tax strategy whose principal purpose was the evasion or avoidance of a federal tax when that purpose was clearly unintended by Congress in enacting the law relied upon; (3) a tax strategy requiring confidentiality (the “if you tell anyone, I’ll shoot you” approach5); and (4) a tax strategy that provided contractual protection of some type.6 Interestingly, the manner in which the caveat appeared on countless e-mails wasn’t even sufficient to opt out of marketed opinion advice.

Yet somehow, the larger tax profession of attorneys and CPAs took comfort that they were shielded from IRS discipline for any tax advice contemplated in section 10.35 because their e-mails said you can’t rely on our advice for penalty protection. In fact, that outcome sounded so cool that at least some practitioners apparently became enamored with the idea that if they didn’t put their tax advice in formal legal writing (whatever that is), they’d have no exposure to malpractice claims of any type regarding that advice.

Today’s Tax Advice Rules

To change the topic for just a moment, written tax advice is now governed under section 10.37 of Circular 230. For years before the covered opinion provisions, section 10.37 was the pertinent provision under Circular 230, and it remained so following the addition of section 10.357 for advice other than covered opinions. It has been revised and expanded to govern all written advice provided by Circular 230 practitioners (attorneys, CPAs, and enrolled agents for purposes of written advice). So, under the written advice provisions of Circular 230, a practitioner should:

One later, critical provision in Circular 230 states:

In the case of an opinion the practitioner knows or has reason to know will be used or referred to by a person other than the practitioner (or a person who is a member of, associated with, or employed by the practitioner’s firm) in promoting, marketing, or recommending to one or more taxpayers a partnership or other entity, investment plan or arrangement a significant purpose of which is the avoidance or evasion of any tax imposed by the Internal Revenue Code, the Commissioner, or delegate, will apply a reasonable practitioner standard, considering all facts and circumstances, with emphasis given to the additional risk caused by the practitioner’s lack of knowledge of the taxpayer’s particular circumstances, when determining whether a practitioner has failed to comply with this section.11 [Emphasis added.]

Some practitioners may contend that those Office of Professional Responsibility folks are out to trap us. And the IRS doesn’t provide a stitch of guidance regarding that directive. How do we deal with that lack of guidance?

Well, one suggestion is to simply save and follow as guidance the requirements of “old” section 10.35. It’s actually a nice guide for what tax opinions that address uncertain areas of the law (or facts) should contain. Following the principles set forth in that provision would surely go a long way toward satisfying OPR that the heightened standard was met by the tax opinion writer.

The New (Improved?) E-Mail Caveat

Once any reason (or excuse) for including e-mail tax advice disclaimers — for example, “to ensure compliance with Treasury Department Circular 230” — disappeared, much of the practice community apparently concluded that they enjoyed the seeming malpractice insulation provided by a caveat that states, “We take no responsibility for bad outcomes with the IRS based on the advice contained in this communication.” Thus began the “save the e-mail legend” movement for written tax advice.

Of course, an obvious problem faced by lawyers and CPAs is that they provide all kinds of e-mail (and other informal) advice. Law firms may offer advice on securities, contract, family, environmental, regulatory, and myriad other areas of the law. CPA firms may offer advice in accounting treatment, tax matters, and an endless list of consulting-type matters. Yet, both professions had generally been stating that it’s only written e-mail tax advice that the recipient can’t rely on. As was pointed out to one malpractice insurance provider, it would look a little silly for a CPA or lawyer to use an e-mail caveat that stated:

Any tax advice contained in this communication, including attachments and enclosures, is not intended as a thorough, in-depth analysis of specific issues, nor is it a substitute for a formal opinion, nor is it sufficient to avoid tax-related penalties.

In fact, what that language would surely imply is that the recipient can rely on e-mail advice in any communications that don’t involve tax advice.

Consequently, we are now treated to this type of e-mail legend:

Any accounting, business, or tax advice contained in this communication, including attachments and enclosures, is not intended as a thorough, in-depth analysis of specific issues, nor is it a substitute for a formal opinion, nor is it sufficient to avoid tax-related penalties. [Lawyers would substitute “legal” for “accounting.”]

Note that the reference to tax-related penalties is retained in this version, whose phrasing is very close to language suggested by the insurer. Also note that with the appendage of this caveat to e-mails, little has been done to save the forests when e-mails are printed out (or to save thumbs when they are scrolled on a device).

Misguided Reliance on the New Caveat

Beside the belief that the caveat provides a defense in a malpractice case about tax advice, CPAs have expressed to me that the caveat provides insulation from discipline under Circular 230 when the advice of people they supervise (partners, associates, or employees) is incorrect. That’s nonsense. And this was a problem — essentially ignored — under Circular 230 before the recent amendments that included the elimination of the covered opinion rules.

Section 10.36, “Procedures to Ensure Compliance,” states:

Any individual subject to the provisions of this part who has (or individuals who have or share) principal authority and responsibility for overseeing a firm’s practice governed by this part, including the provision of advice concerning Federal tax matters and preparation of tax returns, claims for refund, or other documents for submission to the Internal Revenue Service, must take reasonable steps to ensure that the firm has adequate procedures in effect for all members, associates, and employees for purposes of complying with subparts A, B, and C of this part, as applicable.

Section 10.22, “Diligence as to Accuracy,” states:

A practitioner must exercise due diligence . . . in determining the correctness of oral or written representations made by the practitioner to clients with reference to any matter administered by the Internal Revenue Service.

Taken together, the leadership of tax practice can opt out in e-mails all day long and not avoid OPR’s reach regarding erroneous advice given by subordinates. Yes, there is a willful, incompetent, or grossly negligent requirement for discipline concerning supervisory responsibility. It would appear that simply branding out of responsibility for e-mail advice and nothing more — for example, reviewing or monitoring all forms of significant tax advice contemporaneously or within some reasonable time frame — would be grossly negligent, if not a willful failure to supervise. The supervising tax professional and tax practice leaders should keep this in mind.

Return Prep Engagements

One concept floating around the CPA profession is a suggestion to add to return preparation (rather than tax planning or representation) engagement letter language such as:

While we are, of course, available to provide you with [accounting, tax, and business planning] services, it is our policy to put all advice on which a client might rely into a written memorandum before you rely on that advice. We believe this is necessary to avoid confusion and to clarify the specific nature of our advice. You should not rely on any advice that has not been put into writing for you.

This type of language in most tax advice engagement letters for lawyers would likely be recommended, appropriate, and acceptable since the lawyer rarely prepares the tax return regarding which the advice is given. This would be similarly true for the large CPA firm that provides advice outside the return preparation engagement (or, in fact, for any CPA firm that provides tax planning advice under separate, specific engagement agreements).

However, providing in a return preparation engagement letter that a client (taxpayer) may rely only on written advice (a memorandum, e-mail, letter, or otherwise) would appear to go a step too far. It certainly would not insulate the preparer from the return preparer penalty imposed under section 6694(a) for advising on tax positions of which the preparer has or should have knowledge.

And it is unlikely that a return preparer who has taken a position on a tax return during the preparation process (after perhaps analyzing documents or having discussions with the taxpayer) could later raise the defense that she didn’t provide the client written advice regarding the tax treatment that led to the client suffering a significant accuracy-related penalty under section 6662.

In fact, such language in a return preparation engagement letter might be cited by a plaintiff’s lawyer — perhaps successfully — as intentional bad faith on the part of the preparer, who would raise it as defense in a malpractice case for recovery of the penalty and other damages.

However, an interesting take on the quoted engagement letter language was recently noted in a course I was teaching on tax practice conduct. A CPA had given a long-standing return preparation client oral advice that the client had misunderstood, and the CPA admittedly failed to fully answer the client’s question by explaining how a subsequent act might invalidate the first act.

Too often return preparers provide planning advice or answer client questions throughout the year when the only understanding (contract) with the client is the return preparation engagement letter. Clearly, when a tax planning engagement letter exists, a caveat that the reliance may only be on written advice would likely be a valid defense for the preparer. As noted, it becomes problematic when the written reliance exception is included without qualification in a return preparation engagement letter.

However, the return preparation engagement letter could include language like the following to provide the preparer some protection regarding oral or similar informal periodic advice to the client during the rest of the year:

In addition to our tax preparation services and our advice regarding return preparation, we are, of course, available to provide you with tax advice during the year. For planning or similar tax advice, it is our policy to put all advice on which a client might rely into a written memorandum before you rely on that advice. We believe this is necessary to avoid confusion and to clarify the specific nature of our advice. You should not rely on any planning or similar advice that has not been put into writing for you.

While that language is not dramatically different from what was quoted earlier, it appears to insulate the preparer from the type of incorrect or incomplete advice that causes most malpractice claims, while recognizing that the preparer is generally responsible for tax positions taken on a return regardless of whether she provided the client a written communication about the chosen tax treatment. This is as it should be if the practitioner is a professional in the Circular 230 sense.

Meanwhile, it appears that the e-mail caveat isn’t going to die a quiet death. Trees are weeping.

FOOTNOTES

1 See Kip Dellinger, “For the New Year: Dump the E-Mail Caveat,” Tax Notes, Jan. 9, 2012, p. 235 2012 TNT 8-7: Viewpoint; and William R. Davis, “OPR Will Tell Practitioners to Remove Circular 230 Disclaimers,” Tax Notes, June 23, 2014, p. 1360 2014 TNT 117-5: News Stories.

2 The types of tax advice that section 10.35 sought to regulate were clearly developed from a reading of the myriad tax opinions provided (many of them pilfered, expanded, revised, or embellished by subsequent tax opinion writers — not unlike Wikipedia articles). The primary problem with the rule was the lack of a definition for “significant purpose.” Thus, many in the practitioner community interpreted that language far too broadly. See Dellinger, “Circular 230: How Broad Is the Scope of ‘Significant Purpose’?” Tax Notes, June 26, 2006, p. 1503-1509 2006 TNT 123-32: Viewpoint.

3 See Dellinger, supra note 1.

4 Presumably and realistically, just saying “no, don’t” or stating that one cannot provide advice would not subject the writer to the requirements of section 10.35.

5 Some of these transactions apparently appeared mysteriously on Lee A. Sheppard’s doorstep at various times.

6 For the uninitiated: Yes, there were insurance companies that actually offered protection against an IRS disallowance of a tax shelter strategy.

7 Section 10.35 now provides a general competency requirement for all Circular 230 practitioners. See Dellinger, “Here We Go Again: Hand-Wringing Over Circular 230,” Tax Notes, Mar. 25, 2013, p. 1461-1463 2013 TNT 57-9: Viewpoint.

8 Suppose one PowerPoint slide refers to your seven-year investment program, and the next one says that 50 days later you contribute your long and short positions to an S corporation. The next slide says you close your positions, and the following slide probably doesn’t even address your seven-year investment diversification program.

9 The parsers of tax language might really think about the intent of this language for a while. It’s always been part of the written advice requirements and, game playing aside, it should be taken seriously.

10 This is amusing in that one should not take seriously any representation spoon-fed to the client from the tax adviser. The bottom of page 1 through page 2 (and sometimes 3) of most of the late-’90s and early-2000-era tax shelters contained “client” representations that were the handiwork of the opinion draftsman and had little to do with the client’s business or investment objectives.

11 Note the presence of the phrase “recommending to one or more taxpayers a partnership or other entity, investment plan or arrangement a significant purpose of which is the avoidance or evasion of any tax imposed by the Internal Revenue Code.” Here we have that same troublesome language that many practitioners concluded brought just about every type of tax advice, no matter how benign, into the realm of old section 10.35. See Dellinger, “Hand-Wringing Over Circular 230 and E-Mail Caveats,” Tax Notes, Oct. 15, 2012, p. 301 2012 TNT 199-10: Viewpoint; see Dellinger, supra note 2.

END OF FOOTNOTES

Kip Dellinger is a CPA in Santa Monica, California. He is a former chair of the American Institute of Certified Public Accountants Tax Division’s Tax Practice Responsibilities Committee, and he writes and teaches in the areas of tax practice, quality control, and ethics. He is also the recipient of the 2013-2014 Award for Instructor Excellence from the Education Foundation of the California Society of Certified Public Accountants.

 



IRS LTR: Arrangement With For-Profit Won't Jeopardize Group's Exempt Status.

The IRS ruled that an agreement between a tax-exempt research organization and a for-profit company under which the company will pay the organization for the results of its research will not jeopardize the organization’s exemption and will not constitute an unrelated trade or business.

Citations: LTR 201440023

Contact Person: * * *
Identification Number: * * *
Telephone Number: * * *

Uniform Issue List Numbers: 501.03-08, 513.00-00
Release Date: 10/3/2014
Date: July 8, 2014

Employer Identification Number: * * *

LEGEND:

b = * * *
c = * * *
d = * * *
M = * * *
O = * * *
P = * * *

Dear * * *:

This responds to your request for rulings on the effect of the Agreement (described below) on your status as an organization described in §§ 501(c)(3), 509(a)(1), and 170(b)(1)(A)(vi) of the Internal Revenue Code (the “I.R.C.”) and on your liability for unrelated business income tax under §§ 511 through 513.

FACTS

You are exempt from federal income tax under § 501(c)(3) of the Internal Revenue Code. You are not a private foundation within the meaning of § 509(a) because you are described in §§ 509(a)(1) and 170(b)(1)(A)(vi). Your mission is to inform and educate the American public about b, to advocate for c, and conduct research on d. You attempt to disseminate the results of your research as broadly as possible. You distribute your research results primarily through your website, O, and through the media, including print, radio, television, and online media. You maintain an archive of d data known as your P product. The P product can be accessed over your website, O, for non-commercial purposes. You may allow commercial use of the P product for a fee.

You have entered into an agreement (the “Agreement”) with M, a for-profit, major media organization. The Agreement has an initial term of three years, subject to certain early termination and renewal rights. Under the Agreement, you agree to provide substantial portions of the results of your research (the “Information”) to M, and M agrees to pay a periodic fixed fee to you and to make the Information available to users of its electronic products and services.

The Agreement defines the Information as current data delivered on a monthly basis and a historical file of data going back several years. The Information shall consist of your entire P product.

Specifically, you agree to collect, code and process the Information, and to deliver the Information to M in a format and at the delivery frequency specified in the Agreement. You grant M a nonexclusive, worldwide right to use, store, reproduce, create derivative works from, display, and deliver the Information or any part thereof. In addition, M has the right to use the Information for internal business purposes, to market and sell its services, for research and reporting by its multimedia news operation, in its generic, “fair value”, composite or theoretical prices or ratings, or other similar pricing or rating models, and the development and distribution of its proprietary and descriptive databases, and for educational purposes. During the term of the Agreement, you agree not to deliver all or a substantial portion (i.e., 25 percent or more) of the Information to any of the twelve companies listed on a schedule of the Agreement. M acknowledges that substantial portions of the Information are in the public domain and that you do not purport to grant to M any intellectual property rights in such information that is in the public domain. M represents, warrants and covenants that it will use commercially reasonable efforts to incorporate the Information into its product so as to support your objective of broadly disseminating the Information.

If M exercises its right to terminate the Agreement (other than for cause) before the expiration of the initial term, it is obligated to pay you a fixed “termination fee.” In addition, upon termination of the Agreement, M has an option to purchase, for a separate fee, a perpetual license to use the information previously provided to it during the Agreement’s term.

RULINGS REQUESTED

You have requested the following rulings:

1. Your performance of the Agreement and receipt of fees thereunder will not jeopardize your status as an organization exempt from tax under § 501(c)(3) or as an organization that is not a private foundation.

2. Your performance of the Agreement is not an unrelated trade or business.

3. The periodic and termination fees that are or may be payable to you under the Agreement are not royalties.

LAW

I.R.C. § 501(a) exempts from federal income taxation organizations described in § 501(c).

I.R.C. § 501(c)(3) describes organizations organized and operated for charitable, educational, and other enumerated exempt purposes.

I.R.C. § 511 imposes a tax on the unrelated business taxable income of organizations described in § 501(c).

I.R.C. § 512(a)(1) defines the term “unrelated business taxable income” as the gross income derived from any unrelated trade or business (as defined in § 513) regularly carried on, less certain allowable deductions that are directly connected with the carrying on of such trade or business, both computed with the modifications provided in subsection (b).

I.R.C. § 512(b)(2) excludes all royalties from unrelated business taxable income.

I.R.C. § 513(a) defines the term “unrelated trade or business” as any trade or business the conduct of which is not substantially related (aside from the need of such organization for income or funds or the use it makes of the profits derived) to the exercise or performance by such organization of its charitable, educational, or other purpose or function constituting the basis for its exemption under § 501.

Treas. Reg. § 1.501(c)(3)-1(a)(1) provides that, to be exempt as an organization described in § 501(c)(3), an organization must be both organized and operated exclusively for one or more of the purposes specified in such section.

Treas. Reg. § 1.501(c)(3)-1(c)(1) provides that an organization will be regarded as “operated exclusively” for one or more exempt purposes only if it engages primarily in activities which accomplish one or more of such exempt purposes specified in § 501(c)(3).

Treas. Reg. § 1.501(c)(3)-1(d)(1)(i) includes “educational” among the list of purposes for which an organization described in § 501(c)(3) may be exclusively organized and operated.

Treas. Reg. § 1.501(c)(3)-1(d)(1)(ii) provides that an organization is not organized and operated exclusively for one or more of the purposes specified in subdivision (i), above, unless it serves a public rather than a private interest. Thus, to meet the requirement of this subdivision, it is necessary for an organization to establish that it is not organized or operated for the benefit of private interests such as designated individuals, the creator or his family, shareholders of the organization, or persons controlled, directly or indirectly, by such private interests.

Treas. Reg. § 1.501(c)(3)-1(d)(3)(i) provides that the term “educational,” as used in § 501(c)(3) relates to: (a) the instruction or training of the individual for the purpose of improving or developing his capabilities; or (b) the instruction of the public on subjects useful to the individual and beneficial to the community.

Treas. Reg. § 1.513-1(d)(1) provides, in general, that gross income derives from unrelated trade or business, within the meaning of § 513(a), if the conduct of the trade or business which produces the income is not substantially related (other than through the production of funds) to the purposes for which exemption is granted. The presence of this requirement necessitates an examination of the relationship between the business activities which generate the particular income in question — the activities, that is, of producing or distributing the goods or performing the services involved — and the accomplishment of the organization’s exempt purposes.

Treas. Reg. § 1.513-1(d)(2) provides that a trade or business is related to exempt purposes, in the relevant sense, only where the conduct of the business activities has causal relationship to the achievement of exempt purposes (other than through the production of income); and it is substantially related, for purposes of § 513, only if the causal relationship is a substantial one. Thus, for the conduct of trade or business from which a particular amount of gross income is derived to be substantially related to purposes for which exemption is granted, the production or distribution of the goods or the performance of the services from which the gross income is derived must contribute importantly to the accomplishment of those purposes. Where the production or distribution of the goods or the performance of the services does not contribute importantly to the accomplishment of the exempt purposes of an organization, the income from the sale of the goods or the performance of the services does not derive from the conduct of related trade or business. Whether activities productive of gross income contribute importantly to the accomplishment of any purpose for which an organization is granted exemption depends in each case upon the facts and circumstances involved.

Rev. Rul. 70-186, 1970-1 C.B. 129, concerns an organization that was formed to preserve a lake as a public recreational facility and to improve the condition of the water in the lake to enhance its recreational features. It is financed by contributions from lake front property owners, from members of the community adjacent to the lake, and from municipalities bordering the lake. The organization’s principal activity is to treat the water, to remove algae, and to otherwise improve the condition of the water for recreational purposes. These activities constitute charitable activities insofar as they insure the continued use of the lake for public recreational purposes. The benefits to be derived from the organization’s activities flow principally to the general public through the maintenance and improvement of public recreational activities. Any private benefits derived by the lake front property owners do not lessen the public benefits flowing from the organization’s operations. In fact, it would be impossible for the organization to accomplish its purposes without providing benefits to the lake front property owners. Accordingly, it is held that the organization is exempt from Federal income tax under § 501(c)(3).

Rev. Rul. 75-196, 1975-1 C.B. 155, concerns an organization, the principal activity of which is to maintain a law library that is located in the same building as the headquarters of the local bar association, an organization described in § 501(c)(6). The organization’s support is derived primarily from contributions by the local bar association. The rules of the library provide that the facilities are available for use only by members of the local bar association. Membership in the bar association is open to all members of the legal profession in good standing with an office or residence in the municipality. The fact that access to and use of the library facilities are limited to a designated class of persons is not necessarily a bar to recognition of exemption under § 501(c)(3). What is of importance is that the class benefited be broad enough to warrant a conclusion that the educational facility or activity is serving a broad public interest rather than a private interest, and is therefore exclusively educational in nature. The library facilities are available to a significant number of people. The fact that attorneys who use the library may derive personal benefit in the practice of their profession from the information garnered thereby is incidental to this purpose and is, in most instances, a logical by-product of an educational process. Therefore, the limitation of the use of the facilities is reasonable and does not prejudice the exclusively educational nature and purpose of the facility. Accordingly, the organization qualifies for exemption under § 501(c)(3).

Rev. Rul. 80-295, 1980-2 C.B. 194, concerns an organization that was created as a national governing body for amateur athletics to promote systematic physical exercise and education, and foster interest in amateur sports among the public at large, and to encourage widespread public participation in athletics and recreational sports. The organization sponsors, supervises, and regulates programs in a number of different amateur sports. It also arranges for and coordinates open competition for amateur athletics at the local, state, regional, and national levels. The organization receives income each year from the sale of exclusive television and radio broadcasting rights to an independent producer, who contracts with a commercial network to broadcast many of the athletic events sponsored, supervised, and regulated by the organization. The broadcasting of the athletic events promotes the various amateur sports, fosters widespread public interest in the benefits of its nationwide amateur athletic program, and encourages public participation. Therefore, the organization’s sale of broadcasting rights and the resultant broadcasting of its athletic events contributes importantly to the accomplishment of its exempt purposes, is substantially related to the purposes constituting the basis for the organization’s exemption, and, therefore, is not unrelated trade or business within the meaning of § 513.

Section 8.01 of Rev. Proc. 2014-4, 2014-1 I.R.B. 125, states that “[t]he Service may decline to issue a letter ruling or a determination letter when appropriate in the interest of sound tax administration or on other grounds whenever warranted by the facts or circumstances of a particular case.”

ANALYSIS

Issue 1A: Whether the performance of the Agreement and the receipt of fees thereunder would jeopardize your status as an organization exempt from tax under § 501(c)(3)

To be described in § 501(c)(3), an organization must be operated exclusively for an exempt purpose. Treas. Reg. § 1.501(c)(3)-1(a)(1). An organization is regarded as “operated exclusively” of exempt purposes only if it engages primarily in activities which accomplish one or more exempt purposes. Treas. Reg. 1.501(c)(3)-1(c)(1). Exempt purposes include “educational” purposes. Treas. Reg. § 1.501(c)(3)-1(d)(1)(f). The term “educational” relates to the instruction of the public on subjects useful to the individual and beneficial to the community. Treas. Reg. § 1.501(c)(3)-1(d)(3).

Your exempt educational purpose is to inform and educate the American public about b and to advocate for c. You achieve this purpose by tracking, assembling and disseminating unbiased information regarding d. Your performance of the Agreement serves to disseminate the Information more broadly and thus helps to accomplish your educational purposes.

However, the Agreement also benefits M by allowing it to use the Information to market and sell its services, for research and reporting by its news operations, and to develop and distribute its proprietary databases. Although an organization’s operations may be deemed to be beneficial to the public, if they also serve private interests other than incidentally, the organization is not entitled to exemption under § 501(c)(3). Treas. Reg. § 1.501(c)(3)-1(c)(1); Treas. Reg. § 1.501(c)(3)-1(d)(1)(ii). The word “incidental” in this context has both qualitative and quantitative connotations. To be “incidental” in the “qualitative” sense, the private benefit must be a necessary concomitant of the activity which benefits the public at large; in other words, the benefit to the public cannot be achieved without necessarily benefiting certain private individuals. A benefit is quantitatively insubstantial only if it is insubstantial as measured in the context of the overall public benefit conferred by the activity. See Rev. Rul. 70-186.

Under the circumstances, we conclude that the benefit conferred on M under the Agreement is both qualitatively and quantitatively incidental. It is qualitatively incidental because the benefits under the Agreement flow primarily to the general public by enabling you to disseminate the Information to a wider audience, i.e., the subscribers to M’s services. M does not have an exclusive right to, or exclusive use of, the Information, which is otherwise available to the general public for free over your website. M is merely a means by which to broaden the dissemination of the Information and thereby to accomplish your exempt purposes more effectively. In addition, the benefit conferred on M is quantitatively incidental because the benefit derived by M in being able to include the Information in its package of services is insubstantial in comparison with the benefit obtained by the users of those services.

In addition, the Agreement does not confer an impermissible private benefit on M’s subscribers. By their nature, exempt educational activities serve public purposes by providing direct benefits to private parties. The public policy sought to be effected necessitates the dissemination of information and training to individuals, whose increased capabilities may generally serve to improve the public welfare. Further, in an educational context, an organization may be determined to be operating for public purposes even if the general public does not have the same direct access to the educational program as does some smaller, restricted group. See Rev. Rul. 75-196. Although the Agreement will benefit only subscribers to M’s services, the population served is broad enough to warrant a conclusion that the Agreement serves a broad public interest.

Therefore, your performance of the Agreement and your receipt of fees thereunder furthers your exempt purpose, serves a public and not a private interest, and, consequently, will not jeopardize your status as an organization described in § 501(c)(3).

Issue 1B: Whether the performance of the Agreement and the receipt of fees thereunder would jeopardize your status as an organization that is not a private foundation.

We decline to rule on whether the performance of the Agreement and the receipt of fees thereunder would jeopardize your status as an organization that is not a private foundation because of the factual nature of the issue. See Rev. Proc. 2014-4, 2014-1 I.R.B. 125, section 8.01.

Issue 2: Whether the performance of the Agreement is an unrelated trade or business

For purposes of the tax imposed under § 511 on an exempt organization’s unrelated business taxable income (as defined in § 512), an “unrelated trade or business” is a trade or business the conduct of which is not substantially related to the organization’s performance of its exempt functions. I.R.C. § 513(a). A trade or business is “substantially related” to exempt purposes if the production or distribution of the goods or the performance of the services from which the gross income is derived contributes importantly to the accomplishment of the organization’s exempt purposes. Treas. Reg. § 1.513-1(d)(2).

Your exempt educational purpose is to inform and educate the American public about b and to advocate for c. You accomplish this purpose by disseminating unbiased information on the subject of d over your website and through various media outlets. M is a global news and media organization with a large subscriber base for its information services. The performance of the Agreement will enable you to disseminate the Information to M’s subscribers, thus making the Information more widely available and contributing importantly to the accomplishment of your exempt purpose of informing and educating the American public about b and c. See Rev. Rul. 80-295. Consequently, the performance of the Agreement is substantially related to your exempt purpose and not an unrelated trade or business.

Issue 3: Whether the fees that are payable to you under the Agreement constitute royalties within the meaning of § 512(b)(2).

I.R.C. § 511 imposes a tax on the unrelated business taxable income of organizations described in § 501(c)(3). I.R.C. § 512(a)(1) defines “unrelated business taxable income” as gross income derived from an unrelated trade or business. I.R.C. § 512(b)(2) excludes all royalties from unrelated business taxable income. Thus, the issue of whether the fees payable to you under the Agreement constitute royalties would be relevant only if such fees were gross income derived from an unrelated trade or business. Since we have concluded that the performance of the Agreement is not an unrelated trade or business, the fees payable under the Agreement are not gross income derived from an unrelated trade or business. Consequently, there is no need to address this issue.

RULINGS

Accordingly, based on the information submitted, we rule as follows:

1A. Your performance of the Agreement and receipt of fees thereunder will not jeopardize your status as an organization exempt from tax under § 501(c)(3) of the Code.

1B. Because of the factual nature of the issue, we decline to rule on whether your performance of the Agreement and receipt of fees thereunder would jeopardize your status as an organization that is not a private foundation.

2. Your performance of the Agreement is not an unrelated trade or business within the meaning of § 513(a) of the Code.

3. Insofar as the periodic and termination fees payable to you under the Agreement are not gross income derived from an unrelated trade or business, there is no need to rule on whether such fees are royalties.

This ruling will be made available for public inspection under section 6110 of the Code after certain deletions of identifying information are made. For details, see enclosed Notice 437, Notice of Intention to Disclose. A copy of this ruling with deletions that we intend to make available for public inspection is attached to Notice 437. If you disagree with our proposed deletions, you should follow the instructions in Notice 437.

This ruling is directed only to the organization that requested it. Section 6110(k)(3) of the Code provides that it may not be used or cited by others as precedent.

This ruling is based on the facts as they were presented and on the understanding that there will be no material changes in these facts. This ruling does not address the applicability of any section of the Code or regulations to the facts submitted other than with respect to the sections described. Because it could help resolve questions concerning your federal income tax status, this ruling should be kept in your permanent records.

If you have any questions about this ruling, please contact the person whose name and telephone number are shown in the heading of this letter.

In accordance with the Power of Attorney currently on file with the Internal Revenue Service, we are sending a copy of this letter to your authorized representative.

Sincerely,

Michael Seto
Manager
Exempt Organizations, Technical

Enclosure
Notice 437



IRS TE/GE Advisory Committee Requests Applications.

The IRS has requested (IR-2014-96) applications for members to serve on its Advisory Committee on Tax Exempt and Government Entities, which will have vacancies as of June 2015.  Applications are due by November 3, 2014.

 

October 2, 2014

WASHINGTON — The Internal Revenue Service is seeking applications for vacancies on the Advisory Committee on Tax Exempt and Government Entities (ACT). The committee provides a venue for public input on relevant areas of tax administration.

Vacancies exist in the following customer segments:

Employee Plans — two vacancies
Exempt Organizations — two vacancies
Indian Tribal Governments — one vacancy
Tax Exempt Bonds — two vacancies

Members are appointed by the Department of the Treasury and serve two-year terms, beginning in June 2015. Applications will be accepted through Nov. 3, 2014.

The ACT is an organized public forum for the IRS and representatives who deal with employee plans, exempt organizations, tax-exempt bonds, and federal, state, local and Indian tribal governments. The ACT allows the IRS to receive regular input on administrative policy and procedures of the Tax Exempt and Government Entities Division (TE/GE).

Applications can be made by completing an ACT member application form. Applications should reflect the proposed member’s qualifications. Members of the ACT may not be federally registered lobbyists. A notice published in the Federal Register, dated Oct. 2, contains more details about the ACT and the application process.

Applications should be sent by:

Email to Mark.F.O’[email protected],
Fax: 877-801-7395, or
U.S. mail to Mark O’Donnell, TE/GE Communications and Liaison Director, Internal Revenue Service, 1111 Constitution Ave., NW, SE:T:CL, NCA 676, Washington, DC 20224.



EO Update: e-News for Charities & Nonprofits - October 2, 2014

1. Register for IRS Phone Forum: Helping 501(c)(3) organizations with charitable contributions (a primer)

Thursday, Oct. 23 at 2 p.m. ET

Topics include:

Register for this event.

2. Register for EO workshops

Register for our upcoming workshops for small and medium-sized 501(c)(3) organizations on:

Oct.29-30 – Eau Claire, WI
Hosted by University of Wisconsin – Eau Claire

Dec. 9 – Austin, TX
Hosted by Austin Community College



IRS LTR: Utility's Rate Base Reduction Inconsistent with ACRS Rules.

The IRS ruled that the reduction of a public utility company’s rate base by the full amount of its accumulated deferred income tax account balance unreduced by the balance of its account balance relating to net operating loss carryovers would be inconsistent with the requirements of section 168(i)(9) for use of the accelerated cost recovery system.

Citations: LTR 201438003

Third Party Communication: None
Date of Communication: Not Applicable
Person To Contact: * * *, ID No. * * *
Telephone Number: * * *

Index Number: 167.22-01
Release Date: 9/19/2014
Date: June 12, 2014

Refer Reply To: CC:PSI:B06 – PLR-104157-14

LEGEND:

Taxpayer = * * *
Parent = * * *
State A = * * *
Commission A = * * *
Commission B = * * *
Year A = * * *
Year B = * * *
Year C = * * *
Year D = * * *
Date A = * * *
Date B = * * *
Date C = * * *
Date D = * * *
Case = * * *
Director = * * *

Dear * * *:

This letter responds to the request, dated January 24, 2014, and additional submission dated May 19, 2014, submitted on behalf of Taxpayer for a ruling on the application of the normalization rules of the Internal Revenue Code to certain accounting and regulatory procedures, described below.

The representations set out in your letter follow.

Taxpayer is a regulated, investor-owned public utility incorporated under the laws of State A primarily engaged in the business of supplying electricity in State A. Taxpayer is subject to the regulatory jurisdiction of Commission A and Commission B with respect to terms and conditions of service and particularly the rates it may charge for the provision of service. Taxpayer’s rates are established on a rate of return basis.

Taxpayer is wholly owned by Parent, and Taxpayer is included in a consolidated federal income tax return of which Parent is the common parent. Taxpayer employs the accrual method of accounting and reports on a calendar year basis.

Taxpayer filed a rate case application on Date A (Case). In its filing, Taxpayer used as its starting point actual data from the historic test period, calendar Year A. It then projected data for Year B through Year C. Taxpayer updated, amended, and supplemented its data several times during the course of the proceedings. Rates in this proceeding were intended to, and did, go into effect for the period Date B through Date C.

In computing its income tax expense element of cost of service, the tax benefits attributable to accelerated depreciation were normalized and were not flowed thru to ratepayers.

In its rate case filing, Taxpayer anticipated that it would claim accelerated depreciation, including “bonus depreciation” on its tax returns to the extent that such depreciation was available in all years for which data was provided. Additionally, Taxpayer forecasted that it would incur a net operating loss (NOL) in Year D. Taxpayer anticipated that it had the capacity to carry back a portion of this NOL with the remainder producing a net operating loss carryover (NOLC) as of the end of Year D.

On its regulatory books of account, Taxpayer “normalizes” the differences between regulatory depreciation and tax depreciation. This means that, where accelerated depreciation reduces taxable income, the taxes that a taxpayer would have paid if regulatory depreciation (instead of accelerated tax depreciation) were claimed constitute “cost-free capital” to the taxpayer. A taxpayer that normalizes these differences, like Taxpayer, maintains a reserve account showing the amount of tax liability that is deferred as a result of the accelerated depreciation. This reserve is the accumulated deferred income tax (ADIT) account. Taxpayer maintains an ADIT account. In addition, Taxpayer maintains an offsetting series of entries — a “deferred tax asset” and a “deferred tax expense” — that reflect that portion of those ‘tax losses’ which, while due to accelerated depreciation, did not actually defer tax because of the existence of an NOLC.

In the setting of utility rates in State, a utility’s rate base is offset by its ADIT balance. In its rate case filing and throughout the proceeding, Taxpayer maintained that the ADIT balance should be reduced by the amounts that Taxpayer calculates did not actually defer tax due to the presence of the NOLC, as represented in the deferred tax asset account. Thus, Taxpayer argued that the rate base should be reduced as of the end of Year D by its federal ADIT balance net of the deferred tax asset account attributable to the federal NOLC. It based this position on its determination that this net amount represented the true measure of federal income taxes deferred on account of its claiming accelerated tax depreciation deductions and, consequently, the actual quantity of “cost-free” capital available to it. It also asserted that the failure to reduce its rate base offset by the deferred tax asset attributable to the federal NOLC would be inconsistent with the normalization rules Testimony by another participant in Case argued against Taxpayer’s proposed calculation of ADIT.

Commission A, in an order issued on Date D, held that it is inappropriate to include the NOL in rate base for ratemaking purposes. Commission A further stated that it is the intent of the Commission that Taxpayer comply with the normalization method of accounting and tax normalization regulations. Commission noted that if Taxpayer later obtains a ruling from the IRS which affirms Taxpayer’s position, Taxpayer may file seeking an adjustment. Commission A also held that to the extent tax normalization rules require recording the NOL to rate base in the specified years, no rate of return is authorized.

Taxpayer requests that we rule as follows:

1. Under the circumstances described above, the reduction of Taxpayer’s rate base by the full amount of its ADIT account balance unreduced by the balance of its NOLC-related account balance would be inconsistent with (and, hence, violative of) the requirements of § 168(i)(9) and § 1.167(l)-1 of the Income Tax regulations.

2. For purposes of Ruling 1 above, the use of a balance of Taxpayer’s NOLC-related account balance that is less than the amount attributable to accelerated depreciation computed on a “with and without” basis would be inconsistent with (and, hence, violative of) the requirements of § 168(i)(9) and § 1.167(l)-1 of the Income Tax regulations.

3. Under the circumstances described above, the assignment of a zero rate of return to the balance of Taxpayer’s NOLC-related account balance would be inconsistent with (and, hence, violative of) the requirements of § 168(i)(9) and § 1.167(l)-1.

LAW AND ANALYSIS

Section 168(f)(2) of the Code provides that the depreciation deduction determined under section 168 shall not apply to any public utility property (within the meaning of section 168(i)(10)) if the taxpayer does not use a normalization method of accounting.

In order to use a normalization method of accounting, section 168(i)(9)(A)(i) of the Code requires the taxpayer, in computing its tax expense for establishing its cost of service for ratemaking purposes and reflecting operating results in its regulated books of account, to use a method of depreciation with respect to public utility property that is the same as, and a depreciation period for such property that is not shorter than, the method and period used to compute its depreciation expense for such purposes. Under section 168(i)(9)(A)(ii), if the amount allowable as a deduction under section 168 differs from the amount that-would be allowable as a deduction under section 167 using the method, period, first and last year convention, and salvage value used to compute regulated tax expense under section 168(i)(9)(A)(i), the taxpayer must make adjustments to a reserve to reflect the deferral of taxes resulting from such difference.

Section 168(i)(9)(B)(i) of the Code provides that one way the requirements of section 168(i)(9)(A) will not be satisfied is if the taxpayer, for ratemaking purposes, uses a procedure or adjustment which is inconsistent with such requirements. Under section 168(i)(9)(B)(ii), such inconsistent procedures and adjustments include the use of an estimate or projection of the taxpayer’s tax expense, depreciation expense, or reserve for deferred taxes under section 168(i)(9)(A)(ii), unless such estimate or projection is also used, for ratemaking purposes, with respect to all three of these items and with respect to the rate base.

Former section 167(l) of the Code generally provided that public utilities were entitled to use accelerated methods for depreciation if they used a “normalization method of accounting.” A normalization method of accounting was defined in former section 167(l)(3)(G) in a manner consistent with that found in section 168(i)(9)(A). Section 1.167(l)-1(a)(1) of the Income Tax Regulations provides that the normalization requirements for public utility property pertain only to the deferral of federal income tax liability resulting from the use of an accelerated method of depreciation for computing the allowance for depreciation under section 167 and the use of straight-line depreciation for computing tax expense and depreciation expense for purposes of establishing cost of services and for reflecting operating results in regulated books of account. These regulations do not pertain to other book-tax timing differences with respect to state income taxes, F.I.C.A. taxes, construction costs, or any other taxes and items.

Section 1.167(l)-1(h)(1)(i) provides that the reserve established for public utility property should reflect the total amount of the deferral of federal income tax liability resulting from the taxpayer’s use of different depreciation methods for tax and ratemaking purposes.

Section 1.167(l)-1(h)(1)(iii) provides that the amount of federal income tax liability deferred as a result of the use of different depreciation methods for tax and ratemaking purposes is the excess (computed without regard to credits) of the amount the tax liability would have been had the depreciation method for ratemaking purposes been used over the amount of the actual tax liability. This amount shall be taken into account for the taxable year in which the different methods of depreciation are used. If, however, in respect of any taxable year the use of a method of depreciation other than a subsection (1) method for purposes of determining the taxpayer’s reasonable allowance under section 167(a) results in a net operating loss carryover to a year succeeding such taxable year which would not have arisen (or an increase in such carryover which would not have arisen) had the taxpayer determined his reasonable allowance under section 167(a) using a subsection (1) method, then the amount and time of the deferral of tax liability shall be taken into account in such appropriate time and manner as is satisfactory to the district director.

Section 1.167(l)-1(h)(2)(i) provides that the taxpayer must credit this amount of deferred taxes to a reserve for deferred taxes, a depreciation reserve, or other reserve account. This regulation further provides that, with respect to any account, the aggregate amount allocable to deferred tax under section 167(1) shall not be reduced except to reflect the amount for any taxable year by which Federal income taxes are greater by reason of the prior use of different methods of depreciation. That section also notes that the aggregate amount allocable to deferred taxes may be reduced to reflect the amount for any taxable year by which federal income taxes are greater by reason of the prior use of different methods of depreciation under section 1.167(l)-1(h)(1)(i) or to reflect asset retirements or the expiration of the period for depreciation used for determining the allowance for depreciation under section 167(a).

Section 1.167(l)-1(h)(6)(i) provides that, notwithstanding the provisions of subparagraph (1) of that paragraph, a taxpayer does not use a normalization method of regulated accounting if, for ratemaking purposes, the amount of the reserve for deferred taxes under section 167(l) which is excluded from the base to which the taxpayer’s rate of return is applied, or which is treated as no-cost capital in those rate cases in which the rate of return is based upon the cost of capital, exceeds the amount of such reserve for deferred taxes for the period used in determining the taxpayer’s expense in computing cost of service in such ratemaking.

Section 1.167(l)-1(h)(6)(ii) provides that, for the purpose of determining the maximum amount of the reserve to be excluded from the rate base (or to be included as no-cost capital) under subdivision (i), above, if solely an historical period is used to determine depreciation for Federal income tax expense for ratemaking purposes, then the amount of the reserve account for that period is the amount of the reserve (determined under section 1.167(l)-1(h)(2)(i)) at the end of the historical period. If such determination is made by reference both to an historical portion and to a future portion of a period, the amount of the reserve account for the period is the amount of the reserve at the end of the historical portion of the period and a pro rata portion of the amount of any projected increase to be credited or decrease to be charged to the account during the future portion of the period.

Section 1.167(l)-1(h) requires that a utility must maintain a reserve reflecting the total amount of the deferral of federal income tax liability resulting from the taxpayer’s use of different depreciation methods for tax and ratemaking purposes. Taxpayer has done so. Section 1.167(l)-1(h)(6)(i) provides that a taxpayer does not use a normalization method of regulated accounting if, for ratemaking purposes, the amount of the reserve for deferred taxes which is excluded from the base to which the taxpayer’s rate of return is applied, or which is treated as no-cost capital in those rate cases in which the rate of return is based upon the cost of capital, exceeds the amount of such reserve for deferred taxes for the period used in determining the taxpayer’s expense in computing cost of service in such ratemaking. Section 56(a)(1)(D) provides that, with respect to public utility property the Secretary shall prescribe the requirements of a normalization method of accounting for that section.

Regarding the first issue, § 1.167(l)-1(h)(6)(i) provides that a taxpayer does not use a normalization method of regulated accounting if, for ratemaking purposes, the amount of the reserve for deferred taxes which is excluded from the base to which the taxpayer’s rate of return is applied, or which is treated as no-cost capital in those rate cases in which the rate of return is based upon the cost of capital, exceeds the amount of such reserve for deferred taxes for the period used in determining the taxpayer’s expense in computing cost of service in such ratemaking. Because the ADIT account, the reserve account for deferred taxes, reduces rate base, it is clear that the portion of an NOLC that is attributable to accelerated depreciation must be taken into account in calculating the amount of the reserve for deferred taxes (ADIT). Thus, the order by Commission A is not in accord with the normalization requirements.

Regarding the second issue, § 1.167(l)-1(h)(1)(iii) makes clear that the effects of an NOLC must be taken into account for normalization purposes. Section 1.167(l)-1(h)(1)(iii) provides generally that, if, in respect of any year, the use of other than regulatory depreciation for tax purposes results in an NOLC carryover (or an increase in an NOLC which would not have arisen had the taxpayer claimed only regulatory depreciation for tax purposes), then the amount and time of the deferral of tax liability shall be taken into account in such appropriate time and manner as is satisfactory to the district director. While that section provides no specific mandate on methods, it does provide that the Service has discretion to determine whether a particular method satisfies the normalization requirements. The “with or without” methodology employed by Taxpayer is specifically designed to ensure that the portion of the NOLC attributable to accelerated depreciation is correctly taken into account by maximizing the amount of the NOLC attributable to accelerated depreciation. This methodology provides certainty and prevents the possibility of “flow through” of the benefits of accelerated depreciation to ratepayers. Under these facts, any method other than the “with and without” method would not provide the same level of certainty and therefore the use of any other methodology is inconsistent with the normalization rules.

Regarding the third issue, assignment of a zero rate of return to the balance of Taxpayer’s NOLC-related account balance would, in effect, flow the tax benefits of accelerated depreciation deductions through to rate payers. This would violate the normalization provisions.

We rule as follows:

1. Under the circumstances described above, the reduction of Taxpayer’s rate base by the full amount of its ADIT account balance unreduced by the balance of its NOLC-related account balance would be inconsistent with the requirements of § 168(i)(9) and § 1.167(l)-1 of the Income Tax regulations.

2. For purposes of Ruling 1 above, the use of a balance of Taxpayer’s NOLC-related account balance that is less than the amount attributable to accelerated depreciation computed on a “with and without” basis would be inconsistent with the requirements of § 168(i)(9) and § 1.167(l)-1 of the Income Tax regulations.

3. Under the circumstances described above, the assignment of a zero rate of return to the balance of Taxpayer’s NOLC-related account balance would be inconsistent with the requirements of § 168(i)(9) and § 1.167(l)-1.

This ruling is based on the representations submitted by Taxpayer and is only valid if those representations are accurate. The accuracy of these representations is subject to verification on audit.
Except as specifically determined above, no opinion is expressed or implied concerning the Federal income tax consequences of the matters described above.

This ruling is directed only to the taxpayer who requested it. Section 6110(k)(3) of the Code provides it may not be used or cited as precedent. In accordance with the power of attorney on file with this office, a copy of this letter is being sent to your authorized representative. We are also sending a copy of this letter ruling to the Director.

Sincerely,

Peter C. Friedman
Senior Technician Reviewer,
Branch 6
(Passthroughs & Special Industries)
cc:
* * *



NABL Urges Aggregate Treatment of Partnerships.

NABL has submitted comments to the Treasury and the IRS regarding treating a partnership of private businesses and governmental persons (or section 501(c)(3) organizations for qualified 501(c)(3) bonds) as an aggregate of its partners where there is a fixed allocation of all partnership items for the entire measurement period for the bonds or the entire period that the person is a partner. NABL believes that the policies of I.R.C. §§ 141 and 145 are not in any way impaired by permitting aggregate treatment of public-private partnerships in cases where the attributes of ownership in the partnership are fixed for at least as long as any tax-advantaged bonds will remain outstanding.

The comments were prepared by an ad hoc task force led by Matthias Edrich of Greenberg Traurig and approved by NABL’s Board of Directors. These comments supplement NABL’s submissions to the Department of the Treasury and the Internal Revenue Service on December 22, 2006, and February 15, 2008, relating to the proposed allocation and accounting regulations published in the Internal Revenue Bulletin on October 30, 2006 (REG-140379-02; REG-142599-02). To view the September 17, 2014 comments, click here.



Chamber of Commerce Argues Court Erred in Work Product Analysis.

The Chamber of Commerce of the United States of America filed an amicus brief in the Second Circuit arguing that a district court erred when it held that the work product doctrine didn’t apply to documents sought from Ernst & Young LLP in an IRS summons, arguing that the decision conflicts with Second Circuit precedent.

GEORG F.W. SCHAEFFLER, INA-HOLDING SCHAEFFLER GMBH & CO. KG,
SCHAEFFLER HOLDING GMBH & CO. KG, AND SCHAEFFLER HOLDING, LP,
Petitioners — Appellants,
v.
UNITED STATES OF AMERICA,
Respondent-Appellee.

IN THE UNITED STATES COURT OF APPEALS
FOR THE SECOND CIRCUIT

ON APPEAL FROM THE UNITED STATES DISTRICT COURT
FOR THE SOUTHERN DISTRICT OF NEW YORK

BRIEF OF THE CHAMBER OF COMMERCE OF THE UNITED STATES
AS AMICUS CURIAE IN SUPPORT OF APPELLANTS

Kate Comerford Todd
Warren Postman
U.S. CHAMBER LITIGATION CENTER, INC.
1615 H Street, NW
Washington, DC 20062
(202) 463-5337

Robert A. Long
Counsel of Record

Reeves C. Westbrook
Marianna Jackson
Jason Yen
COVINGTON & BURLING LLP
1201 Pennsylvania Avenue, NW
Washington, DC 20004-2401
(202) 662-6000

Counsel for Amicus Curiae
Chamber of Commerce of the
United States of America

September 12, 2014

CORPORATE DISCLOSURE STATEMENT

Pursuant to Federal Rules of Appellate Procedure 26.1, the Chamber of Commerce of the United States of America (the Chamber) is a non-profit, tax-exempt organization incorporated in the District of Columbia. The Chamber has no parent company and no publicly held company has ten percent or greater ownership in the Chamber.

TABLE OF CONTENTS

CORPORATE DISCLOSURE STATEMENT

TABLE OF AUTHORITIES

STATEMENT OF INTEREST

SUMMARY OF THE ARGUMENT

ARGUMENT

I. THE DISTRICT COURT’S APPROACH TO THE WORK PRODUCT DOCTRINE IS
CONTRARY TO THIS COURT’S DECISION IN ADLMAN

A. The District Court’s Analysis Departs From Adlman

1. The Second Circuit Has Adopted A “Because Of” Litigation
Test

2. The District Court’s Approach Conflicts With the “Because
Of” Test

B. The District Court Failed To Properly Analyze Whether the
Legal Advice Would Have Taken the Same Form Absent Litigation

C. The District Court’s Conclusion Is Based On A Misunderstanding
Of Tax Practice

II. THE DISTRICT COURT’S APPROACH IS CONTRARY TO THE POLICIES
UNDERLYING THE WORK PRODUCT DOCTRINE

A. The District Court’s Holding Removes Work Product Protection
For Complex Transactions

B. The District Court’s Holding Creates Perverse Incentives for
Legal Advisors

CONCLUSION

TABLE OF AUTHORITIES

Cases

Hickman v. Taylor, 329 U.S. 495 (1947)

United States v. Adlman, 134 F.3d 1194 (2d Cir. 1998)

United States v. Nobles, 422 U.S. 225 (1975)

Statutes

15 U.S.C. § 45

Other Authorities

31 C.F.R. § 10.37(c)(3)(iii)

Federal Rule of Appellate Procedure 29

Federal Rule of Civil Procedure 26(b)(3)

Internal Revenue Service Data Book 2013

STATEMENT OF INTEREST

The Chamber of Commerce of the United States of America (the “Chamber”) is the nation’s largest federation of business companies and associations, with underlying membership of more than 3,000,000 businesses and professional organizations of every size and in every sector and geographic region of the country. A principal function of the Chamber is to represent the interests of its members in matters before Congress, the Executive Branch, and the courts. To that end, the Chamber regularly files amicus curiae briefs in cases raising issues of concern to the nation’s business community.1

This case presents such an issue. The district court has interpreted the attorney work product doctrine in a way that effectively denies protection to documents created in the context of complex business transactions, even when the documents are created because of anticipated litigation and reveal mental impressions and opinions of counsel. The district court’s decision is at odds with this Court’s decision in United States v. Adlman, 134 F.3d 1194, 1195 (2d Cir. 1998), which holds that “a document created because of anticipated litigation, which tends to reveal mental impressions, conclusions, opinions, or theories concerning the litigation, does not lose work product protection merely because it is intended to assist in the making of a business decision influenced by the likely outcome of the anticipated litigation.” As in Adlman¸ the district court’s decision in this case presents companies with an “untenable choice.” 134 F.3d at 1200. If a company obtains a thorough and candid analysis “reflecting the company’s litigation strategy and its assessment of its strengths and weaknesses,” it will be prejudiced when that analysis is turned over to its litigation adversaries. Id. If, on the other hand, the company “scrimps on candor and completeness to avoid prejudicing its litigation prospects, it subjects itself . . . to ill-informed decisionmaking.” Id. In this case, as in Adlman, “nothing in the policies underlying the work-product doctrine or the text of the Rule itself” justifies “subjecting a litigant to this array of undesirable choices.” Id.

SUMMARY OF THE ARGUMENT

1. The district court misapplied this Court’s decision in Adlman. The district court acknowledged that litigation was highly probable and that the document at issue contained legal strategy and analysis. The district court nevertheless denied work protection by leaping much too quickly from a determination that the company would have sought legal advice even if it had not anticipated litigation to an unjustified conclusion that the advice would have taken the same form regardless of whether litigation was anticipated.

2. The district court’s holding is contrary to the policy goals underlying the work product doctrine, as set forth in Adlman and Hickman v. Taylor, 329 U.S. 495 (1947). The court reasoned that the complexity of the transaction at issue, as well as the novel legal issues it raised, necessarily meant that the company would have sought detailed and lengthy tax advice from outside counsel even if it did not anticipate litigation. If these factors were sufficient to eliminate work product protection, legal advice concerning complex commercial transactions would virtually always go unprotected, effectively eliminating the protection of the work product doctrine in the arena in which it is most needed.

The district court’s decision is also likely to have an adverse effect on the quality of legal advice. As both Hickman and Adlman recognize, a basic purpose of the protection is to provide lawyers with a zone of privacy in which they may freely develop their case. Under the district court’s holding, however, lawyers will hesitate to give candid guidance for fear that their work product will later be revealed to opposing counsel. As a result, businesses will make commercial decisions without the full benefit of uninhibited legal advice, hurting their interests as well as those of their customers.

ARGUMENT

I. THE DISTRICT COURT’S APPROACH TO THE WORK PRODUCT DOCTRINE IS
CONTRARY TO THIS COURT’S DECISION IN ADLMAN.

A. The District Court’s Analysis Departs From Adlman.

1. The Second Circuit Has Adopted A “Because Of” Litigation Test.

The work product doctrine, recognized in Hickman v. Taylor, 329 U.S. 495 (1947), and codified in Federal Rule of Civil Procedure 26(b)(3), provides a qualified protection against disclosure for documents prepared by an attorney in anticipation of litigation. The doctrine is designed “to preserve a zone of privacy in which a lawyer can prepare and develop legal theories and strategy ‘with an eye toward litigation,’ free from unnecessary intrusion by his adversaries.” Adlman, 134 F.3d at 1196 (quoting Hickman, 329 U.S. at 510-11). The principal focus is on encouraging careful and thorough preparation by the attorney and preventing the attorney’s efforts from redounding to the benefit of the opposing party. Hickman, 329 U.S. at 511.

This Court has held that the work product doctrine applies to all documents prepared “because of” litigation. In United States v. Adlman, 134 F.3d 1194 (2d Cir. 1998), the Circuit rejected a narrower formulation of the doctrine under which documents would be protected only if they are prepared “primarily to assist in” litigation, and not if the “primary, ultimate, or exclusive purpose is to assist in making a business decision.” See Adlman, 134 F.3d at 1198. In rejecting that narrower formulation, this Court joined other courts in holding that “[w]here a document is created because of the prospect of litigation . . ., it does not lose protection under this formulation merely because it is [also] created in order to assist with a business decision.” Id. at 1203. Thus, for example, the work product doctrine protects a report concerning the company’s litigation prospects that is written to inform a bank’s lending policy to a company, as well as a memorandum prepared for an independent auditor to determine the amount of reserves for projected litigation. See id. at 1200.

As the Court noted in Adlman, the work product protection is not absolute. Although a document that satisfies the “because of” litigation test is eligible for protection, this shield may be overcome if a district court determines that the opposing party has shown a substantial need for the document and is unable to obtain its contents elsewhere without undue hardship. Id. at 1195. In addition, the court may find that only certain sections of a document require protection. Id. The Court explained, however, that “opinion work product” (documents that tend to reveal the attorney’s mental processes) “receive special protection not accorded factual material,” because a “core” purpose of the work product doctrine is to “shelter[ ] the mental processes of the attorney, providing a privileged area within which he can analyze his client’s case.” Adlman, 134 F.3d at 1197 (quoting United States v. Nobles, 422 U.S. 225, 238 (1975)).

2. The District Court’s Approach Conflicts With the “Because Of” Test.

Under Adlman, the key issue is whether a document was prepared “because of” anticipated litigation. In the instant case, the district court recognized “that Schaeffler believed that litigation was highly probable in light of the significant and difficult tax issues that were raised by the planned refinancing and restructuring.” Op. at 28. In addition, the court acknowledged that a tax memorandum prepared by Ernst & Young (the “EY Tax Memo”) set forth the legal issues and analyzed the potential arguments that could be made by the parties should the IRS audit the company’s return. Op. at 27. Based on these determinations, the court should have concluded that the work product doctrine applied to the EY Tax Memo.

Instead, the court applied a two-part test, based upon the statement in Adlman that work protect protections do not extend to “documents that are prepared in the ordinary course of business or that would have been created in essentially similar form irrespective of the litigation.” 134 F.3d at 1202. First, the district court considered whether the company would have sought out the type of tax advice provided by Ernst and Young if it had not anticipated an audit or litigation. Op. at 29. Second, the court asked whether the advice given would have been different in content or form had the company known that no audit or litigation would ensue. Op. at 30.

As Appellant explains in its brief, this analysis departs from Adlman, which specifically provided that, “[w]here a document is created because of the prospect of litigation . . ., it does not lose protection under this formulation merely because it is [also] created in order to assist with a business decision.” 134 F.3d at 1203. Thus, the Court’s reference to documents that “would have been created in essentially similar form irrespective of the litigation” simply refers to documents that, while potentially prepared with litigation on the horizon, are not core work product; i.e., documents that do not “reveal mental impressions, conclusions, opinions, or theories concerning . . . litigation.” Id. at 1195 (emphasis added).

B. The District Court Failed To Properly Analyze Whether the Legal Advice Would Have Taken the Same Form Absent Litigation.

In addition to applying the wrong standard in determining the application of work product protection, the district court also erred by denying work product protection based on factors that will be present in virtually any complex business transaction. After determining that the company would have sought tax advice even if had not anticipated an audit or litigation, the court jumped far too readily to the conclusion that the tax advice would have been essentially identical in form and content even if litigation not been anticipated. In determining whether a document “would have been created in essentially similar form irrespective of the litigation,” courts must require more than the district court required in this case, or this single phrase in Adlman will effectively negate the work product rule in complex transactions.

The court noted that “the complexity of the tax issues surrounding the relevant transactions engendered the need to hire outside attorneys and advisors as well as the need to generate the lengthy and detailed analysis contained in the EY Tax Memo.” Op. at 29. The district court then asserted that all legal advice considers the relevant legal authorities and analyzes how those authorities would be applied to a particular set of facts. On this basis, the court reasoned that it is of “no significance” that the EY Tax Memo evaluates the chances that specific tax positions will succeed in litigation, and specifically identifies and evaluates arguments that the IRS might advance. Op. at 31.

The district court’s reasoning ignores the reality that the breadth and depth of an attorney’s legal and factual analysis can vary considerably depending upon whether litigation is anticipated. To be sure, it may be difficult to determine what an attorney’s opinion would have looked like in a counterfactual scenario that did not include a risk of litigation. That is particularly true in a case such as this one, where the factors the district court relied on — the size, complexity, and novelty of the transaction — created a prospect of litigation. But such difficulties cut against any conclusive determination that work product would have taken “essentially similar form” absent a prospect of litigation. The purpose of the work product doctrine is to protect the attorney’s specific “mental impressions, conclusions, opinions, or theories concerning . . . litigation.” 134 F.3d at 1195. Given this purpose, a court should not eliminate the work protection absent convincing evidence that substantially the same impressions, conclusions, opinions, or litigation theories would have been conveyed even if litigation had not been anticipated.

Rather than engaging in an analysis of the EY Tax Memo’s detailed identification of significant issues and examination of potential arguments and counter-arguments, the district court effectively assumed that the complex nature of the transaction vitiated the work product protection. Under the district court’s approach, only specific signifiers, such as a discussion of “actions particular to the litigation process” or a section on settlement strategies, would be sufficient to demonstrate that a document was prepared “because of” litigation. By this logic, documents addressing the practical steps of a court case will receive protection, while those considering the core of any litigation — the legal theories and arguments — will be disclosed to adversaries on demand. That would eliminate the heart of the work product doctrine — surely not a result this Court intended to endorse in Adlman.

C. The District Court’s Conclusion Is Based On A Misunderstanding Of Tax Practice.

In concluding that all tax advice regarding a complex transaction would be created in essentially the same form regardless of litigation, the district court relied on a quotation from Circular 230 that prohibits tax practitioners from taking the possibility of audit into account when providing tax advice. Op. at 30 (citing 31 C.F.R. § 10.37(c)(3)(iii) (2014)). The court’s reliance on this language reflects a basic misconception about the practice of tax law. The federal income tax system depends on self-assessment. For this reason, tax practitioners are not permitted to provide advice that would circumvent the self-assessment system by suggesting to taxpayers that the determination of whether to assess should turn not on whether the tax is properly assessable, but instead on whether the client is likely to get caught if it wrongly carries out its self-assessment duties.

This requirement — that advice be provided without regard to the likelihood that the facts underlying the assessment question at issue would be discovered — is irrelevant when considering the prospect of litigation. For example, an advisor may expect that certain items, if not assessed by the taxpayer, will never be discovered on audit and never give rise to litigation, but nonetheless quite clearly are assessable. On the other hand, other items may be certain to be discovered on audit but never give rise to litigation or controversy because the IRS would agree that assessment would be improper. Finally, in some situations an advisor may expect that if an item is discovered on audit (which may be likely or unlikely), controversy may ensue. In short, Circular 230 standards do not imply that all tax advice by definition is prepared for controversy, but only that the self-assessment system duty requires that tax issues be considered on their merits and not on the basis of whether the taxpayer will get caught.

Even if the Court were to assume, contrary to fact, that all tax advice is prepared in anticipation of controversy or litigation, that premise would not imply that no tax advice is protected by the work product doctrine. Indeed, subject to a compelling need analysis, exactly the opposite conclusion would be appropriate — namely, that all tax advice would qualify for the protection. Neither bright-line test makes sense, however, because advice on tax law, like other legal advice, may be prepared to provide the recipient a basis by which a legal duty may be determined, but may also may be prepared as part of the process of preparing for an anticipated controversy. A categorical rule that all tax advice is necessarily given as if litigation were contemplated cannot be squared with reality. And a rule that excludes all tax advice from the work product protection is equally untenable.

II. THE DISTRICT COURT’S APPROACH IS CONTRARY TO THE POLICIES
UNDERLYING THE WORK PRODUCT DOCTRINE.

A. The District Court’s Holding Removes Work Product Protection For Complex Transactions.

The district court’s approach to the work product doctrine effectively eliminates work product protection for tax opinions provided for complex transactions. As a result, businesses selected for audit by the IRS would be placed at a significant disadvantage in the process if their legal counsel’s mental impressions and strategies were disclosed to the government.

The court relied on the fact that the EY Tax Memo concerned “enormously complex transactions” raising “‘complex’ and ‘novel’ federal tax issues” as support for its conclusion that the company would have sought tax advice even absent the threat of litigation. Op. at 29. Most businesses, especially sophisticated businesses, however, seek advance guidance before entering into significant transactions that raise complex and novel issues. Thus, the district court’s reasoning effectively strips work product protection from tax advice given in the context of complicated transactions.

This outcome is contrary to the basic purposes of the work product doctrine. See Adlman, 134 F.3d at 1500 (“Discovery was hardly intended to enable a learned profession to perform its functions either without wits or on wits borrowed from the adversary.” (quoting Hickman, 329 U.S. at 516 (Jackson, J., concurring))). Moreover, the mental impressions of taxpayer’s counsel need not be shared in order for the IRS to prepare its case and the taxpayer’s assessment to be adjudicated fairly. The IRS has nearly 90,000 employees, including a host of talented highly specialized tax law experts.2 It is capable of doing its job without relying on the mental impressions of opposing counsel. Indeed, the district court’s approach could hinder an efficient and productive audit process. A tax opinion may identify legal theories and litigation strategies that the IRS would not have otherwise asserted. In some cases, counsel may believe that the theories lack merit. Nevertheless, an IRS agent, after reading these theories, may choose to investigate or even argue these positions, slowing the process and delaying a final assessment. This unnecessary conflict is a classic example of the government seeking to build its case on the wits of opposing counsel. As a matter of public policy, barriers should not be erected to taxpayers having full access to all the potential issues associated with a tax return position before exercising their duties as the primary assessors of the income tax.

As the Court recognized in Adlman, the policies underlying the work-product doctrine and the text of Rule 26(b)(3) strongly support application of the doctrine in this context. The government imposes on taxpayers a duty to apply and interpret an extraordinarily complicated set of rules and laws to myriad complex transactions, but would limit access to candid advice of counsel by seeking to obtain that advice and turn it against the taxpayer. Where advice is provided to evaluate a taxpayer’s defenses and strategies in litigation, revealing it to litigation adversaries undermines the basic purpose of the work product doctrine. In appropriate cases, the needs of the government may outweigh these policy concerns, but here the government has not asserted such needs. As the government would have it, a taxpayer must ascertain the law, which is often uncertain, and commit to a position on a tax return, choosing either to guess as to how it would defend the position in litigation or to reveal in advance its defense strategy to the government. As in Adlman, neither the purpose nor the text of the work product doctrine counsels in favor of such a result.

The adverse consequences of the district court’s formulation of the work product doctrine extend beyond the tax realm. In denying protection to the EY Tax Memo, the court asserted that businesses had reasons other than the prospect of litigation to obtain legal advice, including a desire to lower their tax bills. Op. at 29-30. As a result, the court concluded that the company would have sought out the same type of advice even in the absence of anticipated litigation. Op. at 30. This rationale could operate to deny protection to many forms of prospective legal advice received by businesses. For example, a business that collects consumer data and is the victim of a data breach may revise its data security procedures to prevent further breach while also complying with Section 5 of the Federal Trade Commission Act. See 15 U.S.C. § 45. In addressing such a breach, the business will likely seek the advice of counsel to assess its data security procedures. Although this legal guidance may be provided in anticipation of litigation with the FTC, the business would also have other incentives to obtain advice, such as maintaining good customer service. Under the district court’s approach, however, the fact that advice prepared in anticipation of litigation may benefit a company in other arenas will weigh against such advice being protected from disclosure.

B. The District Court’s Holding Creates Perverse Incentives for Legal Advisors.

The district court’s opinion significantly narrows the scope of work product protection for tax opinions. This narrowing of the protection will create pressure to shift the standard practice of those providing tax advice. If work product has little or no chance of qualifying for protection, tax practitioners will face pressure to be less candid in counseling their clients. Because their memos and opinions may be disclosed to adversaries, they may refrain from “showing their work” in reaching their conclusions and may choose not to discuss litigation strategies should they conclude that a transaction is likely to be challenged.

Such perverse incentives are not limited to the tax arena. In other contexts, such as the data security context described above, attorneys may also withhold their candid assessment.

Adlman recognized the potential for such negative effects and specifically noted this possibility as a reason for the test it adopted:

If the company declines to [candidly discuss litigation strategies, appraisal of the likelihood of success, and the feasibility of reasonable settlement] or scrimps on candor and completeness to avoid prejudicing its litigation prospects, it subjects itself and its co-venturers to ill-informed decisionmaking. On the other hand, a study reflecting the company’s litigation strategy and its assessment of its strengths and weaknesses cannot be turned over to litigation adversaries without serious prejudice to the company’s prospects in litigation. . . . We perceive nothing in the policies underlying the work — product doctrine or the text of [Rule 26(b)(3)] itself that would justify subjecting a litigant to this array of undesirable choices.

Adlman, 134 F.3d 1194, 1200 (2d Cir. 1998) (citing Hickman, 329 U.S. at 516). Adlman adopted a test that ensures attorneys a zone in which they can consider the facts, analyze the authorities, and formulate a legal strategy. To uphold the district court’s interpretation of the doctrine would significantly constrict that space in a manner that would be “demoralizing” to attorneys, Hickman, 329 U.S. at 512, and injurious to clients.

CONCLUSION

The decision of district court should be reversed.
Respectfully submitted,

Covington & Burling LLP

Robert A. Long
Counsel of Record

Reeves C. Westbrook
Marianna Jackson
Jason Yen
Covington & Burling LLP
1201 Pennsylvania Avenue N.W.
Washington, DC 20004-2401
(202) 662-6000

Counsel for Amicus Curiae
September 12, 2014

CERTIFICATE OF COMPLIANCE

I CERTIFY, pursuant to Federal Rules of Appellate Procedure 29(d) and 32(a)(7) that the foregoing Brief contains 3,751 words, excluding the parts of the Brief exempted under Federal Rule of Appellate Procedure 32. In accordance with Federal Rule of Appellate Procedure 32(a)(5)-(6), this Brief has been prepared in 14-point Times New Roman font.

Dated: September 12, 2014

Robert A. Long
Counsel for Amicus Curiae

CERTIFICATE OF SERVICE

I CERTIFY that on this 12th day of September, 2014, a true and correct copy of the foregoing Brief was served on all counsel of record via CM/ECF pursuant to Local Rule 25.1(h).

Dated: September 12, 2014

Robert A. Long
Counsel for Amicus Curiae

FOOTNOTES

1 Pursuant to Federal Rule of Appellate Procedure 29, the Chamber certifies that no party’s counsel authored this brief in whole or in part, no party’s counsel contributed money that was intended to fund preparing or submitting this brief, and no person, other than the Chamber, its members, or its counsel, contributed money that was intended to fund preparing or submitting this brief. All parties have consented to the filing of this brief.

2 Table 30, Internal Revenue Service Data Book 2013, available at http://www.irs.gov/pub/irs-soi/13databk.pdf.

END OF FOOTNOTES



IRS Issues Guidance on Changes to Pension Funding Stabilization Rules.

The IRS has issued guidance (Notice 2014-53) on changes to the funding stabilization rules for single-employer pension plans under the tax code and ERISA that were made by the Highway and Transportation Funding Act of 2014 (HTFA).

The interest rates used for purposes of minimum funding requirements are a set of three segment rates. Section 430(h)(2)(C)(iv) provides that each of the three segment rates for a plan year is adjusted to fall within a specified range that is determined based on an average of the corresponding segment rates for the 25-year period ending on September 30 of the calendar year preceding the plan year’s first day. For plan years beginning in 2012, each segment rate is adjusted so that it is between 90 and 110 percent of the corresponding 25-year average segment rate. Before HTFA, this range was scheduled to gradually increase for later plan years so that the segment rates for plan years beginning after 2015 would have been between 70 and 130 percent of the corresponding 25-year average segment rates.

HTFA extends the period during which the narrowest range of the 25-year average segment rates applies when determining the segment rates that are used to apply sections 430 and 436. Thus, for plan years beginning in 2012 through 2017, each segment rate is adjusted so that it is between 90 and 110 percent of the corresponding 25-year average segment rate. For later plan years, this range is scheduled to gradually increase so that the segment rates for plan years beginning after 2020 are between 70 and 130 percent of the corresponding 25-year average segment rates.

HTFA also provides that the limitation on interest rates based on the corresponding 25-year average segment rates does not apply for purposes of section 436(d)(2) regarding limitations on accelerated benefit distributions for a plan sponsored by an employer in bankruptcy. Changes to section 430(h)(2)(C)(iv) apply for plan years beginning after December 31, 2012. Under HTFA, a plan sponsor can elect not to have the changes to section 430 apply to any plan year beginning in 2013, either for all purposes or solely when determining the plan’s adjusted funding target attainment percentage for that plan year.

Notice 2014-53 provides procedures for electing to defer use of the HTFA segment rates until the 2014 plan year; rules for elections and designations regarding the minimum funding requirements applicable to a plan for a plan year beginning in 2013; and the reporting requirements if the HTFA segment rates apply to the 2013 plan year. The guidance also provides special rules on the application of the benefit restrictions under section 436 and related rules for a plan year beginning after December 31, 2012, and before October 1, 2014, for a plan for which the HTFA changes are applied when determining its adjusted funding target attainment percentage for the plan year.

_____________________________

Guidance on Pension Funding Stabilization under the
Highway and Transportation Funding Act of 2014 (HATFA)

I. PURPOSE

This notice provides guidance on the changes to the funding stabilization rules for single-employer pension plans under the Internal Revenue Code (Code) and the Employee Retirement Income Security Act of 1974 (ERISA)1 that were made by section 2003 of the Highway and Transportation Funding Act of 2014 (HATFA), Pub. L. No. 113-159, which was enacted on August 8, 2014.

II. BACKGROUND

Section 430 specifies the minimum funding requirements that generally apply to singleemployer defined benefit pension plans pursuant to § 412. Section 430(h)(2) specifies interest rates that are used for purposes of calculating the minimum required contribution. The interest rates that are used for this purpose are a set of three segment rates described in § 430(h)(2)(C)(i), (ii) and (iii), or, alternatively, a full yield curve described in § 430(h)(2)(D)(i).

Section 430(h)(2)(C)(iv), which was added by the Moving Ahead for Progress in the 21st Century Act of 2012 (MAP-21), Pub. L. No.112-141, provides that each of the three segment rates described in § 430(h)(2)(C)(i), (ii) and (iii) for a plan year is adjusted as necessary to fall within a specified range that is determined based on an average of the corresponding segment rates for the 25-year period ending on September 30 of the calendar year preceding the first day of that plan year. For plan years beginning in 2012, each segment rate is adjusted so that it is no less than 90% and no more than 110% of the corresponding 25-year average segment rate. Under § 430(h)(2)(C)(iv)(II) as in effect prior to its modification by HATFA, this range was scheduled to gradually increase for later plan years, so that the segment rates for plan years beginning after 2015 would have been no less than 70% and no more than 130% of the corresponding 25-year average segment rates.

Notice 2012-61, 2012-42 I.R.B. 479, provides guidance regarding the changes to the minimum funding requirements and related rules made by MAP-21. Notice 2012-61 includes general guidance relating to the application of the modified segment rates (referred to in Notice 2012-61 and this notice as the MAP-21 segment rates), measurements for which the modified segment rates do not apply, transition issues, elections, reporting, and other issues.

HATFA extends the period during which the narrowest range around the 25-year average segment rates applies for purposes of determining the segment rates that are used to apply §§ 430 and 436. Under the modifications to § 430(h)(2)(C)(iv) made by HATFA, for plan years beginning in 2012 through 2017, each segment rate is adjusted so that it is no less than 90% and no more than 110% of the corresponding 25-year average segment rate. For later plan years, this range is scheduled to gradually increase, so that the segment rates for plan years beginning after 2020 are no less than 70% and no more than 130% of the corresponding 25-year average segment rates. The segment rates as modified by HATFA are referred to in this notice as the HATFA segment rates.

Section 436 sets forth a series of limitations on the accrual and payment of benefits under an underfunded plan. These limitations are applied during a plan year based on the plan’s adjusted funding target attainment percentage (AFTAP). Section 2003(c) of HATFA provides that the limitation on interest rates based on the corresponding 25-year average segment rates does not apply for purposes of § 436(d)(2) (relating to limitations on accelerated benefit distributions for a plan sponsored by an employer in bankruptcy).

Section 2003(e)(1) of HATFA provides that the modifications to § 430(h)(2)(C)(iv) apply with respect to plan years beginning after December 31, 2012. Under section 2003(e)(2) of HATFA, a plan sponsor can elect not to have the modifications to § 430 apply to any plan year beginning in 2013, either for all purposes or solely for purposes of determining the plan’s AFTAP for that plan year (which is used to apply the benefit restrictions under § 436).

This notice provides guidance on certain issues relating to HATFA. Notice 2012-61 continues to apply except to the extent the statutory provisions have changed.

III. ELECTION TO DEFER USE OF HATFA SEGMENT RATES UNTIL THE 2014 PLAN YEAR

This section III sets forth the procedures for elections made pursuant to section 2003(e)(2) of HATFA that relate to a plan year beginning in 2013.

A. Procedure for electing to defer use of HATFA segment rates

Except as provided in section III.B of this notice (which provides for a deemed election to defer the use of the HATFA segment rates for purposes of both §§ 430 and 436 based on the filing of Form 5500 under some circumstances), a plan sponsor elects to defer the use of the HATFA segment rates, either for all purposes or solely for purposes of § 436, until the first plan year beginning on or after January 1, 2014, by providing written notice to the enrolled actuary for the plan and to the plan administrator. The notice must specify the name of the plan, employer identification number and plan number, and whether the use of the HATFA segment rates is deferred for all purposes or only for determination of the AFTAP used to apply benefit restrictions under § 436.

The election described in this section III.A is irrevocable, and must be made no later than the later of: (1) the deadline for filing the Form 5500, Form 5500-SF or Form 5500-EZ (including extensions) for the plan year beginning in 2013; or (2) December 31, 2014.

B. Deemed election to defer use of the HATFA segment rates for purposes of both §§ 430 and 436 through filing of Form 5500, Form 5500-SF or Form 5500-EZ

With respect to a plan year beginning in 2013, if, on or before December 31, 2014, the Form 5500, Form 5500SF or Form 5500EZ is filed and the Schedule SB reflects the MAP-21 segment rates, then an election to defer use of the HATFA segment rates for purposes of both §§ 430 and 436 until the first plan year beginning on or after January 1, 2014 is deemed made. If an election is deemed made pursuant to this section III.B, the election is permitted to be revoked by filing, no later than December 31, 2014, an amended Form 5500, Form 5500-SF, or Form 5500-EZ for the plan year, with a revised Schedule SB that reflects the use of the HATFA segment rates. Alternatively, the deemed election is permitted to be revoked by either providing written notice of the revocation (which includes the name of the plan, employer identification number and plan number) to the enrolled actuary for the plan and to the plan administrator or by making the election described in section III.A of this notice to defer the use of HATFA segment rates only for purposes of § 436, but only if (1) a copy of the notice of the revocation or of the election is e-mailed to the Pension Benefit Guaranty Corporation (PBGC) at [email protected] on or before December 31, 2014 (including in the subject line of the e-mail the plan sponsor’s employer identification number, the plan number, and the name of the plan), and (2) at the time of the revocation of the deemed election, the plan sponsor is not a debtor in a case under title 11, United States Code, or similar federal or state law. If the plan sponsor revokes the deemed election using this alternative method, then an amended Form 5500, Form 5500-SF, or Form 5500-EZ2 for the plan year must be filed no later than the date on which Form 5500, Form 5500-SF or Form 5500-EZ is timely filed for the following plan year, and the revised Schedule SB must reflect the use of the HATFA segment rates.

If the plan sponsor revokes the deemed election, the plan sponsor can also elect to defer use of the HATFA segment rates only for purposes of § 436 under the rules of section III.A of this notice. An election that is deemed made pursuant to this section III.B is irrevocable if it is not revoked in the time and manner set forth in this section III.B.

IV. SECTION 430 ELECTIONS AND REDESIGNATIONS AVAILABLE FOR THE 2013 PLAN YEAR

This section IV sets forth rules regarding elections and designations relating to the minimum funding requirements applicable to the plan for the plan year beginning in 2013. Any action otherwise permitted in this section IV is not permitted to the extent it (1) would result in the imposition of benefit restrictions under § 436 for the plan year beginning in 2013 or 2014 that would otherwise not be imposed, or (2) would result in an unpaid minimum required contribution for any plan year beginning before 2014. The procedural and timing rules governing the acts permitted under this section IV are in section IV.E of this notice.

A. Reversal of an election to reduce funding balances

A plan sponsor is permitted to elect to reverse all or part of any election under § 1.430(f)-1(e) to reduce the plan’s funding standard carryover balance or prefunding balance as of the first day of a plan year beginning in 2013 if (i) the HATFA segment rates apply for purposes of determining the minimum required contribution for that plan year, and (ii) the reduction election was made on or before September 30, 2014. It is expected that the regulations under § 430(f) will be revised to permit this exception to the general rule that any election to reduce the plan’s funding standard carryover balance or prefunding balance is irrevocable.

Under § 1.436-1(a)(5), there may have been deemed elections to reduce the funding standard carryover balance or prefunding balance to avoid or remove benefit restrictions under § 436 for the plan year beginning in 2013. If the HATFA segment rates are applied retroactively for purposes of § 436 for a plan year beginning in 2013, the election to reverse a reduction under this section IV.A also applies to such a deemed election that was made in conjunction with a certification of the plan’s AFTAP for the plan year. However, any reduction election that was made to avoid or remove benefit restrictions under § 436 during the period before the date of the original AFTAP certification for the 2013 plan year cannot be reversed even if the HATFA segment rates apply retroactively for purposes of § 436 for the plan year. This is because the AFTAP based on the HATFA segment rates will not apply to that portion of the plan year and therefore the reversal of any reduction election that was made to avoid or remove benefit restrictions under § 436 during that period would result in the imposition of new restrictions.

B. Late elections to add excess contributions for the 2013 plan year to the prefunding balance

If the HATFA segment rates apply for purposes of determining the minimum required contribution for a plan year beginning in 2013, the plan sponsor is permitted to make (or increase) the election under § 1.430(f)-1(b)(1)(ii) to add excess contributions for that plan year to the plan’s prefunding balance as of the first day of the following plan year. It is expected that the regulations under § 430(f) will be revised to permit this extension of time to make this election.

C. Redesignation of a section 436 contribution

If the HATFA segment rates are applied retroactively for purposes of § 436 for a plan year beginning in 2013, any section 436 contribution within the meaning of § 1.436-1(j)(7) that was made in connection with the certified AFTAP for that plan year is applied toward the minimum required contribution for that plan year to the extent the contribution is no longer required to avoid or remove the benefit restriction. However, no change is permitted with respect to section 436 contributions that were made in connection with a presumed AFTAP before the AFTAP was certified for the plan year.

D. Redesignation of a contribution originally designated for 2013

Despite the general position of the IRS that a contribution designated for a particular plan year cannot be redesignated to apply for another plan year after the Schedule SB is filed, the plan sponsor may choose to redesignate all or a portion of a contribution that was originally designated as applying to the plan year beginning in 2013 to apply to a plan year that begins in 2014. This rule applies only to contributions made after the end of the 2013 plan year and on or before September 30, 2014 and applies only if the original designation is on a Schedule SB for the 2013 plan year that is filed on or before December 31, 2014.3

E. Procedural and timing rules

Any reversal of an election, election made after the generally applicable deadline, or redesignation of contributions under this section IV is made by the plan sponsor by providing written notification to the plan’s enrolled actuary and plan administrator, and must be made no later than the last day of the plan year beginning in 2014. The written notification must specify the name of the plan, the employer identification number and plan number, and must set forth the relevant details, including the specific dollar amount involved. A conditional or formula-based election does not satisfy this requirement.

V. REPORTING REQUIREMENTS IF THE HATFA SEGMENT RATES APPLY TO THE 2013 PLAN YEAR

With respect to the plan year beginning in 2013, if the plan uses the segment rates and the plan sponsor has not elected to defer the use of the HATFA segment rates in accordance with section III.A or III.B of this notice, then the Schedule SB for that plan year must reflect the use of the HATFA segment rates.

VI. APPLICATION OF § 436 AND RELATED RULES FOR A PLAN YEAR BEGINNING AFTER DECEMBER 31, 2012 AND BEFORE OCTOBER 1, 2014

This notice provides special rules relating to the application of the benefit restrictions under § 436 and related rules for a plan year beginning after December 31, 2012 and before October 1, 2014 for a plan for which the modifications made by HATFA to § 430(h)(2)(C)(iv) are applied for purposes of determining the plan’s AFTAP for the plan year. A plan year to which this section VI applies is referred to in this section VI as an applicable plan year.

A. Presumptions apply based on prior year AFTAP

The benefit restrictions under § 436 for an applicable plan year are applied based on the presumed AFTAP before the date, if any, that the AFTAP is certified for that applicable plan year. Thus, the application of the HATFA segment rates does not affect the application of the presumption rules under § 436(h) for the first plan year for which those rates apply to the plan for purposes of § 436 (but affects the application of those presumption rules for the subsequent plan year).

B. Rules if first certification uses HATFA segment rates

If the first AFTAP certification for an applicable plan year (which may be a range certification pursuant to § 1.436-1(h)(4)(ii)) is made using the HATFA segment rates, the benefit restrictions under § 436 apply based on that AFTAP in accordance with the rules of §§ 1.4361(g) and (h).

C. Rules if first certification uses MAP-21 segment rates

If, on or before September 30, 2014, the AFTAP for an applicable plan year is certified using the MAP-21 segment rates, the AFTAP for that applicable plan year must be determined using the HATFA segment rates. If the change in the AFTAP using the HATFA segment rates rather than the MAP-21 segment rates results in a material change to the AFTAP, then the AFTAP must be recertified. In such a case, the plan sponsor can choose to apply any resulting change in the application of the benefit restrictions under § 436 either (i) prospectively, as described in section VI.D of this notice or (ii) retroactively to the date that the AFTAP was originally certified, as described in section VI.E of this notice. If the HATFA segment rates are applied to determine the certified AFTAP for the plan year beginning in 2013, then the option to apply any change in the application of § 436 as a result of recertification of the AFTAP using the HATFA segment rates prospectively is not available for the plan year beginning in 2014. For the first plan year for which the HATFA segment rates apply for purposes of § 436, if the AFTAP using the HATFA segment rates is certified before the end of the plan year, then in the absence of an affirmative election to apply the changes retroactively as described in section VI.E of this notice, the plan sponsor will be treated as having elected to apply any changes prospectively as described in section VI.D of this notice. All plan operations and elections must be consistent with this choice of whether to apply the AFTAP using the HATFA segment rates retroactively or prospectively, and any plan operations that were inconsistent with this choice must be corrected as described in section VI.F of this notice.

If any AFTAP certification for an applicable plan year using the MAP-21 segment rates is made after September 30, 2014, then the rules regarding a change in the AFTAP set forth in § 1.436-1(h)(4)(iii) and (iv) apply with respect to the determination of the AFTAP for that plan year that must be made using the HATFA segment rates.

D. Prospective application of change in benefit restrictions reflecting HATFA segment rates

If the AFTAP is certified for an applicable plan year using the MAP-21 segment rates, then any subsequent change to that certification (including a certification based on the HATFA segment rates) is subject to the rules regarding a change in the AFTAP set forth in §1.436-1(h)(4)(iii) and (iv).

Section 1.436-1(h)(4)(iii) sets forth rules relating to changes in certified AFTAPs and provides a special rule that deems a change in the AFTAP attributable to certain events as “immaterial,” even if the change would otherwise be a material change. The effect of having an event for which the change in AFTAP is deemed immaterial is that a plan administrator can reflect the event on a prospective basis beginning with the date of the event, provided that the AFTAP is recertified as soon as practicable thereafter. It is expected that § 1.436-1(h)(4)(iii)(C) will be amended to provide that additional events can be added to the list of deemed immaterial events in guidance of general applicability.

If (1) on or before September 30, 2014, the AFTAP is certified for an applicable plan year using the MAP-21 segment rates, (2) a certification for that applicable year is subsequently made using the HATFA segment rates, and (3) the plan sponsor does not choose to apply any change in those restrictions retroactively as described in section VI.E of this notice; then the change in AFTAP attributable to the use of the HATFA segment rates for an applicable plan year under this section VI.D is treated as a deemed immaterial change. The date of the event is October 1, 2014 (or the date of the revised AFTAP certification, if earlier). Accordingly, if the plan sponsor chooses to apply any changes in the § 436 restrictions prospectively for an applicable plan year as described in this section VI.D, any change in benefit restrictions resulting from the updated AFTAP determination using the HATFA segment rates must be effective as of the earlier of (1) October 1, 2014, or (2) the date the AFTAP for the applicable plan year is recertified using the HATFA segment rates.

The requirement that the AFTAP be recertified to reflect the HATFA segment rates as soon as practicable after the event giving rise to the deemed immaterial change will not be satisfied if the recertification occurs later than December 31, 2014.

E. Retroactive application of change in benefit restrictions reflecting HATFA segment rates

If (1) on or before September 30, 2014, the AFTAP is certified for an applicable plan year using the MAP-21 segment rates, (2) a certification for that applicable plan year is subsequently made using the HATFA segment rates, and (3) the plan sponsor elects to apply the AFTAP determined using the HATFA segment rates retroactively as described in this section VI.E; then the operations of the plan must be conformed to that updated AFTAP for the period beginning when the AFTAP for the plan year was originally certified. In addition, if the HATFA segment rates apply for purposes of determining the AFTAP for the plan year beginning in 2013, then operations of the plan during the plan year beginning in 2014 must be conformed to apply the rules of § 1.436-1(g) and (h) using the redetermined 2013 AFTAP as the AFTAP for the preceding plan year, during the period beginning on the first day of the plan year beginning in 2014 and ending when the AFTAP for that plan year was originally certified.

F. Reversal of an election to reduce funding balances and redesignation of section 436 contributions for the 2014 plan year

Sections IV.A and IV.C of this notice permit the reversal of an election to reduce a funding balance and the redesignation of a section 436 contribution for an applicable plan year beginning in 2013. Under this section VI.F, a reversal of an election made on or before October 1, 2014 to reduce a funding balance or a redesignation of a section 436 contribution made on or before October 1, 2014 is permitted for the plan year beginning in 2014.

Any reversal of an election or redesignation of a section 436 contribution under this section VI.F is not permitted to the extent it would result in the imposition of benefit restrictions under § 436 for the plan year beginning in 2014 that would otherwise not be imposed. Accordingly, if the plan year beginning in 2014 is the first applicable plan year, any reduction election that was made to avoid or remove benefit restrictions under § 436 during the period before the date of the original AFTAP certification for that plan year cannot be reversed. This is because the AFTAP based on the HATFA segment rates will not apply to that portion of the plan year and therefore the reversal of any reduction election that was made to avoid or remove benefit restrictions under § 436 during that period would result in the imposition of new restrictions. Similarly, if the plan year beginning in 2014 is the first applicable plan year, no change is permitted with respect to section 436 contributions that were made in connection with a presumed AFTAP before the AFTAP was certified for the plan year.

G. Corrections

Once a plan’s AFTAP for an applicable plan year has been certified using the HATFA segment rates, the plan administrator must take any corrective actions necessary to conform plan operations to this certified AFTAP, if applying this certified AFTAP would have changed the application of the § 436 restrictions for the period (1) beginning with the date of the immaterial event described in section VI.D of this notice (if the AFTAP certification applying the HATFA segment rates applies prospectively under section VI.D) or (2) beginning with the date the AFTAP for the year was first certified, as applicable (if the AFTAP certification applying the HATFA segment rates applies retroactively under section VI.E). If the plan year beginning in 2013 is an applicable plan year, the period for potential correction also includes the period during the 2014 plan year before the AFTAP for that plan year beginning in 2014 was originally certified.

If the corrective actions described in this section VI.G are taken to reflect the application of the new certified AFTAP, then the plan’s operations are treated as having been consistent with the provisions of the plan document relative to the requirements of § 436. For this purpose, the provisions of the Employee Plans Compliance Resolution System (EPCRS), as set forth in Rev. Proc. 2013-12, 2013-4 I.R.B. 313, apply, except that a plan is eligible for self-correction under sections 7, 8, and 9 of Rev. Proc. 2013-12 without regard to the requirements of sections 4.03 (requiring a favorable IRS determination letter) and 4.04 (requiring certain established practices and procedures) of that revenue procedure.

Consistent with § 1.436-1(a)(4)(iii), if unpredictable contingent event benefits due to an event occurring during a plan year beginning in 2013 or 2014 are not permitted to be paid because of restrictions under § 436(b), but are later permitted to be paid as a result of a new certification of the AFTAP for the plan year reflecting the HATFA segment rates, then those unpredictable contingent event benefits must become payable, retroactive to the period those benefits would have been payable under the terms of the plan (other than plan terms implementing the requirements of § 436(b)).

Consistent with § 1.436-1(a)(4)(iv), if a plan amendment with an effective date during a plan year beginning in 2013 or 2014 does not take effect because of the limitations of § 436(c), but is later permitted to take effect as a result of a new certification of the AFTAP for the plan year reflecting the HATFA segment rates, then the plan amendment must automatically take effect as of the first day of that plan year (or, if later, the original effective date of the amendment).

For any prohibited payment that was not permitted to be paid during a plan year beginning in 2013 or 2014 because of the restrictions under § 436(d), but is permitted to be paid as a result of a new certification of the AFTAP reflecting the HATFA segment rates, the plan has taken adequate corrective action if it makes the prohibited payment available to participants or beneficiaries who would have been eligible for the prohibited payment (including a prohibited payment that is available on a restricted basis under § 436(d)(3)) on or after the dates described in the first paragraph of this section VI.G.

For any accruals that were not permitted to accrue during a plan year beginning in 2013 or 2014 because of restrictions under § 436(e), but are permitted to accrue as a result of a new certification of the AFTAP reflecting the HATFA segment rates, the plan has taken adequate corrective action if it restores benefits that accrue during the period that begins on the date described in the first paragraph of this section VI.G.

In the case of a participant or beneficiary who, as a result of any of the changes described in this section VI.G is entitled to increased benefits, to benefits payable at a special early retirement date, or to benefits payable in a different form of payment (and who elects such different form of payment, with spousal consent, if applicable), the required correction is to provide the benefit payments in the increased amount or other form of payment commencing with a new prospective annuity starting date. However, if payments have already commenced, the correction is to provide the participant with (1) future benefit payments that are paid in the same manner and amount as if the participant had begun receiving the corrected payment at his or her original annuity starting date, and (2) a make-up for past underpayments. The make-up for past underpayments is equal to the aggregate difference between the past payments actually received and the amounts that would have been received had the benefit commenced in the correct form of payment at the participant’s original annuity starting date, plus interest to the date of the correction (in accordance with EPCRS), and may be paid as either (i) a single-sum payment, or (ii) an actuarially equivalent increase in the amount of future benefit payments.

VII. PAPERWORK REDUCTION ACT

The collections of information contained in this notice have been reviewed and approved by the Office of Management and Budget in accordance with the Paperwork Reduction Act (44 U.S.C. § 3507) under control number 1545-2095.

An agency may not conduct or sponsor, and a person is not required to respond to, a collection of information unless the collection of information displays a valid OMB control number.

The collections of information in this notice are in sections III, IV, and VI of this notice. The collections of information are required to implement the application of the funding relief under section 2003 of HATFA. The collections of information are mandatory for those plan sponsors making various elections when applying the amendments made by HATFA to a plan and any plan sponsor of a plan for which the 2014 AFTAP was certified using MAP-21 segment rates.

For the collections in section III of this notice (relating to the election and possible amendment of Schedule SB for the 2013 plan year), the estimated total number of respondents is 39,600 plans. The estimated annual burden per respondent varies from 15 minutes to 1 hour and 45 minutes, depending on individual circumstances, with an estimated average of 23 minutes. The estimated total annual reporting and/or recordkeeping burden is 15,200 hours.

For the collections in sections IV and VI of this notice (relating to elections regarding the application of benefit restrictions under § 436), the estimated total number of respondents is 37,000 plans. The estimated annual burden per respondent varies from 15 minutes to 45 minutes, depending on individual circumstances, with an estimated average of 37 minutes. The estimated total annual reporting and/or recordkeeping burden is 22,800 hours.

Estimates of the annualized cost to respondents are not relevant, because each collection of information in this notice is a one-time collection.

Books or records relating to a collection of information must be retained as long as their contents may become material in the administration of any internal revenue law. Generally, tax returns and tax return information are confidential, as required by § 6103.

VIII. DRAFTING INFORMATION

The principal authors of this notice are Tonya B. Manning and Carolyn E. Zimmerman of the Employee Plans, Tax Exempt and Government Entities Division. For further information regarding this notice, please contact the Employee Plans taxpayer assistance answering service at 1-877-829-5500 (a toll free number) or e-mail Ms. Manning or Ms. Zimmerman at [email protected].

FOOTNOTES

1 Under section 101 of Reorganization Plan No. 4 of 1978 (43 FR 47713) and section 3002(c) of ERISA, the Secretary of the Treasury has interpretive jurisdiction over the subject matter addressed in this notice for purposes of ERISA, as well as the Code. Thus, the provisions of this notice pertaining to §§ 430 and 436 of the Code also apply for purposes of sections 303 and 206(g) of ERISA.

2 Schedule SB is not required to be filed for plans for which Form 5500-EZ is filed and certain plans for which Form 5500-SF is filed. For these plans, the Schedule SB must be completed (including being signed by the enrolled actuary) and delivered to the plan administrator, who must retain it. With respect to these plans, references in section III.B of this notice to the filing of an amended Form 5500, Form 5500-SF, or Form 5500-EZ with a revised Schedule SB are applied by substituting the completion and delivery of the revised Schedule SB for the filing of the amended form.

3 With respect to a plan for which the Schedule SB need not be filed, as described in footnote 2 of this notice, the reference to filing of the Schedule SB is replaced by the completion and delivery of the Schedule SB.

END OF FOOTNOTES



The State of Nonprofit Governance.

This report provides a snapshot of nonprofit governance policies and practices among operating public charities. Using IRS Form 990 data, we find that many public charities have good governance policies and practices in place. In 2010, more than 60 percent of organizations had a conflict of interest policy, an independent audit and a compensation review and approval process for their chief executive. We also find that organizational characteristics such as size, type of organization, government funding, age, board size and board independence all appear related to whether or not a public charity chooses to adopt these recommended practices.

Read the Report.

Amy Blackwood, Nathan Dietz, Thomas H. Pollak
September 11, 2014



IRS LTR: Utility Not Violating Normalization Rules.

The IRS ruled that a public utility would violate normalization rules by using any depreciation methodology other than the one it is using or by imputing incremental accumulated deferred income tax on account of reliability plant adjustment rules.

Citations: LTR 201436038

Third Party Communication: None
Date of Communication: Not Applicable
Person To Contact: * * *, ID No. * * *
Telephone Number: * * *

Index Number: 167.22-01
Release Date: 9/5/2014
Date: May 22, 2014

Refer Reply To: CC:PSI:B06 – PLR-148311-13

LEGEND:

Taxpayer = * * *
Parent = * * *
State A = * * *
State B = * * *
State C = * * *
Commission A = * * *
Commission B = * * *
Commission C = * * *
Year A = * * *
Year B = * * *
Date A = * * *
Date B = * * *
Date C = * * *
Date D = * * *
Date E = * * *
Case = * * *
Director = * * *

Dear * * *:

This letter responds to the request, dated November 25, 2013, of Taxpayer for a ruling on the application of the normalization rules of the Internal Revenue Code to certain accounting and regulatory procedures, described below.

The representations set out in your letter follow.

Taxpayer is a regulated public utility incorporated in State A and State B. It is wholly owned, through a limited liability company, by Parent. Taxpayer is engaged in the transmission, distribution, and supply of electricity in State A and State C. Taxpayer also provides natural gas and natural gas transmission services in State A. Taxpayer is subject to the regulatory jurisdiction of Commission A, Commission B, and Commission C with respect to terms and conditions of service and particularly the rates it may charge for the provision of service. Taxpayer’s rates are established on a rate of return basis. Taxpayer takes accelerated depreciation, including “bonus depreciation” where available and, for each year beginning in Year A and ending in Year B, Taxpayer individually (as well as the consolidated return filed by Parent) has or expects to, produce a net operating loss (NOL). On its regulatory books of account, Taxpayer “normalizes” the differences between regulatory depreciation and tax depreciation. This means that, where accelerated depreciation reduces taxable income, the taxes that a taxpayer would have paid if regulatory depreciation (instead of accelerated tax depreciation) were claimed constitute “cost-free capital” to the taxpayer. A taxpayer that normalizes these differences, like Taxpayer, maintains a reserve account showing the amount of tax liability that is deferred as a result of the accelerated depreciation. This reserve is the accumulated deferred income tax (ADIT) account. Taxpayer maintains an ADIT account. In addition, Taxpayer maintains an offsetting series of entries — a “deferred tax asset” and a “deferred tax expense” — that reflect that portion of those ‘tax losses’ which, while due to accelerated depreciation, did not actually defer tax because of the existence of an net operating loss carryover (NOLC). Taxpayer, for normalization purposes, calculates the portion of the NOLC attributable to accelerated depreciation using a “with or without” methodology, meaning that an NOLC is attributable to accelerated depreciation to the extent of the lesser of the accelerated depreciation or the NOLC.

Taxpayer filed a general rate case with Commission B on Date A (Case). The test year used in the Case was the 12 month period ending on Date B. In computing its income tax expense element of cost of service, the tax benefits attributable to accelerated depreciation were normalized in accordance with Commission B policy and were not flowed thru to ratepayers. The data originally filed in Case was updated in the course of proceedings. In establishing the rate base on which Taxpayer was to be allowed to earn a return Commission B offset rate base by Taxpayer’s ADIT balance, using a 13-month average of the month-end balances of the relevant accounts. Taxpayer argued that the ADIT balance should be reduced by the amounts that Taxpayer calculates did not actually defer tax due to the presence of the NOLC, as represented in the deferred tax asset account. Testimony by various other participants in Case argued against Taxpayer’s proposed calculation of ADIT.

On Date C, a settlement agreement was filed with Commission B, incorporating the Taxpayer’s proposed treatment of the tax consequences of its NOLC. In an order issued on Date D, Commission B issued an order approving the settlement agreement and also ordered Taxpayer to seek a ruling on the effects of an NOLC on ADIT. Rates went into effect on Date E.

Taxpayer proposed, and Commission B accepted, that it be permitted to annualize, rather than average, its reliability plant additions and to extend the period of anticipated reliability plant additions to be included in rate base for an additional eight months. Taxpayer also proposed, and Commission B accepted, that no additional ADIT be reflected as a result of these adjustments inasmuch as any additional book and tax depreciation produced by considering these assets would simply increase Taxpayer’s NOLC and thus there would be no net impact on ADIT.

Taxpayer requests that we rule as follows:

1. Under the circumstances described above, the reduction of Taxpayer’s rate base by the full amount of its ADIT account balances offset by a portion of its NOLC-related account balance that is less than the amount attributable to accelerated depreciation computed on a “with or without” basis would be inconsistent with the requirements of § 168(i)(9) and § 1.167(l)-1 of the Income Tax regulations.

2. The imputation of incremental ADIT on account of the reliability plant addition adjustments described above would be inconsistent with the requirements of § 168(i)(9) and § 1.167(l)-1.

LAW AND ANALYSIS

Section 168(f)(2) of the Code provides that the depreciation deduction determined under section 168 shall not apply to any public utility property (within the meaning of section 168(i)(10)) if the taxpayer does not use a normalization method of accounting.

In order to use a normalization method of accounting, section 168(i)(9)(A)(i) of the Code requires the taxpayer, in computing its tax expense for establishing its cost of service for ratemaking purposes and reflecting operating results in its regulated books of account, to use a method of depreciation with respect to public utility property that is the same as, and a depreciation period for such property that is not shorter than, the method and period used to compute its depreciation expense for such purposes. Under section 168(i)(9)(A)(ii), if the amount allowable as a deduction under section 168 differs from the amount that-would be allowable as a deduction under section 167 using the method, period, first and last year convention, and salvage value used to compute regulated tax expense under section 168(i)(9)(A)(i), the taxpayer must make adjustments to a reserve to reflect the deferral of taxes resulting from such difference.

Section 168(i)(9)(B)(i) of the Code provides that one way the requirements of section 168(i)(9)(A) will not be satisfied is if the taxpayer, for ratemaking purposes, uses a procedure or adjustment which is inconsistent with such requirements. Under section 168(i)(9)(B)(ii), such inconsistent procedures and adjustments include the use of an estimate or projection of the taxpayer’s tax expense, depreciation expense, or reserve for deferred taxes under section 168(i)(9)(A)(ii), unless such estimate or projection is also used, for ratemaking purposes, with respect to all three of these items and with respect to the rate base.

Former section 167(l) of the Code generally provided that public utilities were entitled to use accelerated methods for depreciation if they used a “normalization method of accounting.” A normalization method of accounting was defined in former section 167(l)(3)(G) in a manner consistent with that found in section 168(i)(9)(A). Section 1.167(1)-1(a)(1) of the Income Tax Regulations provides that the normalization requirements for public utility property pertain only to the deferral of federal income tax liability resulting from the use of an accelerated method of depreciation for computing the allowance for depreciation under section 167 and the use of straight-line depreciation for computing tax expense and depreciation expense for purposes of establishing cost of services and for reflecting operating results in regulated books of account. These regulations do not pertain to other book-tax timing differences with respect to state income taxes, F.I.C.A. taxes, construction costs, or any other taxes and items.

Section 1.167(l)-1(h)(1)(i) provides that the reserve established for public utility property should reflect the total amount of the deferral of federal income tax liability resulting from the taxpayer’s use of different depreciation methods for tax and ratemaking purposes.

Section 1.167(1)-1(h)(1)(iii) provides that the amount of federal income tax liability deferred as a result of the use of different depreciation methods for tax and ratemaking purposes is the excess (computed without regard to credits) of the amount the tax liability would have been had the depreciation method for ratemaking purposes been used over the amount of the actual tax liability. This amount shall be taken into account for the taxable year in which the different methods of depreciation are used. If, however, in respect of any taxable year the use of a method of depreciation other than a subsection (1) method for purposes of determining the taxpayer’s reasonable allowance under section 167(a) results in a net operating loss carryover to a year succeeding such taxable year which would not have arisen (or an increase in such carryover which would not have arisen) had the taxpayer determined his reasonable allowance under section 167(a) using a subsection (1) method, then the amount and time of the deferral of tax liability shall be taken into account in such appropriate time and manner as is satisfactory to the district director.

Section 1.167(1)-1(h)(2)(i) provides that the taxpayer must credit this amount of deferred taxes to a reserve for deferred taxes, a depreciation reserve, or other reserve account. This regulation further provides that, with respect to any account, the aggregate amount allocable to deferred tax under section 167(1) shall not be reduced except to reflect the amount for any taxable year by which Federal income taxes are greater by reason of the prior use of different methods of depreciation. That section also notes that the aggregate amount allocable to deferred taxes may be reduced to reflect the amount for any taxable year by which federal income taxes are greater by reason of the prior use of different methods of depreciation under section 1.167(1)-1(h)(1)(i) or to reflect asset retirements or the expiration of the period for depreciation used for determining the allowance for depreciation under section 167(a).

Section 1.167(1)-(h)(6)(i) provides that, notwithstanding the provisions of subparagraph (1) of that paragraph, a taxpayer does not use a normalization method of regulated accounting if, for ratemaking purposes, the amount of the reserve for deferred taxes under section 167(l) which is excluded from the base to which the taxpayer’s rate of return is applied, or which is treated as no-cost capital in those rate cases in which the rate of return is based upon the cost of capital, exceeds the amount of such reserve for deferred taxes for the period used in determining the taxpayer’s expense in computing cost of service in such ratemaking.

Section 1.167(1)-(h)(6)(ii) provides that, for the purpose of determining the maximum amount of the reserve to be excluded from the rate base (or to be included as no-cost capital) under subdivision (i), above, if solely an historical period is used to determine depreciation for Federal income tax expense for ratemaking purposes, then the amount of the reserve account for that period is the amount of the reserve (determined under section 1.167(1)-1(h)(2)(i)) at the end of the historical period. If such determination is made by reference both to an historical portion and to a future portion of a period, the amount of the reserve account for the period is the amount of the reserve at the end of the historical portion of the period and a pro rata portion of the amount of any projected increase to be credited or decrease to be charged to the account during the future portion of the period.

Section 1.167(l)-1(h) requires that a utility must maintain a reserve reflecting the total amount of the deferral of federal income tax liability resulting from the taxpayer’s use of different depreciation methods for tax and ratemaking purposes. Taxpayer has done so. Section 1.167(1)-(h)(6)(i) provides that a taxpayer does not use a normalization method of regulated accounting if, for ratemaking purposes, the amount of the reserve for deferred taxes which is excluded from the base to which the taxpayer’s rate of return is applied, or which is treated as no-cost capital in those rate cases in which the rate of return is based upon the cost of capital, exceeds the amount of such reserve for deferred taxes for the period used in determining the taxpayer’s expense in computing cost of service in such ratemaking. Section 56(a)(1)(D) provides that, with respect to public utility property the Secretary shall prescribe the requirements of a normalization method of accounting for that section.

In Case, Commission B has reduced rate base by Taxpayer’s ADIT account, as modified by the account which Taxpayer has designed to calculate the effects of the NOLC. Section 1.167(1)-1(h)(1)(iii) makes clear that the effects of an NOLC must be taken into account for normalization purposes. Further, while that section provides no specific mandate on methods, it does provide that the Service has discretion to determine whether a particular method satisfies the normalization requirements. Section 1.167(1)-(h)(6)(i) provides that a taxpayer does not use a normalization method of regulated accounting if, for ratemaking purposes, the amount of the reserve for deferred taxes which is excluded from the base to which the taxpayer’s rate of return is applied, or which is treated as no-cost capital in those rate cases in which the rate of return is based upon the cost of capital, exceeds the amount of such reserve for deferred taxes for the period used in determining the taxpayer’s expense in computing cost of service in such ratemaking. Because the ADIT account, the reserve account for deferred taxes, reduces rate base, it is clear that the portion of an NOLC that is attributable to accelerated depreciation must be taken into account in calculating the amount of the reserve for deferred taxes (ADIT). Thus, the order by Commission B is in accord with the normalization requirements. The “with or without” methodology employed by Taxpayer is specifically designed to ensure that the portion of the NOLC attributable to accelerated depreciation is correctly taken into account by maximizing the amount of the NOLC attributable to accelerated depreciation. This methodology provides certainty and prevents the possibility of “flow through” of the benefits of accelerated depreciation to ratepayers. Under these facts, any method other than the “with and without” method would not provide the same level of certainty and therefore the use of any other methodology is inconsistent with the normalization rules.

Regarding the second issue, § 1.167(1)-(h)(6)(i) provides, as noted above, that a taxpayer does not use a normalization method of regulated accounting if, for ratemaking purposes, the amount of the reserve for deferred taxes which is excluded from the base to which the taxpayer’s rate of return is applied exceeds the amount of such reserve for deferred taxes for the period used in determining the taxpayer’s expense in computing cost of service in such ratemaking. Increasing Taxpayer’s ADIT account by an amount representing those taxes that would have been deferred absent the NOLC increases the ADIT reserve account (which will then reduce rate base) beyond the permissible amount.

We rule as follows:

1. Under the circumstances described above, the reduction of Taxpayer’s rate base by the full amount of its ADIT account balances offset by a portion of its NOLC-related account balance that is less than the amount attributable to accelerated depreciation computed on a “with or without” basis would be inconsistent with the requirements of § 168(i)(9) and § 1.167(l)-1 of the Income Tax regulations.
2. The imputation of incremental ADIT on account of the reliability plant addition adjustments described above would be inconsistent with the requirements of § 168(i)(9) and § 1.167(l)-1.

This ruling is based on the representations submitted by Taxpayer and is only valid if those representations are accurate. The accuracy of these representations is subject to verification on audit.

Except as specifically determined above, no opinion is expressed or implied concerning the Federal income tax consequences of the matters described above.

This ruling is directed only to the taxpayer who requested it. Section 6110(k)(3) of the Code provides it may not be used or cited as precedent. In accordance with the power of attorney on file with this office, a copy of this letter is being sent to your authorized representative. We are also sending a copy of this letter ruling to the Director.

Sincerely,

Peter C. Friedman
Senior Technician Reviewer,
Branch 6
(Passthroughs & Special Industries)

cc:
* * *



IRS LTR: Utility's Normalization Methodology Is Proper.

The IRS ruled that a utility company would violate section 167 normalization rules by using any depreciation methodology other than the one it is using, by increasing its accumulated deferred income tax account by specified amounts, or by reducing its tax expense element of cost of service to reflect its net operating loss carryover.

Citations: LTR 201436037

Third Party Communication: None
Date of Communication: Not Applicable
Person To Contact: * * *, ID No. * * *
Telephone Number: * * *

Index Number: 167.22-01
Release Date: 9/5/2014
Date: May 22, 2014

Refer Reply To: CC:PSI:B06 – PLR-148310-13

LEGEND:

Taxpayer = * * *
Parent = * * *
State A = * * *
State B = * * *
State C = * * *
Commission A = * * *
Commission B = * * *
Commission C = * * *
Year A = * * *
Year B = * * *
Date A = * * *
Date B = * * *
Date C = * * *
Case = * * *
Director = * * *

Dear * * *:

This letter responds to the request, dated November 25, 2013, of Taxpayer for a ruling on the application of the normalization rules of the Internal Revenue Code to certain accounting and regulatory procedures, described below.

The representations set out in your letter follow.

Taxpayer is a regulated public utility incorporated in State A and State B. It is wholly owned by Parent. Taxpayer is engaged in the transmission, distribution, and supply of electricity in State A and State C. Taxpayer is subject to the regulatory jurisdiction of Commission A, Commission B, and Commission C with respect to terms and conditions of service and particularly the rates it may charge for the provision of service. Taxpayer’s rates are established on a rate of return basis. Taxpayer takes accelerated depreciation, including “bonus depreciation” where available and, for each year beginning in Year A and ending in Year B, Taxpayer individually (as well as the consolidated return filed by Parent) has or expects to, produce a net operating loss (NOL). On its regulatory books of account, Taxpayer “normalizes” the differences between regulatory depreciation and tax depreciation. This means that, where accelerated depreciation reduces taxable income, the taxes that a taxpayer would have paid if regulatory depreciation (instead of accelerated tax depreciation) were claimed constitute “cost-free capital” to the taxpayer. A taxpayer that normalizes these differences, like Taxpayer, maintains a reserve account showing the amount of tax liability that is deferred as a result of the accelerated depreciation. This reserve is the accumulated deferred income tax (ADIT) account. Taxpayer maintains an ADIT account. In addition, Taxpayer maintains an offsetting series of entries — a “deferred tax asset” and a “deferred tax expense” — that reflect that portion of those ‘tax losses’ which, while due to accelerated depreciation, did not actually defer tax because of the existence of an net operating loss carryover (NOLC). Taxpayer, for normalization purposes, calculates the portion of the NOLC attributable to accelerated depreciation using a “with or without” methodology, meaning that an NOLC is attributable to accelerated depreciation to the extent of the lesser of the accelerated depreciation or the NOLC.

Taxpayer filed a general rate case with Commission B on Date A (Case). The test year used in the Case was the 12 month period ending on Date B. In computing its income tax expense element of cost of service, the tax benefits attributable to accelerated depreciation were normalized in accordance with Commission B policy and were not flowed thru to ratepayers. The data originally filed in Case included six months of forecast data, which the Taxpayer updated with actual data in the course of proceedings. In establishing the rate base on which Taxpayer was to be allowed to earn a return Commission B offset rate base by Taxpayer’s ADIT balance, using a 13-month average of the month-end balances of the relevant accounts. Taxpayer argued that the ADIT balance should be reduced by the amounts that Taxpayer calculates did not actually defer tax due to the presence of the NOLC, as represented in the deferred tax asset account. Testimony by various other participants in Case argued against Taxpayer’s proposed calculation of ADIT. One proposal made to Commission B was, if Commission B allowed Taxpayer to reduce the ADIT balance as Taxpayer proposed, then Taxpayer’s income tax expense element of service should be reduced by that same amount.

Commission B, in an order issued on Date C, allowed Taxpayer to reduce ADIT by the amount that Taxpayer calculates did not actually defer tax due to the presence of the NOLC and ordered Taxpayer to seek a ruling on the effects of an NOLC on ADIT. Rates went into effect on Date C.

Taxpayer proposed, and Commission B accepted, that it be permitted to annualize, rather than average, its reliability plant additions and to extend the period of anticipated reliability plant additions to be included in rate base for an additional quarter. Taxpayer also proposed, and Commission B accepted, that no additional ADIT be reflected as a result of these adjustments inasmuch as any additional book and tax depreciation produced by considering these assets would simply increase Taxpayer’s NOLC and thus there would be no net impact on ADIT.

Taxpayer requests that we rule as follows:

1. Under the circumstances described above, the reduction of Taxpayer’s rate base by the full amount of its ADIT account balances offset by a portion of its NOLC-related account balance that is less than the amount attributable to accelerated depreciation computed on a “with or without” basis would be inconsistent with the requirements of § 168(i)(9) and § 1.167(l)-1 of the Income Tax regulations.

2. The imputation of incremental ADIT on account of the reliability plant addition adjustments described above would be inconsistent with the requirements of § 168(i)(9) and § 1.167(l)-1.

3. Under the circumstances described above, any reduction in Taxpayer’s tax expense element of cost of service to reflect the tax benefit of its NOLC would be inconsistent with the requirements of § 168(i)(9) and § 1.167(l)-1.

LAW AND ANALYSIS

Section 168(f)(2) of the Code provides that the depreciation deduction determined under section 168 shall not apply to any public utility property (within the meaning of section 168(i)(10)) if the taxpayer does not use a normalization method of accounting.

In order to use a normalization method of accounting, section 168(i)(9)(A)(i) of the Code requires the taxpayer, in computing its tax expense for establishing its cost of service for ratemaking purposes and reflecting operating results in its regulated books of account, to use a method of depreciation with respect to public utility property that is the same as, and a depreciation period for such property that is not shorter than, the method and period used to compute its depreciation expense for such purposes. Under section 168(i)(9)(A)(ii), if the amount allowable as a deduction under section 168 differs from the amount that-would be allowable as a deduction under section 167 using the method, period, first and last year convention, and salvage value used to compute regulated tax expense under section 168(i)(9)(A)(i), the taxpayer must make adjustments to a reserve to reflect the deferral of taxes resulting from such difference.

Section 168(i)(9)(B)(i) of the Code provides that one way the requirements of section 168(i)(9)(A) will not be satisfied is if the taxpayer, for ratemaking purposes, uses a procedure or adjustment which is inconsistent with such requirements. Under section 168(i)(9)(B)(ii), such inconsistent procedures and adjustments include the use of an estimate or projection of the taxpayer’s tax expense, depreciation expense, or reserve for deferred taxes under section 168(i)(9)(A)(ii), unless such estimate or projection is also used, for ratemaking purposes, with respect to all three of these items and with respect to the rate base.

Former section 167(l) of the Code generally provided that public utilities were entitled to use accelerated methods for depreciation if they used a “normalization method of accounting.” A normalization method of accounting was defined in former section 167(l)(3)(G) in a manner consistent with that found in section 168(i)(9)(A). Section 1.167(1)-1(a)(1) of the Income Tax Regulations provides that the normalization requirements for public utility property pertain only to the deferral of federal income tax liability resulting from the use of an accelerated method of depreciation for computing the allowance for depreciation under section 167 and the use of straight-line depreciation for computing tax expense and depreciation expense for purposes of establishing cost of services and for reflecting operating results in regulated books of account. These regulations do not pertain to other book-tax timing differences with respect to state income taxes, F.I.C.A. taxes, construction costs, or any other taxes and items.

Section 1.167(l)-1(h)(1)(i) provides that the reserve established for public utility property should reflect the total amount of the deferral of federal income tax liability resulting from the taxpayer’s use of different depreciation methods for tax and ratemaking purposes.

Section 1.167(1)-1(h)(1)(iii) provides that the amount of federal income tax liability deferred as a result of the use of different depreciation methods for tax and ratemaking purposes is the excess (computed without regard to credits) of the amount the tax liability would have been had the depreciation method for ratemaking purposes been used over the amount of the actual tax liability. This amount shall be taken into account for the taxable year in which the different methods of depreciation are used. If, however, in respect of any taxable year the use of a method of depreciation other than a subsection (1) method for purposes of determining the taxpayer’s reasonable allowance under section 167(a) results in a net operating loss carryover to a year succeeding such taxable year which would not have arisen (or an increase in such carryover which would not have arisen) had the taxpayer determined his reasonable allowance under section 167(a) using a subsection (1) method, then the amount and time of the deferral of tax liability shall be taken into account in such appropriate time and manner as is satisfactory to the district director.

Section 1.167(1)-1(h)(2)(i) provides that the taxpayer must credit this amount of deferred taxes to a reserve for deferred taxes, a depreciation reserve, or other reserve account. This regulation further provides that, with respect to any account, the aggregate amount allocable to deferred tax under section 167(1) shall not be reduced except to reflect the amount for any taxable year by which Federal income taxes are greater by reason of the prior use of different methods of depreciation. That section also notes that the aggregate amount allocable to deferred taxes may be reduced to reflect the amount for any taxable year by which federal income taxes are greater by reason of the prior use of different methods of depreciation under section 1.167(1)-1(h)(1)(i) or to reflect asset retirements or the expiration of the period for depreciation used for determining the allowance for depreciation under section 167(a).

Section 1.167(1)-(h)(6)(i) provides that, notwithstanding the provisions of subparagraph (1) of that paragraph, a taxpayer does not use a normalization method of regulated accounting if, for ratemaking purposes, the amount of the reserve for deferred taxes under section 167(l) which is excluded from the base to which the taxpayer’s rate of return is applied, or which is treated as no-cost capital in those rate cases in which the rate of return is based upon the cost of capital, exceeds the amount of such reserve for deferred taxes for the period used in determining the taxpayer’s expense in computing cost of service in such ratemaking.

Section 1.167(1)-(h)(6)(ii) provides that, for the purpose of determining the maximum amount of the reserve to be excluded from the rate base (or to be included as no-cost capital) under subdivision (i), above, if solely an historical period is used to determine depreciation for Federal income tax expense for ratemaking purposes, then the amount of the reserve account for that period is the amount of the reserve (determined under section 1.167(1)-1(h)(2)(i)) at the end of the historical period. If such determination is made by reference both to an historical portion and to a future portion of a period, the amount of the reserve account for the period is the amount of the reserve at the end of the historical portion of the period and a pro rata portion of the amount of any projected increase to be credited or decrease to be charged to the account during the future portion of the period.

Section 1.167(l)-1(h) requires that a utility must maintain a reserve reflecting the total amount of the deferral of federal income tax liability resulting from the taxpayer’s use of different depreciation methods for tax and ratemaking purposes. Taxpayer has done so. Section 1.167(1)-(h)(6)(i) provides that a taxpayer does not use a normalization method of regulated accounting if, for ratemaking purposes, the amount of the reserve for deferred taxes which is excluded from the base to which the taxpayer’s rate of return is applied, or which is treated as no-cost capital in those rate cases in which the rate of return is based upon the cost of capital, exceeds the amount of such reserve for deferred taxes for the period used in determining the taxpayer’s expense in computing cost of service in such ratemaking. Section 56(a)(1)(D) provides that, with respect to public utility property the Secretary shall prescribe the requirements of a normalization method of accounting for that section.

In Case, Commission B has reduced rate base by Taxpayer’s ADIT account, as modified by the account which Taxpayer has designed to calculate the effects of the NOLC. Section 1.167(1)-1(h)(1)(iii) makes clear that the effects of an NOLC must be taken into account for normalization purposes. Further, while that section provides no specific mandate on methods, it does provide that the Service has discretion to determine whether a particular method satisfies the normalization requirements. Section 1.167(1)-(h)(6)(i) provides that a taxpayer does not use a normalization method of regulated accounting if, for ratemaking purposes, the amount of the reserve for deferred taxes which is excluded from the base to which the taxpayer’s rate of return is applied, or which is treated as no-cost capital in those rate cases in which the rate of return is based upon the cost of capital, exceeds the amount of such reserve for deferred taxes for the period used in determining the taxpayer’s expense in computing cost of service in such ratemaking. Because the ADIT account, the reserve account for deferred taxes, reduces rate base, it is clear that the portion of an NOLC that is attributable to accelerated depreciation must be taken into account in calculating the amount of the reserve for deferred taxes (ADIT). Thus, the order by Commission B is in accord with the normalization requirements. The “with or without” methodology employed by Taxpayer is specifically designed to ensure that the portion of the NOLC attributable to accelerated depreciation is correctly taken into account by maximizing the amount of the NOLC attributable to accelerated depreciation. This methodology provides certainty and prevents the possibility of “flow through” of the benefits of accelerated depreciation to ratepayers. Under these facts, any method other than the “with and without” method would not provide the same level of certainty and therefore the use of any other methodology is inconsistent with the normalization rules.

Regarding the second issue, § 1.167(1)-(h)(6)(i) provides, as noted above, that a taxpayer does not use a normalization method of regulated accounting if, for ratemaking purposes, the amount of the reserve for deferred taxes which is excluded from the base to which the taxpayer’s rate of return is applied exceeds the amount of such reserve for deferred taxes for the period used in determining the taxpayer’s expense in computing cost of service in such ratemaking. Increasing Taxpayer’s ADIT account by an amount representing those taxes that would have been deferred absent the NOLC increases the ADIT reserve account (which will then reduce rate base) beyond the permissible amount.

Regarding the third issue, reduction of Taxpayer’s tax expense element of cost of service, we believe that such reduction would, in effect, flow through the tax benefits of accelerated depreciation deductions through to rate payers even though the Taxpayer has not yet realized such benefits. This would violate the normalization provisions.

We rule as follows:

1. Under the circumstances described above, the reduction of Taxpayer’s rate base by the full amount of its ADIT account balances offset by a portion of its NOLC-related account balance that is less than the amount attributable to accelerated depreciation computed on a “with or without” basis would be inconsistent with the requirements of § 168(i)(9) and § 1.167(l)-1 of the Income Tax regulations.

2. The imputation of incremental ADIT on account of the reliability plant addition adjustments described above would be inconsistent with the requirements of § 168(i)(9) and § 1.167(l)-1.

3. Under the circumstances described above, any reduction in Taxpayer’s tax expense element of cost of service to reflect the tax benefit of its NOLC would be inconsistent with the requirements of § 168(i)(9) and § 1.167(l)-1.

This ruling is based on the representations submitted by Taxpayer and is only valid if those representations are accurate. The accuracy of these representations is subject to verification on audit.

Except as specifically determined above, no opinion is expressed or implied concerning the Federal income tax consequences of the matters described above.

This ruling is directed only to the taxpayer who requested it. Section 6110(k)(3) of the Code provides it may not be used or cited as precedent. In accordance with the power of attorney on file with this office, a copy of this letter is being sent to your authorized representative. We are also sending a copy of this letter ruling to the Director.

Sincerely,

Peter C. Friedman
Senior Technician Reviewer,
Branch 6
(Passthroughs & Special Industries)
cc:
* * *



FASB Advisory Group Expects Challenges With New Nonprofit Rules.

An advisory group of the Financial Accounting Standards Board on September 4 expressed general support for the board’s efforts to improve nonprofit organizations’ financial statements but also identified challenges that could result from the significant changes being proposed.

At a meeting in Norwalk, Connecticut, members of FASB’s Not-for-Profit Advisory Committee (NAC) expressed concern about the complexity associated with the board’s tentative decisions on the treatment of capital donations and the proposed disclosure of those gifted assets throughout the nonprofit entity’s statement of activities.

NAC member John A. Mattie of PricewaterhouseCoopers LLP said one of the primary goals of the board’s project was to improve the consistency and comparability of financial reporting across the nonprofit industry. Despite those benefits, the proposed rule changes could put more pressure on financial statement preparers regarding the footnote disclosures that must support the nonprofit’s accounting decisions, he said, adding that FASB’s guidance should provide several illustrative examples of those disclosures.

NAC member Michael B. Tarnoff of the Jewish Federation of Metropolitan Chicago said he believes that the rule changes under discussion would motivate nonprofit organizations and their governing boards to ensure that the financial statements reflect how they behave under the policies they’ve adopted. “I see it as an excellent result that we’re moving toward,” he said.

NAC member Bennett Weiner of the Better Business Bureau Wise Giving Alliance said the proposed footnote disclosure communicating information about a nonprofit’s liquidity will provide value to the organization and users of its financial statements.

According to Weiner, the proposed disclosure requirement on liquidity could bring attention to an issue that has been neglected by several nonprofits for a variety of reasons.

However, Weiner expressed concern that some of the changes to nonprofit financial statements being proposed may create differences between the information provided in audited financials and Form 990, “Return of Organization Exempt From Income Tax,” or other government filings. But those differences shouldn’t necessarily dictate what the boards decide because the wheels of government turn slowly, and any change to those documents would represent a significant hurdle, he added.

Jeffrey Mechanick, an assistant director at FASB, said the staff will attempt to perform outreach with some government agencies to the extent that those organizations have the time and ability to contribute, adding that the IRS Tax-Exempt and Government Entities Division could provide valuable feedback on FASB’s project on nonprofit reporting.

FASB member Lawrence Smith admitted that developing accounting standards for the nonprofit sector is particularly challenging because of the wide variety of nonprofits that exist. Although some are strictly nonprofit operations, others are funded by government agencies or operate like for-profit businesses, he noted.

Smith said that while FASB should consider the views of financial statement preparers, users, and auditors when making standard setting decisions, board members must keep the statement users at the front of their minds in deciding how to address a particular accounting issue.

FASB cannot gear nonprofit financial statements toward all users that could provide contributions to an organization, Mechanick said. He added that the board receives the most feedback from grant-making foundations and surrogates for donors, such as watchdog agencies and regulatory bodies.

Concerns With Revenue Standard

At a September 5 meeting with FASB, NAC members said they anticipated that the board’s transition resource group may need to address the implementation problems that nonprofits have regarding the guidance in Accounting Standards Update No. 2014-09, “Revenue From Contracts With Customers (Topic 606).” NAC members expressed particular concern about applying the new revenue standard to healthcare payments and government grants such as social impact bonds.

FASB Chair Russell Golden said the board will provide staff resources to help nonprofit organizations better interpret the revenue recognition guidance, but he advised those entities to confirm whether their implementation problems apply to the existing guidance under U.S. generally accepted accounting principles, the new standard issued in May, or both.

Mechanick added that the implementation problems of healthcare entities and nonprofit organizations also may be examined by the industry task forces that were established by the American Institute of Certified Public Accountants to assist with application of the new guidance. The AICPA Financial Reporting Executive Committee plans to provide its own accounting guide on FASB’s revenue standard, he said.

Thomas Jaworski



IRS Approves Proposed Allocations of Build America Bond Proceeds.

The IRS ruled that the owner of a power plant can make allocations of Build America Bond proceeds, and the expenditure of earnings that accrue after the project period from the investment of sale proceeds of the bonds in a reasonably required reserve to pay principal and non-capital interest will not cause the bonds to fail to be qualified bonds.

Citations: LTR 201435013

Third Party Communication: None
Date of Communication: Not Applicable
Person To Contact: * * *, ID No. * * *
Telephone Number: * * *

Index Number: 148.00-00, 148.02-00, 141.01-01, 54AA.00-00
Release Date: 8/29/2014
Date: May 21, 2014

Refer Reply To: CC:FIP:05 – PLR-148383-13

LEGEND:

Issuer = * * *
Issue 1 = * * *
Issue 2 = * * *
Issue 3 = * * *
Issue 4 = * * *
Date 5 = * * *
Date 1 = * * *
Date 2 = * * *
Date 3 = * * *
Date 4 = * * *
a = * * *
Date 6 = * * *

Dear * * *:

This letter is in response to your request for rulings that (1) the Issuer can make certain proposed allocations related to Issue 2, Issue 3, and Issue 4 under sections 1.141-6(a) and 1.148-6 of the Income Tax Regulations as described below; (2) the expenditure of earnings that accrue subsequent to the project period (within the meaning of section 1.141-1) from the investment of sale proceeds of Issue 3 and Issue 4 in a reasonably required reserve to pay principal and interest that is not a capital expenditure (non-capital interest) on an issue will not cause Issue 3 and Issue 4 to fail to be qualified bonds within the meaning of section 54AA(g)(2); and (3) section 1.148-6(d)(3)(ii)(A)(7) may be applied to account for the expenditure of proceeds of Issue 3 and Issue 4.

FACTS AND REPRESENTATIONS

The Issuer makes the following representations. The Issuer has an undivided ownership interest in an electric generating facility (the Issuer’s portion of this facility is referred to herein as the Project). The Project was not placed in service before Date 5. To finance the Project, the Issuer issued four issues of tax-advantaged bonds: (1) Issue 1, issued as tax-exempt bonds on Date 1, (2) Issue 2, issued as tax-exempt bonds on Date 2, (3) Issue 3, issued as direct pay build America bonds on Date 3, and (4) Issue 4, issued as direct pay build America bonds on Date 4 (Issue 2, Issue 3, and Issue 4 collectively, the Bonds). The Bonds are secured by a parity reserve fund which consists in part of some sale proceeds of Issue 3 and Issue 4. The Issuer represents that this parity reserve fund is a reasonably required reserve under section 148(d) and section 1.148-2(f) with respect to the Bonds. The Issuer expects the total costs of the Project to be lower than estimated as of the issue date of Issue 4 by $a, and thus the Issuer will have unspent proceeds in this amount (the Unspent Amount).

Prior to Date 6, the Issuer had allocated its capital expenditures to proceeds of Issue 1 and the Bonds such that an amount of proceeds of Issue 4 equal to the Unspent Amount was not allocated to any capital expenditure. The Issuer proposes to revise its allocations of expenses to proceeds of the Bonds as described in the Issuer’s request for this ruling (the Proposed Allocations) no later than the date that is 18 months after Date 5 and the date that is 60 days after the fifth anniversary of the issue of the Bonds to which it will allocate its expenditures. At the time that each of the expenses comprising the Proposed Allocations was actually paid, the Issuer had on hand sufficient proceeds of the specific issue of the Bonds to which the expense is allocated under the Proposed Allocations to pay the expense. The Issuer will allocate investments to proceeds of the Bonds for arbitrage and rebate purposes in a manner that is consistent with the Proposed Allocations.

The Issuer also proposes to deposit earnings that accrue subsequent to the project period, as defined in section 1.141-1(b), from the investment of sale proceeds of Issue 3 and Issue 4 in a reasonably required reserve into a bona fide debt service fund and use those earnings to pay principal or interest.

LAW AND ANALYSIS

Revision of Allocations

Section 103(a) provides that, except as provided in subsection (b), gross income does not include interest on any state or local bond. Section 103(b)(1) provides that subsection (a) shall not apply to any private activity bond which is not a qualified bond (within the meaning of section 141). Section 103(b)(2) provides that subsection (a) shall not apply to any arbitrage bond (within the meaning of section 148).

Section 141(a) provides that the term “private activity bond” means any bond issued as part of an issue which (1) meets the private business use test of section 141(b)(1) and the private security or payment test of section 141(b)(2), or (2) meets the private loan financing test of section 141(c). Section 141(b)(1) provides, in general, that an issue meets the private business use test if more than 10 percent of the proceeds of the issue are to be used for any private business use.

Section 148(a) provides that the term “arbitrage bond” means any bond issued as part of an issue any portion of the proceeds of which are reasonably expected (at the time of issuance of the bond) to be used directly or indirectly (1) to acquire higher yielding investments, or (2) to replace funds which were used directly or indirectly to acquire higher yielding investments. Further, for purposes of section 148(a), a bond shall be treated as an arbitrage bond if the issuer intentionally uses any portion of the proceeds of the issue of which such bond is a part in a manner described in (1) or (2).

Section 148(f) provides, in part, that a bond is an arbitrage bond unless the issuer timely rebates to the United States the excess of the amount earned on certain nonpurpose investments over the amount that would be earned on those investments had those investments had a yield equal to the bond yield, plus any income attributable to the excess.

Section 1.141-6(a) provides that for purposes of sections 1.141-1 through 1.141-15, the provisions of section 1.148-6(d) apply for purposes of allocating proceeds to expenditures. Thus, allocations generally may be made using any reasonable, consistently applied accounting method, and allocations under sections 141 and 148 must be consistent with each other.

Section 1.148-6(a)(1) provides that an issuer may use any reasonable, consistently applied accounting method to account for gross proceeds, investments, and expenditures of an issue. However, under section 1.148-6(a)(3), if an issuer fails to maintain books and records sufficient to establish the accounting method for an issue and the allocation of the proceeds of that issue, the accounting and allocation rules under section 1.148-6 are applied using the specific tracing method.

Section 1.148-6(d)(1)(iii) provides that an issuer must account for the allocation of proceeds to expenditures not later than 18 months after the later of the date the expenditure is paid or the date the project, if any, that is financed by the issue is placed in service. This allocation must be made in any event by the date 60 days after the fifth anniversary of the issue date or the date 60 days after the retirement of the issue, if earlier.

Section 54AA(d)(1) provides that, for purposes of section 54AA, the term “build America bond” means any obligation (other than a private activity bond) if (A) the interest on such obligation would (but for section 54AA) be excludable from gross income under section 103; (B) such obligation is issued before January 1, 2011, and (C) the issuer makes an irrevocable election to have section 54AA apply.

The Issuer has requested that we rule on whether it can revise its allocations related to the Bonds under sections 1.141-6(a) and 1.148-6 as provided in the Proposed Allocations. The regulations under sections 141 and 148 apply to build America bonds as well as tax-exempt bonds because section 54AA(d)(1) defines a build America bond as other than a private activity bond and requires that, but for section 54AA, the interest on build America bonds be excludable from gross income under section 103. Accordingly, build America bonds cannot be private activity bonds under section 141 or arbitrage bonds under section 148 and are subject to the regulations under those sections to the extent that the regulations do not conflict with section 54AA.

By not requiring allocations to be determined when the expenditure is paid or incurred, the arbitrage regulations acknowledge that day-to-day practicalities require some flexibility regarding the timing of an issuer’s allocations. We conclude that these practicalities also require flexibility to change allocations, so long as those changes are made within the time frame provided under section 1.148-6(d)(1)(iii). Here, at the time that each of the expenses described in the Proposed Allocations was actually paid, the Issuer had on hand sufficient proceeds of the specific issue of the Bonds to which the expense is allocated under the Proposed Allocations to pay the expense. The Issuer will also allocate investments to proceeds of the Bonds for arbitrage and rebate purposes in a manner that is consistent with the Proposed Allocations.

The Issuer tentatively made the Proposed Allocations within the time frame provided in section 1.148-6(d)(1)(iii). The Project was not placed in service before Date 5, which date is fewer than 18 months prior to Date 6, the date on which the Proposed Allocations were made. Date 6 occurred before the date that is 60 days after the fifth anniversary of any of the issues of the Bonds, and none of the issues of the Bonds have been retired. We conclude that, because the time frame provided in section 1.148-6(d)(1)(iii) had not yet closed and because there were sufficient proceeds on hand when the expenditures were made, Issuer can make the Proposed Allocations under sections 1.141-6(a) and 1.148-6.

Earnings on Sale Proceeds of BABs in Reserve

Section 54AA(a) provides that if a taxpayer holds a build America bond (BAB) on one or more interest payment dates of the bond during any taxable year, there shall be allowed as a credit against income tax for the taxable year an amount equal to the sum of the credits determined under section 54AA(b) with respect to such dates. Subject to limitations under section 54AA(c), section 54AA(b) provides that the amount of the credit with respect to any interest payment date for a build America bond is 35 percent of the amount of interest payable by the issuer with respect to such date.

Section 54AA(g) provides a special rule for qualified bonds issued before January 1, 2011. In the case of a qualified bond issued before January 1, 2011, in lieu of any credit allowed under Section 54AA with respect to such bond, the issuer of such bond shall be allowed a credit as provided in Section 6431.

Section 54AA(g)(2) provides that for purposes of Section 54AA(g), the term “qualified bond” means any BAB issued as part of an issue if (A) 100 percent of the excess of (i) the available project proceeds (as defined in Section 54A) of such issue, over (ii) the amounts in a reasonably required reserve (within the meaning of Section 150(a)(3)) with respect to such issue, are to be used for capital expenditures; and (B) the issuer makes an irrevocable election to have Section 54AA(g) apply.

Section 54A(e)(4) provides that the term “available project proceeds” means (A) the excess of the proceeds from the sale of an issue, over the issuance costs financed by the issue (to the extent that such costs do not exceed 2 percent of such proceeds), and (B) the proceeds from any investment of the excess described in (A).

Section 150(a)(3) provides that the term “net proceeds” means, with respect to any issue, the proceeds of such issue reduced by amounts in a reasonably required reserve or replacement fund.

Section 1.141-1(b) provides that for purposes of applying sections 1.141-1 through 1.141-16, the term “project period” means the period beginning on the issue date and ending on the date that the project is placed in service.

Section 1.148-6(d)(3)(i) provides that, except as otherwise provided in paragraph (d)(3) or paragraph (d)(4), proceeds of an issue may only be allocated to working capital expenditures as of any date to the extent that those working capital expenditures exceed available amounts (as defined in paragraph (d)(3)(iii)) as of that date (i.e., a “proceeds-spent-last” method). Section 1.148-6(d)(3)(ii)(A)(7) provides that the general rule in paragraph (d)(3)(i) does not apply to expenditures to pay principal or interest on an issue paid from investment earnings on a reserve or replacement fund that are deposited in a bona fide debt service fund.

The Issuer has requested that we rule on whether the expenditure of earnings that accrue subsequent to the project period (within the meaning of section 1.141-1) from the investment of sale proceeds of Issue 3 and Issue 4 in a reasonably required reserve to pay principal and non-capital interest on an issue will not cause Issue 3 and Issue 4 to fail to be qualified bonds within the meaning of section 54AA(g)(2). It has also requested that we rule on whether section 1.148-6(d)(3)(ii)(A)(7) may be applied to account for the expenditure of proceeds of Issue 3 and Issue 4.

The plain language of section 54AA(g)(2)(A) does not answer the question of whether investment earnings on the sale proceeds of Issue 3 and Issue 4 in a reasonably required reserve may be used to pay principal and non-capital interest. The answer turns on whether such investment earnings are included in “available project proceeds” under section 54AA(g)(2)(A)(i) or in “the amounts in a reasonably required reserve” under section 54AA(g)(2)(A)(ii). Although section 54AA(g)(2)(A)(i) cross-references the definition of “available project proceeds” in section 54A(e)(4), proceeds of bonds issued under section 54A may not be used to fund a reasonably required reserve. Accordingly, the definition of “available project proceeds” in section 54A does not address investment earnings on sale proceeds deposited in a reasonably required reserve.

If earnings on sale proceeds of Issue 3 and Issue 4 in a reasonably required reserve are included in “available project proceeds” under section 54AA(g)(2)(A)(i), then the Issuer would be required to spend those earnings on capital expenditures long after the Project is complete. We conclude, instead, that the earnings on the sale proceeds of Issue 3 and Issue 4 in a reasonably required reserve that accrue after the end of the project period, as defined in section 1.141-1(b), are not “available project proceeds” within the meaning of section 54AA(g)(2)(A)(i) and, therefore, may be used to pay principal and non-capital interest without causing Issue 3 and Issue 4 to fail to be qualified bonds under section 54AA(g)(2).

As stated above, Issue 3 and Issue 4 are build America bonds and, therefore, subject to the regulations under section 148 to the extent that the regulations do not conflict with section 54AA. For example, any working capital expenditures permitted under section 54AA must be allocated for arbitrage purposes to the proceeds of Issue 3 and Issue 4 using a proceeds-spent-last method, as provided in section 1.148-6(d)(3)(i). We conclude that section 1.148-6(d)(3)(ii)(A)(7) applies to preclude application of the proceeds-spent-last method of allocation to the payment of principal or interest from earnings on sale proceeds of Issue 3 and Issue 4 in the reasonably required reserve that accrue after the end of the project period and that are first deposited in a bona fide debt service fund.

CONCLUSION

Based strictly on the information submitted and representations made, we conclude that (1) the Issuer can make the Proposed Allocations under sections 1.141-6(a) and 1.148-6; (2) the expenditure of earnings that accrue subsequent to the project period (within the meaning of section 1.141-1) from the investment of sale proceeds of Issue 3 and Issue 4 in a reasonably required reserve to pay principal and non-capital interest on an issue will not cause Issue 3 and Issue 4 to fail to be qualified bonds within the meaning of section 54AA(g)(2); and (3) section 1.148-6(d)(3)(ii)(A)(7) may be applied as provided above to account for the expenditure of proceeds of Issue 3 and Issue 4.

Except as expressly provided herein, no opinion is expressed or implied concerning the tax consequences of any aspect of any transaction or item discussed or referenced in this letter. Specifically, we express no opinion on any allocations related to Issue 1, whether Issue 1 or Issue 2 are tax-exempt under section 103, or whether Issue 3 or Issue 4 are build America bonds under section 54AA.

This ruling is directed only to the taxpayer requesting it. Section 6110(k)(3) of the Code provides that it may not be used or cited as precedent.

In accordance with the Power of Attorney on file with this office, a copy of this letter is being sent to your authorized representative.

The rulings contained in this letter are based upon information and representations submitted by the taxpayer and accompanied by a penalty of perjury statement executed by an appropriate party. While this office has not verified any of the material submitted in support of the request for rulings, it is subject to verification on examination.

Sincerely,

Timothy L. Jones
Senior Counsel
(Financial Institutions & Products)



Orrick: IRS Issues Additional Guidance on "Start Of Construction" Requirement for Renewable Energy Tax Credits.

On August 8, 2014, the IRS released Notice 2014-46, which provides additional guidance on the “start of construction” requirements for the investment tax credit (ITC) and production tax credit (PTC). As discussed below, Notice 2014-46 provides additional guidance on satisfying the physical work test, the effect of transfers of a facility after construction has begun, and also modifies the five percent safe harbor.

As a result of the American Taxpayer Relief Act of 2012, to claim ITC or PTC with respect to a renewable energy project, construction must have begun before January 1, 2014. The IRS has previously issued guidance on the start of construction requirements in Notices 2013-29 and 2013-60. Notice 2013-29 provides two methods by which to satisfy the start of construction requirement. One method is to perform physical work of a significant nature before January 1, 2014. The other method is to pay or incur five percent or more of the total cost of a facility before January 1, 2014 (the five percent safe harbor). In addition, work on the project must be “continuous” in order for either method to be met (by meeting a “continuous program of construction” test or a “continuous efforts” test, as applicable).

In Notice 2013-60, the IRS clarified Notice 2013-29 by (i) providing that the “continuous” work tests would be deemed met if a facility is placed in service before January 1, 2016, (ii) clarifying that a taxpayer could look through a master contract in certain situations for purposes of both the physical work test and the five percent safe harbor, and (iii) clarifying that the start of construction requirement can be met with respect to a facility even if the facility is later transferred to a different taxpayer who then places the facility in service.

Notice 2014-46 clarifies that there is no fixed minimum threshold amount of work that must be performed (or cost that must be paid or incurred) to satisfy the physical work test. Notice 2013-29 provided an example in which a taxpayer met the physical work test with respect to a 50 turbine wind farm by excavating foundations for 10 wind turbines (that is, 20% of the total turbines). Notice 2014-46 states that this example is not intended to indicate that there is a 20% minimum threshold amount of work that must be performed to satisfy the physical work test.

Notice 2014-46 also provides additional guidance with respect to transfers of a facility after construction has begun. The Notice provides that if a taxpayer begins construction of a facility in 2013 with the intent to develop a facility at a certain site, but thereafter transfers equipment and other components to a different site, the work performed or costs paid or incurred with respect to the first site will be taken into account in determining whether the start of construction requirement is met with respect to the facility placed in service at the second site. However, the Notice also provides that, in the case of a transfer consisting solely of tangible personal property between two unrelated parties, work performed or costs paid or incurred by the transferor will not be taken into account with respect to the transferee in determining whether the start of construction requirement is met. However, if the transferee is related to the transferor, the transferee can “piggyback” on the costs paid or work performed by the transferor. A transferor will be related to a transferee partnership if it has a more than 20% capital or profits interest in the transferee.

Finally, Notice 2014-46 modifies the five percent safe harbor by providing an exception for single projects that are comprised of multiple facilities which do not meet the overall five percent requirement. If a single project is comprised of multiple facilities (for example, a wind farm comprised of multiple wind turbines), and a taxpayer has paid or incurred at least three percent of the total cost of the facility before January 1, 2014, then the taxpayer will be treated as satisfying the five percent safe harbor with respect to some of the individual facilities so long as the total aggregate cost of those individual facilities is not greater than twenty times the amount the taxpayer paid or incurred before January 1, 2014. The following example illustrates this rule: A taxpayer incurs $30,000 in costs prior to January 1, 2014 with respect to a five turbine wind farm. The total cost of the wind farm is $800,000 and each turbine costs $160,000. The five percent test is not met with respect to the entire wind farm because the costs incurred prior to January 1, 2014 ($30,000) are less than five percent of the total cost of the wind farm ($40,000). However, under the modified safe harbor rule in Notice 2014-46, the taxpayer is treated as satisfying the five percent safe harbor with respect to three of the turbines. The total cost of three turbines ($480,000) is less than twenty times the amount of costs incurred prior to January 1, 2014 ($600,000).

Last Updated: August 21 2014
Article by Greg R. Riddle and Wolfram Pohl
Orrick

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.



NABL Issues Guidance for Certain Conduit Bond Deals.

WASHINGTON – Lawyers involved in a conduit bond financing for a charitable nonprofit organization should decide as soon as possible which of them is responsible for ensuring the tax-exempt status of the borrower, the National Association of Bond Lawyers concludes in a just-released paper.

The 24-page paper, called “The 501(c)(3) Opinion In Qualified 501(c)(3) Bond Transactions,” follows a few recent cases in which the Internal Revenue Service questioned the tax-exempt status of bonds after the nonprofit borrower lost its tax-exempt status because it failed to file Form 990s, which are annual financial reports.

However, NABL president Allen Robertson, a lawyer with Robinson, Bradshaw & Hinson in Charlotte, N.C., said that while the paper talks about the loss of tax-exempt status, it wasn’t prompted by anything other than a need to provide guidance where none existed.

“We’ve noted from our members that the predominant practice now is to rely on borrower’s counsel and that’s something that’s been developed over the last 20 or 30 years,” Robertson said.

But a lot of lawyers representing a charitable nonprofit are not used to giving opinions other than for conduit bond financings and there is no guidance for them to turn to in writing such opinions.

“”There wasn’t any sort of paper or treatise that borrower’s counsel or bond counsel could go to to sort of learn about the opinion, how you might phrase it, what it might mean, and the diligence that you need to do to support it,” Robertson said. “We felt we were really trying to fill a gap.”

NABL plans to send the paper to groups that might benefit from it, such as the National Association of Health and Educational Facilities Finance Authorities and the American Hospital Association. The majority of 501(c)(3) organizations are educational and health care entities, but others exist, he said.

The paper is divided into four parts. The first summarizes how a charitable nonprofit becomes and maintains its status as a 501(c)(3) organization. The second covers the 501(c)(3) opinion and interpretations of its core phrases and related provisions, as well as information of ancillary opinions that are sometimes needed. The third part addresses the due diligence needed to support the opinion, as well as federal tax matters that are important. The fourth part deals with additional due diligence that may be needed by either the borrower’s counsel or bond counsel.

In Part I, NABL says that to qualify as a 501(c)(3) organization, an entity: must be organized and operated for certain specified exempt purposes; is prohibited from using any of its net earnings for the benefit of a private shareholder or individual; cannot engage in activities that are related to a political campaign or that attempt to influence legislation; and must file annual Form 990s, which provide information on its finances.

The paper notes that there are additional requirements for organizations operating one or more hospital facilities as well as for those organizations that must comply with provisions of the Patient Protection and Affordable Care Act.

Most charitable organizations must apply to the IRS for 501(c)(3) status, but churches and certain religiously-affiliated entities such as schools and hospitals are exempted.

In Part II, NABL says the 501(c)(3) opinion should address two points. First, it should say whether the borrower is still a 501(c)(3) organization as of the date of the opinion, meaning its tax-exempt status has not been revoked. Second, it should say whether the borrower has continued to meet all of the requirements for a 501(c)(3) organization, meaning its tax-exempt status could not be revoked.

This section describes other opinions the borrower’s counsel might be asked to render. For example, the borrower’s counsel might be asked to provide a Section 513 opinion that states the bond-financed project is, or will not be, used in an unrelated trade or business.

In Part III, NABL lists the issues that the borrower’s counsel should investigate, such as whether the organization’s documents set forth its charitable purpose and provide for distribution of assets in the event of dissolution. Counsel should find out if the organization has been recognized and is currently recognized as having 501(c)(3) status as well as whether it has operated to further its exempt purpose.

Other key questions that must be probed are whether the organization has served private interests, engaged in political campaigning or excessive lobbying, or unrelated business activity. Finally, the borrower’s counsel should determine if the organization has met its Form 990 filing requirements.

NABL describes the documents that must be examined to make these determinations. It also details additional information that must be obtained for certain hospitals and health care borrowers as well requirements that must be met under the Affordable Care Act.

Part IV addresses the issue of whether bond counsel can exclusively rely on the 501(c)(3) opinion of borrower’s counsel. NABL said most bond counsel relying on such opinions typically state they are doing so.

THE BOND BUYER
BY LYNN HUME
AUG 26, 2014 3:33pm ET



IRS LTR: VEBA's Settlement Amount Is Exempt Function Income.

The IRS ruled that an amount paid to a limited liability company the sole member of which is a tax-exempt voluntary employees’ beneficiary association established as a result of a settlement agreement following a bankruptcy is exempt function income under section 512(a)(3)(B) and will not be treated as unrelated business taxable income.

Contact Person: * * *
Identification Number: * * *
Telephone Number: * * *

UIL: 501.09-00, 512.00-00, 512.09-03, 7701.00-00
Release Date: 8/22/2014
Date: May 30, 2014

Employer Identification Number: * * *

LEGEND:

Debtors = * * *
LLC = * * *
State = * * *
x = * * *

Dear * * *:

This responds to your ruling request dated December 9, 2013 as to the federal tax consequences of the proposed transactions under the Internal Revenue Code (I.R.C.) and the Federal Tax Regulations.

FACTS

You are a trust, a voluntary employees’ beneficiary association (VEBA), recognized as tax-exempt as an organization described under § 501(c)(9).
You were established as a result of a Settlement Agreement approved by the United States Bankruptcy Court after Debtors filed voluntary petitions for relief under chapter 11 of title 11 of the Bankruptcy Code. Debtors had historically provided a number of benefits to their retired employees and the retirees’ surviving spouses and eligible dependents through various welfare benefit programs (“Retiree Welfare Plans”).

The Bankruptcy Court issued an order directing the Office of the United States Trustee to appoint a Retiree Committee to represent the interests of the Retiree Welfare Plans’ retirees and beneficiaries. Following negotiations between Debtors and the Retiree Committee, the Bankruptcy Court issued an order approving a Settlement Agreement in which the parties mutually agreed to the termination and termination date of the Retiree Welfare Plans. As part of the Settlement Agreement, a Settlement Amount of $x would be paid to a limited liability company (“LLC”) whose single member is to be you. LLC was required to hold the Settlement Amount in its account for a minimum of five business days before distributions were to be made to you in your capacity as the single member of LLC.

The Settlement Agreement further provided that the Retiree Committee intended that you provide medical benefits to eligible retiree claim holders, based on an Apportionment Methodology.

In accordance with the terms of the Settlement Agreement, the Retiree Committee established you. Shortly thereafter, LLC was formed under the laws of State with you as the single member. No election has been made on a Form 8832, Entity Classification Election, to treat LLC as an association taxable as a corporation.

The LLC Agreement provides that the sole purpose of LLC is to function as a conduit by which the consideration payable by Debtors under the Settlement Agreement is to be contributed to you. The LLC Agreement further provides that as soon as reasonably possible following LLC’s receipt of the Settlement Amount from Debtors, and after paying or making reasonable provision for any expenses, liabilities, reserves or other contingencies, LLC shall distribute all available funds to you. Moreover, upon dissolution of LLC, and after paying or making reasonable provision for creditors, all remaining funds of LLC will be distributed to you. The LLC Agreement further provides that the management of LLC shall be vested solely in you but that you have the right to delegate its management rights and powers.

Debtors paid an initial installment of the Settlement Amount to LLC shortly after LLC was formed. The following month, Debtors paid the balance of the Settlement Amount to LLC. These amounts were deposited into an interest-bearing account maintained by LLC. The next month, LLC distributed the full Settlement Amount to you, and the Retiree Welfare Plans were terminated.

Pursuant to your trust documents and the Settlement Agreement, you will use the Settlement Amount to provide healthcare reimbursement benefits to retiree participants, their spouses and their dependents, as permitted under § 501(c)(9), and based on the Apportionment Methodology as set forth in the Settlement Agreement.

RULING REQUESTED

You have requested the following ruling:

That the Settlement Amount be treated as “exempt function income” under § 512(a)(3)(B), with the further result that no portion of the Settlement Amount will be treated as “unrelated business taxable income” to you.
LAW

Section 501(a) provides that an organization described in § 501(c) (including a VEBA described in § 501(c)(9)) shall be exempt from taxation unless the exemption is denied under §§ 502 or 503.

Section 511 imposes tax on the unrelated business taxable income (as described in § 512) of organizations described in § 501(c).

Section 512(a)(3)(A) provides that, in the case of an organization described in § 501(c)(9), the term “unrelated business taxable income” means the gross income (excluding any exempt function income), less the allowable deductions that are directly connected with the production of gross income (excluding exempt function income), both computed with specified modifications.

Section 512(a)(3)(B) provides that the term “exempt function income” means, for a § 501(c)(9) organization, the gross income from dues, fees, charges, or similar amounts paid by members of the organization as consideration for providing the members or their dependents or guests goods, facilities, or services in furtherance of the organization to which such income is paid. Such term also means all income (other than an amount equal to the gross income derived from any unrelated trade or business carried on by the organization) which is set aside to provide for the payment of life, sick, accident, or other benefits, including reasonable costs of administration directly connected with the provision of such benefits.

Section 512(a)(3)(E) provides that the amounts set aside as of the close of a taxable year for the payment of life, sick, accident, or other benefits may not be taken into account for purposes of determining “exempt function income” to the extent that such amounts exceed the qualified asset limit, determined under §§ 419A(c) and 419A(f)(7), for such taxable year. In calculating the qualified asset account limit for this purpose, a reserve for post-retirement medical benefits under § 419A(c)(2)(A) is not to be taken into account. See, also Temp. Treas. Reg. § 1.512(a)-5T, Q&A-3(a), and Prop. Treas. Reg. § 1.512(a)-5.

Treas. Reg. § 1.512(a)-5T, Q&A-3(b), provides that the exempt function income of a VEBA includes certain amounts paid by members of the VEBA (“member contributions”). Member contributions include both employee contributions and employer contributions to a VEBA.

Treas. Reg. § 301.7701-1(a)(1) provides that the Code prescribes the classification of various organizations for federal tax purposes. Whether an organization is an entity separate from its owners for federal tax purposes is a matter of federal tax law and does not depend on whether the organization is recognized as an entity under local law.

Treas. Reg. § 301.7701-2(a) provides, in part, that a business entity is any entity recognized for federal tax purposes (including a disregarded entity) that is not properly classified as a trust under § 301.7701-4 or otherwise subject to special treatment under the Code. A business entity is domestic if it is created or organized in the United States, or under the law of the United States or of any State. See § 301.7701-5(a).

Treas. Reg. § 301.7701-3(a) provides, in part, that a business entity that is not classified as a corporation under § 301.7701-2(b)(1), (3), (4), (5), (6), (7), or (8) (an eligible entity) can elect its classification for federal tax purposes. An eligible entity with a single owner can elect to be classified as an association or to be disregarded as an entity separate from its owner.

Treas. Reg. § 301.7701-3(b)(1)(ii) provides, in part, that unless the entity elects otherwise, a domestic eligible entity is disregarded as an entity separate from its owner if it has a single owner.

Treas. Reg. § 301.7701-2(a) provides, in part, that if the entity is disregarded, its activities are treated in the same manner as a sole proprietorship, branch, or division of the owner. However, for employment and certain excise tax purposes, a disregarded entity is treated as a corporation. See § 301.7701-2(c)(2)(iv) and (v).

Announcement 99-102, 1999-43 I.R.B. 545, provides that when the owner of an eligible entity that is treated as a disregarded entity is exempt from taxation under section 501(a) of the Code, it must include, as its own, information pertaining to the finances and operation of the disregarded entity in its annual information return. Announcement 99-102 further states that “when an entity is disregarded as separate from its owner, its operations are treated as a branch or division of the owner.”

ANALYSIS

Debtors contributed the Settlement Amount to LLC. Under the Settlement Agreement, LLC was required after paying or making reasonable provision for any expenses, liabilities, reserves or other contingencies, to distribute the remaining Settlement Amount to you which you will use to provide medical benefits to participants (their spouses and eligible dependents) of the Reimbursement Plan. Pursuant to your trust documents and the Settlement Agreement, you will use the Settlement Amount specifically to provide healthcare reimbursement benefits permitted under § 501(c)(9).

Based on the information provided, you are the single member of LLC and LLC has not made an election to be treated as an association taxable as a corporation. Accordingly, LLC is disregarded as an entity separate from its owner and its activities are treated as yours. As a result, the Settlement Amount paid to LLC by Debtors is treated as if paid to you by Debtors.

Further, the retirees eligible to receive medical benefits from you had been employed by Debtors and had been eligible to receive welfare benefits under Debtors’ Retiree Benefit Plans. Based on these facts, we conclude that the Settlement Amount is treated as employer contributions to you.

Pursuant to Treas. Reg. § 1.512(a)-5T, Q&A-3(b), employer contributions to a VEBA are treated as exempt function income and, therefore, excluded from the definition of “unrelated business taxable income.”

Accordingly, we conclude that the Settlement Amount is exempt function income under the first sentence of § 512(a)(3)(B), with the further result that no portion of the Settlement Amount will be treated as unrelated business taxable income to you.

RULING

Based on the information submitted, representations made, and the authorities cited above, we rule that:

The Settlement Amount is treated as “exempt function income” under § 512(a)(3)(B), with the further result that no portion of the Settlement Amount will be treated as “unrelated business taxable income” to you.

This ruling will be made available for public inspection under § 6110 after certain deletions of identifying information are made. For details, see enclosed Notice 437, Notice of Intention to Disclose. A copy of this ruling with deletions that we intend to make available for public inspection is attached to Notice 437. If you disagree with our proposed deletions, you should follow the instructions in Notice 437.
This ruling is directed only to the organization that requested it. Section 6110(k)(3) provides that it may not be used or cited by others as precedent.

This ruling is based on the facts as they were presented and on the understanding that there will be no material changes in these facts. This ruling does not address the applicability of any section of the Code or regulations to the facts submitted other than with respect to the sections described. Because it could help resolve questions concerning your federal income tax status, this ruling should be kept in your permanent records.

If you have any questions about this ruling, please contact the person whose name and telephone number are shown in the heading of this letter.

In accordance with the Power of Attorney currently on file with the Internal Revenue Service, we are sending a copy of this letter to your authorized representative.

Sincerely,

Michael Seto
Manager, EO Technical
Enclosure
Notice 437

Citations: LTR 201434025



IRS EO Update: e-News for Charities and Nonprofits - August 20, 2014

1. Register for IRS phone forum this Thursday: Essential Information for 501(c)(8) and 501(c)(10) Fraternal Organizations

Thursday, August 21
2 pm, Eastern

Topics include:

Register for this presentation.

2. IRS “Taxpayer Bill of Rights” Available in six languages.

Read news release.

3. Register for EO workshops

Register for our upcoming workshops for small and medium-sized 501(c)(3) organizations on:

Sept. 8 – 9 – San Francisco, CA
Hosted by the University of San Francisco LLM in Taxation Program

Sept. 17 – Blackwood, NJ
Hosted by Camden Community College

Sept. 18 – South Orange, NJ
Hosted by Seton Hall University

Oct.29-30 – Eau Claire, WI
Hosted by University of Wisconsin – Eau Claire

Dec. 9 – Austin, TX
Hosted by Austin Community College

If you have a technical or procedural question relating to Exempt Organizations, visit the Charities and Nonprofits homepage on the IRS.gov Web site.

If you have a specific question about exempt organizations, call EO Customer Account Services at 1-877-829-5500.



H.R. 5319 Would Change Manufacturing Bond Rules.

H.R. 5319, the Modernizing American Manufacturing Bonds Act, introduced by Rep. Randy Hultgren, R-Ill., would expand qualifications for small issue manufacturing bonds to include intangible property production.

113TH CONGRESS
2D SESSION

H.R. 5319

To amend the Internal Revenue Code of 1986 to modify certain
rules applicable to qualified small issue manufacturing bonds.

IN THE HOUSE OF REPRESENTATIVES

JULY 31, 2014

Mr. HULTGREN (for himself and Mr. NEAL) introduced the following
bill; which was referred to the Committee on Ways and Means

A BILL

To amend the Internal Revenue Code of 1986 to modify certain rules applicable to qualified small issue manufacturing bonds.
Be it enacted by the Senate and House of Representatives of the United States of America in Congress assembled,

SECTION 1. SHORT TITLE.

This Act may be cited as the “Modernizing American Manufacturing Bonds Act”.

SEC. 2. MODIFICATIONS TO QUALIFIED SMALL ISSUE BONDS.

(a) MANUFACTURING FACILITIES TO INCLUDE PRODUCTION OF INTANGIBLE PROPERTY AND FUNCTIONALLY RELATED FACILITIES. — Subparagraph (C) of section 144(a)(12) of the Internal Revenue Code of 1986 is amended to read as follows:

“(C) MANUFACTURING FACILITY. — For purposes of this paragraph —

“(i) IN GENERAL. — The term ‘manufacturing facility’ means any facility which —

“(I) is used in the manufacturing or production of tangible personal property (including the processing resulting in a change in the condition of such property),

“(II) is used in the creation or production of intangible property which is described in section 197(d)(1)(C)(iii), or

“(III) is functionally related and subordinate to a facility described in subclause (I) or (II) if such facility is located on the same site as the facility described in subclause (I) or (II).

“(ii) CERTAIN FACILITIES INCLUDED. — The term ‘manufacturing facility’ includes facilities that are directly related and ancillary to a manufacturing facility (determined without regard to this clause) if —

“(I) those facilities are located on the same site as the manufacturing facility, and

“(II) not more than 25 percent of the net proceeds of the issue are used to provide those facilities.

“(iii) LIMITATION ON OFFICE SPACE. — A rule similar to the rule of section 142(b)(2) shall apply for purposes of clause (i).

“(iv) LIMITATION ON REFUNDINGS FOR CERTAIN PROPERTY. — Subclauses (II) and (III) of clause (i) shall not apply to any bond issued on or before the date of the enactment of the Modernizing American Manufacturing Bonds Act, or to any bond issued to refund a bond issued on or before such date (other than a bond to which clause (iii) of this subparagraph (as in effect before the date of the enactment of the Modernizing American Manufacturing Bonds Act applies)), either directly or in a series of refundings.”.

(b) INCREASE IN LIMITATIONS. — Paragraph (4) of section 144(a) of the Internal Revenue Code of 1986 is amended —

(1) by striking “$10,000,000” in subparagraph (A)(i) and inserting “$30,000,000”, and

(2) by striking “$10,000,000” in the heading and inserting “$30,000,000”.

(c) EFFECTIVE DATE. — The amendments made by this section shall apply to obligations issued after the date of the enactment of this Act.



Disaster-Related Guidance Suspends Some Rules on Bond-Financed Housing.

The IRS issued guidance (Rev. Proc. 2014-50) to automatically suspend some requirements under section 142(d) for qualified residential rental projects financed with exempt facility bonds issued by state and local governments under section 142.
In the year following a presidential declaration of a qualifying major disaster, the revenue procedure suspends the income requirements for units occupied by individuals displaced by the disaster and modifies other requirements of section 142(d) to accommodate the suspension. The guidance provides relief for bond projects as well as bond/low-income housing tax credit (LIHTC) projects.

Under the revenue procedure, a project operator may provide emergency housing relief for less than the designated temporary housing period. The revenue procedure explains the circumstances under which an operator may accept a displaced individual as a tenant and explains requirements for the provision of emergency housing relief.

The guidance also provides that the occupancy of a unit by a displaced individual during the temporary housing period is treated as satisfying the non-transient use requirement under reg. section 1.103-8(b)(4). Further, the guidance discusses the treatment of displaced individuals under the next-available-unit rule, the income qualifications for units in bond projects and bond/LIHTC projects during the temporary housing period, the treatment of a unit vacated by a displaced individual, and the income qualifications when the temporary housing period ends.

Rev. Proc. 2014-50 is effective for major disasters declared on or after August 21, 2014.

Citations: Rev. Proc. 2014-50; 2014-37 IRB 1

Administrative, Procedural, and Miscellaneous

26 CFR 601.105: Examination of returns and claims for refund, credit, or abatement; determination of correct tax liability.

(Also Part 1, §§ 142 and 42; 1.103-8)

SECTION 1. PURPOSE

In the context of a Major Disaster, this revenue procedure provides temporary relief from certain requirements of § 142(d) of the Internal Revenue Code for Issuers and Operators. This revenue procedure also provides emergency housing relief for individuals who are displaced by a Major Disaster from their principal residences in certain Major Disaster Areas. This revenue procedure provides relief for both Bond Projects and Bond/LIHTC Projects. For Bond/LIHTC Projects, see also Rev. Proc. 2014-49, I.R.B. 2014-37, which provides for emergency housing relief under § 42 in response to Major Disasters. See section 4 of this revenue procedure for definitions of certain capitalized terms appearing throughout this revenue procedure.

SECTION 2. BACKGROUND

.01 Upon issuance of the President’s declaration of a Major Disaster, the Federal Emergency Management Agency (FEMA) may designate particular cities, counties, or other local jurisdictions covered by the declaration as eligible for Individual Assistance, Public Assistance, or both. With respect to some previous Presidential declarations of Major Disasters, the Internal Revenue Service (Service) issued notices providing relief from certain requirements under §§ 42 and 142(d) to facilitate emergency housing relief for Displaced Individuals without regard to the income of those Displaced Individuals.

.02 Generally, under § 103, private activity bonds that are not qualified bonds within the meaning of § 141 are not tax-exempt. Section 141(e) provides in part that the term “qualified bond” means any private activity bond if such bond is an exempt facility bond, and § 142(a) provides in part that the term “exempt facility bond” means any bond issued as part of an issue 95 percent or more of the net proceeds of which are to be used to provide qualified residential rental projects. To be a qualified residential rental project, a residential rental housing project must meet the requirements in § 142(d). The requirements include the following rules.

(1) At all times during the qualified project period, a specified percentage of the residential units must be occupied by individuals whose income does not exceed applicable income limits (the set-aside requirements). § 142(d)(1) and (d)(6).

(2) The qualified project period begins on the first day on which 10 percent of the residential units in the Project are occupied and ends on the latest of (a) the date that is 15 years after the date on which 50 percent of the residential units in the Project are occupied, (b) the first day on which no tax-exempt private activity bond issued with respect to the Project is outstanding, or (c) the date on which any assistance provided with respect to the Project under section 8 of the United States Housing Act of 1937 terminates. § 142(d)(2)(A).

(3) Generally, if the income of an occupant of a residential unit was at or below the applicable income limits when occupancy of that unit began, the occupant’s income is treated as continuing to be at or below those limits throughout that occupant’s occupancy. If, however, the income of the occupant rises above a specified percentage of the applicable income limit, the occupant’s income is treated as continuing to be at or below the applicable income limit only if the next available unit in the same project that meets certain criteria is occupied by a person whose income is at or below the applicable income limit (the next-available-unit rule). § 142(d)(3)(B).

(4) The Owner may elect to treat the project as a deep rent skewed project, in which case certain modifications to the next-available-unit rule, an additional set-aside requirement, and certain rent restrictions apply. § 142(d)(4).

(5) Under regulations issued under the predecessor to § 142(d), units in a qualified residential rental project cannot be used on a transient basis. § 1.103-8(b)(4)(i) of the Income Tax Regulations.

SECTION 3. SCOPE

This revenue procedure applies when the President has declared a Major Disaster. This revenue procedure applies to Displaced Individuals and to all Projects, Issuers, and Operators both inside and outside States containing a Major Disaster Area.

SECTION 4. DEFINITIONS

The following definitions apply for this revenue procedure.

.01 Agency. With respect to a Bond/LIHTC Project, the Agency is the governmental housing credit agency that has jurisdiction over the Project.

.02 Bond Project. A Bond Project is a Project that is not subject to the low-income housing credit requirements under § 42.

.03 Bond/LIHTC Project. A Bond/LIHTC Project is a Project that is also subject to the low-income housing credit requirements under § 42.

.04 Displaced Individual. A Displaced Individual is an individual who is displaced from his or her principal residence as a result of a Major Disaster and whose principal residence was located in a Major Disaster Area designated as eligible for Individual Assistance by FEMA.

.05 Issuer. The Issuer is the entity that issued tax-exempt, exempt facility bonds for a Project under §§ 142(d) and 103.

.06 Low-Income Individual. A Low-Income Individual is an individual whose income either is at or below the applicable income limit or is treated as at or below the applicable income limit under § 142(d)(3)(B).

.07 Major Disaster. A Major Disaster is an event for which the President has declared a major disaster under the Robert T. Stafford Disaster Relief and Emergency Assistance Act, 42 U.S.C. 5121 et seq.

.08 Major Disaster Area. A Major Disaster Area is any city, county, or other local jurisdiction for which a Major Disaster has been declared by the President and which has been designated by FEMA as eligible for Individual Assistance, Public Assistance, or both.

.09 Market-Rate Unit. A Market-Rate Unit is a unit occupied by an individual that is not a Low-Income Individual.

.10 Operator. The Operator of a Project is the person to whom the Issuer or Owner delegates responsibility for ensuring that the Project continues to meet the requirements applicable to qualified residential rental projects under §§ 142 (d) and 103. (That person may be, but does not have to be, the Owner.)

.11 Owner. An Owner is the owner of a Project.

.12 Project. A Project is a qualified residential rental project that is financed with exempt facility bonds under § 142(d), whether or not it is also subject to the low-income housing credit requirements under § 42.

.13 Temporary Housing Period. A Temporary Housing Period is the period, if any, beginning on the first day of the incident period, as determined by FEMA, and ending on the date determined by the Issuer under section 5.02 of this revenue procedure.

SECTION 5. EMERGENCY HOUSING RELIEF — REQUIREMENTS AND RESTRICTIONS

.01 Requirements for Relief. For an Operator to use the relief provided in section 6 of this revenue procedure, the conditions in this section 5 must be satisfied.

.02 Issuer Approval.

(1) The Issuer provides written approval to the Operator for use of the Project to house Displaced Individuals and specifies the date on which the Temporary Housing Period for the Project ends. The Temporary Housing Period cannot exceed 12 months from the end of the month in which the President declared the Major Disaster.

(2) Issuer approval is required even if a Bond/LIHTC Project subject to Rev. Proc. 2014-49 receives approval from the Agency (as contemplated in Section 12.02(1) of Rev. Proc. 2014-49). An Issuer that provides approval for a Bond/LIHTC Project must adopt for purposes of § 142(d) and this revenue procedure the same Temporary Housing Period that the Agency adopts for purposes of § 42 for that Bond/LIHTC Project.

.03 Protection of Existing Tenants. No existing tenant whose income is, or is treated as, at or below an applicable income limit under § 142(d) may be evicted or otherwise have his or her occupancy terminated solely to provide emergency housing relief for a Displaced Individual.

.04 Recordkeeping Requirements. The Operator complies with the recordkeeping requirements in section 7 of this revenue procedure.

.05 Rent Restrictions. If units are treated as occupied by Low-Income Individuals under section 6 of this revenue procedure because they house Displaced Individuals, then rent restrictions are applicable in deep rent skewed Projects and in Bond/LITHC Projects. In these cases, the amounts that the Displaced Individuals are charged as gross rent must satisfy §§ 142(d)(4)(B) and 42(g)(2) to the extent that those provisions are applicable.

.06 Project Meets All Remaining Requirements. Except as expressly provided in this revenue procedure, a Project meets all other rules and requirements of §§ 142(d) and 103.

SECTION 6. EMERGENCY HOUSING RELIEF — IMPLEMENTATION

.01 Discretion to Apply Relief.

(1) This revenue procedure authorizes but does not require provision of emergency housing relief to Displaced Individuals during the Temporary Housing Period. If an Operator chooses not to provide emergency housing relief under sections 5, 6, and 7 of this revenue procedure, then all of the rules under § 142 (d) apply.

(2) If an Operator chooses to provide emergency housing relief under sections 5, 6, and 7 of this revenue procedure then —

(A) The Operator may provide emergency housing relief for less than the full Temporary Housing Period;

(B) If a Displaced Individual has demonstrated qualification as low income and the Operator wishes to accept the individual as a tenant, the Operator may either accept the Displaced Individual as a low-income tenant applying all the rules under § 142(d) or provide emergency housing relief to the Displaced Individual under sections 5, 6, and 7 of this revenue procedure; and

(C) If a Displaced Individual has not demonstrated qualification as low income and the Operator wishes to accept the individual as a tenant, the Operator may either accept the Displaced Individual as a tenant that is not a low-income tenant or provide emergency housing relief to the Displaced Individual under sections 5, 6, and 7 of this revenue procedure.

.02 Satisfaction of the Non-Transient Use Requirement. The occupancy of a unit in a Project by a Displaced Individual during the Temporary Housing Period is treated as satisfying the non-transient use requirement under § 1.103-8 (b)(4).

.03 Treatment of Displaced Individuals Under the Next-Available-Unit Rule. During the Temporary Housing Period, for purposes of determining compliance with the next-available-unit rule under § 142(d)(3)(B), an Operator disregards any unit then occupied by one or more Displaced Individuals and applies the rule based solely on occupancy by persons who are not Displaced Individuals. See sections 6.04 and 6.05 of this revenue procedure for the treatment of income of Displaced Individuals for purposes of § 142(d).

.04 Income Qualification of Units in Bond Projects During Temporary Housing Period. If a Displaced Individual begins occupancy of a unit in a Bond Project during the Temporary Housing Period, then the unit retains the status it had immediately before that occupancy. The actual income of the Displaced Individual occupying the unit is disregarded during the Temporary Housing Period for purposes of § 142(d). That is —

(1) If a unit in a Bond Project was a unit occupied by a Low-Income Individual, a Market-Rate Unit, a unit never previously occupied, or an unavailable unit, then the unit remains as such while occupied by a Displaced Individual during the Temporary Housing Period, regardless of the occupancy by, or income of, the Displaced Individual. See Rev. Proc. 2004-39, 2004-2 C.B. 49 (treating never previously occupied units as unavailable).

(2) The income of the Displaced Individual occupying the unit does not affect whether the Bond Project satisfies the set-aside requirement, including the additional set-aside requirement for deep rent skewed Projects.

.05 Income Qualification of Units in Bond/LIHTC Projects During Temporary Housing Period. During the Temporary Housing Period, a unit in a Bond/LIHTC Project then occupied by a Displaced Individual is treated for purposes of § 142(d) in a manner similar to how it is treated for purposes of § 42 under Rev. Proc. 2014-49. That is, during the Temporary Housing Period —

(1) The actual income of the Displaced Individual occupying the unit is disregarded for purposes of § 142(d);

(2) To the extent provided in Rev. Proc. 2014-49, if a Displaced Individual takes occupancy of a unit in a Bond/LIHTC Project during the first year of the credit period, the unit is treated as a unit occupied by a Low-Income Individual; and if, after the first year of the credit period, a Displaced Individual begins occupancy of a unit, that unit retains the status that it had before occupancy by the Displaced Individual, whether as a unit occupied by a Low-Income Individual, a Market-Rate Unit, a unit never previously occupied, or an unavailable unit, as the case may be.

.06 Treatment of a Unit Vacated by a Displaced Individual.

(1) If a Displaced Individual vacates a unit in a Project before the end of the Temporary Housing Period, that unit retains the status provided under section 6.04 or section 6.05 of this revenue procedure until it is occupied by the next tenant, even if the next tenant takes occupancy after the end of the Temporary Housing Period. If the next tenant is also a Displaced Individual and begins occupancy during the Temporary Housing Period, the status of the unit is determined under section 6.04 or 6.05 of this revenue procedure. If the next tenant is not a Displaced Individual or begins occupancy after the end of the Temporary Housing Period, the status of the unit is determined under § 142(d).

(2) For as long as a unit retains its status because of the application of this section 6.06, the relief provided under section 6.08 of this revenue procedure applies to that unit. In particular, the unit is disregarded for determining the start of the qualified project period.

.07 Income Qualifications when Temporary Housing Period Ends.

(1) If a Displaced Individual continues to occupy a unit in the Project at the end of the Temporary Housing Period, then except as provided in section 6.07(3) of this revenue procedure, the status of the unit occupied by the Displaced Individual and the income of that individual are re-evaluated as though the individual commenced occupancy of the unit on the day immediately following the end of the Temporary Housing Period. For example, a unit is a Market-Rate Unit beginning immediately after the end of the Temporary Housing Period if, immediately after the end of the Temporary Housing Period, the Displaced Individual’s income exceeds the applicable income limit.

(2) If the Project fails to comply with the set-aside requirement of § 142(d) solely because of continued occupancy of a unit after the Temporary Housing Period by a Displaced Individual, a 60-day period is allowed for correction.

(3) If the Displaced Individual was accepted as a low-income tenant applying all the rules under § 142(d) as permitted by section 6.01(2)(B) of this revenue procedure, then all the rules under § 142(d) apply to the Displaced individual, including § 142(d)(3)(B).

.08 Qualified Project Period.

(1) Start of the Qualified Project Period. Occupancy of a unit by a Displaced Individual during the Temporary Housing Period does not count for determining the beginning of the qualified project period under § 142(d)(2)(A). Thus, this occupancy is not used to determine the first day on which 10 percent of the residential units in a Project are occupied for purposes of § 142(d)(2)(A).

(2) End of the Qualified Project Period. Occupancy of a unit in a Project by any tenant (whether a Displaced Individual or someone who is not a Displaced Individual) counts for purposes of determining the end of the qualified project period under § 142(d)(2)(A)(i). However, solely for purposes of § 142(d)(2)(A) (iii), the Project is treated as continuing to receive assistance under section 8 of the United States Housing Act of 1937 until the end of the Temporary Housing Period plus 180 days.

SECTION 7. EMERGENCY HOUSING RELIEF — RECORDKEEPING

.01 Operators must maintain certain information concerning each Displaced Individual temporarily housed in the Project under sections 5 and 6 of this revenue procedure. For each Displaced Individual, the records must contain the following items in a statement signed by the Displaced Individual under penalties of perjury:

(1) The name of the Displaced Individual;

(2) The address of the principal residence at the time of the Major Disaster of the Displaced Individual;

(3) The Displaced Individual’s social security number; and

(4) A statement that he or she was displaced from his or her principal residence as a result of a Major Disaster and that his or her principal residence was located in a city, county, or other local jurisdiction that is covered by the President’s declaration of a Major Disaster and that is designated as eligible for Individual Assistance by FEMA because of the Major Disaster.

.02 The Operator must maintain a record both of the Issuer’s approval of the Project’s use for Displaced Individuals and of the approved Temporary Housing Period. The Operator must report to the Issuer at the end of the Temporary Housing Period a list of the names of the Displaced Individuals and the dates the Displaced Individuals began occupancy. The Operator must also provide any dates Displaced Individuals ceased occupancy and, if applicable, the date each unit occupied by a Displaced Individual becomes occupied by a subsequent tenant.

.03 The Operator must maintain the records described in this section as part of the annual compliance monitoring process imposed under § 142(d) and provide this information to the Service upon request. For purposes of § 42, Operators of Bond/LIHTC Projects are also subject to the recordkeeping requirements of Rev. Proc. 2014-49.

SECTION 8. EFFECTIVE DATE

This revenue procedure is effective for Major Disasters declared on or after August 21, 2014.

SECTION 9. PAPERWORK REDUCTION ACT

The collection of information contained in this revenue procedure has been reviewed and approved by the Office of Management and Budget in accordance with the Paperwork Reduction Act (44 U.S.C. 3507) under control number 1545-2237.

A Federal Agency may not conduct or sponsor, and a person is not required to respond to, a collection of information unless the collection of information displays a valid OMB control number.

The collection of information in this revenue procedure is in section 7. This information is required to enable the Service to verify whether the Operators and Displaced Individuals satisfy various requirements for the relief provided in this revenue procedure. The collection of information is required to obtain a benefit. The likely respondents are individuals, businesses, and state and local governments.

The estimated total annual recordkeeping burden is 675 hours.

The estimated annual burden per recordkeeper is approximately 30 minutes. The estimated number of recordkeepers is 1,350.

Books or records relating to a collection of information must be retained as long as their contents may become material to the administration of the internal revenue law. Generally, tax returns and tax return information are confidential, as required by § 6103.

SECTION 10. DRAFTING INFORMATION

The principal authors of this revenue procedure are Timothy L. Jones and Spence Hanemann of the Office of Associate Chief Counsel (Financial Institutions & Products). For further information regarding this revenue procedure, contact Mr. Hanemann at (202) 317-6980 (not a toll-free call).



GFOA Files Supreme Court Amicus Brief in Maryland Income Tax Case.

The GFOA joined its partner national associations on an amicus, or friend of the court, brief filed by the State and Local Legal Center before the Supreme Court in the case of Comptroller v. Wynne. In this case, the Supreme Court will determine whether the U.S. Constitution requires states to give a credit for taxes paid on income earned out-of-state.

The Wynnes of Howard County, Maryland, received S-corporation income that was generated and taxed in numerous states. While Maryland law allowed the Wynnes to receive a tax credit against their Maryland state taxes for income taxes paid to other states, it did not allow them to claim a credit against their Maryland county taxes. The Wynne’s challenged Maryland law.

Maryland’s highest state court held that Maryland’s failure to grant a credit against Maryland’s county tax violated the U.S. Constitution’s dormant Commerce Clause, which denies states the power to unjustifiably discriminate against or burden interstate commerce. The Maryland Court of Appeals noted that if every state imposed a county tax without a credit, interstate commerce would be disadvantaged. Taxpayers who earn income out of state would be “systematically taxed at higher rates relative to taxpayers who earn income entirely within their home state.”

The State and Local Legal Center’s amicus brief challenges the Maryland Court of Appeals decision on several grounds. First, the brief argues that the power of state and local governments to tax the income of their residents, wherever earned, has been upheld repeatedly by the Supreme Court. Second, the brief maintains that the scope of the “dormant Commerce Clause” regarding individual non-resident income taxes has not been clearly defined by the court and should not now be construed to mandate credits. Third, the brief argues that taxation is a legislative matter that should not usurped by the judiciary.

The brief also discusses the difficult tax policy choices faced by state and local leaders. For example, if Maryland were required to provide a dollar-for-dollar tax credit, a neighbor with substantial out-of-state income would contribute significantly less to pay for local services than a neighbor earning the same income in-state, even though both take equal advantage of local services. To counterbalance this dollar-for-dollar tax credit, a county would need to raise some other tax, which would fall disproportionately on some other neighbor and often be more regressive. Maryland’s choice to avoid these results “does not cross any constitutional line,” the brief states.

Click here to read the amicus brief.

Tuesday, August 12, 2014



McDermott: IRS Issues Additional Guidance With Respect to 2013 Beginning Of Construction Rules for Wind and Other Renewable Projects.

The Internal Revenue Service (Service) issued Notice 2014-46 (Notice) on August 8, 2014, to provide further guidance on meeting the beginning of construction requirements for wind and other qualified facilities (biomass, geothermal, landfill gas, trash, hydropower, and marine and hydrokinetic facilities). The Notice addresses the requirements of the physical work test and the transfer of a facility after construction has begun, as well as the five percent safe harbor.

Background

Section 407 of the American Taxpayer Relief Act of 2012 extended until January 1, 2014, the production tax credit (PTC) and the investment tax credit (ITC) for electricity produced from qualified facilities. Congress also liberalized the timing requirement for a qualified facility so that a taxpayer may meet the January 1, 2014, deadline by “beginning construction” on the facility by such date. Previously, a taxpayer could only meet the deadline by placing the facility in service.

The Notice clarifies and modifies two prior notices (Notices 2013-29 and 2013-60, both referred to herein as the Prior Guidance), providing taxpayers with initial guidance with respect to when construction will be considered to have begun in 2013 for purposes of the PTC and ITC. The Notice was issued in response to questions from industry participants and practitioners arising from the Prior Guidance.

Notice 2013-29

Under Notice 2013-29, a taxpayer may establish that construction has begun on a qualified facility by demonstrating that “physical work of a significant nature” has begun (Physical Work Test) or by satisfying a five percent safe harbor (Safe Harbor). Notice 2013-29 lists several examples of work that meets the Physical Work Test, including, with respect to a wind energy facility, the beginning of the exaction for the foundation, the setting of anchor bolts into the ground or the pouring of the concrete pads of the foundation. Both work completed onsite or off-site may be taken into account. The Service also imposed a requirement that a “continuous program of construction,” as defined in the Prior Guidance (Continuous Construction Test), be maintained after performance of physical work in 2013.

The Safe Harbor set forth in Notice 2013-29 provides that the construction of a qualified facility is considered to begin before January 1, 2014, if a taxpayer pays or incurs (within the meaning of Treas. Reg. § 1.461-1(a)(1) and (2)) five percent or more of the total cost of the facility before such date. Thereafter, the taxpayer must make continuous efforts to advance toward completion of the facility (Continuous Efforts Test) to be deemed to have begun construction.

For more information on these tests and their requirements, see McDermott’s Notice 2013-29 article.

Notice 2013-60

In September 2013, the Service issued Notice 2013-60, clarifying questions left outstanding by Notice 2013-29. [See McDermott’s summary in its Notice 2013-60 article.] First, Notice 2013-60 provided that a facility will be considered to satisfy the Continuous Construction Test and the Continuous Efforts Test if it is placed in service before January 1, 2016. Second, Notice 2013-60 permitted a taxpayer to claim the PTC or ITC even if the taxpayer was not the owner of the facility on the date construction began.

Notice 2014-46

The Physical Work Test

One of the primary questions raised by industry participants and practitioners with respect to the Physical Work Test described in the Prior Guidance was how much physical work is required in 2013. This question arose, in part, due to an example in section 4.04(3) of Notice 2013-29, in which the taxpayer began construction on 10 of 50 planned wind turbines before January 1, 2014, and was deemed to have begun construction on the wind facility in 2013. The example implied to some that there was a 20-percent threshold on the amount of physical work that must be performed in 2013.

The Notice clarifies that the Physical Work Test focuses on the nature of the work performed rather than the amount or cost of such work. Citing the examples in section 4.02 of Notice 2013-29, it makes clear that these examples are a non-exclusive list of activities that would satisfy the Physical Work Test because they constitute physical work “of a significant nature.” The examples include beginning of the excavation for the foundation for a wind turbine, the setting of anchor bolts into the ground or the pouring of the concrete pads of the foundation. Additionally, physical work on a custom-designed transformer meets the Physical Work Test because power conditioning equipment is an integral part of the activity performed by the facility. Lastly, starting construction on roads that are integral to the activity performed at the facility is an example of physical work of a significant nature. The Notice also clarifies that the example cited above relating to construction of 10 of 50 planned wind turbines in 2013 was not intended to indicate a 20-percent minimum threshold requirement to satisfy the Physical Work Test. As provided in the Notice, assuming the work performed is of a significant nature, there is no fixed minimum amount or work or monetary or percentage threshold required to satisfy the Physical Work Test.

The Notice focuses, therefore, on whether 2013 work is “significant,” and implies that such work must be with respect to property that is “integral to the facility” to qualify. While the examples cited in the Prior Guidance and the Notice do not cover all of the types of physical work that were performed on development projects in 2013, the Notice’s provisions do imply that, for example, the excavation of a single turbine foundation could be sufficient, so long as the Continuous Construction Test is met after 2013. Furthermore, that Continuous Construction Test might be met even if some turbine foundations are excavated in 2013 and then no activity occurs with respect to the project for some time, so long as the project is ultimately placed in service prior to January 1, 2016. In short, while not listing or defining all of the types of property that might be considered integral to a facility, the Notice makes clear that there is no threshold level of work that must have occurred in 2013 for construction to have begun.

Transfer of a Facility After Construction Has Begun

Notice 2014-46 also reiterates that the taxpayer who begins construction of a facility and the taxpayer who places it in service need not be the same person. However, the Notice adds a requirement to transfers to unrelated parties that mimics, although described in less detail in the Notice, the requirements established by the U.S. Department of the Treasury (Treasury) in Frequently Asked Questions #23 and #24 in connection with the grant in lieu of ITC. More reading on those requirements can be found here.

The additional requirement added by the Notice is intended to prevent taxpayers from selling bare Safe Harbor-eligible equipment or equipment that met the Physical Work Test in 2013, as opposed to transferring entire projects that are in the development stages. The Notice provides that any amount paid by a transferor to an unrelated transferee in a transfer consisting solely of tangible personal property will not be taken into account with respect to the transferee for purposes of the Physical Work Test or Safe Harbor.

Thus, the Notice imposes two alternative requirements on transfers of projects to other parties. Either that party must be “related” under Internal Revenue Code Section 197(f)(9)(C) (which generally imposes a 20 percent ownership test) to the transferor, or the transfer must be of a project on which development has commenced. The Treasury’s Frequently Asked Questions referenced above may provide some guidance to taxpayers, although they are not explicitly made applicable in the Notice, as to whether development has begun. Generally, development is evidenced by activity such as acquiring land, obtaining permits and licenses, entering into a power purchase agreement, entering into an interconnection agreement or contracting with an engineering, procurement and construction contractor.

The Notice also clarifies that a taxpayer may begin construction of a facility in 2013 with the intent to develop at a certain site, but thereafter transfer equipment and other components of the facility to a different site, and the work performed or amounts paid or incurred in 2013 can be taken into account for purposes of determining whether the facility meets the Physical Work Test or Safe Harbor.

The Five Percent Safe Harbor

According to Notice 2013-29, the Safe Harbor is not satisfied if the amount a taxpayer paid or incurred before January 1, 2014, with respect to the total cost of a facility that is a single project comprised of multiple facilities is less than five percent of the total cost of the facility at the time that it is placed in service. However, the Notice modifies this rule by providing that, if a taxpayer incurred at least three percent of the total cost of such a facility before January 1, 2014, the Safe Harbor may be satisfied with respect to some (although not all) of the individual facilities that are part of this larger project. A taxpayer may claim the PTC or ITC on the individual facilities if the aggregate cost of such facilities at the time the project was placed in service is not greater than 20 times the amount the taxpayer paid or incurred before January 1, 2014.

If, with respect to a single facility that cannot be separated into individual facilities, the amount the taxpayer paid or incurred before January 1, 2014, was less than five percent of the total cost of the facility at the time it was placed in service, then the taxpayer will not satisfy the Safe Harbor with respect to any portion of the facility.

The Notice provides examples of application of these rules that indicate that a wind turbine is considered a single facility, which has been previously confirmed in other guidance issued by the Service, and that a single boiler and turbine generator in a biomass project cannot be separated into multiple facilities.

Conclusion

The Notice clarifies several issues regarding the application of the Physical Work Test and Safe Harbor. Probably most significantly, the Service has clarified that there is not a minimum amount of work required to satisfy the Physical Work Test, which may result in a fresh look at projects previously thought not to have met this test based on the amount of physical work performed in 2013.

Last Updated: August 14 2014
Article by Madeline M. Chiampou, Chelsea E. Hess, Justin Jesse, Martha Groves Pugh and Philip Tingle
McDermott Will & Emery



H.R. 5330 Would Make Build America Bonds Permanent.

H.R. 5330, the Bringing Urgent Investment to Local Development (BUILD) Act, introduced by Rep. John Conyers Jr., D-Mich., would permanently extend the tax treatment for Build America Bonds and provide recovery zone economic development bonds for cities with significant unemployment or poverty circumstances.

113TH CONGRESS
2D SESSION

H.R. 5330

To amend the Internal Revenue Code of 1986 to make the tax treatment
for certain build America bonds permanent and to provide for recovery
zone economic development bonds for certain cities, and for other
purposes.

IN THE HOUSE OF REPRESENTATIVES

JULY 31, 2014

Mr. CONYERS (for himself, Mr. RANGEL, Ms. KAPTUR, Ms. NORTON, Ms.
JACKSON LEE, Mr. MEEKS, Ms. WILSON of Florida, and Ms. LEE of
California) introduced the following bill; which was referred to the
Committee on Ways and Means

A BILL

To amend the Internal Revenue Code of 1986 to make the tax treatment for certain build America bonds permanent and to provide for recovery zone economic development bonds for certain cities, and for other purposes.

Be it enacted by the Senate and House of Representatives of the United States of America in Congress assembled,

SECTION 1. SHORT TITLE.

This Act may be cited as the “Bringing Urgent In vestment to Local Development Act” or the “BUILD Act”.

SEC. 2. BUILD AMERICA BONDS MADE PERMANENT; RECOVERY ZONE ECONOMIC DEVELOPMENT BONDS FOR CERTAIN CITIES.

(a) IN GENERAL. — Subparagraph (B) of section 54AA(d)(1) of the Internal Revenue Code of 1986 is amended by inserting “or during a period beginning on or after the date of the enactment of the Bringing Urgent Investment to Local Development Act,” after “January 1, 2011,”.

(b) REDUCTION IN CREDIT PERCENTAGE TO BOND HOLDERS. — Subsection (b) of section 54AA of such Code is amended to read as follows:

“(b) AMOUNT OF CREDIT. —

“(1) IN GENERAL. — The amount of the credit determined under this subsection with respect to any interest payment date for a build America bond is the applicable percentage of the amount of interest payable by the issuer with respect to such date.

“(2) APPLICABLE PERCENTAGE. — For purposes of paragraph (1), the applicable percentage shall be determined under the following table:

“In the case of a bond issued The applicable
during calendar year: percentage is:
______________________________________________________________________

2014 35
2015 32
2016 31
2017 30
2018 29
2019 and thereafter 28.”.

(c) EXTENSION OF PAYMENTS TO ISSUERS. —

(1) IN GENERAL. — Section 6431 of such Code is amended —

(A) by inserting “or during a period beginning on or after the date of the enactment of the Bringing Urgent Investment to Local Development Act,” after “January 1, 2011,” in subsection (a), and

(B) by striking “before January 1, 2011” in subsection (f)(1)(B) and inserting “during a particular period”.

(2) CONFORMING AMENDMENTS. — Subsection (g) of section 54AA of such Code is amended —

(A) by inserting “or during a period beginning on or after the date of the enactment of the Bringing Urgent Investment to Local Development Act,” after “January 1, 2011,”, and

(B) by striking “QUALIFIED BONDS ISSUED BEFORE 2011” in the heading and inserting “CERTAIN QUALIFIED BONDS”.

(d) REDUCTION IN PERCENTAGE OF PAYMENTS TO ISSUERS. — Subsection (b) of section 6431 of such Code is amended —

(1) by striking “The Secretary” and inserting the following:

“(1) IN GENERAL. — The Secretary”,

(2) by striking “35 percent” and inserting “the applicable percentage”, and

(3) by adding at the end the following new paragraph:

“(2) APPLICABLE PERCENTAGE. — For purposes of this subsection, the term ‘applicable percentage’ means the percentage determined in accordance with the following table:

“In the case of a bond issued The applicable
during calendar year: percentage is:
______________________________________________________________________

2014 35
2015 32
2016 31
2017 30
2018 29
2019 and thereafter 28.”.

(e) RECOVERY ZONE ECONOMIC DEVELOPMENT BONDS FOR CERTAIN CITIES. —

(1) IN GENERAL. — Section 54AA of such Code is amended by redesignating subsection (h) as sub section (i) and by inserting after subsection (g) the following:

“(h) SPECIAL RULE FOR RECOVERY ZONE ECONOMIC DEVELOPMENT BONDS FOR CERTAIN CITIES. — In the case of an economic development extension bond —

“(1) ISSUER ALLOWED REFUNDABLE CREDIT. — In lieu of any credit allowed under this section with respect to such bond, the issuer of such bond shall be allowed a credit as provided in section 6431.

“(2) APPLICABLE PERCENTAGE. — The applicable percentage under subsection (b) shall be 35 percent.

“(3) ECONOMIC DEVELOPMENT EXTENSION BOND. — For purposes of this subsection —

“(A) IN GENERAL. — The term ‘economic development extension bond’ means any build America bond issued as part of an issue if —

“(i) 100 percent of the excess of —

“(I) the available project proceeds (as defined in section 54A) of such issue, over

“(II) the amounts in a reason ably required reserve (within the meaning of section 150(a)(3)) with respect to such issue, are to be used for one or more qualified purposes, and

“(ii) the issuer makes an irrevocable election to have this subsection apply and designates such bond for purposes of this section.

“(B) QUALIFIED PURPOSES. — The term ‘qualified purposes’ means —

“(i) any qualified economic development purpose (as defined in section 1400U-2(c), applied by treating specified cities (and only specified cities) as recovery zones), and

“(ii) any refinancing of indebtedness of a specified city which is outstanding on the date of the enactment of this sub section.

“(C) SPECIFIED CITY. — The term ‘specified city’ means any principal city for a metropolitan statistical area (as determined by the Office of Management and Budget) which —

“(i) has an average unemployment rate of not less than 150 percent of the national average rate for the last calendar year ending before the date of the enactment of this section,

“(ii) has a poverty rate of not less that 150 percent of the national poverty rate for the last calendar year ending be fore the date of the enactment of this section, or

“(iii) has lost at least 20 percent of its population between calendar year 2000 and calendar year 2010.

“(D) LIMITATION ON AMOUNT OF BONDS DESIGNATED. —

“(i) IN GENERAL. — The maximum aggregate face amount of bonds which may be designated under subparagraph (A) with respect to any specified city shall not exceed the bond limitation allocated to such city under clause (ii).

“(ii) ALLOCATION. — The Secretary shall allocate bond limitation to each specified city such that the bond limitation allocated to such city bears the same proportion to $1,000,000,000 as the population of such city (as determined for purposes of the 2010 census) bears to the total population of all specified cities (as so determined).”.

(2) PAYMENTS TO ISSUERS. — Section 6431 of such Code is amended by adding at the end the following:

“(g) APPLICATION OF SECTION TO CERTAIN ECONOMIC DEVELOPMENT EXTENSION BONDS. —

“(1) IN GENERAL. — An economic development extension bond shall be treated as a qualified bond for purposes of this section.

“(2) APPLICABLE PERCENTAGE. — The applicable percentage under subsection (b) shall be 35 per cent.”.

(f) CURRENT REFUNDINGS PERMITTED. — Subsection (g) of section 54AA of such Code is amended by adding at the end the following new paragraph:

“(3) TREATMENT OF CURRENT REFUNDING BONDS. —

“(A) IN GENERAL. — For purposes of this subsection, the term ‘qualified bond’ includes any bond (or series of bonds) issued to refund a qualified bond if —

“(i) the average maturity date of the issue of which the refunding bond is a part is not later than the average maturity date of the bonds to be refunded by such issue,

“(ii) the amount of the refunding bond does not exceed the outstanding amount of the refunded bond, and

“(iii) the refunded bond is redeemed not later than 90 days after the date of the issuance of the refunding bond.

“(B) APPLICABLE PERCENTAGE. — In the case of a refunding bond referred to in subparagraph (A), the applicable percentage with respect to such bond under section 6431(b) shall be the lowest percentage specified in paragraph (2) of such section.

“(C) DETERMINATION OF AVERAGE MATURITY. — For purposes of subparagraph (A)(i), average maturity shall be determined in accordance with section 147(b)(2)(A).

“(D) ISSUANCE RESTRICTION NOT APPLICABLE. — Subsection (d)(1)(B) shall not apply to a refunding bond referred to in subparagraph (A).”.

(g) GROSS-UP OF PAYMENT TO ISSUERS IN CASE OF SEQUESTRATION. — In the case of any payment under section 6431(b) of the Internal Revenue Code of 1986 made after the date of the enactment of this Act to which sequestration applies, the amount of such payment shall be increased to an amount equal to —

(1) such payment (determined before such sequestration), multiplied by

(2) the quotient obtained by dividing 1 by the amount by which 1 exceeds the percentage reduction in such payment pursuant to such sequestration.

For purposes of this subsection, the term “sequestration” means any reduction in direct spending ordered in accordance with a sequestration report prepared by the Director of the Office and Management and Budget pursuant to the Balanced Budget and Emergency Deficit Control Act of 1985 or the Statutory Pay-As-You-Go Act of 2010.

(h) EFFECTIVE DATE. — The amendments made by this section shall apply to obligations issued on or after the date of the enactment of this Act.



H.R. 5347 Would Extend Qualified Zone Academy Bonds.

H.R. 5347, introduced by House Ways and Means Committee member Ron Kind, D-Wis., would extend qualified zone academy bonds for two years, reduce the private business contribution requirement, and make technical corrections.

113TH CONGRESS
2D SESSION

H.R. 5347

To amend the Internal Revenue Code of 1986
to extend qualified zone academy bonds for 2 years
and to reduce the private business contribution requirement
with respect to such bonds, and for other purposes.

IN THE HOUSE OF REPRESENTATIVES

JULY 31, 2014

Mr. KIND (for himself and Mr. KELLY of Pennsylvania)
introduced the following bill;
which was referred to the Committee on Ways and Means

A BILL

To amend the Internal Revenue Code of 1986 to extend qualified zone academy bonds for 2 years and to reduce the private business contribution requirement with respect to such bonds, and for other purposes.

Be it enacted by the Senate and House of Representatives of the United States of America in Congress assembled,

SECTION 1. EXTENSION AND MODIFICATION OF QUALIFIED ZONE ACADEMY BONDS.

(a) EXTENSION. — Paragraph (1) of section 54E(c) of the Internal Revenue Code of 1986 is amended by striking “and 2013” and inserting “2013, 2014, and 2015”.

(b) REDUCTION OF PRIVATE BUSINESS CONTRIBUTION REQUIREMENT. — Subsection (b) of section 54E of such Code is amended by striking “10 percent” and inserting “5 percent”.

(c) EFFECTIVE DATE. — The amendments made by subsections (a) and (b) shall apply to obligations issued after December 31, 2013.

(d) TECHNICAL CORRECTION AND CONFORMING AMENDMENT. —

(1) IN GENERAL. — Clause (iii) of section 6431(f)(3)(A) of such Code is amended —

(A) by striking “2011” and inserting “years after 2010”, and

(B) by striking “of such allocation” and inserting “of any such allocation”.

(2) EFFECTIVE DATE. — The amendments made by this subsection shall take effect as if included in section 310 of the American Taxpayer Relief Act of 2012.



IRS LTR: Hospital Organization is Denied Exemption.

The IRS denied tax-exempt status to an organization seeking exemption as a cooperative hospital service organization because it is not organized and operated on a cooperative basis and is not organized and operated solely to perform, on a centralized basis, a service enumerated under section 501(e)(1)(A).

Citations: LTR 201433018

Contact Person: * * *
Identification Number: * * *
Contact Number: * * *
UIL Code: 501.03-00, 501.03-32
Release Date: 8/15/2014
Date: May 20, 2014
Employer Identification Number: * * *
Form Required To Be Filed: * * *
Tax Years: * * *

Dear * * *:

This is our final determination that you do not qualify for exemption from Federal income tax as an organization described in Internal Revenue Code section 501(c)(3). Recently, we sent you a letter in response to your application that proposed an adverse determination. The letter explained the facts, law and rationale, and gave you 30 days to file a protest. Since we did not receive a protest within the requisite 30 days, the proposed adverse determination is now final.

You must file Federal income tax returns on the form and for the years listed above within 30 days of this letter, unless you request an extension of time to file. File the returns in accordance with their instructions, and do not send them to this office. Failure to file the returns timely may result in a penalty.

We will make this letter and our proposed adverse determination letter available for public inspection under Code section 6110, after deleting certain identifying information. Please read the enclosed Notice 437, Notice of Intention to Disclose, and review the two attached letters that show our proposed deletions. If you disagree with our proposed deletions, follow the instructions in Notice 437. If you agree with our deletions, you do not need to take any further action.

If you have any questions about this letter, please contact the person whose name and telephone number are shown in the heading of this letter. If you have any questions about your Federal income tax status and responsibilities, please contact IRS Customer Service at 1-800-829-1040 or the IRS Customer Service number for businesses, 1-800-829-4933. The IRS Customer Service number for people with hearing impairments is 1-800-829-4059.

Sincerely,

Tamera Ripperda
Director, Exempt Organizations
Rulings and Agreements
Enclosure
Notice 437
Redacted Proposed Adverse Determination Letter
Redacted Final Adverse Determination Letter
* * * * *

Contact Person: * * *
Identification Number: * * *
Contact Number: * * *
Fax Number: * * *

Uil Code: 501.03-00, 501.03-32
Date: March 21, 2014

Employer Identification Number: * * *

LEGEND:

Hospital 1 = * * *
Hospital 2 = * * *
Hospital 3 = * * *
Date 1 = * * *
Taxpayer = * * *
Plan = * * *
$x = * * *

Dear * * *:

We have considered your application for recognition of exemption from Federal income tax under § 501(a) of the Internal Revenue Code (“Code”) as an organization described in § 501(c)(3). Based on the information provided, we have concluded that you do not qualify for exemption under that section. The basis for our conclusion is set forth below.

FACTS

You are organized as a nonprofit corporation under state law. Your Articles of Incorporation state that: “The purpose of the Corporation is to enhance collaboration and the development of shared services among nonprofit hospital members and any and all other purposes permitted by law.” You have members, and each member must at all times be an organization described in § 501(c)(3). Your current members are three tax-exempt hospitals: Hospital 1, Hospital 2, and Hospital 3.
Each of your members has equal representation in your governance. Your Bylaws provide that “[e]ach member shall designate two individuals who may act on behalf of such member on matters submitted to the members. Each member shall have one vote on each matter submitted to the members.”

The members elect your Board of Directors. The number of directors shall be equal to the number of members. Immediately prior to the election of directors by the members, each member shall designate one director candidate. Each of the members shall vote for each of the candidates. Your current Board of Directors consists of three members: your president and director is also the president of Hospital 1. Your secretary and director is the president of Hospital 2. Your treasurer and director is the president of Hospital 3. Your directors do not receive compensation for their services.

You were formed to be a cooperative hospital service organization. You are designed to evaluate and offer various shared service opportunities among your members, including cost savings possibilities and opportunities to enhance clinical, support, and management services and programs through the cooperative efforts of your members. You provide purchasing services to your member hospitals. Specifically, with the assistance of an independent actuarial, employee benefits, and human resources consulting firm, you negotiated and contracted life, disability, and dental insurance for physicians of your patron-hospitals. The contracts are group contracts specific to each of your member entities and cover or benefit both eligible physician employees and all other eligible employees of your member hospitals. At this time you do not offer any other types of services, though you may offer management services, support programs, and clinical shared services in the future. For example, you intend to share management services, including assistance between hospitals when a key or critical position is open or a project is being undertaken at one member institution and another member institution has a manager with specific expertise in that project area. You would look to share consultative services between the three member hospitals such as looking at different staffing models and how best to utilize all available resources.

On your Form 1023, you state:

In compliance with section 501(e)(2), within 8 1/2 months after the close of the Company’s taxable year, the Company allocates or pays all of its net earnings to its patron-hospitals based upon the services performed for them. To date, the Company has retained its earnings to support the exploration and expansion of the services it provides to the patron-hospitals. These retained earnings have been allocated equally among the patron hospitals.

In your letter of Date 1, you state that your current retained earnings are $x, which equals your net income for the period October 1, 2010, through September 9, 2011. You also state that these earnings are held in your account and utilized for shared services such as consultants, educational opportunities, or other expenses incurred and agreed upon by the directors, and that, thus far, no earnings have been allocated between the patron hospitals.

LAW

Section 501(c)(3) provides for the exemption from federal income tax of organizations that are organized and operated exclusively for charitable, scientific or educational purposes, or for the prevention of cruelty to children, provided no part of the organization’s net earnings inures to the benefit of any private shareholder or individual.

Section 501(e) provides that an organization shall be treated as an organization organized and operated exclusively for charitable purposes under section 501(c)(3) if: (1) the organization is organized and operated solely (A) to perform, on a centralized basis, one or more of the following services which, if performed on its own behalf by a hospital which is an organization described in section 501(c)(3) and exempt from taxation under section 501(a), would constitute activities in exercising or performing the purpose or function constituting the basis for its exemption: data processing, purchasing (including the purchasing of insurance on a group basis), warehousing, billing and collection (including the purchase of patron accounts receivable on a recourse basis), food, clinical, industrial engineering, laboratory, printing, communications, record center, and personnel (including selection, testing, training, and education of personnel) services; and (B) to perform such services solely for two or more hospitals each of which is: (i) an organization described in section 501(c)(3) and exempt from tax under section 501(a), (ii) a constituent part of an organization described in section 501(c)(3) which is exempt from taxation under section 501(a) and which, if organized and operated as a separate entity, would constitute an organization described in section 501(c)(3), or (iii) owned and operated by the United States, a state, the District of Columbia, or a possession of the United States, or a political subdivision or an agency or instrumentality of the foregoing; (2) such organization is organized and operated on a cooperative basis and allocates or pays, within 8 1/2 months after the close of its tax year, all net earnings to patrons on the basis of services performed for them; and; (3) if such organization has capital stock, all of such stock outstanding is owned by its patrons.

Section 1.501(e)-1(a) of the Income Tax Regulations (“regulations”) provides that section 501(e) is the exclusive and controlling section under which a cooperative hospital service organization can qualify as a charitable organization. A cooperative hospital service organization which meets the requirements of section 501(e) and this section shall be treated as an organization described in section 501(c)(3), exempt from taxation under section 501(a), and referred to in section 170(b)(1)(A)(iii). In order to qualify for tax exempt status, a cooperative hospital service organization must (1) be organized and operated on a cooperative basis; (2) perform, on a centralized basis, only one or more specifically enumerated services which, if performed directly by a tax exempt hospital, would constitute activities in the exercise or performance of the purpose or function constituting the basis for its exemption; and (3) perform such service or services solely for two or more patron-hospitals.

Section 1.501(e)-1(b)(1) provides that in order to meet the requirements of section 501(e), the organization must be organized and operated on a cooperative basis (whether or not under a specific statute on cooperatives) and must allocate or pay all of its net earnings within 8 1/2 months after the close of the taxable year to its patron-hospitals on the basis of the percentage of its services performed for each patron. To “allocate” its net earnings to its patron-hospitals, the organization must make appropriate bookkeeping entries and provide timely written notice to each patron-hospital disclosing to the patron-hospital the amount allocated to it on the books of the organization.

Section 1.501(e)-1(b)(3) provides that exemption will not be denied a cooperative hospital service organization solely because the organization, instead of paying all net earnings to its patron-hospitals, retains an amount for such purposes as retiring indebtedness, expanding the services of the organization, or for any other necessary purpose and allocates such amounts to its patrons. However, such funds may not be accumulated beyond the reasonably anticipated needs of the organization. Moreover, where an organization retains net earnings for necessary purposes, the organization’s records must show each patron’s rights and interests in the funds retained.

Section 1.501(e)-1(c) provides that an organization will meet the requirements of section 501(e) only if the organization performs, on a centralized basis, one or more of the following services and only such services: data processing, purchasing (including the purchasing and dispensing of drugs and pharmaceuticals to patron-hospitals), warehousing, billing and collection, food, clinical (including radiology), industrial engineering (including the installation, maintenance and repair of biomedical and similar equipment), laboratory, printing, communications, record center, and personnel (including recruitment, selection, testing, training, education and placement of personnel) services. An organization is not described in § 501(e) if, in addition to or instead of one or more of these specified services, the organization performs any other service (other than services referred to under paragraph (b)(4) that are incidental to the conduct of exempt purposes or functions).

In HCSC-Laundry v. United States, 450 U.S. 1, 6 (1981), the Supreme Court held that, as a basic principal of statutory construction, § 501(e), a specific statute, controls over a general provision such as § 501(c)(3). In addition, the court said that the legislative history showed that Congress intended § 501(e) to be exclusive and controlling for cooperative hospital service organizations.

In Florida Hospital Trust Fund v. Commissioner, 103 T.C. 140, 153 (1994), the Tax Court stated that “from our perspective, the plain meaning of the phrase ‘purchasing of insurance on a group basis’ denotes a commercial transaction in which a cooperative hospital service organization negotiates and executes the purchase of insurance for its membership as a group.”

ANALYSIS

We have determined that you do not qualify as a cooperative hospital service organization under § 501(e) of the Code. First, you are not organized or operated on a cooperative basis. Secondly, you are not organized and operated solely to perform, on a centralized basis, a service enumerated in § 501(e)(1)(A).

Section 1.501(e)-1(b)(1) of the regulations provides that, in order to meet the requirements of § 501(e), an organization must be organized and operated on a cooperative basis (whether or not under a specific statute on cooperatives) and must allocate or pay all of its net earnings within 8 1/2 months after the close of the taxable year to its patron-hospitals on the basis of the percentage of its services performed for each patron. Your Articles of Incorporation neither mention that you are structured on a cooperative basis nor do they require you to allocate or pay, within eight and one-half months after the close of each taxable year, all of your net earnings to your patron hospitals on the basis of the percentage of your services performed for each. Thus, you are not organized on a cooperative basis as required by the regulations.

Section 1.501(e)-1(b)(3) says that a cooperative hospital service organization need not pay all its net earnings to its patron hospitals, but may retain an amount for a necessary purpose so long as it allocates such amounts to its patrons. Where the organization retains net earnings for necessary purposes, its records must show each patron’s rights and interests in the funds retained. Furthermore, § 1.501(e)-1(b)(1) says that to “allocate” its net earnings to its patron-hospitals, the organization must make appropriate bookkeeping entries and provide timely written notice to each patron-hospital disclosing to the patron-hospital the amount allocated to it on the books of the organization. In your Form 1023 (filed only three months after the close of your first taxable year), you stated without further explanation or evidence, that:

In compliance with section 501(e)(2), within 8 and one-half months after the close of the Company’s taxable year, the Company allocates or pays all of its net earnings to its patron-hospitals based upon the services performed for them. To date, the Company has retained its earnings to support the exploration and expansion of the services it provides to the patron-hospitals. These retained earnings have been allocated equally among the patron hospitals [emphasis added].

However, in your letter of Date 1, and in response to our request for additional information about how you allocate earnings among your member hospitals, you stated that: “Taxpayer’s earnings are held in the Taxpayer account and utilized for shared services such as consultants, educational opportunities, or other expenses incurred and agreed upon by the directors. Thus far, no earnings have been allocated between the patron hospitals [emphasis added].”

Not only do these two statements contradict each other, but by the time you submitted your Date 1 letter, you should have already made payments or allocations to your patron-hospitals for your tax years ending in 2009 and 2010. By your own admission, then, you have not complied with § 501(e)(2) and § 1.501(e)-1(b)(1).

Furthermore, to qualify as a cooperative hospital service organization, you must perform, on a centralized basis, one of the services specified in § 501(e)(1)(A), but only such services. You appear to be relying on that part of the statute that provides that a cooperative hospital service organization may engage in “the purchasing of insurance on a group basis.” But it is not clear to us that your activities amount to purchasing insurance. In Florida Hospital Trust Fund v. Comm’r, 103 T.C. at 153, the Tax Court stated that “from our perspective, the plain meaning of the phrase ‘purchasing of insurance on a group basis’ denotes a commercial transaction in which a cooperative hospital service organization negotiates and executes the purchase of insurance for its membership as a group.” In your application Form 1023, you state that you “coordinate the purchasing of life, disability, and dental insurance on a group basis,” and that you have “negotiated and contracted for life, dental, and disability insurance,” however you never say that you executed the purchase of insurance for your members as a group. Your Form 1023 “statement of revenues and expenses” shows expenses for “professional fees” and a small amount of unclassified expenses. A “profit and loss statement” submitted with your letter of Date 1, shows expenses for “insurance initiatives.” We are uncertain whether any of these amounts went toward the purchase of insurance on a group basis.

In response to our request for copies of contracts you have negotiated, you provided a copy of three contract applications with Plan, one for each of your members. Each application lists one of your members as the “Name of Group” and the member’s address as the “billing address.” Under “Additional Provisions,” the application states that: “This agreement is part of the Taxpayer purchasing alliance made up of [Taxpayer’s patron members]. Each participating entity will have separate banking arrangements.” Each application is executed by an authorized representative of the member hospital named in the application. Given this language, it is unclear to us whether you actually execute and purchase insurance on behalf of your members, or whether you merely coordinate the selection of insurance providers and negotiate the terms of the policies, but leave the execution and purchasing of the policies to the individual members. Furthermore, in the future, you intend to offer services with respect to the sharing of management services, resource and educational opportunities, and nursing and provider staff among and between your member hospitals. It is unclear whether any of these services are among the specific services enumerated in § 501(e)(1)(A). It is likewise unclear whether the sharing of such services among or between the hospitals is the same as the performance of services “on a centralized basis.” Consequently, we cannot say that you are operated solely to perform, on a centralized basis, a permissible service (and only a permissible service) under § 501(e)(1).

Because § 1.501(e)-1(a) says, and the Supreme Court in HCSC-Laundry v. United States holds, that § 501(e) creates the exclusive means by which a separate entity that provides shared services to otherwise unrelated hospitals may qualify for exemption as an organization described in § 501(c)(3), your failure to satisfy the requirements of § 501(e) means that you also fail to satisfy the requirements of § 501(c)(3).

CONCLUSION

In light of the above, we conclude that you are not organized and operated exclusively for exempt purposes within the meaning of § 501(c)(3).
You have the right to file a protest if you believe this determination is incorrect. To protest, you must submit a statement of your views and fully explain your reasoning. You must submit the statement, signed by one of your officers, within 30 days from the date of this letter. We will consider your statement and decide if the information affects our determination.

Your protest statement should be accompanied by the following declaration:

Under penalties of perjury, I declare that I have examined this protest statement, including accompanying documents, and, to the best of my knowledge and belief, the statement contains all the relevant facts, and such facts are true, correct, and complete.

You also have a right to request a conference to discuss your protest. This request should be made when you file your protest statement. An attorney, certified public accountant, or an individual enrolled to practice before the IRS may represent you. If you want representation during the conference procedures, you must file a proper power of attorney, Form 2848, Power of Attorney and Declaration of Representative, if you have not already done so. For more information about representation, see Publication 947, Practice before the IRS and Power of Attorney. All forms and publications mentioned in this letter can be found at www.irs.gov, Forms and Publications.

If you do not file a protest within 30 days, you will not be able to file a suit for declaratory judgment in court because the IRS will consider the failure to protest as a failure to exhaust available administrative remedies. Code section 7428(b)(2) provides, in part, that a declaratory judgment or decree shall not be issued in any proceeding unless the Tax Court, the United States Court of Federal Claims, or the District Court of the United States for the District of Columbia determines that the organization involved has exhausted all of the administrative remedies available to it within the IRS.

If you do not intend to protest this determination, you do not need to take any further action. If we do not hear from you within 30 days, we will issue a final adverse determination letter. That letter will provide information about filing tax returns and other matters.

Please send your protest statement, Form 2848 and any supporting documents to this address:

Internal Revenue Service
1111 Constitution Ave, N.W.
Washington, DC 20224

You may also fax your statement using the fax number shown in the heading of this letter. If you fax your statement, please call the person identified in the heading of this letter to confirm that he or she received your fax.
If you have any questions, please contact the person whose name and telephone number are shown in the heading of this letter.

Thank you for your cooperation. We have sent a copy of this letter to your representative as indicated in your power of attorney.

Sincerely,

Michael Seto
Manager,
Exempt Organizations Technical



IRS Clarifies Guidance on Construction of Energy Facilities.

The IRS has clarified (Notice 2014-46) prior guidance (Notice 2013-29, Notice 2013-60) on the construction of qualified energy facilities, addressing the application of the physical work test and the ability to transfer a facility after construction has begun. The notice also modifies the application of the 5 percent safe harbor.

Under the physical work test, a taxpayer may establish the beginning of construction by beginning physical work of a significant nature as described in Notice 2013-29 or by meeting the safe harbor in that notice. Under the safe harbor, a taxpayer must show that after the facility is placed in service, 5 percent or more of its total cost was paid or incurred before January 1, 2014. Both the physical work test and the safe harbor require that a taxpayer make continuous progress toward completion once construction has begun.

Notice 2013-60 in part clarifies that the transfer of a facility after construction has begun will not necessarily prevent a facility from qualifying for the renewable electricity production tax credit (PTC) under section 45 or the energy investment tax credit (ITC) under section 48. The notice also explains how to satisfy either the continuous construction test or the continuous efforts test for purposes of establishing continuous progress.

Notice 2014-46 clarifies the application of the physical work test and the effect that some transfers of a facility after construction has begun will have on a taxpayer’s ability to qualify for the PTC or the ITC. Specifically, a fully or partially developed facility may be transferred without losing its qualification under the physical work test or the safe harbor for purposes of the PTC or the ITC. Addressing equipment relocations, the notice explains that the taxpayer may begin construction in 2013, intending to develop it at one site, but instead transfer equipment to a different site, complete its development, and place it in service. In this case, the work performed or amount paid or incurred before January 1, 2014, may be taken into account for purposes of determining whether the facility satisfies the physical work test or the safe harbor. For transfers consisting solely of tangible personal property to an unrelated transferee, any work performed or amount paid or incurred by the transferor for that property will not count toward the transferee’s satisfaction of the physical work test or the safe harbor.

Notice 2014-46 modifies the application of the safe harbor for some facilities for which a taxpayer paid or incurred less than 5 percent, but at least 3 percent, of the total cost of the facility before January 1, 2014. The notice discusses single projects composed of multiple facilities, stating the PTC or ITC may be claimed on some but not all the individual facilities. The guidance also states that a taxpayer won’t satisfy the safe harbor for any part of a single facility that is not a single project composed of multiple individual facilities and that cannot be separated into individual facilities if the amount the taxpayer paid or incurred before January 1, 2014, for the total cost is less than 5 percent of the total cost of the facility at the time it is placed in service. Examples illustrate these modifications and clarifications.

—————————-

Clarification and Modification of Notice 2013-29 and Notice 2013-60

Part III — Administrative, Procedural, and Miscellaneous

SECTION 1. PURPOSE

On January 2, 2013, the American Taxpayer Relief Act of 2012, Pub. L. No. 112-240, 126 Stat. 2313(ATRA), modified the definition of certain qualified facilities under section 45(d) of the Internal Revenue Code (the Code) by replacing the placed in service requirement with a beginning of construction requirement. Accordingly, a taxpayer will be eligible to receive the renewable electricity production tax credit (PTC) under section 45, or the energy investment tax credit (ITC) under section 48 in lieu of the PTC, with respect to such a facility if construction of such facility began before January 1, 2014.

Notice 2013-29, 2013-1 C.B. 1085, provides two methods to determine when construction has begun on a qualified facility: (i) a “physical work” test and (ii) a five percent safe harbor. Notice 2013-60, 2013-2 C.B. 431, clarifies Notice 2013-29 regarding (i) the determination of whether a taxpayer satisfies either the continuous construction requirement or the continuous efforts requirement of those methods with respect to a facility, (ii) the applicability of the “master contract” provision, and (iii) the ability to transfer a facility after construction has begun. This notice further clarifies Notices 2013-29 and 2013-60 regarding (i) how to satisfy the physical work test and (ii) the effect of various types of transfers with respect to a facility after construction has begun. In addition, this notice modifies the application of the five percent safe harbor.

The guidance provided in this notice applies the rules of sections 45 and 48 as in effect on January 1, 2014. The Internal Revenue Service (Service) will not issue private letter rulings to taxpayers regarding the application of this notice or the application of the beginning of construction requirement under sections 45(d) and 48(a)(5) as provided in Notice 2013-29 and Notice 2013-60.

SECTION 2. BACKGROUND

A taxpayer may establish the beginning of construction by beginning physical work of a significant nature as described in section 4 of Notice 2013-29 (Physical Work Test). Alternatively, a taxpayer may establish the beginning of construction by meeting the safe harbor provided in section 5 of Notice 2013-29 (Safe Harbor). A taxpayer can satisfy the Safe Harbor with respect to a facility by demonstrating, after the facility is placed in service, that five percent or more of the total cost of the facility was paid or incurred before January 1, 2014. Both methods require that a taxpayer make continuous progress towards completion once construction has begun (as set forth in section 4.06 (Continuous Construction Test) and section 5.02 (Continuous Efforts Test) of Notice 2013-29, respectively).

In response to a significant number of questions received after the publication of Notice 2013-29, the Treasury Department and the Service issued Notice 2013-60, which in part clarifies that the transfer of a facility after construction has begun will not necessarily prevent a facility from qualifying for the PTC or the ITC. Additionally, section 3.02 of Notice 2013-60 provides a method for taxpayers to satisfy either the Continuous Construction Test or the Continuous Efforts Test. If a taxpayer places a facility in service before January 1, 2016, the facility will be considered to satisfy the Continuous Construction Test (for purposes of satisfying the Physical Work Test) or the Continuous Efforts Test (for purposes of satisfying the Safe Harbor), regardless of the amount of physical work performed or the amount of costs paid or incurred with respect to the facility between December 31, 2013, and January 1, 2016.

After the publication of Notice 2013-60, the Treasury Department and the Service received requests for further clarification regarding how to satisfy the Physical Work Test as well as questions regarding the effect of various types of transfers with respect to a facility after construction has begun. This notice clarifies the application of the Physical Work Test and the effect that certain transfers with respect to a facility after construction has begun will have on a taxpayer’s ability to qualify for the PTC or the ITC. In addition, this notice modifies the application of the Safe Harbor for certain facilities with respect to which a taxpayer paid or incurred less than five percent, but at least three percent, of the total cost of the facility before January 1, 2014.

SECTION 3. PHYSICAL WORK TEST

The Physical Work Test requires that a taxpayer begin physical work of a significant nature (as defined in section 4.02 of Notice 2013-29) prior to January 1, 2014. This test focuses on the nature of the work performed, not the amount or cost. Notice 2013-29 describes several activities that constitute physical work of a significant nature. These activities are merely examples and not an exclusive list of the activities that will satisfy the Physical Work Test. For example, section 4.02 of Notice 2013-29 provides:

[I]n the case of a facility for the production of electricity from a wind turbine, on-site physical work of a significant nature begins with the beginning of the excavation for the foundation, the setting of anchor bolts into the ground, or the pouring of the concrete pads of the foundation.

Section 4.05(1) of Notice 2013-29 provides:

[P]hysical work on a custom-designed transformer that steps up the voltage of electricity produced at the facility to the voltage needed for transmission is physical work of a significant nature with respect to the facility because power conditioning equipment is an integral part of the activity performed by the facility.

Section 4.05(2) of Notice 2013-29 provides:

Roads that are integral to the facility are integral to the activity performed by the facility; these include onsite roads that are used for moving materials to be processed (for example, biomass) and roads for equipment to operate and maintain the qualified facility. Starting construction on these roads constitutes physical work of a significant nature with respect to the facility.

Beginning work on any one of the activities described above will constitute physical work of a significant nature.

Section 4.04(3) of Notice 2013-29 provides an example in which X, a developer of a 50 turbine wind farm, is found to satisfy the beginning of construction requirement in part based on the stated fact that, in 2013, for 10 of the 50 turbines, X excavates the site for the foundations of the wind turbines and pours concrete for the supporting pads. This example illustrates the “single project” concept set forth in section 4.04(2) of Notice 2013-29 and is not intended to indicate that there is a 20% threshold or minimum amount of work required to satisfy the Physical Work Test. Assuming the work performed is of a significant nature, there is no fixed minimum amount of work or monetary or percentage threshold required to satisfy the Physical Work Test.

As provided in section 4.01 of Notice 2013-29 the Service will closely scrutinize a facility, and may determine that construction has not begun on a facility before January 1, 2014, if a taxpayer does not maintain a continuous program of construction as determined under section 4.06 of Notice 2013-29 and section 3.02 of Notice 2013-60.

SECTION 4. TRANSFERS WITH RESPECT TO A FACILITY

.01 In general. Certain of the definitions of a qualified facility provided in section 45(d) require that the construction of the facility begin before January 1, 2014. There is no statutory requirement that the taxpayer that places the facility in service also be the taxpayer that begins construction of the facility. See Notice 2013-60, section 5.01. Moreover, section 48(a)(5)(D) defines “qualified property” (which may be eligible for the ITC in lieu of the PTC) as certain property that is “constructed, reconstructed, erected, or acquired by the taxpayer.” (Emphasis added.) Thus, except as provided in section 4.03 of this notice, a fully or partially developed facility may be transferred without losing its qualification under the Physical Work Test or the Safe Harbor for purposes of the PTC or the ITC. For example, a taxpayer may acquire a facility (that consists of more than just tangible personal property) from an unrelated developer that had begun construction of the facility prior to January 1, 2014, and thereafter the taxpayer may complete the development of that facility and place it in service. The work performed or amount paid or incurred prior to January 1, 2014, by the unrelated transferor developer may be taken into account for purposes of determining whether the facility satisfies the Physical Work Test or Safe Harbor.

.02 Relocation of equipment by a taxpayer. A taxpayer also may begin construction of a facility in 2013 with the intent to develop the facility at a certain site, but thereafter transfer equipment and other components of the facility to a different site, complete its development, and place it in service. The work performed or amount paid or incurred prior to January 1, 2014, by such a taxpayer may be taken into account for purposes of determining whether the facility satisfies the Physical Work Test or the Safe Harbor.

.03 Transfers of equipment between unrelated parties. In the case of a transfer consisting solely of tangible personal property (including contractual rights to such property under a binding written contract) to a transferee not related (defined for these purposes by reference to section 197(f)(9)(C)) to the transferor, any work performed or amount paid or incurred by the transferor with respect to such property so transferred will not be taken into account with respect to the transferee for purposes of the Physical Work Test or the Safe Harbor.

Example. Developer D intends to develop and operate Facility K at a location to be determined. Prior to January 1, 2014, Developer D pays or incurs $60,000 to have tangible personal property integral to Facility K manufactured off-site pursuant to a binding written contract. Thereafter Developer D incurs no further development costs and engages in no further development activity with respect to Facility K. In January 2014, Developer D sells the tangible personal property to Developer E, a party unrelated to Developer D. Developer E is developing and intends to operate Facility L, a facility located on a parcel of land owned by Developer E. Developer E incorporates the tangible personal property acquired from Developer D into Facility L. In October 2015, Developer E places Facility L in service on the parcel of land. The total cost of Facility L is $1,000,000.

Amounts paid or incurred by Developer D prior to January 1, 2014, for the tangible personal property will not be taken into account for purposes of satisfying the Safe Harbor with respect to Facility L. However, if without regard to these components, Developer E has otherwise satisfied the Physical Work Test or the Safe Harbor with respect to Facility L, Developer E will be eligible to claim the PTC with respect to electricity generated by Facility L and sold to an unrelated party. In such a case, Developer E may alternatively elect to claim the ITC in lieu of the PTC.

SECTION 5. SAFE HARBOR

.01 Single project. If the amount a taxpayer paid or incurred before January 1, 2014, with respect to the total cost of a facility that is a single project comprised of multiple facilities (as described in section 4.04(2) of Notice 2013-29) is less than five percent of the total cost of the facility at the time the facility is placed in service, the Safe Harbor is not fully satisfied. However, if a taxpayer paid or incurred at least three percent of the total cost of such a facility before January 1, 2014, the Safe Harbor may be satisfied and the PTC or ITC may be claimed with respect to some, but not all, of the individual facilities (as described in section 4.04(1) of Notice 2013-29) comprising the project. In this situation, a taxpayer may claim the PTC or ITC on any number of individual facilities as long as the total aggregate cost of those individual facilities at the time the project is placed in service is not greater than twenty times the amount the taxpayer paid or incurred before January 1, 2014. The Continuous Efforts Test of section 5.02 of Notice 2013-29 must also be met to qualify for the Safe Harbor.

.02 Single facility. If the amount a taxpayer actually paid or incurred before January 1, 2014, with respect to the total cost of a single facility that is not a single project comprised of multiple individual facilities (as described in section 4.04(2) of Notice 2013-29), and that cannot be separated into individual facilities, is less than five percent of the total cost of the facility at the time the facility is placed in service, then the taxpayer will not satisfy the Safe Harbor with respect to any portion of the facility.

.03 Examples — (a) Example 1. Developer incurs $30,000 in costs prior to January 1, 2014, to construct Project M, a five-turbine wind farm, that will be operated as a single project (as described in section 4.04(2) of Notice 2013-29). In October 2015, Developer places Project M in service. The total cost of Project M is $800,000, with each turbine costing $160,000. Although Developer did not pay or incur five percent of the total cost of Project M before January 1, 2014, Developer did pay or incur at least three percent of the total cost of Project M before January 1, 2014. In addition, because Developer placed Project M in service before January 1, 2016, Developer is deemed to satisfy the Continuous Efforts Test pursuant to section 3.02 of Notice 2013-60. Accordingly, Developer will be treated as satisfying the Safe Harbor with respect to three of the turbines of Project M, as their total aggregate cost of $480,000 is not greater than twenty times the $30,000 in costs incurred by Developer prior to January 1, 2014. Thus, Developer may claim the PTC on electricity produced from three of the turbines of Project M or the ITC based on $480,000, the cost of three of the turbines of Project M.

(b) Example 2. Developer incurs $25,000 in costs prior to January 1, 2014, to construct Facility N, an open-loop biomass facility, partly comprised of one boiler and one turbine generator that are functionally interdependent. In October 2015, Developer places Facility N in service. The total cost of Facility N is $600,000. Because Developer did not pay or incur five percent of the actual total cost of Facility N before January 1, 2014, and because the boiler and turbine generator are integral parts of a single facility that is not a single project comprised of multiple facilities (as described in section 4.04(2) of Notice 2013-29), Developer will not satisfy the Safe Harbor. However, if physical work of a significant nature began (within the meaning of section 4.01 of Notice 2013-29, as clarified by section 3 of this notice) before January 1, 2014, Developer may be able to claim the PTC or the ITC with respect to Facility N.

SECTION 6. EFFECT ON OTHER DOCUMENTS

Notice 2013-29, 2013-1 C.B. 1085, and Notice 2013-60, 2013-2 C.B. 431, are clarified and modified.

SECTION 7. DRAFTING INFORMATION

The principal author of this notice is Jennifer C. Bernardini of the Office of Associate Chief Counsel (Passthroughs & Special Industries). For further information regarding this notice contact Ms. Bernardini on (202) 317-6853 (not a toll-free call).



New IRS Form May Fuel Nonprofit Political Activity.

When it comes to political campaign activity and section 501(c)(3) compliance issues, what was old may become new again, thanks to a new IRS exemption application form, several experts told Tax Analysts recently.

The IRS has rolled out Form 1023-EZ, “Streamlined Application for Recognition of Exemption Under Section 501(c)(3) of the Internal Revenue Code” 2014 TNT 127-51: Forms Watch. The form’s instructions 2014 TNT 76-41: Forms Watch remind applicants that 501(c)(3) groups cannot directly or indirectly participate or intervene in any campaign at the federal, state, or local level on behalf of, or in opposition to, any candidate. But critics have said the streamlined form creates major compliance risks, effectively greenlighting potential 501(c)(3) organizations with minimal inquiry into their activities.

IRS Commissioner John Koskinen has defended the form, telling Tax Analysts in a July interview that the simpler, electronic form will allow the agency to more effectively use its resources.

The trouble is, the form is a checklist and not a “true application,” said Arthur Rieman of the Law Firm for Non-Profits. The form, he said, allows organizations to claim exempt status using “the honor system.” The nearly automatic exemption that Form 1023-EZ filers can get will allow those wishing to game the system to use their 501(c)(3) approval to do whatever they want, until they shut down the organization or the IRS catches them, he said.

Section 501(c)(4) social welfare organizations play a significant role in campaigns now. But thanks to the new IRS form, charities will be the next wave of politically active exempt organizations, said Marcus Owens of Caplin & Drysdale during a panel discussion in Washington in early July.

There won’t be any IRS inquiry into the planned activities of an organization filing the Form 1023-EZ, and the IRS’s ability to audit those groups is constrained, said Owens, who formerly served as EO director in the IRS Tax-Exempt and Government Entities Division.

“The IRS conducts audits of somewhere around 2,500 to 3,000 tax-exempt organizations a year — there are one and a half million of them,” Owens said. “So your chances, once you have tax-exempt status, of losing that status in an audit are virtually nil unless you tie yourself to the door of the IRS building and proclaim you’re going to violate the tax law.”

Prior Political Involvement

The political use of nonprofit organizations started with the use of 501(c)(3) groups in the 1990s to push the bounds of issue advocacy, said University of Miami law professor Frances Hill. If there are political operatives who decide it’s time to again use 501(c)(3) organizations for “muscular issue advocacy” as part of an electoral strategy, they can find a way to make it happen, she said.
“This is all a matter of tactical planning,” Hill said. “We started out with [former Rep.] Newt Gingrich and his 501(c)(3)s, a cluster of them. I think we may be returning to that.”

In 2003 the IRS restored section 501(c)(3) status to a pair of groups with ties to Gingrich — the Howard H. Callaway Foundation and the Abraham Lincoln Opportunity Foundation. The Callaway Foundation made grants to the Lincoln Foundation, whose attorney said the group was formed to allow Republicans to support charitable causes in the Denver area. Gingrich had been accused of improperly using charitable funds for political purposes.

Political campaigns have since transformed, and the most effective messaging now focuses on issues rather than candidates, Owens said. After the Supreme Court’s decision in Citizens United v. FEC, 558 U.S. 310 (2010), he said, campaigns are increasingly following a structure pioneered by former Sen. Jesse Helms, who had a network of organizations working for him, including a charity that prospected for donors.

The new streamlined 501(c)(3) application paves the way for that trend to continue, Owens said. “A modern political campaign is really now a collection of different organizations,” he said, adding, “A (c)(4) could, for example, talk about the various candidate positions but in a way that doesn’t necessarily suggest one over the other so that it has a nonpartisan feel to it. The expedited processing procedure will make it easy to create . . . a swarm of (c)(3)s, all relatively small but very targeted in their educational efforts.”

Section 501(c)(3) status allows an organization both to offer its donors the charitable contribution deduction and to create “a halo” around the message it is advocating, Owens said.

“Talking about issues like the environment, for example, or for that matter Second Amendment kinds of rights, is easily cast as an educational activity under section 501(c)(3),” he said, adding that such messaging is likely to have “a higher credibility with the viewer or the listener than a more overt political message or the same message coming from an acknowledged political source.”

Pop-Up Charities and Other Fears

State and federal regulators alike may have a hard time tracking down some politically active 501(c)(3) groups. An organization can be exempt under state law and not under federal law, Hill said, adding that some states permit various types of nonprofit organizations to engage in considerably more political campaign activity. Even if some organizations ultimately lose their federal exemptions, they might keep their state tax-exempt status, she said.

Owens said that if, as he fears, a swarm of ostensibly educational but truly political 501(c)(3)s develops close to an election, those groups will likely have a lifespan of less than a year. And if they never file a Form 990, all the IRS will have to use in tracking them down is the Form 1023-EZ.

“It won’t contain much information,” Owens said. “It may contain an address that is a post office box somewhere.”

The potential emergence of these pop-up organizations is the concern regarding the new form, Hill said. There are no safeguards against political activity in the new application process, she said, though she added that the long form exemption application for charities doesn’t prevent substantial campaign activity anyway.

State regulators don’t have the resources, either, to deal with pop-up organizations that disappear before anyone has learned of them, said Douglas M. Mancino of Hunton & Williams LLP. He said he shares concerns about the potential for abusive pop-up charities, political or otherwise, to launch using the streamlined application.

Mancino said that he’s interested in seeing what kind of statistical sampling the IRS comes up with to review the activities of organizations that file the streamlined form, but that developing that sampling takes time. And a lot can happen before that work is done, he said.

“Frankly, armed with a determination letter, you really can go out and do a lot of damage to the sector,” Mancino said.

When the IRS released the final form on July 1, Benjamin Takis of Tax-Exempt Solutions PLLC said that unless the IRS can hold organizations accountable for inaccurate financial projections or misrepresenting their purpose or activities, there is a substantial risk of fraud and noncompliance.

Takis later expanded on those concerns, saying, “There is certainly a lot of gray area in the definition of political activity for organizations that are looking to game the system, and the Form 1023-EZ will only make it harder for the IRS to combat these tactics.”

On the state-level regulation issue, Takis said, “I don’t know of any legal obligation for the IRS to design forms and policies in a way that eases the burden on states, but the Form 1023-EZ certainly disrupts the balance that has developed between federal and state oversight of charities, and the effects of this disruption could be profound.”

State charity regulators aren’t exactly welcoming the new IRS form. In an April 30 letter 2014 TNT 144-77: IRS Tax Correspondence to the IRS, the National Association of State Charity Officials condemned the streamlined form, saying it would pave the way for fraud and increase the burden on state regulators, whose enforcement capabilities are already stretched thin.

Given the comments the state charity officials group submitted, it appears state regulators will treat use of the Form 1023-EZ as a red flag, Mancino and a colleague, Ofer Lion, wrote in a client alert posted on their firm’s website. Mancino and Lion also wrote that early returns suggest that Form 1023-EZ filers are receiving determination letters within three weeks.

IRS Defends the Form

Up to 70 percent of all organizations applying for 501(c)(3) status will be eligible to file the streamlined form, the IRS said in a statement. Organizations are instructed that they must not substantially engage in activities that contradict their exempt purpose, and the agency said it will ramp up its education and outreach work to organizations eligible to file the Form 1023-EZ.

In a July 1 memo 2014 TNT 129-52: Other IRS Documents providing interim guidance on the form, Matthew Weir, IRS director of EO rulings and agreements, said IRS examiners will review submitted Forms 1023-EZ in order of submission, while ensuring all fields on the form are complete. Using a sampling plan, determinations specialists will perform a predetermination review on randomly selected cases before issuing a determination letter, the memo says.

Koskinen told Tax Analysts that this new exemption application process will allow smaller organizations to obtain approval while avoiding the same scrutiny given to larger organizations, without the IRS sacrificing its improved monitoring of all organizations. “The net result is that there will be less risk to the public,” he said.

Applicants will file the new Form 1023-EZ electronically, which will allow the agency to more easily screen applications with inconsistent answers or ones that raise questions before it issues approvals, Koskinen said. The agency will also test the accuracy of the short form by taking a statistical sampling of streamlined applications and subjecting them to the more rigorous, full exemption application, he said. The IRS will do still another sampling of Form 1023-EZ applicants a year after they’re approved and audit “how they’re doing and what they are doing,” Koskinen said.

“We’ll be better at the front end, but we’ll have more resources available to check on people at the back end and see are you doing what you said you were going to do,” Koskinen said. “Are you still doing the right thing? Now we’ll know.”

Takis interpreted the situation differently. “One challenge for the IRS will be that the Form 1023-EZ is likely to lead to many more organizations getting formed and applying for 501(c)(3) status, so it’s going to be that much harder for the IRS to keep track of all these organizations and find the bad actors,” he said.

David van den Berg
Tax Analysts



EO Short Form Filers Don't Have to Reveal Personal Addresses.

Organizations listing their high-level officials on the IRS’s streamlined exemption application for charities may use the organizations’ mailing addresses rather than the personal mailing addresses of the officials, according to the IRS.

Form 1023-EZ, “Streamlined Application for Recognition of Exemption Under Section 501(c)(3) of the Internal Revenue Code,” instructs those organizations eligible to use the form to list the names, titles, and mailing addresses of their officers, directors, and trustees. In the August 6 edition of its EO Update, the IRS clarified that an organization’s mailing address can be used instead of an official’s personal mailing address. The change has been made in the form’s instructions, the IRS added.

The IRS introduced the short form July 1 following the release in April of a draft version. IRS officials have expressed hope that the streamlined application, which asks applicants for less information than the standard Form 1023, will make the application process less burdensome for small organizations. Some practitioners, however, worry that the short form does not ask for enough information about applicants’ proposed operations, potentially allowing organizations to abuse the system.



Mayor Seeks Policy Changes for Infrastructure Improvements.

Terre Haute, Ind., Mayor Duke Bennett has expressed support for tax policies that promote investment in the nation’s infrastructure, urging Treasury to make it easier to use public-private partnerships to address bond funding challenges stemming from the transfer of ownership or control of water and wastewater infrastructure to a private partner.

[Editor’s Note: Treasury received substantially similar letters from the mayors of Wabash, Ind.; Orland Park, Ill.; and Overland, Mo.]

July 21, 2014

The Honorable Mark Mazur
Assistant Secretary for Tax Policy
Department of the Treasury
1500 Pennsylvania Avenue, NW
Washington, DC 20220

The Honorable William Wilkins
Chief Counsel
Internal Revenue Service
1111 Constitution Avenue, NW
Washington, DC 20224

RE: Tax Policies Supporting Infrastructure Investment: Section 141 Fix

Dear Mr. Mazur and Mr. Wilkins:

On behalf of the City of Terre Haute, I wish to express my strong support for tax policies that promote investment in the nation’s infrastructure such as water, wastewater, roads, parking garages, storm water facilities, etc. The U.S. Conference of Mayors Water Council also supports such tax policies and we appreciate your help.

The U.S. Environmental Protection Agency has estimated that we must invest more than $500 billion over the next 20 years to improve or replace existing water, wastewater, and fire safety systems. This investment is necessary to bring old infrastructure into compliance with the Clean Water Act, the Safe Drinking Water Act, and other environmental statutes, to repair broken and leaking pipes that waste more than 7 billion gallons daily, and to realize the benefits of modern water conservation technologies. Addressing these dramatic needs will require focused, dedicated and robust participation by the public sector and private sectors. The financial scope of the water and wastewater infrastructure deficit is simply too great for any one sector of service providers to tackle alone.

The private sector is working closely with local governments on a wide range of public private partnerships (P3) to promote greater investment in water and waste water infrastructure. These P3s often begin a number of years after a community has made a substantial investment of its own through the issuance of tax-exempt bonds. However, when the P3 involves the transfer of ownership or control of the water infrastructure to a private partner, that partner may be required to undertake remedial actions to preserve the tax-exempt status of the bonds, such as redemption, defeasance, or re-investment of the proceeds in an approved alternate use.

As you know, redemption is often precluded by the terms of the bonds themselves. Defeasance is unnecessarily costly in the current low interest rate environment: too much capital ends up locked up in ultra-low interest Treasury securities that could otherwise be put to use addressing critical community needs. We hope the Treasury Department will take action to help reduce the defeasance penalty while the difference between rates earned by Treasuries and municipal bonds remains high. The applicable regulations were designed decades ago before P3s became popular, and represent a serious hindrance to deploying P3s to address America’s water and wastewater challenges.

If you or your staff has any questions, please don’t hesitate to contact me or my staff at 812.244.2303

Respectfully,

Duke A. Bennett
Mayor
City of Terre Haute
Terre Haute, IN



One Michigan Mayor Will Sue to Keep the State's Property Tax on Manufacturing Equipment.

Warren Mayor Jim Fouts said he plans to file a lawsuit Friday to overturn the passage of Proposal 1, which will phase out the personal property tax on manufacturing equipment in Michigan.

Fouts said the lawsuit will contend the ballot proposal violated state law by using wording tilted toward promoting its passage. He called the wording “confusing,” “one-sided,” and “blatantly unlawful,” in a news release today announcing that he has directed the city attorney to file the lawsuit Friday in the Michigan Court of Claims.

“State of Michigan law is crystal-clear prohibiting slanted ballot language for any proposal,” he said, adding that he was the only elected official in Michigan to oppose the question.

Proposal 1, which won handily in Tuesday’s election, will phase out the tax on industrial and some commercial equipment between 2016 and 2023. It is an unpopular tax among manufacturers, of which Warren has many large industrial taxpayers. Most of the revenue from it goes to local governments.

Kelly Rossman-McKinney, communications director for Michigan Citizens for Strong and Safe Communities, which campaigned for the proposal, said the proposal was vetted by the Legislature and legal counsel and she does not expect any problems with the language. She said the Legislature debated the idea in December 2012 and in February and March of this year so Fouts “had plenty of opportunities to express his concerns.”

Rossman-McKinney said she was not surprised Fouts intends to sue, but she is surprised that he’s using taxpayers’ dollars to do it. She said he may want “to be cautious” using city resources when a majority of Warren voters supported the proposal. Rossman-McKinney said the proposal won in every county in the state.

“I understand that he’s a maverick,” she said. “It’s one thing to be a maverick on your own dime. It’s another thing to be a maverick on the taxpayers’ dime.”

Fouts said he’s “responding to a lot of disappointed voters,” including more than 30 senior citizens he spoke with today at a senior picnic, who indicated they were confused by the proposal.

The proposal replaces lost local revenue by shifting money from the state’s 6% use tax that is charged on items such as Internet and mail-order purchases, telephone service and hotel accommodations.

Fouts said wording in the proposal was a “sales pitch appealing to all voters.” He cited such phrases as “helping small businesses grow and create jobs,” “modernize the tax system,” “police safety, fire protection, and ambulance emergency services,” “aid to local school districts” and “prohibiting the authority from increasing taxes.”

He said the seniors he talked with today didn’t understand the proposal, but they didn’t want to vote against jobs, police and fire. He questioned the phrases, such as what does it mean to “modernize the tax system?”

Fouts said the proposal purposely avoided using words like “tax cuts for large manufacturers” because that would have caused a “voter backlash” diminishing the chances for approval.

“But tax breaks for large manufacturers is the essence of the proposal with minimal tax breaks for small businesses,” Fouts said. “And state legislators conveniently left out the use tax increase in the proposal’s language.”

Fouts said the city of Warren is expected to lose $10 million to $11 million in 2016 and it’s unclear how much it will receive from the use tax. He said many cities, such as Detroit, Pontiac and Sterling Heights, will take a hit.

Fouts said the proposal was sold to benefit small businesses that would create up to 15,000 new jobs, but large manufacturers benefit with $500 million in tax reductions. He said the average taxpayer “will be the victim with higher taxes.”

Fouts said he knows he is facing “an uphill fight, but I believe the proposal was bad for cities and state taxpayers.”

Fouts said he also will make a formal complaint about state legislators sending out mailings, at taxpayers’ expense, expressing support for the proposal without printing opposing arguments.

“They broke state law governing fairness in franking privileges by legislators, and they should reimburse the state for that abuse,” he said in his news release.

BY MCCLATCHY NEWS | AUGUST 8, 2014
By Christina Hall

(c)2014 the Detroit Free Press



IRS Consolidates Memos on TE/GE's Expedited Application Process.

The IRS Tax-Exempt and Government Entities division has issued guidance (TEGE-07-0714-0022) consolidating into one document prior memoranda on the optional expedited process for some pending section 501(c)(4) tax-exempt applications.

_____________________________________

July 28, 2014

Affected IRM: IRM 7.20.2
Expiration Date: July 28, 2016

MEMORANDUM FOR EXEMPT ORGANIZATIONS DETERMINATIONS UNIT AND EXEMPT ORGANIZATIONS TECHNICAL UNIT

FROM:
Matthew A. Weir
Director, Rulings and Agreements,
Exempt Organizations

SUBJECT:

Interim Guidance on Optional Expedited Process for Applicants for Section 501(c)(4) Status Who Received a Letter 5228 Before December 23, 2013

On June 25, 2013, Exempt Organizations issued Interim Guidance Memo TEGE-07-0613-08 (the “June 25, 2013 memorandum”), which provided interim administrative guidance to the Exempt Organizations Determinations Unit (EOD) and the Exempt Organizations Technical Unit (EOT) regarding an optional expedited process for applicants for section 501(c)(4) status with applications pending for more than 120 days as of May 28, 2013, that indicate the organization may be involved in political campaign intervention or issue advocacy (“identified pending applications”). The June 25, 2013 memorandum was reissued without modification as Interim Guidance Memo TEGE-07-0614-0016.

Since the issuance of the original June 25, 2013 memorandum, other interim guidance memoranda were released that modified some portions of the process originally described in the June 25, 2013 memorandum. These memoranda included Interim Guidance Memo TEGE-07-0713-12 (July 18, 2013) (providing for the transfer of applications to EOT), Interim Guidance Memorandum TEGE-07-0913-14 (September 10, 2013) (stating that referrals will now be sent through the Exempt Organizations Examinations Classifications Unit instead of the Review of Operations Unit), and Interim Guidance Memorandum TEGE-07-0514-0012 (May 19, 2014) (providing for Office of Appeals review of proposed adverse determinations issued by EOT).

EOT has processed cases according to the procedures described in all applicable interim guidance impacting the optional expedited program as initially described in the June 25, 2013 memorandum. The purpose of this Interim Guidance is to consolidate the various interim guidance memoranda impacting the original optional expedited program described in the June 25, 2013 memorandum into a single document that clearly describes the process that Exempt Organizations has used and will continue to use in processing the identified pending applications.

This memorandum applies only to applicants for section 501(c)(4) status who received a Letter 5228 (6-2013), Application Notification of Expedited 501(c)(4) Option, before December 23, 2013. Applicants for section 501(c)(4) status who receive a Letter 5228 (9-2013) on or after December 23, 2013, are subject to the expanded optional expedited process described in TEGE-07-1213-24 (December 23, 2013) or any of its future updates. Applicants for section 501(c)(4) status who have not yet received a Letter 5228 but believe they may be eligible for the optional expedited process should also consult TEGE-07-1213-24 (December 23, 2013) or any of its future updates.

The content of this memorandum will be incorporated in IRM 7.20.2.

Please contact the Senior Manager, Rulings and Agreements, Technical with any questions regarding the application of this memorandum.

cc:
www.IRS.gov
* * * * *

Optional Expedited Process for Applicants for Section 501(c)(4) Status Who Received a Letter 5228 before December 23, 2013

Outlined below are the steps of the process for achieving expedited and fair processing of the exemption applications of those applicants for section 501(c)(4) status that received a Letter 5228, Application Notification of Expedited 501(c)(4) Option (6-2013),1 before December 23, 2013 (hereinafter, “identified pending applications”). All identified pending applications had been pending 120 or more days since filing as of May 28, 2013 and indicated the applicant may be involved in political campaign intervention or issue advocacy.

Step 1: IRS Ensures Reviews for Private Inurement

The IRS will promptly review all signed identified pending applications to ensure the case does not indicate any private inurement.

If there are no private inurement concerns, the identified pending application will proceed to step 2. If there are concerns with private inurement, the identified pending application will be transferred to EOT after completion of Step 1 for all other identified pending applications.2

If any identified pending applications are determined ready to be granted favorable status, EOD will proceed to issuing the favorable determination letter and steps 2 through 5 will not apply to such applications.

Step 2: Offering Expedited Option Process

By letter to the applicant (Letter 5228), EOD will provide an optional expedited process for all identified pending applications for which there are no indications of private inurement. The optional expedited process will permit these applicants to make representations under penalties of perjury regarding their past, current, and anticipated future political campaign intervention and social welfare activity. Applicants choosing to make the representations will receive a favorable determination letter from the IRS without further review. The favorable determination letter will be issued within two weeks of receipt of the signed representations.

This process is optional; applicants may determine whether they want to provide the representations, assuming they are able to do so, or whether they want the IRS to continue to review their application with regard to political campaign intervention or advocacy issues and requirements for section 501(c)(4) status.

Letter 5228 will request a response by the applicant within 45 days. During the period in which the applicant is considering whether to make the representations in Letter 5228, EOD will transfer the identified pending applications to EOT.3 During this period, EOT, with assistance from Chief Counsel attorneys, will review the identified pending applications for purposes of making a proposed recommendation should the applicant not provide the representations in Letter 5228. If EOT and Chief Counsel attorneys determine a favorable determination is warranted, EOT will issue a favorable determination letter4 and steps 3 through 5 will not apply to such application.5

Step 3: IRS Processing of Applications

Optional Expedited Process: Any applicant that provides the representations under penalties of perjury will receive a favorable determination from EOD or EOT6 within 2 weeks of receiving the signed representations. Like all organizations receiving a favorable determination of exempt status, the organization may be subject to examination by the IRS and the organization’s exempt status may be revoked if, and as of the tax year in which, the facts and circumstances indicate exempt status is no longer warranted. Revocation may be retroactive to the date of formation if the facts and circumstances indicate the representations were not accurate. An organization may no longer rely on the determination letter issued as part of this optional expedited process for any tax year in which its activities are no longer consistent with the representations, if the applicable legal standards change, or if the determination letter is revoked. If the organization determines that it continues to be described in section 501(c)(4) notwithstanding the fact that its activities are no longer consistent with the representations, it may continue to take the position that it is described in section 501(c)(4) and file Form 990, Return of Organization Exempt From Income Tax, but it must notify the IRS about such representations ceasing to be correct on Schedule O, Supplemental Information, of the Form 990.

An organization receiving Letter 5228 that provides the representations may be referred to the Exempt Organizations Classification Unit7 for subsequent review.

Regular Process: If an applicant received Letter 5228 and does not provide the additional representations under the optional expedited process within 45 days from the date of the letter, EOT will review and process the pending application under Steps 4 and 5.

Step 4: Reviewing the Pending Application under the Regular Process — Documenting Review and Recommendations

Review of the pending applications under the regular process will include review by EOT, Chief Counsel attorneys, and (in some cases) a second layer of review by supervisory personnel in Chief Counsel and Exempt Organizations.8

EOT and Chief Counsel attorneys will review the facts and circumstances in the pending application and any other materials to determine if the organization is operated primarily for social welfare purposes, including by evaluating the amount of political campaign intervention activity. The issues will be analyzed as quickly as possible under current law, using available resources in applying the law to the facts.

Under the regular process, EOT and Chief Counsel attorneys will document9 their review of the pending application and their recommendation regarding a favorable or adverse determination or a request for additional information.

Favorable Recommendation: If the recommendation of both EOT and Chief Counsel attorneys is for a favorable determination, EOT will issue the favorable determination. In some cases, Exempt Organizations Technical and Chief Counsel attorneys may recommend referral of a recipient of a favorable determination to the Exempt Organizations Classification Unit for subsequent review.10

Adverse Recommendation: If the recommendation of both EOT and Chief Counsel attorneys is for an adverse determination and the supervisory personnel agree with this recommendation, Chief Counsel attorneys will assist EOT in preparing the proposed adverse determination letter and EOT will follow normal processes in issuing the letter and notifying the applicant that it may file a protest and request a conference with EOT (which would be provided on an expedited basis).

Pursuant to Interim Guidance Memorandum TEGE-07-0514-0012 (May 19, 2014), applicants receiving a proposed adverse determination letter from Exempt Organizations Technical may also request review of their application by the IRS Office of Appeals. EOT will advise applicants with pending proposed adverse determination letters that they may request review by the Appeals Office.

If the organization files a protest and/or has a conference with EOT, and that protest and/or conference results in a changed recommendation to a favorable determination, EOT will issue the favorable determination.

If the protest and/or adverse conference does not result in a changed recommendation and the applicant timely requests review by the Appeals Office, EOT will forward the case to the Appeals Office.11

If the applicant does not timely file a protest or if the applicant files a protest but the protest and/or adverse conference does not result in a changed recommendation and the applicant does not timely request Appeals Office review, EOT will issue a final adverse determination.

Additional Information: If the recommendation of both EOT and Chief Counsel attorneys is that additional information is needed to make a determination, Chief Counsel attorneys will assist EOT in preparing a letter that requests such additional information and EOT will send the letter to the applicant. If and when the applicant has provided the requested additional information, EOT and Chief Counsel attorneys will review the additional information to determine whether the organization is operated primarily for social welfare purposes under current law. EOT and Chief Counsel attorneys will then follow the process for a favorable or adverse recommendation (or for a disagreement with respect to the recommendation) described in this Step 4.

Disagreement Between Exempt Organization Technical and Chief Counsel Attorneys: If EOT and Chief Counsel attorneys disagree on their recommendation, the application will be discussed with supervisory personnel.to reach resolution on the recommendation.12

FOOTNOTES

1 All references to Letter 5228 made hereinafter are intended to refer to the Letter 5228 approved in June 2013 that was sent to certain applicants before December 23, 2013.

2 The original June 25, 2013 memorandum provided that pending applications “will be referred to Exempt Organizations Technical for technical assistance with regard to private inurement issues after completion of Step 1 for all other pending applications.” The July 18, 2013 Interim Guidance Memo TEGE-07-0713-12 (the “July 18, 2013 memorandum”) modified that step to provide that the “[t]hose identified pending applications raising inurement concerns (described in Step 1) have already been formally transferred to Exempt Organizations Technical.”

3 The June 25, 2013 memorandum provided that, “During the period in which the applicant is considering the expedited option process, Exempt Organizations Determinations will refer the pending applications to Exempt Organizations Technical for technical assistance.” This language was modified by the July 18, 2013 memorandum which instructed EOD to formally transfer the identified pending applications to EOT rather than referring them for technical assistance.

4 The June 25, 2013 memorandum provided that “Exempt Organizations Technical will instruct Exempt Organizations Determinations to issue a favorable determination letter. . . .” This language was modified by the July 18, 2013 memorandum which stated, “Because all identified pending applications have been formally transferred to Exempt Organizations Technical, the favorable determination letters described in Step 2 will be issued by Exempt Organizations Technical rather than Exempt Organizations Determinations.”

5 In such cases, the favorable determination letter will include an addendum that will instruct the applicant to disregard the Letter 5228 it had received.

6 The original June 25, 2013 memorandum provided that favorable determination letters would be “issued within two weeks of receipt of the signed representations by Exempt Organizations Determinations.” Because the July 18, 2013 memorandum stated that cases would be formally transferred to EOT during the 45-day period, favorable determination letters could also be issued by EOT.

7 The June 25, 2013 memorandum originally stated that an “organization receiving the expedited option letter that provides the representations may be referred to the Review of Operations Unit for subsequent review.” Under Interim Guidance Memorandum TEGE-07-0913-14 (September 10, 2013), the Review of Operations Unit no longer accepts referrals. Instead referrals must go through the Exempt Organizations Examinations Classification Unit

8 The June 25, 2013 memorandum said that review of pending applications would include, in some cases, review by a new Advocacy Application Review Committee (the “Review Committee”), which was to be “comprised of 3 career executives from the IRS and the Office of Chief Counsel,” which were identified in a footnote as the “Director, EO; Commissioner (TE/GE); and Division Counsel/Associate Chief Counsel (TEGE), or their delegates.” As discussed further in note 11, the process of referring cases to the Review Committee was superseded by Interim Guidance Memorandum TEGE-07-0514-0012 (May 19, 2014),

9 Documentation will be done consistently through a template; reviewer will be noted by an identifying number rather than by name.

10 The June 25, 2013 memorandum originally stated “Any level of review may note a recommendation, or review an earlier level’s recommendation, regarding referral to the Review of Operations Unit.” As noted above in note 7, referrals now go through the Exempt Organizations Classification Unit.

11 The June 25, 2013 memorandum stated that if an “adverse conference is held and does not result in a changed recommendation, the pending application will be sent to the Review Committee in Step 5.” Step 5 was superseded by Interim Guidance Memorandum TEGE-07-0514-0012 (May 19, 2014), which stated that it “supersede[d] any prior IRM section or Interim Guidance that may provide for alternative procedures, including the Interim Guidance Memoranda TEGE-07-0613-08 and TEGE-07-1213-24 which provided for an optional expedited program for certain section 501(c)(4) organizations.”

12 The June 25, 2013 memorandum said that applications would be sent to Review Committee in the event of disagreement between EOT and Chief Counsel attorneys. As discussed in note 11, the process of referring cases to the Advocacy Application Review Committee was superseded by Interim Guidance Memorandum TEGE-07-0514-0012 (May 19, 2014).

END OF FOOTNOTES



IRS: Early Registration Discount Is Available for Tax Forums

The IRS has encouraged enrolled agents, CPAs, certified financial planners, and other tax professionals to attend the next tax forum at National Harbor in Maryland, noting that those who sign up by the preregistration deadline of August 5 will pay a discounted rate.

The IRS nationwide tax forums are three-day events that provide tax professionals current information on federal and state tax issues presented by IRS experts and partner organizations. The forums offer a chance to receive up to 18 continuing education credits through a variety of seminars and workshops. There are two remaining opportunities to attend a forum this year.

__________________________________

WASHINGTON — The next 2014 IRS Nationwide Tax Forum will be held at National Harbor in Maryland near Washington, D.C., and the IRS invites enrolled agents, certified public accountants, certified financial planners and other tax professionals to attend. Those who sign up by the pre-registration date of Aug. 5 will save $130 off the on-site price.

The IRS Nationwide Tax Forums are three-day events that provide tax professionals with the most up-to-date information on federal and state tax issues presented by experts from the IRS and its partner organizations through a variety of training seminars and workshops. John M. Dalrymple, IRS Deputy Commissioner for Services and Enforcement, will give the keynote speech at the National Harbor forum.

The forums previously held this summer in Chicago, San Diego and New Orleans were well attended. Including the upcoming forum at the National Harbor, there are only two remaining opportunities to attend a forum this year.

   Remaining Forums
 _____________________________________________________________________

                                                Pre-Registration
 Location                 Forum Dates           Deadline for $225 Rate
 _____________________________________________________________________

 National Harbor, Md.     Aug. 19 - 21          Aug. 5
 Orlando, Fla.            Aug. 26 - 28          Aug. 12

The cost of enrollment for those who pre-register is $225 per person, a savings of $130 off the late or on-site registration price of $355. Pre-registration ends two weeks prior to the start of each forum.

More than 40 separate seminars and workshops are being offered, and enrolled agents and certified public accountants may earn up to 18 Continuing Professional Education Credits in each location. Additionally, these seminars may qualify for continuing education credit for certified financial planners, pending review and acceptance by the Certified Financial Planner Board.

A few days before the start of each forum, attendees will be able to download, print or to load onto their mobile devices slide presentations from the seminars.

National Participating Association Members

Members of the participating associations below qualify for discounted enrollment costs if they meet the pre-registration deadlines above. Members who meet the early registration deadline would pay $215 and should contact their association directly for more information:

Case Resolution Room

After a one year hiatus, the IRS Case Resolution Program has returned to the Tax Forums. Between 2011 and 2012, the Case Resolution staff has worked over 2,100 cases with a resolution rate of over 97 percent. Tax professionals who plan to meet with IRS representatives about actual cases are reminded to bring a valid power of attorney.

Exhibit Hall

In addition to the seminars, the forums also feature a two-day expo with representatives from tax, financial, and business communities offering their products, services and expertise designed with the tax professional in mind.

In a survey of 2013 attendees, the forums received an overall 94 percent satisfaction rate. 2014 marks the 24th year that the IRS has hosted these forums to help educate and interact with the tax professional community.

Registration Information

For more information, or to register online, visit www.irstaxforum.com.



IRS Releases Publication for Public Charity Tax Compliance.

The IRS has released Publication 4221-PC (rev. July 2014), Compliance Guide for 501(c)(3) Public Charities, which identifies activities that could jeopardize a public charity’s tax-exempt status and addresses general compliance requirements on record keeping, reporting, and disclosure for section 501(c)(3) exempt organizations.



IRS LTR: Structure Change Won't Affect Exempt Status of Electric Power Group.

The IRS ruled that the tax-exempt status of an organization formed to ensure reliable supplies of electric power and to carry out other energy-related tasks will not be jeopardized when it establishes a structure under which it will become the central counterparty to transactions consummated through the markets it administers.

Contact Person: * * *
Identification Number: * * *
Telephone Number: * * *

UIL: 501.06-00, 513.00-00
Release Date: 7/25/2014
Date: April 28, 2014

Employer Identification Number: * * *

Dear * * *:

This letter is in reference to your request from your authorized representative. You are requesting rulings whether your establishment of a central counterparty structure, pursuant to which you will become the central counterparty to transactions that take place in the markets you administer, will affect your status as an organization described in I.R.C. § 501(c)(6) or will give rise to income from an unrelated trade or business within the meaning of § 513(a).

FACTS

You are recognized as an organization exempt from federal income tax under § 501(c)(6). You are organized and operated for the purpose of improving the business conditions of the power and electricity line of business with the meaning of Treas. Reg. § 1.501(c)(6)-1. You are mandated by the Federal Energy Regulatory Committee (FERC) to ensure reliable supplies of power, adequate transmission infrastructure, and competitive wholesale prices of electricity. You are designated as a regional transmission organization (RTO) by FERC.

FERC is responsible for regulating the transmission and wholesale sale of electric energy in interstate commerce to ensure reliability of electric service, nondiscriminatory access to transmission facilities, and that rates charged are reasonable. Prior to your creation, FERC directly regulated the vertically integrated utilities that owned generation, transmission, and distribution facilities in your region.

As part of the process of deregulation and the introduction of market competition into the wholesale electricity market, FERC charged you with providing independent, open and fair access to electricity transmission systems, facilitating market-based wholesale electricity rates, and ensuring effective and reliable management and operation of the bulk power system in your region. This includes the responsibility of ensuring that rates charged for transmission and the wholesale sale of electric energy are reasonable.

In furtherance of your responsibilities, you administer markets for the wholesale purchase and sale of electric energy and related products and services. In order to cover your operating expenses, you collect fees from the producers and wholesale purchasers of electric power in your region. These fees as well as the rules and procedures for the electricity markets you administer are set forth in your tariffs, which must be approved by FERC. The contracts, agreements or transactions offered under your FERC-approved tariffs are for the wholesale purchase and sale of electric energy and related products and services (during the first calendar quarter next year, you plan to begin offering related financial transactions, which do not involve physical delivery of electricity).

Currently, you administer a real-time energy imbalance market whereby market participants can compare real-time prices from many sources to make the most cost-effective decisions to purchase or sell energy into the market. Additionally, you settle the various positions of the market participants on an aggregate basis and both collect and remit payments to the market participants on a weekly basis. While you act as the administrator of the markets, clearing and settling purchases and sales by market participants, you currently do not take title to the electric energy or related products and services purchased and sold in the markets.

Additionally, you have been approved by FERC to develop and administer additional, more advanced markets which will provide additional benefits to current and new market participants. You are currently in the development stage and have received conditional approval from FERC of tariff changes to implement your new market.

FERC monitors the credit practices of the wholesale electric markets. In its order No. 741, “Credit Reforms in Organized Wholesale Electric Markets,” (Oct. 21, 2010), 133 FERC ¶ 61.060, and its Order No. 741-A “Credit Reforms in Organized Wholesale Electric Markets,” (Feb. 17, 2011). 134 FERC ¶ 61,126, FERC raised a question about the ability of an RTO or an independent system operator (ISO), in the event of the bankruptcy or a market participant, to set off or net the market positions of the bankrupt market participant. FERC’s concern is that an ISO or RTO might not satisfy the “mutuality” requirement for setoff when those obligations are based upon different purchase and sale transactions because there is potential ambiguity as to the role of the ISO and RTO in the transactions. FERC therefore directed you (as well as other ISOs and RTOs) to submit a compliance filing with a proposed tariff revision that includes one or the following options:

1. establish yourself as a central counterparty to transactions with market participants;

2. require market participants to provide a security interest in their transactions in order to establish collateral requirements based on net exposure;

3. propose another alternative, which provides the same degree of protection as the two above-mentioned methods; or

4. choose none of the three above alternatives and instead establish credit requirements for market participants based on their gross obligations.

In response to the specific FERC orders above, you intend to pursue option 1: tariff amendments proposing to establish yourself as the central counterparty to all transactions that take place in the new market you will administer. Specifically, you will take title to the electric energy and related products purchased and sold in the markets. You represent that your role as central counterparty will not affect the clearing price, because the prices you pay to providers will exactly match the prices you receive from the sellers. You concluded that option 1 is the best balance between (i) fostering market liquidity and efficiency; and (ii) minimizing the risk of defaults. All transactions in which you engage will be pursuant to a FERC-approved tariff. The revisions to the tariff establishing you as central counterparty will be filed with FERC and will go into effect only if approved by FERC.

You have represented that your proposed activities as the central counterparty to transactions in the markets you administer (i) will not require an amendment to any of your organizing documents or any change in your organization; (ii) will require only minor revisions to your FERC-approved tariff; (iii) will result in no net profit or loss to you; and (iv) will not directly affect market clearing prices for electric energy and related products and services in the wholesale electric markets you administer. You have also represented that you are not aware of any statute or law that prohibits a government from acting as or performing the functions of an RTO, and that your operations will not change materially following your assumption of the central counterparty role.

RULINGS REQUESTED

1. Your establishment and implementation of a central counterparty structure pursuant to which you will become the central counterparty to transactions consummated through the markets you administer will not adversely affect your status as an organization exempt from federal income tax under § 501(c)(6).

2. The revenues you receive by virtue of being the central counterparty to transactions consummated through the markets you administer will not be classified as income from an unrelated trade or business within the meaning of § 513(a).

LAW

I.R.C. § 501(c)(6) provides for the exemption from federal income tax of business leagues, chambers of commerce, real-estate boards, boards of trade, or professional football leagues (whether or not administering a pension fund for football players), not organized for profit and no part of the net earnings of which inures to the benefit of any private shareholder or individual.
I.R.C. § 511(a)(1) imposes a tax on the unrelated business taxable income of organizations described in § 501(c)(6).

I.R.C. § 512(a)(1) states that the term “unrelated business taxable income” means the gross income derived by any organization from any unrelated trade or business (as defined in § 513) regularly carried on by it, less the applicable deductions, and computed with the modifications in § 512(b).

I.R.C. § 513(a) provides that the term “unrelated trade or business” means, in the case of any organization subject to the tax imposed by § 511, any trade or business the conduct of which is not substantially related (aside from the need of such organization for income or funds or the use it makes of the profits derived) to the exercise or performance by such organization of the purpose or function constituting the basis for its exemption under § 501.

Treas. Reg. § 1.501(c)(6)-1 provides that a business league is an association of persons having some common business interest, the purpose of which is to promote such common interest and not to engage in a regular business of a kind ordinarily carried on for profit. It is an organization of the same general class as a chamber of commerce or board of trade. Thus, its activities should be directed to the improvement of business conditions of one or more lines of business as distinguished from the performance of particular services for individual persons.

Treas. Reg. § 1.513-1(d)(1) provides, in general, that gross income derives from “unrelated trade or business,” within the meaning of § 513(a), if the conduct of the trade or business which produces the income is not substantially related (other than through the production of funds) to the purposes for which exemption is granted.

Treas. Reg. § 1.513-1(d)(2) provides that trade or business is “related” to exempt purposes, in the relevant sense, only where the conduct of the business activities has causal relationship to the achievement of exempt purposes (other than through the production of income); and it is “substantially related,” for purposes of § 513, only if the causal relationship is a substantial one. Thus, for the conduct of trade or business from which a particular amount of gross income is derived to be substantially related to purposes for which exemption is granted, the production or distribution of the goods or the performance of the services from which the gross income is derived must contribute importantly to the accomplishment of those purposes.

ANALYSIS

Ruling 1

As an RTO for your particular region, you improve the business conditions of the power and electricity line of business by being responsible for administering the market-based regulation of the wholesale electricity market and ensuring that rates charged for transmission and sale of electric energy are reasonable. Pursuant to FERC’s mandate, you ensure reliable supplies of power, adequate transmission infrastructure, and competitive wholesale prices of electricity.

Your establishment and implementation of a central counterparty structure pursuant to which you will become the central counterparty to transactions in the markets you administer, is a response to credit reforms mandated in FERC Order Nos. 741 and 741-A. Your activities as the central counterparty will not require an amendment to any of your organizing documents, though certain revisions to your FERC-approved tariff will be required for implementation of the central counterparty structure. These revisions must be approved by FERC prior to implementation.

As central counterparty, you will take title for a brief period of time to the electric energy and related products that are the subject matter of those transactions. Your role as a central counterparty will not affect the clearing price, because the prices you pay to producers will exactly match the prices you receive from the wholesale purchasers. Apart from taking title to electric energy and related products in your capacity as central counterparty, your market administration activities will remain essentially the same. Your activities as the central counterparty will result in no net profit or loss to you.

By mandating the ISOs and RTOs revise their tariffs to implement enhanced credit practices, FERC has established how you must conduct your market administration activities to provide for the nondiscriminatory and efficient transmission of electric energy. A default by one or more market participants could lead to a larger default in the market, disrupting services and the flow of electricity as well as raising the costs of doing business in the electricity market and a corresponding increase in rates paid. By acting as the central counterparty, you will be able to offset the obligations of a defaulting participant against payments owed to that participant, reducing the impact of one participant’s default on the operations of other participants. The market participants are not able to do this themselves because of the clearing price system you use and the lack of contract privity with the defaulting party. Your sole purpose in acting as a central counterparty is to reduce the disruptions caused by a participant’s default and in turn fulfill your responsibility for administering the market-based regulation of the wholesale electricity market and ensuring that rates charged for transmission and sale of electric energy are reasonable, in line with your exempt purpose within the meaning of Treas. Reg. § 1.501(c)(6)-1. You will not generate any net income from the activity.

Accordingly, the implementation of the central counterparty structure, and your activities as the central counterparty to each transaction in the markets you administer, will not adversely affect your status as an exempt organization described in § 501(c)(6) as compared to your previous operations.

Ruling 2

Section 513(a) defines the term “unrelated trade or business” as any trade or business which is not substantially related to the performance of an organization’s exempt purpose. Treas. Reg. § 1.513-1(d)(2) states that a trade or business in substantially related to an organization’s exempt purpose if it contributes importantly to the accomplishment of that purpose. As stated above, by acting as a central counterparty you will reduce the disruptions caused by a market participant’s default. This contributes importantly to the accomplishment of your exempt purpose of improving the business conditions of the power and electricity line of business by administering the market-based regulation of the wholesale electricity market and ensuring that rates charged for transmission and sale of electric energy are reasonable. Therefore, acting as a central counterparty is substantially related to your exempt purpose and will not constitute an “unrelated trade or business” within the meaning of § 513(a).

RULINGS

Accordingly, based on the facts and circumstances discussed above, we rule as follows:

1. Your establishment and implementation of a central counterparty structure pursuant to which you will become the central counterparty to transactions consummated through the markets you administer will not adversely affect your status as an organization exempt from federal income tax under § 501(c)(6).

2. The revenues you receive by virtue of being the central counterparty to transactions consummated through the markets you administer will not be classified as income from an unrelated trade or business within the meaning of § 513(a).

These rulings are based on the facts as they were presented and on the understanding that there will be no material changes in these facts. Any changes that may have a bearing upon your tax status should be reported to the Service. Because it could help resolve questions concerning your federal income tax status, this ruling should be kept in your permanent records. Pursuant to a Power of Attorney on file in this office, a copy of this letter is being sent to your authorized representative.
Except as we have specifically ruled herein, we express no opinion as to the consequences of this transaction under the cited provisions or under any other provision of the Code.

This ruling will be made available for public inspection under § 6110 after certain deletions of identifying information are made. For details, see enclosed Notice 437, Notice of Intention to Disclose. A copy of this ruling with deletions that we intend to make available for public inspection is attached to Notice 437. If you disagree with our proposed deletions, you should follow the instructions in Notice 437.

This ruling is directed only to the organization that requested it. § 6110(k)(3) provides that it may not be used or cited as precedent.

If there are any questions about this ruling, contact the person whose name and telephone number are shown in the heading of this letter.

Sincerely yours,

Mike Seto
Manager, Exempt Organizations
Enclosure
Notice 437

Citations: LTR 201430018



IRS LTR: Change in Proposed Bond Use Meets Notice and Approval Requirements.

The IRS ruled that a taxpayer’s proposed use of bond proceeds for construction on a different site than what was published in a public notice was an insubstantial deviation and will not cause the bonds to fail to meet the public notice and approval requirements.

Third Party Communication: None
Date of Communication: Not Applicable
Person To Contact: * * *
Telephone Number: * * *

Index Number: 147.00-00, 147.06-00
Release Date: 7/25/2014
Date: April 3, 2014

Refer Reply To: CC:FIP:B05 – PLR-103353-14

LEGEND:

Authority = * * *
Borrower = * * *
State = * * *
University = * * *
Bonds = * * *
Date 1 = * * *
Date 2 = * * *
Project 1 = * * *
Project 2 = * * *
Project 3 = * * *

Dear * * *:

This is in response to your request for a ruling that the use of bond proceeds as described below will be an insubstantial deviation for purposes of the public notice and approval requirements set forth in § 147(f) of the Internal Revenue Code (the “Code”) and § 5f.103-2 of the temporary Income Tax Regulations.

FACTS AND REPRESENTATIONS

You make the following factual representations. Authority is a public trust and public corporation of State, created in part to assist in financing educational services and facilities through loans to nonprofit corporations.
Borrower is a State nonprofit corporation and an organization described in § 501(c)(3). One purpose of Borrower is to plan, finance, construct, develop, maintain, and operate sports stadiums, pavilions, field houses, or other buildings, for the exclusive use of University and University’s Department of Athletics.

On Date 1, Authority published a public notice (the “TEFRA Notice”) in newspapers of general circulation covering State and the localities in which the projects described in such Notice were to be located. The TEFRA Notice provided the place, date, and time of the public hearing relating to the proposed issuance of the Bonds, which were issued on Date 2. The TEFRA Notice also set forth the maximum aggregate principal amount of the Bonds and indicated that the proceeds of the Bonds would be loaned to Borrower and used to finance the costs to acquire, construct, expand, install, and equip certain improvements to Project 1, Project 2, and Project 3, all athletic facilities and collectively referred to herein as the “Projects”, on the campus of University.

More specifically, the TEFRA Notice provided general descriptions designed to inform the public of the location of the site for Project 1, two potential site locations for Project 2, and two potential site locations for Project 3. All sites were identified by references to street boundaries and/or proximity to well-known facilities within the campus of University. With respect to Project 3, Borrower and University have subsequently, after the publication of the TEFRA Notice and issuance of the Bonds, determined that the site of Project 3 must be relocated to a different location (the “Revised Location”) on the campus of University. The Revised Location is no more than one-tenth of a mile from one of the potential sites of Project 3 described in the TEFRA Notice. The portion of the Bond proceeds available for Project 3 will be used to construct the same type of athletic facility as stated in the TEFRA Notice the same as originally approved.

LAW AND ANALYSIS

Section 103(a) provides that, except as provided in § 103(b), gross income does not include interest on any State or local bond. Section 103(b) provides, in part, that § 103(a) shall not apply to any private activity bond that is not a qualified bond within the meaning of § 141. Section 141(e)(1)(A) provides, in part, that the term “qualified bond” means any private activity bond that is a qualified 501(c)(3) bond, is part of an issue that meets the applicable requirements of § 146, and meets the applicable requirements of § 147.

Section 147(f)(1) provides that a private activity bond is not a qualified bond unless it satisfies the requirements of paragraph (2). Section 147(f)(2)(A)(i) provides that a bond satisfies the requirements of paragraph (2) if the bond is issued as part of an issue that has been approved by the governmental unit that issued the bond or by the governmental unit on whose behalf the bond was issued. Section 147(f)(2)(B) treats an issue as having been approved by a governmental unit if the issue is approved by the applicable elected representative of the governmental unit after a public hearing following reasonable public notice.

Under § 5f.103-2(f)(2), a facility is within the scope of an approval if the notice of public hearing and the approval contain all of the following: (i) a general functional description of the type and use of the facility to be financed; (ii) the maximum aggregate face amount of obligations to be issued with respect to the facility; (iii) the initial owner, operator, or manager of the facility; and (iv) the prospective location of the facility by its street address or, if none, by a general description designed to inform readers of its specific location. The term “facility” as defined in § 5f.103-2(f)(4) includes a tract or adjoining tracts of land, improvements thereon and any personal property used in connection with such real property. Separate tracts of land (including improvements and connected personal property) may be treated as one facility only if they are used in an integrated operation.

Section 5f.103-(2)(f) further provides that an approval is valid with respect to any issue used to provide publicly approved facilities, notwithstanding insubstantial deviations with respect to the maximum aggregate face amount of the bonds issued under the approval for the facility, the name of its initial owner, manager, or operator, or the type or location of the facility from that described in the approval. An approval or notice of public hearing is not adequate if any of the items in § 5f.103-2(f)(2)(i) through (iv), with respect to the facility to be financed, are unknown on the date of the public notice or the date of the approval.

Section 5f.103-2(g)(2) provides, in part, that a public hearing means a forum providing a reasonable opportunity for interested individuals to express their views, both orally and in writing, on the proposed issue of bonds and the location and nature of a proposed facility to be financed. Section 5f.103-2(g)(3) provides that reasonable public notice means published notice reasonably designed to inform residents of the affected governmental units, including residents of the issuing unit and the governmental unit where a facility is to be located, of the proposed issue. The notice must state the time and date for the hearing and contain the information contained in § 5f.103-2(f)(2).

The purpose of the public notice and approval requirement of § 147(f) is to ensure that the affected members of the general public will be notified of a pending bond issue and made aware of the intended use of the proceeds. In this case, the Revised Location of Project 3 is no more than one-tenth of a mile from one of the potential sites of Project 3 described in the TEFRA Notice. The Revised Location of Project 3 remains on the campus of University. The portion of the Bond proceeds available for Project 3 will still be used for the same purpose as originally stated in the TEFRA Notice, i.e., to construct the same type of athletic facility the same as originally approved.

While the use of Bond proceeds to construct Project 3 at the Revised Location was not expected or foreseen at the time the Bonds were issued, the Notice did not fail to put the public in the affected area on notice as to Borrower’s intention to use the Bond proceeds to finance projects that consist of improvements to certain athletic facilities located on the campus of University. Thus, the TEFRA Notice originally published in newspapers of general circulation covering State and the affected localities provided the general public in those localities with all of the pertinent information regarding the Projects as required by § 147(f) and § 5f.103-2(f).

CONCLUSION

Based on the factual representations set forth above, we conclude that the proposed use of Bond proceeds to construct Project 3 at the Revised Location constitutes an insubstantial deviation from the uses of the Bond proceeds described in the TEFRA Notice, and will not cause the Bonds to fail to meet the public notice and approval requirements of § 147(f) and § 5f.103-2(f).

Except as expressly provided herein, no opinion is expressed or implied concerning the tax consequences of any transaction or item discussed or referenced in this letter.

This ruling is directed only to the taxpayer who requested it. Section 6110(k)(3) provides that it may not be used or cited as precedent.

In accordance with a Power of Attorney on file with this office, a copy of this letter is being sent to Authority’s authorized representative.

The ruling contained in this letter is based upon information and representations submitted by Authority and accompanied by a penalty of perjury statement executed by an appropriate party. While this office has not verified any of the materials submitted in support of the request for a ruling, it is subject to verification upon examination.

Sincerely,

Associate Chief Counsel
(Financial Institutions and
Products)

By: James A. Polfer
Chief
Branch 5

Citations: LTR 201430001



Water Companies Request Guidance on Public-Private Partnerships.

Michael Deane of the National Association of Water Companies has written to Treasury regarding the application of the rules on tax-exempt bonds in the context of public-private partnerships involving water and wastewater treatment systems, focusing on the possible loss of the tax exemption on outstanding debt under such arrangements.

July 11, 2014

The Honorable Mark Mazur
Assistant Secretary for Tax Policy
Department of the Treasury
1500 Pennsylvania Avenue, NW
Washington, DC 20220

The Honorable William Wilkins
Chief Counsel
Internal Revenue Service
1111Constitution Avenue, NW
Washington, DC 20224

RE: Guidance under section 141

Dear Mr. Mazur and Mr. Wilkins:

On behalf of the National Association of Water Companies (NAWC), I am writing to follow up on our previous discussions with the Treasury tax policy staff regarding the application of the rules related to tax-exempt bonds in the context of public-private partnerships (P3s) involving water and wastewater treatment systems. In our previous meetings, we discussed a particular impediment — possible loss of the tax exemption on outstanding tax exempt debt — to the utilization of private capital in water and waste water infrastructure projects in cases where a state or local government desires to enter into a long-term lease, concession, or operating agreement with a private company under which the company would assume the operation of water facilities that have been financed with tax-exempt debt. Treasury regulations under section 141 outline several “remedial actions” that the bond issuers in such cases may take to preserve the tax-exempt status of the debt, but as we discussed in the meetings, those actions are unavailable as a practical matter in typical cases involving water facilities. To ensure that the relief intended in the Treasury regulations is, in fact, available, we request that the Treasury issue guidance, as explained below, to clarify that one of the allowable remedial actions — alternative use of disposition proceeds — applies in the case of long-term leases, concessions, and operating agreements.

Background

NAWC is the trade association for private water operating companies. Private water companies serve more than 73 million Americans, nearly one-fourth of the population. Our member companies are eager to assist in the badly needed improvement of the country’s water infrastructure.

As you know, President Obama has repeatedly called the public’s attention to the distressed state of the country’s basic infrastructure; he has expressed support for private sector participation in infrastructure improvement. Just recently he signed the Water Resources Reform and Development Act — a measure that envisions P3s — and reiterated that the federal government must step up its efforts to bring infrastructure up to world standards by addressing the $2 trillion of deferred maintenance in the country’s basic infrastructure. In addition, in his FY 2015 budget, the President proposed lifting the state-by-state volume cap on issuances of private activity bonds for water and waste water infrastructure projects, as a way attracting more private capital and private-sector managerial expertise to such projects. As the President recognizes, clean, safe and affordable water and water treatment services are fundamental and basic infrastructure needs of all Americans.

There is a growing interest among local governments today in entering into concession/lease agreement P3 transactions as a means of improving the management, financial and operational condition of their drinking and wastewater systems by upgrading water and wastewater systems and other types of infrastructure assets. These transactions generally take the form of long-term leases, concessions, or operating agreements (referred to collectively hereafter as “concessions”), where a private company essentially leases specified infrastructure assets for a 30-40 year period. Although these arrangements do not typically transfer tax ownership of the related facilities, they generally result in the concessionaire being responsible for the operation and maintenance and capital improvements with respect to the facilities. Both the term of these concessions and the manner in which the concessionaires are compensated generally prevent these arrangements from qualifying under the safe harbors for management contracts provided under Revenue Procedure 97-13.

Private water companies currently operate over 2,000 municipally owned water and wastewater facilities under P3s — which largely were set up under a contract operations and maintenance structured agreement, rather than as a concession-lease-based agreement. P3 contractual agreements combine the skills, assets, and resources of the public and private sectors to deliver water service or maintain water facilities for the benefit of the general public. The benefits to the country of private-sector capital through P3s are clear: The country’s drinking water systems face an annual shortfall of at least $11 billion to replace aging facilities and to comply with existing and future federal water regulations (without including the growth in the demand for drinking water over the next 20 years).1 Similarly, the Environmental Protection Agency has estimated that the nation must invest more than $380 billion over the next 20 years to update or replace existing water systems and build new ones to meet increasing demand.

Treasury Regulations

The Internal Revenue Code generally provides that interest on “private activity bonds” is not excluded from gross income for federal income tax purposes. The private activity bond prohibition contains exceptions for bond-financed “exempt facilities,” including water and wastewater facilities. The applicable Treasury regulations provide that the private activity bond prohibition is applied based on the issuer’s reasonable expectations on the issue date of tax-exempt bonds and also applied subsequently if a “deliberate action” is taken by the issuer that causes such bonds to meet the private activity bond tests. Generally, the execution of a long term concession for a facility financed by tax-exempt bonds will be considered a deliberate action that causes the private activity bond tests to be met.

Under Section 1.141-12 of the Treasury Regulations, a post-issuance deliberate action that results in the associated bonds meeting the private activity bond test will cause the interest on the bonds to become taxable unless a permitted remedial action is taken by the issuer. In the context of bonds for water and wastewater treatment systems in which a P3 transaction is entered into, there are three possible remedial actions that can be taken:

(1) Defeasance and redemption of the bonds.
(2) Compliance with the “alternative use of facilities” rule through a deemed reissuance of the bonds.
(3) Compliance with the “alternative use of disposition proceeds” rule.

As a practical matter, the first remedial action, defeasance, is impractical in typical circumstances today because of the country’s low-interest-rate environment. To defease bonds bearing an interest rate of five or six percent by creating an escrow account to pay those bonds and funding it with Treasury securities yielding one percent or less would require a capital outlay substantially exceeding the principal balance of the outstanding debt. We estimate that defeasance could reduce as much as 15 percent of the value of typical transactions to the communities undertaking them.

The second possible remedial action, alternative use of facilities, is also impractical. Under that rule, a deliberate action will not result in loss of tax-exempt status if the bonds can be treated as newly issued bonds and, as such, can satisfy all of the requirements for newly issued tax-exempt bonds for the facility financed. For example, since water facilities are exempt facilities, it is possible that the bonds deemed to be reissued would satisfy the tax rules at the time of reissuance. However, one of the regulatory requirements is that the issuer obtain an allocation of the state private activity bond volume cap in an amount equal to the amount of the outstanding bonds. For a P3 transaction that can take years to consummate, that requirement can be an insurmountable problem because of the difficulty in receiving assurance from state officials that sufficient volume cap will be made available at the time the P3 transaction is closed. Further, in certain states the applicable volume cap allocation legislation or process seems not to permit volume cap to be used for this type of deemed reissuance. Another roadblock for the deemed reissuance approach is the re-characterization of the interest on the bonds as a type of income subject to the alternative minimum tax. To deal with that consequence without forcing the bondholders to have a change in tax treatment, the IRS permits the issuer in these circumstances to make a payment equal to the present value of the product of .0014 and the amount of the bonds outstanding in each remaining year. That payment is a further hurdle to the transaction, with no benefit to the residents of the community served by the utility.

Request for Guidance

The third possible remedial action, alternative use of disposition proceeds, permits issuers to avoid the loss of the tax-exempt status of bonds upon a cash sale “or other disposition” of a facility financed by the bonds, provided the issuer uses the cash for other governmental purposes within 2 years, such as other infrastructure projects. The regulations, however, are unclear as to the application of that remedial action in some situations. In particular, the application of this rule is uncertain in the case of concession arrangements since it is unclear whether this type of arrangement is a “disposition” and, if so, how concession payments made over the term of the arrangement are dealt with under this remedial action. As described above, concession arrangements in which a private party obtains operational control of a facility for a substantial period of years but with a state or local government retaining ownership, have become the preferred form of P3s for water and waste water facilities today.

A simple clarification in the regulations that would have the effect of substantially unleashing P3s would be the following:

Revise the definition of “disposition proceeds” in the regulations to include amounts derived from a concession, provided the arrangement does not have the effect of transferring tax ownership of the property to the new user.
Revise the cash consideration requirement of the regulations for transactions other than sales to require the consideration to be exclusively cash, paid either at the time of the transaction or later pursuant to the terms of the concession.
Modify the two-year expenditure window of the regulations to require that the issuer reasonably expect to expend the cash disposition proceeds within three years of the execution of the arrangement or, if later, within one year of the receipt of any cash installment under the arrangement.

Clarify that permitted alternative uses of disposition proceeds include the payment of debt service on other obligations of the issuer or to make contributions to public pension funds, provided that the other applicable tax requirements are satisfied. These clarifications would facilitate sales of infrastructure facilities, and long term leases or concession arrangements that are treated as sales for tax purposes, while still resulting in the disposition proceeds being used for purposes that qualify for tax-exempt financing. As a result, these changes are consistent with the purpose of the existing regulations; we see no policy reason for the regulations to prohibit these uses of disposition proceeds. For example, distinguishing between the redemption of the bonds that financed the facility being sold and the redemption of other tax-exempt bonds of the issuer of those bonds serves no policy imperative, as both are valid governmental purposes.

We believe the Treasury should provide guidance reflecting the above changes in the regulations as soon as possible. There is certainly nothing in the statute to preclude the Treasury from issuing such guidance, and such guidance would be fully consistent with the President’s policy of promoting investment in U.S. infrastructure.

The regulations clearly were originally intended to provide state and local governments a reasonable path for preserving the tax-exempt status of bonds in cases of transfers of facilities financed by the bonds, particularly where those facilities could have qualified for tax-exempt private activity bond financing. The above guidance would provide precisely such a path with respect to transfers of facilities through the standard type of P3 arrangement used today — concessions.

We would be pleased to discuss this further with you.

Sincerely,

Michael Deane
Executive Director
National Association of Water
Companies
Washington, DC

cc:
Mr. Kent Hiteshew, Office of State and Local Finance
Ms. Vicky Tsilas, Office of Tax Legislative Counsel

FOOTNOTE

1 The American Society of Civil Engineers 2009 Report Card for America’s Infrastructure

END OF FOOTNOTE



Womble Carlyle: Counties, Towns and Cities Still in the Cross Hairs.

On Wednesday the Senate rolled out a new PCS for HB 1224 – Economic Development Changes that added what lobbyists for local government groups were expecting to be additional authority over local taxes but was instead a limitation of those powers.

North Carolina operates an economic development funding program called JMAC operated by the Department of Commerce. The fund provides grants to certain approved companies who meet job creation thresholds. The grants have time limits and limits on funding amounts. The bill allows companies in Tier 2 counties (poor) to join Tier 1 counties (poorest) to be eligible. The bill also limits the number of JMAC grants to five whose total cost cannot exceed $79 million (up from $69 million). **My experience as a legislative staffer was that the JMAC program was amended only when it needed to fit with an economic development opportunity. Further specifications that indicate a grant recipient is in mind: if a large manufacturer is investing in its manufacturing process – transitioning from coal to natural gas – with additional pollution controls it may be eligible. The bill also grows JMAC by establishing that the Department of Commerce cannot enter into more than five agreements/grants, with total aggregate cost not to exceed $79 million (was, $69 million).

Wednesday’s new section which surprised local government groups was a provision allowing counties to increase local sales tax in increments of 1/4 %, by referendum to fund education OR local transportation projects, but not both at the same time. The total local sales tax in a jurisdiction must not exceed 2.5%, and the funds cannot be shared with municipalities. This provision proved to be very controversial and the bill was returned to committee for further consideration.

View HB 1224 here: http://www.ncleg.net/Sessions/2013/Bills/House/PDF/H1224v2.pdf

Last Updated: July 19 2014
Article by Laura DeVivo



Seventh Circuit Affirms Denial of Retirement Fund's Exempt Status.

The Seventh Circuit affirmed a district court decision that held that ABA Retirement Funds didn’t qualify as a tax-exempt business league under section 501(c)(6), finding that it didn’t work to improve the conditions of the legal profession generally and it engaged in business ordinarily conducted for profit.

ABA RETIREMENT FUNDS,
Plaintiff-Appellant,
v.
UNITED STATES OF AMERICA,
Defendant-Appellee.

IN THE UNITED STATES COURT OF APPEALS
FOR THE SEVENTH CIRCUIT

APPEAL FROM THE UNITED STATES DISTRICT COURT FOR THE
NORTHERN DISTRICT OF ILLINOIS, EASTERN DIVISION

No. 09 C 6993 — John J. Tharp, Jr., Judge.

ARGUED JUNE 5, 2014 — DECIDED JULY 21, 2014

Before WOOD, Chief Judge, and EASTERBROOK and KANNE, Circuit Judges.
WOOD, Chief Judge.

ABA Retirement Funds, to which we refer simply as ABA Retirement, appeals the district court’s denial of its request for tax-exempt status for the years 2000 through 2002. Agreeing with the Internal Revenue Service, the district court found that ABA Retirement was not a tax-exempt “business league” under 26 U.S.C. § 501(c)(6) during the relevant period. We agree with that assessment and affirm.

I

Because the district court granted summary judgment for the United States, the account that follows represents the undisputed facts along with all reasonable inferences that favor ABA Retirement. See FED. R. CIV. P. 56(c). ABA Retirement is an Illinois not-for-profit corporation whose predecessor, American Bar Retirement Association, was incorporated in 1963 at the direction of the American Bar Association as a non-profit corporation. The entity’s name later changed to ABA Retirement Funds, but the change has no effect on the issues before us, and so we use only the current name. The prospectus for the new entity stated that it was organized “for the sole purpose of providing members of the [ABA] and their employees with a retirement plan designed to take advantage of the income tax benefits which apply to a qualified retirement plan.” To that end, the prospectus continued, ABA Retirement was charged with “promoting and facilitating the operation of [tax-qualified retirement plans], and this is the only activity” in which ABA Retirement was expected to engage.

While ABA Retirement’s stated purpose was to provide members of the ABA (and later organizations with at least one ABA-member participant) with retirement plans, ABA Retirement itself did not have members in the traditional sense. Its day-to-day operations were run by John Puetz and a staff of three; its only “members” were the people who made up the ABA’s Board of Governors. These “members,” of whom there were about 38 from 2000 to 2002, appointed the officers of ABA Retirement and the trustee of its retirement plans. In time, ABA Retirement created several master retirement plans for adoption by lawyers and law firms. We will refer to these plans in the aggregate as “the Plan” and the Plan in combination with ABA Retirement and its vendors’ activities done in connection with it as “the Program.”

Until 1992, the Program was offered pursuant to a group annuity contract issued by Equitable Life Insurance Company of America (Equitable). At that time, members of the ABA Retirement’s Board of Directors were the trustees of the master trusts. They had direct responsibility for the selection, retention, and termination of the managers of the investment options offered by the Program. That changed in 1999 when ABA Retirement hired State Street Bank and Trust to replace Equitable and perform additional duties as sole Plan trustee, at which point the ABA Retirement directors ceased to be trustees in order to comply with federal securities law. Under the new arrangement, while ABA Retirement was no longer a trustee, it created and maintained the IRS-approved master tax-qualified retirement plans and took on the role of Plan fiduciary. Had ABA Retirement not undertaken the fiduciary role, the federal Employee Retirement Income Security Act (ERISA) would have required an employer who adopted the retirement plans for its employees either to assume the duties or hire a third party to do so. The Program as a whole competed with other retirement plans in the market.

ABA Retirement, as Plan fiduciary, had the authority to engage, monitor, and fire its trustee, State Street. It was responsible for the design and maintenance of Plan documents (including making sure that they were tax-qualified), oversight of vendors, contract negotiations, and the review and approval of State Street’s annual marketing plan. The latter task included making recommendations to State Street about targets for growth of participants and assets. ABA Retirement also made the plans available to the public without charge from 2000 to 2002. The free documents, however, did not come with an adoption agreement, even though they were tailored to ABA Retirement’s trust. State Street was responsible for marketing generally, but ABA Retirement promoted the Plan through mail solicitations to attorneys, Sections of the ABA, and other bar groups. It did not limit itself to advertising the plans; it actively worked both to publicize them and to see that they were sold. State Street handled record keeping, a variety of administrative services, and the direct marketing of the Plan to the legal profession (though ABA Retirement reviewed and approved the annual marketing plan). State Street had the authority to engage and fire investment advisors, but it was required to consult with ABA Retirement and give full consideration to ABA Retirement’s recommendations. As noted, ABA Retirement had the power to fire State Street.

ABA Retirement had a financial incentive to increase plan assets, since the Plan paid ABA Retirement a program expense fee for its services in connection with the Program based on a percentage of the total invested assets, excluding assets invested in self-directed brokerage accounts. Those who wished to pursue the self-directed route were required to invest a minimum of 5% of their total investment in accounts that would be subject to the program expense fee. ABA Retirement received the interest on the funds. The amount in the funds was not trivial; on its tax returns for 2000, 2001, and 2002, ABA Retirement reported a gross income of $1,861,258, $1,667,862, and $1,601,217, respectively. Its taxable income for those years was $672,098, $384,972, and $411,874; it held assets worth approximately $3.5 million. The tax returns show that ABA Retirement described itself as an employee benefit fund, and its product was retirement plans.

For a long time, it appears that ABA Retirement’s revenues were not large enough to raise tax concerns among its managers. It treated itself as a taxable entity until 2004, when it sought tax-exempt status at the time it filed its Form 1024. In August 2005, the IRS notified ABA Retirement that ABA Retirement did not qualify for the exemption from federal income tax under section 501(c)(6) of the Code. ABA Retirement then filed administrative claims for refunds on the taxes it paid from 2000 through 2002 and, again, those were denied. ABA Retirement responded with this suit, arguing that it was a tax-exempt “business league” under I.R.C. § 501(c)(6), 26 U.S.C. § 501(c)(6), during the period from 2000 to 2002, and thus was entitled to a refund for federal income taxes paid. The government contended that ABA Retirement was not a “business league” and thus it owed the taxes. The district court agreed with the government and granted summary judgment in its favor. ABA Retirement appeals.

II

The question whether an association is a business league for purposes of 26 U.S.C. § 501(c)(6) is a mixed question of law and fact, but on summary judgment we must accept the facts in the light most favorable to the nonmoving party and ask whether the law nonetheless requires judgment for the movant. See Guide Int’l Corp. v. United States, 948 F.2d 360, 361 (7th Cir. 1991). Our review is de novo. See Hakim v. Accenture U.S. Pension Plan, 718 F.3d 675, 681 (7th Cir. 2013).
We begin with the language of the key statute, 26 U.S.C. § 501(c)(6), which grants a tax exemption to:

Business leagues, chambers of commerce, real-estate boards, boards of trade, or professional football leagues (whether or not administering a pension fund for football players), not organized for profit and no part of the net earnings of which inures to the benefit of any private shareholder or individual.

The statute does not define “business league,” and the term “has no well-defined meaning or common usage outside the perimeters of § 501(c)(6).” Nat’l Muffler Dealers Ass’n, Inc. v. United States, 440 U.S. 472, 476 (1979). In fact, the Court noted that the precise term “business league” is one “so general . . . as to render an interpretive regulation appropriate.” Id. (citing Helvering v. Reynolds Co., 306 U.S. 110, 114 (1939)).

The Treasury Department furnished just what the Court called for. See Treas. Reg. § 1.501(c)(6)-1 (1978), 26 C.F.R. § 1.501(c)(6)-1; see also Nat’l Muffler, 440 U.S. at 484 (Treasury regulation “merits serious deference”). Paraphrased, the regulation provides that an organization qualifies as a business league if and only if it is an association (1) “of persons having some common business interest;” (2) “the purpose of which is to promote such common interest;” (3) that is not organized for profit; (4) that does not “engage in a regular business of a kind ordinarily carried on for profit;” (5) whose activities are “directed to the improvement of business conditions of one or more lines of business as distinguished from the performance of particular services for individual persons,” and; (6) that is “of the same general class as a chamber of commerce or board of trade.” See Treas. Reg. § 1.501(c)(6)-1, 26 C.F.R. § 1.501(c)(6)-1.

This is not a close case; save for the fact that it is a nonprofit corporation, ABA Retirement fails every necessary condition for business league status. Because the district court’s opinion is thorough, here we focus on just two of the reasons why ABA Retirement is not a business league: (1) its activities are not directed to the improvement of business conditions for the legal field generally; and (2) it engages in a business ordinarily conducted for profit.

1. Improving business conditions of the legal profession

One of the prerequisites to business-league status is that the entity’s activities must be “directed to the improvement of business conditions of one or more lines of business as distinguished from the performance of particular services for individual persons.” Treas. Reg. 1.501(c)(6)-1 (emphasis added). ABA Retirement fails to satisfy this requirement for at least two reasons: first, it characterized its business as the provision of individual benefits; and second, it has not shown anything that could reasonably be called improvement of business conditions for the legal profession generally.

On the tax returns it filed for the relevant years ABA Retirement stated that its business was the operation of an employee benefit fund and its product was retirement plans. This is a perfectly good business, but it is one that provides benefits to individual persons, not to an entire field of commerce. We have no doubt that, as § 1.501(c)(6)-1 recognizes, some organizations may improve business conditions in a line of business by performing services that benefit individual industry participants. Although state-created and thus not quite on point here, the Washington State Apple Advertising Commission illustrates the general idea. See Hunt v. Wash. State Apple Adver. Comm’n, 432 U.S. 333 (1977). Another example might be the Owner-Operator Independent Drivers Association. See Owner-Operator Indep. Driver Ass’n, Inc. v. Fed. Motor Carrier Safety Admin., 656 F.3d 580 (7th Cir. 2011). But those individual benefits must be incidental to the industry-wide benefits. The regulation requires improvement of business conditions “as distinguished from” the performance of particular services. That requires line-drawing. Organizations that provide benefits to an industry only by benefitting specific individuals within that industry fall on the other side of the “business league” line. ABA Retirement counters that lawyers secure in their retirement are happy, confident lawyers, and this is reflected in the general satisfaction quotient for the profession as a whole. That may be true: we do not doubt that retirement planning is good for the legal profession generally (as it is for everyone else), but ABA Retirement furnished that benefit almost exclusively by providing a particular service to particular persons, namely, retirement plans for those who signed up for its Program. The fact that it also distributed some materials without charge does not change the nature of the enterprise.

Assoc. Master Barbers & Beauticians of Am., Inc. v. Comm’r of Internal Revenue, 69 T.C. 53 (1977), is instructive. It stands for the proposition that regardless of whether an organization’s activities further an exempt purpose, if those actions do not use non-exempt means, they will not receive tax-exempt status. The association in question was a non-profit entity that had been organized to unify master barbers. Id. at 55. The court did not question that the described goal would improve the conditions of the master barber industry. In trying to achieve this goal, the association provided its members with (among other things) various types of insurance, from which it received commissions. Id. at 59.

The tax court recognized that an organization “whose principal purpose and activity is such as to qualify for ‘business league’ exemption does not lose its exempt status by engaging in incidental activities which standing alone would be subject to taxation.” It therefore proceeded to “examine the extent of petitioner’s insurance activities to see if they constitute[d] only incidental, as opposed to substantial, activities.” Id. at 67. It found that the association’s insurance activities were directed towards providing benefits to individuals within the industry and those activities were substantial. This was enough, it held, to require a finding that the association did not qualify for business league status. Here, we know that ABA Retirement’s involvement with the Program was in no way “incidental” — it was the fiduciary, and its own prospectus states that it was incorporated “for the purpose of promoting and facilitating the operation of the Plan and this is the only activity in which it is expected that ABA Retirement will engage.” ABA Retirement’s day-to-day goal was to promote its own plan first and general retirement savings in the legal profession second; it therefore cannot receive tax-exempt status under § 501(c)(6).

2. Business ordinarily conducted for profit

Related to the finding that ABA Retirement’s activities were aimed primarily at the provision of services to individual persons was the fact that it engaged in the business of providing retirement plans, a business ordinarily conducted for profit. ABA Retirement argues that the district court reached this conclusion by “conflating” ABA Retirement with the Program. It explains that while the Program itself may have been a business ordinarily conducted for profit, the Program was administered by State Street and ABA Retirement simply sponsored the Program as part of its mission to improve the condition of the legal industry.
ABA Retirement focuses on the “sponsoring” language because, pursuant to IRS regulations, a trade organization “having characteristics similar to those described in section 1.501(c)(6)-1 of the regulations” (i.e. characteristics similar to a business league) is permitted to sponsor retirement plans without losing its tax-exempt status. Rev. Proc. 89-9, 1989-1 C.B. 780, superseded by Rev. Proc. 2000-20, 2000-1 C.B. 553. Because the IRS approved ABA Retirement’s retirement plans, and a condition of that approval that the organization have characteristics “similar to” a business league, ABA Retirement argues it is therefore a business league entitled to the exemption. Unfortunately, this is a bridge too far.

As a matter of logic, simply because x has “characteristics similar to” y does not necessarily make x a y. A cucumber has characteristics similar to a zucchini but it is not, in fact, a zucchini. And, while having characteristics similar to a zucchini may be enough for some purposes (for instance, to stand in as a zucchini in an impressionist still life), it will not be enough when an object possessing all the characteristics of a zucchini — in other words, a zucchini itself — is required (say, when making zucchini bread). In order to be a business league for purposes of 26 U.S.C. § 501(c)(6), ABA Retirement must satisfy every condition laid out in § 1.501(c)(6)-1; for purposes of Rev. Proc. 89-9 it needed only to have characteristics “similar to” those in the regulation.

Returning to the question at hand — whether ABA Retirement was engaged in business ordinarily done for profit during the relevant period — the answer is an unequivocal yes. ABA Retirement did not just sponsor the Program; it was the Program fiduciary. Assuming fiduciary duties on behalf of law firms that sign up for the Program is itself an act ordinarily done for profit. ABA Retirement has cited no case, nor can we find one, in which an entity was a plan fiduciary under ERISA and yet qualified as an exempt business league.

ABA Retirement finally relies on Am. Acad. of Family Physicians v. United States, 91 F.3d 1155 (8th Cir. 1996), where the Eighth Circuit found that the Academy’s sponsorship of a group insurance program did not translate into taxable business activity by the Academy. See id. at 1159. Again, however, we see important differences between that case and ours. First, the question was not whether the Academy was a business league but instead whether the payments it received through its sponsorship of the insurance plans were taxable under 26 U.S.C. § 511 as “unrelated business taxable income.” Our case involves the antecedent question whether ABA Retirement is a business league. As we explained above, ABA Retirement’s activities were not primarily directed toward the improvement of the legal profession as distinguished from the performance of particular services for individual persons. Second, even if we put that aside, there are other crucial differences between ABA Retirement and the Academy. In Family Physicians, the insurance program was administered “in its entirety by an unrelated, non-exempt corporation” over which the Academy “had no administrative or underwriting responsibilities” for the policies. 91 F.3d at 1159. The amounts paid to the Academy in relation to the insurance program “were neither brokerage fees nor other compensation for commercial services, but were the way the parties decided to acknowledge the Academy’s eventual claim to the excess reserves while [the policy administrator] was still holding and using the reserves.” Id. In contrast, nearly all of ABA Retirement’s income came from a program expense fee State Street paid it for services in connection with the Program. The fee was also based on a percentage of the total invested assets. Unlike the Academy, ABA Retirement was the Plan fiduciary. Family Physicians does not compel a different result.

* * * * *

We conclude that ABA Retirement is not a business league under 26 U.S.C. § 501(c)(6). We therefore AFFIRM the judgment of the district court.



IRS Outlines Professional Responsibilities Under Circular 230.

The IRS has posted to its website information on who is subject to the Circular 230 practice standards and information on some of their responsibilities.

GUIDANCE TO PRACTITIONERS REGARDING PROFESSIONAL OBLIGATIONS
UNDER TREASURY CIRCULAR NO. 230

Who is Subject to Treasury Circular No. 2301

The provisions of Treasury Circular No. 230 apply to:

The Internal Revenue Service’s Office of Professional Responsibility (OPR) may propose the censure, suspension, or disbarment of any practitioner, and the disqualification of any appraiser, from practice before the Internal Revenue Service if the individual is shown to be incompetent or disreputable, fails to comply with any regulation in Treasury Circular No. 230, or with intent to defraud, willfully and knowingly misleads or threatens a client or prospective client. OPR may also propose a monetary penalty for an individual, and/or the employer of any individual subject to Treasury Circular No. 230, for violations of Circular 230 if (i) the violations occurred in connection with the individual’s activities on behalf of the employer and (ii) the employer knew or reasonably should have known of the individual’s conduct. Treasury Circular No. 230 § 10.3, § 10.7, § 10.8, § 10.50. 31 U.S.C. 330(b).

Selected Obligations Under Treasury Circular No. 230

The following is a summary description of certain obligations under Treasury Circular No. 230. This summary does not address all provisions of the Regulations. You should read the Circular/Regulations for a more complete understanding of the duties and obligations of someone practicing before the IRS.

Due Diligence. You must exercise due diligence in preparing and filing tax returns and other documents/submissions, and in determining the correctness of representations made by you to your client or to the IRS. You can rely on the work product of another person if you use reasonable care in engaging, supervising, training, and evaluating that person, taking into account the nature of the relationship between you and that person. You generally may rely in good faith and without verification on information furnished by your client, but you cannot ignore other information that has been furnished to you or which is actually known by you. You must make reasonable inquiries if any information furnished to you appears to be incorrect, incomplete or inconsistent with other facts or assumptions. Treasury Circular No. 230 § 10.22, § 10.34(d).

Competence. You must have the necessary knowledge, skill, thoroughness, and preparation necessary for the matter for which you have been engaged. You may be able to provide competent representation by researching and educating yourself on the issue or by consulting with another tax professional who has established competence in the field in question, but in doing so you must consider the requirements of Internal Revenue Code § 7216. Treasury Circular No. 230 § 10.35.

Conflicts of Interest. A conflict of interest exists if representing one of your clients will be directly adverse to another client. A conflict of interest also exists if there is a significant risk that representing a client will be materially limited by your responsibilities to another client, a former client or a third person, or by your personal interests. When a conflict of interest exists, you may not represent a client in an IRS matter unless (i) you reasonably believe that you can provide competent and diligent representation to all affected clients, (ii) your representation is not prohibited by law, and (iii) all affected clients give informed, written consent to your representation. You must retain these consents for 36 months and make them available to the IRS upon request. Treasury Circular No. 230 § 10.29.

Tax Return Positions. You cannot sign a tax return or refund claim or advise a client to take a position on a tax return or refund claim that you know or should know contains a position (i) for which there is no reasonable basis, (ii) which is an unreasonable position under Internal Revenue Code § 6694(a)(2), or (iii) which is a willful attempt to understate tax liability or a reckless or intentional disregard of rules or regulations. An unreasonable position is one which lacks substantial authority as defined in IRC § 6662 but has a reasonable basis, and is disclosed. For purposes of Circular 230, disclosure requires that you inform a client of any penalties that are reasonably likely to apply to the client with respect to a tax return position if you advised the client regarding the position or you prepared or signed the tax return and how to avoid the penalties through disclosure on the tax return (or, by not taking the position). Treasury Circular No. 230 § 10.34.

Written Tax Advice. In providing written advice concerning any Federal tax matter, you must (i) base your advice on reasonable assumptions, (ii) reasonably consider all relevant facts that you know or should know, and (iii) use reasonable efforts to identify and ascertain the relevant facts. You cannot rely upon representations, statements, findings, or agreements that are unreasonable or that you know to be incorrect, inconsistent, or incomplete. You must not take into account the possibility that a tax return will not be audited or that a matter will not be raised on audit in evaluating a Federal tax matter. In providing your written advice, you may rely in good faith on the advice of another practitioner only if that advice is reasonable considering all facts and circumstances. You cannot rely on the advice of a person whom you know or should know is not competent to provide the advice or who has an unresolved conflict of interest as defined in 10.29. Treasury Circular No. 230 10.37.

Errors and Omissions. If you know that a client has not complied with the U.S. revenue laws or has made an error in, or omission from, any return, affidavit, or other document which the client submitted or executed under U.S. revenue laws, you must promptly inform the client of that noncompliance, error, or omission and advise the client regarding the consequences under the Code and regulations of that noncompliance, error, or omission. Depending on the particular facts and circumstances, the consequences of an error or omission could include (among other things) additional tax liability, civil penalties, interest, criminal penalties, and an extension of the statute of limitations. Treasury Circular No. 230 § 10.21.

Furnishing Information to the IRS. If you receive a proper and lawful request for records or information from the IRS, you must promptly submit the requested information unless in good faith you reasonably believe that it is privileged. If the requested information is not in your or your client’s possession, you must promptly inform the requesting IRS personnel of that fact. You must also provide any information you may have regarding who is in possession of the requested information, but you are not required (i) to make inquiries of anyone other than your client or (ii) to verify information provided by your client regarding the person(s) in possession of the requested information. You must not interfere with any lawful IRS attempt to obtain information unless in good faith you reasonably believe that the information is privileged. You cannot advise a client to submit any document to the IRS that is frivolous or that contains or omits information in a manner demonstrating an intentional disregard of a rule or regulation unless you also advise the client to submit a document that evidences a good faith challenge to the rule or regulation. Treasury Circular No. 230 § 10.20, § 10.34(b).

Handling Matters Promptly. You cannot unreasonably delay the prompt disposition of any matter before the Internal Revenue Service. This applies with respect to responding to your client as well as to IRS personnel. You cannot advise a client to submit any document to the IRS with the purpose of delaying or impeding the administration of the Federal tax laws. Treasury Circular No. 230 § 10.23, § 10.34(b).

Client Records. On request of a client, you must promptly return any client records necessary for the client to comply with his or her Federal tax obligations, even if there is a dispute over fees. You may keep copies of these records. If state law allows you to retain a client’s records in the case of a fee dispute, you need only return the records that must be attached to the client’s return but you must provide the client with reasonable access to review and copy any additional client records retained by you that are necessary for the client to comply with his or her Federal tax obligations. The term “client records” includes all written or electronic materials provided to you by the client or a third party. “Client records” also include any tax return or other document that you prepared and previously delivered to the client, if that return or document is necessary for the client to comply with his or her current Federal tax obligations. You are not required to provide a client with of your work product — i.e., any return, refund claim, or other document that you have prepared but not yet delivered to the client if (i) you are withholding the document pending the client’s payment of fees related to the document and (ii) your contract with the client requires the payment of those fees prior to delivery. Treasury Circular No. 230 § 10.28.

Fee Arrangements. You cannot charge an unconscionable fee for services in any matter before the IRS. You also cannot charge a contingent fee for services in any IRS matter except for services in connection with:

Treasury Circular No. 230 § 10.27, IRS Notice 2008-43.

Solicitation. With respect to any Internal Revenue Service matter, you may not use any form of public communication or private solicitation containing a false, fraudulent, or coercive statement or claim; or a misleading or deceptive statement or claim. You also may not assist, or accept assistance from, any person or entity who obtains clients or otherwise practices in violation of the solicitation provisions. Treasury Circular No.230 § 10.30.

Negotiating Checks. You may not endorse, negotiate, electronically transfer, or direct the deposit of any government check relating to a Federal tax liability issued to a client. This prohibits any person subject to Treasury Circular No. 230 from directing or accepting payment from the government to the taxpayer into an account owned or controlled by that person. Treasury Circular No. 230 § 10.31.

Supervisory Responsibilities. If you have or share principal authority and responsibility for overseeing your firm’s tax practice, you must take reasonable steps to ensure that your firm has adequate procedures in place to raise awareness and to promote compliance with Circular 230 by your firm’s members, associates, and employees. Treasury Circular No. 230 § 10.36.

Best Practices. In addition to the rules with which persons must comply, Treasury Circular No. 230, § 10.33 includes aspirational best practices for those who provide include:

Acting fairly and with integrity in practice before the Internal Revenue Service.

FOOTNOTE

1 All references to the publication called Treasury Circular No. 230 are to the June, 2014 version found at http://www.irs.gov/pub/irs-pdf/pcir230.pdf. The corresponding Regulations are available at 31 CFR Subtitle A, Part 10.

END OF FOOTNOTE



IRS Issues Interim Guidance on Using Electronic Signatures.

The IRS has issued a memorandum (AP-08-0714-0006) providing interim guidance on the appropriate use of electronic signatures on Appeals letters and documents.

July 15, 2014

Expiration Date: July 18, 2016

Affected IRM: 8.6.4, Reaching Settlement and
Securing an Appeals Agreement Form

MEMORANDUM FOR:
Director, Field Operations West
Director, Field Operations East
Director, Specialty Operations
Acting Director, Campus Operations
Director, Account Processing & Support
Director, Appeals Quality Measurement System

FROM:
John V. Cardone
Director, Policy Quality & Case Support

SUBJECT:
Interim Guidance re: Electronic Signature Use on Appeals Letters
and Documents

This memorandum serves as interim guidance to Appeals employees regarding the appropriate use of electronic signatures until it is incorporated in IRM Part 8. This guidance is effective as of July 18, 2014.

Appeals is adopting the following electronic procedures that comply with the Government Paperwork Elimination Act (GPEA):

1. A person (i.e., the signer) must use an acceptable electronic form of signature;
2. The electronic form of signature must be executed or adopted by a person with the intent to sign the electronic record (e.g. to indicate a person’s approval of the information contained in the electronic record);
3. The electronic form of signature must be attached to or associated with the electronic record being signed;
4. There must be a means to identify and authenticate a particular person as the signer; and
5. There must be a means to preserve the integrity of the signed record.

Note: See Use of Electronic Signatures in Federal Organization Transactions, dated January 25, 2013, prepared by General Services Administration (GSA).

As clarification regarding an acceptable and legally sufficient electronic handwritten signature, Appeals will use a method that:

A. Identifies and authenticates a particular person as the source of the electronic message;
B. Indicates such person’s approval of the information contained in the electronic message; and
C. Displays the signer’s signature pictorially either as a scanned image of the signer’s written signature or as the signer’s signature captured by use of a signature pad or written stylus device.

Copies of the signed documents must be included in the case file.
Appeals may use an electronic signature on the following documents:

Document Description
______________________________________________________________________________

Form 906 Closing Agreement on Final Determination Covering
Specific Matters

Form 866 Agreement as to Final Determination of Tax Liability

Form 870-AD series Offer to Waive Restrictions on Assessment and
Collection of Tax Deficiency and to Accept
Overassessment

Form 890-AD Estate Tax Offer of Waiver of Restrictions on
Assessment and Collection of Deficiency in Tax and of
Acceptance of Overassessment

Form 2504-AD Excise or Employment Tax-Offer of Agreement to
Assessment and Collection of Additional Tax and Offer
of Acceptance of Overassessment

Form 2751-AD Trust Fund Recovery Penalty-Offer of Agreement to
Assessment and Collection

Form 870-IS Waiver of Collection Restrictions in Innocent Spouse
Cases

Letter 3193 Notice of Determination

Letters 894 & 901 Notice of Deficiency

In addition to the documents identified above, electronic handwritten signatures may be used on closing letters to taxpayers and internal use documents. For example, Form 5402 (Appeals Transmittal and Case Memo) and Letter 913 (Closing Letter — Agreed Case) would be appropriate for electronic signature use.

At this time, however, the documents in the table below require an original signature:

Document Description
______________________________________________________________________________

Form 872 series Consent to Extend the Time to Assess Tax
Form 656 Offer in Compromise

This guidance will be incorporated in IRM 8.6.4, Conference and Settlement Practices — Reaching Settlement and Securing an Appeals Agreement Form. Should the guidance pertain to other Appeals IRM subsections, authors may cite IRM 8.6.4 as a cross reference.

A link is available on the Appeals website, providing step-by-step instructions on the creation and use of electronic signatures.

If you have any questions, please contact Appeals Senior Program Analysts John Gonzalez and/or David Zito.

Distribution: www.IRS.gov



IRS Corrects Dates in Regs on Streamlined Exemption Process.

The IRS has corrected sunset dates in the text of temporary regulations (T.D. 9674) that provide guidance on a streamlined application process that eligible organizations may use to apply for recognition of tax-exempt status under section 501(c)(3).

Guidelines for the Streamlined Process of Applying
for Recognition of Section 501(c)(3) Status

DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 1

Treasury Decision 9674

RIN 1545-BM07

Correction
In rule document 2014-15623 on pages 37630-37632 of the issue of Wednesday, July 2, 2014 make the following corrections:

§ 1.501(a)-1T [Corrected]

1. On page 37631, in the third column, in § 1.501(a)-1T(f)(2), in the third line, “July 1, 2017” should read “June 30, 2017”.

§ 1.501(c)(3)-1T [Corrected]

2. On page 37632, in the first column, in § 1.501(c)(3)-1T(h)(2), in the third line, “July 1, 2017” should read “June 30, 2017”.

§ 1.508-1T [Corrected]

3. On page 37632, in the third column, in § 1.508-1T(c)(2), in the third and fourth lines, “July 3, 2017” should read “June 30, 2017”.

[FR Doc. C2-02014-15623 Filed 07/17/2014 at 8:45 am; Publication Date: 07/18/2014]



Comments Sought on Amortizable Bond Premium Regs.

The IRS has requested public comment on information collections under final regulations (T.D. 8746) on the income tax treatment of bond premium and bond insurance premium; comments are due by September 15, 2014.



Blame It on the ROO: Form 1023-EZ and Decline of EO Determinations.

Brad Bedingfield discusses the future role of the IRS Review of Operations Unit within the exempt organizations division.

With the development of streamlined procedures for processing applications for tax-exempt status, including the new Form 1023-EZ, the IRS EO division appears to be moving toward a self-certification system. The success of that strategy will depend largely on how well the IRS can strengthen its examination programs, including its Review of Operations Unit, also known as the “ROO.”

* * * * *

Lois Lerner’s now infamous comments at a May 10, 2013, conference regarding the handling of Tea Party applications for tax-exempt status may have marked the beginning of the end for the IRS exempt organizations determinations function. What had been a gradual shift of resources from review of initial applications to later examinations is quickly becoming a landslide. When the dust settles, many organizations seeking exempt status may enjoy something very close to a self-certification system. Whether that shift blows open the doors for bad actors to claim exempt status under false pretenses may depend largely on the success of a small and little-known program within the EO division, which may now morph (in some form) into one of its most important: the IRS Review of Operations Unit, also known as the “ROO.”

What Is the ROO?

The ROO began in 2005, on the recommendation of the IRS Advisory Committee on Tax Exempt and Government Entities.1 At the heart of the ROO was a recognition that not every organization is entirely truthful in its initial application and that many organizations — even “good” ones — evolve significantly in their early years. EO determinations specialists have suspicions that an applicant isn’t telling the whole story. They have a mechanism for asking for additional information: the so-called development letter.2 However, development letters are intended to solicit information necessary to make a determination, not to stress test an organization’s representations or to catch organizations in a lie. A determinations specialist is generally reviewing an organization before it’s really done anything. What if there is reason to suspect that an applicant may not really intend to operate for exempt purposes but there is no track record of activity to allow the specialist to prove it?

Since 2005 a determinations specialist has the option of approving an application subject to a ROO referral.3 The applicant receives its exemption letter, but behind the scenes its file is sent to a team of specialists, who, after a few years have passed, perform a “no-contact” review of the organization (as opposed to a compliance review or correspondence examination, which involve remote correspondence with the organization, or a field examination, which may involve an on-site review4). The organization has no way of knowing (without access to the IRS’s internal file5) whether it is under ROO review. A ROO specialist will look at the first few years of annual returns (Form 990, 990-EZ, 990-PF, or 990-N) and at whatever information is publicly available regarding the organization, including information on its website. The specialist will then compare that information with the original application for recognition of exempt status. If there are inconsistencies or other causes for concern, the specialist may refer the case for further examination.

Why Expand It?

In the wake of the Tea Party scandal, the IRS hired “Lean Six Sigma” consultants to review the internal processes and workflow systems of the EO division.6 Those consultants identified various inefficiencies in the current determinations process, in part attributable to the fact that the IRS traditionally has tried to provide substantial review of purportedly EOs both on the front end — through the determinations process — and on the back end — through examinations.7 Whether an organization is exempt often depends on multiple facts and circumstances tests, which require significant time and resources to review adequately. At the same time, an effective examinations program arguably requires auditing a sufficient percentage of organizations to discourage others from playing the audit lottery. However, only a very small percentage of EOs get audited every year.8 By trying to catch bad actors on both the front end and the back end, dwindling IRS resources are doubly stretched, and more and more organizations slip through the cracks altogether.

This resource crunch is nothing new to the IRS, although it has been particularly acute in recent years. The EO division has long tried to find more efficient ways to catch bad actors while allowing good charities to get on with their programs. In recent years, it has experimented with special compliance projects, the development of risk analytics, and tiered determinations processing.9 In its determinations function, the IRS created teams of specialists to handle specific kinds of cases more efficiently, and it developed tracking and processing systems (such as the ill-fated “be on the lookout,” or BOLO list) to direct cases to specialists. In the meantime, however, resources continued to dwindle, even as Congress added new duties, such as offshore account initiatives, the Affordable Care Act, and auto-revocation.

With dwindling resources on both the determinations side and the examinations side, the ROO, which sits somewhere between the two,10 is an attractive option. Inefficiencies on the determinations side are particularly problematic because the more time specialists spend pushing back on unqualified applicants, the more time other organizations have to wait in line for recognition of exempt status. Since 2010, when a massive influx of auto-revocation reinstatement cases flooded the system, many organizations now wait more than a year just to be assigned to a determinations specialist, and enough cases are taking multiple years to process that the IRS has had to issue guidance on what to do about organizations that are automatically revoked for failure to file annual returns for three years while awaiting review of their applications.11 Offloading that time-consuming initial review to the ROO would, in theory, allow the “good” organizations to get their exemption letters and get on with their charitable programs, while shifting the initial filtering process just a few years down the road, when the IRS can test organizations against actual activities, not just representations.

Will It Work?

The IRS is clearly betting that it will work. When it recently began allowing section 501(c)(4) applicants to attest that they would not engage in more than a designated amount of political activity, in lieu of full case development on that issue during the application process, the IRS signaled that reliance on attestations might be supplemented by a ROO referral.12 More recently, the IRS has been developing a more streamlined application process for section 501(c)(3) applicants, including a new Form 1023-EZ for some smaller organizations,13 and reliance on attestations rather than full development for many other applicants.14 IRS officials have stated that they intend to balance those streamlined application procedures with a more “robust compliance process on the back end.”15

Form 1023-EZ appears to contemplate possible ROO referrals for some organizations. Part III, in particular, asks a series of questions (lines 4 through 11) regarding potential activities, including payment of compensation, international activity, lobbying activity, and specified financial transactions.16 According to the Instructions for Form 1023-EZ, the answers to those questions do not affect eligibility to file the form.17 Organizations that answer yes to any of those questions are not asked for additional information, as they would be in a traditional Form 1023 application. What, then, is the purpose of the questions? It seems likely that at least one purpose is to generate data that may be used in deciding which organizations will receive a ROO or other examination referral.18

If the IRS does intend to rely heavily on the ROO, the agency will certainly need to expand it. As of September 2012, there were only 40 ROO specialists.19 Presumably, more will be needed to provide a meaningful backstop to the more than 60,000 applications the IRS receives each year. IRS officials have indicated that once the new streamlined application procedures are in place and the current backlog of applications has been addressed, determinations personnel will likely be reassigned to examinations (which includes the ROO).20

Also, the IRS will need to tighten its internal documentation and processes regarding ROO referrals and processing. In theory, at least some ROO referrals are randomly selected.21 However, it appears that many organizations may have historically been chosen for ROO referral based on a particular specialist’s gut reaction to the organization’s application.22 For this reason, the ROO has been criticized as prone to abuse — indeed, the House Ways and Means Committee recently called out the ROO (to which many Tea Party applications were referred) as the IRS’s “surveillance program.”23 Unless the IRS has sufficient resources to require a ROO referral for all organizations claiming tax-exempt status (or at least for all Form 1023-EZ filers), it will need to develop and publish objective criteria for determining what organizations get referred to the ROO, and it may need to combat the surveillance program characterization somewhat by at least informing organizations that they are or have been subject to the ROO.

However, even the most robust and transparent ROO program will not result in review of new EOs until some time after they have received exemption letters. Many governmental and other organizations, in granting tax preferences or otherwise in dealing with new EOs, rely to some extent on the fact that the IRS has performed some sort of meaningful initial review, and they have criticized the new streamlined processes as diluting the weight that an IRS exemption letter now may carry (at least in an organization’s first few years).24 State officials and others are understandably concerned that shifting review to the ROO or other examination program will open the floodgates for purported EOs that might not have survived the traditional IRS application process.

It remains to be seen whether the IRS will find a way to filter out at least some of the unqualified applications upfront. Form 1023-EZ, unlike Form 1023, must be electronically filed. Electronic filing could in theory give the IRS an increased opportunity to educate applicants regarding the requirements for tax exemption as they complete the application, and perhaps the opportunity to weed out some applications through an interactive application process. The electronic Form 1023-EZ does not, however, appear to include such interaction between the Form and the Instructions. The IRS has estimated that organizations will take an average of 8.9 hours to complete the 2 1/2-page Form 1023-EZ.25 That estimate assumes that applicants will spend substantial time reviewing the Instructions in a good-faith attempt to understand the requirements for exempt status. That assumption may be naïve, however, and it does not account for the bad-faith attempt by organizations to take advantage of the lack of initial review.

Moreover, it is not yet clear what the consequences will be for an organization that incorrectly files a Form 1023-EZ.26 Some organizations may violate the filing criteria inadvertently. For example, the Form 1023-EZ Instructions preclude an organization with more than $50,000 of annual revenue in its early years from using the form. What if the organization is more successful in its early fundraising than anticipated? Will its exempt status be revoked? Will its initial exemption letter be viewed as somehow contingent on continued compliance (at least during the first few years) with the Form 1023-EZ filing criteria? What about organizations that never intended to comply with the filing criteria? The threat of revocation, even retroactive revocation, will unlikely be a sufficient deterrent. Will the IRS actively pursue fraud or criminal penalties against enough bad-faith applicants to provide a meaningful chilling effect? The ultimate success of the streamlined application process and consolidation of resources on the examinations side will depend not just on beefing up the ROO or other examination programs but also on finding some way at least to limit the perception that bad actors are likely to get away with disingenuous Form 1023-EZ filings.

What Should We Expect?

At first blush, it appears that the universe of organizations that can file Form 1023-EZ is relatively small. An organization that anticipates more than $50,000 in annual revenue, or $250,000 in assets, in its early years doesn’t qualify.27 Also excluded are supporting organizations, sponsors of donor-advised funds, schools, churches, and many others.28 When submitting a prior draft Form 1023-EZ to the Office of Management and Budget for its review, the IRS stated that it expected only about 17 percent of applicants will use the form.29 However, that draft provided significantly higher filing thresholds ($200,000 in annual revenue and $500,000 in assets). With the lower thresholds, the initial percentage may be lower.

However, the IRS may allow Form 1023-EZ to eventually be used by a much higher percentage of applicants. TE/GE Commissioner Sunita Lough has indicated that the filing criteria are not “cut in stone,” and that perhaps as many as 70 percent of applicants may eventually use this form.30 Further, it appears that many Form 1023 applications will rely more on attestations than traditional case development at the determinations stage.31 Therefore, it seems likely that an ever-increasing percentage of organizations will receive exemption letters without significant upfront review.

What Should We Do?

If an organization clearly meets the Form 1023-EZ criteria and is willing to monitor with special care its annual returns, its website, and other public activity in its first five years, the lure of Form 1023-EZ is compelling. Instead of the current long wait times — even for many simple applications — organizations could get their exemption letters in “weeks rather than months” (or years).32 The ability to get an exemption letter and begin activities quickly can make all the difference to a young organization trying to jump-start its charitable programs.

However, an organization that (1) has any doubt about whether it will meet the Form 1023-EZ filing criteria in its early years; (2) must answer yes to any of the questions in Part III, lines 4 through 11; or (3) is concerned about the weight that state officials or others may give to an “EZ” determination letter may want to file a full Form 1023 application. It can be difficult to wait months or years for a determination. However, the IRS has committed to (eventually) processing all applications in six months or less, and because of the heavy backlog over the past several years, applicants have learned various methods (such as fiscal sponsors) to begin their charitable activities to some extent while waiting for a determination.

As of July 1, 2014, Form 1023-EZ is ready for electronic filing. It will be interesting to see how many organizations file the new form, and to what extent fear of the ROO can keep these new EOs in line.

FOOTNOTES

1 See Treasury Inspector General for Tax Administration, “Performance Measures and Improved Case Tracking Would Help the Exempt Organizations Function Better Allocate Resources” (Mar. 13, 2008) 2008 TNT 58-21: Treasury Reports.
2 See Internal Revenue Manual section 7.29.3.2.1.

3 See IRM section 7.20.1.5.2. The ROO also monitors organizations denied exemption to ensure that they are not holding themselves out as exempt. See IRM section 7.20.1.5.2(2).

4 See IRM section 4.75.27. See also IRS EO division, “FY 2012 Annual Report & FY 2013 Workplan,” at 5 (Jan. 25, 2013) 2013 TNT 18-57: Other IRS Documents (fiscal 2012 report).

5 Specifically, Form 14266, which documents the reasons for the ROO referral.

6 Lean Six Sigma is a management re-engineering method used to optimize business performance.

7 See IRS EO division memorandum, “Streamlined Processing Guidelines for All Cases” (Feb. 28, 2014) 2014 TNT 46-64: Other IRS Documents.

8 See fiscal 2012 report, supra note 4, at 5.

9 Id.

10 The ROO is technically part of the IRS Exempt Organizations Compliance Area, a subdivision of EO Examinations. Id. at 2.

11 See IRS EO division memorandum, “Processing Guidelines for Certain Pending Applications of Exempt Organizations That Fail to File Annual Information Returns for Three Consecutive Years” (Mar. 14, 2014) 2014 TNT 59-31: Other IRS Documents.

12 See IRS EO division memorandum, “Interim Guidance on Optional Expedited Process for Certain Exemption Applications Under Section 501(c)(4)” (June 25, 2013) 2013 TNT 125-55: Other IRS Documents; IRS EO division memorandum, “Amendment to Interim Guidance on Optional Expedited Process for Certain Exemption Applications Under Section 501(c)(4)” (July 18, 2013) 2013 TNT 140-50: Other IRS Documents; and IRS EO division memorandum, “Expansion of Optional Expedited Process for Certain Exemption Applications Under Section 501(c)(4)” (Dec. 23, 2013).

13 See Form 1023-EZ; and Instructions for Form 1023-EZ (rev. June 2014) 2014 TNT 127-51: Forms Watch.

14 See “Streamlined Processing Guidelines,” supra note 7.

15 See EO Tax Journal 2014-83; Diane Freda, “IRS to Roll Out Form 1023-EZ in Summer, Anticipates Little Risk of Noncompliance,” Bloomberg BNA (Apr. 25, 2014) (reporting on an April 23 media call with IRS TE/GE Commissioner Sunita Lough); and John Koskinen, testimony on the fiscal 2015 IRS budget, at 11 (Apr. 7, 2014) 2014 TNT 67-31: IRS Testimony.

16 See Form 1023-EZ, supra note 13.

17 See Instructions for Form 1023-EZ, supra note 13.

18 Moreover, these questions may make it easier for the IRS to revoke the organization’s exempt status, perhaps retroactively, if an organization’s actual activities are inconsistent with these representations.

19 See fiscal 2012 report, supra note 4, at 12.

20 See supra note 15.

21 See fiscal 2012 report, supra note 4, at 12 (describing the ROO as consisting of “randomly selected follow-ups”).

22 See IRM section 7.20.1.5(2)(B) (“A Review of Operations (ROO) follow-up referral is prepared when a determination specialist has concerns about the past, present, or future activities of the organization but does not have sufficient cause to deny exemption”); and IRM section 7.20.1.5.2 (“ROO follow-up referrals should be made for material issues when questionable activity is likely to occur, e.g., future operations may impact exempt status, generate UBI or other tax liabilities, or necessitate a change in private foundation classification”).

23 See Ways and Means Committee letter to Attorney General Eric Holder, at 7 (Apr. 9, 2014) 2014 TNT 69-26: Congressional Tax Correspondence.

24 See, e.g., National Association of State Charity Officials, comments on proposed Form 1023-EZ (Apr. 30, 2014), available at http://www.nasconet.org/nasco-submits-comment-on-proposed-form-1023-ez/; and http://www.councilofnonprofits.org.

25 See Instructions for Form 1023-EZ, supra note 13, at 10.

26 See Rev. Proc. 2014-40, section 8.02.

27 See Instructions for Form 1023-EZ, supra note 13.

28 Id.

29 See draft Instructions for Form 1023-EZ (Feb. 10, 2014).

30 See EO Tax Journal 2014-83, supra note 15; and Fred Stokeld, “Streamlined Exemption Application Could Pose Compliance Problems,” Tax Notes, Apr. 28, 2014, p. 439 2014 TNT 76-7: News Stories (reporting on April 23 telephone remarks by Lough).

31 See supra note 12.

32 Koskinen testimony, supra note 15, at 11.

END OF FOOTNOTES

By Brad Bedingfield

Brad Bedingfield is an attorney with Goulston & Storrs PC in Boston and a former tax law specialist in the IRS Exempt Organizations division.



The Affordable Care Act’s Employer Shared Responsibility Provisions – What Government Employers Need to Know.

Free Webcast by the IRS office of Federal State and Local Governments

Date: July 24, 2014

Time: 12 p.m. Eastern Time

Learn about the following topics pertaining to the Affordable Care Act:

To register: Click here. You will use the same link to attend the event.

Please feel free to forward this message to anyone who you believe would be interested and would value this educational opportunity.



IRS: Revenue From Nonprofit Hospital's Lab Services Isn't Taxable.

In technical advice, the IRS concluded that a tax-exempt hospital’s performance of laboratory testing for patients of private physicians located in a city, which is served by the hospital and designated as a “medically underserved population,” is not an unrelated trade or business under section 513.
The hospital is dedicated to improving the health status of the city’s communities by enhancing preventive and primary care and by providing health education. The hospital, which is located in a rural area, describes itself as being committed to improving access to healthcare and to providing services to the underserved.

Rev. Rul. 85-110 provides that while generally a tax-exempt hospital’s performance of laboratory testing services for nonpatients constitutes an unrelated trade or business, there may be unique circumstances when those services may further the hospital’s exempt function. Those circumstances may exist if other laboratories are not available within a reasonable distance from the area served by the hospital or the laboratories are unable or inadequate to conduct tests needed by nonpatients.

The IRS determined in this case that while other laboratories are available and able to conduct tests for individuals who are not the hospital’s patients, they are unable to do so adequately. The nearest full-service, commercial laboratory facility isn’t within a reasonable distance of the city and its turnaround time for test results is much slower than the hospital’s. The inability of other laboratories to adequately serve the patients of private physicians located in the city and its surrounding communities served by the hospital constitutes a unique circumstance under Rev. Rul. 85-110.

Accordingly, the IRS concluded that the hospital’s performance of laboratory testing for the patients of private physicians located in the city and surrounding communities served by the hospital isn’t an unrelated trade or business under section 513. The provision of laboratory services for those individuals is substantially related to, and contributes importantly to, the hospital’s tax-exempt purpose of improving the health of the city and its surrounding communities. As a result, the hospital’s revenue from that activity is not taxable under section 511.

Citations: TAM 201428030

Taxpayer’s Name: * * *
Taxpayer’s Address: * * *
Taxpayer’s ID No.: * * *
Years involved: * * *
Conference held: * * *

UIL: 513.04-00
Release Date: 7/11/2014
Date: March 7, 2008

* * * Area Manager, EO Examinations

LEGEND:

A = * * *
B = * * *
C = * * *
D = * * *
E = * * *
F = * * *
G = * * *
H = * * *
l = * * *
J = * * *
K = * * *
L = * * *
M = * * *
N = * * *
O = * * *
P = * * *
q = * * *
r = * * *
s = * * *
t = * * *
u = * * *
v = * * *
w = * * *
x = * * *
y = * * *
z-zz = * * *
xx = * * *
yy = * * *

ISSUE

Is A’s performance of laboratory testing for the patients of private physicians located in B and the surrounding communities served by A an unrelated trade or business within the meaning of Section 513 of the Internal Revenue Code?

FACTS

A is a nonprofit corporation formed on F in state C. Its Articles of incorporation state that it was formed to hold title to a hospital building and manage, maintain, and carry on said hospital.

The Internal Revenue Service recognized A as exempt from federal income taxation under [now] section 501(c)(3) of the Code, and as a hospital described in section 170(b)(1)(A)(iii). A is located in the city of B, in state C.

According to A’s Bylaws, the hospital is dedicated to improving the health status of the communities of B, G, H, I, J, and K by enhancing preventive and primary care, and by providing health education. A describes itself as being committed to improving access to care and to providing services to the underserved.

B is designated as a “medically underserved population” by the U.S. Department of Health and Human Services, Hearth Resources and Services Administration, Bureau of Health Professions, Shortage Designation Branch. The United States Census Bureau’s Census 2000 data indicate that A is located in a rural area. Residents of B and surrounding communities are eligible to participate in the U.S. Department of Agriculture’s Rural Housing Program.

A operates a full-service medical laboratory onsite within the hospital that strives to provide a high level of service to its community. A operates its laboratory 24 hours a day, seven days a week, 365 days a year. One of the laboratory’s three pathologists, certified by the American College of Pathologists, is available to provide feedback to physicians 24 hours a day, seven days a week. Depending on the specific test ordered, the laboratory generally provides completed test results to the ordering physician within z-zz hours following receipt of a sample for testing, regardless of the time of day the test is ordered.

The majority of A’s laboratory testing services are provided to A’s patients. On average, approximately p% of tests performed by the A laboratory have historically involved testing for patients of private physicians (not patients of A) located in B and the surrounding communities of G, H, I, J, and K. A has historically reported income from these tests, for income tax purposes, as giving rise to unrelated business income (UBI). Approximately q% of all A’s testing for patients of private physicians represents emergency testing, for which the A laboratory reports results within r hour(s) of receipt of the sample.

Private physicians who refer their patients to A for testing generally have admitting privileges at A. They typically draw the samples in their private offices. The samples are then picked up by an A employee for testing at the A laboratory. Depending on the location of the particular doctor’s office or facility being served, the A courier may pick up samples for testing as many as s times per day.

A neither advertises its laboratory testing services nor employs salespeople or marketing professionals. Instead, physicians typically learn about A’s laboratory services through A’s new physician orientation process and through talking with other physicians.

There are no full-service, commercial or noncommercial laboratories in B or in any of B’s surrounding communities. The nearest noncommercial laboratories are those of community Hospital N, which lies to the west of A and its surrounding communities, and community Hospital O, which lies to the east of A and its surrounding communities. The service areas of these other hospitals’ laboratories do not overlap with A’s laboratory service area.

The nearest full-service, commercial testing laboratory is D, located in E, in state C, approximately t miles from B. The round trip driving time between the D laboratory and B is generally u hours.

D operates drawing stations in both L and M (each approximately v miles from B), each of which is located between B and D’s laboratory in E. The drawing stations perform no testing services on-site. Rather, these stations draw samples which are transported to the D facility in E for testing and analysis. The samples drawn at the stations are generally picked up by D near the end of the day. In comparison, A picks up samples as frequently as s times per day.

D offers medical testing services to B-area physicians by providing a courier service which picks up samples from physicians’ B-area offices and transports the samples to D’s laboratory in E for testing. A indicated that D’s courier generally picks up samples from physicians’ offices located in B and its surrounding communities after the close of the physicians’ normal business hours. The D courier then completes its route and delivers the samples to D’s laboratory. Commonly ordered tests may be processed during the night, whereas less commonly ordered tests may be batched for processing later. Results of completed tests may be reported to the ordering physician w or more times per day depending upon D’s arrangement with the specific physician.

The turnaround time for B-area physicians who send samples to D varies depending on whether the samples are drawn before or after D’s daily pick up, and whether the laboratory tests are completed before or after D’s scheduled delivery of test results. A B-area physician who draws a sample in his or her office in the morning for a commonly processed test would generally anticipate receiving laboratory test results from D the following morning (a turnaround time of up to x hours). In contrast, A’s test result delivery in such a scenario is generally z-zz hours.

A states that D also offers emergency testing services. D typically performs each emergency test and provides the results of the test within y hours of receipt of the sample by D’s courier. In comparison, A’s emergency service generally provides a maximum turnaround of r hour(s).

D does not advertise in the B telephone book or actively market its laboratory work in the B area. Furthermore, the president of A’s medical staff reported that neither he nor A have ever been solicited by D.

A states that most physicians in B and its surrounding communities use A’s laboratory to test samples from their patients. A believes that the consensus of the private physicians in the B area is that A’s laboratory services are adequate for their patients, whereas D’s laboratory services are inadequate.

A represents that B-area doctors view the substantial difference in laboratory turnaround times between the A laboratory and the D as a critical distinction that may have important medical consequences for their patients, particularly for those who are elderly. A emphasizes the importance of timely information to doctors’ medical decision making. Timing is critical, as several hours difference in receiving test results can make a significant difference in patient diagnosis and treatment. A states that that the recent trend toward reduced inpatient hospitalization and shorter inpatient stays has generally reduced the ability of physicians to physically observe patients and increased physicians’ dependence upon outpatient, post-hospitalization laboratory testing. Consequently, physicians are required to make quicker medical decisions with respect to their patients. The need to order further tests, the need to modify medication levels, and the need to refer patients for emergency room care, inpatient check-in, or surgery are all vital medical decisions which frequently depend upon timely results of laboratory tests, according to A. For example, the results of a complete blood count test could indicate whether a patient is bleeding internally, suffering from coronary heart disease, or experiencing a heart attack, and could indicate the need for immediate medical intervention.

APPLICABLE LAW

Section 511 of the Code imposes a tax on the unrelated business taxable income (defined in section 512) of organizations exempt from tax under section 501(c).
Section 512 of the Code provides that the term “unrelated business taxable income” means the gross income derived by any organization from any unrelated trade or business (defined in section 513) regularly carried on by it, less the allowable deductions which are directly connected with the carrying on of such trade or business.

Section 513(a) of the Code provides that the term “unrelated trade or business” means, in the case of any organization subject to the tax imposed by section 511, any trade or business the conduct of which is not substantially related to the exercise or performance by such organization of its charitable, educational, or other purpose or function constituting the basis for its exemption.

Section 1.513-1(d)(2) of the regulations provides that a trade or business is “related” to exempt purposes only where the conduct of the business activities has a causal relationship to the achievement of exempt purposes (other than through the production of income). Further, it is “substantially related,” for purposes of section 513 of the Code, only if the causal relationship is a substantial one. For this relationship to exist, the production or the performance of the services from which the gross income is derived must contribute importantly to the accomplishment of exempt purposes. Whether the activities productive of gross income contribute importantly to such purposes depends in each case upon the facts and circumstances involved.

Rev. Rul. 85-110, 1985-1 C.B. 166, addresses whether the performance of diagnostic laboratory testing by a tax exempt hospital upon specimens from patients of private physicians (who are not patients of the hospital) constitutes unrelated trade or business within the meaning of section 513 of the Code. The hospital laboratory performed diagnostic laboratory testing upon specimens obtained by non-employee staff physicians at non-hospital facilities from members of the public who were not Hospital patients. The revenue ruling stated that commercial laboratories that performed testing identical to that performed by the hospital were available in the area and provided testing services on a timely basis. As such, the hospital laboratory’s testing for the patients of private physicians who were not Hospital patients constituted a separate trade or business.

Rev. Rul. 85-110 provides that the provision of diagnostic laboratory testing to a private physician’s patients (who are not Hospital patients) normally constitutes an unrelated trade or business for a tax-exempt hospital The revenue ruling also provides an exception to the general rule, stating in part.

. . . if other laboratories are not available within a reasonable distance from the area served by the Hospital Or are clearly unable or inadequate to conduct tests needed by Hospital Nonpatients, a hospital’s testing services may further its exempt function of promoting community health. Whether such unique circumstances exist will be decided by the Internal Revenue Service on a case-by-case basis.

ANALYSIS

Rev. Rul. 85-110 provides that although the general rule is that the providing of laboratory testing services by a tax exempt hospital to nonpatients constitutes unrelated trade or business, unique circumstances may exist whereby such services may further the hospital’s exempt function. Such “unique circumstances” may exist if other laboratories are (1) not available within a reasonable distance from the area served by the hospital, or (2) clearly unable or inadequate to conduct tests needed by Hospital Nonpatients. See Rev. Rul. 85-110. Here, although other laboratories are available and able to conduct tests needed by A’s nonpatients, they are unable to do so adequately, for the reasons described below. Thus, unique circumstances exist whereby A’s laboratory services to nonpatents in B and its surrounding communities further its tax exempt purpose.

The tax-exempt purpose of A is to improve the health status of B and its surrounding communities. A is located in B, which is designated as a “medically underserved population” by the U.S. Department of Health and Human Services. A is located in a rural area, according to the U.S. Census Bureau.

The nearest full-service, commercial laboratory facility to the A laboratory is D, which is approximately t miles and a u-hour round trip from A’s laboratory. The general turnaround time for results from A’s laboratory, z-zz hours, is considerably faster than D’s turnaround time. A estimates the average differential in turnaround time to be between xx and yy hours.

A believes that the consensus of the private physicians in the B area is that A’s laboratory services are adequate for their patients, whereas D’s laboratory services are inadequate. A indicates that most physicians in B and the surrounding communities utilize A’s laboratory for speedier results, primarily because of the substantial difference in turnaround time between A’s laboratory and D. The difference in turnaround time can have important medical consequences for patients. A difference of several hours in receiving test results can make a significant difference in patient diagnosis and treatment, as test results may indicate the need for immediate medical intervention, including modifying medication levels, providing further testing or treatment, or conducting surgery. For instance, the results of a complete blood count test could indicate whether a patient is bleeding internally, suffering from coronary heart disease, or experiencing a heart attack, and could indicate the need for immediate medical intervention.

Therefore, although D’s laboratory is available for use by physicians and patients in B and its surrounding communities, D is not within a reasonable distance of those communities to adequately serve their health care needs, particularly the needs of patients for timely laboratory testing. See Rev. Rul. 85-110. Because A provides adequate laboratory services to B and its surrounding communities, A promotes the health of the community, and its laboratory services contribute importantly to the accomplishment of A’s tax exempt purpose of improving the health of its community. See section 1.513-1(d)(2) of the regulations.

Accordingly, the inability of other laboratories to adequately serve the patients of private physicians located in B and the surrounding communities served by A constitutes “unique circumstances” under Rev. Rul. 85-110. Thus, A’s provision of laboratory services to such patients furthers A’s tax exempt purpose of improving the health of B and its surrounding communities.

CONCLUSION

A’s performance of laboratory testing for the patients of private physicians located in B and the surrounding communities served by A is not an unrelated trade or business within the meaning of section 513 of the Code. The provision of laboratory services for such persons is substantially related to, and contributes importantly to. As tax exempt purpose of improving the health of B and its surrounding communities, consistent with section 1.513-1(d)(2) of the regulations and the “unique circumstances” test of Rev Rul. 85-110. Accordingly. A’s revenues from such activity is not taxable under section 511 of the Code.



IRS LTR: IRS Grants Extension of Expenditure Period for Bond Proceeds.

The IRS granted a school district an extension of the original expenditure period for available project proceeds of qualified school construction bonds because the district’s failure to spend the bond proceeds was due to reasonable cause and the district will spend the remaining proceeds for qualified purposes with due diligence.

Citations: LTR 201428001

Third Party Communication: None
Date of Communication: Not Applicable
Person To Contact: * * * , ID No. * * *
Telephone Number: * * *

Index Number: 54F.00-00
Release Date: 7/11/2014
Date: April 07, 2014

Refer Reply To: CC:FIP:B05 – PLR-108519-14

LEGEND:
District = * * *
State = * * *
City = * * *
School = * * *
Bonds = * * *
Date 1 = * * *
Date 2 = * * *
Date 3 = * * *

Dear * * * :

This is in response to your request under § 54A(d)(2)(B)(iii) of the Internal Revenue Code for an extension of the expenditure period for the available project proceeds of qualified tax credit bonds.

FACTS AND REPRESENTATIONS

You make the following factual representations. District is a public school district and political subdivision of State.

District issued the Bonds on Date 1 and designated the Bonds as qualified school construction bonds within the meaning of § 54F(a)(3). All available project proceeds of the Bonds were to be spent on constructing, rehabilitating, and repairing School (the “Project”), and were expected to be spent before Date 2.

The original three-year expenditure period for the Bonds under § 54A(d)(2)(B)(i) will expire on Date 2 (the “Original Expenditure Period”). The Project entailed (1) construction of a new gymnasium and classroom wing for School, (b) completely rehabilitating School’s original building, (3) demolishing an unneeded previous addition to School, and (4) acquiring real estate adjacent to School for use as parking space and an outdoor play area. School is an historic three-story public school facility which is approximately 140 years old and located in City. As of Date 1, District did expect that all of the available project proceeds of the Bonds would be spent on the Project by the expiration date of the Original Expenditure Period.

District is unable to expend all of the available project proceeds by the expiration date of the Original Expenditure Period because several unexpected events have caused unanticipated delays in the programming and design of the Project and in the acquisition, construction, rehabilitation, and repair of the Project. The programming and design phase of the Project was unexpectedly increased from 18 to 24 months because of Project alterations made by each of the governing authorities of the two City historic districts which School borders. These alterations were made over the course of several meetings by the authorities and increased the time it took to design the Project. The programming and design phase of the Project was also unexpectedly lengthened because the magnitude of damage caused by a fire which had occurred prior to the Bonds being issued was greater than anticipated, and required District to develop more extensive rehabilitation and repair plans than it had originally thought necessary.

The acquisition, construction, rehabilitation, and repair phase of the Project was delayed by several unexpected events. First, City was late in issuing a building permit, which caused Project construction delays by pushing the construction of the building envelope and site development for School into a winter season with above average snowfall and uncharacteristically cold temperatures. Second, construction of a new addition to School required that the foundation of the addition and the foundation of School tie-in together. When the existing foundation of School was exposed it was discovered to have deteriorated more than expected and was unusable in some areas. Rehabilitation of this unanticipated condition caused additional Project construction delays. District expects to expend the remaining available project proceeds of the Bonds by Date 3.

District submitted this request for a ruling prior to Date 2.

LAW AND ANALYSIS

Section 54A(d)(1) provides that a qualified school construction bond is treated as a qualified tax credit bond for purposes of Section 54A.

Section 54A(d)(2)(B)(i) provides in part that to the extent that less than 100 percent of the available project proceeds of the issue are expended by the close of the expenditure period for 1 or more qualified purposes, the issuer shall redeem all of the nonqualified bonds within 90 days after the end of such period.

Section 54A(d)(2)(B)(ii) provides that for purposes of this subpart, the term “expenditure period” means, with respect to any issue, the 3-year period beginning on the date of issuance. Such term shall include any extension of such period under clause (iii).

Section 54A(d)(2)(B)(iii) provides that upon submission of a request prior to the expiration of the expenditure period (determined without regard to any extension under this clause), the Secretary may extend such period if the issuer establishes that the failure to expend the proceeds within the original expenditure period is due to reasonable cause and the expenditures for qualified purposes will continue to proceed with due diligence.

Section 54A(d)((2)(C)(iv) provides that for purposes of this paragraph, in the case of a qualified zone academy bond, a “qualified purpose” means a purpose specified in § 54E(a)(1).

Section 54A(e)(4) of the Code defines “available project proceeds” to mean (A) the excess of (i) the proceeds from the sale of an issue, over (ii) the issuance costs financed by the issue (to the extent that such costs do not exceed 2 percent of such proceeds), and (B) the proceeds from any investment of the excess described in subparagraph (A).

The Project was identified prior to the issuance of the Bonds and District reasonably expected to spend all of its allocable available project proceeds within the three-year period. The expected failure to spend all the available project proceeds of the Bonds by the expiration of the three-year period on Date 2 has been caused by events that were not reasonably expected at the time the Bonds were issued and were beyond the control of District. However, District to the extent possible considering the described unexpected external events that resulted in unforeseen delays, has and will continue to exercise due diligence in spending the remaining available project proceeds on the Project. District expects to spend all available project proceeds of the Bonds not later than Date 3.

CONCLUSION

Under the facts and circumstances of this case, we conclude that District’s expected failure to expend the available project proceeds of the Bonds by Date 2 is due to reasonable cause and that District’s continued expenditure of the proceeds for qualified purposes will proceed with due diligence. Therefore, District is granted an extension of the Original Expenditure Period with respect to the Bonds until Date 3.

Except as expressly provided herein, no opinion is expressed or implied concerning the tax consequences of any transaction or item discussed or referenced in this letter.

This ruling is directed only to the taxpayer who requested it. Section 6110(k)(3) provides that it may not be used or cited as precedent.

In accordance with a Power of Attorney on file with this office, a copy of this letter is being sent to District’s authorized representative.

The ruling contained in this letter is based upon information and representations submitted by District and accompanied by a penalty of perjury statement executed by an appropriate party. While this office has not verified any of the materials submitted in support of the request for a ruling, it is subject to verification upon examination.

Sincerely,

Associate Chief Counsel
(Financial Institutions &
Products)

By:
Timothy L. Jones
Senior Counsel, Branch 5



IRS LTR: Support of Organization's Program Won't Affect Club's Exemption.

The IRS ruled that a social club’s support of a social welfare organization established to conduct events for the club’s members and the general public will not affect the club’s exempt status, finding that the organization’s gross receipts will not be attributed to the club and other payments will not be deemed gross receipts to the club.

Citations: LTR 201428009

Contact Person: * * *
Identification Number: * * *
Telephone Number: * * *

UIL: 501.07-00; 501.07-05
Release Date: 7/11/2014
Date: February 10, 2014

Employer Identification Number: * * *

LEGEND:

M = * * *
P = * * *
r = * * *
S = * * *

Dear * * *:

This responds to your letter dated June 24, 2011, in which you request rulings with respect to certain transactions between M and P, and their effect on M’s status as an organization described in I.R.C. § 501(c)(7).

FACTS

M is organized as a not-for-profit corporation under state law. It is recognized as a social club described in § 501(c)(7). M has actively fostered interest in amateur r by organizing and conducting regional, national, and international r that were open or by invitation to both its members and nonmembers. These events were in addition to those organized solely for M’s members.

P is organized as a not-for-profit corporation under state law. It is recognized as a social welfare organization described in § 501(c)(4). It was established to conduct the amateur open and by invitation r events previously conducted by M for members and nonmembers.

P has no members. Its activities are managed by a six-member board of directors. All of its directors and officers are presently members of M, though there is no requirement that they be so. Two directors are appointed by M, while the rest are presently neither trustees nor directors of M. P’s bylaws provide that a majority of P’s directors must at all times consist of persons who are not concurrently either a trustee or an officer of M, and that P’s president must be a director who is not concurrently a trustee or officer of M.

P will conduct those open and by invitation r agreed with M. P will utilize volunteers and contractors to conduct its events; it does not expect to have employees of its own. In carrying out its responsibilities, P will utilize certain facilities, equipment, intellectual property and website facilities made available by M without cost. M will provide office space and record storage facilities to P without cost, and P will reimburse M for services provided by M’s S Office and certain administrative employees (based on an allocable share of their compensation and benefits and their time devoted to P activities). P may either pay M for catering services and accommodations (based on member pricing rates) or obtain them from third parties.

More specifically, M and P have entered into an Administration Agreement, among the provision of which are the following —

S Office Personnel. During the Term [of the Agreement] M agrees to make available to P the services of its S Office personnel . . . for use in planning and conducting [ r ] Events & Programs, provided that P shall reimburse M for its allocable share of the compensation and benefits provided to such personnel based on the time that such employees devote to P activities.

Administrative Services. During the Term, M agrees to provide to P such administrative services (including bookkeeping, clerical, secretarial, annual filings) relating to conducting Events & Programs and maintaining P’s annual reporting requirements as P may request, and P agrees to reimburse M for its allocable share of the compensation and benefits provided to such personnel based on the time that such employees devote to P activities.

Insurance. During the Term, M agrees to include P as a named insured under its current personal injury and property damage insurance coverage so as to cover P’s activities in conducting its Events & Programs. P agrees to reimburse M for P’s allocable share of the premiums for such coverage as determined by the insurer(s), provided that M may in its discretion waive all or part of such reimbursement. P shall obtain, at its own cost, directors and officers liability insurance for P’s directors and officers at the same level as that provided currently by M to its trustees and officers.

M and P maintain separate books and records on which their respective revenues and disbursements are recorded. They also maintain separate bank accounts into which their respective revenues are deposited and from which their respective expenses are paid. For accounting purposes, they will have separate audited financial statements, and they will file separate annual information returns on Form 990.
For accounting and Form 990 reporting purposes, M does not include P’s allocable share of the compensation and benefits provided to S Office and administrative personnel or P’s allocable share of insurance premiums in expenses when paid by M. Rather, such amounts are recorded as advances to P. Conversely, M does not include reimbursements by P in revenue, but, instead, records them as the payment of an advance.

RULINGS REQUESTED

M has requested the following rulings:

1. The gross receipts of P will not be attributed to M for purposes of determining M’s compliance with the 15 percent limit on nonmember gross receipts under § 501(c)(7).

2. Payments made by P to M to reimburse M for shared services of S Office and certain administrative personnel, and for personal injury and property damage insurance coverage, will be regarded as reimbursements for advances made for the benefit of P and will not be deemed to be nonmember gross receipts to M.

3. M’s exemption under § 501(c)(7) will not be adversely affected by its support of P’s r program.

LAW

I.R.C. § 501(a) exempts from federal income taxation organizations described in § 501(c).

I.R.C. § 501(c)(7) describes clubs organized for pleasure, recreation, and other nonprofitable purposes, substantially all of the activities of which are for such purposes and no part of the net earnings of which inures to the benefit of any private shareholder.

Treas. Reg. § 1.501(c)(7)-1(a) provides that the exemption provided by § 501(a) for organizations described in § 501(c)(7) applies only to clubs which are organized and operated exclusively for pleasure, recreation, and other nonprofitable purposes, but does not apply to any club if any part of its earnings inures to the benefit of any private shareholder. In general, this exemption extends to social and recreation clubs which are supported solely by membership fees, dues, and assessments. However, a club otherwise entitled to exemption will not be disqualified because it raises revenue from members through the use of club facilities or in connection with club activities.

Treas. Reg. § 1.501(c)(7)-1(b) provides that a club which engages in business, such as making its social and recreational facilities available to the general public, is not organized and operated exclusively for pleasure, recreation, and other nonprofitable purposes, and is not exempt under § 501(a).

In Moline Properties v. Comm’r, 319 U.S. 436 (1943), the Supreme Court said that “[t]he doctrine of corporate entity fills a useful purpose in business life. Whether the purpose be to gain an advantage under the law of the state of incorporation or to avoid or to comply with the demands of creditors or to serve the creator’s personal or undisclosed convenience, so long as that purpose is the equivalent of a business activity or is followed by the carrying on of business by the corporation, the corporate remains a separate taxable entity. . . . In general, in matters relating to the revenue, the corporate form may be disregarded where it is a sham or unreal. Id. at 438-39. In response to the argument that the corporation was a mere agent of its sole stockholder, the Court said that “the mere fact of the existence of a corporation with one or several stockholders, regardless of the corporation’s business activities, does not make the corporation the agent of its stockholders.

In National Carbide Corp. v. Comm’r, 336 U.S. 422, 437 (1949), the Supreme Court said that a finding of a “true agency” relationship turns on several factors. “Whether the corporation operates in the name and for the account of the principal, binds the principal by its actions, transmits money received to the principal, and whether receipt of income is attributable to the services of employees of the principal and to assets belong to the principal are some of the relevant considerations in determining whether a true agency exists. If the corporation is a true agent, its relations with the principal must not be dependent upon the fact that it is owned by the principal, if such is the case. Its business purposes must be the carrying on of the normal duties of an agent.”

In Krivo Indus. Supply Co. v. Nat’l Distillers & Chem. Corp., 483 F.2d 1098 (5th Cir. 1973) the court examined the “instrumentality doctrine,” which allows the separate legal existence of a corporation to be disregarded when that corporation is a mere instrumentality of a dominant entity. Specifically, the court was called upon to determine whether a creditor corporation should be held liable for debts of its borrower, where the financial circumstances of the borrower put the creditor in a position to exert substantial influence over the operations of the borrower. Id. at 1101. The corporate form is not lightly disregarded; however, a subservient corporation’s separate existence may be disregarded if the subservient corporation exists to further the purposes of the parent/dominant corporation and the subservient corporation has no separate, independent existence of its own. Id. at 1102. Direct and actual operative control of the subservient corporation is required to apply the instrumentality doctrine. The court will look past stock ownership to the specific facts to determine whether the dominant entity, in fact, possessed full control over the subservient corporation and whether, through its manipulation of the subservient corporation, a third party was harmed. Id. at 1104. The court held that the “absence of an independent corporate purpose is most apparent in those cases in which the dominant corporation, to further its own corporate purposes, either organized or acquired the subservient corporation.” Id. at 1105. The court found that the creditor lacked the level of control over the borrower for the instrumentality doctrine to apply. Id. at 1114.

In United States v. Fort Worth Club of Fort Worth, Texas, 345 F.2d 52, (5th Cir. 1965), a § 501(c)(7) social club, through its wholly owned subsidiary, owned a 13 story building. The building was used in part by the club, and the remainder of the building was rented to commercial tenants. Each month, the subsidiary corporation turned over its income less expenses to the club. The club deposited these funds in its general bank account and drew on this account to pay expenses. The court held that the club was not organized and operated exclusively for social purposes, because, through a wholly owned subsidiary, the club was in the business of leasing office space to the public. The court said that the social club was attempting to accomplish indirectly what it could not accomplish directly — to derive income from dealings with the general public.

Rev. Rul. 68-74, 1968-1 C.B. 267, concerns a social club that operates as a nonprofit corporation to promote yachting and other activities for the pleasure and recreation of its members. In addition to a clubhouse, the club owns yachting facilities, including a marina for the mooring and servicing of boats. The club formed a wholly owned stock corporation to which it leases its marina facilities for a rental that is based on the value of the facilities so leased. The subsidiary corporation operates the marina as a business for profit, and pays Federal income taxes on its earnings. Facilities in excess of membership usage are offered to the general public at the same rental as that paid by club members. The ruling states that the club, as sole owner of the subsidiary and the leased facilities, is entitled to receive all profits of the subsidiary and all rental payments for the facilities. To the extent that the subsidiary’s profits and rental payments result from the business done with the general public, (1) nonmember income inures to the members of the club within the meaning of § 501(c)(7), and (2) the club is not supported solely by membership fees, dues, and assessments within the meaning of § 1.501(c)(7)-1. Accordingly, the ruling holds that the activities and operations of the wholly owned subsidiary are considered to be those of the club for purposes of determining whether the club is engaging in business with the general public for profit. The ruling cites United States v. Fort Worth Club for the proposition that social clubs claiming exemption under § 501(c)(7) may not do indirectly what they cannot do directly. A club may not insulate itself from the effects of business activities carried on with the general public for profit by forming a subsidiary corporation to carry out those activities.

In Rev. Rul. 84-138, 1984-2 C.B. 123, the taxpayer, a management investment company that elected to be taxed as a regulated investment company under subchapter M (§§ 851-855), established S, a wholly-owned subsidiary, to operate as a small business investment company under the Small Business Act of 1958. S also elected to be taxed as a regulated investment company under subchapter M. Because the taxpayer and S use the same facilities and some of the same personnel, it was agreed that taxpayer would pay all the expenses for general and administrative overhead, including personnel costs. S agreed to reimburse the taxpayer for its pro rata share of these expenses on an arms-length basis. The taxpayer was not engaged in the business of receiving compensation for services of the type that were reimbursed. The reimbursements were not included in gross income and no deduction was taken by the taxpayer for S’s share of the expenses. The Service found that the amounts taxpayer received as reimbursement for paying S’s general and administrative overhead expenses, including personnel costs, represented advancements made on behalf of S. Citing Rev. Rul. 80-348 (holding that amounts paid by a labor union to reimburse delegates from local chapters for expenses of traveling from home to attend a convention are not includible in gross income if the delegates have a right or expectation of reimbursement), the Service ruled that the amounts received in reimbursement for advances are not includible in gross income under § 61(a).

ANALYSIS

Issue 1: Whether the gross receipts of P would be attributed to M for purposes of determining M’s tax-exempt status under § 501(c)(7).

Under the “separate-identity principle” annunciated in Moline Properties, Inc. v. Comm’r, the activities of a subsidiary will not be attributed to its parent unless (1) the subsidiary lacks a business purpose, or (2) the subsidiary is merely an arm or an agent of the parent. Aside from the fact that P is not a subsidiary of M, P was organized and is operated for the valid business purpose of conducting r events for M’s members and for the general public, thus satisfying the first prong.

P also satisfies the second prong. Under the holding in National Carbide Corp. v. Comm’r, the finding of a true agency relationship turns on factors such as whether the corporation operates in the name and for the account of the principal, binds the principal by its actions, transmits money received to the principal, and whether receipt of income is attributable to the services of employees of the principal and to assets belonging to the principal. P is a separately incorporated entity. P operates under its own name and for its own account, not under the name or for the account of M. P’s board of directors is not controlled by M, and M is not involved in the day-to-day management of P. P cannot bind M by its actions. P does not transmit the money it receives to M, except to reimburse M for certain administrative, insurance, and catering expenses. Although P will utilize some employees and assets of M under the Administrative Agreement, P will utilize volunteers and contractors to conduct the r events. And unlike the situation described in Krivo Indus. Supply Co., M does not have the direct and actual operative control of P that is required to apply the instrumentality doctrine. Therefore, under the separate-identity principle of Moline Properties v. Comm’r, the activities of P should not be attributed to M.

Nevertheless, United States v. Fort Worth Club of Fort Worth, Texas and Rev. Rul. 68-74 appear to hold that the activities and operations of a wholly-owned subsidiary could be considered those of its § 501(c)(7) parent for purposes of determining whether the parent is engaging in a business with the general public for profit for purposes of § 1.501(c)(7)-1(b), regardless of whether the subsidiary has a valid business purpose and is not a merely an arm, agent, or instrumentality of its parent. P, however, is not a wholly-owned subsidiary of M. Its bylaws provide that a majority of its directors must at all times consist of persons who are not concurrently either a trustee or an officer of M, and that P’s President must be a director who is not concurrently a trustee or officer of M.

Consequently, we hold that the gross receipts of P would not be attributed to M for purposes of determining the percentage of M’s gross receipts that M receives from sources outside its membership or that are derived from the use of M’s facilities or services by the general public.

Issue 2: Whether the payments made by P to M under the Administration Agreement to reimburse M for shared services of M’s S Office and certain administrative personnel, and for P’s allocable share of the premiums for personal injury and property damage insurance coverage, would be deemed to be nonmember gross receipts to M.

“Gross receipts” for purposes of determining tax-exempt status of § 501(c)(7) organizations are the income from a club’s usual activities, and include admissions, membership fees, dues, assessments, investment income, and normal recurring capital gains on investments. While M will receive amounts from P in reimbursement for the expense of providing P with the services of its S Office and certain administrative personnel, and for the cost of personal injury and property damage insurance coverage allocable to P’s r Events & Programs, such amounts cannot be considered income from M’s usual activities. M is not engaged in the business of rendering the services of its S Office and administrative personnel, or of providing personal injury and property damage insurance coverage, to others for profit. Under the reasoning of Rev. Rul. 84-138, amounts paid by M for these expenses represent advancements made on behalf of P, and amounts received in reimbursement for such advancements are not gross income. Reflecting this reasoning, M does not include these amounts in revenue for accounting or Form 990 reporting purposes. Consequently, since the amounts are not “income” and are not derived from M’s usual activities, they do not constitute gross receipts for purposes of determining M’s tax-exempt status under § 501(c)(7).

Issue 3: Whether M’s exemption under § 501(c)(7) would be adversely affected by its support of P’s r program.

M will support P’s r program by allowing P to use a portion of its facilities, equipment, and intellectual property without charge. As explained in Issue 2, above, M will also make available to P its S Office and administrative personnel in return for reimbursement.

When Congress amended § 501(c)(7) in 1976, it made clear that a social club should not lose its tax-exempt status if it receives no more than 35 percent of its gross receipts from sources outside its membership and, within that 35-percent amount, if no more than 15 percent of its gross receipts is derived from the use of its facilities or services by the general public. See S. Rep. No. 94-1318, at 4 (1976), reprinted in 1976 U.S.C.C.A.N. 6051, 6054.

You have asked us to assume that, for purposes of this ruling, such payments as M will receive from P (except those amounts received as reimbursement under the Administration Agreement), together with other nonmember payments, will make up no more than 15 percent of your total gross receipts. In Issue 1, above, we determined that the activities of P will not be attributed to M. Furthermore, in Issue 2, above, we determined that payments received from P under the Administration Agreement will not be considered gross receipts of M for purposes of determining M’s exempt status under § 501(c)(7). Therefore, under these circumstances, we conclude that M’s exemption under § 501(c)(7) will not be adversely affected by its support of P’s r program.

CONCLUSION

In light of the foregoing, we rule as follows:

1. The gross receipts of P will not be attributed to M for purposes of determining M’s tax-exempt status under § 501(c)(7).

2. The payments made by P to M under the Administration Agreement to reimburse M for shared services of M’s S Office and certain administrative personnel, and for P’s allocable share of the premiums for personal injury and property damage insurance coverage, will not be deemed to be gross receipts to M for purposes of determining M’s tax-exempt status under § 501(c)(7).

3. M’s exemption under § 501(c)(7) will not be adversely affected by its support of P’s r program.

This ruling will be made available for public inspection under section 6110 of the Code after certain deletions of identifying information are made. For details, see enclosed Notice 437, Notice of Intention to Disclose. A copy of this ruling with deletions that we intend to make available for public inspection is attached to Notice 437. If you disagree with our proposed deletions, you should follow the instructions in Notice 437.

This ruling is directed only to the organization that requested it. Section 6110(k)(3) of the Code provides that it may not be used or cited by others as precedent.

This ruling is based on the facts as they were presented and on the understanding that there will be no material changes in these facts. This ruling does not address the applicability of any section of the Code or regulations to the facts submitted other than with respect to the sections described. Because it could help resolve questions concerning your federal income tax status, this ruling should be kept in your permanent records.

If you have any questions about this ruling, please contact the person whose name and telephone number are shown in the heading of this letter.

In accordance with the Power of Attorney currently on file with the Internal Revenue Service, we are sending a copy of this letter to your authorized representative.

Sincerely,

Steven B. Grodnitzky
Manager, Exempt Organizations
Technical Group 1
Enclosure
Notice 437



Congress Should End – Not Extend – the Ban on State and Local Taxation of Internet Access Subscriptions.

The Internet Tax Freedom Act (ITFA), enacted in 1998 and temporarily renewed in 2001, 2004, and 2007, imposed a moratorium on new state and local taxes on monthly Internet access fees while preserving (“grandfathering”) existing Internet access taxes. The House Judiciary Committee recently approved a bill to eliminate the grandfather provision and permanently ban all state and local taxation of Internet access subscriptions. This represents the first time that Congress has seriously considered a permanent ban on taxing Internet service for all states, including those now using these taxes to help support public services. Rather than extend ITFA indefinitely, Congress should lift the ban and let states decide whether they and their local governments will impose their sales and telecommunications taxes on Internet access charges.

Center on Budget and Policy Priorities
By Michael Mazerov
July 10, 2014

Read the Full Report.



IRS Corrects Regs on Streamlined Exemption Process.

The IRS has corrected an error in final and temporary regulations (T.D. 9674) that provide guidance on a streamlined application process that eligible organizations may use to apply for recognition of tax-exempt status under section 501(c)(3).

Guidelines for the Streamlined Process of Applying for
Recognition of Section 501(c)(3) Status

DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 1

Treasury Decision 9674

RIN 1545-BM07

Correction

In rule document 2014-15623 on pages 37630-37632 of the issue of Wednesday, July 2, 2014 make the following correction:

PART 1 — INCOME TAXES

On page 37631, in the third column, in the 26th line from the bottom, “§ 1.501(c)(3)” should read “§ 1.501(c)(3)-1T”.

[FR Doc. C1-2014-15623 Filed 7-9-14; 8:45 am]

BILLING CODE 1505-01-D

[FR Doc. C1-02014-15623 Filed 07/09/2014 at 8:45 am; Publication Date: 07/10/2014]



IRS Provides Procedures for Using Form 1023-EZ.

The IRS has issued guidance providing the procedures for applying for and issuing determination letters on tax-exempt status under section 501(c)(3) via Form 1023-EZ, “Streamlined Application for Recognition of Exemption Under Section 501(c)(3) of the Internal Revenue Code.”

An eligible organization may, but is not required to, seek recognition of tax-exempt status under section 501(c)(3) by submitting a Form 1023-EZ in accordance with Rev. Proc. 2014-40. The revenue procedure is generally available for specified U.S. organizations with assets of $250,000 or less and annual gross receipts of $50,000 or less. The current user fee for submitting an application under the revenue procedure is $400.

Rev. Proc. 2014-40 also provides the procedures that the IRS will use to process a Form 1023-EZ, including a provision that allows the IRS to request additional information from any organization before accepting a Form 1023-EZ for processing or making a determination of exempt status.

Rev. Proc. 2014-40 is effective July 1, 2014, and amplifies Rev. Proc. 2014-4, Rev. Proc. 2014-5, Rev. Proc. 2014-9, Rev. Proc. 2014-10, and Rev. Proc. 2014-11 and supplements Rev. Proc. 2014-8.



Final, Temporary Regs Published on Streamlined Exemption Process.

The IRS has published final and temporary regulations that provide guidance on a streamlined application process that eligible organizations may use to apply for recognition of tax-exempt status under section 501(c)(3). The text of the temporary regs also serves as the text of concurrently issued proposed regs.

The IRS is developing a streamlined form and procedures for some smaller organizations to make the process of meeting the section 508 notice requirements more efficient for those organizations. Thus, effective July 1, 2014, the final and temporary regs amend the applicable rules to allow eligible organizations to use a streamlined process to meet the section 508 requirements.

The regs give Treasury and the IRS the authority to issue guidance providing an exception to the requirement that an organization applying for tax-exempt status provide a detailed statement of its proposed activities. The regs also amend provisions on the IRS’s ability to revoke a determination because of a change in the law or regulations, or for other good cause, to refer to the IRS’s authority to do so retroactively under section 7805(b). According to the preamble, no substantive change is intended by this amendment.

The regs amend a requirement that an organization claiming to be exempt from filing annual returns file with and as a part of its application a statement supporting its claim. According to the preamble, the change allows the IRS to issue guidance providing other methods of notifying the IRS that the organization is claiming an annual filing exemption. The regs provide that eligible organizations may use Form 1023-EZ, “Streamlined Application for Recognition of Exemption Under Section 501(c)(3) of the Internal Revenue Code,” to notify the IRS of their applications for tax-exempt status under section 501(c)(3). The IRS has concurrently issued guidance that provides the procedures for applying for recognition of exemption using Form 1023-EZ. The regs also make some technical changes that are described in the preamble.



Small Organizations Seeking Charitable Status Can Use Short Form.

Small organizations seeking tax-exempt status as charitable entities can now use a shorter, simpler application introduced by the IRS July 1, although some practitioners who raised questions when the IRS released the draft form in spring remain concerned.

Form 1023-EZ, “Streamlined Application for Recognition of Exemption Under Section 501(c)(3) of the Internal Revenue Code,” is about 2 1/2 pages long, compared to the standard Form 1023, which runs 26 pages. Unlike the standard form, the streamlined application does not require applicants to provide detailed statements of their planned activities.

“We believe that many small organizations will be able to complete this form without creating major compliance risks,” IRS Commissioner John Koskinen said in a release. “Rather than using large amounts of IRS resources up front reviewing complex applications during a lengthy process, we believe the streamlined form will allow us to devote more compliance activity on the back end to ensure groups are actually doing the charitable work they apply to do.”

But some practitioners expressed misgivings about the fact that filers will not have to provide details about their activities. “I still think the IRS ought to be asking for some information about their activities and their proposed budgets,” said Charles M. Watkins of Webster, Chamberlain & Bean LLP, who expressed similar reservations when the draft was released. He said charities that want to register with the states for fundraising purposes may face questions about their activities from state charity regulators because that information will not be available on the Form 1023-EZ.

Arthur Rieman of The Law Firm for Non-Profits, who criticized the draft in comments earlier this year, said the release of the form was premature and possibly wrongheaded. “Clearly there is a need to streamline the exemption application review process,” he said. “However, doing so in this manner has the potential to open the floodgates to people who will use the relaxed requirements for exemption to game and abuse the system to reap profit and private gain at the expense of the trusting public. Ultimately, the entire charitable sector may be tarnished.”

The form’s eligibility requirements ameliorate, but do not eliminate, the potential for abuse compared to the requirements promulgated in the draft, Rieman said. Because exemption for Form 1023-EZ applicants apparently will be all but automatic, anyone who attests to meeting the requirements — whether legitimately or not — can obtain section 501(c)(3) status, he said, adding that “once they obtain their determination letter, fraudsters will be able to use and abuse that status with impunity for several years.”

Rieman also said that although the IRS could revoke exemption if an organization misstates information on the form, neither the form nor its instructions inform applicants that inaccurate information can lead to revocation. “Apparently any revocations will follow the same procedure as applies to other 501(c)(3) organizations,” he said. “This will give an abusive Form 1023-EZ applicant years to rip off the public before it is shut down.”

The IRS also said most organizations with gross receipts of $50,000 or less and assets of $250,000 or less can use the new form. Those figures are less than those in the draft, in which the gross receipts threshold was $200,000 or less and the total assets figure was $500,000 or less.

Eve Rose Borenstein of Borenstein and McVeigh Law Office LLC said she was pleased with limiting the form “to the very smallest organizations.” She said the new form is “akin to a self-registration process” that will provide the IRS with “a known pool of new, now-recognized 501(c)(3)s who can be provided targeted education. The originally proposed limits would have injected much more risk for abuse.”

Benjamin Takis of Tax-Exempt Solutions PLLC said the IRS’s decision to reduce the thresholds is a positive development. He wondered, though, whether the agency will be able to follow through with increased enforcement on the “back end,” as it has promised.

“Unless the Service is able to hold organizations accountable for inaccurate financial projections or misrepresentation of their purpose or activities, the risk of fraud and noncompliance remains significant,” Takis said.

In addition to organizations with receipts and assets above the thresholds, entities ineligible to use the form include those formed under the laws of foreign countries; successors to for-profit entities; churches or conventions or associations of churches; schools, colleges, or universities; hospitals or medical research organizations; supporting organizations described in section 509(a)(3); credit counseling organizations; and organizations that maintain or plan to maintain donor-advised funds. Organizations that are successors to or controlled by entities whose exempt status has been suspended because they have been identified with terrorism also may not use the short form.

Applicants must fill out an eligibility checklist before completing the form, which must be filed using pay.gov, with a $400 user fee due at filing. Revenue Procedure 2014-40, 2014-30 IRB 1 has more information about the new form, which also was accompanied by the publication of final and temporary regulations on the streamlined application process.

Fred Stokeld
Tax Analysts



IRS LTR: Organization Not Required to Submit New Exemption Application.

The IRS ruled that the conversion of a public nonprofit corporation into a nonprofit corporation under state law did not result in the creation of a new entity and, accordingly, the corporation is not required to submit a new application for tax-exempt status.

Citations: LTR 201426028

Contact Person: * * *
Identification Number: * * *
Telephone Number: * * *

UIL Number: 501.03-05
Release Date: 6/27/2014
Date: April 1, 2014

Employer Identification Number: * * *

LEGEND:

State = * * *

Dear * * *:

This is in response to your ruling request dated September 6, 2013, requesting a ruling that you are not required to submit a new Application foe Exemption under I.R.C. § 508(a).

FACTS

You have been recognized as an organization exempt under § 501(a) of the Code because you are described in § 501(c)(3) and are classified as a public charity within the meaning of §§ 509(a)(2). You were formed by act of the State Legislature. This act established your purpose, the processes of appointing and electing your directors and officers, and other specifics about your operations. Your purpose is to administer the Federal Family Education Loan Program. You review applications of students to determine eligibility for student loans, guarantee loans made to students, and perform various other administrative functions. Your enabling statute describes you as a “public nonprofit corporation . . . [with] all the powers and duties incident to a nonprofit corporation under the [ State ] Non-Profit Corporation Act.”

You state that as a corporation created pursuant to an act of State Legislature you were not required to file articles of creation or incorporation with the state.

Your enabling statute was amended multiple times, but these amendments did not alter your purposes or corporate form. However, recently the State Legislature enacted legislation impacting your corporate identity. This legislation states that you are “converted . . . from a public nonprofit corporation to a nonprofit corporation.” It directs you “to effectuate the conversion” by filing “a certificate of formation” or “certificate of conversion,” as deemed appropriate by the State Secretary of State. Also, the legislation states that, even with this conversion, you, “continue[ ] in existence uninterrupted from the date of [your] creation.” In addition, you state that your act of filing a Certificate of Conversion is a purely administrative act that does not impact your corporate structure or the continuous recognition of your nonprofit corporation status form your date of creation. Finally, under this legislation, your purpose and operations remain the same.

You abided by the requirements of this statute and filed documents determined to be appropriate by the State Secretary of State. You filed a certificate of conversion and attached to it a certificate of formation. Your certificate of conversion states that you are “a statutorily enabled [ State ] public nonprofit corporation” that is “converting to a nonprofit corporation formed under [State] Business Organizations Code.” The certificate of conversion adds that you are “continuing [your] uninterrupted existence.” The attached certificate of formation states that you were formed by the State Legislature pursuant to your original enabling statute.

RULING REQUEST

You requested the following ruling:
That a new entity was not created upon your filing a Certificate of Conversion with the Secretary of State of State and as such you are not required to submit a new Application for Exemption.

LAW

I.R.C. § 501(c)(3) exempts from taxation “Corporations, and any community chest, fund, or foundation” that fit certain criteria.
I.R.C. § 508(a) states that “New organizations must notify secretary that they are applying for recognition of section 501(c)(3) status.”

Treas. Reg. 1.501(a)-1(a)(3) provides that an organization claiming exemption under I.R.C. § 501(a) and described in any paragraph of I.R.C. § 501(c) shall file the form of application prescribed by the Commissioner.

Treas. Reg. § 1.508-1(a) states that “New organizations must notify the Commissioner that they are applying for recognition of section 501(c)(3) status.”

Treas. Reg. § 1.508-1(a)(1) provides that in general an organization organized after October 9, 1969, will not be treated as described in I.R.C. § 501(c)(3) unless such organization has given the Commissioner notice.

American New Covenant Church v. Commissioner, 74 T.C. 293, 301 (T.C. 1980) considered the question of whether a new organization was formed during the following course of actions. An unincorporated association filed an application for exemption. While its application was pending, the unincorporated association stated that it had changed its name and also it presented articles of incorporation bearing this new name. The Service determined that a new entity had been formed by the filing of these articles of incorporation. It concluded that 1) the newly formed corporation was distinctive from the unincorporated association that had previously filed an application for exemption and 2) the newly formed corporation needed to file its own application. The Tax Court agreed, ruling “that the two organizations [should] be treated as separate, independent legal entities.” It stated, that the Service, “was entirely justified in insisting that [the newly formed corporation] submit a new application in order to determine whether it met the regulation requirements for tax-exempt status.”

Rev. Rul. 67-390; 1967-2 C.B. 179, consider four situations in which organizations previously ruled as exempt underwent structural changes.

Case 1. An exempt trust was reorganized and adopted a corporate form to carry out the same purposes for which the trust had been established. Its operations were not changed.

Case 2. An exempt unincorporated association was incorporated and continued the operations which had qualified it for exemption.

Case 3. An exempt organization incorporated under state law was reincorporated by an Act of Congress to carry out the same purposes contained in the state charter.

Case 4. An exempt organization incorporated under the laws of one state was reincorporated under the laws of another state with no change in its purposes.

The ruling held that in all four situations, a new legal entity had been created and the new legal entity was required to apply for exemption. The old organization’s exemption would not suffice.
Rev. Rul. 77-469, 1977-2 C.B. 196, held that an organization that filed its application for exemption less than 15 months after its incorporation under state law was exempt as of the date of its incorporation even though it had operated as an unincorporated association for three years prior to its incorporation. The ruling highlighted that the corporation was a new legal entity from the unincorporated one.

ANALYSIS

You were formed by an act of the State legislature as a public nonprofit corporation under State law. Thereafter, the State legislature declared that you would no longer be a public nonprofit corporation, but instead you would be a nonprofit corporation under State law. You then took the appropriate steps to convert yourself from a public nonprofit corporation to a nonprofit corporation.
Under I.R.C. § 508(a) and Treas. Reg. § 1.508-1(a), provides that an organization claiming exemption under I.R.C. § 501(a) and described in any paragraph of I.R.C. § 501(c) shall file the form of application prescribed by the Commissioner

Rev. Rul. 67-390 considered four cases in which organizations that were recognized as exempt underwent structural changes, and the Revenue Ruling concluded that by these structural changes new organizations were formed. American New Covenant Church v. Commissioner, 74 T.C. 293, 301 (T.C. 1980) and Rev. Rul. 77-469 found that new organizations were created when unincorporated associations filed documents to incorporate themselves. Your situation of converting from public nonprofit corporation to a nonprofit corporation is distinctive from every one of these cases. Thus, your conversion does not amount to the creation of a new organization for purposes of I.R.C. § 508(a) and Treas. Reg. § 1.508-1(a).

RULINGS

Based on your facts and representations, we rule as follows:
A new entity was not created upon your filing of a Certificate of Conversion and you are not required to submit a new Application for recognition of exemption.

This ruling will be made available for public inspection under section 6110 of the Code after certain deletions of identifying information are made. For details, see enclosed Notice 437, Notice of Intention to Disclose. A copy of this ruling with deletions that we intend to make available for public inspection is attached to Notice 437. If you disagree with our proposed deletions, you should follow the instructions in Notice 437.

This ruling is directed only to the organization that requested it. Section 6110(k)(3) of the Code provides that it may not be used or cited by others as precedent.

This ruling is based on the facts as they were presented and on the understanding that there will be no material changes in these facts. This ruling does not address the applicability of any section of the Code or regulations to the facts submitted other than with respect to the sections described. Because it could help resolve questions concerning your federal income tax status, this ruling should be kept in your permanent records.

If you have any questions about this ruling, please contact the person whose name and telephone number are shown in the heading of this letter.

In accordance with the Power of Attorney currently on file with the Internal Revenue Service, we are sending a copy of this letter to your authorized representative.

Sincerely,

Michael Seto
Manager
EO Technical
Enclosure
Notice 437



IRS LTR: State Instrumentality Granted Extension to Expend Bond Proceeds.

The IRS granted an extension of the original expenditure period for a state instrumentality to expend the available project proceeds of qualified school construction bonds because the expected failure is due to reasonable cause and the instrumentality’s continued expenditure of the proceeds for qualified purposes will proceed with due diligence.

Citations: LTR 201426022

Third Party Communication: None
Date of Communication: Not Applicable
Person To Contact: * * *
Telephone Number: * * *

Index Number: 54F.00-00
Release Date: 6/27/2014
Date: April 2, 2014

Refer Reply To: CC:FIP:B05 – PLR-149991-13

LEGEND:

Authority = * * *
State = * * *
Bonds = * * *
Date 1 = * * *
Date 2 = * * *
Date 3 = * * *

Dear * * *:

This is in response to your request under § 54A(d)(2)(B)(iii) of the Internal Revenue Code for an extension of the expenditure period for the available project proceeds of qualified tax credit bonds.

FACTS AND REPRESENTATIONS

You make the following factual representations. Authority is a body corporate and politic constituting an instrumentality of State, empowered to issue bonds for any of its corporate purposes. The primary functions of Authority are to design and construct office buildings, quarters, courts, warehouses, shops, schools, health facilities, social welfare facilities, and related facilities for lease to State or any of its departments, agencies, instrumentalities, or municipalities.
Authority issued the Bonds on Date 1 and designated the Bonds as qualified school construction bonds within the meaning of § 54F(a)(3). All available project proceeds of the Bonds were to be spent on a portion of the cost of constructing, renovating, and improving approximately 100 public school facilities and acquiring land together with equipment, furnishings, landscaping, and other site improvements (the “Project”), and were expected to be spent before Date 2.

The original three-year expenditure period for the Bonds under § 54A(d)(2)(B)(i) will expire on Date 2 (the “Original Expenditure Period”). However, several unexpected events have resulted in an unforeseen delay in the expenditure of the available project proceeds of the Bonds.

With respect to 12 of the approximately 100 public school facilities, the rehabilitation and construction work is expected to be completed by Date 2, but certain unexpected events have caused an unforeseen delay such that the available project proceeds allocated to those 12 schools is not expected to be spent by Date 2. These unexpected events involve either the contractor’s poor performance delaying completion of the work, or resolving disputes over contract claims submitted by the contractor.

With respect to four of the approximately 100 public school facilities, due to unforeseen situations, rehabilitation and construction work will not be completed by Date 2. These unforeseen situations involve projects where either (1) a default notice has been issued to the contractor due to poor performance and negotiations are ongoing with the contractor’s surety company for ratification of a project takeover agreement to complete the project, (2) the scope of the contracted work is being revised, or (3) the start of construction has been delayed because State has not yet granted the land use authorization.

With respect to five of the approximately 100 public school facilities originally identified as part of the Project, the proposed work has been cancelled and the schools removed from the Project. Three new public school facility projects (the “Added Projects”) have been added to the Project. One of the Added Projects has been completed and fully disbursed. At the other two Added Projects, pre-construction activities have begun and construction is expected to start in the near future.

All of the available project proceeds of the Bonds will be spent on the Project by Date 3, or three years after the Original Expenditure Period expires. The Added Projects do not extend the delay in spending all of the available project proceeds of the Bonds. Even without the addition of the Added Projects, all of the available project proceeds of the Bonds would not be spent on the Project until Date 3.

Authority submitted this request for a ruling prior to Date 2.

LAW AND ANALYSIS

Section 54A(d)(1) provides that a qualified school construction bond is treated as a qualified tax credit bond for purposes of Section 54A.
Section 54A(d)(2)(B)(i) provides in part that to the extent that less than 100 percent of the available project proceeds of the issue are expended by the close of the expenditure period for 1 or more qualified purposes, the issuer shall redeem all of the nonqualified bonds within 90 days after the end of such period.

Section 54A(d)(2)(B)(ii) provides that for purposes of this subpart, the term “expenditure period” means, with respect to any issue, the 3-year period beginning on the date of issuance. Such term shall include any extension of such period under clause (iii).

Section 54A(d)(2)(B)(iii) provides that upon submission of a request prior to the expiration of the expenditure period (determined without regard to any extension under this clause), the Secretary may extend such period if the issuer establishes that the failure to expend the proceeds within the original expenditure period is due to reasonable cause and the expenditures for qualified purposes will continue to proceed with due diligence.

Section 54A(d)((2)(C)(iv) provides that for purposes of this paragraph, in the case of a qualified zone academy bond, a “qualified purpose” means a purpose specified in § 54E(a)(1).

Section 54A(e)(4) of the Code defines “available project proceeds” to mean (A) the excess of (i) the proceeds from the sale of an issue, over (ii) the issuance costs financed by the issue (to the extent that such costs do not exceed 2 percent of such proceeds), and (B) the proceeds from any investment of the excess described in subparagraph (A).

The Project was identified prior to the issuance of the Bonds and Authority reasonably expected to spend all of its allocable available project proceeds within the three-year period. The expected failure to spend all the available project proceeds of the Bonds by the expiration of the three-year period on Date 2 has been caused by events that were not reasonably expected at the time the Bonds were issued and were beyond the control of Authority. However, Authority to the extent possible considering the described unexpected external events that resulted in unforeseen delays, has and will continue to exercise due diligence in spending the remaining available project proceeds on the Project. Authority expects to spend all available project proceeds not later than Date 3, or three years after the Original Expenditure Period expires.

CONCLUSION

Under the facts and circumstances of this case, we conclude that Authority’s expected failure to expend the available project proceeds of the Bonds by Date 2 is due to reasonable cause and that Authority’s continued expenditure of the proceeds for qualified purposes will proceed with due diligence. Therefore, Authority is granted an extension of the Original Expenditure Period with respect to the Bonds until Date 3.
Except as expressly provided herein, no opinion is expressed or implied concerning the tax consequences of any transaction or item discussed or referenced in this letter.

This ruling is directed only to the taxpayer who requested it. Section 6110(k)(3) provides that it may not be used or cited as precedent.

In accordance with a Power of Attorney on file with this office, a copy of this letter is being sent to Authority’s authorized representative.

The ruling contained in this letter is based upon information and representations submitted by Authority and accompanied by a penalty of perjury statement executed by an appropriate party. While this office has not verified any of the materials submitted in support of the request for a ruling, it is subject to verification upon examination.

Sincerely,

Associate Chief Counsel
(Financial Institutions & Products)

By: Timothy L. Jones
Senior Counsel, Branch 5



GFOA: House Judiciary Committee Approves State and Local Tax Preemption Legislation.

The House Judiciary approved the GFOA-opposed Permanent Internet Tax Freedom Act, H.R. 3086, which would permanently preempt state and local governments’ authority to assess taxes on Internet access and pave the way for other industries to argue that they too deserve special protections from state and local taxation. Rep John Conyers (D-MI), the committee’s ranking member, offered a GFOA-supported amendment to extend the moratorium for an additional four years, rather than making it permanent; he argued that a permanent extension is unwarranted because the Internet is no longer a nascent industry needing unlimited federal tax protection to grow and prosper. The amendment, while supported by many committee members, was not approved. In addition, if the bill becomes law, ten states that currently have the authority to tax Internet access under the Act’s 1998 grandfather clause would lose that authority, as this original grandfather provision would expire as part of H.R. 3086. Seven of these ten states, including Hawaii, New Mexico, North Dakota, Ohio, South Dakota, Texas, and Wisconsin, currently tax Internet access. The loss of revenue for these states from the elimination of the grandfather provision is estimated at half a billion dollars a year.

Thursday, June 26, 2014

In the coming weeks, H.R. 3086 is expected to be considered by the full House. GFOA members should continue to urge their Congressional delegations to support a fair, short-term extension of the Internet tax moratorium, rather than a permanent moratorium, and to retain the long-standing grandfather provisions.



IRS Fed State & Local Governments - July 2014 Newsletter.

July 2014 edition of the FSLG Newsletter

Inside This Issue:

Download the July edition.



Hogan Lovells: Fair Market Value and Uncertainty Regarding Highest and Best Use.

In this article, Montague argues that the Tax Court’s valuation in Palmer Ranch Holdings did not reflect the property’s true fair market value because it failed to account for uncertainty regarding the property’s highest and best use.

* * * * *

The central valuation issue in the recent Tax Court case Palmer Ranch Holdings Ltd. v. Commissioner1 was the question of the property’s highest and best use. The partnership claimed a charitable contribution deduction of nearly $24 million for the donation of a conservation easement on 82.19 acres of undeveloped land in Sarasota County, Florida. In valuing the property, the partnership’s appraiser relied on a land use analysis that concluded the highest and best use for the property was a 360-unit multifamily development. However, the property’s zoning on the valuation date did not permit such a use.2 For that reason, the IRS insisted that the property’s highest and best use was for low-density residential development as permitted by the property’s then-current zoning, resulting in a substantially lower valuation.3 As in many conservation easement cases, the Tax Court was asked to decide the valuation dispute. Unfortunately, because the court considered the question of highest and best use separately from its analysis of the fair market value, it arrived at a value that exceeded the property’s true fair market value.
Background on Valuing Conservation Easements

In general, when a taxpayer makes a charitable contribution of property other than money, the contribution amount is the fair market value of the property at the time of the contribution.4 The regulations under section 170 define fair market value as “the price at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or sell and both having a reasonable knowledge of relevant facts.”5

The regulations provide specific guidance on valuing conservation easements: If a substantial record of sales of comparable easements exists, the fair market value of the donated easement should be based on the sales prices of those comparable easements; otherwise, it is acceptable to use what is known as the before-and-after method,6 which is often used for conservation easements because there is rarely a record of sales of comparable easements.7 As its name suggests, the before-and-after method considers “the difference between the fair market value of the property it encumbers before the granting of the restriction and the fair market value of the encumbered property after the granting of the restriction.”8 Using language closely modeled on the legislative history,9 the regulations provide:

If before and after valuation is used, the fair market value of the property before contribution of the conservation restriction must take into account not only the current use of the property but also an objective assessment of how immediate or remote the likelihood is that the property, absent the restriction, would in fact be developed, as well as any effect from zoning, conservation, or historic preservation laws that already restrict the property’s potential highest and best use.10

In Hilborn v. Commissioner11 — one of the earliest and most frequently cited cases applying the before-and-after method — the Tax Court explained that the before value:

is arrived at by first determining the highest and best use of the property in its current condition unrestricted by the easement. At this stage the suitability of the property’s current use under existing zoning and market conditions and realistic alternative uses are examined. Any suggested use higher than current use requires both “closeness in time” and “reasonable probability.” Next, to the extent possible, the three commonly recognized methods of valuing property (capitalized net operating income, replacement cost, and comparable sales) are used, but are modified to take into account any peculiarities of the property which impact on the relative weight to be afforded each respective method.12

Hilborn seems to require that the court apply a two-step approach to valuation: First, it must determine the highest and best use of the property, and second, it must determine the fair market value of the property given the highest and best use determined in the first step. However, that two-step approach is inconsistent with the requirement that the property be valued at its fair market value. To understand that inconsistency, it is helpful to consider the application of the two-step approach in Palmer Ranch Holdings.

The Valuation in Palmer Ranch Holdings

When the conservation easement was donated on December 19, 2006, the 82.19 acres designated parcel B-10 was zoned RE-1, permitting residential development no denser than one house for every two acres.13 Nevertheless, the partnership’s appraiser determined that the highest and best use of the land was for a multifamily development, which would have necessitated rezoning to moderate density residential, permitting development of up to 5 units per acre.14 The IRS pointed to several facts that it contended made rezoning unlikely.

First, and most significantly, only two years before the valuation date, the board of county commissioners (BOCC) denied an application to develop and rezone part of parcel B-10 and an adjacent parcel B-9. In 2003 the partnership agreed to sell 86.9 acres in parcels B-9 and B-10 to a developer contingent on the BOCC’s approval of applications for development and rezoning the land to residential single family, which would have permitted development of 3.5 units per acre. In June 2004 the BOCC denied the development application by a 3-2 vote. Although the separate rezoning application was not voted on at that time, the BOCC presumably would not have approved it. In August 2004 the developer revised and resubmitted its applications, seeking to develop only parcel B-9 and to rezone it to residential multifamily, permitting up to six units per acre. In October 2004 the BOCC denied both the revised development plan and the rezoning application, again by a 3-2 vote. The ordinance issued by the BOCC in conjunction with its denial instructed the developer to resubmit its application including parcel B-10 that showed a plan “to keep Parcel B-10 intact as it related to the Eagle Preservation Area, the wetlands, and the wildlife corridor.”15

Second, the IRS pointed to several environmental concerns that might have prevented rezoning. Those concerns included the BOCC’s directive that future development plans keep parcel B-10 intact, as well as a comprehensive plan adopted by Sarasota County designating an eagle nest zone and a wildlife corridor, which included part of parcel B-10.16 The Eagle Preservation Area referred to in the 2004 ordinance included an eagle nest on parcel B-10 with a U.S. Fish and Wildlife Service-designated primary protection zone of 750 feet, and a secondary protection zone of 1,500 feet. In June 2006 the protection zone was reduced to 660 feet.17

Third, the IRS contended that multifamily development was not reasonably probable because Sarasota County regulations required residential developments of at least 100 units to have two fully functional access points, which parcel B-10 lacked. To achieve access, a developer would have had to obtain an easement on parcel B-9 and county approval to extend another road.18

Fourth and finally, the IRS pointed out that there had been vigorous neighborhood opposition to the 2004 rezoning attempt, which it contended would have resurfaced in response to any new rezoning application.19

The Tax Court considered each of the IRS’s arguments. It rejected the first argument, weakly stating that the “rezoning history does not eliminate the reasonable probability on the valuation date of a successful zoning.” As grounds for its conclusion, it reasoned that the previous rezoning attempt was of limited predictive value because it was two years before the valuation date and, although the BOCC had previously rejected a development plan that included parcel B-10, the only rezoning application considered by the BOCC was for the adjacent parcel B-9. It also noted that the initial rezoning application had been rejected by a close vote.20 The court similarly rejected the second argument because the size of the Eagle Preservation Area had shrunk since 2004 and because some development had previously been allowed in the wildlife corridor, although it did not mention the density of that development.21 The court rejected the third and fourth arguments because even though there had previously been vigorous neighborhood opposition to the development, it was not certain that the opposition would resurface or that it would be successful in preventing rezoning.22 The court concluded that “there is a reasonable probability that parcel B-10 could have been successfully rezoned to allow for the development of multifamily dwellings. Therefore, the highest and best use of the property is development for multifamily dwellings.”23

The Tax Court did not attempt to assign a percentage to the probability of rezoning, but it is safe to say that the percentage was not very high — perhaps even less than 50 percent. The phrase “reasonable probability” comes directly from Hilborn; it does not appear in the regulations or the legislative history. Although the Tax Court has not defined the term “reasonable probability,” it is generally considered to be less than “more likely than not.”24 In rejecting each of the IRS arguments for why rezoning would be improbable in Palmer Ranch Holdings, the court stated only that each argument did not preclude the reasonable probability of rezoning. Rezoning would not have been a sure bet. Yet because the court was applying the two-step approach articulated in Hilborn, once it decided that there was a reasonable probability of rezoning, it then concluded that the highest and best use of the property was for multifamily dwellings, and it went on to calculate the before value as if the property had been rezoned as of the valuation date.

Highest and Best Use as a Component of FMV

The problem with the two-step approach to valuation articulated in Hilborn25 and applied in Palmer Ranch Holdings is that it is not equivalent to fair market value. No willing buyer would have paid a price equal to the before value arrived at by the Tax Court. For purposes of valuation, the court’s method treated what it probably considered to be a less than 50 percent chance that the property could have been rezoned as if it were a 100 percent certainty.26 Any buyer considering purchasing the property would have taken into account that there was a significant possibility that the rezoning application would have been rejected. After all, a development plan for a less-dense subdivision on the same parcel two years before had been denied, and a rezoning application for the adjacent parcel had also been denied. Those facts cast serious doubt on the probability that rezoning would have been granted, even if they do not preclude the possibility. Accordingly, any buyer with a reasonable knowledge of the relevant facts would have discounted the price to account for that uncertainty.27

Instead of considering the highest and best use of the property separately from its fair market value, the court should have considered it as a component of fair market value. In other words, the court should have considered the possibility that the property could have been used for multifamily development but discounted the value of that use to account for its uncertainty, just as a hypothetical buyer would have done. Doing so would have resulted in a fair market value between that arrived at by the partnership’s appraiser, who assumed the property could be rezoned, and the IRS appraiser, who assumed that rezoning was impossible. That approach is the only one consistent with the regulations’ requirement that the property be assigned its fair market value.

The two-step approach is also inconsistent with the approach to fair market value taken by other courts and by the Tax Court in some other cases. In discussing a property’s highest and best use, along with Hilborn the Tax Court often cites Olson v. United States,28 a 1934 Supreme Court case. However, Olson is inconsistent with the two-step valuation approach endorsed in Hilborn. Olson was a condemnation proceeding in which the property owners insisted that the highest and most profitable use for their land was the construction of a power plant. The Supreme Court stated that the fair market value of property:

does not depend upon the uses to which [the owner] has devoted his land but is to be arrived at upon just consideration of all the uses for which it is suitable. The highest and most profitable use for which the property is adaptable and needed or likely to be needed in the reasonably near future is to be considered, not necessarily as the measure of value, but to the full extent that the prospect of demand for such use affects the market value while the property is privately held.29

In other words, the highest and best use to which the property is adaptable and likely to be used in the near future should be considered as one factor affecting fair market value — that is, to the extent it would influence demand for the property. It is not determinative of fair market value as it is in Hilborn. As the Tax Court correctly stated in Boltar LLC v. Commissioner30: “The concept of ‘highest and best use’ is an element in the determination of fair market value, but it does not eliminate the requirement that a hypothetical willing buyer would purchase the subject property for the indicated value.”

Although Hilborn is frequently cited in Tax Court cases considering the valuation of conservation easements, its two-step approach to valuation has not often been applied.31 Whether the court uses a two-step approach or considers highest and best use as a component of fair market value will make little difference in cases in which the proposed rezoning or other alternative use is a near certainty. As noted above, Palmer Ranch Holdings is not such a case.

In at least two cases with similar uncertainty about whether rezoning would be granted, the Tax Court has correctly used uncertainty as a factor in determining fair market value. For instance, in Mathis v. Commissioner,32 the Tax Court stated that although the prospects for zoning were uncertain, the IRS appraiser was wrong not to give any weight to such a possibility. Because the court concluded that both the IRS and the taxpayer miscalculated the chances that the property would be rezoned, it adjusted the property’s fair market value accordingly. Similarly, in Hay v. Commissioner,33 the court concluded that on the valuation date, the highest and best use of the property was uncertain because of the challenge of obtaining the necessary zoning and other approvals, and it therefore adjusted the property’s value to account for the uncertainty. The Tax Court should have followed a similar approach in Palmer Ranch Holdings.34

To arrive at the fair market value required by the regulations, the Tax Court should decline to follow the two-step approach of Hilborn and instead consider the highest and best use of the property as a component of its fair market value analysis.

FOOTNOTES

1 T.C. Memo. 2014-79 2014 TNT 88-14: Court Opinions.

2 Id. at *4-*7.

3 Id. at *22.

4 Reg. section 1.170A-1(c)(1).

5 Reg. section 1.170A-1(c)(2).

6 Reg. section 1.170A-14(h)(3)(i).

7 See, e.g., Hilborn v. Commissioner, 85 T.C. 677 (1985); Butler v. Commissioner, T.C. Memo. 2012-72 2012 TNT 54-13: Court Opinions; Simmons v. Commissioner, T.C. Memo. 2009-208 2009 TNT 177-17: Court Opinions, aff’d, 646 F.3d 6 (D.C. Cir. 2011) 2011 TNT 120-13: Court Opinions.

8 Reg. section 1.170A-14(h)(3)(i).

9 S. Rep. No. 96-1007, at 14-15 (1980).

10 Reg. section 1.170A-14(h)(3)(ii).

11 Hilborn v. Commissioner, 85 T.C. 677.

12 Id. at 689. Although Hilborn continues to be one of the most frequently cited cases concerning the valuation of conservation easements, it predates the issuance of the regulations quoted in supra note 10.

13 Palmer Ranch Holdings, at *22.

14 Id. at *7.

15 Id. at *8-*10.

16 Id. at *28-*29.

17 Id. at *11-*12.

18 Id. at *34-*35.

19 Id. at *35-*36.

20 Id. at *27-*28.

21 Id. at *29-*31.

22 Id. at *34-*36.

23 Id. at *36.

24 See Kyles v. Whitley, 514 U.S. 419, 434 (1995).

25 Because there was general agreement in Hilborn on the highest and best use of the property, the two-step approach did not result in a markedly different valuation in that case.

26 Even if the court in Palmer Ranch Holdings considered the chance of rezoning to be more than 50 percent, as noted above, the reasonable probability standard from Hilborn does not require even that degree of certainty.

27 More than likely, the buyer would have included a contingency in the offer for obtaining the necessary rezoning and other approvals. But the regulations require that the property be assigned a fair market value as of the valuation date. On that date a hypothetical buyer purchasing the property would have been confronted with the uncertainty of rezoning.

28 292 U.S. 246 (1934).

29 Id. at 255 (citations omitted, emphasis added).

30 136 T.C. 326, 336 (2011) 2011 TNT 66-10: Court Opinions; see also the Tax Court’s extensive discussion of the relationship between highest and best use and fair market value in Whitehouse Hotel Limited Partnership v. Commissioner, 139 T.C. 304, 330-337 (2012) 2012 TNT 206-8: Court Opinions.

31 One other case in which it has been applied with similar consequences is Stanley Works v. Commissioner, 87 T.C. 389 (1986). In that case, the taxpayer contended that the highest and best use of the property before the conservation easement was a hydroelectric power plant. The court rejected IRS arguments that the use was not reasonably probable given environmental concerns and public opposition and concluded that use was a “reasonable probability.” Id. at 408. As in Palmer Ranch Holdings, despite the uncertainty regarding necessary approvals for use as a power plant, the court went on to value the property as if those approvals would have been granted. Id. at 411, 413. Again, no reasonably informed buyer would have purchased the property on the valuation date without discounting the price to account for the uncertainty.

32 T.C. Memo. 1989-254.

33 T.C. Memo. 1992-409.

34 Taxpayers who are in a position similar to the partnership in Palmer Ranch Holdings but who feel confident that their property will be rezoned should obtain that rezoning before donating a conservation easement. That the partnership failed to do so suggests that it thought rezoning was unlikely.

END OF FOOTNOTES

John Montague
John Montague is an associate at Hogan Lovells US LLP. The views expressed in this article are his own and do not necessarily reflect the views of Hogan Lovells or any of its clients.



IRS Memo Addresses Healthcare Credit for Small Tax-Exempt Employers.

The IRS Tax-Exempt and Government Entities Division has issued a memorandum (TEGE-04-0614-0015) providing interim guidance to examining agents auditing small tax-exempt employers that may be eligible for the small business healthcare tax credit under section 45R.

The purpose of the interim guidance, which is effective immediately, is to ensure consistency in the application of section 45R, which provides a tax credit to eligible small employers — including tax-exempt organizations — that provide health insurance coverage to their employees. For tax-exempt employers, the credit under section 45R is a refundable credit based on premiums paid. The interim guidance provides that if a tax-exempt employer appears to be eligible for the tax credit, examining agents must inform the employer of its potential eligibility.

To ensure accuracy in verifying eligibility and computation of the credit, the interim guidance provides that agents must obtain technical consultation before proposing allowance, disallowance, or adjustment of the section 45R credit. And according to the guidance, required sequestration reductions include a reduction to the refundable portion of the section 45R credit for small tax-exempt employers. The sequestration reduction rate for the refund portion of this credit is 7.2 percent for refunds processed in the fiscal year ending September 30, 2014.

June 12, 2014

Affected IRM: 4.75.11, 4.75.13

Expiration Date: June 12, 2015

MEMORANDUM FOR
ALL EO EXAMINATIONS MANAGERS
AND
ALL EO EXAMINATIONS REVENUE AGENTS

FROM:
Mary A. Epps
Acting Director, EO Examinations

SUBJECT:
IRC 45R Credit for Small Tax-Exempt Employers

This memorandum provides interim guidance to examining agents when auditing small tax-exempt employers that may be eligible for the Small Business Health Care Tax Credit under section 45R of the Internal Revenue Code (IRC).

The purpose of this memorandum is to ensure consistency in the application of a recently enacted tax law affecting tax-exempt organizations.

IRC 45R was added by the Affordable Care Act (March 23, 2010), Public Law No. 111-148. The law provides a tax credit to eligible small employers, including tax-exempt organizations that provide health insurance coverage to their employees. Definitions and background information can be found in Proposed Regulations sections 1.45R-0 through 1.45R-5 (78 FR 52719; 2013-38 I.R.B 211); Notice 2014-06, Rev. Proc. 2013-35, Notice 2010-82, Notice 2010-44,and Rev. Rul. 2010-13.

For tax-exempt employers, the tax credit under IRC 45R is a refundable credit based on premiums paid. If a tax-exempt employer appears to be eligible for the tax credit, examining agents must inform the employer of its potential eligibility. If the employer wants to claim the tax credit it can file with the examiner Form 990-T, Exempt Organization Business Income Tax Return, and attach Form 8941, Credit for Small Employer Health Insurance Premiums. If Form 990-T has already been filed, the tax-exempt employer must file an amended Form 990-T with Form 8941 attached.

Examining agents can refer tax-exempt employers to the online Estimator in order to allow them to get an estimate of the tax credit. This tool, developed by the Taxpayer Advocate Service, is located online at: http://www.taxpayeradvocate.irs.gov/calculator/SBHCTC.htm#StartCalculator.

Caution: This calculation will only provide an estimate of the credit. Tax-exempt employers and examining agents may not rely on the correctness of this calculation. To determine the exact amount of the Small Business Healthcare Tax Credit, tax-exempt employers must complete the Form 8941 and attach it along with the other appropriate forms and file it together with Form 990-T.

In order to ensure accuracy in verifying eligibility and computation of the credit, agents will not propose allowance, disallowance or adjustment of the tax credit without first obtaining technical consultation. Examining agents must consult with Mandatory Review by submitting an e-mail to the mailbox at *TEGE EO Review Staff.

Include the following information in the e-mail:

Mandatory Review will then provide further instructions to the agent on how to proceed and whom to contact. Examining agents will use principal issue code (PIC) 24E for any case where the issue of applicability of the tax credit is raised in an examination.

According to the requirements of the Balanced Budget and Emergency Deficit Control Act of 1985, as amended, certain automatic sequestration reductions to credits began March 1, 2013. These required sequestration reductions include a reduction to the refundable portion of the IRC 45R credit for small tax-exempt employers. The sequestration reduction rate for the refund portion of this credit is 7.2% for refunds processed in the fiscal year ending September 30, 2014. This sequestration reduction rate will be applied unless and until a law is enacted that cancels or otherwise impacts the sequester.

This temporary guidance is effective immediately.

The contents of this memorandum (or any permanent guidance developed) will be incorporated into IRMs 4.75.11 and 4.75.13.

Please submit your questions to Mandatory Review via *TEGE EO Review Staff.

DISTRIBUTION:
www.irs.gov

Citations: TEGE-04-0614-0015



Court Holds FOIA Suit Seeking Forms 990 May Proceed.

A U.S. district court refused to dismiss a Freedom of Information Act suit seeking the 2011 Forms 990 of nine tax-exempt organizations specifically in Modernized e-File format or any other machine-readable format, holding that section 6104 doesn’t supersede FOIA or preclude the FOIA claim.

PUBLIC.RESOURCE.ORG,
Plaintiff,
v.
UNITED STATES INTERNAL REVENUE SERVICE,
Defendant.

UNITED STATES DISTRICT COURT
NORTHERN DISTRICT OF CALIFORNIA

ORDER DENYING DEFENDANT’S MOTION TO DISMISS

Re: Dkt. No. 14

INTRODUCTION

This motion to dismiss presents the question of whether the Freedom of Information Act (“FOIA”) is superseded by section 6104 of the Internal Revenue Code, a previously enacted disclosure statute concerning Form 990 filings. Public.Resource.org (“PRO”) seeks the tax return data of several nonprofit organizations in “machine-readable format.” The United States Internal Revenue Service (“IRS”) refuses because it contends that FOIA is superseded by section 6104 and its internal rules for releasing the requested data. Because of the breadth of FOIA’s disclosure requirements, which has been repeatedly upheld by the courts, and the inapplicability of the cases on which the IRS relies, there is no basis to conclude that FOIA is superseded by section 6104. The IRS’s motion is DENIED.

BACKGROUND

On March 11, 2013, PRO submitted a request for tax return data to the IRS pursuant to FOIA, 5 U.S.C. § 552. PRO requested the Form 990 filings of nine tax-exempt organizations from 2011, specifically in Modernized e-File (MeF) format or “any other machine-readable format.” Complaint, Ex. F. The IRS uses the MeF format for all Forms 990 filed electronically.

The IRS responded to PRO on March 19, 2013, indicating that data are “excluded from disclosure in response to a written FOIA request” if such data are otherwise available through an established agency procedure. Compl., Ex. G at 1. The IRS directed PRO to Form 4506-A, which the IRS developed exclusively for requesting copies of tax-exempt organizations’ annual Form 990 filings. Id. Form 4506-A allows the public to request digital copies of tax information on either CDs or DVDs, and in either “Alchemy” or “raw” format. Id. at 2-3. Discs with Alchemy-formatted data contain image files that are searchable in a database using Alchemy software. Discs with raw data contain image files in Tagged Image File (“TIF”) format.

PRO contends that neither format satisfies its request for “machine-readable” data, and that Form 4506-A is therefore “inadequate” to satisfy PRO’s FOIA request. Compl., Ex. H at 1. On April 12, 2013, PRO’s counsel wrote to the IRS to request that it reconsider its position. In response, the IRS stated in a letter dated May 1, 2013, that it was unable to comply with PRO’s FOIA request because Forms 990 in MeF format contain data that are protected from disclosure by section 6103(a) of the Internal Revenue Code, and because the existing process for releasing electronically filed Forms 990 is to convert MeF data into a Portable Document Format (“PDF”) replica of the paper form, then redact the protected information. Compl., Ex. I.

PRO then filed this action on June 18, 2013, seeking declaratory and injunctive relief under both FOIA and the Administrative Procedure Act (“APA”), 5 U.S.C. § 703. Compl. ¶¶ 61-62, 67-68. I heard argument on the IRS’s motion to dismiss on June 18, 2013.

LEGAL STANDARD

Under Federal Rule of Civil Procedure 12(b)(6), a district court must dismiss a complaint if it fails to state a claim upon which relief can be granted. To survive a Rule 12(b)(6) motion to dismiss, the plaintiff must allege “enough facts to state a claim to relief that is plausible on its face.” Bell Atl. Corp. v. Twombly, 550 U.S. 544, 570 (2007). This “facial plausibility” standard requires the plaintiff to allege facts that add up to “more than a sheer possibility that a defendant has acted unlawfully.” Ashcroft v. Iqbal, 556 U.S. 662, 678 (2009). While courts do not require “heightened fact pleading of specifics,” a plaintiff must allege facts sufficient to “raise a right to relief above the speculative level.” Twombly, 550 U.S. at 555.

In deciding whether the plaintiff has stated a claim upon which relief can be granted, the court must assume that the plaintiff’s allegations are true and must draw all reasonable inferences in the plaintiff’s favor. See Usher v. City of Los Angeles, 828 F.2d 556, 561 (9th Cir. 1987). However, the court is not required to accept as true “allegations that are merely conclusory, unwarranted deductions of fact, or unreasonable inferences.” In re Gilead Scis. Sec. Litig., 536 F.3d 1049, 1055 (9th Cir. 2008).

DISCUSSION

The IRS seeks dismissal of both the FOIA and the APA causes of action for failure to state a claim. First, the IRS contends that section 6104 of the Internal Revenue Code, 26 U.S.C. § 6104, supersedes FOIA and precludes a FOIA claim. Def.’s Mot. to Dismiss at 7. Second, the IRS contends that the APA claim must be dismissed “by necessity” as the corollary of a favorable ruling on the FOIA claim. Id. at 8.

I. THE FREEDOM OF INFORMATION ACT

FOIA requires that a federal agency, upon receipt of a valid FOIA request, “provide the record in any form or format requested by the person if the record is readily reproducible by the agency in that form or format.” 5 U.S.C. § 552(a)(3)(B). The scope of FOIA’s disclosure requirements is broad, and courts have repeatedly declined to impose limits on FOIA that the statute itself does not expressly admit. Envtl. Prot. Agency v. Mink, 410 U.S. 73, 79-80 (1973), superseded by statute on other grounds; Dep’t of Interior v. Klamath Water Users Protective Ass’n, 532 U.S. 1, 7 (2001); Maricopa Audubon Soc. v. U.S. Forest Serv., 108 F.3d 1082, 1085 (9th Cir. 1997). Although FOIA provides enumerated exemptions to disclosure, these exemptions “are ‘explicitly made exclusive,’ meaning that information not falling within any of the exemptions has to be disclosed.” Yonemoto v. Dep’t. of Veterans Affairs, 686 F.3d 681, 687 (9th Cir. 2012) (citations omitted) (quoting Mink, 410 U.S. at 79); see also 5 U.S.C. § 552(b).

FOIA’s breadth reflects its “central purpose of exposing to public scrutiny official information that sheds light on an agency’s performance of its statutory duties.” U.S. Dep’t of Justice v. Reporters Comm. for Freedom of the Press, 489 U.S. 749, 750 (1989). As this purpose cannot be served by a disclosure scheme relying solely on ad hoc agency consent, FOIA establishes a “comprehensive scheme,” U.S. Dep’t of Justice v. Tax Analysts, 492 U.S. 136, 153 (1989), that aims to “provide a ‘workable formula’ that ‘balances and protects all interests.'” Mink, 410 U.S. at 80. This formula is backstopped by the courts, which provide individuals an opportunity to vindicate their “judicially enforceable public right to secure . . . information from possibly unwilling official hands.” Id.; see also 5 U.S.C. § 552(a)(4)(B).

In its motion, the IRS does not dispute that it is an agency subject to FOIA, that the data in question qualify as “records” under the definition of the statute, or that the records were withheld. Rather, the IRS argues that FOIA has no application because the requested documents fall within section 6104, which provides the exclusive means by which Form 990 data are releasable. Def.’s Mot. to Dismiss at 1. For the reasons discussed below, I reject the IRS’s argument.

A. The statutory scheme of the Internal Revenue Code.

The IRS contrasts FOIA’s broad language mandating disclosure with the “comprehensive nondisclosure paradigm anchored by [s]ection 6103 of the Internal Revenue Code.” Def.’s Mot. to Dismiss at 4. Under section 6103, all tax returns are presumptively confidential “except as authorized by [title 26].” 26 U.S.C. § 6103(a). Section 6104 provides one of several exceptions to this general nondisclosure rule, requiring, in relevant part, that Form 990 data “be made available to the public at such times and in such places as the Secretary may prescribe.” 26 U.S.C. § 6104(b). However, section 6104(b) does not “authorize the Secretary to disclose the name or address of any contributor to any organization or trust” required to file a Form 990. Id. According to the IRS, section 6103 and 6104 operate jointly as a “controlling statutory scheme” for the release of Form 990 data, with each imposing complementary “nondisclosure mandates” on the IRS. Def.’s Mot. to Dismiss at 4, 5. The IRS also notes that the Treasury has issued a regulation specifically governing disclosure under section 6104, which describes how the Form 990 data may be viewed or obtained. 26 C.F.R. § 301.6104(b)-1 to (d)-1.

B. Section 6104 is distinguishable from statutes held to supersede FOIA.

The IRS argues that the specific and detailed statutory scheme governing disclosure of Forms 990 supersedes the more general requirements of FOIA.1 Here the IRS relies on the “well settled rule of statutory construction” that “a specific statute will not be controlled by a general statute” unless there is clear legislative intent to the contrary. Def.’s Mot. to Dismiss at 7; Donaldson v. U.S., 653 F.2d 414, 418 (9th Cir. 1981). The IRS points to two lines of cases finding FOIA’s general disclosure requirements superseded by more specific alternatives — the first dealing with section 6110 of the Internal Revenue Code, and the second dealing with the Presidential Recordings and Materials Preservation Act of 1974. Pub. L. 93-526, title I, §§ 101-106, 88 Stat. 1695-1698 (hereinafter “Materials Act”).

The IRS reads both the canon and the cases too broadly. The textual touchstone for evaluating whether a statute might supersede FOIA is not the level of precision with which the statute defines covered records, but the comprehensiveness of its procedural scheme. See Julian v. U.S. Dep’t of Justice, 806 F.2d 1411, 1420 (9th Cir. 1986), aff’d, 486 U.S. 1, 108 (1988) (finding that FOIA was not superseded by a statute whose scheme lacked the “specificity or particularity required to displace FOIA”). Both section 6110 and the Materials Act are distinguishable from section 6104 in this respect.

In Tax Analysts v. I.R.S., the District Court held that the detailed provisions of Section 6110, enacted after FOIA as part of the Tax Reform Act of 1976, indicated that Congress intended to supplant FOIA disclosure with respect to requests for the IRS’s written determinations. Tax Analysts v. I.R.S., No. CIV.A. 96-2285, 2000 WL 689324 (D.D.C. Mar. 31, 2000), at *1. The Ninth Circuit similarly noted that section 6110 “replace[d] the procedures of FOIA . . . [with] a new set of procedures to be applicable to requests under section 6110.” Long v. U.S. I.R.S., 742 F.2d 1173, 1178 (9th Cir. 1984). The Long court found that the wholesale displacement of FOIA procedures in section 6110 was indicative of Congress’s desire to displace FOIA itself. Id.

The disclosure scheme provided by section 6104 is simply not of the same kind as that provided by section 6110, which sets forth detailed rules governing “[e]xemptions from disclosure” that plainly operate as a more limited replacement for the exemptions in FOIA itself. Compare 26 U.S.C. § 6110(c) (1982) with 5 U.S.C. § 552(b) (1982). Section 6110 lays out independent administrative remedies for disclosure disputes, 26 U.S.C. § 6110(f)(2)-(3) (1982), independent judicial remedies, § 6110(f)(4)-(5), and a schedule for disclosure and postponement of disclosure. § 6110(g)(1)-(4). It also establishes a specific forum for civil suits and an independent scheme for damages. Compare 26 U.S.C. § 6110(i) (1982) with 5 U.S.C. § 552(a)(4)(B)-(G) (1982). Most importantly, section 6110 expressly supersedes FOIA. 26 U.S.C. § 6110(l) (1982); see also Church of Scientology of Cal. v. I.R.S., 792 F.2d 146, 149 (D.C. Cir. 1986) (“Significantly, Congress did not leave us to speculate whether [section 6110] was comprehensive enough to constitute an implicit pro tanto repeal of FOIA; the last subsection specifies that the prescribed civil remedy in the Claims Court shall be the exclusive means of obtaining disclosure. . . .).

By contrast, section 6104 provides that Forms 990 should generally be made available for disclosure, with certain precise exceptions. This is manifestly different from a statute that purports to alter the procedural elements of FOIA and the means of judicial review. The content of section 6104 is more consistent with the IRS’s depiction of the statute as a carefully delineated exception to the general nondisclosure rule from section 6103, Def.’s Mot. to Dismiss at 4, that the Ninth Circuit has already found insufficient to supersede FOIA. Long, 742 F.2d at 1178 (“[Congress’s] failure to do likewise in amending section 6103 is highly persuasive of an intent not to preempt the procedural provisions of FOIA as to requests under section 6103.”). Absent express language or a procedural scheme ostensibly displacing FOIA procedures, section 6104 — like section 6103 — cannot be held to supersede FOIA.

The Materials Act case, Ricchio v. Kline, 773 F.2d 1389, 1394-95 (D.C. Cir. 1985), is inapposite. The Materials Act created a procedure for collecting and making public certain “historical materials” related to “abuses of governmental power” during the Nixon Administration. Pub. L. 93-526, title I, §§ 101(b), 104(a), 88 Stat. 1695-1697 (1974). The statute required the General Services Administration to propose public access regulations consistent with seven enumerated factors, including affected individuals’ right to an impartial trial, the protection of national security, and the private interest of President Nixon and his heirs in materials of trivial historical value. § 104(a), 88 Stat. 1696-1697. These regulations were then submitted to Congress and subject to potential disapproval. § 104(c), 88 Stat. 1697. The Act did not contain express language superseding FOIA.

In considering the statute, the D.C. Circuit in Ricchio found that “Congress provided a comprehensive, carefully tailored and detailed procedure designed to protect both the interest of the public . . . and of President Nixon.” Ricchio, 773 F.2d at 1395. The court held that the Materials Act was intended to supplant FOIA as the exclusive method for obtaining specific documents of great public interest, namely “the Watergate Force’s transcripts of the tape recordings of President Nixon’s White House conversations.” Id.; see also Julian, 806 F.2d at 1420. The court made clear that FOIA was superseded only with respect to this “specific, narrowly limited material,” and not with respect to the vast remainder of presidential records to which the Materials Act disclosure scheme also applied. Ricchio, 773 F.2d at 1395; see Reporters Comm. for Freedom of the Press v. Sampson, 591 F.2d 944, 948 & n.12 (D.C. Cir. 1978) (“[W]e believe that the existence of an alternate method of access is completely compatible with Congress’s intent to guarantee that materials from the Nixon presidency [be] available to the public.”).

The IRS asserts that section 6104 compares favorably with the Materials Act in that both “specif[y] categories of records that [are] subject to [their] provisions . . . and specifically authorize[ ] the promulgation of procedural rules governing their disclosure to the public.” Reply at 8. That much is true. However, a statute cannot be “comprehensive enough” to supersede FOIA simply by specifying categories of records exempt from disclosure, since this is a means of identifying statutory exemptions pursuant to FOIA. 5 U.S.C. § 552(b)(3)(A). If this sufficed, most statutory exemptions would supersede FOIA. Moreover, in the Materials Act, Congress authorized the creation of public disclosure regulations under specific constraints, in a unique context, and in a tightly controlled fashion. See §§ 102-104, 88 Stat. 1696-1698. The disclosure rules were to be submitted to Congress, tailored to the sensitive circumstances surrounding disclosure of the president’s Watergate-related records and subject to judicial review on specified terms. § 105, 88 Stat. 1698. Even then, the D.C. Circuit held that FOIA was only superseded with respect to a small, closed subset of presidential records. Ricchio, 773 F.2d at 1395. Ricchio does not provide persuasive guidance for this case. See Julian, 806 F.2d at 1420 (distinguishing the Materials Act from the procedures governing disclosure of prisoners’ presentence investigation reports, while also declining to adopt the reasoning in Ricchio).

C. Legislative history and intent indicate that FOIA applies to section 6104.

The IRS also argues that the relationship between section 6104 and FOIA is ambiguous as a result of FOIA’s later date of enactment. Def.’s Mot. to Dismiss at 7 (“Because [s]ection 6104 predates the FOIA, it is not required to include specific language as to its effect on the FOIA, and the Court must instead turn to traditional rules of statutory construction.”). Again the IRS stresses that “a precisely drawn, detailed statute preempts more general statutory remedies,” and the IRS argues that this resolves the ambiguity between the statutes in favor of section 6104. Mot. to Dismiss at 7 (quoting Brown v. General Services Administration, 425 U.S. 820, 834-35 (1976)).

The IRS’s argument is again overbroad. Courts will defer to the more narrowly drawn statute only “where there is no clear legislative intent to the contrary.” Donaldson, 653 F.2d at 418. Although the intent of section 6104 may be ambiguous in relation to FOIA, the reverse is not true. Courts have consistently understood FOIA as intended for broad application, with only limited exceptions. Church of Scientology of Cal., 792 F.2d at 149 (“FOIA is a structural statute, designed to apply across-the-board to many substantive programs; it explicitly accommodates other laws by excluding from its disclosure requirement documents ‘specifically exempted from disclosure’ by other statutes, 5 U.S.C. § 552(b)(3).”); see also N.L.R.B. v. Robbins Tire & Rubber Co., 437 U.S. 214, 220-21 (1978).

While I am leery of going down the path of legislative history too far, as the IRS invites me to do, I note my disagreement with its analysis. The IRS attempts to draw a distinction between pro-disclosure and nondisclosure statutes in FOIA’s legislative history. Reply at 5-6. As it notes, FOIA arose in response to expansive agency interpretations of the discretion previously afforded under section 3 of the APA to deny access to public records. Id. at 5; S. REP. NO. 89-813 at 38-39 (“After it became apparent that section 3 of the Administration Procedure Act was being used as an excuse for secrecy, proposals for change began.”). The IRS contends that this demonstrates Congress’s intent to apply FOIA only to those documents previously subject to discretionary withholding under section 3 of the APA, and not to statutory schemes that provided disclosure by other means at the time of FOIA’s original enactment. Reply at 6. As section 6104 predated FOIA and provided such other means, the IRS argues that section 6104 must supersede.

This argument is unpersuasive for several reasons. First, it mistakes legislative motivation for legislative intent, improperly reading the purpose of the statute as limited to the set of circumstances that gave rise to it. Such a narrow reading yields results incompatible with the language of FOIA, 5 U.S.C. § 552(b)(3), and the legislative record. S. REP. NO. 89-813 at 38 (“It is the purpose of the present bill to eliminate [portions of section 3 of the APA], to establish a general philosophy of full agency disclosure unless information is exempted under clearly delineated statutory language and to provide a court procedure by which citizens and the press may obtain information wrongfully withheld.”). FOIA is broad precisely because Congress sought a comprehensive solution to what it viewed as a wide-ranging problem. Mink, 410 U.S. at 79-80. The pre-FOIA disclosure statutes will necessarily be narrower by comparison. FOIA’s breadth cannot be both its purpose and its undoing. As the Supreme Court has held, “the clear legislative intent of the FOIA [is] to assure public access to all governmental records whose disclosure would not significantly harm specific governmental interests.” Dep’t of Air Force v. Rose, 425 U.S. 352, 365 (1976) (internal parentheses omitted) (quoting Soucie v. David, 448 F.2d 1067, 1080 (D.C. Cir. 1971)).

Second, where genuine disputes exist as to the legislative intent of FOIA, “the recognized principal purpose of the FOIA requires [courts] to choose that interpretation most favoring disclosure.” Rose, 425 U.S. at 366; see generally Sinito v. U.S. Dep’t of Justice, 176 F.3d 512, 514 (D.C. Cir. 1999) (discussing FOIA remedies and FOIA’s potential function as a remedial statute). The IRS advances a theory by which any pre-existing disclosure statute could conceivably supplant FOIA, even where the pre-existing statute provides for significantly less disclosure than mandated by FOIA. Reply at 6. FOIA’s pro-disclosure purpose would then be frustrated not by earlier nondisclosure statutes, but by earlier statutes with comparable pro-disclosure aims. Absent clear language to that effect, I cannot accept that Congress intended FOIA’s “‘workable’ rules” of disclosure to turn on such an opaque distinction. F.T.C. v. Grolier Inc., 462 U.S. 19, 27 (1983) (holding, in the context of FOIA’s (b)(5) exemption, that “establishing a discrete category of exempt information[ ] implements the congressional intent to provide ‘workable’ rules”).

Finally, the IRS contends that Congress, after enacting FOIA, “could have amended [s]ection 6104 to indicate that the FOIA would provide the scheme for the production of Forms 990, but it declined to do so.” Def.’s Mot. to Dismiss at 7, 8. However, the IRS offers nothing to suggest that failing to introduce such an amendment was an affirmative act. Indeed, failure to amend is equally strong evidence of Congress’s expectation that FOIA already governed.

D. The relationship between sections 6104 and 6103 confirms that FOIA governs.

The IRS frames section 6104 as operating within a statutory scheme “anchored by [s]ection 6103,” in which adjacent subsections of section 6104 operate as pro-disclosure and nondisclosure mandates with respect to specific records. Def.’s Mot. to Dismiss at 4; 26 U.S.C. § 6104(a), (b). The IRS notes that without section 6104, release of Forms 990 would be completely barred by the nondisclosure provision for tax return information in section 6103(a). Def.’s Mot. to Dismiss at 8. The D.C. Circuit has generally accepted such a view of the statutes’ relationship to one another. Tax Analysts v. I.R.S., 214 F.3d 179, 183 (D.C. Cir. 2000) (“I.R.C. § 6104 therefore may be characterized as an exception to the exception from the general disclosure rule offered by FOIA Exemption 3 and I.R.C. § 6103.”); see also Lehrfeld v. Richardson, 132 F.3d 1463, 1467 (D.C. Cir. 1998).

However, it is unclear on what basis this depiction of section 6104 advances the IRS’s position on FOIA preemption. Indeed, the Ninth Circuit has already considered and rejected the FOIA preemption argument with respect to section 6103. Long, 742 F.2d at 1177-78 (“Exemption 3 of FOIA was designed to give effect to just such explicit nondisclosure statutes as section 6103.”); 5 U.S.C. § 552(b)(3). The D.C. Circuit has reached the same conclusion on multiple occasions. Tax Analysts v. I.R.S., 117 F.3d 607, 611 (D.C. Cir. 1997) (“That § 6103 is the sort of nondisclosure statute contemplated by FOIA exemption 3 is beyond dispute.”); Maxwell v. Snow, 409 F.3d 354, 355 (D.C. Cir. 2005) (“Section 6103 thus ‘does not supersede FOIA but rather gives rise to an exemption under Exemption 3’ and FOIA procedures must still be followed in applying § 6103.” (quoting Church of Scientology of Cal., 792 F.2d at 149-50)). If a tension exists between the pro-disclosure purposes of FOIA and the confidentiality interests of section 6103, FOIA itself provides the mechanism for reconciling the two. Therefore, in linking together sections 6103 and 6104 as “a comprehensive nondisclosure paradigm,” the IRS articulates an argument not for preempting FOIA, but for a statutory exemption pursuant to FOIA. Def.’s Mot. to Dismiss at 4. Statutes providing such an exemption are subsumed within FOIA, and the burden then lies with the federal agency to demonstrate that the exemption applies to the discrete record request at issue. Kamman v. U.S. I.R.S., 56 F.3d 46, 48 (9th Cir. 1995); 5 U.S.C. § 552(a)(4)(B).

E. IRS regulations cannot be found to supersede FOIA absent statutory intent.

Finally, the IRS relies on the detailed access provisions contained in the regulation adopted to effect section 6104’s mandates. Section 6104 delegates to the Secretary of the Treasury the authority to promulgate certain implementing regulations. 26 U.S.C. § 6104(b) (“The information required to be furnished [by section 6104] . . . shall be made available to the public at such times and in such places as the Secretary may prescribe.”). The IRS contends that — at least as of November 2002 — Treasury adopted regulations that “expressly construe[ ] section 6104 as providing a comprehensive and exclusive disclosure scheme.” Reply at 4-5; see 26 C.F.R. § 601.702(d)(3).

However, the IRS misstates the extent of the Secretary’s power. The rulemaking power is only a limited grant of authority “to adopt regulations to carry into effect the will of Congress as expressed by the statute.” U.S. v. Larionoff, 431 U.S. 864, 873 n.12 (1977). If a dispute arises as to proper statutory interpretation, courts and federal agencies must defer to congressional intent. Lessner v. U.S. Dep’t of Commerce, 827 F.2d 1333, 1335 (9th Cir. 1987). “If the intent of Congress is clear, that is the end of the matter.” Chevron, U.S.A., Inc. v. Natural Res. Def. Council, Inc., 467 U.S. 837, 842 (1984).

As discussed, the congressional intent behind FOIA is clear, and nothing in the text, structure, purpose, or legislative history of either statute indicates that section 6104 should supersede FOIA. See Tax Analysts v. I.R.S., 350 F.3d 100, 103 (D.C. Cir. 2003) (holding that certain regulations implementing section 6110 were inconsistent with the statute’s meaning, as determined by these “traditional tools of statutory interpretation” (quoting Pharm. Research & Mfrs. of Am. v. Thompson, 251 F.3d 219, 224 (D.C. Cir. 2001))). The IRS cannot achieve through rulemaking what it was not permitted to do by Congress.

II. ADMINISTRATIVE PROCEDURE ACT

As an alternative to its claims under FOIA, PRO seeks declaratory and injunctive relief under the APA, challenging as arbitrary and capricious the IRS’s determination that Forms 990 in MeF format are not required to be released under FOIA. Compl. ¶¶ 61-62. The IRS argues that this claim should be dismissed for the same reason as the FOIA claim — that section 6104 preempts FOIA. Def.’s Mot. to Dismiss at 8. As I have determined that section 6104 does not preempt, and as the IRS raises no additional arguments, the IRS’s motion fails with respect to the APA claim. While PRO will eventually have to elect its remedy, it need not do so now.

CONCLUSION

For the reasons set forth above, Defendant’s motion to dismiss for failure to state a claim is DENIED.
IT IS SO ORDERED.

DATED: June 20, 2014.

William H. Orrick
United States District Judge
FOOTNOTE

1 Focusing on its argument that section 6104 preempts FOIA, the IRS does not argue that section 6104 creates a statutory exemption to FOIA under 5 U.S.C. § 552(b)(3). FOIA’s (b)(3) exemption provides that material can be withheld from production under FOIA where a statute “requires that the matters be withheld from the public in such a manner as to leave no discretion on the issue; or [ ] establishes particular criteria for withholding or refers to particular types of matters to be withheld.” 5 U.S.C. § 552(b)(3)(A).

END OF FOOTNOTE



IRS LTR: Easement Sale Won't Jeopardize Club's Exemption.

The IRS ruled that a social and recreational club’s sale of a conservation easement will not jeopardize its tax-exempt status and that the club’s use of the sale proceeds to make capital improvements will constitute other property purchased and used directly in the performance of the club’s exempt function if purchased within a specified time.

Citations: LTR 201425016

Contact Person: * * *
Identification Number: * * *
Telephone Number: * * *

Uniform Issue List: 511.00-00, 512.00-00, 512.01-00, 512.09-03
Release Date: 6/20/2014
Date: March 28, 2014

Employer Identification Number: * * *

LEGEND:
Towns = * * *
Amount 1 = * * *
Year 1 = * * *
Amount 2 = * * *
Year 2 = * * *
Year 3 = * * *
Amount 3 = * * *
City = * * *
Date 1 = * * *
Amount 4 = * * *
Amount 5 = * * *

Dear * * *:

This is in response to your letter dated January 11, 2013, in which you requested certain rulings with respect to I.R.C. § 512(a)(3)(D).

BACKGROUND

You are recognized as an organization classified under § 501(c)(7). You are a social and recreational club located in Towns formed for the purpose of golf and other recreation. You have been operated continuously as a social club since you were recognized as exempt well over fifty years ago. You were formed for the primary purpose of owning and operating a private club for golf and other leisure activities for the recreation of your members. You own approximately one hundred and fifty plus acres (“Property”). All of your recreational facilities are located on the Property and you own no other real property. Your facilities include an 18-hole golf course, tennis courts and tennis shed, a swimming pool and pool house, staff house, and clubhouse.

You borrowed Amount 1 in debt in Year 1 and Amount 2 in Year 2 to make improvements to your Property. The debt was used exclusively to renovate the golf course, pool house, and clubhouse. You refinanced your debt in Year 3 for Amount 3 to pay off your original debts from Year 1 and Year 2.

On Date 1, you entered into an agreement with City for a conservation easement attaching to Amount 4 acres consisting primarily of your 18-hole golf course, surrounding wetlands, and shrubs. City seeks the easement since your land contains natural resources, such as watercourses, wetlands, and forests, which serve as a source of drinking water for residents of City. The easement is granted for the purpose of limiting development and disturbance of the easement property, preventing pollution, and protecting any portion of the City’s water supply system, including its reservoirs and tributaries. City will pay you Amount 5 for the easement.

As part of the easement you have agreed that you will not construct new paved roads; create new building envelopes with subsurface sewage treatment systems, paved surfaces, or wells; or store, bury, or dispose of hazardous materials designated by local, state, or federal regulations or dispose of cars, trash, sewage, or uncomposted animal waste. Furthermore, the easement restricts your ability to disturb the surface, subsurface, or trees on the easement land, though it does not remove those options entirely. The easement also provides for a building envelope for you where your current impervious surfaces are permitted along with certain expansions limited by the easement and subject to prior approval. Additionally, City will have the right to enter the land for inspections in order to monitor your use of the land. The easement will run with the land in perpetuity, thus restricting any future sale of the land. Finally, you have also agreed to terms for a Water Resource Protection Plan that dictates the manner you are permitted to care for your grounds to include the amount and type of fertilizer, herbicide, and pesticide as well as how often such efforts can occur. Your members, however, can, and will, continue to use the land for all of your traditional recreational activities such as golfing.

You intend to use the proceeds of the conservation easement agreement to make capital improvements to the Property. These improvements include renovating, expanding, and updating your existing club house; purchasing additional equipment and fixtures for the club house; renovating and expanding your staff house; updating and repairing your golf course; replacing equipment used to maintain golf course; renovating your golf cart barn; repaying and expanding your parking lot; building a new turf management maintenance facility; replacing pool, pool furniture, pump house, heating equipment and engaging in other pool repairs; repairing and updating pool house; refurbishing and expanding tennis courts and tennis house; updating irrigation system; and updating, expanding, and replacing ponds, water resources, and waste systems. All of the updated properties are used by your members in furtherance of your recreational purposes. In addition to expending money to make improvements to your facilities and land, you intend to pay off some of the refinanced debt from Year 3.

RULINGS REQUESTED

1. The sale of the easement will not jeopardize your exempt status under § 501(a) and § 501(c)(7).

2. The use of the proceeds of the sale of the easement to improve the golf course, purchase personal property and equipment and add on to, improve, or renovate your facilities, inclusive of those items listed on Exhibit “C,” will constitute expenditures for property used directly in the performance of your exempt function for purposes of § 512(a)(3)D) and as such those proceeds will be exempt from tax.

3. The time period for reinvestment of the proceeds of sale of the easement specified in Section 512(a)(3)(D) begins one year before the date of closing of the sale not when the downpayment is deposited with the Escrow Agent or when the contract was signed.

LAW

I.R.C. § 501(c)(7) describes clubs that are organized for pleasure, recreation, and other nonprofit purposes, substantially all of the activities of which are for such purposes and no part of the net earnings of which inures to the benefit of any private shareholder.

I.R.C. § 512(a)(3)(A) defines unrelated business income, for an organization recognized under § 501(c)(7), as gross income (excluding any exempt function income) less the deductions allowed, both computed with the modifications provided in paragraphs (6), (10), (11), and (12) of § 512(b).

I.R.C. § 512(a)(3)(B) defines exempt function income for § 501(c)(7) organizations to mean gross income from dues, fees, charges, or similar amounts paid by members of the organization as consideration for providing the goods, facilities, and services in furtherance of the purposes of the organization.

I.R.C. § 512(a)(3)(D) provides that if property used directly in the performance of the exempt function of an organization described in § 501(c)(7) is sold by such organization, and within a period beginning one year before the date of such sale, and ending three years after such date, other property is purchased and used by such organization directly in the performance of its exempt function, gain (if any) from such sale shall be recognized only to the extent that such organization’s sales price of the old property exceeds the organization’s cost of purchasing the other property.

I.R.C. § 1031 provides that no gain or loss shall be recognized on the sale or exchange of property held for productive use in a trade or business or for investment if such property is exchanged solely for property of like kind which is to be held either for productive use in a trade or business or for investment. The date of the exchange is when the taxpayer transfers the property relinquished in the exchange.

Treas. Reg. § 1.501(c)(7)-1(b) provides that a club which engages in business, such as selling real estate, is not organized and operated exclusively for pleasure, recreation, and other nonprofitable purposes. However, an incidental sale of property will not deprive the club of its exemption.

Senate Report No. 91-552, 1st Session, 1969-3 C.B. 423, 470-71 explained the reasons for enacting § 512(a)(3)(D), noting:

“[T]he tax on investment income is not to apply to the gain on the sale of assets used by the organizations in the performance of their exempt functions to the extent the proceeds are reinvested in assets used for such purposes within the period beginning 1 year before the date of sale and ending three years after that date. The committee believes that it is appropriate not to apply the tax on investment income in this case because the organization is merely reinvesting the funds formerly used for the benefit of its members in other types of assets for the same purposes. They are not being withdrawn for gain by the members of the organization. For example, where a social club sells its clubhouse and uses the entire proceeds to build or purchase a larger clubhouse, the gain on the sale will not be taxed if the proceeds are reinvested in the new clubhouse within three years.”

Rev. Rul. 69-232, 1969-1 C.B. 154 provides that even though a profit is realized, the sale of property will not cause a social club to lose its exemption provided the sale is incidental in that it does not represent a departure from the club’s exempt purposes. All of the facts and circumstances of a sale must be considered in determining the club’s primary purpose in making the sale, including: (1) the purpose of the club in purchasing the property; (2) the use the club makes of the property; (3) the reason for the sale; and (4) the method used in making the sale.
In Atlanta Athletic Club v. Commissioner, 980 F.2d 1409 (11th Cir. 1993), expenditures made for the construction of a tennis center and the renovation of a clubhouse were deemed to be purchases of other property for purposes of § 512(a)(3)(D). In analyzing whether the club’s property was used directly in the performance of its exempt function prior to the sale, the court looked at the club’s actual use of the property, regardless of continuity or regularity, rather than the club’s intent for use.

In Tamarisk Country Club v. Commissioner, 84 T.C. 756 (1985 [CCH Dec. 42, 047]), the Tax Court held that § 512(a)(3)(D) does not require the purchase of property that is of like kind or use to the property sold. Expenditures for golf carts, land improvements, and other items were qualifying purchases of other property for purposes of that section. However, the court found that the club’s use of sale proceeds to repay debt owed and refund assessments to its members constituted a withdrawal for gain by the members of the club, who benefited from the decrease in the club’s debt and return of the assessments, therefore subjecting the applicable proceeds to unrelated business income tax.

In Deer Park Country Club v. Commissioner, 70 T.C.M. (CCH) 1445, the sale of land that was never actually used for club purposes was not qualified for non-recognition under § 512(a)(3)(D), regardless of the fact that the organization originally purchased the land with the intent of using it for its exempt function.

ANALYSIS

Clubs that engage in the selling of real estate will not be considered to be operated for exempt purposes under § 501(c)(7). Section 1.501(c)(7)-1(b). However, if the selling of real estate is incidental to the club’s exempt purpose it will not jeopardize the club’s exemption. Id. Rev. Rul. 69-232, supra, provides that even if a sale results in a profit it will not result in a loss of exemption as long as it does not represent a departure from the club’s exempt purpose. All the facts and circumstances are to be taken into account when determining whether a departure from the exempt purposes has occurred. Id. Items to consider include (1) the purpose of the club in purchasing the property; (2) the use the club makes of the property; (3) the reasons for the sale; and (4) the method used in making the sale. Id.
In this case, you have purchased the property with which the easement will run for the purpose of playing golf and other recreation, which are your exempt purposes. You have used this property since buying it and will continue to do so after the sale of the easement, for playing golf and other recreational activities. You are selling the easement in order to raise capital to invest in improvements to the grounds and equipment of your club. You are not selling the property as part of an ongoing plan to sell or develop real estate, and this sale is a one-time occurrence. The sale of this easement will not jeopardize your exemption under § 501(c)(7) of the Code.

You also requested a ruling that gain from the sale of a conservation easement will not be taxable income if reinvested in property furthering your exempt purpose. Section 512(a)(3) provides special rules defining taxable income for organizations described in § 501(c)(7). Specifically, gains from the sale of property, which has been used for the exempt purpose of certain organizations, will not be recognized, and therefore will not be taxed, to the extent that the sale price is reinvested in property used for the organization’s exempt purpose, if that reinvestment occurs within one year prior to and three years following the sale of property. Section 512(a)(3)(D). This statute is further clarified by case law, which requires that the property being sold must have been “directly used” for the exempt purposes of the organization, see Atlanta Athletic Club, 980 F.2d 1409, not for some other benefit of the organization, see Deer Park Country Club, 70 T.C.M. (CCH) 1445, and must be reinvested into property up to the “organization’s sales price” and not “withdrawn for the gain by the members of the organization.” See Tamarisk Country Club, 84 T.C. 756.

The sale of the easement is considered by the Service to be a sale of property within the Internal Revenue Code. The easement will be attached to the land in perpetuity affecting all future transactions regarding the land. The easement removes your ability to construct new paved roads; create new building envelopes with subsurface sewage treatment systems, paved surfaces, or wells; or store, bury, or dispose of hazardous materials. It additionally hinders your ability to disturb or remove surface and subsurface areas as well as trees, though it does not remove those options entirely. The easement also gives access of your land to City in order to ensure such activities are not taking place. Given the significant restrictions on you, and any purchaser of the land, and the rights provided to City, you have sold property.

The property you have sold must have been used directly for your exempt purpose. Section 512(a)(3)(D). You use the land over which the easement runs primarily for golf as the land contains your 18-hole golf course, including hazards and forest, which promotes your recreational and social comingling purposes, and other recreational facilities that are used by members to join together and engage in recreation. These activities are in direct furtherance of your exempt purpose. See e.g., Atlanta Athletic Club, 980 F.2d 1409. Thus, we conclude that the sale of the easement meets the first criteria because it is attached to land directly used for your exempt purposes. The fact that you continue to use the land under the easement for your exempt purposes does not alter the conclusion that you have sold property that you used for an exempt purpose.

You have stated that you intend to use a portion of the funds generated from the sale of the easement for capital investments in your facilities and equipment. These investments include improvements to your club house and staff house; improvements to your golf course, golf barn, and parking lot; improvements to your pool, pool house, and tennis courts; and updating, expanding, and replacing ponds, water resources, and irrigation and waste systems.

Purchasing personal property and updating real property constitutes the purchase of property for purposes of § 512(a)(3)(D). Congressional commentary on § 512(a)(3)(D) in the senate report uses the term assets where the statute uses the term property. S. Rep. No. 91-552, supra. Furthermore, the intent of the social club exemption is to allow individuals to pool their money for pleasure and not be taxed since they would not have been taxed had they spent that money on pleasure individually. Id. Given Congress’ intent in providing special rules for unrelated business income for organizations exempt under § 501(c)(7) the purchase of equipment and capital improvements to land are considered reinvestments in property for your exempt purpose. The gain on the sale (less selling expenses) that is used on capital projects similar to those described herein that are used exclusively in furtherance of your exempt purpose within three years from the closing of the sale of the easement will not be recognized for tax purposes pursuant to § 512(a)(3)(D).

Finally, you requested a ruling that the date of sale of property for purposes of section 512(a)(3)(D) is the closing date of the sale, not when the downpayment is deposited with the escrow agent or when the contract was signed. Section 1031 describes that the date of sale or exchange of like kind property transactions is the date when the taxpayer relinquishes control of the old property. Here, for purposes of determining when the sale occurs in § 512(a)(3)(D), we rule that the date when you relinquish control of the property and title transfers under local law as the date when the sale occurs. Presuming the date of title transfer is the date of closing under local law, then we rule the date of sale under § 512(a)(3)(D) is the date of closing.

RULINGS

1. The sale of the easement will not jeopardize your exempt status under § 501(a) and § 501(c)(7).

2. The use of the proceeds of the sale of the easement to improve the golf course, purchase personal property and equipment and add on to, improve, or renovate your facilities, inclusive of those items listed on Exhibit “C,” will constitute other property purchased and used directly in the performance of your exempt function for purposes of § 512(a)(3)(D) so long as the purchase occur within three years after the closing of the sale of the conservation easement. Additionally, capital improvements described above made in the year preceding closing will constitute other property purchased and used directly in the performance of your exempt function for purposes of § 512(a)(3)(D).

3. The date of sale of property for purposes of section 512(a)(3)(D) is the closing date of the sale.

This ruling will be made available for public inspection under section 6110 of the Code after certain deletions of identifying information are made. For details, see enclosed Notice 437, Notice of Intention to Disclose. A copy of this ruling with deletions that we intend to make available for public inspection is attached to Notice 437. If you disagree with our proposed deletions, you should follow the instructions in Notice 437.

This ruling is directed only to the organization that requested it. Section 6110(k)(3) of the Code provides that it may not be used or cited by others as precedent.

This ruling is based on the facts as they were presented and on the understanding that there will be no material changes in these facts. This ruling does not address the applicability of any section of the Code or regulations to the facts submitted other than with respect to the sections described. Because it could help resolve questions concerning your federal income tax status, this ruling should be kept in your permanent records.

If you have any questions about this ruling, please contact the person whose name and telephone number are shown in the heading of this letter.

In accordance with the Power of Attorney currently on file with the Internal Revenue Service, we are sending a copy of this letter to your authorized representative.

Sincerely,

Michael Seto
Manager, EO Technical
Enclosure
Notice 437



IRS LTR: Tax-Exempt Orgs' LLC Is Exempt From Mortgage Pool Rules.

The IRS ruled that a nonprofit limited liability company formed by two tax-exempt organizations as part of a program to help individuals obtain affordable housing through direct financing is exempt from the taxable mortgage pool rules.

Citations: LTR 201425001

Third Party Communication: None
Date of Communication: Not Applicable
Person To Contact: * * *, ID No. * * *
Telephone Number: * * *

7701.26-00, 115.03-00
Release Date: 6/20/2014
Date: December 18, 2013

Refer Reply To: CC:FIP:B06 – PLR-123088-13

LEGEND:

Corporation A = * * *
Corporation B = * * *
State = * * *
Area A = * * *
Area B = * * *
Program = * * *
Target Areas = * * *
Entity A = * * *
Program LLC = * * *
Corporation A LLC = * * *
Corporation B LLC = * * *
Date 1 = * * *
a = * * *
b = * * *
c = * * *
d = * * *
e = * * *
f = * * *

Dear * * *:

This responds to a letter dated May 15, 2013, and supplemental correspondence dated August 29, 2013, and November 4, 2013, submitted on behalf of Corporation A requesting a ruling under section 7701(i) of the Internal Revenue Code (1986) (the “Code”) that expansion of Corporation A’s joint non-profit home financing program with Corporation B to include the issuance of multiple maturity debt financing by an LLC will not result in treatment of the LLC as a taxable mortgage pool.

FACTS

Corporation A and Corporation B (collectively, the “Corporations”) are organizations exempt from taxation under section 501(c)(3) of the Code. The Corporations assist low and moderate income individuals to obtain adequate and affordable housing within certain areas in State that have been identified as in moderate or high need for community stabilization. Corporation A and Corporation B provide assistance in Area A and Area B, respectively. The Corporations implement various programs intended to counteract housing deterioration in these communities. The Corporations operate in cooperation with, or on behalf of, various State and local governmental agencies, and neighborhood organizations.

As of Date 1, the Corporations jointly operate a home ownership program (the “Program”) that provides financing directly to low and moderate income borrowers for the purchase of single-family owner-occupied homes (the “Loans”). To qualify for a Loan, a borrower must be ineligible for conforming market rate mortgage financing and must meet certain income requirements. At least a percent of the Loans must be provided to borrowers with incomes less than b percent of the area median income as determined by the U.S. Department of Housing and Urban Development (“HUD”). To date, less than c percent of borrowers had incomes above b percent of HUD area median income and more than d percent had incomes below a percent. Homes purchased through the Program are located in one of several Target Areas identified as in need of community stabilization.

The Loans are currently in the form of contracts for deeds, or land installment contracts, that are treated as mortgages for federal income tax purposes. The Program might be expanded in the future to include conventional mortgages. The maximum principal amount of a Loan is $e, and since inception of the Program, the average principal amount of a Loan has been $f. The Loans have maturities of 10 years and bear fixed interest rates. One of the Program’s goals is to assist the borrower in ultimately refinancing into a 30-year mortgage. The Program has implemented safeguards to mitigate a borrower’s risk of default on a Loan, including extensive screening, financial counseling through a non-profit community-based counseling service, education, and other assistance in the event that the borrower experiences financial difficulty (including possible modification of a payment plan).

The Program is funded by charitable contributions and debt financing from the State housing finance agency, quasi-governmental and other housing non-profit entities, private sector donors, and investors. Credit enhancement for debt issued to fund the Program is often provided by several cities and counties in State, as well as nonprofit organization Entity A.

The Corporations wish to expand the Program to include the issuance of multiple maturity debt financing (the “Notes”) secured by a pledge of the Loans. The Corporations have jointly established a special purpose limited liability company (“Program LLC”) in order to issue the Notes. Program LLC is a nonprofit limited liability company organized under the law of State, the membership interests in which are owned by the Corporations through their wholly-owned disregarded entities, Corporation A LLC and Corporation B LLC. The Corporations represent that they may establish additional limited liability companies in the future. The Corporations represent that Program LLC will issue the Notes in multiple tranches with different maturity dates and interest rates in order to attract a broader base of investors with varied investment goals, which will expand the capacity of the Program to originate Loans. Under the related debt financing agreements, the Corporations may be required (or permitted) to repurchase a Loan in the event of a breach of certain representations, warranties or covenants in the related debt financing agreement if such breach materially affects the value of the Loan. In general, the lenders (or their agent) have the right to enforce the repurchase obligation against the Corporations (or related party). If a Loan is repurchased, it will have no impact on the ability of the borrower to remain in possession of her home. The Corporations have the right to exercise various remedies against the borrower if she is in default under a Loan.

Investors in the Notes are expected to include the State finance agency, quasi-governmental and other housing non-profit entities, and private sector investors. Credit enhancement for the Notes is expected to continue to be provided by several cities and counties in State, as well as nonprofit organization Entity A. The proceeds of the Notes will be used exclusively for the acquisition of homes eligible for inclusion in the Program, and the origination or purchase of Loans. The Corporations request a ruling that Program LLC’s financing of pledged Loans with debt instruments having multiple maturities does not cause the LLC to be a taxable mortgage pool under section 7701(i) of the Code.

The Corporations represent that, with respect to any Notes issued by Program LLC that would cause Program LLC to be a taxable mortgage pool but for the requested ruling, Program LLC will hold, either directly or indirectly through an indenture trustee or other custodian who will hold the pledged Loans to satisfy the Notes, the remaining beneficial interest in all assets that support the Notes until they are retired.

LAW AND ANALYSIS

Section 7701(i)(1) provides that a taxable mortgage pool shall be treated as a separate corporation which may not be treated as an includible corporation with any other corporation for purposes of section 1501.

Section 7701(i)(2)(A) provides that in general, a taxable mortgage pool is any entity (other than a REMIC) if (i) substantially all of the assets of such entity consists of debt obligations (or interests therein) and more than 50 percent of such debt obligations (or interests) consists of real estate mortgages (or interests therein), (ii) such entity is the obligor under debt obligations with 2 or more maturities, and (iii) under the terms of the debt obligations referred to in clause (ii) (or underlying arrangement), payments on such debt obligations bear a relationship to payments on the debt obligations (or interests) referred to in clause (i).

Section 7701(i)(2)(B) provides that any portion of an entity which meets the definition of subparagraph (A) shall be treated as a taxable mortgage pool (“TMP”).

Section 301.7701(i)-4(a)(1) of the Procedure and Administration Regulations excludes certain governmental bond programs from the TMP rules. It provides that regardless of whether an entity satisfies any of the requirements of section 7701(i)(2)(A), an entity is not classified as a TMP if — (i) The entity is a State, territory, a possession of the United States, the District of Columbia, or any political subdivision thereof (within the meaning of § 1.103-1(b) of this chapter), or is empowered to issue obligations on behalf of one of the foregoing; (ii) The entity issues the debt obligations in the performance of a governmental purpose; and (iii) The entity holds the remaining interests in all assets that support those debt obligations until the debt obligations issued by the entity are retired.

The term “governmental purpose” means an essential governmental function within the meaning of section 115 and does not include mere packaging of debt obligations for resale in the secondary market. § 301.7701(i)-4(a)(2).

Section 301.7701(i)-4(a)(3) provides that if an entity is not described in paragraph (a)(1) of this section, but has a similar purpose, then the Commissioner may determine that the entity is not classified as a taxable mortgage pool.

Neither of the Corporations nor Program LLC are an entity described in section 301.7701(i)-4(a)(1)(i). Nevertheless Program LLC may qualify for an exemption from the TMP rules pursuant to section 301.7701(i)-4(a)(3), if it is found that the issuance of the Notes has a similar purpose as described in section 301.7701(i)-4(a)(1)(ii), that is, Program LLC’s purpose in issuing Notes is to issue debt obligations in the performance of a governmental purpose and Program LLC meets the requirements of section 301.7701(i)-4(a)(1)(iii). In order to meet the requirement of “performance of a governmental purpose,” Program LLC must satisfy the requirements under section 301.7701(i)-4(a)(2) that the issuance of the Notes (1) is in performance of an essential governmental function within the meaning of section 115 and (2) is not the mere packaging of debt obligations for resale in the secondary market.

In providing an exclusion from gross income, section 115 requires, among other things, that the income be derived in “the exercise of any essential governmental function.”

Rev. Rul. 77-261, 1977-2 C.B. 45, holds, “Income from a fund, established under a written declaration of trust by a State, for the temporary investment of cash balances of the State and its political subdivisions . . . is excludable from gross income. . . .” The ruling reasons that the “investment of positive cash balances . . . in order to receive some yield on the funds until needed to meet expenses is a necessary incident of the power of the State or political subdivision to collect taxes and other revenues for use in meeting governmental expenses.” In addressing the meaning of an “essential governmental function” for purposes of section 115, the ruling states, “Congress did not desire in any way to restrict a State’s participation in enterprises that might be useful in carrying out those projects desirable from the standpoint of the State government which, on a broad consideration of the question, may be the function of the sovereign to conduct.”

CONCLUSION

Based on the information submitted and representations made, we conclude that Corporation A and Corporation B have satisfied the requirements under section 301.7701(i)-4(a)(1) for Program LLC to be exempt from the TMP rules under the facts and circumstances. Program LLC will hold, either directly or indirectly through an indenture trustee or other custodian, the remaining interests in Loans that support Notes issued by Program LLC until those Notes are retired. The activities of the Corporations and Program LLC provide funding to enable low and moderate income individuals to borrow the money they need to purchase housing in communities identified as in need of stabilization. Neither the Corporations nor Program LLC are in the business of purchasing and selling of debt obligations on the secondary market, rather Program LLC will function as the direct issuer of such bonds. Accordingly, Program LLC’s issuance of Notes is in the performance of a governmental purpose for purposes of section 301.7701(i)-4(a)(2) because (1) its activities qualify as an “essential governmental function” under section 115, and (2) its issuance of Notes is not “the mere packaging of debt obligations for resale on the secondary market.”

This ruling is limited to the exemption of Program LLC’s issuance of Notes from the TMP rules under section 301.7701(i)-4. This ruling’s application is limited to the facts, representations, Code sections, and regulations cited herein. No opinion is expressed with regard to whether Program LLC could meet the requirements of a REMIC under section 860D(a), whether Program LLC would otherwise be a TMP under section 7701(i), whether it is otherwise exempt under section 501(c)(3), or whether Program LLC’s issuance of Notes satisfies either the accrual requirement or the private benefit requirement of section 115.

Except as expressly provided herein, no opinion is expressed or implied concerning the tax consequences of any aspect of any transaction or item discussed or referenced in this letter.

This ruling is directed only to the taxpayer that requested it. Section 6110(k)(3) provides that it may not be used or cited as precedent. In accordance with the provisions of a Power of Attorney on file, we are sending a copy of this ruling letter to your authorized representative.

The rulings contained in this letter are based upon information and representations submitted by the taxpayer and accompanied by a penalty of perjury statement executed by an appropriate party. While this office has not verified any of the material submitted in support of the request for rulings, it is subject to verification on examination.

Sincerely

Mary Brewer
Assistant to the Branch Chief
Office of Chief Counsel, Branch 6
(Financial Institutions & Products)



EO Update: e-News for Charities & Nonprofits - June 20, 2014

1. ACT submits UBIT recommendations

The advisory committee suggests ways to improve reporting of unrelated business income. Read recommendations.

2. IRS adopts “Taxpayer Bill of Rights”

The IRS recently announced the adoption of a Taxpayer Bill of Rights that will become a cornerstone document to provide the nation’s taxpayers with a better understanding of their rights. Read news release.

3. Register for the June 26 webcast: Unrelated Business Income (UBI) and Exempt Organizations

2 p.m. ET – Register for this presentation.

Learn about:

4. IRS recorded phone forum presentations posted

Review recently posted phone forum recorded presentations on the IRS Stay Exempt Resource Library page:

Good Governance makes sense for exempt organizations
Stay Exempt: A guide for charitable organizations with changing leadership presentation

5. New FBAR Form 114 due June 30

U.S. persons, including tax-exempt organizations, with a financial interest in, or signature authority over, a foreign financial account (or accounts) with aggregate value of more than $10,000 at any time during the calendar year must file Form 114, Report of Foreign Bank and Financial Accounts (FBAR). FBARs for the 2013 year are due June 30.



IRS Exempt Bonds Director Emphasizes Clarity and Transparency.

The new head of tax-exempt bonds (TEB) at the IRS said June 19 she is trying to ensure clarity and transparency in all of the agency’s public documents on exempt financing.

During an IRS webcast, Rebecca Harrigal, director (TEB), IRS Tax-Exempt and Government Entities Division, who assumed her role in October, said she wants to be sure that the exempt bond community understands what the IRS is trying to accomplish and that the agency explains its actions as transparently as possible. For example, TEB is making significant revisions to its voluntary closing agreement program (VCAP) manual to make it clearer and has developed standardized closing agreements that will be posted online, she said.

TEB is also making efforts to measure customer satisfaction, particularly following examinations, Harrigal said, adding that the IRS hopes to have a satisfaction survey in place early in 2015. She also said her office continues to evaluate and update its programs, such as taking steps this year to ensure the arbitrage rebate penalty is applied in a flexible manner. TEB has also put its compliance check program on hold while it evaluates the program to determine when it will be used in the future, she said.

Harrigal said she is looking at other IRS offices, such as the Large Business and International Division, to see whether they have practices in place that TEB could adopt. TEB is also targeting older inventory, particularly old VCAP and examination cases, to see if those could be moved more quickly, she said.

TEB continues to focus on post-issuance compliance, according to Harrigal. She said the IRS needs to be flexible in this area to allow best practices to develop and that IRS compliance tests “should not be on any particular format for the post-issuance compliance; rather, it should be on the effectiveness of that post-issuance compliance.”

Harrigal said TEB hopes to conduct two more webcasts this summer, one on arbitrage and the other on qualified section 501(c)(3) bonds.

Fred Stokeld



FASB Won't Require Tax Status Disclosure From Nonprofit Entities.

The Financial Accounting Standards Board on June 18 tentatively decided that its nonprofit financial reporting project will not produce requirements for nonprofit organizations to disclose their tax-exempt status in the financial statement footnotes.

At a meeting in Norwalk, Connecticut, Richard Cole, a FASB project manager, said that members of the board’s Not-for-Profit Advisory Committee had suggested that nonprofit entities should be required to disclose their tax status under section 501(c)(3) because that status may affect an individual’s ability to record a tax deduction for a donation or gift granted to the nonprofit.

Cole said that while the staff agreed that information about a nonprofit’s tax status could be useful for some financial statement users, they didn’t believe that a footnote disclosure should be required because that information can be easily obtained from other sources.

FASB member Thomas Linsmeier supported the staff recommendation but he added that his vote against requiring a footnote disclosure was not based on the existing tax status information found in Form 990, “Return of Exempt Organization.” “I’m not sure that it’s our role to be necessarily overly emphasizing the tax deductibility of items within reported financial statements, other than indicating what the tax is,” he added.

Based on the staff’s recommendation, the board will not pursue more disclosure from nonprofit organizations on governing board policies or the risks of operating in international jurisdictions.

FASB will seek the added support of its Not-for-Profit Advisory Committee before finalizing its tentative decision not to pursue those additional footnote disclosure requirements.

FASB agreed that the staff efforts should proceed regarding potential improvements to the accounting and disclosure requirements for the underwater endowment funds held by a nonprofit entity.

The board clarified a recent tentative decision on the presentation and disclosure of investment expenses by voting to remove the proposed requirement to disclose the investment expenses that have been netted against the investment return of mutual and hedge funds.

Cloud Computing

FASB accepted a staff recommendation to issue a proposed accounting standards update to amend the Accounting Standards Codification (ASC) by including implementation guidance to better indicate the accounting for customers’ fees paid in cloud computing arrangements.

To assist the customer’s determination on whether a cloud computing arrangement should be accounted for as a license or a service contract from the service provider, the board tentatively decided that it will add the revenue recognition guidance from ASC 985, “Software,” to the internal-use software guidance under ASC 350, “Intangibles — Goodwill and Other.”

FASB decided that the proposed update will be effective for public entities in the annual and interim periods beginning after December 15, 2015. All other entities can begin applying the guidance for the annual periods beginning after December 15, 2015, and for the interim periods beginning after that initial annual report. The board would permit entities to elect a retrospective or prospective transition method when applying the guidance.

The staff said that the exposure draft of the proposed accounting standard update will likely be released by late July or early August. The board agreed to provide a 90-day public comment period for the exposure draft.

Treasury recently announced that it may expand existing regulations or draft new regs to help determine the appropriate sourcing for cloud computing transactions.

Thomas Jaworski



Hospital Group Seeks Changes to Tax-Exempt Bond Rules.

The American Hospital Association has urged Treasury to modify the tax-exempt bond rules, noting that the current rules pose a barrier to hospital and medical foundations’ use of specific types of arrangements that are encouraged by the Affordable Care Act, such as accountable care organizations, bundled payments, and other shared savings programs.

June 12, 2014

Vicky Tsilas
Associate Tax Legislative Counsel
Office of the Tax Legislative Counsel
Department of the Treasury
1500 Pennsylvania Avenue, NW Room 3044
Washington DC 20220

Johanna Som de Cerff
Senior Technician Reviewer
Office of Chief Counsel
Internal Revenue Service
1111 Constitution Avenue, NW
Washington, DC 20224

Dear Ms. Tsilas and Ms, Som de Cerff:

Thank you for taking the time on May 20th to discuss with me, Mike Rock and representatives from several of the American Hospital Association’s hospital members the importance of updating tax-exempt bond rules to accommodate the intent, requirements and incentives of the Affordable Care Act (ACA) for high-quality, cost-effective health services.

As we discussed, current rules as embodied in Rev. Proc. 97-13 present a barrier to hospital and medical foundation use of particular arrangements that are encouraged by the ACA, such as accountable care organizations, bundled payments and other shared savings programs. Furthermore, hospitals face significant penalties tinder readmission reduction and value-based purchasing programs. Rev. Proc. 97-13 prevents the types of arrangements that can effectively align incentives among physicians, hospitals, medical foundations and other health care service providers to meet the goals of the ACA.

During our call, you asked for (1) suggestions on the types of quality measures hospitals or medical foundations use in management contracts to incentivize physicians that should be considered acceptable under the “private business use” standards; and (2) suggested language to allow retroactivity of the new rules after any new guidance is issued (or old agreements that are materially modified or extended after that date).

Quality Measures

A number of third-party organizations develop and evaluate quality measures for the purpose of evaluating and reporting on the performance of health care providers.

Public measure developers include the Center for Medicare and Medicaid Services (CMS), and the Agency for Healthcare Research and Quality (AHRQ). CMS currently uses measures to financially reward providers who are able to deliver better-quality care to beneficiaries at a lower cost. CMS defines quality measures as, “tools that help (us) measure or quantify healthcare processes, outcomes, patient perceptions, and organizational structure and/or systems that are associated with the ability to provide high-quality health care and/or that relate to one or more quality goals for health care. These goals include: effective, safe, efficient, patient-centered, equitable, and timely care.”

Non-profit, private developers of quality measures include the Joint Commission, which evaluates and accredits more than 20,000 healthcare organizations and programs in the United States, and the National Quality Forum (NQF), a multi-stakeholder organization that endorses consensus standards for performance measurement. The measures they develop are predominantly used by payers in public reporting and provider incentive programs. The NQF, for instance, uses four criteria to assess a measure for endorsement:

(1) Important to measure and report to keep our focus on priority areas, where the evidence is highest that measurement can have a positive impact on healthcare quality.
(2) Scientifically acceptable, so that the measure when implemented will produce consistent (reliable) and credible (valid) results about the quality of care.
(3) Useable and relevant to ensure that intended users — consumers, purchasers, providers, and policy makers — can understand the results of the measure and are likely to find them useful for quality improvement and decision-making.
(4) Feasible to collect with data that can be readily available for measurement and retrievable without undue burden.

It is also important to recognize that pursing quality measures may also have the additional benefit of reducing costs by eliminating unnecessary or duplicative tests, promoting the efficient use of supplies, facilitating coordination with other providers, or reducing length of stay. Management contracts between hospitals or medical foundations and physicians or other providers should not give rise to private use if they base incentive compensation on quality measures including those that have the added benefit of producing gains in the efficiency and effectiveness of care. Further, such compensation should be permitted to be structured on a sliding basis without limit on its frequency. Finally, hospitals or medical foundations should have flexibility in the terms of the management contract in order to ensure the quality measures can be accomplished.

Effective Date

We believe that any new rules should generally apply for new agreements entered into after the new guidance is issued (or old agreements that are materially modified or extended, except under a renewal option, after that date). We also suggest a 90-day delay between the date of publication and the effective date so that healthcare providers with outstanding or proposed tax-exempt bonds have time to digest the rules and won’t have to apply them to agreements that have already been negotiated but not yet signed. We also believe flexibility should be provided by allowing healthcare providers with outstanding tax-exempt bonds the option to apply the new rules retroactively to older agreements. The following is our suggested language:

“_. Effective Date

This [revenue procedure] is effective for any agreement entered into, materially modified, or extended (other than pursuant to a renewal option) on or after [DATE THAT IS 90 DAYS AFTER DATE OF PUBLICATION]. In addition, healthcare providers with outstanding tax-exempt bond may apply this revenue procedure to any agreement entered into prior to [DATE THAT IS 90 DAYS AFTER DATE OF PUBLICATION].”

Conclusion

The need to improve the quality and cost-effectiveness of health care delivery requires hospitals and medical foundations to integrate among themselves and with other providers by sharing financial risk through incentives, encouraging the streamlining of management services. Regulatory barriers such as the private use rules related to tax-exempt bond financing constrain the pace of innovation and increase the cost of care. Your efforts to update those rules are vital to the success of the payment and quality reforms of the ACA. Our recommendations aim to ensure that quality incentives would not give rise to private use, and that any new guidance allows healthcare providers with outstanding tax-exempt bonds the option to apply the new rules retroactively to older agreements.

Sincerely,

Melinda Reid Hatton
Senior Vice President and General
Counsel
American Hospital Association
Washington, DC

Cc:
Daniel Foster
Health Counsel, Office of Representative Jim McDermott



IRS LTR: Healthcare Organization's Exemption Not Jeopardized by Agreement.

The IRS ruled that an agreement between the parent of a nonprofit healthcare system and a nonprofit hospital plan corporation under which the parent and its affiliates will receive funds for hospital construction projects will not jeopardize the parent’s tax-exempt status or its supporting organization classification.

Citations: LTR 201424025

Contact Person: * * *
Identification Number: * * *
Telephone Number: * * *

Uniform Issue list: 501.03-00, 509.03-00, 511.00-00
Release Date: 6/13/2014
Date: March 18, 2014

Employer Identification Number:* * *

LEGEND:

Plan = * * *
Hospital = * * *
x = * * *
Year 1 = * * *
Year 2 = * * *
Year 3 = * * *

Dear * * *:

This responds to your letter of February 24, 2009, in which you request rulings on the application of the federal tax laws to the transactions described below.

You are exempt from federal income taxation under § 501(a) of the Internal Revenue Code as an organization described in § 501 (c)(3). For foundation classification purposes, you are a supporting organization within the meaning of § 509(a)(3). Your mission is to promote health by acting as the parent of a nonprofit health care system and by raising funds and otherwise supporting the health care system.

You are the sole member of various health care corporations that are exempt from federal income taxation under § 501(a) as an organization described in § 501(c)(3) (the “Affiliates”), including two acute care hospitals, a specialty hospital that operates a Medicare-certified psychiatric hospital that provides outpatient services, a corporation that provides outpatient and inpatient physician services through employed physicians, a fundraising foundation, and a corporation that operates a radiation therapy center. None of these Affiliates is a private foundation within the meaning of § 509 of the Code.

Plan is a nonprofit hospital plan corporation that provides fully insured products and administers employer-funded health care plans to residents in the region of the state in which you operate. Plan represents the largest nongovernmental payer for patient services provided by your Affiliates.

Your Affiliates maintain a self-funded health insurance plan for their employees and covered dependents. Each Affiliate contributes funds to the self-funded health insurance plan on a monthly basis to cover health care claims and related fees and expenses, including third party administrator (TPA) services.

Plan provides the TPA services for this self-funded health insurance plan. Plan began providing these TPA services pursuant to a 5-year agreement with you effective in July of Year 2. You selected Plan to be TPA after putting out a bid for these services and determining that Plan offered the best overall proposal in terms of pricing, capabilities and services among the bidders.

You have undertaken an approximately $62.5x capital improvement project (the “Project”) that will involve critically needed health care facilities and equipment improvements, expansions, and updates for the Affiliates. At one Affiliate hospital, the Project will result in a newly remodeled hospital campus with * * * square feet of new hospital space (including new space for emergency services, imaging services, and surgical services), a new acute-care bed patient tower enabling the transition of all multi-patient rooms to single occupancy, and a new hospital entrance. At another Affiliate hospital, the Project will result in the expansion of medical oncology services, the expansion and renovation of the radiation therapy area (including the installation of state-of-the-art stereotactic technology), and other upgrades throughout the facility. At a third Affiliate hospital, the Project will include the remodeling of inpatient rooms and a new addition to the main entrance to the long-term care center to provide a family visitation center. You state that the Project is needed to improve health care for patients, enhance delivery and service capabilities, enhance patient safety, increase patient privacy, increase staff effectiveness, health, and safety through a better workplace, and improve building operating efficiencies.

In Year 1, Plan and the state Insurance Department entered into an agreement requiring Plan to make a specified annual financial commitment to providing health insurance through state approved programs for persons of low income and other community benefit activities approved by the Insurance Department. This agreement resulted in Plan seeking ways to reinvest its surplus funds in community health projects. In that context, Plan offered you financial assistance for the Project. This financial assistance was provided pursuant to an agreement (the “Agreement”) between you and Plan (the “Parties”).

Under the Agreement, which was effective in January of Year 3 (“Effective Date”), Plan agreed to make available to you and your Affiliates a total amount of $6x. (the “Funding”). Pursuant to the Agreement, Plan paid your Affiliate, Hospital, the total amount of the Funding over a one year period to cover the costs and expenses associated with construction of Hospital’s new acute-care bed patient tower and remodeling of Hospital’s campus with * * * square feet of new hospital space including new space for emergency services, imaging services, and surgical services. The Funding was also used in the development/construction of a new Energy Service Center and a new hospital entrance. The Funding was contributed to, and booked by, Hospital, not you.

Under the Agreement, the Funding is conditioned on you and your Affiliates meeting the following seven obligations. First, during the first three years of the Agreement’s five-year term (the “Term”), you and your Affiliates that has employees with health coverage agreed to continue to use Plan as the exclusive TPA for their self-funded health insurance plan, provided the terms and conditions offered by Plan were commercially reasonable. The Agreement allows you to hire an independent actuary mutually agreeable to the Parties to analyze and validate the reasonableness of the rates offered by Plan. If the independent actuary determines that Plan’s rates are not reasonable, Plan is required to either adjust its rates in accordance with the evaluation of the independent actuary, or elect not to accept the rates of the independent actuary and permit you and your Affiliates not to use Plan as their administrative services provider without you being in default under the Agreement.

Although the Agreement required you and your Affiliates to use Plan as your TPA for the first three years of the Term, you and your Affiliates were already obligated to use Plan to perform this function for the first half of this three-year period under the five-year agreement that had been effective since July of Year 2. When the five-year term of the agreement effective July of Year 2 expired, you negotiated a one-year and then a three-year extension of the contract on an arm’s length basis. These negotiations and renewal processes were conducted without regard to, and independent of, the Agreement, which had been consummated and completed by the time the negotiations took place. You state that the extensions provided for fair and reasonable administrative fees that remained within the reasonable range of administrative fees by reference to the bids you had previously received for these administrative services. More generally, you represent that all the fees paid to Plan for administrative and related services have been, and continue to be, commercially reasonable, developed through arm’s length negotiations, for fair market value, and comparable to (or below) what similarly-situated entities would be paid for equivalent services.

Second, you agreed to enter into mutually-agreed extensions to the current terms, or to establish mutually-agreed new terms, of certain provider agreements between Plan and your Affiliates (the “System Provider Agreements”). Under the Agreement, the specified System Provider Agreements will have their current terms extended or have agreed new terms for a period at least equal to the Agreement’s Term and continuing through the natural expiration of any relevant provider agreement that has a natural expiration longer than Term. You represent that the mutually-agreed-upon new terms of the System Provider Agreements with Plan were commercially reasonable, developed by the Parties through arm’s length negotiations, and provide for fair and reasonable reimbursements for your Affiliates’ provision of healthcare services.

Third, you agreed to establish a committee of your Board of Directors (the “Liaison Committee”) to meet with a committee established by Plan’s Board of Directors up to four times a year during Term. The purpose of such meetings is for the Liaison Committee to provide the Plan’s committee with information on the use of the Funding and information on current and future plans and programs that affect Plan members. The meetings are for discussion purposes only and do not involve in any way a delegation of authority by you to Plan.

Fourth, you agreed to provide a “Change of Control Notice” to Plan in the event you receive an offer for a Change of Control Transaction1 for yourself or certain enumerated Affiliates during the Term and granted Plan the right to either (i) notify you of its approval of your entering into the Change of Control Transaction on the condition that the party that offered the transaction assume all of your obligations under the Agreement, or (ii) notify you of its disapproval of your entering into the Transaction. Proceeding with the Change of Control Transaction after notice of Plan’s disapproval would constitute a default under the Agreement.

Fifth, you agreed to adopt and provide to Plan certain performance metrics, including financial and clinical milestones. The performance metrics, which are to be developed by you in your complete discretion, were required to be provided to Plan on or before Effective Date and are reviewed and updated by your Board of Directors at least annually during the Term. In the event that you fail to materially meet your annual performance metrics during the Term, the Agreement provides that you will develop and share with Plan action plans that allow you to achieve the performance metrics. In the event that you fail to meet performance metrics for two consecutive years during the Term, Plan may require you to hire an independent consultant to recommend ways for you to achieve minimum performance metrics. Your refusal to either hire an independent consultant after being directed to do so by Plan, or to timely prepare and submit performance metrics and updates to Plan, would be a default under the Agreement. You state that you developed and adopted these performance metrics, and reported them to Plan, primarily to demonstrate that the Funding provided under the Agreement was being used to further your § 501(c)(3) charitable purposes, specifically addressing your goals of providing high quality healthcare services and improving clinical performance, all in a financially viable manner.

Sixth, you agreed to cooperate with a new medical college described under § 501(c)(3) to develop and implement mutually-agreed-upon student rotations, residency, and/or teaching programs at you and your Affiliates. You have no obligation under the agreement to provide any financial assistance to the medical college. You state that you view the medical college as an integral partner in carrying out your tax-exempt healthcare mission, principally with respect to alleviating the increasingly severe shortage of physicians in some of the areas you serve. You believe that having physician instructors and the medical college’s students on site will have an overall positive impact on the medical staff of your hospitals as well as on the care they provide. You also believe that, by introducing medical students to clinical practice in your service area, this cooperation will continue to provide you with an enhanced ability to recruit and retain well trained and highly-qualified physicians and allow you to carry out your § 501(c)(3) healthcare mission.

Seventh, within twelve months of Effective Date, you and Plan agreed to identify and initiate specific mutually-agreed-upon projects, including regional information technology projects and clinical quality improvement projects. You state that your only obligation under the Agreement was to seek mutually-agreed-upon opportunities in good faith and that there was no affirmative obligation for you to agree to or fund any specific project. You engaged in discussions and planning with Plan to develop a health information exchange (which you say would have been important to improving your delivery of healthcare). but you and Plan never implemented that exchange because a similar health information exchange became operational first. You did not identify or initiate any other projects within 12 months of the Effective Date and have not identified or initiated any other projects since. You state that the failure to identify and initiate a mutually-agreed-upon project was a not a default under the Agreement because any obligation to pursue a project was contingent on mutual agreement being reached. You state. further. that you would not have agreed to initiate any project that was not in furtherance of or substantially related to your exempt purposes.

A failure to fulfill any of these seven obligations during the Term would result in a default. meaning that you would need to repay an amount up to the amount of Funding received (without interest). As an alternative to repayment, Plan may seek alternative remedies. including a decree compelling specific performance under the Agreement or orders restraining and enjoining any act that would constitute a breach under the Agreement.

RULINGS REQUESTED

The following rulings have been requested:

1. By entering into the Agreement and fulfilling your obligations thereunder. you will not jeopardize your status as an organization described in § 501(c)(3)
2. By entering into the Agreement and fulfilling your obligations thereunder, you will not jeopardize your classification as a supporting organization described in § 509(a)(3).
3. The Funding you received under the Agreement will not constitute unrelated business taxable income within the meaning of §§ 511-514.

LAW

I.R.C. § 501(a) exempts from federal income taxation organizations described in § 501(c), among others.

I.R.C. § 501(c)(3) describes corporations, trusts, and associations organized and operated exclusively for charitable and other enumerated exempt purposes, no part of the net earnings of which inures to the benefit of any private shareholder or individual.

I.R.C. § 507(d)(2)(A) provides that the term “substantial contributor” means any person who contributed or bequeathed an aggregate amount of more than $5.000 to the organization. if such amount is more than 2 percent of the total contributions and bequests received by the organization before the close of the taxable year of the organization in which the contribution or bequest is received by the organization from such person.

I.R.C. § 509 defines the term “private foundation” as a domestic or foreign organization described in § 501(c)(3) other than an organization described in § 509(a)(1), (2), (3), or (4).

I.R.C. § 509(a)(3) describes an organization which

A. Is organized, and at all times thereafter is operated, exclusively for the benefit of, to perform the functions of, or to carry out the purposes of one or more specified organizations described in § 509(a)(1) or (2);
B. Is (i) operated, supervised or controlled in connection with one or more organizations described in § 509(a)(1) or (2); (ii) supervised or controlled in connection with one or more such organizations; or (iii) operated in connection with one or more such organizations, and
C. Is not controlled directly or indirectly by one or more disqualified persons (as defined in § 4946) other than foundation managers and other than one or more organizations described in § 509(a)(1) or (2).

I.R.C. § 511 imposes a tax for each taxable year on the unrelated business taxable income of organizations described in § 501(c).
I.R.C. § 512(a) defines “unrelated business taxable income” as the gross income derived by any organization from any unrelated trade or business regularly carried on by it, less allowable deductions which are directly related to the carrying on of such trade or business, both computed with the modifications provided in § 512(b).

I.R.C. § 513(a) defines the term “unrelated trade or business” as any trade or business the conduct of which is not substantially related (aside from the need of such organization for income or funds or the use it makes of the profits derived) to the exercise or performance by such organization of its charitable or other purpose or function constituting the basis for its exemption under § 501.

I.R.C. § 4946(a)(1)(A) provides that “disqualified person” includes a person who is a substantial contributor to the organization, as defined in § 507(d)(2).

Treas. Reg. § 1.501(c)(3)-1(c)(1) provides that an organization will be regarded as “operated exclusively” for one or more exempt purposes only if it engages primarily in activities that accomplish one or more of such exempt purposes specified in § 501 (c)(3). An organization will not be so regarded if more than an insubstantial part of its activities is not in furtherance of an exempt purpose.

Treas. Reg. § 1.501(c)(3)-1(d)(1)(ii) provides that an organization is not organized or operated exclusively for one or more exempt purposes unless it serves a public rather than a private interest. Thus, it is necessary for an organization to establish that it is not organized and operated for the benefit of private interests such as designated individuals, the creator or his family, shareholders of the organization, or persons controlled, directly or indirectly, by such private interests.

Treas. Reg. § 1.501(c)(3)-1(d)(2) provides that the term “charitable” is used in § 501(c)(3) in its generally accepted legal sense. The promotion of health has long been recognized as a charitable purpose. See Restatement (Second) of Trusts, §§ 368, 372; IV Scott on Trusts, §§ 368, 372 (3rd ed. 1967); and Revenue Ruling 69-545, 1969-2 C. B. 117.

Treas. Reg. § 1.502-1(b) provides that if a subsidiary organization of a tax-exempt organization would itself be exempt on the ground that its activities are an integral part of the exempt activities of the parent organization, its exemption will not be lost because, as a matter of accounting between the two organizations, the subsidiary derives a profit from its dealings with its parent organization, for example, a subsidiary organization which is operated for the sole purpose of furnishing electric power used by its parent organization, a tax-exempt educational organization, in carrying on its educational activities. However, the subsidiary organization is not exempt from tax if it is operated for the primary purpose of carrying on a trade or business which would be an unrelated trade or business (that is, unrelated to exempt activities) if regularly carried on by the parent organization.

Treas. Reg. § 1.509(a)-4(j)(1) provides that an organization will be considered “controlled,” for purposes of § 509(a)(3)(C), if disqualified persons, by aggregating their votes or positions or authority, may require such organization to perform any act which Significantly affects its operations or may prevent such organization from performing such act.

Treas. Reg. § 1.513-1(a) provides that, unless one of the specific exceptions of § 512 or 513 is applicable, gross income of an exempt organization subject to the tax imposed by § 511 is includible in the computation of unrelated business taxable income if: (1) It is income from trade or business; (2) such trade or business is regularly carried on by the organization; and (3) the conduct of such trade or business is not substantially related (other than through the production of funds) to the organization’s performance of its exempt functions.

Treas. Reg. § 1.513-1(b) provides that, for purposes of § 513, the term trade or business has the same meaning it has in § 162, and generally includes any activity carried on for the production of income from the sale of goods or performance of services.

Treas. Reg. § 1.513-1(d)(2) provides that a trade or business is related to exempt purposes, in the relevant sense, only where the conduct of the business activity has a causal relationship to the achievement of exempt purposes (other than through the production of income), and it is substantially related, for purposes of § 513, only if the causal relationship is a substantial one. Thus, for the conduct of trade or business from which a particular amount of gross income is derived to be substantially related to purposes for which exemption is granted, the production or distribution of the goods or the performance of the services from which the gross income is derived must contribute importantly to the accomplishment of those purposes. Whether activities productive of gross income contribute importantly to the accomplishment of any purpose for which an organization is granted exemption depends in each case upon the facts and circumstances involved.

Rev. Rul. 78-41, 1978-1 C.B. 148, concerns a trust created by a § 501(c)(3) tax-exempt hospital for the sole purpose of accumulating and holding funds to be used to satisfy malpractice claims against the hospital, and from which the hospital directs the bank-trustee to make payments to claimants. By serving as a repository for funds paid in by the hospital, and by making payments at the direction of the hospital to persons with malpractice claims against the hospital, the trust is operating as an integral part of the hospital. Of equal importance is the fact that the trust is performing a function that the hospital could do directly. Accordingly, the organization is operated exclusively for charitable purposes and, thus, is exempt from federal income tax under § 501(c)(3).

ANALYSIS

Issue 1: Whether by entering into the Agreement and fulfilling your obligations thereunder, you jeopardize your status as an organization described in § 501(c)(3).
You have been recognized as an organization described in § 501(c)(3) because, by serving as the corporate parent of your § 501(c)(3) Affiliates, you perform an essential service for your Affiliates and, therefore, your activities are an integral part of the exempt charitable activities of your Affiliates within the meaning of § 1.502-1(b). Rev. Rul. 78-41. By entering into the Agreement and fulfilling the obligations thereunder, your activities will continue to support your Affiliates and be an integral part of their healthcare activities in furtherance of charitable purposes. Your Affiliate, Hospital, used the Funding received under the Agreement to improve the quality of patient care, expand hospital facilities, and advance medical training, education, and research programs.

As for the obligations under the Agreement, you represent that the extensions of your administrative services contact and System Provider Agreements with Plan were negotiated at arm’s length and resulted in reasonable, fair market value compensation. The Agreement specifically stipulates that your use of Plan as the TPA for your Affiliates’ self-funded health insurance plan would be on “commercially reasonable” terms and gives you the right to hire an independent actuary to analyze and validate the reasonableness of rates offered by Plan. In the event an actuary were engaged under this provision, either Plan must accept the actuary’s rates or you are relieved of the obligation to hire Plan as an administrative services organization without being in default under the Agreement. The Agreement also requires that the extensions of the System Provider Agreements be “mutually agreed” upon by you and Plan, and you represent that the System Provider Agreement terms you negotiated at arm’s length and agreed upon ensure your Affiliates fair and reasonable reimbursements for their provision of health care services to patients insured by Plan. Thus, any private benefit to Plan as a result of your agreeing to extend your administrative services contract and the System Provider Agreements is insubstantial and incidental to the essential services you provide in fulfillment of the exempt purposes of your Affiliates.

The Agreement’s requirements that you establish a Liaison Committee to provide Plan with information on the use of the Funding and to adopt and report on financial and clinical milestones (that were developed solely at your discretion) appear to be reasonable precautions to ensure that the Funding would be used to further § 501(c)(3) purposes by promoting the health of the community, as do the Agreement’s provisions regarding Change of Control Transactions during the Term.

The student rotations, residency, and/or teaching programs you agreed to develop and implement in cooperation with the medical college were to be “mutually agreed upon” and require no financial commitment from you. Moreover, these activities are consistent with your purpose of providing services in fulfillment of the exempt purposes of your Affiliates because they positively impact patient care and help to train and recruit qualified physicians.

Finally, your agreement to identify and initiate a mutually-agreed-upon project within the first 12 months after Effective Date did not require you to identify and initiate any project that you did not agree to and you have represented that you would not agree to any project that did not further your exempt purposes.

Thus, by entering into the Agreement and fulfilling your obligations thereunder, you will not jeopardize your status as an organization described in § 501(c)(3).

Issue 2: Whether by entering into the Agreement and fulfilling your obligations thereunder. you jeopardize your classification as a supporting organization described in § 509(a)(3).

For purposes of private foundation classification, you are classified as a supporting organization described in § 509(a)(3) because you are organized and operated exclusively for the benefit of, to perform the functions of, or to carry out the purposes of your Affiliates, which are classified as organizations described in § 509(a)(1).

You will not cease to be organized and operated exclusively for the benefit of, to perform the functions of, or to carry out the purposes of your Affiliates as a result of entering into the. Agreement and fulfilling the obligations thereunder. The Agreement also will not affect whether you are operated, supervised or controlled by or in connection with your Affiliates.

To be described in § 509(a)(3), you also must not be controlled directly or indirectly by one or more disqualified persons. You state that all of the Funding was designated for and paid to and for the use of Hospital and that it was Hospital, not you, that booked the Funding on its balance sheet for accounting purposes. You state that, because Plan did not contribute any funds to you under the Agreement, Plan did not become a substantial contributor to you and thus is not a disqualified person.

However, even if Plan were considered a “substantial contributor” and thus a disqualified person with respect to you, the Agreement did not result in you or your Affiliates being controlled directly or indirectly by Plan within the meaning of § 509(a)(3)(C). Taken together, your obligations under the Agreement do not give Plan the ability to require you or your Affiliates to perform any act which significantly affects your or your Affiliates’ operations or to prevent you or your Affiliates from performing such act. While the provisions related to Change of Control Transactions could affect your operations, they do not give Plan the power to prevent you from entering into such transactions. Rather, even if Plan objects to a Change in Control Transaction, you can proceed with the transaction as long as you repay certain amounts of the Funding that Plan paid to you.

Consequently, by entering into the Agreement and fulfilling your obligations thereunder, you will not jeopardize your classification as a supporting organization described in § 509(a)(3).

Issue 3: Whether the Funding you received under the Agreement constitutes unrelated business taxable income within the meaning of §§ 511-514.

You state that the Funding was contributed to and booked by Hospital, not you. Thus, you did not receive any income which could be unrelated business taxable income with respect to you. However, even if the Funding had been contributed to you, your obligations under the Agreement either do not constitute a trade or business within the meaning of § 1.513-1(b) or are substantially related to your exempt purposes within the meaning of § 1.513-1(d)(2). To the extent a portion of the Funding constitutes a payment to extend your contract with Plan to provide TPA services for your Affiliates’ self-funded health insurance plan for the first three years of the Term, such payment would only serve as a reduction to the price you pay in exchange for Plan’s services; it would not constitute your performance of services (or sale of goods) in exchange for income.

The obligation to enter into mutually-agreed-upon extensions of the System Provider Agreements relates to your negotiation of the compensation your Affiliates receive in exchange for their provision of the health care services constituting the basis of their exemption under § 501(c)(3) and, hence, is substantially related to your exempt purposes. Your agreement to cooperate with a medical college to develop and implement mutually agreed-upon student rotations, residency, or teaching programs is also substantially related to your exempt purpose.

The obligations to inform Plan, via the Liaison Committee, on the use of the Funding and to adopt and report on certain clinical and financial performance metrics appear to be reasonable precautions to ensure that the Funding would be used to further § 501(c)(3) purposes by promoting the health of the community, as do the Agreement’s provisions regarding Change of Control Transactions during the Term.

Finally, the obligation to identify and initiate a project was contingent on your reaching a mutual agreement with Plan on a project, and you represent you would not have agreed to any project that was not substantially related to your exempt purpose.

Thus, the Funding you received under the Agreement will not constitute unrelated business taxable income within the meaning of §§ 511-514.

RULINGS

Based on the information submitted, we rule as follows:

1. By entering into the Agreement and fulfilling your obligations thereunder, you will not jeopardize your status as an organization described in § 501(c)(3).
2. By entering into the Agreement and fulfilling your obligations thereunder, you will not jeopardize your classification as a supporting organization described in § 509(a)(3).
3. The Funding you received under the Agreement will not constitute unrelated business taxable income within the meaning of §§ 511-514.

This ruling will be made available for public inspection under § 6110 after certain deletions of identifying information are made. For details, see enclosed Notice 437, Notice of Intention to Disclose. A copy of this ruling with deletions that we intend to make available for public inspection is attached to Notice 437. If you disagree with our proposed deletions, you should follow the instructions in Notice 437.
This ruling is directed only to the organization that requested it. I.R.C. § 6110(k)(3) provides that it may not be used or cited by others as precedent.

This ruling is based on the facts as they were presented and on the understanding that there will be no material changes in these facts. This ruling does not address the applicability of any section of the Code or regulations to the facts submitted other than with respect to the sections described. Because it could help resolved questions concerning your federal income tax status, this ruling should be kept in your permanent records.

If you have any questions about this ruling, please contact the person whose name and telephone number are shown in the heading of this letter.

In accordance with the Power of Attorney currently on file with the Internal Revenue Service, we are sending a copy of this letter to your authorized representative.

Sincerely,

Michael Seto
Manager, EO Technical
Enclosure
Notice 437

FOOTNOTE

1 The Agreement defines a “Change of Control Transaction” as any sale or other disposition of all or substantially all of the assets, or any merger, consolidation, or other similar transaction that results in any individual or entity other than you or your Board having the authority to appoint or elect a majority of the board of directors or similar managing body of yours or any of your Affiliates. However, a Change of Control Transaction does not include any transaction with a tax-exempt, locally controlled provider (as defined in the Agreement) that is not in the insurance business.

END OF FOOTNOTE



'On Behalf of' Issuers May Issue Tribal Economic Development Bonds

In generic legal advice, the IRS concluded that an Indian tribal government that receives an allocation of volume cap to issue tribal economic development bonds may designate an “on behalf of issuer” to issue the bonds.
An Indian tribal government is treated as a state for purposes of section 103. Section 7871(f)(2) provides in part that, for a tribal economic development bond, the bond shall be treated as if it were issued by a state, and the Indian tribal government issuing the bond and any instrumentality of the tribal government shall be treated as a state for purposes of section 141. Section 7871(f)(3)(A) defines a tribal economic development bond as any bond issued by an Indian tribal government, the interest on which would be exempt from tax under section 103 if issued by a state or local government.

A tribal government that receives an allocation of volume cap to issue tribal economic development bonds may designate an “on behalf of issuer,” within the rules applicable to bonds issued under section 103, that is formed under the laws of that tribal government to issue those bonds. The proceeds of any bonds issued in this manner will be treated as if they were proceeds of bonds issued by the Indian tribal government that received the allocation.

UILC: 103.02-02, 7871.00-00
Release Date: 6/13/2014
Date: June 9, 2014

CC:FIP:05:SWHanemann – POSTN-143922-13

to:
Director, Tax-Exempt Bonds

from:
Associate Chief Counsel
(Financial Institutions & Products)

subject:
On-Behalf-Of Issuers of Tribal Economic Development Bonds

This advice may not be used or cited as precedent.

ISSUE

Can an Indian tribal government that receives an allocation of volume cap to issue tribal economic development bonds designate an “on behalf of issuer” to issue those bonds?

LAW AND ANALYSIS

Section 103(a) provides that, except as provided in § 103(b), gross income does not include interest on any State or local bond. Section 103(b) provides in part that § 103(a) shall not apply to any private activity bond which is not a qualified bond. Section 103(c)(1) defines the term “State or local bond” as an obligation of a State or political subdivision thereof. Section 103(c)(2) defines the term State to include the District of Columbia and any possession of the United States. Section 1.103-1(b) of the Income Tax Regulations provides in part that obligations issued by or on behalf of any State or local governmental unit by constituted authorities empowered to issue such obligations are the obligations of such a unit.
Section 7871(a)(4) provides that, subject to § 7871(c), an Indian tribal government shall be treated as a State for purposes of § 103. Section 7871(c)(1) provides that § 103(a) shall apply to any obligation issued by an Indian tribal government (or subdivision thereof) only if such obligation is part of an issue substantially all of the proceeds of which are to be used in the exercise of any essential governmental function. Section 7871(c)(2) generally provides that, with very limited exception, § 103(a) shall not apply to any private activity bond (as defined in section 141(a)) issued by an Indian tribal government (or subdivision thereof).

Section 7871(f)(2) provides in part that, in the case of a tribal economic development bond, notwithstanding § 7871(c), such bond shall be treated for purposes of the Code in the same manner as if such bond were issued by a State, and the Indian tribal government issuing such bond and any instrumentality of such Indian tribal government shall be treated as a State for purposes of section 141. Section 7871(f)(3)(A) defines a “tribal economic development bond” in relevant part as any bond issued by an Indian tribal government, the interest on which would be exempt from tax under section 103 if issued by a State or local government.

An Indian tribal government that receives an allocation of volume cap to issue tribal economic development bonds may designate an “on behalf of issuer”, within the rules applicable to bonds issued under § 103, that is formed under the laws of that tribal government to issue those bonds. The proceeds of any bonds issued by such an “on behalf of” issuer will be treated as if they were proceeds of bonds issued by the Indian tribal government that received the allocation. See Notice 2009-51, 2009-28 I.R.B. 128.

Please call (202) 317-6980 if you have any further questions.

Helen M. Hubbard
Associate Chief Counsel
(Financial Institutions and
Products)

Citations: AM 2014-005



IRS LTR: Advance Refunding Bonds Won't Become Transferred Proceeds.

The IRS ruled that none of the unspent proceeds or allocable investments of the advance refunding bonds of a utility system owner will become transferred proceeds or investments of the proposed tax-exempt current refunding bonds.

Citations: LTR 201424002

Third Party Communication: None
Date of Communication: Not Applicable
Person To Contact: * * *, ID No. * * *
Telephone Number: * * *

Index Number: 148.00-00
Release Date: 6/13/2014
Date: February 25, 2014

Refer Reply To: CC:FIP:BRANCH 5 – PLR-116921-13

LEGEND:

Issuer = * * *
Advance Refunding Bonds = * * *
Proposed Tax-Exempt Current Refunding Bonds = * * *
Date 1 = * * *
a = * * *
b = * * *
c = * * *

Dear * * *:

This is in response to your request for a ruling that none of the proceeds of the Advance Refunding Bonds in the defeasance escrow described below will become transferred proceeds, under § 1.148-9(b) of the Income Tax Regulations, of the proposed tax-exempt bonds, the proceeds of which are to be used to currently refund a specified portion of the Advance Refunding Bonds.

FACTS AND REPRESENTATIONS

Issuer makes the following factual representations. Issuer owns, operates, and maintains a combined water and sewer utility system (the Utility System). Issuer financed the construction and improvement of the Utility System with a number of issues of bonds As part of an effort to obtain relief from certain requirements relating to the use of the Utility System revenues, Issuer issued the Advance Refunding Bonds, on Date 1, to defease a issues of revenue bonds (the Prior Issues). Certain of the Advance Refunding Bonds were issued as non-callable bonds. The proceeds of the Advance Refunding Bonds and the proceeds of a bona fide debt service fund allocable to the outstanding Prior Issues were deposited in a defeasance escrow fund (the Escrow) and used to purchase investments to repay the Prior Issues.
Issuer has fully redeemed b of the a Prior Issues (the Discharged Prior Issues) using a portion of the Escrow. Issuer expects to use the unspent proceeds of the Advance Refunding Bonds in the Escrow (the Unspent Proceeds) to pay the debt service on the outstanding bonds of the remaining c Prior Issues (the Outstanding Prior Issues).

Prior to the issuance of the proposed bonds (described below), Issuer proposes to use the multipurpose allocation rules of § 1.148-9(h) to allocate the bonds, proceeds, and investments of the Advance Refunding Bonds into a separate issues, the purpose of each of which is to refund one of the Prior Issues. Issuer represents it will allocate the bonds of the Advance Refunding Bonds ratably to those separate issues and allocate the sales proceeds based on the present value of the refunded debt service on the Prior Issues in accordance with §§ 1.148-9(h)(4)(i) and (ii). It will allocate the investments in the Escrow purchased with proceeds of the Advance Refunding Bonds, based on the maturities and amounts of the investments, to the separate issues in accordance with the debt service payments of the Prior Issues that the respective investments are expected to pay.

Issuer intends to issue bonds to refund the callable portion of the Advance Refunding Bonds. Issuer proposes to issue the Proposed Tax-Exempt Current Refunding Bonds to currently refund the callable Advance Refunding Bonds it will have allocated to the separate issues the purposes of which are to refund the respective Discharged Prior Issues and issue taxable bonds (the Proposed Taxable Bonds) to refund the callable Advance Refunding Bonds it will have allocated to the separate issues the purposes of which are to refund the respective Outstanding Prior Issues.

LAW AND ANALYSIS

Section 148(a) of the Internal Revenue Code (Code) provides that, for purposes of § 103, the term “arbitrage bond” means any bond issued as part of an issue any portion of the proceeds of which are reasonably expected (at the time of issuance of the bond) to be used directly or indirectly to acquire higher yielding investments, or to replace funds which were used directly or indirectly to acquire higher yielding investments. For purposes of § 148(a), a bond shall be treated as an arbitrage bond if the issuer intentionally uses any portion of the proceeds of the issue of which such bond is a part in a manner described above.

Section 1.148-0(b) provides that §§ 1.148-1 through 1.148-11 apply generally for purposes of the arbitrage restrictions on State and local bonds under § 148.

Section 1.148-9(b) provides that when proceeds of the refunding issue discharge any of the outstanding principal amount of the prior issue, proceeds of the prior issue become transferred proceeds of the refunding issue and cease to be proceeds of the prior issue. The amount of proceeds of the prior issue that becomes transferred proceeds of the refunding issue is an amount equal to the proceeds of the prior issue on the date of that discharge multiplied by a fraction the numerator of which is the principal amount of the prior issue discharged with proceeds of the refunding issue on the date of that discharge and the denominator of which is the total outstanding principal amount of the prior issue on the date immediately before the date of the discharge. Principal amount means, in reference to a plain par bond, its stated principal amount, and in reference to any other bond, its present value.

Section 1.148-9(c)(1)(ii) provides that, when proceeds of a prior issue become transferred proceeds of a refunding issue, investments (and the related payments and receipts) of proceeds of the prior issue that are held in a refunding escrow for another issue are allocated to the transferred proceeds under the ratable allocation method described in § 1.148-9(c)(1)(iii). Section 1.148-9(c)(1)(iii) provides that, under the ratable allocation method, a ratable portion of each nonpurpose and purpose investment of proceeds of the prior issue is allocated to transferred proceeds of the refunding issue.

Section 1.148-9(h)(1) provides that the portion of the bonds of a multipurpose issue reasonably allocated to any separate purpose under § 1.148-9(h) is treated as a separate issue for all purposes of § 148, except for certain arbitrage purposes listed therein. Such exceptions include determining the yield on a multipurpose issue and the yield on investments for purposes of the arbitrage yield restrictions of § 148 and the arbitrage rebate requirements of § 148(f).

Section 1.148-1(b) defines a multipurpose issue as an issue the proceeds of which are used for two or more separate purposes determined in accordance with § 1.148-9(h). Section 1.148-9(h)(3)(i) provides, in part, that separate purposes of a multipurpose issue include refunding a separate prior issue, financing a separate purpose investment, financing a construction issue (as defined in § 1.148-7(f)) and any clearly discrete governmental purpose reasonably expected to be financed by the issue.

Section 1.148-9(h)(2)(i) provides that § 1.148-9(h) applies to allocations of multipurpose issues, including allocations involving the refunding purposes of the issue. Except as otherwise provided in § 1.148-9(h), proceeds, investments, and bonds of a multipurpose issue may be allocated among the various separate purposes of the issue using any reasonable, consistently applied allocation method. An allocation is not reasonable if it achieves more favorable results under sections 148 or 149(d) than could be achieved with actual separate issues. Allocations under § 1.148-9(h) may be made at any time, but once made may not be changed.

Section 1.148-9(h)(4)(i) provides that after reasonable adjustment of the issue price to account for common costs, the portion of the bonds of a multipurpose issue allocated to a separate purpose must have an issue price that bears the same ratio to the aggregate issue price of the multipurpose issue as the portion of the sale proceeds of the multipurpose issue used for that separate purpose bears to the aggregate sale proceeds of the multipurpose issue. For a refunding issue used to refund two or more prior issues, the portion of the sales proceeds allocated to the refunding of a separate prior issue is based on the present value of the refunded debt service on that prior issue, using the yield on investments in the refunding escrow allocable to the entire refunding issue as the discount rate.

Section 1.148-9(h)(4)(ii) provides that the use of the relative amount of sales proceeds used for each separate purpose to ratably allocate each bond or a ratable number of substantially identical whole bonds is a reasonable method for allocating bonds of a multipurpose issue.

Section 1.148-9(h)(4)(v) provides, in part, that for each portion of a multipurpose issue that is used to refund a separate prior issue, a method of allocating bonds of that issue is reasonable under § 1.148-9(h) if, in addition to the requirements of §§ 1.148-9(h)(1) and (2), the portion of the bonds allocated to the refunding of that prior issue results from a pro rata allocation under § 1.148-9(h)(4)(ii).

Section 1.148-9(i)(1) provides that, for purposes of § 1.148-9(h)(3)(i), the separate purposes of a prior issue include the refunded and unrefunded portions of the prior issue. Thus, the refunded and unrefunded portions are treated as separate issues under § 1.148-9(h)(1). Those separate issues must satisfy the requirements of §§ 1.148-9(h) and (i). The refunded portion of the bonds of a prior issue is based on the fraction the numerator of which is the principal amount of the prior issue to be paid with the proceeds of the refunding issue and the denominator of which is the outstanding principal amount of the bonds of the prior issue, each determined as of the issue date of the refunding issue.

Section 1.148-9(i)(2) provides that, as of the issue date of a partial refunding issue under § 1.148-9(i), unspent proceeds of the prior issue are allocated ratably between the refunded and unrefunded portions of the prior issue and the investments allocable to those unspent proceeds are allocated in the manner required for the allocation of investments to transferred proceeds under § 1.148-9(c)(1)(ii).

Section 1.148-9(i)(3) provides that if the refunded and unrefunded portions of a prior issue are treated as separate issues under § 1.148-9(i), then, except to the extent that the context clearly requires otherwise (e.g., references to the aggregate prior issue in the mixed escrow rule in § 1.148-9(c)(2)), all references in § 1.148-9 to prior issue refer only the refunded portion of that prior issue.

When proceeds of a refunding issue discharge any of the outstanding principal of a prior issue, unspent proceeds of the prior issue become transferred proceeds of the refunding issue and investments allocated to unspent proceeds of the prior issue are allocated to those transferred proceeds. For none of the Unspent Proceeds (and allocable investments) in the Escrow to become transferred proceeds (and investments) of the Proposed Tax-Exempt Current Refunding Bonds, the Unspent Proceeds (and investments) must have been allocated to an issue other than one to be refunded by the Proposed Tax-Exempt Current Refunding Bonds. To achieve this result, Issuer proposes to apply the multipurpose issue allocation rules to separate the Advance Refunding Bonds into separate issues. This requires, first, that the Advance Refunding Bonds be a multipurpose issue, that is, an issue the proceeds of which are used for two or more separate purposes under 1.148-9(h). Under § 1.148-9(h)(3)(i), separate purposes of a multipurpose issue include refunding of a separate prior issue. The Advance Refunding Bonds refunded a separate prior issues, i.e., the Prior Issues. Accordingly, the Advance Refunding Bonds issue is a multipurpose issue.

Second, the Issuer must allocate the bonds, proceeds, and investments of the Advance Refunding Bonds among the separate purposes using a reasonable, consistently applied method. Issuer represents that it will allocate the bonds and sale proceeds of the Advance Refunding Bonds among the separate purposes of refunding the respective Prior Issues in accordance with §§ 1.148-9(h)(4)(i) and (ii). As stated in these provisions and § 1.148-9(h)(4)(v) applicable to refunding bonds, these allocations are reasonable. Further, Issuer will apply these methods consistently to all the bonds and sale proceeds. Because the present value of the debt service on the Discharged Prior Issues is zero as of the date of the multipurpose allocation, no Unspent Proceeds will be allocated to the b separate issues of the Advance Refunding Bonds the purposes of which are to refund the respective Discharged Prior Issues.

Issuer will allocate the investments of the Advance Refunding Bonds among the separate purposes according to the debt service payments of the Prior Issues that the respective investments are expected to pay. Issuer expects to use all of the investments remaining in the Escrow to pay debt service on the c Outstanding Prior Issues, and thus Issuer will allocate all of the investments among the c separate issues the purposes of which are to refund the respective Outstanding Prior Issues. All investments allocable to the debt service of the b Discharged Prior Issues have been liquidated and the proceeds spent to fully repay the Discharged Prior Issues. This allocation of investments does not achieve more favorable results under § 148 or § 149(d) than could be achieved with actual separate issues to refund the respective Prior Issues. Thus, we conclude that Issuer’s method of allocating the investments to the separate purposes is a reasonable, consistently applied method.

Because Issuer’s methods of allocating the bonds, proceeds, and investments of the Advance Refunding Bonds among the separate purposes of that issue are reasonable, consistently applied methods, the bonds allocated to the refunding of each of the Prior Issues may be treated as separate issues under § 1.148-9(h). As a result, all of the Unspent Proceeds and allocable investments in the Escrow will be allocated among the separate issues of the Advance Refunding Bonds the respective purposes of which are to refund one of the Outstanding Prior Issues, and no Unspent Proceeds or investments will be allocated among the separate issues of the Advance Refunding Bonds the respective purposes of which are to refund one of the Discharged Prior Issues.

Finally, the Proposed Tax-Exempt Current Refunding Bonds and the Proposed Taxable Bonds will not refund the non-callable bonds of the Advance Refunding Bonds. In allocating all of the Advance Refunding Bonds ratably among the a separate purposes, Issuer will allocate the non-callable bonds ratably among those purposes. Thus, each of the a separate issues will include non-callable bonds that will not be refunded.

Pursuant to § 1.148-9(i), the refunded and unrefunded portions of a prior issue are separate purposes of the prior issue and treated as separate issues. Further, unspent proceeds of the prior issue and allocable investments held in a refunding escrow are to be allocated ratably between the refunded and unrefunded portions. Accordingly, each of the separate issues within the Advance Refunding Bonds will be further divided into its refunded and unrefunded portions. Thus, the Unspent Proceeds and allocable investments to be allocated to each of the separate issues the purpose of which is to refund one of the Outstanding Prior Issues will be further allocated ratably between the refunded and unrefunded portions of each of those separate issues of the Advance Refunding Bonds. Because no Unspent Proceeds or investments will be allocated to the separate issues of the Advance Refunding Bonds the respective purposes of which are to refund one of the Discharged Prior Issues, no Unspent Proceeds or investments will be allocated to the refunded or unrefunded portions of those separate issues.

Accordingly, when proceeds of the Proposed Tax-Exempt Current Refunding Bonds refund portions of those separate issues of the Advance Refunding Bonds, no Unspent Proceeds or investments of the Advance Refunding Bonds will become transferred proceeds of the Proposed Tax-Exempt Current Refunding Bonds.

CONCLUSION

Accordingly, we conclude that, under the facts and circumstances described above, none of the Unspent Proceeds or allocable investments of the Advance Refunding Bonds will become transferred proceeds or investments of the Proposed Tax-Exempt Current Refunding Bonds under § 1.148-9(b).

Except as expressly provided herein, no opinion is expressed or implied concerning the tax consequences of any aspect of any transaction or item discussed or referenced in this letter.

This ruling is directed only to the taxpayer requesting it. Section 6110(k)(3) of the Code provides that it may not be used or cited as precedent.

In accordance with the Power of Attorney on file with this office, a copy of this letter is being sent to your authorized representative.

A copy of this letter must be attached to any return to which it is relevant.

The rulings contained in this letter are based upon information and representations submitted by the taxpayer and accompanied by a penalty of perjury statement executed by an appropriate party. While this office has not verified any of the material submitted in support of the request for rulings, it is subject to verification on examination.

Sincerely,

Associate Chief Counsel
(Financial Institutions & Products)

By: Johanna Som de Cerff
Senior Technician Reviewer
Branch 5



IRS Eliminates Circular 230 Covered Opinion Rules in Final Regs.

The Internal Revenue Service (IRS) has issued final “Circular 230” regulations governing the standards for written advice by practitioners. The final regulations eliminate some of the requirements regarding tax opinions classified as “covered opinions” by modifying the standards governing written advice. The IRS received comments that overwhelmingly recommended that these provisions be eliminated.

The new regulations replace the old Covered Opinion rules in Circular 230 requiring attorneys to include disclaimers on emails and letters that advice given couldn’t be relied upon to avoid penalties. Under Section 10.37, practitioners are required to base all written advice on “reasonable factual and legal assumptions, exercise reasonable reliance, and consider all relevant facts that the practitioner knows or reasonably should know.” Also under Section 10.37 is the addition of a definition for certain things that do not constitute written advice. The rules now state that “government submissions on matters of general policy are not considered written tax advice on a Federal tax matter….”

The final regulations were released on Monday, and took effect on Thursday, June 12, 2014, and can be seen here.



The Tax Exemption Under Section 501(c)(4).

This brief discusses the justification for income tax exemption for organizations qualifying under section 501(c)(4). It explores why these organizations are deemed unworthy of the charitable contribution deduction but nevertheless entitled to be exempt on their entire income. It notes that income tax exemption generally only benefits entities that accumulate funds, suggesting accumulation is desirable. It further points out that the subsidy from income tax exemption for long-term accumulation can exceed the benefit of the charitable deduction. The brief concludes that income tax exemption under section 501(c)(4) cannot be justified either on the grounds that it is relatively unimportant or by analogy to the treatment of mutual organizations, whose exemption has been circumscribed.

Dan Halperin

Read complete document: PDF



FASB Hears Mixed Feedback on Nonprofit Expense Reporting.

The Financial Accounting Standards Board on June 10 heard feedback on proposed nonprofit reporting requirements that some members of the nonprofit sector thought were burdensome while others believed them to be aligned with the existing transparency required from those organizations.

During a teleconference meeting with FASB’s Not-for-Profit Advisory Committee (NAC), Jeffrey Mechanick, an assistant director at FASB, said that if the board completes deliberations on the nonprofit reporting project the week of June 16, the staff can begin to prepare an exposure draft of the proposed requirements that could be issued in October.

According to Mechanick, the exposure draft will likely be subject to a public comment period of at least four months to provide stakeholders adequate time to weigh in on the proposed rule changes. The rulemaking proposal also will illustrate how various types of nonprofit organizations should present the newly required financial disclosures, he said.

On May 14 FASB tentatively decided that a nonprofit organization should disclose the costs of investment activities it performs itself as well as those conducted on its behalf by a third party to generate investment income. According to the board, the required disclosure would include all expenses that are direct and contracted to the nonprofit organization. (Prior coverage 2014 TNT 94-9: News Stories.)

Mechanick said the American Institute of Certified Public Accountants Not-for-Profit Expert Panel had suggested that FASB consider those disclosure requirements for investment expenses.

NAC member Clara Miller of the F.B. Heron Foundation supported the proposed disclosure requirements for nonprofit organizations, saying that those entities have a public duty of care that involves being transparent about the cost of their operations. Because investment activities are becoming a core business for many nonprofit institutions, the related expenses should be disclosed like every other business expense, she added.

Most nonprofit institutions should have the required management capacity and funding to provide the disclosure on investment expense, said Miller, adding that the presentation of investment expense is required for tax compliance.

NAC member Norman C. Mosrie of Dixon Hughes Goodman expressed concern that the proposed disclosure requirements would be burdensome for larger nonprofit institutions that maintain hundreds of different types of investments and mutual funds.

Mosrie also questioned how useful the reported expense information would be to a potential donor or lender to a nonprofit organization, adding that those parties would likely be more concerned with the information about the total investment return.

NAC member Stephen Golding of the University of Pennsylvania was concerned about the timeline for the proposed nonprofit requirements for financial reporting that could be issued in the second half of the year. He suggested that the board instead gather more feedback on the possible changes associated with investment expense disclosure and cash flow presentation before a formal proposal is issued.

“I do feel like in a way we are the guinea pigs here” with some of the proposed changes, in advance of similar potential rule changes for the for-profit sector, Golding said.

FASB member Lawrence Smith said that proposed presentation and disclosure requirements represent important communications to users of nonprofit financial statements.

Smith said it is important that FASB move toward an exposure draft of those proposed requirements in order to receive a broad range of stakeholder views that can be considered during re-deliberations. He added that a less formal document may not receive the same attention from the board’s constituency.

Thomas Jaworski



IRS Outlines Guidance on Internal Use Software Research. Activities.

In e-mailed advice, the IRS addressed the current legal standard for the internal use software exception under section 41, outlining the applicable internal use software guidance and recent case law.

Citations: ECC 201423023

UILC: 41.00-00
Release Date: 6/6/2014
ID: CCA_2014052909222361

From: * * *
Sent: Thursday, May 29, 2014 9:22:23 AM
To: * * *
Cc: * * *
Bcc:
Subject: RE: CCA Request — IUS Legal Standard

Hello * * *

This is in response to your request regarding the current legal standard for the internal use software exception under section 41. Presently, the only published internal use software guidance is in the ANPRM, issued on December 31, 2003. The ANPRM provides, in relevant part, that for taxable years beginning after December 31, 1985, and until further guidance is published in the Federal Register, taxpayers may continue to rely upon all provisions of the 2001 proposed regulations, or all provisions of TD 8930 with respect to their internal use software research activities. For example, the ANPRM requires taxpayers relying upon the internal use software rules of TD 8930 to also apply the “discovery” test as set forth in TD 8930. Concurrent with the publication of the ANPRM, the Treasury Department and the IRS finalized the 2001 proposed regulations in the Federal Register as TD 9104 on December 31, 2003. TD 9104 retained the “discovery” test in the same manner as the 2001 proposed regulations but removed the internal use software provisions and marked § 1.41-4(c)(6) as “Reserved.” TD 9104 applied to taxable years ending on or after December 31, 2003; however, TD 9104 stated that the IRS would not challenge return positions that are consistent with its rules for taxable years ending before December 31, 2003.

Since publication of the ANPRM, its enforceability was questioned by the court in FedEx Corporation v. United States of America, 108 AFTR 2d 2011-5669 (W.D.Tenn Mar 28, 2011), denying reconsideration of 103 AFTR 2d 2009-2722, 2009-1 USTC ¶ 50,435 (W.D.Tenn 2009). The court questioned the authority to require taxpayers to comply with the ANPRM that may partly conflict with TD 9104 and allowed the taxpayer to apply the internal use software rules of TD 8930 while applying the general eligibility rules under TD 9104. Please note, however, that the taxable years at issue in FedEx were prior to the issuance of the ANPRM.

TD 9104 clearly states that the IRS would not challenge return positions that are consistent with its rules for prior years; therefore, it is inappropriate for the IRS to challenge taxpayers who apply the general eligibility provisions of TD 9104. Since the ANPRM is the only internal use software guidance available, taxpayers may continue to follow the ANPRM in its entirety. However, we should not challenge taxpayers that choose instead to follow only the internal use software provisions of § 1.41-4(c)(6) in either TD 8930 or the 2001 proposed regulations, and follow TD 9104 for the general eligibility rules for qualified research.

I hope this answers your question. Please let me know if you want to discuss further.

Thank you

* * *



H.R. 4757 Would Expand Bond Exceptions for Farmers.

H.R. 4757, introduced by Rep. Tom Latham, R-Iowa, would expand exceptions to private activity bond rules for first-time farmers.

113TH CONGRESS
2D SESSION

H.R. 4757

To amend the Internal Revenue Code of 1986 to expand certain
exceptions to the private activity bond rules for first-time
farmers, and for other purposes.

IN THE HOUSE OF REPRESENTATIVES

MAY 29, 2014

Mr. LATHAM introduced the following bill; which was referred to
the Committee on Ways and Means

A BILL

To amend the Internal Revenue Code of 1986 to expand certain exceptions to the private activity bond rules for first-time farmers, and for other purposes.
Be it enacted by the Senate and House of Representatives of the United States of America in Congress assembled,

SECTION 1. EXPANSION OF CERTAIN EXCEPTIONS TO THE PRIVATE ACTIVITY BOND RULES FOR FIRST-TIME FARMERS.

(a) INCREASE IN DOLLAR LIMITATION. —

(1) IN GENERAL. — Section 147(c)(2)(A) of the 8 Internal Revenue Code of 1986 is amended by striking “$450,000” and inserting “$509,600”.

(2) REPEAL OF SEPARATE LOWER DOLLAR LIMITATION ON USED FARM EQUIPMENT. — Section 147(c)(2) of such Code is amended by striking subparagraph (F) and by redesignating subparagraphs (G) and (H) as subparagraphs (F) and (G), respectively.

(3) QUALIFIED SMALL ISSUE BOND LIMITATION CONFORMED TO INCREASED DOLLAR LIMITATION. — Section 144(a)(11)(A) of such Code is amended by striking “$250,000” and inserting “$509,600”.

(4) INFLATION ADJUSTMENT. —

(A) IN GENERAL. — Section 147(c)(2)(G) of such Code, as redesignated by paragraph (2), is amended —

(i) by striking “after 2008, the dollar amount in subparagraph (A) shall be increased” and inserting “after 2014, the dollar amounts in subparagraph (A) and section 144(a)(11)(A) shall each be increased”, and

(ii) by striking “2007” in clause (ii) and inserting “2013”.

(B) CROSS REFERENCE. — Section 144(a)(11) of such Code is amended by adding at the end the following new subparagraph:

“(D) INFLATION ADJUSTMENT. — For inflation adjustment of dollar amount contained in subparagraph (A), see section 147(c)(2)(G).”.

(b) SUBSTANTIAL FARMLAND DETERMINED ON BASIS OF AVERAGE RATHER THAN MEDIAN FARM SIZE. — Section 147(c)(2)(E) of such Code is amended by striking “median” and inserting “average”.

(c) EFFECTIVE DATE. — The amendments made by this section shall apply to bonds issued after the date of the enactment of this Act.



IRS Rules on Tax Treatment of Cooperative's Proposed Settlement.

The IRS ruled that an electric cooperative’s tax-exempt status will not be jeopardized by a proposed settlement with former members to redeem their capital credits, that the discounted portion of redeemed capital credits will not be included in income, and that the redemption of capital credits will constitute patronage dividends or sourced income.

Citations: LTR 201423027

Contact Person: * * *
Identification Number: * * *
Telephone Number: * * *

UIL 501.12-03
Release Date: 6/6/2014
Date: March 13, 2014

Employer Identification Number: * * *

LEGEND:

State = * * *
Date = * * *
X = * * *
Year = * * *

Dear * * *:

We have considered your ruling request regarding the tax consequences relating to the proposed transactions described below.

FACTS

You are an electric cooperative, formed as a cooperative, nonprofit, membership corporation under the laws of State on Date. You are organized under your bylaws to operate on a cooperative, nonprofit basis for the mutual benefit of your members. You are exempt from federal income tax under § 501(c)(12) of the Internal Revenue Code (“Code”). In the past you have satisfied, and you expect to continue to satisfy, the member income requirements for exemption under § 501(c)(12).

You have approximately X current members. Your members are entitled to vote on all matters presented at meetings of the members, and all questions put to vote to the members are generally decided by majority vote. Your governing board is composed of nine trustees, all of whom are elected by the members at your annual meetings. Members elect the trustees on a one member, one vote basis. In addition, a trustee may be removed and replaced by a majority vote of the members upon a member initiated petition signed by the lesser of 10% or 400 members.

Pursuant to your bylaws, you are obligated to account to all of your members on a patronage basis for all amounts received and receivable from electric energy in excess of operating costs and expenses properly chargeable against the furnishing of such services. You are required to credit to a capital account all such amounts in excess of operating costs and expenses for each member. You are obligated to maintain books and records reflecting the amount of capital credited to each patron’s account on an annual basis and to notify members of the capital credited to their accounts within a reasonable time after the close of the fiscal year.

Your bylaws provide that, in the event of your dissolution or liquidation, all of your outstanding indebtedness will be paid first, and then outstanding capital credits of current and former members will be retired, without priority, on a pro rata basis. The remaining property and assets — representing your “net savings” account — will then be distributed among the members and the former members in proportion to the patronage each bears to the total patronage of all members during the seven years next preceding the date of filing of the certificate of dissolution.

Your bylaws also provide that, at any time prior to dissolution or liquidation, capital credited to the members’ accounts may be retired in full or in part if the Board determines that your financial condition would not be impaired thereby. In the event of a capital credit retirement occurring earlier than the time scheduled by the Board, the amount of the capital credit may be discounted to present value in accordance with applicable accounting standards and as the Board may determine to establish the amount to be received by the distribute in respect to such early retirement.

The Board has adopted a policy for the regular assignment and retirement/payment of capital credits (“Policy”). The Policy provides that, upon payment of discounted capital credits, the difference between the discounted value paid and the stated value of the member’s or patron’s capital account will be credited to an equity account in the name of the member or patron to be held as retired capital. Thus your members retain a continuing property right in the net savings for the difference between the stated value of the patronage allocation and any discounted value that has been paid.

In Year you were sued by a group of former members (“Former Members”) who allege that you should immediately retire capital credits of a member once the member ceases taking power from you and thus ceases to be your customer. You have negotiated a settlement proposal with the Former Members (“Settlement Proposal”), which provides that, after off-setting their bad debt, you will then discount to present value all capital credits of the Former Members and pay out such capital credits over a defined period.

The parties have agreed that the rate of return of a competing electric utility within your service area should be used as the capital credit discount/present value rate. The capital credits allocated to the Former Members will be discounted on a ten-year basis, and then immediately retired as a condition of the settlement. Pursuant to the Settlement Proposal, the Former Members will receive their pro rata share of the discounted capital credit amount, less attorneys’ fees, administrative costs, and payment of compensation to the class representatives.

The discounted portion of the Former Members’ redeemed capital credits — the difference between the discounted amount and the original amount in the capital credit account — will be retained on your books as permanent equity and available for distribution to the members and former members upon dissolution and liquidation as part of your net savings account. It will not be reallocated to the capital credit accounts of current members.

You request the following rulings:

1. The proposed transaction consisting of your (a) entering into a settlement agreement consistent with the terms of the Settlement Proposal, (b) redeeming capital credits of the Former Members at a discount rate pursuant to the terms thereof, and (c) transferring the discounted portion to your permanent equity will not adversely affect your tax-exempt status under § 501(c)(12).

2. The discounted portion of the Former Members’ redeemed capital credits will not be included in your income for purposes of the 85 percent member income test under § 501(c)(12).

3. The redemption of the capital credits of the Former Members pursuant to the Settlement Proposal will constitute patronage dividends or patronage sourced income.

LAW

Section 501(c)(12) of the Code provides for the exemption from federal income tax of benevolent life insurance associations of a purely local character, mutual ditch or irrigation companies, mutual or cooperative telephone companies, or like organizations, but only if 85 percent or more of the income consists of amounts collected from members for the sole purpose of meeting losses and expenses.
Rev. Rul. 72-36, 1972-1 C.B. 151, describes certain basic characteristics an organization must have in order to be a cooperative organization described in § 501(c)(12)(A). These characteristics include the following: A cooperative must keep adequate records of each member’s rights and interest in the assets of the organization. A cooperative must not retain more funds than it needs to meet current losses and expenses. The rights and interests of members in the organization’s savings must be determined in proportion to their business with the organization. A member’s rights and interests may not be forfeited upon the withdrawal or termination of membership. Upon dissolution, gains from the liquidation of assets should be distributed to all current and former members in proportion to the value or quantity of business that each did with the cooperative over the years.

This ruling also addresses a situation involving forfeiture of a former member’s rights and interests where the bylaws provide for such action upon withdrawal from the cooperative or termination. It states that even if forfeiture is permitted by the bylaws, the organization has not operated on a cooperative basis and should not be recognized as tax-exempt.

In Puget Sound Plywood, Inc. v. Commissioner, 44 T.C. 305 (1965), acq. 1966-1 C.B. 3, the court stated that an organization must meet certain common law requirements in order to be a cooperative. These common law requirements include: democratic control of the organization by members, the organization operates at cost for the benefit of members, and the contributors of capital to the organization do not control or receive most of the pecuniary benefits of the organization’s operations (i.e. subordination of capital).

DISCUSSION

Section 501(c)(12) of the Code provides for the federal tax exemption of cooperative telephone companies or like organizations, including mutual or cooperative electric companies, and other cooperative organizations not relevant here. While the term “cooperative” is not defined in I.R.C. § 501(c)(12) or the regulations thereunder, a cooperative has been traditionally and historically defined as a voluntary, membership business organization that is organized in response to the economic needs of and to perform services for its members, and not to realize monetary gains as a separate legal entity. A cooperative is organized and operated for the benefit of and is democratically controlled by its members. See Puget Sound Plywood Inc., v. Commissioner, 44 T.C. 305 (1965), acq. 1966-1 C.B. 3. Hence, to qualify for exemption under I.R.C. § 501(c)(12), an organization must be a cooperative and organized and operated as such. Puget Sound Plywood v. Commissioner describes the principles that are fundamental to the organization and operation of cooperatives. They are: (1) democratic control by the members, (2) operation at cost, and (3) subordination of capital. These principles apply to organizations described in I.R.C. § 501(c)(12).

Democratic control requires that the cooperative be governed by members and on a one-member, one-vote basis. Each member has a single vote regardless of the amount of business he or she does with the organization. The issue of democratic control is a question of fact.

Operation at cost requires that the cooperative’s net earnings or savings derived from furnishing services in excess of costs and expenses be returned to its members in proportion to the amount of business conducted with them. This principle ensures that a cooperative’s net savings from members are returned to members in proportion to the amount of business each transacts with the cooperative. A cooperative satisfies this requirement by making annual allocations of patronage to members.

Subordination of capital has two requirements. First, control of the cooperative and ownership of the pecuniary benefits arising from the cooperative’s business remains in the hands of the members rather than with non-patron equity investors. Second, the returns on equity investments must be limited. Hence, the net savings that accrue to the cooperative from the business activities it transacts with its members will largely inure to the benefit of those members rather than to its equity investors. The rationale for these limitations is to ensure that the cooperative remains faithful to its purpose — providing services at the lowest possible prices (or highest possible prices for a marketing cooperative) to its members and not to realize profits for capital. If it were otherwise, the emphasis then would likely be on protection of returns of equity capital rather than services to members, and this would destroy the basic purpose of cooperatives. See Puget Sound Plywood Inc., v. Commissioner, 44 T.C. 305 (1965), acq. 1966-1 C.B. 3.

Rev. Rul. 72-36, supra, describes additional fundamental requirements for operation of cooperatives described in I.R.C. § 501(c)(12). It requires that a member’s rights and interest in the assets of a cooperative cannot be forfeited upon termination of membership. It also requires that upon dissolution, a cooperative must distribute any gains from the sales of its assets to those who were members during the period that the assets were owned.

A. Redemption of Capital Credits at Discount

A fundamental tenet of cooperative operation is that the earnings of a cooperative are allocated and ultimately distributed to its members based on the amount of business (patronage) done with those members. The amount a cooperative member pays for the cooperative’s services less the cost of providing such services is allocated to the member. Thus, the presumption is that the cooperative’s services are provided at cost to the members. But it is impractical for such a cooperative to return immediately all the amounts or earnings to its members because the cooperative needs to have reserves in order to operate, meet unexpected expenses, or to expand. These amounts or earnings are held by the cooperative for a certain period of time as prescribed by cooperative bylaws and are allocated as capital credits to accounts kept for each member. These capital credits are returned to the members or former members when the cooperative redeems them (i.e., sends a check for the amount of the capital credits) at the end of the prescribed time.

The primary issue raised by the transaction described in the Settlement Proposal is whether it violates any of the cooperative requirements described Puget Sound Plywood, Inc., v. Commissioner, 44 T.C. 305 (1965), acq. 1966-1 C.B. 3, and Rev. Rul. 72-36. The cooperative principle of democratic control by members is satisfied because the redemption of capital credits at discount will not affect member voting rights or governing rights. We also note that the transaction described in the Settlement Proposal is consistent with the fiduciary duties of the cooperative (and its board of directors and management) to former members, and their ability to enforce their rights in the courts. See Lamesa Cooperative Gin v. Commissioner, 78 T.C. 894 (1982). The cooperative principle of operating at cost is satisfied because the members’ right to receive the excess over the cost of electricity service (i.e. capital credits) is also not adversely affected.

The cooperative principle of subordination of capital is satisfied because the transaction described in the Settlement Proposal does not adversely affect the members’ control and ownership of the cooperative assets. The cooperative requirement that there is no forfeiture of former members’ rights to assets of the cooperative is not violated. Specifically, the terms of the Settlement Proposal permit the Former Members to receive the present value of their capital credit accounts at a date before dissolution and liquidation of the company. The discount rate is in accordance with the prevailing market rate. Further, by discounting to present value, the Former Members are not treated more favorably than current members.

B. Transfer of Discount Portion of Capital Credits to Net Savings

Pursuant to the Policy, the difference between the discounted value paid to Former Members and the value stated in the member’s account will be credited to an equity account within your net savings account in the name of that member. In accordance with your Bylaws, the retired capital in the net savings account will be distributed to Former Members upon dissolution prior to distributing any remaining amounts in the net savings account.

Based on the facts presented, we do not believe that your establishment of this second capital account for each member would create taxable income to you as a cooperative. Analogizing to a corporate transaction, under § 1032, a corporation will not recognize gain or loss on the receipt of money or property in exchange for stock. Therefore, when a stockholder contributes money in exchange for stock in the corporation, the corporation does not have taxable income. Applied to a cooperative, so long as the member contributed money to the cooperative in the capacity of a member, the cooperative would not have income.

It appears that, according to your Policy, you are simply transferring money already received from members from one equity account to another equity account. As a result, it appears that nothing has changed and you will not receive any income pursuant to the transaction. The transfer of the discounted portion from the Former Members’ capital credit accounts to an equity account within the net savings account where their continuing equity interest will be recorded is simply an organizational tool.

C. Redemption of Capital Credits Constitute Patronage Dividends or Patronage Sourced Income

Regarding whether the redemption of capital credits are excluded from income as patronage dividends or patronage sourced income, in Pomeroy Cooperative Grain Co. v. United States, 31 T.C. 674, 685-686 (1958), the U.S. Tax Court held that an allocation must represent true patronage dividends to be given an exclusion from gross income. According to the court, three prerequisites must be satisfied to exclude patronage dividends from gross income:

(1) The allocations must have been made under a pre-existing legal obligation, one which existed when the patrons transacted their business with the cooperative.

(2) The allocations must have been made out of profits or income realized from transactions with the particular patrons (members) for whose benefit the allocations were made, and not out of profits or income realized from transactions with other persons or organizations.

(3) The allocations must have been made equitably, so that profits realized from selling merchandise or services to patrons, and profits from marketing products purchased from patrons, were allocated ratably to the particular persons whose patronage created each particular type of profit.

You maintain that the redemption of the Former Members’ capital credit accounts qualify as patronage dividends, excluded from gross income, because they will be made under a pre-existing legal obligation, on the basis of patronage, and from profits derived from the patrons’ business dealings with you. Based on your representations, it appears that the requirements set forth by the U.S. Tax Court in Pomeroy Cooperative Grain Co. v. United States, 31 T.C. 674, 685-686 (1958) have been satisfied, and we have found no contrary authority.

RULING

Accordingly, based on the foregoing facts and circumstances, we rule as follows:

1. The transaction described in the Settlement Proposal, consisting of your (a) entering into a settlement agreement, the terms of which are not yet finalized, but will be consistent with the Settlement Proposal, (b) redeeming capital credits of the Former Members at a discount/present day value rate pursuant to the terms thereof, and (c) transferring the discounted portion to your permanent equity will not adversely affect your tax-exempt status under Section 501(c)(12) of the Code.

2. The discounted portion of the Former Members’ redeemed capital credits will not be included in your income for purposes of the 85 percent member income test under Section 501(c)(12) of the Code.

3. The redemption of the capital credits of the Former members pursuant to the Settlement Proposal will constitute patronage dividends or patronage sourced income.

This ruling will be made available for public inspection under section 6110 of the Code after certain deletions of identifying information are made. For details, see enclosed Notice 437, Notice of Intention to Disclose. A copy of this ruling with deletions that we intend to make available for public inspection is attached to Notice 437. If you disagree with our proposed deletions, you should follow the instructions in Notice 437.

This ruling is directed only to the organization that requested it. Section 6110(k)(3) of the Code provides that it may not be used or cited by others as precedent.

This ruling is based on the facts as they were presented and on the understanding that there will be no material changes in these facts. This ruling does not address the applicability of any section of the Code or regulations to the facts submitted other than with respect to the sections described. Because it could help resolve questions concerning your federal income tax status, this ruling should be kept in your permanent records.

If you have any questions about this ruling, please contact the person whose name and telephone number are shown in the heading of this letter.

In accordance with the Power of Attorney currently on file with the Internal Revenue Service, we are sending a copy of this letter to your authorized representative.

Sincerely,

Mary J. Salins
Manager, Exempt Organizations
Technical Group 4
Enclosure
Notice 437



IRS LTR: Tax-Exempt Status Not Affected by Loan Servicing Activity.

The IRS ruled that an organization’s activity of servicing direct student loans originated by the Education Department under the Healthcare and Education Reconciliation Act of 2010 won’t affect the organization’s tax-exempt status and that revenue generated from the activity won’t constitute unrelated business taxable income under sections 512 and 513.

Citations: LTR 201423028

Contact Person: * * *
Identification Number: * * *
Contact Number: * * *
FAX Number: * * *

UIL: 501.03-00, 512.00-00, 513.00-00
Release Date: 6/6/2014
Date: March 12, 2014

Employer Identification Number: * * *

LEGEND:
State = * * *
Commission = * * *
Year = * * *

Dear * * *:

This is in response to your letter dated December 3, 2010, requesting a ruling relating to changes in your federal student loan activities as a result of the 2010 Healthcare and Education Reconciliation Act of 2010 (HCERA).

FACTS

You are a nonprofit organization incorporated under the laws of State and recognized as exempt from federal income tax as an organization described in § 501(c)(3) of the Internal Revenue Code (Code) and as a publicly supported organization under §§ 170(b)(1)(A)(vi) and 509(a)(1). You were formed at the request of the then-governor of State to facilitate and promote post-secondary education in State by financing the purchase, sale, and general marketing of student loans guaranteed by the U.S. government under the Higher Education Act of 1965 (HEA).
In a designation letter, the governor of State specifically requested that you:

. . . assist [ State ] by making arrangements necessary for providing a statewide student loan acquisition program through a not-for-profit corporation [under the HEA] . . . [You] should be established and operated exclusively for the purpose of acquiring student loan notes incurred under the [HEA] . . . The program to be established should be as comprehensive as feasible within the limitations of the applicable provisions of federal and state law.

According to your original Articles of Incorporation (AOI), you were organized exclusively for the purpose of acquiring student loan notes incurred under the HEA and to devote any excess income to purchase additional student loan notes or to pay income to State.

On your Form 1023, Application for Recognition for Exemption, you stated that you would engage in the purchase of qualified loans from banks and other participating financial institutions. You stated that your primary activity was to purchase and service student loans guaranteed by the U.S. government made under the Federal Family Education Loan Program (FFELP), which was part of the HEA. The governor of State designated you, under the HEA, as the sole entity for State to provide funds and acquire student loan notes from lenders representing loans to State students attending schools anywhere and loans to students from other states attending State schools.

According to your AOI, your 11-member board of directors is comprised of the following members:

2 directors from State banking institutions

1 director from State savings and loan institutions

1 director from State credit unions

1 director from State regents’ institutions

1 director from State private colleges and universities

1 director from State “Merged Area Schools”

4 directors from the general public

Each of your board members is, and has always been, appointed by the governor of State. Each of them serves on your board “by reason of being appointed by public officials, and some of the above persons serve as members of the governing body by reason of being public officials.” Your AOI also provide that upon dissolution all of your property, after the payment of debts and expenses, will vest in and become the property of State.

Historically, you have raised revenues to purchase student loans from the sale of bonds. As your revenue base increased, you began engaging in new activities aimed at benefitting students: you established a borrower benefits program (e.g., reducing interest rates for timely payments); a private loan program to supplement the financial needs of students; an interest forgiveness program for student loans issued to U.S. military members; and a student loan forgiveness program for individuals engaged in specialized professions (e.g., nursing) in State. You also established an independent § 501(c)(3) organization to assist students in completing financial aid forms issued by the U.S. Department of Education (DOE).

In Year, under legislation enacted by the State legislature, your purposes were expanded allowing you to originate and service private loans to students who are State residents or students attending an educational institution in State. You engaged in this activity in partnership with Commission, the designated guarantor of federally guaranteed students loans originated under FFELP for the DOE.

In 2010, the U.S. Congress passed the HCERA, under which the federal government discontinued guaranteeing student loans originated under the FFELP. Instead, effective July 1, 2010, federal student loans are now made directly by the U.S. government to borrowers. According to the floor discussion accompanying the legislation, the “provisions of this legislation will convert all new Federal student loans to the Direct Loan Program . . . saving $61 billion over the next 10 years. These changes will also upgrade the customer service borrowers receive when repaying their loans. ” 156 Cong. Rec. S1923, S1984 (daily ed. Mar. 24, 2010) (Sen. Harkin).

HCERA also amended 20 U.S.C. § 1078f by adding subsection (4) which provides that the Secretary of Education may award contracts for servicing federal direct student loans to “eligible non-profit service providers.”1 One of the ways to satisfy the criteria for eligible non-profit service providers is exemption under section 501(c)(3), along with other requirements. Id. The floor discussion accompanying the legislation noted: “[T]his legislation recognizes that non-for-profit servicers play a unique and valuable role in helping students in their States succeed in postsecondary education and that students should continue to benefit from the assistance provided by not-for-profit servicers.” 156 Cong. Rec. S1923, S1984 (daily ed. Mar. 24, 2010) (Sen. Harkin).

Prior to HCERA, 20 U.S.C. § 1078f provided that contracts may be awarded to “only entities which the Secretary determines are qualified to provide such services and supplies and will comply with the procedures applicable to the award of such contracts.” The section also contained a preference for certain state agencies since the Secretary is directed (when considering entering into agreements with entities who already have agreements under 20 U.S.C. § 1078(b) and (c)) to “give special consideration to State agencies with a history of high quality performance to perform services for institutions of higher education within their State.” See 20 U.S.C. § 1078f(a)(2).

With the enactment of the HCERA, you will now service student loans owned by the federal government, rather than loans you acquire in the secondary market or originate on your own. You will also begin servicing the federal direct loans of students residing throughout the United States, rather than just State residents or non-resident students attending school in State. Initially, the minimum number of loans required by law to be allocated by the DOE to qualified non-profit corporations is 100,000. By the end of your 2014 fiscal year, you project that you will be servicing one million loans for the DOE. Your goal is to ultimately service two million or more loans for the DOE.

To effectuate your new duties, you amended your AOI to allow you to enter into contracts relating to the origination, servicing, and collection of student loans and to establish and operate data systems for the maintenance of records for the direct student loan program.

Over time, your revenue attributable to direct loan servicing will represent an increasing percentage of your total revenue. Your use of all revenue, including those generated from servicing federal direct loans, will remain substantially unchanged after the adoption of HCERA.

RULINGS REQUESTED

You have requested the following rulings:

1) Performing loan services on direct student loans originated by the DOE under the HCERA will not adversely affect your exempt status under § 501(c)(3).
2) Revenue generated from performing these loan services will not constitute unrelated business taxable income under §§ 512 and 513.

LAW

Section 501(c)(3) of the Code provides for the exemption from federal income tax of organizations organized and operated exclusively for religious, charitable, or educational purposes.

Section 511(a) of the Code imposes a tax on the unrelated business taxable income of organizations described in § 501(c).

Section 512(a)(1) of the Code defines the term “unrelated business taxable income” as the gross income derived by any organization from any unrelated trade or business regularly carried on by it, less certain allowable deductions and modifications.

Section 513(a) of the Code defines the term “unrelated trade or business” as any trade or business the conduct of which is not substantially related (aside from the need of such organization for income or funds or the use it makes of the profits derived) to the exercise or performance by such organization of the functions constituting the basis for its exemption.

Section 1.501(c)(3)-1(a)(1) of the Income Tax Regulations (regulations) provides that to be exempt as an organization described in § 501(c)(3), an organization must be both organized and operated exclusively for one or more purposes specified in such section. If an organization fails to meet either the organizational test or the operational test, it is not exempt.

Section 1.501(c)(3)-1(c)(1) of the regulations provides that an organization will be regarded as “operated exclusively” for exempt purposes only if it engages primarily in activities that accomplish one or more of the exempt purposes specified in § 501(c)(3). An organization will not be so regarded if more than an insubstantial part of its activities is not in furtherance of an exempt purpose.

Section 1.501(c)(3)-1(d)(2) of the regulations provides a definition of the term “charitable” as it is used in § 501(c)(3). The term “charitable” is used in its generally accepted legal sense and includes both the advancement of education and the lessening of the burdens of the government. Further, the term “educational” as used in § 501(c)(3), relates both to the instruction or training of the individual for the purpose of improving or developing his or her capabilities and instruction of the public on subjects useful to the individual and beneficial to the community.

Section 1.513-1(d)(2) of the regulations provides that a trade or business is “related” to exempt purposes, in the relevant sense, only where the conduct of the business activities has a causal relationship to the achievement of exempt purposes, and it is “substantially related” only if the causal relationship is a substantial one. For the conduct of trade or business from which a particular amount of gross income is derived to be substantially related to purposes for which exemption is granted, the production or distribution of the goods or the performance of services from which the gross income is derived must contribute importantly to the accomplishment of those purposes.

Rev. Rul. 85-2, 1985-1 C.B. 178, set forth the following criteria for determining whether an organization’s activities lessen the burdens of government: first, whether the governmental unit considers the organization’s activities to be its burden; and second, whether these activities actually lessen the burden of the governmental unit. An activity is a burden of the government if there is an objective manifestation by the governmental unit that it considers the activities of the organization to be its burden. The interrelationship between the governmental unit and the organization may provide evidence that the governmental unit considers the activity to be its burden. Whether the organization is actually lessening the burdens of government is determined by considering all of the relevant facts and circumstances. Rev. Rul. 85-2 held an organization that provides legal advice and training to volunteers who serve as guardian ad litems in juvenile court lessens the burdens of government and is exempt under section 501(c)(3). The juvenile court required the appointment of guardians ad litem. The organization’s training of lay volunteers was an integral part of the government’s program of providing guardians ad litem. The organization actually was lessening the government’s burden because the government could not continue its present program unless it trained lay volunteers itself or appointed attorneys to act as guardians.

Rev. Rul. 85-1, 1985-1 C.B. 177, held an organization that assisted a county’s law enforcement agencies in more effectively policing illegal narcotics traffic lessened the burdens of government and was exempt under section 501(c)(3). The municipality demonstrated that these activities were a part of its burden because the organization funded activities the municipality treats as an integral part of its program to prevent the trafficking of illegal narcotics. The organization actually lessened that burden by enabling the municipality to augment its law enforcement activities in the area of illegal drug traffic without the appropriation of additional governmental funds.

Indiana Crop Improvement Association, Inc. v. Commissioner, 76 T.C. 394, acq., 1981-2 C.B. 1, held an association whose primary activity was the certification of crop seed under State and Federal law was exempt under section 501(c)(3). The association was delegated these functions in accordance with State law. The court concluded the association lessens the burdens of government, finding it “direct assists the U.S. Department of Agriculture in enforcing the standards and procedures established in the regulations under the Federal Seed Act within the State, and provides a public service to Indiana which the State legislature clearly considers to be necessary and appropriate.” 76 T.C. at 398-399.

Professional Standards Review Organizations of Queens County v. Commissioner, 74 T.C. 240 (1980), held a professional standards review organization authorized by the Department of Health, Education, and Welfare lessened the burdens of government under section 501(c)(3). Congress authorized the establishment of independent review organizations to advance the important congressional policy of ensuring the effective, efficient, and economical delivery of health care services to Medicare and Medicaid beneficiaries. 74 T.C. at 245. Congress believed the formation of review organizations was “necessary for the Government to make its Medicare and Medicaid programs cost-effective.” 74 T.C. at 249. Congress determined it was “preferable and appropriate that organizations of professionals undertake review of members of their profession rather than for Government to assume that role,” for which it was “ill equipped.” 74 T.C. at 249. The court concluded the organization lessened the burdens of the federal government. 74 T.C. at 251. See Virginia Professional Standards Review Foundation v. Blumenthal, 466 F. Supp. 1164 (D.D.C. 1979), appeal dismissed., Civ. No. 79-1501 (D.C. Cir. 8/13/1979) (Professional standards review organization was exempt under section 501(c)(3) where its principal purposes were to ensure effective and economical delivery of health care services to patients and reduce unnecessary spending on health care programs).

ANALYSIS

Pursuant to HCERA, the U.S. Government discontinued guaranteeing student loans originated under the FFELP. Under the new law, the U.S. Government now makes student loans directly to borrowers, establishing the provision of student loans as the government’s burden. See PSRO of Queens County (Implementing Medicare and Medicaid programs was a governmental burden); Indiana Crop (Implementing Federal Seed Act standards and procedures was a governmental burden); Rev. Rul. 85-2 (guardian ad litem program was governmental burden); Rev. Rul. 85-1 (policing illegal narcotics traffic was governmental burden).

HCERA provided that the Secretary of Education may award contracts for servicing the federal direct student loans to eligible non-profit service providers. The statute specifically provided that exemption under section 501(c)(3) is one of the ways to be eligible as a non-profit service provider, along with other requirements. Congress enacted HCERA with the expectation the direct loan program would produce substantial savings for the U.S. Government. It specifically provided for section 501(c)(3) organizations to service the new federal direct student loans, aware of the unique and valuable role of non-profit service providers to the program and the beneficial assistance they provided to students. See Professional Standards Review Organizations of Queens County, 74 T.C. at 249 (Review organizations were necessary to make Federal programs cost-effective, and the Government was ill-equipped to assume their role); Indiana Crop Improvement Association, 76 T.C. at 398-399 (organization directly assisted the Federal government enforcing regulatory standards and procedures); Rev. Rul. 85-1 (organization’s activities were an integral part of governmental program); Rev. Rul. 85-2 (organization’s activities were an integral part of governmental program). Therefore, based on all the facts and circumstances, your activities of servicing direct student loans the Department of Education originates under the HCERA further the exempt purpose of lessening the burdens of government.

Ruling #1:

Your activity of servicing student loans the Department of Education originates under the HCERA primarily furthers an exempt purpose under § 501(c)(3).

Ruling #2:

Your activity of servicing direct student loans for the DOE is substantially related to the performance of the functions that constitute the basis of your exemption. Thus, the revenue you generate from this activity will not constitute unrelated business taxable income under §§ 512 and 513.

RULINGS

Based on the foregoing, we rule as follows:

1. Servicing direct student loans originated by the DOE under the HCERA furthers your exempt purposes under § 501(c)(3), and it will not adversely affect your exempt status under § 501(c)(3).

2. The revenue generated from servicing direct student loans originated by the DOE under the HCERA will not constitute unrelated business taxable income under §§ 512 and 513.

This ruling will be made available for public inspection under § 6110 after certain deletions of identifying information are made. For details, see enclosed Notice 437, Notice of Intention to Disclose. A copy of this ruling with deletions that we intend to make available for public inspection is attached to Notice 437. If you disagree with our proposed deletions, you should follow the instructions in Notice 437.
This ruling is directed only to the organization that requested it. Section 6110(k)(3) of the Code provides that it may not be used or cited by others as precedent.

This ruling is based on the facts as they were presented and on the understanding that there will be no material changes in these facts. This ruling does not address the applicability of any section of the Code or regulations to the facts submitted other than with respect to the sections described. Because it could help resolve questions concerning your federal income tax status, this ruling should be kept in your permanent records.

If you have any questions about this ruling, please contact the person whose name and telephone number are shown in the heading of this letter.

In accordance with the Power of Attorney currently on file with the Internal Revenue Service, we are sending a copy of this letter to your authorized representative.

Sincerely,

Michael Seto
Manager, Exempt Organizations
Technical
Enclosure:
Notice 437

FOOTNOTE

1 The definition for an “eligible not-for-profit servicer” includes an entity “(A) that is not owned or controlled in whole or in part by — (i) a for-profit entity; or (ii) a nonprofit entity having its principal place of business in another State; and (B) that — (i) as of July 1, 2009 — (I) meets the definition of an eligible not-for-profit holder under section 1085(p) of this title . . . and (II) was performing, or had entered into a contract with a third party servicer . . . who was performing, student loan servicing functions for loans made under part B of this subchapter; (ii) notwithstanding clause (i), as of July 1, 2009 — (I) is the sole beneficial owner of a loan for which the special allowance rate is calculated under section 1087-1(b)(2)(I)(vi)(II) of this title because the loan is held by an eligible lender trustee that is an eligible not-for-profit holder as defined under section 1085(p)(1)(D) of this title; and (II) was performing, or had entered into a contract with a third party servicer (as such term is defined in section 1088(c) of this title) who was performing, student loan servicing functions for loans made under part B of this title. . . .” 20 U.S.C. § 1087f(a)(4). An eligible not-for-profit holder is defined as “an eligible lender under subsection (d) . . . that is — (A) a State, or a political subdivision, authority, agency, or other instrumentality thereof, including such entities that are eligible to issue bonds described in section 1.103-1 of Title 26, Code of Federal Regulations, or section 144(b) of Title 26; (B) an entity described in section 150(d)(2) of such title that has not made the election described in section 150(d)(3) of such title; (C) an entity described in section 501(c)(3) of such title; or (D) acting as a trustee on behalf of a State, political subdivision, authority, agency, instrumentality, or other entity described in subparagraph (A), (B), or (C), regardless of whether such State, political subdivision, authority, agency, instrumentality, or other entity is an eligible lender under subsection (d).” 20 U.S.C. § 1085(p).

END OF FOOTNOTE



IRS LTR: Change to Board Composition Wouldn't Affect Exempt Status.

The IRS ruled that an organization associated with healthcare facilities operated by a public university wouldn’t lose its section 501(c)(3) exemption or its public charity status as a result of proposed changes that would make the organization’s board of directors identical to the university’s board.

Citations: LTR 201423026

Contact Person: * * *
Identification Number: * * *
Telephone Number: * * *

UIL Number: 501.03-05
Release Date: 6/6/2014
Date: March 12, 2014

Employer Identification Number: * * *

LEGEND:

Date = * * *
Public University = * * *
State = * * *

Dear * * *:

We have considered your ruling request dated February 7, 2014, submitted by your authorized representative, requesting rulings about maintaining your recognition of exemption from federal income taxation and public charity status.

FACTS

You are a nonprofit organization incorporated under the laws of State. On Date, you received recognition of exemption under § 501(c)(3) and were classified as a public charity under §§ 170(b)(1)(A)(iii) and 509(a)(1). You are associated with Public University, a public body created by an act of the State legislature. Public University operates three health care facilities. Your exempt purpose is offering medical care, research and education at these health care facilities. Specifically, you provide patient care, engage in investigative studies, and teach students.
Currently, your board has nineteen members. Nine of those directors are ex-officio members and hold concurrent positions with Public University. The remaining ten directors are members of the general public. All directors serve three-year terms. You are proposing to change the composition of your board of directors. Following your proposed change, the members of your board of directors will be identical to those of the board of Public University. Public University’s board has seventeen members. It has two ex-officio members — State’s Governor and State’s Superintendent of Education. The remaining fifteen members are by appointed by the State’s Governor with the consent of the State Senate. Three appointed members represent the county in which Public University is located. Three represent State at large. Nine represent the nine State Senate districts surrounding the area in which Public University is located.

You will effectuate this change to your board composition by amending your articles of incorporation and bylaws. Also, the members of Public University’s board of directors will resolve to accept their new positions as your directors. None of your new directors will receive compensation from you or any organization related to you. Further, none of your new directors will be related to each other through business or family relationships.

You represent that you are making this change to coordinate your and Public University’s delivery of medical services and to simplify your and Public University’s system of financial reporting. You have represented, and submitted documentation showing, that this change will not alter your purpose, mission, or operations. It will affect your board composition only.

RULINGS REQUESTED

1) That the proposed amendments to your articles of incorporation and by-laws (and their implementation) will not result in revocation of or otherwise adversely affect your exemption under § 501(c)(3).
2) That the proposed amendments to your articles of incorporation and by-laws (and their implementation) will not adversely affect your status as an organization described in §§ 509(a)(1) and 170(b)(1)(a)(iii).

LAW

I.R.C. § 170(b)(1)(A)(iii) describes an organization the principal purpose or functions of which are the providing of medical or hospital care or medical education or medical research.

I.R.C. § 501(c)(3) provides that organizations may be exempted from tax if they are organized and operated exclusively for religious, charitable, scientific, testing for public safety, literary, or educational purposes and “no part of the net earnings of which inures to the benefit of any private shareholder or individual.” I.R.C. § 509(a) provides that an organization exempt under I.R.C. § 501(c)(3) is a private foundation unless the organization is excepted under I.R.C. §§ 509(a)(1), (2), (3), or (4).

I.R.C. § 509(a)(1) provides that an organization described in I.R.C. § 501(c)(3) is other than a private foundation if it is described in I.R.C. § 170(b)(1)(A) (other than in clauses (vii) and (viii)).

Treas. Reg. § 1.170A-9(d)(1) provides that an organization is described in § 170(b)(1)(A)(iii) if —

(i) It is a hospital; and
(ii) Its principal purpose or function is the providing of medical or hospital care or medical education or medical research.

Rev. Rul. 69-545, 1969-2 C. B. 117 compares two hospitals. The first hospital is controlled by a board of trustees composed of independent civic leaders. The hospital maintains an open medical staff, with privileges available to all qualified physicians; it operates a full-time emergency room open to all regardless of ability to pay; and it otherwise admits all patients able to pay (either themselves, or through third party payers such as private health insurance or government programs such as Medicare). In contrast, the second hospital is controlled by physicians who have a substantial economic interest in the hospital. This hospital restricts the number of physicians admitted to the medical staff, enters into favorable rental agreements with the individuals who control the hospital, and limits emergency room and hospital admission substantially to the patients of the physicians who control the hospital. Rev. Rul. 69-545 notes that in considering whether a nonprofit hospital is operated to serve a private interest, the Service will weigh all the relevant facts and circumstances in each case, including the use and control of the hospital. The revenue ruling concludes that the first hospital continues to qualify as an organization described in § 501(c)(3) and the second hospital does not because it is operated for the private benefit of the physicians who control the hospital.
Rev. Rul. 83-157, 1983-2 C.B. 94 states that the following factors indicative that an organization promotes health for the benefit of the community: a board of directors drawn from the community, an open medical staff policy, treatment of persons paying their bills with the aid of public programs like Medicare and Medicaid, and the application of any surplus to improving facilities, equipment, patient care, and medical training, education, and research, indicate that the hospital is operating exclusively to benefit the community.

ANALYSIS

Ruling 1: That the proposed amendments to your articles of incorporation and by-laws (and their implementation) will not result in revocation of or otherwise adversely affect your exemption under § 501(c)(3).

On Date, you received recognition as an organization exempt under § 501(c)(3). You are an organization that provides health care. Your previous recognition of exemption means that the Service determined that you provide health care in a charitable manner and for the benefit of the community. One factor that indicates that an organization provides care in a charitable manner is the composition of its board. See Rev. Rul. 69-545, 1969-2 C. B. 117; Rev. Rul. 83-157, 1983-2 C.B. 94. Currently, nine of your board members are public officials and the remaining ten members are from the general public. The inclusion of several community members on your board indicates that you provide health care for the benefit of the community.

You are proposing to change your board composition such that it will be identical to the board of Public University. Following this change, your board will be made up of State’s Governor, State’s Superintendent of Education, and fifteen individuals are by appointed by the Governor with the consent of the State Senate. These appointed individuals will represent State at large and specified areas within State. Your proposed board will be a community board. Your board members will be public officials and people appointed by public officials to represent certain geographic areas. They will have no family or business relationships to each other. They will serve without receiving compensation. Accordingly, these individuals will represent community rather than private interests. By contrast the board of the hospital found to be non-exempt in Rev. Rul. 69-545 was composed of physicians having economic interest in the organization. Your proposed board is a broad based community board and denotes that you operate for a charitable purpose.

Your proposal will not change the community nature of your board. Further, you represent that the proposed board plan will not affect your mission and operations. Accordingly, your proposal will not adversely affect your exemption under § 501(c)(3).

Ruling 2: That the proposed amendments to your articles of incorporation and by-laws (and their implementation) will not adversely affect your status as an organization described in §§ 509(a)(1) and 170(b)(1)(a)(iii).

On Date, you received recognition as a public charity under §§ 170(b)(1)(a)(iii) and § 509(a)(1). Thus, the Service determined that you are a hospital with a principal purpose of proving medical care, education or research. See Treas. Reg. § 1.170A-9(d)(1). You represented that your proposed change will affect only your board composition, and not your mission and operations. Accordingly, your proposal will not change your recognition under §§ 170(b)(1)(a)(iii) and § 509(a)(1).

RULINGS

1) The proposed amendments to your articles of incorporation and by-laws (and their implementation) will not result in revocation of or otherwise adversely affect your exemption under § 501(c)(3).
2) The proposed amendments to your articles of incorporation and by-laws (and their implementation) will not adversely affect your status as an organization described in §§ 509(a)(1) and 170(b)(1)(a)(iii).

This ruling will be made available for public inspection under section 6110 of the Code after certain deletions of identifying information are made. For details, see enclosed Notice 437, Notice of Intention to Disclose. A copy of this ruling with deletions that we intend to make available for public inspection is attached to Notice 437. If you disagree with our proposed deletions, you should follow the instructions in Notice 437.
This ruling is directed only to the organization that requested it. Section 6110(k)(3) of the Code provides that it may not be used or cited by others as precedent.

This ruling is based on the facts as they were presented and on the understanding that there will be no material changes in these facts. This ruling does not address the applicability of any section of the Code or regulations to the facts submitted other than with respect to the sections described. Because it could help resolve questions concerning your federal income tax status, this ruling should be kept in your permanent records.

If you have any questions about this ruling, please contact the person whose name and telephone number are shown in the heading of this letter.

In accordance with the Power of Attorney currently on file with the Internal Revenue Service, we are sending a copy of this letter to your authorized representative.

Sincerely,

Ronald J. Shoemaker
Manager, Exempt Organizations
Technical Group 2
Enclosure
Notice 437



Illinois – Cloud Computing Receipts Characterized as Services for Sales Factor Apportionment Purposes.

The Illinois Department of Revenue ruled that agreements for information technology hosting and cloud computing are properly characterized as service contracts for Illinois sales factor apportionment purposes. [Illinois Private Letter Ruling IT 14-0003 PLR (4/24/2014)]

Download PDF.

Jun 03, 2014



Shearman & Sterling: Litigation Heats Up in Section 1603 Cash Grant Program for Renewable Energy Projects

Following the 2008 financial crisis, Congress enacted Section 1603 of the American Recovery and Reinvestment Act of 2009, which established a cash grant program for applicants with eligible energy properties. Energy industry participants relied upon the government to calculate the awards in a manner consistent with the calculation of tax credits under Internal Revenue Code section 48, but the government has, in some cases, awarded smaller grants after changing its formula for such calculations. Some energy participants, feeling shortchanged by the government’s methodology, are now suing.

The Origins of the Section 1603 Program

Congress enacted Section 1603 of the American Recovery and Reinvestment Act of 2009 (“the Section 1603 Program”) during the economic recession.1 The 1603 Program reimburses eligible applicants for part of the cost of installing specified energy property used in a trade or business or for the production of income after the energy property is placed in service. An applicant who accepts a Section 1603 grant elects not to claim the energy tax credits under Internal Revenue Code section 48 or the renewable energy production tax credit under Internal Revenue Code section 45 for otherwise qualifying facilities placed into service on or after January 1, 2009.2

The Section 1603 Program created an investment incentive in the tax equity market in response to the reduced demand for investment tax credits that began during the recession. The program had several stated purposes, including preserving and creating jobs, promoting economic recovery, spurring technological advances, and investing in infrastructure and environmental protection. Originally set to expire at the end of 2010, the program was extended through the end of 2011.

Under the Section 1603 Program, the Treasury Department awarded more than 9,000 grants, totaling $18.5 billion.3 Wind energy projects accounted for $12.6 billion of grants awarded, and solar power projects accounted for $4.4 billion.4 Geothermal heat pump, biomass, hydropower, landfill gas, and fuel cell energy properties constituted the other ten percent of grant awards.5

Program Participants and Government Dispute Grant Awards

Controversy has now arisen over certain of the grant awards, and during the past two years several participants in the Section 1603 program have filed suit against the United States alleging violation of the statutory and regulatory obligations of Section 1603. Generally, the plaintiffs in these cases claim that the government paid less than the program mandated because the government changed its basis calculation for the projects, thereby undermining the economic expectations of the participants. Although Treasury is allowing unsatisfied participants to pay back grant awards received under the Section 1603 Program and claim tax credits instead, some participants have chosen to litigate the issue instead.

Legal Basis for Suit

Section 1603(a) generally provides that the Secretary of the Treasury shall provide a grant for reimbursement to each person who applies for such grant and has placed in service specified energy property, subject to certain other conditions. Under section 1603(b), the amount of the grant is the applicable percentage of the basis of the property, which is either thirty or ten percent depending upon the type of property. Treasury promulgated cost basis rules to determine the basis for investment property that are different from the basic rules that apply under Internal Revenue Code section 48.

Blue Heron Properties v. US

On July 24, 2013, Blue Heron Properties, LLC (“BHP”), a company with multiple energy projects, brought suit against the United States in the Federal Court of Claims complaining that the government made grant payments substantially less than the amounts to which BHP was entitled under Section 1603.6 According to the complaint, BHP submitted an application for a grant payment in connection with its project First Brandon Oaks System.7 BHP claimed the full purchase price as a cost basis, and Treasury awarded the full amount requested, $10.50 a watt.8 After BHP purchased three additional solar panel systems at prices between $9.52 and $10.50 a watt, BHP applied for grant payments under Section 1603 for those projects.9 The complaint alleges that BHP met all the program conditions and was therefore entitled to thirty percent of its basis in each project.10 Instead, Treasury only awarded one of the three projects the full grant amount and accepted only $5.56 and $5.43 a watt for the two reduced grant awards.11 The complaint alleges that this is a violation of Section 1603.12

RP1 Fuel Cell LLC v. US

In RP1 Fuel Cell LLC v. US, another grant application that had placed in service two fuel cell power plants in California brought suit against the United States for reduced grant awards.13 The plaintiffs began construction of their fuel cells in 2011 and placed them into service in 2012, within the timeframes specified in Section 1603(a).14 According to the complaint, Treasury, without explanation, awarded a grant payment reduced by $1.6 billion after removing all costs relating to gas conditioning equipment associated with the project.15

Other 1603 Litigation

The litigants in four other Section 1603 cases allege similar harms and focus on the government’s calculation of cost basis. In Vasco Winds, LLC v. US, the grant applicant filed a complaint after the government used a reduced cost basis to calculate the grant aware for its wind farm in California.16 As a result the grant applicant received approximately $6 million less than requested. After being denied a full grant award for their energy facilities, the plaintiffs in Sequoia Pacific Solar I, LLC, v. US17 and Mustang Hills, LLC v. US18 filed a complaint alleging, among other things, that Treasury improperly changed the rules of the Section 1603 Program, reduced grant payments by improperly changing the basis calculation, and undermined the economic assumptions of industry participants. Most recently, the plaintiff in Fire Island Wind LLC v. United States, alleged that the government improperly denied reimbursement to the plaintiff for construction costs associated with the construction of a Doppler Navigation System (“DNS”), in Anchorage Alaska.19 Construction of the DNS was required by the Federal Aviation Administration to obtain approval for the construction of a 17.6 megawatt wind turbine project on Fire Island.

All these cases are still in the early stages of litigation, and it is likely that more plaintiffs will come forward. Grant applications have six years after a grant is paid to file suit.

Report by the Treasury Inspector General for Tax Administration

Presently, the government is not appearing to back down from its tough stance on the Section 1603 Program grants either. On January 31, the Treasury Inspector General for Tax Administration (“TIGTA”) released a report finding significant compliance problems among participants in the energy grants in lieu of tax credits program in its first review of returns claiming Section 1603 grants.20 After examining the returns of 83 taxpayers seeking Section 1603 grants, the IRS’s Small Business/Self-Employed Division found that changes were necessary to 51 of the returns.21 Large Business and International reviewed 16 returns and found significant issues resulting in changes for eight.22

The review’s initial focus was on taxpayers’ 2009 tax returns but has been expanded to include 2010 and 2011 tax returns now, too.23 The stage is set for more litigation.

Footnotes

1 Pub. L. No. 111-5, 123 Stat. 115 (2009).

2 See id.; see also Joint Committee on Taxation, General Explanation of Tax Legislation Enacted in the 111th Congress at 109-110. JCS-2-11 No. 6 (I.R.S.), 2011 WL 940372.

3 Review of Section 1603 Grants in Lieu of Energy Investment Tax Credit, Memorandum for Deputy Commissioner for Services and Enforcement from R. David Holmgren, ref. no. 2014-IE-R006, Dec. 17, 2013, p. 1.

4 Id. at 2.

5 Id. at 2.

6 Compl. filed in Blue Heron Properties, LLC v. United States, No. 1:13-cv-00505 (Fed. Ct. Jul. 24, 2013).

7 Id. at 5-6.

8 Id. at 6.

9 Id. at 6-7.

10 Id. at 7-8.

11 Id. at 7-9.

12 Id. at 9.

13 Comp. No. 1:13-cv-00552 (Fed. Cl. Aug. 6, 2013).

14 Id. at 19.

15 Id. at 13, 19.

16 Compl. No. 1:13-cv-00697 (Fed. Cl. Sept. 18, 2013).

17 Compl. No. 1:13-cv-00139-ECH (Fed. Cl. Feb. 2, 2013).

18 Compl. No. 1:14-cv-00047-TCW (Fed. Cl. Jan. 22, 2014).

19Compl. No. 1:14-cv-403T (Fed. Cl. May 12, 2014).

20 Eric Kroh, “IRS Compliance Review finds Problems with Energy Grants Program.” Tax Analysts, Feb. 3, 2014.

21 Id.

22 Id.

23 Id.

Last Updated: June 2 2014
Article by Douglas R. McFadyen
Shearman & Sterling LLP

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.



S. 2345 Would Exempt Water, Sewage Facility Bonds From Cap.

S. 2345, the Sustainable Water Infrastructure Investment Act of 2013, introduced by Senate Finance Committee member Robert Menendez, D-N.J., would exempt bonds for water and sewage facilities from the volume cap on private activity bonds.

113TH CONGRESS
2D SESSION

S. 2345

To amend the Internal Revenue Code of 1986 to provide that the volume
cap for private activity bonds shall not apply to bonds for
facilities for the furnishing of water and sewage facilities.

IN THE SENATE OF THE UNITED STATES

MAY 15, 2014

Mr. MENENDEZ (for himself and Mr. CRAPO) introduced the following
bill; which was read twice and referred to the Committee on Finance

A BILL

To amend the Internal Revenue Code of 1986 to provide that the volume cap for private activity bonds shall not apply to bonds for facilities for the furnishing of water and sewage facilities.
Be it enacted by the Senate and House of Representatives of the United States of America in Congress assembled,

SECTION 1. SHORT TITLE.

This Act may be cited as the “Sustainable Water Infrastructure Investment Act of 2013”.

SEC. 2. FINDINGS AND PURPOSE.

(a) FINDINGS. — Congress finds the following:

(1) Our Nation’s water and wastewater systems are among the best in the world, providing safe drinking water and sanitation to our citizens.

(2) In addition to protecting the health of our citizens, community water systems are essential to our local economies, enabling industries to achieve growth and productivity that make America strong and prosperous.

(3) Regulated under title XIV of the Public Health Service Act (42 U.S.C. 300f et seq.; commonly known as the “Safe Drinking Water Act”) and the Federal Water Pollution Control Act (33 U.S.C. 1251 et seq.), community drinking water systems and wastewater collection and treatment facilities are critical elements in the Nation’s infrastructure.

(4) Water and wastewater infrastructure is comprised of a mixture of old and new technology. In many local communities across the Nation, the old infrastructure has deteriorated to critical conditions and is very costly to replace. Recent government studies have estimated costs of $500,000,000,000 to $800,000,000,000 over the next 20 years for maintaining and improving the existing inventory, building new infrastructure, and meeting new water quality standards.

(5) The historical approach of funding infrastructure is insufficient to meet the investment needs of the future.

(6) The Federal partnership with State and local communities has played a pivotal role in improving the Nation’s water quality and drinking water supplies. Federal assistance under this partnership has been the linchpin of these improvements.

(7) In light of constrained Federal budgets, the availability of exempt-facility financing represents an important financing tool to help close the gap between funds currently being invested and water infrastructure needs, preserving the Federal partnership.

(8) Providing alternative financing solutions, such as tax-exempt securities, encourages investment in water and wastewater infrastructure that in turn creates local jobs and protects the health of our citizens.

(9) Federally mandated State volume cap restrictions in conjunction with other priorities have limited the use of tax-exempt securities on water and wastewater infrastructure investment.

(10) Removal of State volume caps for water and wastewater infrastructure will accelerate and increase overall investment in the Nation’s critical water infrastructure; facilitate increased use of innovative infrastructure delivery methods supporting sustainable water systems through public-private partnerships that optimize design, financing, construction, and long-term management, maintenance and viability; and provide for more effective risk management of complex water infrastructure projects by municipal utility and private sector partners.

(b) PURPOSE. — The purpose of this Act is to provide alternative financing for long-term infrastructure capital investment programs, and to restore the Nation’s safe drinking water and wastewater infrastructure capability and protect the health of our citizens.

SEC. 3. EXEMPT-FACILITY BONDS FOR SEWAGE AND WATER SUPPLY FACILITIES.

(a) BONDS FOR WATER AND SEWAGE FACILITIES EXEMPT FROM VOLUME CAP ON PRIVATE ACTIVITY BONDS. — Paragraph (3) of section 146(g) of the Internal Revenue Code of 1986 is amended by inserting “(4), (5),” after “(2),”.

(b) CONFORMING CHANGE. — Paragraphs (2) and (3)(B) of section 146(k) of the Internal Revenue Code of 1986 are both amended by striking “(4), (5), (6),” and inserting “(6)”.

(c) EFFECTIVE DATE. — The amendments made by this section shall apply to obligations issued after the date of the enactment of this Act.



IRS LTR: VEBA's Exemption Not Jeopardized.

The IRS ruled that a voluntary employees’ beneficiary association’s tax-exempt status will not be jeopardized when it provides benefits to active and retired staff of a labor union’s affiliates who are not members of the union or its affiliates.

Citations: LTR 201422025

Contact Person: * * *
Identification Number: * * *
Telephone Number: * * *

UIL: 501.09-00, 501.09-04
Release Date: 5/30/2014
Date: March 6, 2014

Employer Identification Number: * * *

LEGEND:

Association = * * *
x = * * *

Dear * * *:

We have considered your ruling request dated June 26, 2012, as amended on January 2, 2014, concerning your proposal to provide welfare benefits to certain actively employed and retired non-member staff of the state and local affiliates of Association.

FACTS

You are a voluntary employees’ beneficiary association (VEBA) exempt under § 501(c)(9) of Internal Revenue Code. The Association established and controls you. You provide certain life, accidental death and dismemberment, and other insurance benefits to the Association’s members.

The Association, your sponsor, is a national labor union recognized as exempt under § 501(c)(5). The Association operates through a network of affiliated state and local associations. The Association charters these affiliates and requires that they meet certain standards in order to retain their affiliation with Association. The Association requires members of its state and local affiliates to join the Association, unless they are otherwise ineligible. Because of this structure, nearly all members of the Association’s state and local affiliates (99%) are also members of the Association.

You propose to amend your plan to allow participation by certain actively employed and retired staff of the Association’s state and local affiliates (“proposed participants”). The proposed participants are not members of, and are not eligible for membership in, the Association or its state and local affiliates. You estimate the number of proposed participates to be x. You certify that, on at least one day of each quarter of your taxable year, 90 percent of your total membership consists of members of the Association and its affiliates.

RULINGS REQUESTED

You have requested the following rulings:

1. The participation of non-member actively employed and retired staff of the Association’s state and local affiliates will not jeopardize your exempt status under § 501(a) as an organization described in § 501(c)(9).
LAW

I.R.C. § 501(c)(9) exempts VEBAs from federal income if no part of the net earnings of such association inures (other than through such payments) to the benefit of any private shareholder or individual tax. A VEBA provides for the payment of life, sick, accident, or other benefits to the members of such association or their dependents or designated beneficiaries.
Treas. Reg. § 1.501(c)(9)-1 provides that, for an organization to be described in § 501(c)(9), it must be an employees’ association; membership in the association must be voluntary; the organization must provide for the payment of life, sick, accident, or other benefits to its members or their dependents or designated beneficiaries, and substantially all of its operations are in furtherance of providing such benefits; and no part of the net earnings of the organization can inure, other than by payment of the permitted benefits to the benefit of any private shareholder or individual.

Treas. Reg. § 1.509(c)(9)-2(a)(1) provides that the membership of a VEBA must consist of individuals who become entitled to participate by reason of their being employees and whose eligibility for membership is defined by reference to objective standards that constitute an employment-related common bond among such individuals. Typically, those eligible for membership in a VEBA are defined by reference to a common employer (or affiliated employers), to coverage under one or more collective bargaining agreements (with respect to benefits provided by reason of such agreement(s)), to membership in a labor union, or to membership in one or more locals of a national or international labor union. For example, membership in VEBA might be open to all employees of a particular employer, or to employees in specified job classifications working for certain employers at specified locations and who are entitled to benefits by reason of one or more collective bargaining agreements. In addition, employees of one or more employers engaged in the same line of business in the same geographic locale will be considered to share an employment-related bond for purposes of an organization through which their employers provide benefits. Employees of a labor union also will be considered to share an employment-related common bond with members of the union, and employees of a VEBA will be considered to share an employment-related common bond with members of the VEBA. Whether a group of individuals is defined by reference to a permissible standard or standards is a question to be determined with regard to all the facts and circumstances, taking into account the guidelines set forth in this paragraph. Exemption will not be denied merely because the membership of an association includes some individuals who are not employees (within the meaning of § 1.501(c)(9)-2(b)), provided that such individuals share an employment-related bond with the employee-members. Such individuals may include, for example, the proprietor of a business whose employees are members of the association. For purposes of the preceding two sentences, an association will be considered to be composed of employees if 90 percent of the total membership of the association on one day of each quarter of the association’s taxable year consists of employees (within the meaning of § 1.509(c)(9)-2(b)).

Treas. Reg. § 1.509(c)(9)-2(b) provides that whether an individual is an employee is determined by reference to the legal and bona fide relationship of employer and employee. The term employee includes the following:

(1) An individual who is considered an employee:

(i) For employment tax purposes under subtitle C of the Internal Revenue Code and the regulations thereunder, or
(ii) For purposes of a collective bargaining agreement,

whether or not the individual could qualify as an employee under applicable common law rules. This would include any person who is considered an employee for purposes of the Labor Management Relations Act of 1947, 61 Stat. 136, as amended, 29 U.S.C. 141 (1979).

(2) An individual who became entitled to membership in the association by reason of being or having been an employee. Thus, an individual who would otherwise qualify under this paragraph will continue to qualify as an employee even though such individual is on leave of absence, works temporarily for another employer or as an independent contractor, or has been terminated by reason of retirement, disability or layoff. For example, an individual who in the normal course of employment is employed intermittently by more than one employer in an industry characterized by short-term employment by several different employers will not, by reason of temporary unemployment, cease to be an employee within the meaning of this paragraph.

(3) The surviving spouse and dependents of an employee (if, for purposes of the 90-percent test of § 1.501(c)(9)-2(a)(1) they are considered to be members of the association).

In Water Quality Asso. Employees’ Benefit Corp. v. United States, 795 F.2d 1303 (7th Cir. 1986), the court invalidated a regulation under § 501(c)(9) that required all employees to be of the “same geographic locale.” Nonetheless, the court confirmed “[t]hat the quintessential element of a section 501(c)(9) tax-exempt VEBA is the commonality of interests among its employee members.”

ANALYSIS

Your information establishes that you are a VEBA recognized under § 501(c)(9) providing certain welfare benefits to the members of the Association. You propose to amend your governing instrument to provide benefits to certain active and retired staff of the Association’s state and local affiliates who are not members of the Association or its state and local affiliates (“proposed participants”).

The membership of a VEBA must consist of individuals: (1) who became entitled to participate by reason of their being employees; and (2) whose eligibility for membership is defined by reference to objective standards that constitute an employment-related common bond among such individuals. Treas. Reg. § 1.509(c)(9)-2(a)(1). The proposed participants are all active or retired employees of the Association’s state and local affiliates. Treas. Reg. § 1.501(c)(9)-2(b). Thus, the issue is whether the proposed participants share an employment-related common bond with the members of the Association and its state and local affiliates. Even though the proposed participants are not members of the Association, they share an employment-related common bond with members of the Association and with members of the state and local affiliates of the Association.

The purpose of requiring an employment-related common bond is to evidence “a commonality of interests among [the VEBA’s] employee members.” Water Quality Assoc. Employees’ Benefit Corp. v. United States, 795 F.2d 1303 (7th Cir. 1986). The regulations list several categories of individuals that “will be considered” to share an employment related common bond:

Employees of one or more employers engaged in the same line of business in the same geographic locale;
Employees of a labor union with the members of that labor union;
Employees of a VEBA with the members of that VEBA.

Treas. Reg. § 1.501(c)(3)-2(a)(1). The same commonality of interests that exists between the employees of the labor union or VEBA and its respective members exists between the proposed participants and the members of the Association’s state and local affiliates. Accordingly, the proposed participants share an employment-related common bond with the members of the state and local affiliates who are also the members of the Association.

CONCLUSION

Based on the foregoing, we rule as follows:

1. The participation of non-member actively employed and retired staff of the Association’s state and local affiliates will not jeopardize your exempt status under § 501(a) as an organization described in § 501(c)(9).

This ruling is based on the representation that at least 90% of your total membership consists of members the Association and its state and local affiliates on one day of each quarter of your taxable year. See Treas. Reg. § 1.501(c)(9)-2(a)(1).

This ruling will be made available for public inspection under section 6110 of the Code after certain deletions of identifying information are made. For details, see enclosed Notice 437, Notice of Intention to Disclose. A copy of this ruling with deletions that we intend to make available for public inspection is attached to Notice 437. If you disagree with our proposed deletions, you should follow the instructions in Notice 437.

This ruling is directed only to the organization that requested it. Section 6110(k)(3) of the Code provides that it may not be used or cited by others as precedent.

This ruling is based on the facts as they were presented and on the understanding that there will be no material changes in these facts. This ruling does not address the applicability of any section of the Code or regulations to the facts submitted other than with respect to the sections described. Because it could help resolve questions concerning your federal income tax status, this ruling should be kept in your permanent records.

If you have any questions about this ruling, please contact the person whose name and telephone number are shown in the heading of this letter.

In accordance with the Power of Attorney currently on file with the Internal Revenue Service, we are sending a copy of this letter to your authorized representative.

Sincerely,

Theodore Lieber
Manager, Exempt Organizations
Technical Group 3
Enclosure
Notice 437



IRS Further Extends Application of Streamlined E/O Process.

The IRS Tax-Exempt and Government Entities Division has issued a memorandum (TEGE-07-0514-0014) further extending a streamlined application process to cases processed by the IRS’s exempt organizations rulings and agreements employees, including exempt organizations technical and guidance employees.
The IRS developed the streamlined application process using Lean Six Sigma Organization concepts described in a prior memo (TEGE-07-0214-02) that applied to cases processed by the IRS’s exempt organizations determinations and quality assurance units.

MEMORANDUM FOR EXEMPT ORGANIZATIONS TECHNICAL UNIT
AND EXEMPT ORGANIZATIONS GUIDANCE UNIT

DEPARTMENT OF THE TREASURY
INTERNAL REVENUE SERVICE
WASHINGTON, D.C. 20224

May 23, 2014

Control No: TEGE-07-0514-0014
Affected IRM: IRM 7.29.3
Expiration Date: May 23, 2015

FROM:

Stephen A. Martin /s/ Stephen A. Martin
Acting Director, Rulings and Agreements, Exempt Organizations

SUBJECT:

Streamlined Processing Guidelines for Cases Extended to All EO R&A Employees

To assist in the processing and review of applications, the streamlined process developed using the LSSO concepts and discussed in TEGE-07-0214-02 (February 28 memo) is now extended to all of Exempt Organizations Rulings and Agreements, including Exempt Organizations Technical (EOT) and Exempt Organizations Guidance (EOG). This modification is made in the interest of fair and efficient tax administration.

Specialists in EOT and EOG will receive training on the streamlined concepts developed during the LSSO process (see attachment to February 28 memo). The training includes assessing risk and using paragraphs in notices developed by the LSSO team (see attachment to February 28 memo). To further assist in the implementation of the LSSO pilot, EOT and EOG employees will follow and implement the following procedures effective upon issuance of this memo:

1. Specialists will use Letter 1312 (with any necessary return address modifications) when corresponding with organizations.
2. Specialists will use the paragraphs as described in the attachment (to February 28 memo) and where appropriate for Letter 1312.
3. The inventory will be allocated among specialists based on the number selected to work the cases.
4. The specialists will work the cases to completion using the LSSO concepts.

The contents of the memorandum will be incorporated into IRM 7.29.3.
Please contact the Senior Manager, Rulings and Agreements, Technical with any questions regarding the application of this memorandum.

cc:
www.irs.gov

Citations: TEGE-07-0514-0014



Success-Based Fee Safe Harbor Not Limited to Investment Bankers.

Taxpayers can include success-based fees paid to professionals other than just investment bankers when making a safe harbor election for allocating such fees paid in business acquisitions or reorganizations, an IRS official said May 29.

The safe harbor is available as long as the payment adheres to the definition of a success-based fee in Rev. Proc. 2011-29, 2011-18 IRB 746 , and meets the other requirements, Scott Dinwiddie, special counsel, IRS Office of Associate Chief Counsel (Income Tax and Accounting), said at a Federal Bar Association insurance tax seminar in Washington.

Rev. Proc. 2011-29 offers taxpayers a simplified method for allocating success-based fees paid in transactions described under reg. section 1.263(a)-5(e)(3) that contain both activities that facilitate a covered transaction and those that do not. In lieu of maintaining the supporting documentation required by the regulation, taxpayers electing the safe harbor can treat 70 percent of the success-based fee as an amount that does not facilitate the transaction. The remaining portion of the fee must be capitalized as an amount that does facilitate the transaction.

Practitioners attending a panel on capitalization at the seminar said that though companies have historically paid success-based fees to investment bankers, they have seen a recent increase in such fees paid to attorneys.

In a July 2012 legal memorandum (ILM 201234027), the IRS concluded that nonrefundable milestone payments are not success-based fees and do not qualify for the safe harbor. However, in two later directives (LB&I-04-0413-002 ; LB&I-04-0114-001 ), the IRS Large Business & International Division told examiners not to challenge a taxpayer’s treatment of eligible milestone payments for investment banking services made or incurred in a covered transaction under reg. section 1.263(a)-5(e)(3) regarding a success-based fee if the requirements are met. Jennifer Kennedy of PricewaterhouseCoopers LLP said the LB&I directives do not appear to afford the same treatment to milestone payments made to attorneys.

Dinwiddie said the directives’ limitation to only investment banking payments may create some tension for practitioners. However, he said, LB&I’s exam function has the authority to determine that it doesn’t want to pursue those fees for reasons of administrative convenience as long as the taxpayer is otherwise in compliance. The directives are likely of limited scope because they reflect the issues field agents are actually dealing with and “where the dollars are,” Dinwiddie said.

In several recent letter rulings, such as LTR 201405010 and LTR 201338009, the IRS granted a taxpayer an extension of time to file the mandatory statement regarding the election to use the safe harbor method of allocating success-based fees. Dinwiddie said that in those cases the taxpayers simply forgot to attach the election statement but that they deducted 70 percent in accordance with the safe harbor. He said that while the IRS would consider similar relief for a taxpayer that had neither attached the statement nor taken the deduction on its tax return, it would be a much harder case for the taxpayer to make.

by Jaime Arora



District Court Holding 'Eviscerates' Work Product Protection.

A district court holding that the work product doctrine does not protect a tax memo prepared by an accounting firm from disclosure to the IRS “eviscerates” the doctrine, a practitioner told Tax Analysts May 29.

Rachel Leigh Partain of Caplin & Drysdale said the analysis by the U.S. District Court for the Southern District of New York in its May 28 holding in Schaeffler v. U.S., No. 1:13-cv-04864 (S.D.N.Y. 2014) was hard to comprehend.

“Frankly, I don’t understand how work product exists after this opinion,” Partain said. “I don’t know what would satisfy this court that a tax memo is work product.”

In Schaeffler, the court denied the petitioner’s motion to quash an IRS administrative summons on the grounds that it called for privileged materials. As part of a complex debt refinancing and corporate restructuring done to address solvency issues, the Schaeffler Group, a German manufacturer, hired EY to provide it with tax advice on the U.S. tax implications of the transaction. EY prepared tax memoranda and in accordance with an agreement it shared its analyses with a consortium of banks that had financed the original transaction that was being refinanced and restructured.

In the agreement, both parties expressed a desire to share privileged, protected, and confidential documents and analyses without waiving those privileges. As part of the refinancing, the banking consortium also agreed to subordinate its claims to Schaeffler Group owner Georg F.W. Schaeffler’s personal tax liabilities and provide an additional line of credit to pay the liabilities. Also, the parties agreed that the consortium would have the opportunity to advise on any contesting or settlement of a tax dispute, which the taxpayer expected was possible at the earliest planning stages of the refinancing and restructuring.

Regarding the work product doctrine, the court held that although the protection was not waived after disclosure with the consortium because of the parties’ similar interests as well as the contractual obligation to keep the information confidential, the privilege still did not apply. The court reasoned that the EY tax memo would have been created in an essentially similar form had litigation not been expected. The fact that the memo weighed the chances of success in court for some tax positions did not indicate that the document would have been created differently, the court held.

Partain took exception to the court’s rationale.

“This court treats a tax memo as a document that would have been prepared for other reasons,” Partain said. “The court said the taxpayer would have received a 321-page memo regardless of whether it anticipated being audited or not. Not only that, the memo would have looked exactly the same.” Partain added that it is uncommon for taxpayers to receive a tax memo of such a length and form unless they expect litigation.

The court cited Circular 230’s stipulation that tax practitioners not allow the possibility that a tax return will remain unaudited to affect the advice they give.

Judge Gabriel W. Gorenstein said in his opinion, “When tax practitioners give advice to clients, they must ignore the actual possibility of an audit — and, by extension, litigation — in opining on the tax implications of a transaction. Thus, when providing legal advice on the tax treatment of the restructuring and refinancing transactions, the Ernst & Young advisors had a responsibility to consider in full the relevant legal issues regardless of whether they anticipated an audit and ensuing litigation with the IRS.”

Partain said that the court’s interpretation of Circular 230 is incorrect. Circular 230 stands for the proposition that an adviser cannot “take the audit lottery into account” when providing tax advice to a client, she said.

Under Circular 230, an adviser has to assume the taxpayer will be audited, Partain said. “The fact that this taxpayer obtained a Circular 230-compliant memo rather than a non-compliant memo demonstrates that the memo was prepared because of the anticipation of audit and litigation,” she said.

Does Not Comport With Adlman

Partain said that because the court’s holding does not comport with the liberal standard of work product protection enunciated in United States v. Adlman, 134 F.3d 1194, 1196 (2d Cir. 1998) , she would not be surprised if the decision was overturned on appeal. Adlman holds that a document used for other purposes can still receive work product protection if it is prepared in such form because of the prospect of litigation, Partain said.

Robin L. Greenhouse of McDermott Will & Emery LLP said that although the court used the language of Adlman in setting forth the legal standard, it appeared to be applying the Fifth Circuit’s narrower “primarily-to-assist-in-litigation” standard when determining if a document should be afforded protection. That standard, however, was rejected by the Second Circuit in Adlman.

The Schaeffler court “is looking for some sort of memo that addresses litigation strategy,” Greenhouse said. “For example, it would say, ‘If we go to litigation, we will move for summary judgment, or we are going to do this discovery.'”

When the Schaeffler court is applying the portion of Adlman that says if a document would have been prepared in essentially the same way then it is not work product, what Adlman is really referring to is business documents, Greenhouse said. Such documents might include a step plan, but not a tax memo that addresses the likelihood of success on the merits, she said.

Although the court’s opinion could be seen as being limited by the facts and circumstances, if it was to be applied more broadly it could mean that the work product doctrine and the attorney-client privilege were mutually exclusive, which is clearly wrong and contrary to the Adlman case, Greenhouse said.

Attorney-Client Privilege Waived

Regarding the attorney-client privilege, the court held that although the privilege is not waived when disclosures are made to parties who are engaged in a common legal enterprise, which is known as the common interest rule, that rule does not apply to a relationship that is mainly an economic one, as was the case in Schaeffler, and therefore that privilege likewise does not apply.

The consortium’s “enormous stake” in the tax consequences of Schaeffler’s refinancing and restructuring did not equate to a common interest and therefore the disclosure of documents to the consortium waived the privilege, the court said.

“It is not enough that the Bank Consortium had a desire for Schaeffler to succeed in a dispute with the IRS. What is lacking is any common legal stake in Schaeffler’s putative litigation with the IRS. If the Bank Consortium could have been named as a co-defendant in the anticipated dispute with the IRS, the result would undoubtedly be different,” Gorenstein said.

The court likewise gave no credence in terms of its application to the attorney-client privilege to the agreement the consortium and the Schaeffler Group made before the litigation that sought to preserve privilege while sharing tax memoranda.

Partain said that although the case likely does not move the needle on common legal interest rule, given that not many favorable common legal interest decisions exist, every decision helps to further refine the parameters of the waiver exception.

The Schaeffler decision comes on the heels of AD Investment 2000 Fund LLC v. Commissioner, 142 T.C. No. 13 (2014) . In that decision, the Tax Court held that taxpayers forfeit the protection of attorney-client privilege on tax opinion letters from a law firm if they seek to avoid accuracy-related penalties by asserting affirmative defenses of good faith and state of mind.

by Andrew Velarde



IRS' TEB Office: Village Center CDD Ruling Should Be Retroactive.

The Internal Revenue Service’s tax-exempt bond office is arguing there should be retroactive application of the chief counsel office’s technical advice memorandum that concluded the Village Center Community Development District in Florida is not qualified to issue tax-exempt bonds.

The ruling, if it stands and is retroactive, “would render taxable the interest on some $426 million of bonds” issued from 1993 to 2004, the Village Center CDD has told TEB.

The TAM, issued in May 2013, found that the CDD is not a political subdivision for purposes of issuing tax-exempt bonds because its board is, and always will be, controlled by the developer rather than publicly-elected officials.

The CDD opposes the conclusion, but said that even if the TAM is upheld, it should be applied prospectively. The CDD claims TEB mischaracterized the basis upon which it is seeking prospective application.

The IRS chief counsel’s office has to decide whether it will grant the district’s request for relief from the TAM being applied retroactively. Ordinarily, TAMs are applied retroactively, but the IRS has discretionary authority to prescribe they only be applied in the future.

If the chief counsel’s office denies the district’s request, a years-long audit of the CDD’s bonds will continue. If the IRS concludes the audit and determines the bonds are taxable, the district can appeal the ruling to the agency’s Office of Appeals. If the appeals office also finds the bonds to be taxable, the CDD will want to pursue litigation in court, said Richard Chirls, a partner at Orrick, Herrington & Sutcliffe in New York. Chirls is working with Perry Israel, a lawyer with his own practice in Sacramento, Calif., on the Village Center case. Israel represents the Village Center CDD and Chirls represents a related CDD.

The Village Center CDD’s request for relief is not only significant for it, but is also important for other districts and the broader municipal finance community, Chirls said. If the chief counsel’s office decides that the TAM only will be applied prospectively, the market would have comfort that future guidance from the Treasury Department on the definition of a political subdivision would be forward looking, he said.

The IRS and Treasury has put the definition of a political subdivision on its priority guidance plan.

Last summer, the CDD asked the IRS to reconsider the TAM, but the IRS denied this request. Additionally, in August 2013, the district requested relief under Internal Revenue Code section 7805(b) that the TAM not be applied retroactively, and it provided supplements to this request in October and November.

TEB said last month that it disagreed that the TAM should be applied prospectively. TEB said the CDD has to show why its situation is so unique that it deserves to be granted relief from being applied retroactively, but it has not met its burden of proving that there are rare or unusual circumstances. Instead, TEB believes the district was arguing that the TAM was wrong, essentially re-raising the request to reconsider the TAM that was already denied.

In a reply to TEB sent to that office and the chief counsel’s office on May 20, the CDD said that TEB incorrectly characterized its basis for requesting relief.

For the purpose of the request for relief only, the CDD will accept that the TAM was correct. However, the district said it relied on existing IRS practice and published positions at the time it issued its bonds, and the TAM applies a new theory. Moreover, applying this theory retroactively would be a rare and unusual circumstance that “would work inequitable results,” the CDD said.

The TAM concludes that the CDD is not a political subdivision because it’s not a division of the state. But when authorities have discussed whether an entity is a division of a state, they haven’t required it to be answerable to a general public electorate. Instead, they have discussed other factors such as the public purpose of the entity and the treatment of it as a “public body corporate” by state law, which the district satisfies, the CDD said.

The CDD noted that a National Association of Bond Lawyers review of more than 250 private-letter rulings found that only one even suggests that control by an electorate was relevant to determining whether an issuer is a political subdivision. However, in that ruling, accountability to an electorate was not identified as a necessary factor.

The CDD acknowledges that it is not enough to show it relied on previous IRS rulings to get relief, and that it also must show that applying the TAM retroactively would be inequitable. But that is the case in this circumstance, the CDD said.

The district noted that the IRS had previously audited some of its bonds and upheld their tax-exemption. Also, audits of other “landowner-controlled” districts have closed with no change to the bonds’ tax-exempt status. “To apply a new interpretation of the requirement of control that requires that the entity be answerable to a general electorate would, in light of the past practice, work an inequitable result upon not only the [CDD], but also its nearly 100,000 residents and the hundreds, if not thousands, of holders of its bonds,” the district said.

BY NAOMI JAGODA
MAY 23, 2014 4:12pm ET



Register for the Form 990-N and 990-EZ Filing Tips Webcast.

Thursday, May 29 – 2 p.m. Eastern Time

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To receive CE credit (and a certificate of completion) you must view the presentation for a minimum of 50 minutes.

Register for this presentation.



IRS Releases Draft Form 990-EZ for 2014.

The IRS has released draft Form 990-EZ, “Short Form, Return of Organization Exempt From Income Tax.”

 



IRS Announces TE/GE Advisory Committee Meeting, New Members.

The IRS has announced (IR-2014-65) that its Advisory Committee on Tax-Exempt and Government Entities plans to hold a public meeting June 11 to present its recommendations to agency leaders on employee retirement plans; tax-exempt organizations; tax-exempt bonds; and federal, state, local, and Indian tribal governments. Ten newly appointed members of the panel will also be introduced at the meeting.

May 21, 2014

WASHINGTON — The Internal Revenue Service’s Advisory Committee on Tax Exempt and Government Entities (ACT) will hold a public meeting on June 11, when the panel will submit its annual reports and recommendations to senior IRS executives.Ten newly appointed members of the panel (listed below) will also be introduced at the public meeting. They will begin two-year terms and join 10 returning members.

The ACT includes external stakeholders and representatives who deal with employee retirement plans; tax-exempt organizations; tax-exempt bonds; federal, state, local and Indian tribal governments. ACT members are appointed by the Secretary of the Treasury and generally serve two-year terms. They advise the IRS on operational policy and procedural improvements.

At the public meeting, five ACT project teams will present the following five reports that include recommendations on:

The ACT was established under the Federal Advisory Committee Act to provide an organized public forum for discussion of relevant issues affecting the tax exempt and government entities communities.The ACT’s public meeting will begin at 9:30 a.m. EDT on June 11, 2014, at the IRS headquarters at 1111 Constitution Ave. NW, Washington, D.C. The 2014 ACT reports will be available on IRS.gov on the day of the meeting.

Due to limited seating and security requirements, members of the public interested in attending the public meeting should call Cynthia PhillipsGrady to confirm their attendance. She can be reached at 202-317-8782 (not a toll-free call). Attendees must have photo identification and are encouraged to arrive at least 30 minutes before the session begins.

The 10 new members of the ACT are listed below and grouped by their relevant project team:

Employee Plans

Christopher W. Shankle, Shreveport, La.

Shankle is a Retirement Services Specialist at Capital One in Shreveport. He works on a broad array of employee benefits issues, including retirement plan administration, testing and disclosure. For the last five years, he has led an American Institute of Certified Public Accountants (AICPA) technical resource panel on employee benefit plans monitoring legislative and regulatory activity. Shankle has been involved in numerous outreach initiatives on employee benefits issues. He has a bachelor’s degree in accounting from the University of Mississippi and is a licensed CPA in Mississippi and Louisiana.

Matthew I. Whitehorn, Philadelphia

Whitehorn is a partner and chair of the employee benefits group at Dilworth Paxton in Philadelphia. He has more than 25 years of experience working with qualified and non-qualified plans including 457 plans, deferred compensation plans and 403(b) plans. Whitehorn chairs the Philadelphia Bar Association’s employee benefits committee. Whitehorn has a B.A. in History from Johns Hopkins University, a J.D. from Villanova University and an LL.M. in Taxation from Temple University School of Law.

Exempt Organizations

Amy C. Madsen, Baltimore

Madsen is the director of standards at the Excellence Institute, a program of the Maryland Association of Nonprofit Organizations. She is involved in education and has experience with small/medium-size exempt organizations. Madsen received her Bachelor of Arts degree at Virginia Polytechnic Institute and State University, and her Masters of Arts in Policy Studies at Johns Hopkins University.

Andrew Watt, Arlington, Va.

Watt is the president and CEO of the Association of Fundraising Professionals, based in Arlington. AFP is a 30,000-member association of individuals who generate philanthropic support for nonprofit organizations. From 1993 to 2005 Watt was employed by a similar organization in Britain. He has international experience, fundraising expertise and experience with small/medium nonprofits. He received his B.A. at the University of Edinburgh.

Government Entities: Federal, State and Local Governments

David P. Augustine, San Francisco

Augustine is currently serving as Tax Collector under the Office of Treasurer and Tax Collector for the city/county of San Francisco. Augustine oversees 125 employees encompassing four operating sections: Business Tax, Property Tax, Legal and the Bureau of Delinquent Revenue. He has more than 10 years of professional experience, including legal experience in the municipal finance/bond arena, and is an active member of the Government Finance Officers Association. He has also received several awards for his work in developing new business practices. Augustine received his J.D. from Stanford University Law School in 2002 and a certificate from the Harvard University Kennedy School of Government — Executive Education.

Dean J. Conder, Denver

Conder is the Deputy State Social Security Administrator for the State of Colorado and has more than 13 years of experience working with state and local governments on FICA tax compliance matters and related training. He is a member of the National Conference of State Social Security Administrators and serves as its training and succession planning chairperson. He co-authored an article on “Common Errors in State and Local Government FICA and Public Retirement System Compliance,” which was published in the Government Finance Review (GFOA) in August 2009. He has also served as a state level board member for the state’s Section 457 retirement plan. Conder previously served on the IRS Taxpayer Advocacy Panel. He is a past president of the National Association of State Social Security Administrators. Conder holds a M.S. degree from the University of Denver College of Law.

Vandee V. DeVore, Jefferson City, Mo.

DeVore is the Deputy State Social Security Administrator for the State of Missouri and has more than 25 years of government experience, including experience as an accountant, auditor, payroll manager and Assistant Director, Division of Accounting. As the Assistant Director, Division of Accounting, DeVore oversaw and managed statewide payroll, including tax withholding, reporting and reconciliations, Social Security Administration and statewide employee benefit budget preparation. As the Deputy State Social Security Administrator, DeVore acts for the state with respect to its responsibilities for maintaining and administering the provisions of the state’s Section 218 agreement/modifications and the proper application of Social Security and Medicare coverage. She is an active member of the National Conference of State Social Security Administrators and is currently an officer. DeVore is also an adjunct instructor of governmental and non-profit accounting at Columbia College in Missouri. She has a B.A. degree in accounting from William Woods College in Missouri and a M.B.A. from Columbia College.

Government Entities: Indian Tribal Governments

Stefani A. Dalrymple, Fairbanks, Alaska

Dalrymple is a CPA and owner of Yukon Accounting & Consulting in Fairbanks. For the past 10 years, she has worked primarily with the Native Alaskan villages and organizations in rural Alaska to ensure compliance with federal and state tax and accounting requirements. Stefani has also served directly as a tribal government employee in the capacities of both Fiscal Officer and Payroll Manager. Dalrymple earned her Bachelor of Science degree in Accounting at the University of Alaska Fairbanks.

Tino Batt, Fort Hall, Idaho

Batt is a member of the Fort Hall Business Council, the governing body of the Shoshone-Bannock Tribes of Idaho. He has served in the appointed position of Tribal Treasurer since 2009. In this position, Batt is involved in monitoring the financial management and accounting practices of all tribal entities operating within the tribal government structure. Batt also serves on the Board of Directors for the Native American Bank and has served since 2005 as a volunteer with the Volunteer Income Tax Assistance (VITA) program. In addition, he represents the Shoshone-Bannock Tribes at the Tribal Interior Budget Council (TIBC), which provides a forum and process for tribes and federal officials to work together in developing annual budget requests for Indian programs in the Department of Interior. Batt has a Bachelor of Science degree in human resource/corporate training and development from Idaho State University.

Government Entities: Tax Exempt Bonds

Floyd Newton III, Atlanta

Newton is a partner at King & Spalding in Atlanta in the public finance practice. He has more than 30 years of broad experience with tax-exempt bonds. Newton is an active member of the ABA Tax Section 103 Committee and the National Association of Bond Lawyers. He was President of NABL in 1998-1999 and served on NABL’s Board of Directors from 1994-2000. Newton received a Bachelor’s degree, magna cum laude, from Princeton University, and received a Juris Doctorate, magna cum laude, from the University of Georgia Law School.

ACT Members Continuing on the Committee in 2014

Employee Plans

Exempt Organizations

Indian Tribal Governments

Tax Exempt Bonds

 



Wyden’s Build America Bonds Reboot Relies on Cities: Muni Credit.

On paper, Senator Ron Wyden’s idea to resurrect the Build America Bonds program would go a long way toward fixing the nation’s crumbling highways and bridges.

The federally subsidized municipal bonds created in the 2009 U.S. economic stimulus proved popular with Wall Street investors and went on to finance almost $190 billion of public-works projects. Now, as Wyden tries to jump-start debate on long-term highway funding, he’s struggling to gain traction.

Even with benchmark municipal yields at 11-month lows, localities are selling fewer bonds as they mend their finances after the recession sapped revenue. The federal government let the Build America Bonds program expire at the end of 2010 and later scaled back the 35 percent subsidy to issuers as part of broader spending cuts.

“Many governments were burned pretty badly,” Steve Benjamin, mayor of Columbia, South Carolina, said in an interview. “The confidence is just not there.”

A reboot of Build America Bonds would take a large enough federal subsidy to entice states to run up debt after the recession, said Scott Pattison executive director of the National Association of State Budget Officers.

Fresh Memories

“The memory is still pretty fresh,” Pattison said in a telephone interview. “The sweetener would have to be pretty significant.”

Wyden, an Oregon Democrat who runs the Senate Finance Committee, has been pitching ideas to finance a six-year measure boosting infrastructure spending and replenish the U.S. Highway Trust Fund. That pool may not be able to meet its financial obligations as early as July. He said last week that while he hasn’t decided on an approach, it may include boosting the 18.4 cents-per-gallon gasoline tax and restoring Build America Bonds.

“There are two pieces in the transportation funding equation,” Wyden said in an interview. “One is funding, which is the downstream approaches like the gas tax. Then on top of that, I want to focus on finance because Build America Bonds was so successful.”

By most measures, the program was just that. Municipalities sold $188 billion of the taxable bonds to finance investment in infrastructure such as water, road and transit projects, data compiled by Bloomberg show.

Investors Gain

The securities became the fastest-growing part of the $3.7 trillion municipal market and drew international buyers. The debt has earned 9.6 percent this year through May 20, beating the 6.3 percent gain for the entire local-bond market, Bank of America Merrill Lynch data show.

Municipalities have sold about $95 billion of long-term, fixed-rate debt this year, down from $132 billion in the same period of 2013, Bloomberg data show.

Wyden would also have to win over debt-reduction Republicans in Congress who had complained that the original 35 percent subsidy on municipalities’ interest payments was too expensive.

Build America Bonds may cost the Treasury about $3.8 billion in the current budget year, according to the White House Office of Management and Budget.

President Barack Obama has proposed a four-year, $302 billion highway bill that would raise $150 billion through taxes on overseas earnings and by closing loopholes that would normally let companies defer those obligations.

Republican Compromise

The Senate Environment and Public Works Committee last week approved a six-year highway measure that calls for the same amount of money annually as the current two-year, $105 billion bill expiring in September, plus inflation. The panel left it up to Wyden and his Finance Committee to figure out how to pay for it.

Some senior Republicans on Wyden’s panel said his idea of restarting Build America Bonds deserves consideration if it helps prod debate on the highway measure. That includes Senator Orrin Hatch of Utah, the committee’s top Republican, and Senator Charles Grassley, an Iowa Republican.

“I’ve never been a big fan of Build America Bonds, because it’s just another way of spending and getting us deeper into debt,” Hatch said in an interview. “But then again, it may be one of the ways we’ll have to do it under the current difficulties we’re in. There’s no question we’re going to have to try and find money for highways.”

Three Wins

Some proposals already are on the table. In April, Senator Edward Markey, a Massachusetts Democrat, introduced a bill resurrecting Build America Bonds and making the program permanent. It would set the subsidy for states and localities at 31 percent in 2014, gradually lowering it to 28 percent in 2017 and later years.

It’s a companion measure to a bill introduced last year by Representative Richard Neal, also a Massachusetts Democrat.

Markey said his proposal is a “win-win-win for cities, states and the entire country.” His home state issued almost $5 billion in bonds when Build America was operating, with most of the funds used to repair or rebuild hundreds of bridges across the state.

In 2013 and again this year, Obama proposed similar securities providing direct interest-payment subsidies targeted at infrastructure, only to see them make little headway in Congress.

Meanwhile, not a single House Republican has signed onto Neal’s bill. House Ways and Means Committee Chairman Dave Camp, a Michigan Republican, has made clear in the past he’s not a fan of Build America Bonds. In 2010, he called it a “heavily subsidized spending program providing direct payments to state and local governments that issue bonds.”

Municipal Skeptics

“It doesn’t solve the funding problem,” said Joshua Schank, president of the Eno Center for Transportation, a nonpartisan policy research group based in Washington. “If anything, this will cost money.”

Wyden said that testimony this month before his committee bolsters his effort. Jayan Dhru, senior managing director for corporate and infrastructure ratings at Standard & Poor’s, told the Senate Finance Committee on May 6 that as much as $200 billion a year in additional infrastructure funding could be obtained through private investors.

He told the committee that investors are “well-positioned to fill the void” with approaches like public-private partnerships.

State and local officials may hesitate after the across-the-board federal spending cuts, known as sequestration, that began last year, said Susan Collet, a lobbyist for the Bond Dealers of America in Washington.

“They’re worried about proposals that could be subject to the federal government readily clawing back part of the subsidy,” said Collet, whose group represents securities firms. “Investors and issuers are going to be more skeptical than last time these proposals were introduced.”

By Laura Litvan and William Selway May 22, 2014

To contact the reporters on this story: Laura Litvan in Washington at [email protected]; William Selway in Washington at [email protected]

 

 


Novogradac News Brief: Renewable Energy Tax Credits.

Published By Novogradac & Company LLP

On March 11, 28 senators sent a letter to Senate Majority Leader Harry Reid, D-Nev., and Finance Committee Chairman Ron Wyden D-Ore., stating their support for the consideration of the Renewable Energy Parity Act of 2014 (S. 2003). The Senators wrote to express their support for modifying the eligibility standard under the Section 48 investment tax credit (ITC) in a tax extenders package. The bill would extend the ITC for solar projects under construction. Currently, a project must be placed in service by Dec. 31, 2016 to qualify. The letter is available at www.energytaxcredits.com

***

On March 17, the Massachusetts Department of Energy Resources (DOER) released the draft Assurance of Qualification Guideline for review and comment. The DOER is specifically looking for feedback on the process for obtaining extended reservation periods under Section 5.B. of the guideline. Comments are due by March 28. The guideline outlines the process by which the DOER will grant assurances of qualification to projects under the Solar Renewable Energy Credit (SREC-II) Solar Carve-Out program. The SREC-II shifts development away from large, standalone ground-mounts and toward three specific market sectors: residential or carport projects or any project up to 25 kilowatts; rooftop or ground-mounted projects greater than 25 kilowatts with at least two-thirds of annual output used on-site; and landfill or brownfield projects, or projects up to 650 kilowatts with less than two-thirds of annual output used on-site. Projects that do not fall into one of these categories will be in the managed growth market sector. The program’s goal is to install 1.6 gigawatts of solar photovoltaic projects by 2020. The program is expected to become effective early in the second quarter, once formal review proceedings are completed. The draft guideline is available at www.mass.gov/eea.

***

On March 21, Sens. Mark Udall, D-Colo., and Chuck Grassley, R-Iowa, along with 24 other senators, sent a letter to the Senate Finance Committee urging extension of the ITC and production tax credit (PTC) for wind energy in the tax-extender legislation. The PTC expired at the end of 2013. The letter states that wind energy provides power to more than 15 million homes across the and that the industry has spurred $105 billion in investment in the U.S. economy. They close the letter by stating that the legislation should be taken into consideration immediately. The letter is available at www.energytaxcredits.com.

***

On March 31, the American Council on Renewable Energy (ACORE) released the report, “Outlook for Renewable Energy in America: 2014.” The report was co-authored by the U.S. Renewable Energy Trade Associations, and evaluates the energy market and forecasts each renewable energy technology sector from the perspectives of U.S. renewable energy trade associations. The articles in the report detail specific market drivers for the biofuel, biomass, geothermal, hydropower, solar, waste and wind energy sectors. The report is available at www.energytaxcredits.com.

***

On March 19, SunEdison announced the completed construction of the Cascade solar power plant. The 24 megawatt (MW) direct current solar power plant located in the California Desert, is working with San Diego Gas & Electric to supply the company renewable electricity through a 20-year power purchase agreement (PPA). The PPA was given under the California Renewable Auction Mechanism. SunEdison, a solar technology manufacturer and provider of solar energy services, worked with Wells Fargo, which provided tax equity financing for the 150-acre solar power plant. SunEdison Renewable Operation Center, which provides asset management, monitoring, field dispatch and reporting services, will manage the plant.

***

New Generation Power Texas LLC announced on Feb. 13 that it has begun construction on the first phase of the Texas Wind Farm. In order to qualify for the PTC, which expired at the end of 2013, the renewable energy company works on pre-construction development, early investments and permitting. The 400 MW wind farm is located in Haskell County outside of Dallas, Texas, on 22,000 acres of land. Construction will be completed in two phases, with total costs estimated to be between $650 and $700 million. The wind farm is expected to produce more than 1,800 million megawatt hours (MWh) of energy annually. Rosendin Electric Inc., an engineering, power and communications provider, will be the primary contractor. Construction of both phases is expected to be complete by the end of 2015.

***

On April 2, the Treasury Inspector General for Tax Administration (TIGTA) released the report, “Recovery Act: Processes for Ensuring Compliance with Qualifying Advanced Energy Project Credit Requirements Can Be Strengthened.” TIGTA conducted the audit to assess the effectiveness of the Internal Revenue Services’ (IRS’) efforts to ensure manufacturer compliance with advanced energy credit requirements. The report, published on Feb. 6, found that the IRS ensured manufacturers complied with agreement and certification requirements. However, the report stated that the IRS does not have a process to identify individual taxpayers who incorrectly claim the tax credit. TIGTA found that more than 1,000 individual taxpayers who claimed more than $3 million in Advanced Energy Credits for Tax Year 2011 but did not appear to have a relationship with a manufacturer that was awarded the credit. TIGTA provided recommendations for the IRS to develop processes to ensure that changes in projects are fully evaluated and to ensure that individuals are properly claiming the credit. The report is available at www.energytaxcredits.com.



EO Update: e-News for Charities & Nonprofits - May 16, 2014

 

Register for the IRC 501(c)(6) Organizations Phone Forum.

Thursday, May 22 – 11 a.m. Eastern Time

Topics include:

  • To file or not to file an application for recognition of exemption
  • Form 1024: Applying for exemption
  • Annual filing requirements for exempt organizations
  • Permitted 501(c)(6) purposes and activities

To receive CE credit (and a certificate of completion) you must view the presentation for a minimum of 50 minutes.

Register for this presentation.


IRS LTR: IRS Extends Expenditure Period for Bond Proceeds.

The IRS has agreed to extend the period for expending the proceeds of bonds to finance a school construction project after concluding the borrower’s expected failure to meet the original expenditure date was due to reasonable cause.

 

Citations: LTR 201420016

Third Party Communication: None

Date of Communication: Not Applicable
Person To Contact: * * *
Telephone Number: * * *

Index Number: 54F.00-00
Release Date: 5/16/2014

Date: February 3, 2014

Refer Reply To: CC:FIP:B05 – PLR-147648-13

LEGEND:

Authority = * * *
Borrower = * * *
State = * * *
Bonds = * * *
School Site = * * *
New Facility = * * *
Town = * * *
Date 1 = * * *
Date 2 = * * *
Date 3 = * * *
Date 4 = * * *
Date 5 = * * *
Date 6 = * * *

Dear * * *:

This is in response to your request under § 54A(d)(2)(B)(iii) of the Internal Revenue Code for an extension of the expenditure period for the available project proceeds of qualified tax credit bonds.

FACTS AND REPRESENTATIONS

You make the following factual representations. Authority is a political subdivision of State, organized in part to assist in financing programs or loans to non-profit corporations and political subdivisions in State, including educational organizations described in § 501(c)(3) such as Borrower.Authority issued the Bonds on Date 1 and designated the Bonds as qualified school construction bonds within the meaning of § 54F(a)(3). All available project proceeds of the Bonds were to be spent on acquiring the School Site and construction of the New Facility (the “Project”), and were expected to be spent before Date 2.

The original three-year expenditure period for the Bonds under § 54A(d)(2)(B)(i) expired on Date 2 (the “Original Expenditure Period”). Borrower started its search for a suitable site for the New Facility approximately two years prior to the issuance of the Bonds, and had been making plans during that two-year period for financing and constructing the New Facility. Borrower identified a site which it intended to acquire approximately one month after the Bonds were issued. However, progress toward completion of both phases of the Project within the original schedule was delayed significantly by unanticipated events which arose before issuance of the Bonds. These events included a prolonged search for an appropriate site for the New Facility after a court-ordered change in location from the initial site. A school at the initial site was not expected to achieve federal desegregation goals in the area.

Immediately upon the court’s determination, Borrower began searching for another site for the New Facility. On Date 3, approximately eight months after the Bonds were issued, Borrower entered into an agreement to purchase a substitute site. However, after Borrower completed plans for development of the substitute site, Town’s engineers determined that Town could not furnish sewer services to the substitute site due to the high cost of sewage treatment facilities. After again conducting a search for an appropriate site, Borrower settled on and acquired the School Site. Construction work began on Date 4 to extend water and sewer lines to the School Site. Borrower expects to complete construction of the New Facility by Date 5, or approximately six months after the Original Expenditure Period expired. Borrower expects to spend all available project proceeds not later than Date 6, or two years after the Original Expenditure Period expired.

Authority submitted this request for a ruling prior to Date 2.

LAW AND ANALYSIS

Section 54A(d)(1) provides that a qualified school construction bond is treated as a qualified tax credit bond for purposes of Section 54A.Section 54A(d)(2)(B)(i) provides in part that to the extent that less than 100 percent of the available project proceeds of the issue are expended by the close of the expenditure period for 1 or more qualified purposes, the issuer shall redeem all of the nonqualified bonds within 90 days after the end of such period.

Section 54A(d)(2)(B)(ii) provides that for purposes of this subpart, the term “expenditure period” means, with respect to any issue, the 3-year period beginning on the date of issuance. Such term shall include any extension of such period under clause (iii).

Section 54A(d)(2)(B)(iii) provides that upon submission of a request prior to the expiration of the expenditure period (determined without regard to any extension under this clause), the Secretary may extend such period if the issuer establishes that the failure to expend the proceeds within the original expenditure period is due to reasonable cause and the expenditures for qualified purposes will continue to proceed with due diligence.

Section 54A(d)((2)(C)(iv) provides that for purposes of this paragraph, in the case of a qualified zone academy bond, a “qualified purpose” means a purpose specified in § 54E(a)(1).

Section 54A(e)(4) of the Code defines “available project proceeds” to mean (A) the excess of (i) the proceeds from the sale of an issue, over (ii) the issuance costs financed by the issue (to the extent that such costs do not exceed 2 percent of such proceeds), and (B) the proceeds from any investment of the excess described in subparagraph (A).

The Project was identified prior to the issuance of the Bonds and Borrower reasonably expected to spend all of its allocable available project proceeds within the three-year period. The expected failure to spend all the available project proceeds of the Bonds by the expiration of the three-year period on Date 2 has been caused by events that were not reasonably expected at the time the Bonds were issued and were beyond the control of Borrower. However, Borrower to the extent possible considering the described unexpected external events that resulted in unforeseen delays, has and will continue to exercise due diligence in spending the remaining available project proceeds on the Project. Borrower expects to spend all available project proceeds not later than Date 6, or two years after the Original Expenditure Period expired.

CONCLUSION

Under the facts and circumstances of this case, we conclude that Borrower’s expected failure to expend the available project proceeds of the Bonds by Date 2 is due to reasonable cause and that Borrower’s continued expenditure of the proceeds for qualified purposes will proceed with due diligence. Therefore, Authority is granted an extension of the Original Expenditure Period with respect to the Bonds until Date 6.Except as expressly provided herein, no opinion is expressed or implied concerning the tax consequences of any transaction or item discussed or referenced in this letter.

This ruling is directed only to the taxpayer who requested it. Section 6110(k)(3) provides that it may not be used or cited as precedent.

In accordance with a Power of Attorney on file with this office, a copy of this letter is being sent to Authority’s authorized representative.

The ruling contained in this letter is based upon information and representations submitted by Authority and accompanied by a penalty of perjury statement executed by an appropriate party. While this office has not verified any of the materials submitted in support of the request for a ruling, it is subject to verification upon examination.

                  Sincerely,
                  Associate Chief Counsel
                  (Financial Institutions & Products)
                  By: Timothy L. Jones
                  Senior Counsel, Branch 5


IRS LTR: Arrangements Won't Hurt Group's Tax-Exempt Status.

The IRS ruled that modified arrangements in which several senior executive employees of a tax-exempt organization would become employees of a corporation and then would be “seconded” back to the organization would not adversely affect the organization’s tax-exempt status.

Contact Person: * * *
Identification Number: * * *
Telephone Number: * * *
UIL: 501.00-00, 501.03-00, 501.33-00
Release Date: 5/9/2014
Date: February 14, 2014
Employer Identification Number: * * *

LEGEND:

Corporation = * * *
Year = * * *

Dear * * *:

This is in response to your letter dated January 26, 2012, in which you requested a ruling that if you implement a proposed modification to an existing secondment arrangement, you will continue to be recognized as a tax-exempt organization described in § 501(c)(3) of the Internal Revenue Code of 1986, as amended (Code). This letter supersedes our letter dated December 20, 2013, which is hereby withdrawn.

FACTS

You have been recognized as an organization exempt under § 501(c)(3) of the Code and classified as an organization other than a private foundation because you normally receive a substantial part of your support from contributions from the general public, within the meaning of §§ 509(a)(1) and 170(b)(1)(A)(vi). Your charitable purposes are to receive and administer funds for religious, charitable, scientific, and educational purposes. You also are a sponsoring organization for donor advised funds within the meaning of § 4966(d)(1) that makes grants from your investment income and assets. You are an independent organization associated with Corporation.You propose to make changes to the workforce arrangement that you currently have with Corporation. Under the proposal, three of your senior executive employees would become employees of Corporation and then would be seconded back to you. Currently, all of your staff except for these three employees are employed by Corporationand seconded to you on a full-time basis. Your existing Administrative Services Agreement with Corporation would be amended to cover payroll services and employee benefits for the three additional employees. The Administrative Services Agreement provides that you will pay Corporation annually an administrative fee not to exceed five basis points times the average daily balance of all donor-advised fund accounts maintained by you, which shall be due and payable quarterly. Corporation maintains the right to waive or reduce this fee at any time. Amounts payable are to be reviewed annually to ensure that all amounts payable are priced at or below fair market value. However, you state that Corporation has waived this fee for you and provided these services and infrastructure free of charge since Year.

You will continue to be independent of Corporation. The changes to your Administrative Services Agreement will have no effect on your Board of Directors. Your Board of Directors consists of one employee of Corporation and five independent directors. Your Board of Directors meets three times a year to address your strategy and progress, to approve recommendations from committees, and to review and approve grants made, among other things. The three employees who will be added to the Administrative Service Agreement attend all Board meetings as your top officials and inform the Board of your day-to-day operations. The approval and appointment of these three employees will continue to be made by the Board on an annual basis. You maintain full control of whether or not any seconded employee remains your employee. You maintain the responsibility of interviewing, negotiating compensation and benefits, and approving the hiring of any employee that will be seconded to you. And, you also maintain control over future negotiations and decisions regarding compensation and benefits for any seconded employees.

You state that after the three senior executive employees are seconded back to you, you will continue to be organized and operated for the charitable purpose of promoting philanthropy and will not confer on any party any impermissible private benefit or private inurement. You also represent that corporate law dictates that a duty of loyalty is owed to you, rather than to Corporation, once the employees are seconded to you.

In addition to the independent control and management performed by your Board of Directors, you also offer many options for donor advised funds to make investments in addition to those offered by Corporation. You offer a variety of investment pools featuring top performing mutual funds. Half of these funds are offered through other investment firms. Additionally, donors to larger accounts are permitted to have the funds in such accounts be managed by independent investment advisors who are not associated with Corporation.

RULING REQUESTED
    You will continue to be recognized as a tax-exempt organization described in § 501(c)(3) if you implement the proposed modification to the existing Administrative Services Agreement.
LAW

I.R.C. § 501(c)(3) provides that organizations may be exempted from tax if they are organized and operated exclusively for religious, charitable, scientific, testing for public safety, literary, or educational purposes and “no part of the net earnings of which inures to the benefit of any private shareholder or individual.”Treas. Reg. § 1.501(c)(3)-1(a)(1) provides that in order to be exempt under § 501(c)(3), an organization must be both organized and operated exclusively for one or more of the exempt purposes specified in that section.

Treas. Reg. § 1.501(c)(3)-1(d)(1)(ii) provides that an organization is not organized or operated exclusively for one or more exempt purposes unless it serves a public rather than a private interest. To meet the requirement of this subsection, the burden of proof is on the organization to show that it is not organized or operated for the benefit of private interests, such as designated individuals, the creator or his family, shareholders of the organization, or persons controlled, directly or indirectly, by such private interests.

Revenue Ruling 70-186, 1970-1 C.B. 128, discusses an organization formed to preserve and enhance a lake as a public recreational facility by treating the water. The lake is large, bordering on several municipalities. The public uses it extensively for recreation. Along its shores are public beaches, launching ramps, and other public facilities. The organization is financed by contributions from lake front property owners, members of the adjacent community, and municipalities bordering the lake. The revenue ruling concludes that the benefits from the organization’s activities flow principally to the general public through well-maintained and improved public recreational facilities. Any private benefits derived by the lake front property owners do not lessen the public benefits flowing from the organization’s operations. In fact, it would be impossible for the organization to accomplish its purposes without providing benefits to the lake front property owners.

Revenue Ruling 73-407, 1973-2 C.B. 383, states that a contribution by a private foundation to a public charity that was conditioned upon the agreement of the public charity to change its name to that of a substantial contributor to the private foundation and not to change it again for 100 years was not an act of self-dealing because the resulting benefit to the substantial contributor was incidental and tenuous, and not economic in nature.

Revenue Ruling 98-15, 1998-1 C.B. 718, provides two scenarios where exempt hospitals enter joint ventures with for-profit hospitals. In the first scenario, the exempt hospital maintains control of the board and the day-to-day operations of the LLC that owns the hospital. The governing documents of the LLC require it to operate any hospital it owns in a manner that furthers charitable purposes by promoting health for a broad cross section of its community. In the event of a conflict between operation in accordance with the community benefit standard and any duty to maximize profits, the members of the governing board are to satisfy the community benefit standard without regard to the consequences for maximizing profitability. In addition, all returns of capital and distributions of earnings made to owners of the LLC are to be proportional to their ownership interests in the LLC. The terms of the governing documents are legal, binding, and enforceable under applicable state law.

In the second scenario of Revenue Ruling 98-15, control and management of the hospital is transferred to an LLC, the board of directors of which consists of three members appointed by the exempt organization and three appointed by the for-profit. Major operating decisions (budgets, distributions of earnings, etc.) have to be approved by a majority of the board.

In both scenarios, the exempt hospitals receive income interests in proportion to the assets contributed to the joint ventures. Only in the first scenario was the hospital activity considered to continue as an exempt activity and not to be operated for the private benefit of the for-profit hospital.

In Church by Mail v. Commissioner, 765 F.2d 1387 (9th Cir. 1985), aff’g 48 T.C.M. (CCH) 471 (1984), the Tax Court found it unnecessary to consider the reasonableness of payments made by the applicant to a business owned by its officers. The 9th Circuit Court of Appeals, in affirming the Tax Court’s decision, stated: “The critical inquiry is not whether particular contractual payments to a related for-profit organization are reasonable or excessive, but instead whether the entire enterprise is carried on in such a manner that the for-profit organization benefits substantially from the operation of the Church.”

Broadway Theatre League of Lynchburg, Virginia v. U.S., 293 F. Supp. 346, 355 (D.C. VA. 1968), states that “An organization can incur ordinary and necessary expenditures in its regular activities without losing its exempt status.St. Germain Foundation v. Commission, 26 TC 648 (1956); A. A. Allen Revivals, Inc., PH TC Memo 1963-281. A contract entered into by a foundation, for its benefit, even if the contract is responsible for the creation of the foundation, is not necessarily as a matter of law executed to avoid taxation. Commissioner of Internal Revenue v. Orton, 173 F.2d 483 (6th Cir. 1949).”

In est of Hawaii v. Commissioner, 71 T.C. 1067, 1081-82 (1979), the Tax Court held that compensation need not be unreasonable or exceed fair market value to constitute private benefit, stating “[n]or can we agree with petitioner that the critical inquiry is whether the payments made to International were reasonable or excessive. Regardless of whether the payments made by petitioner to International were excessive, International and EST, Inc., benefited substantially from the operation of petitioner.”

In P.L.L. Scholarship v. Commissioner, 82 T.C. 196 (1984), the Tax Court found that an organization that operated charitable bingo on the premises of a bar allowed the bar to increase its sales of food and drinks by its operations in the bar, thereby benefiting the bar in more than an insubstantial way. The organization and bar were controlled by some of the same persons. The Court held that the operations of the organization and bar were so interrelated as to be “functionally inseparable,” the effect of which was that any economic benefit the bar received was not incidental.

In International Postgraduate Medical Foundation v. Commissioner, T.C. Memo 1989-36; 56 T.C.M. (CCH) 1140 (1989), an organization, the activity of which was to conduct continuing medical education tours abroad and which exclusively used one for-profit travel agency to arrange its travel tours, was found not to be operated exclusively for purposes described in § 501(c)(3). The same individuals controlled both the organization and the for-profit travel agency, and the organization did not solicit bids from any other travel agency. Both entities shared the same office. The Tax Court found that the organization was not operated exclusively for one or more exempt purposes because of its provision of benefits to the travel agency.

ANALYSIS

To continue to qualify as an exempt organization described in § 501(c)(3), you must be organized and operated for one or more exempt purposes. Section 1.501(c)(3)-1(a)(1). An organization is not organized or operated exclusively for one or more exempt purposes unless it serves a public rather than a private interest. To meet this requirement, the burden of proof is on the organization to show that it is not organized or operated for the benefit of private interests, such as designated individuals, its creator or his family, shareholders of the organization, or persons controlled, directly or indirectly, by such private interests. Section 1.501(c)(3)-1(d)(1)(ii).You propose to make changes to your workforce arrangement with Corporation. Under the proposal, three of your current employees will become employees of Corporation. Under the Administrative Services Agreement between you and Corporation, those same three employees would be seconded back to you. In addition, your Administrative Services Agreement would be amended to cover the payroll services and employee benefits for those three employees.

In certain cases, an organization contracting its services away may be found to no longer perform an exempt function because it has contracted out all of its activities and control. This is not the case with you, however, as your Board of Directors continues to be independent of Corporation. Additionally, an organization is permitted to contract out some services for a fee to a for-profit corporation without jeopardizing its tax exemption. See Broadway Theatre, 293 F. Supp. at 355. Your Board of Directors will still meet quarterly to evaluate and approve your grants for charitable purposes, despite the contract for administrative and employment services. Additionally, your funds will be used to pay for the seconded employees, and they will remain responsive to you. You will determine the employees’ compensation and whether or not they will remain employed by Corporation for your purposes. Furthermore, you represent that corporate law cases have determined that such seconded employees owe a duty of loyalty to you, rather than to Corporation. Given your exercise of control over the seconded employees and your operations through your independent Board of Directors, you have not contracted away your exempt activities.

Additionally, in order to be operated for an exempt purpose, you must be operated for a public, rather than private, benefit. Section 1.501(c)(3)-1(d)(1)(ii). When assessing whether an organization is formed for a private benefit, “the critical inquiry is not whether particular contractual payments to a related for-profit organization are reasonable or excessive, but instead whether the entire enterprise is carried on in such a manner that the for-profit organization benefits substantially” from the operation of the exempt organization. Church by Mail, 765 F.2d at 1392. One way in which a for-profit organization might benefit substantially from the operation of an exempt organization is by being the exclusive client of that for-profit. This is especially true in cases where both the for-profit and the non-profit are controlled by the same persons. In Church by Mail, 765 F.2d 1387, the for-profit organization ran a printing business for the church’s publications, which was the non-profit’s sole purpose. The printing company had been started by the founders of the church and operated exclusively to provide printing for that church. The for-profit printing company would not have existed if not for the existence of the church. Also, in est of Hawaii, 71 T.C. 1067, the non-profit school exclusively taught the lessons of a for-profit company run by employees of another, related for-profit company. The non-profit purchased, taught, and promoted exclusively the material of the for-profit company. There, the purpose of the non-profit was determined to be the distribution and collection of income for the for-profit company. Here, however, business from you constitutes less than one percent of the business of Corporation, and you are not controlled by Corporation. The separation of control, combined with the fact that your operations do not serve to “substantially benefit” Corporation, suggests that you are not operated for the private benefit of Corporation.

Additionally, an organization might be operated for private benefit if it exclusively uses a related for-profit to provide its services without seeking out the best possible service provider, International Postgraduate, 56 T.C.M. (CCH) 1140, or if its operations are conducted in a manner that any external business is sent exclusively to that for-profit.P.L.L. Scholarship, 82 T.C. 196. This is especially true when the non-profit and for-profit organizations are controlled by the same persons. Again, you and Corporation are not controlled by the same persons. Additionally, you do not exclusively use the investment products of Corporation; rather, you provide donors with the opportunity to invest in outside funds. Furthermore, you allow large donors to select outside fund advisors. The access to outside investment products and advisors also means that the operation of your program does not merely act as a means to provide business opportunities to Corporation through a captive audience, such as the one in P.L.L. Scholarship, 82 T.C. 196.

While you do contract exclusively with Corporation for your Administrative Service Agreement, the agreement provides for the use of the employees at cost, as if you were employing them directly, and Corporation has waived any fees for the administrative services since Year. Therefore, there has been no financial gain to Corporation in the Administrative Services Agreement. Any private benefit that may be gained by Corporation in providing you with seconded employees, including your highest ranking executives, is incidental. See Rev. Rul. 70-186, supra(indicating that specific benefits to a defined group may be incidental to the performance of an exempt organization and, thus, are not incompatible with tax exemption). Rev. Rul. 98-15, supra, describes two scenarios where tax exempt organizations enter joint ventures with for-profit corporations. In the first scenario, the tax exempt organization maintains control over the joint venture and is able to ensure that its operations further the charitable purpose of the tax-exempt organization. The for-profit organization that enters the joint venture receives a proportionate amount of any income generated by the joint venture, but this sharing of revenue is considered to be incidental to the furtherance of the exempt organization’s purpose, furthered by the joint venture. Here, your activities create income for Corporation through the investment activities of your donor-advised funds, but this income represents less than one percent of Corporation‘s overall income, and you maintain control over your funds and activities through an independent board, as described above. Your continued control over your activities allows you to further your own exempt purpose and not the private benefit of Corporation. You are not operated for the private benefit of Corporation, and the inclusion of your highest ranking employees in your Administrative Services Agreement is not incompatible with your tax exemption under § 501(a).

RULING
      Implementation of the proposed modification to the existing secondment arrangement between you and

Corporation

     will not adversely affect your status as a tax-exempt organization described in § 501(c)(3).

This ruling will be made available for public inspection under § 6110 after certain deletions of identifying information are made. For details, see enclosed Notice 437, Notice of Intention to Disclose. A copy of this ruling with deletions that we intend to make available for public inspection is attached to Notice 437. If you disagree with our proposed deletions, you should follow the instructions in Notice 437.This ruling is directed only to the organization that requested it. Section 6110(k)(3) provides that it may not be used or cited by others as precedent.

This ruling is based on the facts as they were presented and on the understanding that there will be no material changes in these facts. This ruling does not address the applicability of any section of the Code or regulations to the facts submitted other than with respect to the sections described. Because it could help resolve questions concerning your federal income tax status, this ruling should be kept in your permanent records.

If you have any questions about this ruling, please contact the person whose name and telephone number are shown in the heading of this letter.

In accordance with the Power of Attorney currently on file with the Internal Revenue Service, we are sending a copy of this letter to your authorized representative.

                  Sincerely,
                  Ronald Shoemaker
                  Manager, Exempt Organizations
                  Technical Group 2

Enclosure
Notice 437

Citations: LTR 201419015



ABA Meeting: IRS Standardizing Exempt Bond Closing Agreements.

The IRS is taking steps to standardize and simplify its voluntary compliance program in the area of tax-exempt bonds, an agency official said May 9.

Rebecca Harrigal, director (tax-exempt bonds), IRS Tax-Exempt and Government Entities Division, said her office is creating two standard closing agreements: one for field operations and one for the compliance and program management office. Most closing agreements will fit within those categories, she said. Harrigal spoke at the Tax-Exempt Financing session of the American Bar Association Section of Taxation meeting in Washington.

The agency hopes the simplification will help it apply its limited resources where they are most needed, Harrigal said. Any problems or concerns that bond counsel have had with closing agreements should be brought to the attention of the IRS now because those issues may be addressed through the establishment of the standard closing agreements, she said.

The IRS also is significantly rewriting its voluntary closing agreement program manual, Harrigal said, adding that the Service will try to standardize as much as it can. There is a new closing agreement team that will look at all nonstandard closing agreements and will get involved “when closing agreement terms get changed from the standard language that we’re working on,” she said. “They will be looking for consistency and enforceability in those,” she added.

MAY 12, 2014

by Fred Stokeld



ABA Meeting: IRS Official Addresses Concerns About EO Form.

An IRS official May 9 addressed concerns that have been raised about the recently released draft of a simplified application for tax-exempt status, saying there could be changes as to who is and is not eligible to use the new form.

Speaking at the Exempt Organizations session of the American Bar Association Section of Taxation meeting in Washington, Sunita Lough, commissioner, IRS Tax-Exempt and Government Entities Division, discussed the draft Form 1023-EZ, “Streamlined Application for Recognition of Exemption Under Section 501(c)(3) of the Internal Revenue Code,” which the IRS introduced last month and which organizations can use if they have annual gross receipts of $200,000 or less and meet other eligibility requirements.

Practitioners have asked why some categories of EOs — hospitals, colleges and universities, and organizations with donor-advised funds, to name a few — would be ineligible to use the short form. Lough said the draft and its eligibility requirements are not set in stone and that some categories of organizations not eligible to use the simplified application could become eligible later and vice versa. She said the IRS will need to review its eligibility checklist to determine whether to make changes.

Other commentators have noted that unlike the longer Form 1023, the draft Form 1023-EZ does not require a narrative statement of an applicant’s exempt purpose, leading some to wonder how the IRS will determine whether an organization will pursue charitable activities. But Lough said a narrative statement is not necessarily dispositive of how an organization will operate and that the IRS believes looking at what a small organization does after receiving its determination letter will show whether it is furthering exempt functions.

In response to worries that the Form 1023-EZ will not be an adequate learning tool because of its simplicity, Lough said the IRS has tried to make the instructions educational, adding that information will also be available on the EO portion of the IRS website.

The IRS will do some predetermination checks on a sample of Forms 1023-EZ by asking filers about items they have checked on the form, according to Lough. The contacts will give the IRS feedback on areas of the form and instructions that may need improvement, she said.

Lough said she expects the Form 1023-EZ to be ready for electronic filing by midsummer.

MAY 12, 2014

by Fred Stokeld



Exemption Applicants Can Appeal Determinations, Koskinen Says.

The Service has changed its process for reviewing organizations’ appeals of unfavorable determinations for tax-exempt status, IRS Commissioner John Koskinen said May 7 at a hearing of the House Ways and Means Oversight Subcommittee.

Previously, some conservative groups’ appeals were directed to a trio of IRS executives rather than to the independent appeals function established for that purpose by the Internal Revenue Service Restructuring and Reform Act of 1998. The changes should safeguard exemption applicants’ right of appeal, whether they originally went through the exempt organizations office in Cincinnati or through IRS headquarters in Washington, Koskinen said.

Koskinen was responding to a question by subcommittee Chair Charles W. Boustany Jr., R-La., who noted that some groups alleged that the IRS had denied their rights to appeal the determinations.

Boustany also inquired about what he called the apparent subversion by former IRS official Lois Lerner of internal agency controls to prevent taxpayer targeting. Koskinen said, “I think the process that I hope will reassure Americans is that, not only do we have a structure in place, [but] we’re trying to build a structure that will accept and be welcoming to people who say there’s a problem that needs to be looked into,” whether the source is Congress, IRS oversight bodies, taxpayers, or IRS employees.

Asked by Boustany about alleged abuse of audit selection criteria by IRS examiners against conservative groups and donors, Koskinen told the committee that the IRS is negotiating with the National Treasury Employees Union, which represents most IRS workers, over performance awards given to employees disciplined for being delinquent on their taxes. The commissioner said he hoped that a ban on such awards would be included in the union’s contracts and in IRS regulations and policies, although he did not specify a time frame.

“Legislation is kind of a blunt instrument,” Koskinen told Rep. Sam Johnson, R-Texas, who is promoting his No Bonuses for Tax Delinquent IRS Employees Act of 2014 (H.R. 4531), which seeks an absolute ban on such awards. “You will be satisfied, I hope, with our union negotiations, that policies we have are appropriate,” Koskinen said.

The NTEU’s contract with the IRS expires October 1, although the two sides can agree to an extension.

The commissioner also weighed in on the debate over reviving private collection of debts owed to the IRS, as included in the Senate Finance Committee’s tax extenders bill (the Expiring Provisions Improvement, Reform, and Efficiency (EXPIRE) Act of 2014 (S. 2260)). Previous experiences with the strategy revealed it to be unexpectedly expensive and inefficient, Koskinen said. Private debt collection was also limited because it did not include enforcement authority, he noted.

Koskinen said a recent phone scam, in which fraudsters representing themselves as IRS employees called taxpayers and threatened them with jail unless they paid supposed tax debts, raises questions about the public reception to private collections. “If you’re surprised to be hearing from us on the phone, you’re probably not hearing from us,” he said, noting that the IRS does not initiate contact by phone.

The commissioner also made a pitch for Congress to enact several administration proposals, including accelerating due dates for information returns to facilitate faster and better matching with tax returns to prevent refund fraud, and authorizing the IRS to regulate return preparers.

Granting the IRS correctible error authority also would allow the Service to make more corrections to taxpayers’ returns using independently verifiable information, without initiating an audit as is required now, Koskinen noted.

Subcommittee ranking minority member John Lewis, D-Ga., expressed concerns about the IRS’s budget.

“Your workload is getting heavier,” Lewis said. “The issues you face are becoming more and more complex. But your appropriation keeps getting smaller.” Noting the Service’s ongoing battles against tax-related identity theft and its grappling with needs of low-income and elderly taxpayers, compared with the Service’s continued funding crunch, Lewis asked, “Are you being set up for failure, for disaster?”

Koskinen replied, “No, we have a very can-do agency.” But he added, “I am very concerned. I’ve never dealt with an organization, even a major one in bankruptcy, that is so consistently understaffed across the board.”

The IRS Oversight Board in a May 7 report said the Service’s shrinking and uncertain budget and “unfunded legislative mandates” are harming both enforcement and taxpayers’ ability to comply with tax laws.

MAY 8, 2014
by William Hoffman


Guidance Requested on Deductibility of Water Right Contributions.

Thomas Hicks of Trout Unlimited has asked the IRS to include on its 2014-2015 priority guidance list (Notice 2014-18) guidance that clarifies the deductibility of a charitable contribution of an entire interest of an appropriative water right to an organization described in section 170(c) and an undivided portion of the taxpayer’s entire interest in an appropriative water right under section 170(f)(3)(B)(ii).

 

April 30, 2014

Internal Revenue Service
Attn: CC:PA:LPD:PR
(Notice 2012-25)
Room 5203
P.O. Box 7604
Ben Franklin Station
Washington, D.C. 20044
RE: IRS Notice 2014-18 Public Comment on Recommendations for 2014-2015 Priority Guidance Plan List
Trout Unlimited submits these recommendations for the 2014-2015 Priority Guidance Plan. There remains a continued and overwhelming need for the IRS to clarify an ambiguity in the federal tax deductibility of charitable contributions of entire and certain partial interest of appropriative water rights.Published administrative guidance is sought to clarify Internal Revenue Code (I.R.C.) § 170 and the deductibility of a charitable contribution of:

      1. an entire interest of an appropriative water right to an organization described in I.R.C. § 170(c); and

2. an undivided portion of the taxpayer’s entire interest in an appropriative water right under I.R.C. § 170(f)(3)(B)(ii).
This 2014 recommendation is based upon an initial April 2012 recommendation and an October 2012 Revenue Ruling Request. In this interim, there has been increased public interest in the outcome of this Request. Attached is related correspondence between U.S. Senator Max Baucus and the IRS Commissioner. In addition, there are other letters in support from Washington State Department of Ecology, Oregon Water Resources Department, Montana Department of Fish, Wildlife & Parks, and others.Timely resolution of these federal tax ambiguities is important for taxpayers in appropriative water right states. It is particularly important now, in times of climate change and drought, to obtain clarity regarding these questions.

Please call 415.309.2098 if you have any questions or we can be of any further assistance.

                  Sincerely,
                  Thomas Hicks
                  Of Counsel, TU Western Water
                  Project
                  Trout Unlimited
                  Laura Ziemer
                  Senior Counsel and Water Policy
                  Advisor
                  TU Western Water Project
                  Trout Unlimited

cc:
Karin Gross
Internal Revenue Service
Office of Chief Counsel
CC:ITA:01 — Room 4043
1111 Constitution Ave. NW
Washington, DC 20224
E-mail: [email protected]

Ruth Madrigal
Attorney Advisor
Office of Tax Policy
U.S. Department of the Treasury
1500 Pennsylvania Ave. NW
Washington, DC 20220
E-mail: [email protected]



Guidance Requested on Treatment of Charitable Contributions Costs.

Marc Gerson of Miller & Chevalier has asked the IRS to include on its 2014-2015 priority guidance list (Notice 2014-18) guidance clarifying the treatment under current law of current year acquisition costs for charitable contributions of inventory and other property under section 170(e)(3).

 

April 30, 2014
Courier’s Desk Internal Revenue Service
Attn: CC:PA:LPD:PR (Notice 2014-18)
1111 Constitution Avenue, N.W.
Washington, D.C. 20224

Re: Recommendation for the 2014-2015 Priority Guidance Plan Pursuant to Notice 2014-18

To Whom It May Concern:

Pursuant to Notice 2014-18, 2014-15 I.R.B. 1 (the “Notice”), Miller & Chevalier Chartered respectfully requests that guidance in the form of a notice clarifying the treatment under current law of current year acquisition costs with respect to charitable contributions of inventory and other property under Section 170(e)(3) of the Internal Revenue Code1 (as contemplated by Notice 2008-90, 2008-43 I.R.B. 1000) be included on the 2014-2015 Priority Guidance Plan under the jurisdiction of the Office of Associate Chief Counsel (Income Tax & Accounting).

I. Requested Guidance Pursuant to Section 170(e)(3)

Guidance in the form of a notice is requested clarifying the treatment under current law of current year acquisition costs with respect to charitable contributions of inventory and other property under Section 170(e)(3) for the benefit of the ill, the needy, or infants.2 Specifically, such guidance should provide that such current year acquisition costs are treated as cost of goods sold (and, therefore, not classified and deducted as a charitable contribution) under current law. Such guidance will provide certainty that, consistent with the existing regulatory charitable contribution regime, donors of inventory and other property for the benefit of the ill, the needy, or infants will under all circumstances (i) be allowed to recover their basis in donated inventory or other property, and (ii) be able to compute the enhanced charitable contribution deduction available under Section 170(e)(3). For your consideration, (i) enclosed as Exhibit A is a draft notice providing the requested clarifying guidance, and (ii) enclosed as Exhibit B is an example demonstrating the application of such guidance.

It should be noted that the application of Section 170(e)(3) to current year acquisition costs is particularly important in the context of charitable contributions of food to satisfy the increased demand on food banks and other hunger relief agencies as a result of the current economic situation.3 In order to ensure that such contributions continue to satisfy such increased demand, it is respectfully requested that guidance with respect to the treatment of such current year acquisition costs be included on the 2014-2015 Priority Guidance Plan and then be issued in the form of a notice drafted by the Office of Associate Chief Counsel (Income Tax & Accounting) as soon as practically possible thereafter.4

II. Discussion

Section 170(e)(1) provides the general rule that donors are permitted a deduction for charitable contributions of ordinary income and capital gain property equal to the lower of the donor’s basis or the fair market value of the property at the time of donation. Treas. Reg. § 1.170A-1(c)(4) provides that under this general rule (i) current year acquisition costs (i.e., purchases) with respect to contributed property should be treated as cost of goods sold (and, therefore, not classified and deducted as a charitable contribution), and (ii) prior year acquisition costs with respect to contributed property that are included in opening inventory in the year of contribution should be “removed” from inventory and classified and deducted as a charitable contribution (the so-called “removal rule”).5 This longstanding regulation ensures that donors will recover current year acquisition costs through cost of goods sold without regard to the limitations imposed on charitable contributions under Section 170, primarily the taxable income limitation of Section 170(b)(2).

Section 170(e)(3) is a special incentive designed to provide an enhanced charitable deduction (the so-called “bump”) with respect to donations of inventory and other property for the benefit of the ill, the needy or infants equal to the lower of (i) twice the cost basis of the contributed property, or (ii) the cost basis plus one-half of the appreciation in excess of basis. Treas. Reg. § 1.170A-4A(c)(3) provides that “[n]otwithstanding the rules of § 1.170A-1(c)(4), the donor of the property which is inventory contributed under this section must make a corresponding adjustment to cost of goods sold by decreasing the cost of goods sold by the lesser of the fair market value of the contributed item or the amount of basis. . . .”

Clarification is necessary with respect to the treatment of current year acquisition costs with respect to charitable contributions of inventory and other property under Section 170(e)(3). Specifically, there is uncertainty regarding the scope and application of Treas. Reg. § 1.170A-4A(c)(3) and, in particular, whether current year acquisition costs with respect to charitable contributions under Section 170(e)(3) are (i) treated as cost of goods sold under the general rule of Section 170(e)(1) and Treas. Reg. § 1.170A-1(c)(4), or (ii) subject to the removal rule and classified and deducted as charitable contributions under Treas. Reg. § 1.170A-4A(c)(3).6 We respectfully request that clarifying guidance in the form of a notice be issued that such costs are treated as cost of goods sold under current law and regulations, as such treatment is consistent with the intent of the existing regulatory charitable contribution regime as described above.

The regulatory development of Treas. Reg. § 1.170A-4A(c)(3) clearly supports the treatment of current year acquisition costs as cost of goods sold. Treas. Reg. § 1.170A-4A(c)(3) originally required the donor to apply the removal rule by reducing its cost of goods sold by the basis of the donated property.7 The Treasury Department and the Internal Revenue Service (the “IRS”), however, recognized that this rule created a problem with respect to “underwater” inventory having a fair market value less than its basis:

      Where the basis of the contributed inventory property qualifying under section 170(e)(3) exceeds the property’s fair market value, the underlying purpose of the section to encourage contributions of this type of property for the purposes specified in section 170(e)(3) may be frustrated. This is because the entire basis of the contributed property is removed from the cost of goods sold while the charitable contribution is limited to the property’s fair market value. It would be more advantageous for the taxpayer to destroy or sell the property than to contribute it for the care of the ill, the needy, or infants. A taxpayer would then be entitled to deduct its entire basis in the property as a loss deduction under section 165 or as part of the cost of goods sold as compared to a charitable contribution amount limited to the property’s fair market value.

8
Treas. Reg. § 1.170A-4A(c)(3) was subsequently amended by T.D. 7962 “[i]n order to remove this disincentive.”9 It is important to note, however, that although not explicit in the text of T.D. 7962 or the regulation itself, it is clear that the amended regulation was directed at limiting the removal rule with respect to prior year acquisition costs10 and was not intended to override the established treatment of current year acquisition costs as cost of goods sold under the general rule of Section 170(e)(1) and Treas. Reg. § 1.170A-1(c)(4).Treas. Reg. § 1.170A-4A(c)(3) by its terms applies to “property which is inventory.” Designation of property as “inventory” is limited to prior year acquisition costs under the existing regulatory charitable contribution regime as evidenced by Treas. Reg. § 1.170A-1(c)(4), which distinguishes between (i) “[a]ny costs and expenses pertaining to the contributed property which were incurred in taxable years preceding the year of contribution and are properlyreflected in the opening inventory for the year of contribution” (i.e., prior year acquisition costs subject to the removal rule), and (ii) “[a]ny costs and expenses pertaining to the contributed property which are incurred in the year of contribution” (i.e., current year acquisition costs treated as cost of goods sold). Current year acquisition costs by definition are not “inventory” (i.e., they remain as part of cost of goods sold in the current year and, therefore, are never reflected in inventory) and, therefore, should not be subject to the application of Treas. Reg. § 1.170A-4A(c)(3) which as noted above is limited to “property which is inventory.“11

It should be noted that it is our understanding that some parties have interpreted the introductory language of the regulation (i.e., “[n]otwithstanding the rules of § 1.170A-1(c)(4)”) to disregard the established treatment of current year acquisition costs as cost of goods sold, when such language should for the reasons described above be limited to an interpretation of the application of the removal rule to prior year acquisition costs. As detailed above, the context of the amendment to Treas. Reg. § 1.170A-4A(c)(3) was clearly limited to the treatment of prior year acquisition costs and there is nothing to suggest that the established treatment of current year acquisition costs as cost of goods sold under Treas. Reg. § 1.170A-1(c)(4) was intended to be modified. This is further supported by the fact that Treas. Reg. § 1.170A-4A(c)(3) was amended without being subject to the normal notice and comment procedures and effective date limitations of the Administrative Procedure Act (the “APA”) as the Treasury Department and the IRS determined that the amendment “merely liberalize[d] the provisions of § 1.170A-4A(c)(3).”12Therefore, it was “found unnecessary to issue it with notice and public procedure under [the APA] or subject to the effective date limitation of [the APA].”13 It is respectfully submitted that the amendment to Treas. Reg. § 1.170A-4A(c)(3) was not intended as a restriction on the established treatment of current year acquisition costs as cost of goods sold under Treas. Reg. § 1.170A-1(c)(4), since if it was intended as such a restriction the Treasury Department and the IRS presumably would not have viewed the amendment as a “liberalization” and, therefore, would have been compelled to follow the required APA procedures.

Despite the fact that the context of the amendment to Treas. Reg. § 1.170A-4A(c)(3) suggests that the removal rule provided by that regulation be limited to prior year acquisition costs, the fact that there is not an explicit reference to such prior year acquisition costs has created uncertainty as to the treatment of current year acquisition costs. In response to taxpayer concerns regarding this uncertainty,14 the Office of Associate Chief Counsel (Income Tax & Accounting) issued Notice 2008-90, which allowed taxpayers to treat current year acquisition costs as cost of goods sold in certain circumstances.15 The notice itself, however, announced a larger study of the treatment of charitable contributions under Section 170(e)(3) and contemplated the issuance of future guidance.16 Consistent with the underlying intent of this study, it is respectfully submitted that such future guidance be included on the 2014-2015 Priority Guidance Plan and ultimately be issued by the Office of Associate Chief Counsel (Income Tax & Accounting) to provide comprehensive clarification that current year acquisition costs are treated as cost of goods sold under current law in all circumstances.

III. Appropriateness of Inclusion of Requested Guidance on the 2014-2015 Priority Guidance Plan

Pursuant to the Notice, the Treasury Department and the IRS consider the following in reviewing recommendations and selecting projects for inclusion on the 2014-2015 Priority Guidance Plan: (i) whether the recommended guidance resolves significant issues relevant to many taxpayers; (ii) whether the recommended guidance promotes sound tax administration; (iii) whether the recommended guidance can be drafted in a manner that will enable taxpayers to easily understand and apply the guidance; (iv) whether the recommended guidance involves regulations that are outmoded, ineffective, insufficient, or excessively burdensome and that should be modified, streamlined, expanded, or repealed; (v) whether the IRS can administer the recommended guidance on a uniform basis; and (vi) whether the recommended guidance reduces controversy and lessens the burden on taxpayers or the IRS.

It is respectfully submitted that the recommended guidance satisfies each of these criteria. With respect to the first criteria, the recommended guidance resolves significant issues relevant to many taxpayers. Specifically, the treatment of current year acquisition costs under Section 170(e)(3) impacts the wide number of donors and recipients of charitable contributions of inventory and other property for the benefit of the ill, the needy, or infants. This is particularly true with respect to donors of food (including grocery stores, food manufacturers and others), as well as food banks and other hunger relief agencies that are the recipients of such donations.17 Uncertainty regarding the treatment of current year acquisition costs has caused such donors to consider suspending or eliminating long-standing charitable donation programs. In this regard, such uncertainty has caused such donors to consider destroying or otherwise disposing of inventory and other property (and claiming a loss deduction) rather than donating it in order to ensure that they recover the basis of such property without being subject to the taxable income limitation of Section 170(b)(2).18

With respect to the fourth criteria, the recommended guidance involves regulations that are ineffective because, as discussed above, such guidance would address the uncertainty regarding the scope and application of Treas. Reg. § 1.170A-4A(c)(3)19 and, in particular, whether current year acquisition costs with respect to charitable contributions under Section 170(e)(3) are (i) treated as costs of goods sold under the general rule of Section 170(e)(1) and Treas. Reg. § 1.170A-1(c)(4), or (ii) subject to the removal rule and classified and deducted as charitable contributions under Treas. Reg. § 1.170A-4A(c)(3).

With respect to the remaining criteria, the recommended guidance would (i) promote sound tax administration, (ii) be drafted in a manner that will enable taxpayers to easily understand and apply it, (iii) be administered by the IRS on a uniform basis, and (iv) reduce controversy and lessens the burden on taxpayers or the IRS. As evidenced by the draft notice enclosed as Exhibit A and the example demonstrating the application of that draft notice enclosed as Exhibit B, the recommended guidance allows for the simple classification of acquisition costs and the straightforward calculation of the Section 170(e)(3) enhanced deduction. Such classification and calculation is (i) easily applied by taxpayers and easily administered and reviewed by the IRS,20 and (ii) would result in relatively little if any additional recordkeeping or compliance burden for taxpayers.

* * * * * *

Thank you in advance for your consideration of this request. We appreciate the opportunity to submit this request and would welcome the opportunity to meet with the Treasury Department and the IRS to discuss it in greater detail or to answer any questions that you may have.

                  Respectfully submitted,
                  Marc J. Gerson
                  Miller & Chevalier Chartered
                  Washington, DC

Enclosures

cc:
Alexa M. Claybon
M. Ruth M. Madrigal
Treasury Department Office of Tax Policy

Andrew J. Keyso, Jr.
Associate Chief Counsel (Income Tax & Accounting)

Roy A. Hirschhorn
Chief, Branch 6
Associate Chief Counsel (Income Tax & Accounting)

Steven I. Hurok
Citrin Cooperman

* * * * *Exhibit A
Draft Notice

Part III — Administrative, Procedural, and MiscellaneousCharitable Contributions of Inventory And Other Property Under § 170(e)(3)

Notice 2014-[XX]

SECTION 1. OVERVIEW

This notice provides guidance clarifying the treatment under current law of current year acquisition costs with respect to charitable contributions of inventory and other property that constitute qualified contributions as defined in Section 170(e)(3) of the Internal Revenue Code.

SECTION 2. GUIDANCE UNDER SECTION 170(e)(3)

For a particular qualified contribution of inventory and other property under § 170(e)(3) that otherwise satisfies the requirements of § 170 and the relevant regulations, any costs and expenses pertaining to the contributed property which are incurred in the year of contribution and would, under the method of accounting used, be properly reflected in the cost of goods sold for such year (“current year acquisition costs”) are to be treated as part of the cost of goods sold for such year.

SECTION 3. RELIANCE ON NOTICE

Taxpayers may rely on this notice unless and until further guidance is issued.

SECTION 4. DRAFTING INFORMATION

The principal author of this notice is [insert] of the Office of Associate Chief Counsel (Income Tax & Accounting). For further information regarding this notice contact [insert] at [insert] (not a toll free call).

Exhibit B
Example

Corporation X has taxable income of $2,000 for 2014. Corporation X makes a charitable contribution of food to a local food bank in 2014. The contribution is a “qualified contribution” under Section 170(e)(3)(A). The food was purchased during 2014 and had a basis of $100 and a fair market value of $150 on the date of contribution. The amount and classification of the resulting deductions for 2014 are as follows: Portion of deduction classified and allowed as cost of goods sold
 ("COGS")

 Cost basis                                                        $100

 Portion of deduction classified as charitable contribution

 Fair market value of contributed property                         $150
 Reduction for 50% of profit ($150 - $100)                        ($25)
 Net                                                               $125

 Twice cost basis of contributed property                          $200

 Lower of net (computed above) or twice cost basis                 $125
 Portion of deduction classified and allowed as COGS             ($100)
 Net Section 170(e)(3) "bump"                                       $25

 Application of Section 170(b) taxable income limitation

 Total 2014 charitable contribution                                 $25
 Taxable income limitation (10% of $2,000)                         $200
 Charitable contribution deduction in 2014                          $25

 Total cost recovery in 2014

 Portion of deduction classified and allowed as COGS               $100
 Charitable contribution deduction in 2014                          $25

FOOTNOTES

1 All section references are to the Internal Revenue Code of 1986, as amended, and the Treasury Regulations promulgated thereunder, unless otherwise specified.2 Because such guidance would clarify the treatment of current year acquisition costs under current law, such guidance should be applicable retroactively.

3 Increased demand on food banks and other hunger relief agencies, and the increased efforts of donors of food to satisfy such demand, has been widely reported. See, e.g., Nixon, “Food Banks Anticipate Impact of Cuts to Food Stamps, New York Times (Jan, 22, 2014); Bello, “Food Stamp Cuts Create High Demand For Food Bank Supplies,” USA Today (Nov. 4, 2013). See also Feeding America, 2013 Annual Report (noting that the Feeding America nationwide network of member food banks provided 3.2 billion meals to 37 million people in the United States in a single year).

4 As discussed in greater detail herein, the requested guidance with respect to the treatment of current year acquisition costs may be issued in a manner that is consistent with the existing regulatory charitable contribution regime (i.e., such that no modification of the existing regulations would be required). Therefore, it is respectfully requested that guidance be issued in the form of a notice such that it may be issued in an expedited fashion. To the extent that the Treasury Department and the Internal Revenue Service are considering the issuance of broader guidance under Section 170(e)(3) that would in fact require a modification to the existing regulations, it is respectfully requested that the requested guidance with respect to the treatment of current year acquisition costs be issued in the form of a notice in advance of such regulations for the compelling socioeconomic circumstances discussed above.

5 Treas. Reg. § 1.170A-1(c)(4) (“Any costs and expenses pertaining to the contributed property which were incurred in taxable years preceding the year of contribution and are properly reflected in the opening inventory for the year of contribution must be removed from inventory and are not a part of the cost of goods sold for purposes of determining gross income for the year of contribution. Any costs and expenses pertaining to the contributed property which are incurred in the year of contribution and would, under the method of accounting used, be properly reflected in the cost of goods sold for such year are to be treated as part of the cost of goods sold for such year.”).

6 See American Institute of Certified Public Accountants, Compendium of Legislative Proposals — Simplification and Technical Proposals, at 74-76 (Feb. 19, 2014) (the “AICPA Legislative Proposals”). Although the AICPA Legislative Proposals suggest that such uncertainty may be resolved through legislation amending Section 170(e)(3), it is respectfully submitted that because the classification of current year acquisition costs is addressed through the existing regulatory charitable contribution regime as described above, such uncertainty may be clarified through the guidance requested in this submission.

7 Former Treas. Reg. § 1.170A-4A(c)(3), T.D. 7807, 1983-2 C.B. 41, 45 (“The donor of property which is inventory contributed under this section must make a corresponding adjustment to cost of goods sold by decreasing the cost of goods sold by the amount of basis. . . .”).

8 T.D. 7962, 1984-2 C.B. 57.

9 Id.

10 The Treasury Department and the IRS could, of course, amend the regulation with respect to the treatment of prior year acquisition costs. Such an amendment, however, is beyond the scope of the requested guidance contained herein.

11 Furthermore, as noted above, Treas. Reg. § 1.170A-4A(c)(3) was amended to address situations involving “underwater” inventory that has decreased in value. T.D. 7962, 1984-2 C.B. 57. Such “underwater” inventory situations are most prevalent with respect to prior year acquisition costs as opposed to current year acquisition costs given the greater opportunity for valuation disparities to occur with respect to prior year acquisition costs. See also Treas. Reg. § 1.170A-4A(c)(4) Ex. 1 (500% increase in fair market value of donated property suggests property was included in beginning of year inventory as prior year acquisition costs).

12 1984-2 C.B. 57.

13 Id.

14 See “Attorneys Alert Treasury to Unintended Consequences of Existing Charitable Contribution Regs,” 2008 TNT 94-19 2008 TNT 94-19: Treasury Tax Correspondence (May 2, 2008) (the “2008 Treasury Submission”).

15 Notice 2008-90 at Section 2. See also “Firm Makes Recommendation for Treatment of Charitable Contributions of Inventory Property,” 2009 TNT 17-21 2009 TNT 17-21: IRS Tax Correspondence (Jan. 22, 2009) (the “2009 Treasury Submission”).

16 Notice 2008-90 at Sections 1, 4.

17 See Footnote 3 and accompanying text

18 See 2008 Treasury Submission. As a result of this uncertainty, the Treasury Department and the IRS issued Notice 2008-90, which allows taxpayers in certain circumstances to recover their tax basis in donated inventory and other property as cost of goods sold. See 2009 Treasury Submission.

19 As noted above, such uncertainty is caused, in particular, by the introductory language of that regulation (i.e., “[n]otwithstanding the rules of § 1.170A-1(c)(4)”).

20 Furthermore, the promulgation of the recommended guidance would not prevent the IRS from challenging other issues with respect to the Section 170(e)(3) enhanced deduction. See CCA 201012061 (Nov. 10, 2009) (Notice 2008-90 does not prevent IRS from challenging other issues under Section 170(e)(3)). In addition, the IRS’s ability to administer the recommended guidance would be enhanced if, consistent with the 2009 Treasury Submission, such guidance was limited to Section 170(e)(3) contributions of inventory and other property and not expanded to apply to Section 170(e)(4) contributions of scientific property used for research and Section 170(e)(5) contributions of computer technology and equipment for educational purposes, despite the cross reference in those sections to Section 170(e)(3). See 2009 Treasury Submission.

END OF FOOTNOTES


Draft of Simplified EO Application Presents Problems, Group Says.

Draft Form 1023-EZ, “Streamlined Application for Recognition of Exemption Under Section 501(c)(3) of the Internal Revenue Code,” would decrease the quality of information the IRS needs to make informed decisions, according to Tim Delaney of the National Council of Nonprofits.

 

April 30, 2014

Office of Information and Regulatory Affairs
Office of Management and Budget
Attention: Desk Officer for Treasury
New Executive Office Building, Room 10235
Washington, DC 20503

Treasury PRA Clearance Officer
1750 Pennsylvania Avenue NW, Suite 8140
Washington, DC 20220

    RE: TREASURY DEPARTMENT’S PROPOSAL TO RADICALLY ALTER THE PROCESS FOR OBTAINING TAX-EXEMPT STATUS VIA AN ALTERNATIVE FORM 1023-EZ APPLICATION FOR RECOGNITION OF EXEMPTION UNDER SECTION 501(c)(3) OF THE INTERNAL REVENUE CODE

Dear Office of Management and Budget Officials:The National Council of Nonprofits submits the following comments in response to the Treasury Department’s Notice of Submission for OMB Review published in the Federal Register (79 FR 18124) on March 26, 2014. That Notice invited “comments regarding the burden estimate, or any other aspect of the information collection” associated with the Internal Revenue Service (IRS) proposal to radically alter the process for obtaining tax-exempt status by “introducing an ‘EZ’ version of the Form 1023 as an alternative in applying for recognition of exemption from federal income tax under section 501(c)(3).”

As explained below, we are concerned that the proposed new Form 1023-EZ and related streamlined approval process for tax-exemption will:

      1. Decrease, rather than improve, the quality of information the IRS needs to make informed decisions;

2. Reduce public trust; and

3. Inappropriately shift the IRS’ obligations onto others — foisting burdens on the public, existing charitable nonprofits, the funding community, and state charity regulators.
OMB should not approve the proposed Form 1023-EZ; instead, OMB should — consistent with the Paperwork Reduction Act — put the public’s interest in “accountability, transparency, and openness in Government and society” before the interest of simply reducing a backlog at the IRS, significant though it may be. See 44 U.S.C. § 3501.We agree with the IRS that the long-established Form 1023 and application process need review and streamlining. However, we are concerned that the proposed new EZ Form and related express-lane approval process go too far and too fast, representing radical departures from proven protocols. In response to the Treasury Notice seeking “suggestions for reducing the burden,” the IRS should meet first with other key stakeholders — including the public, existing charitable nonprofits, the funding community, and state charity regulators, such as occurred when the IRS redesigned the Form 990. Therefore, we are sending a copy of these Comments to the Commissioner of Tax Exempt and Government Entities and the Director of the IRS Exempt Organizations Division to alert them to our serious concerns and request that they withdraw the proposed new form and gather more input before radically changing the way applications for tax-exemption are evaluated by the IRS.

The Interests of the National Council of Nonprofits

The National Council of Nonprofits is a 501(c)(3) charitable nonprofit that serves as a trusted resource and advocate for America’s charitable nonprofits. Through our network of State Associations and 25,000-plus members — the nation’s largest network of charitable nonprofits — we serve as a central coordinator and mobilizer to help nonprofits achieve greater collective impact in local communities across the country. We identify emerging trends, share proven practices, and promote solutions that benefit charitable nonprofits and the communities they serve. Our core mission is “to advance the vital role, capacity, and voice of charitable nonprofit organizations through our state and national networks.”An IRS decision to grant status as a charitable nonprofit is a momentous one creating cascading results, so it should not be done lightly. Through operation of longstanding interdependent federal and state laws, many things happen once the IRS issues a determination letter recognizing an organization as being exempt from federal income tax under section 501(c)(3). For instance, in many states it activates exemptions from state income taxes and local property taxes. Also, it triggers eligibility for charitable nonprofits to receive donations that are deductible at the federal and usually state levels. In exchange for these and other benefits of being recognized as tax-exempt, charitable nonprofits and private foundations forfeit certain rights. For example, they are not allowed to support or oppose political candidates. Plus, they give up privacy rights afforded to others — they file federal tax information returns annually that are open to public inspection. And the list of inter-related federal, state, local, and private causes and effects/costs and benefits goes on.

The IRS’ proposed new Form 1023-EZ and related process for obtaining express-lane authority to solicit charitable deductions are radical departures from proven protocols that could have a profound impact on the foregoing inter-related balancing that involves the nonprofit community. To underscore the significance of what the proposed changes could mean, consider the following observations we have received from nonprofit leaders across the country in the last several days since learning about the Paperwork Reduction Act review (emphasis added):

  • I counsel new nonprofits weekly, and though I appreciate the IRS’s attempt at efficiency, I think this could be disastrous. I think that we need to look at the overall confidence this move could erode with the American public over time (based on potentially “legitimate” nonprofits seeking funding for causes that have not been thoroughly vetted). This wouldn’t happen immediately, but it could be a bad legacy to leave for the next generation of leadership, one that would be difficult to course correct once people became use to the ease of the process.
  • The current process is slow but it requires effort and energy and pushes away those that are not prepared. At a minimum allows some thoughtfulness and energy in describing who you are and how you will operate. To remove the requirement simply pushes the clean up to 3 years from now as the system falls apart and there is a backlash of onerous exams and audits.
  • We don’t need a proliferation of tax exempt organizations. Already, cultivating and recruiting functional boards is a challenge. Funding is a challenge.
  • Having gone through the application process with a museum I helped start, we were put through the ringer by the IRS which to some extent forced us to think through our plans (mission, vision, intent, how we would operate, etc.) ultimately, I believe, making us stronger.
  • While I recognize the process in and of itself is not necessarily user friendly, it has supported a perception of the awesome responsibility to become tax exempt and serving the community. In making the process more streamlined it may only lessen the perception of the “awesome” responsibility to the community that a group has after being granted the tax status.
  • While the idea of simplifying the application process for smaller organizations is laudable, the proposed Form 1023 EZ goes way too far. Although a charity is supposed to review the requirements in advance and attest to having the requisite purposes and documents, this proposal removes the crucial step of having someone independent (in this case, the IRS) to verify the existence of these documents or ensure that the required provisions are actually in place. Although the IRS estimates that it will take 14 hours to fill out the new Form 1023 EZ, I could easily see many applicants spending as little as an hour or so — not because they deliberately intend to skirt the law, but because they simply don’t know or understand what they are required to certify. Sure, they may (or may not) have the documents, but do they even say the right things? We’ve encountered similar situations through our legal assistance program for startup organizations, simply because people often “don’t know what they don’t know” without a legal review or a competent IRS agent. Clearly,without these safeguards in place, the door could be opened for improper approval of thousands of applications each year.
  • Generally, Form 1023 is not very accessible, too long, and quite cumbersome. The form should be simplified, but this EZ form does this too much. There some useful exercises that are part of the 1023 filing process that are useful in setting up a sustainable organization (bylaws, business/revenue plan, conflict of interest policies, the programs narrative). The full 1023 is overwhelming and is discouraging to some, but also a deterrent to those with only half-baked plans and ideas. I understand that the IRS wants to clear the backlog, but this may not be the best solution as it is in its current draft format. If the 1023 EZ was improved in some ways, it might be a good option.
  • This change could wreak added havoc for regulators, since the rigorous review of EO applications will not have been done beforehand, opening the door for all kinds of problems in terms of non-compliance (again, intentional or otherwise) and enforcement issues for both state and federal regulators. In terms of wise utilization of IRS resources, this may actually cost more in the long run, and could seriously undermine public trust in the sector if problems end up increasing as a result.

Before such a potentially significant change is implemented, it merits far greater public input than just a limited Paperwork Reduction Act review. The IRS should seek the views of not only existing charitable nonprofits (many of which, in hindsight, recognize the value of slowing down to complete the Form 1023), donors and foundations (many of whom — because they already question whether there are too many nonprofits — may want to be heard on the subject of possible proliferation), researchers (who may express concern that a valuable source of information — all parts of the Form 1023 application, plus accompanying documentation — will no longer be available to them), and state charity regulators (whom we understand will be filling separate comments to detail their concerns and reiterate their position in 2012 when they “uniformly oppose[d] a Form 1023-EZ”1).

Background

During the last several years, the IRS has accumulated a backlog of pending applications for tax-exempt status.2According to an internal IRS memorandum dated February 28, 2014, IRS managers have been analyzing how to streamline its processes. That memorandum suggests that the only goals considered in connection with the proposed streamlined process were to reduce (a) the IRS backlog of filings and (b) the informational burden for the applicants. Both are laudable goals. However, focusing on those two exclusively ignored multiple other perspectives and significantly sidestepped the IRS’ obligation to base a determination about tax-exempt status on solid information rather than a mere certification. This excerpt from the memo suggests the IRS focused on its own internal management issues rather than any consideration of the possible external consequences that its proposed radical changes might create:
The assessment concluded that the current process has high inventory, limited resources, inaccurate forms, outdated IRMs, continuously changing procedures, multiple touch points, multiple work streams, and non-standard processes. In addition, inadequate technical tax law training has not equipped the workforce to effectively/ efficiently complete the work.
The memorandum also reveals that the IRS has been working on this issue internally since at least June 2013. However, neither the memo nor a review of the IRS website shows any indication that the IRS invited the public or affected stakeholders to provide their informed perspectives, until Treasury filed its narrow Paperwork Reduction Act Notice in the Federal Register on March 31, 2014. That is most unfortunate, because the proposed Form 1023-EZ is a radical departure from the more meaningful review that multiple stakeholders have relied on the IRS to conduct with profound care.The Notice published in the Federal Register on March 31, 2014 asking for comments on the new form by April 30, 2014 may suffer from a fatal procedural flaw. The Notice referenced a draft Form 1023-EZ that was two pages in length, dated February 19, 2014 (labeled “Version A, Cycle 4”). Yet almost a month later, the IRS disclosed a possible substitute two-and-a-half page draft Form 1023-EZ, dated April 23 (labeled “Version A, Cycle 12”). It appears that Treasury gave OMB and thereby the public one version of the Form 1023-EZ, but the IRS has revised the form during the comment period without resubmitting it for approval. The two forms, while carrying the same title and similar in many respects, contain material differences. The subsequent version expressly allows use by organizations seeking two alternatives for reinstatement after automatic revocation, while the first version does not provide them. If the Paperwork Reduction Act process is to be meaningful, then the document being submitted for public comment and OMB approval should not be a moving target. At a bare minimum, OMB, rather than approve the Form 1023-EZ that the Treasury submitted for public comment on March 26, should require Treasury to resubmit.
I. The Proposed EZ Form and Express-Lane Approval Process Will Decrease, Rather Than Improve, the Quality of Information the IRS Needs to Make Informed Decisions
To ensure that organizations are properly qualified and prepared to earn tax exempt status and thus eligible to receive deductible contributions, the IRS has required organizations seeking tax-exempt status under section 501(c)(3) to apply for that benefit. For decades, the IRS has used Form 1023 for groups seeking exemption under section 501(c)(3) (public charities and private foundations). The Form 1023 requires organizations to think through the fiduciary and governance responsibilities of the board of directors as well as identify what the organization will achieve, and how it will be funded.Typically, during a regular review of exemption applications, IRS employees ask questions and require submissions that ensure that start-up groups have at least a passing understanding of such concepts as not furthering non-exempt purposes and private inurement. Unless that sort of verification process is ensured in the streamlined process, there is a risk that recognition for tax-exemptions will be handed to applicants that fail to meet statutory requirements or do not have a threshold understanding of what tax-exempt status requires of their activities and operations. The streamlined procedures only require that a filing organization “certify” compliance (as opposed to the IRS verifying compliance). As enumerated below, in our opinion the 1023-EZ streamlined approval process does not give the IRS enough quality information to determine eligibility for federal tax-exemption. Moreover, there are a few vague questions in the proposed form that may prove problematic for applicants.

The proposed Form 1023-EZ (looking at the official February 19, Version A, Cycle 4):

      1. Has no requirement that the applicant demonstrate it has adopted bylaws.

2. Part II, Lines 5, 6, and 7: Unless the instructions are very detailed, easily understandable, and specific, many applicants will need guidance in order to understand the organizational test and to complete the certifications accurately on a truly informed basis.

3. Part III, Line 2: Rather than asking the applicant to describe what its purposes are (which requires the IRS to have trained examiners to discern whether the description meets the operational test), the Form 1023-EZ invites applicants to “check all that apply” and offers eight categories that may prove confusing to applicants since their perceptions of their own organizations may not fit into those pre-selected legal categories.

4. Part III, lines 4-11: These questions require a “yes” or “no” answer. Many of these questions ask about activities that could go over the line into impermissible conduct by a 501(c)(3) organization, but may also be permissible, depending on the circumstances. If the IRS intends to use the responses to these “yes” or “no” questions to deny tax-exempt status, without probing further into the expected activities of the applicant on, that would be inappropriate and harmful to those attempting to establish legitimate tax-exempt public charities but who misunderstand the concepts or have language differences. Consequently, including these questions on the form requires an investigation of the responses, which therefore must be reflected in the protocol /procedures for the examining IRS agent.

5. Part IV, under the heading: “Part IV is designed to classify you as an organization that is either a private foundation or a public charity. Public charity status is a more favorable tax status than private foundation status.”(Emphasis added.) It seems curious for the IRS, as the regulating entity responsible for evaluating eligibility for tax-exemption, to be advising the filing organization as to the more advantageous tax status.

6. Part IV, Line 1: These three sub-questions require a level of understanding of the federal Tax Code and public support test that we submit most of the applicant using the 1023-EZ will not have. Consequently, these questions are likely to lead to errors by the applicants which will only lead to increased burdens, both on the IRS (unless it has a smooth efficient process planned to educate filing organizations) and the applicants down the road that may inaccurately complete the form, only to have their applications rejected.

7. Unlike in Part V of the existing Form 1023, the proposed Form 1023-EZ does not ask sufficient questions about the family relationships of board members or the business relationships between the applicant and its board members for the IRS to determine whether there is a risk of private inurement or private benefit.

8. The current Form 1023 application process asks the applicant to submit its organizing documents, which then become part of the public record. With the streamlined process, organizing documents will not be required if the applicant uses the certification option. This reduces the amount of data available to researchers and the public about the charitable nonprofit community (and creates a disconnect with the Form 990, which asks filing organizations to submit updates/amendments to their organizing documents).

9. Pointedly, there is no question on the proposed Form 1023-EZ asking whether the filing organization has a conflict of interest policy, which is a fundamental governance document for any tax-exempt organization and should be part of the scrutiny given by the IRS at this critical juncture in evaluating eligibility for tax-exemption. The existing full Form 1023 does.

10. There should be more guidance in the instructions about the annual filing requirement — including the thresholds for which version of the Form 990 should be filed.
We support efficiency and reducing burdens to applicants, but not at the expense of accountability. In filing these comments we find ourselves in an ironic position. In most instances, the National Council of Nonprofits would applaud efforts to simplify and streamline government forms and processes. See, e.g., our statement commending OMB for its work streamlining the government grant process and our Streamlining Reports, such as Partnering for Impact: Government-Nonprofit Contracting Task Forces Produce Results for Taxpayers. Yet here, in looking at the full picture over the long-term, we are concerned that the advantages of a rapid-fire approval process will not outweigh (a) the risks and ramifications of recognizing groups as tax-exempt that may not be prepared to meet ongoing exempt organization requirements, or (b) the risk of not recognizing eligible groups that make errors completing the Form 1023-EZ due to lack of guidance by the IRS in a streamlined process.
II. Concerns That the Proposed New Form and Related Express-Lane Approval Process Will Reduce Public Trust
We expressly and emphatically reject any notion that smaller organizations are more likely to evade the law or commit errors, purposefully or otherwise. Smaller does not equate to incompetent or fraudulent. Yet if the IRS significantly lowers the bar for recognition for applicants claiming to be smaller, then it stands to reason that bad actors will seek to exploit this weakness in the overall application system and opt to use the EZ express-lane approval process to avoid the transparency mandate that is integral to the current Form 1023 application process. When fraudulent disguises itself in this situation, everyone suffers. Thus, we are concerned that the proposed radical diminishment of information available to the IRS to make informed determinations about Section 501(c)(3) status will erode public trust in charitable nonprofits.For individual charitable nonprofits, earning the public’s trust starts with the application for tax-exemption.3 Federal law has long required each charitable nonprofit to make its organization’s application for tax-exemption, including all supporting documents and related correspondence, freely available for public inspection. Reducing the Form 1023-EZ to a simple check-off form renders the mandate of transparency to public scrutiny a rather empty and meaningless exercise.

The IRS has an obligation to ensure that organizations are properly qualified as tax exempt and thus eligible to receive deductible contributions. Completing the Form 1023 requires organizations to think through and identify their anticipated sources of revenue and planned activities, as well as demonstrate that the filing organization is organized in accordance with the Internal Revenue Code’s requirements for public charity or private foundation status. Typically the process of completing the application is time-consuming, often due to back-and-forth communications between the IRS and the filing organization, all of which are subject to public disclosure. In fact, those communications provide a window of transparency for the public into the process by which applicants are evaluated and recognized by the IRS as tax-exempt. In contrast, with the streamlined process of merely asking filing organizations to certify to the existence of various provisions in their organizing documents, the transparency that the public has come to expect (the ability to view organizing documents and understand why tax-exemption was either recognized or denied) will be eliminated.
III. The IRS Is Inappropriately Shifting Its Duties onto Others — Foisting Burdens on the Public, Existing Charitable Nonprofits, and State Charity Regulators
The IRS recognizes that it is stepping back from its front-end enforcement work in favor of having a “robust compliance process at the back end.”4 Yet, as noted above, a complex interdependent system relies on the IRS to perform its vital front-end duties. Furthermore, as the IRS continues to be underfunded and understaffed to conduct current compliance tasks, it should not rely on expanding back end enforcement as a remedy for lowering the initial barrier to entry. By abandoning aspects of its initial screening role, the IRS is passing its responsibilities onto others, creating new burdens for them. That is fundamentally unfair, especially when the IRS has not conducted a full risk assessment with other partners in the complex system that rely on the IRS to do its duty.Increases Potential Burdens to Taxpayers

By abdicating important aspects of its front-end review of tax-exempt eligibility, the IRS is shifting burdens to others, including the public, which will potentially be faced with more expensive back end enforcement actions for groups that received fast-track tax-exemption, but are not following the procedures expected of tax-exempt organizations. The IRS has indicated that it does not have enough auditors to do needed back end enforcement work, so this effort to create an expedited process to solve an immediate backlog problem may only exacerbate problems at the back end, creating more costs for taxpayers to clean things up when things go awry.

Increases Burdens for Existing Nonprofits

As mentioned earlier, each charitable nonprofit relies on the public’s trust in order to continue to attract resources to advance its mission. The proposed easy-application/easy-approval process portends damaging the public trust that legitimate charitable nonprofits earned and need to operate in local communities across America. When negative stories get published about nonprofits (even non-charitable nonprofits, such as social welfare organizations), it hurts all nonprofits, making it more difficult to recruit board members, volunteers, and obtain donations to advance charitable missions.

Increases Burdens to State Governments

By abdicating its front-end review of tax-exempt eligibility, the IRS is also shifting part of its enforcement duties and costs to state charity officials, who now rely on the IRS’ known-to-be-tough scrutiny in the tax-exempt determinations process. The abdication of the IRS’ scrutiny could lead to problems in the field, adding to the potential distrust of charitable nonprofits and the IRS’ determination process.
IV. The Proposed EZ Form and Approval Overlook the Value of the Full Form 1023
As the IRS ACT report, “Exempt Organizations: Form 1023 — Updating It for the Future,” observed:

    The primary reason we do not recommend the development of a Form 1023-EZ is because Form 1023 serves an important educational purpose for applying organizations. Through its questions, the form forces the applying organization to think somewhat deeply about its activities, finances, and management. The form also signals to the organization that it is entering into a (probably unfamiliar) comprehensive regulatory regime, and working through the questions on the form provides the organization with a great deal of information about compliance with this regime. We agree with the many practitioners we spoke with who believe that the educational benefits of Form 1023 are especially important for small organizations. And we do not believe that a significantly shorter Form 1023 could provide a comparable level of these benefits.

Our concern is that rather than help smaller groups start out on the right foot, the fast-track approval process will loosen the threshold requirements that currently ensure a thoughtful process that makes a newly-forming exempt organization aware of its initial and ongoing obligations. Without a significant effort by the IRS to educate newly formed groups about the obligations of tax-exemption, filing out the proposed Form 1023 EZ will be just as confusing, and perhaps more confusing because of the lack of explanation, than the existing Form 1023. Since by definition the streamlined process will result in the IRS spending less time reviewing the applications, we are equally concerned about applicants using the proposed Form 1023 EZ only to have their applications denied — when in other circumstances a more thorough review would have resulted in recognition of tax-exempt status.

* * *

As a network that assists individuals who are in the process of creating charitable nonprofits, we agree that the existing Form 1023 and associated approval process need to be improved. But we reject a perspective that puts more weight on a short-term myopic perspective of what’s easiest for the IRS today, rather than on a process that over the long-term serves and supports everyone — applicants, charitable nonprofits, funders, state charity regulators, and the public.
V. Recommendations
The National Council of Nonprofits calls on the OMB to not approve the Form 1023 EZ. We also urge the Treasury Department and IRS to:

      1. Withdraw the proposed Form 1023-EZ and streamlined determinations process;

2. Continue the reform effort because the old Form 1023 and application review process need updating, but do so only with guidance from the public, the charitable nonprofit community and its stakeholders, so the appropriate balance can be struck between increasing efficiency, minimizing the burden on the filing organization and the IRS, and enhancing public trust.

                  Respectfully submitted,
                  Tim Delaney
                  National Council of Nonprofits
                  Washington, DC

Copies to:

Sunita Lough
Commissioner of Tax Exempt and Government Entities
Internal Revenue Service
111 Constitution Avenue NW, Room 1519
Washington, DC 20224

Tamera Ripperda
Director, Exempt Organizations
Tax Exempt Organizations Division
Internal Revenue Service
111 Constitution Avenue NW, Room 1519
Washington, DC 20224

FOOTNOTES

1 See IRS Advisory Committee on Tax Exempt and Government Entities (IRS ACT), “Exempt Organizations: Form 1023 — Updating It for the Future,” in Report of Recommendations (June 6, 2012) at 32 of Exempt Organizations report (page 104 of PDF) (emphasis added).2 We recognize that some of the backlog may be due to reduced funding, forcing the IRS workforce to be reduced by about 10 percent since 2010. See Prepared Remarks of Commissioner of Internal Revenue Service John Koskinen before the National Press Club, April 2, 2014. That backlog may have grown when more than 250 IRS employees were diverted to comply with information requests by six investigations dealing with the Exempt Organizations Division that oversees the applications for both 501(c)(3) charitable nonprofits and the 501(c)(4) social welfare organizations that has generated so much negative publicity in the last year.

3 The National Council of Nonprofits’ Public Policy Agenda notes, among other things: “The nonprofit community recognizes that mission-driven nonprofits can be successful only by earning and maintaining public trust through appropriate transparency, which can be guided by reasonable regulation that recognizes the unique role of these organizations in communities.”

4 “A new streamlined process for the Form 1023-EZ . . . will also allow the IRS to concentrate more on compliance for Section 501(c)(3) organizations at the back end.” See Diane Freda, ” IRS to Roll Out Form 1023-EZ in Summer, Anticipates Little Risk of Noncompliance,” Bloomberg BNA (April 25, 2014) (media call with Sunita Lough, IRS



JCT Provides Overview of Highway Infrastructure Tax Provisions.

The Joint Committee on Taxation in a report (JCX-49-14) prepared for a May 6 Senate Finance Committee hearing provided an overview of the Highway Trust Fund and other selected methods for financing surface transportation infrastructure.The report describes the six separate excise taxes that finance the Highway Trust Fund and legislation regarding the fund balance; public-private partnerships and related tax considerations and benefits, including depreciation of tangible infrastructure assets, amortization of intangible assets, and recovery of investment in the lease of land; and tax-exempt financing that is available for specific transportation infrastructure, including governmental bonds and qualified private activity bonds.

The report also briefly describes tax-credit and direct-pay bonds, such as the clean renewable energy bonds, qualified energy conservation bonds, qualified zone academy bonds, qualified school construction bonds, and Build America Bonds, and legislative proposals to create a tax-credit bond program for infrastructure and a national infrastructure bank.

 

OVERVIEW OF SELECTED TAX PROVISIONS RELATING TO THE
FINANCING OF SURFACE TRANSPORTATION INFRASTRUCTURE

Scheduled for a Public Hearing
Before the
SENATE COMMITTEE ON FINANCE
on May 6, 2014Prepared by the Staff
of the
JOINT COMMITTEE ON TAXATIONMay 5, 2014

JCX-49-14

                                CONTENTS

 INTRODUCTION AND SUMMARY

      I. OVERVIEW OF THE HIGHWAY TRUST FUND AND RELATED EXCISE TAXES

     II. SELECTED METHODS FOR INFRASTRUCTURE PROJECT FINANCE

           A. Public-Private Partnerships

           B. Tax-Exempt Financing for Transportation Infrastructure

           C. Other Methods and Proposals for Infrastructure Project
              Finance

                1. Overview: tax-credit bonds and direct-pay bonds

                2. Tax-credit bonds for infrastructure proposals

                3. National infrastructure bank proposals

INTRODUCTION AND SUMMARY

The Senate Committee on Finance has scheduled a public hearing on May 6, 2014, to examine public financing of highways and transit. This document,1 prepared by the staff of the Joint Committee on Taxation, provides a description of present-law provisions relating to the Highway Trust Fund and its dedicated taxes, and an overview of public-private partnerships and related tax considerations, and a description of tax-exempt financing that is available for certain transportation infrastructure. The document also briefly describes tax-credit and direct-pay bonds, a proposal to create a tax-credit bond program for infrastructure, and proposals to create a national infrastructure bank.The Highway Trust Fund was established in 1956. It is divided into two accounts, a Highway Account and a Mass Transit Account, each of which is the funding source for specific programs. The Highway Trust Fund is funded by taxes on motor fuels (i.e., gasoline, kerosene, diesel fuel, and certain alternative fuels), a manufacturer’s tax on heavy vehicle tires, a retail sales tax on certain trucks, highway trailers and tractors, and an annual use tax for heavy highway vehicles.

In addition to infrastructure projects financed through the use of Federal trust funds, such projects may be financed through the use of public-private partnerships. The Department of Transportation defines public-private partnerships broadly to include “contractual agreements formed between a public agency and private sector entity that allow for greater private sector participation in the delivery and financing of transportation projects.”2 For example, a public-private partnership might contemplate a private firm taking on all the design and construction risks for a new project, or a private firm operating a project for a period of years following construction, and obtaining an economic return based on the relative success of its management. State and local governments have shown increasing interest in public-private partnership arrangements as the cost of infrastructure development and maintenance continues to increase. Tax benefits associated with public-private partnerships include depreciation of tangible infrastructure assets and amortization of intangible assets.

Debt also may be used to finance infrastructure projects. Tax-exempt bonds issued by State and local governments may be classified as either governmental bonds or private activity bonds. Present law does not limit the types of facilities that can be financed with governmental bonds. Thus, State and local governments can issue tax-exempt governmental bonds to finance a broad range of transportation infrastructure projects, including highways, railways, airports, etc. However, while the types of projects eligible for governmental bond financing are not circumscribed, present law imposes restrictions on the extent to which private parties may benefit from such financing. State and local governments may issue qualified private activity bonds for certain transportation infrastructure such as airports, port facilities, mass commuting facilities, high-speed intercity rail facilities and qualified highway or surface freight transfer facilities.

Another form of tax-preferred financing is the tax-credit bond. A taxpayer holding a tax credit bond on a credit allowance date is entitled to a tax credit. Examples of tax-credit bonds are qualified zone academy bonds, qualified school construction bonds, new clean renewable energy bonds, and qualified energy conservation bonds. Among the proposals for tax-credit bonds to finance infrastructure is S. 1250, the Transportation and Regional Infrastructure Project Bonds Act of 2013 (the “TRIP Bonds Act”). The TRIP Bonds Act would provide authority for the issuance of tax-credit bonds to assist State and local governments in funding transportation infrastructure, including roads, bridges, transit, rail, ports and inland waterways.

The American Recovery and Reinvestment Act of 2009 (“ARRA”) created a new category of bond, the Build America Bond. There are two types of Build America Bonds, the “tax-credit” Build America Bond and the “direct-pay” Build America Bond. The tax-credit Build America Bond provides a Federal tax credit to the bondholder equal to 35 percent of the interest payable by the issuer.3 At the election of the issuer, a direct-pay Build America Bond provides the State or local government issuer with a 35 percent interest subsidy, in the form of a cash payment from the Federal Government, in lieu of providing a tax credit to the bondholder. Tax-credit Build America Bonds may be issued to finance any governmental purpose for which tax-exempt governmental bonds (excluding private activity bonds) could be issued. The eligible uses of proceeds and types of financings for direct-pay Build America Bonds are more limited than for tax-credit Build America Bonds. Direct-pay Build America Bonds are to finance only capital expenditures that could have been financed with tax-exempt governmental bonds. Authority to issue all types of Build America Bonds expired on December 31, 2010.

To supplement bonds issued by State and local governments and other financing mechanisms, there are proposals to create a national infrastructure bank to provide financing to infrastructure projects of national and/or regional significance. Most recently, versions of the infrastructure bank proposal have been included in S.1716, the “Building and Renewing Infrastructure for Development and Growth in Employment Act” or the “BRIDGE Act,” in S. 1957, the “Partnership to Build America Act of 2014” and in the President’s fiscal year 2015 budget proposal.

I. OVERVIEW OF THE HIGHWAY TRUST FUND AND
RELATED EXCISE TAXES

The Highway Trust Fund was established in 1956 to coordinate the Federal role in highway construction and maintenance activities, including the development of the then-new Interstate Highway System. The Highway Trust Fund is divided into two accounts, a Highway Account and a Mass Transit Account, each of which is the funding source for specific programs.4 Highway Trust Fund expenditure purposes have been revised with the passage of each authorization Act enacted since the establishment of the Highway Trust Fund in 1956. In general, expenditures authorized under those Acts (as the Acts were in effect on the date of enactment of the most recent such authorizing Act) are approved Highway Trust Fund expenditure purposes under the Code. Expenditures from the Highway Trust Fund are authorized through September 30, 2014.Most Federal surface transportation programs funded by the Highway Trust Fund span four major areas of investment: highway infrastructure, transit infrastructure and operations, highway safety, and motor carrier safety.5The funds are distributed either by formula or on a discretionary basis through several individual grant programs.6

Revenue sources for the Highway Trust Fund

Six separate excise taxes are imposed to finance the Federal Highway Trust Fund program. Three of these taxes are imposed on highway motor fuels and the substantial majority of the revenues produced by the Highway Trust Fund excise taxes are derived from the taxes on motor fuels. The remaining three are a retail sales tax on heavy highway vehicles (trucks, trailers and certain tractors), a manufacturers’ excise tax on heavy vehicle tires, and an annual use tax on heavy vehicles. Except for 4.3 cents per gallon of the Highway Trust Fund fuels tax rates, these taxes generally do not apply after September 30, 2016. The 4.3-cents-per-gallon portion of the fuels tax rates is permanent.7 The annual use tax expires on October 1, 2017. The taxes dedicated to the Highway Trust Fund are summarized below.

Highway motor fuels taxes

The Highway Trust Fund motor fuels tax rates are as follows:8

 Gasoline                           18.3 cents per gallon
 Diesel fuel and kerosene           24.3 cents per gallon9
 Alternative fuels                  24.3 and 18.3 cents per gallon10

The Code imposes tax on gasoline, diesel fuel, and kerosene (“taxable fuels”) upon removal from a refinery or on importation, unless the fuel is transferred in bulk by registered pipeline or barge to a registered terminal facility.11Typically, these fuels are transferred by pipeline or barge in large quantities (“bulk”) to terminal storage facilities that are located closer to destination retail markets. The fuel is then taxed when it “breaks bulk,” i.e., when it is removed from the terminal, typically by truck or rail car, for delivery to a smaller wholesale facility or a retail outlet. The majority of the fuel taxes are imposed upon removal at the terminal. The party liable for payment of the taxes is the “position holder,” i.e., the person shown on the records of the terminal facility as controlling the fuel.12

All persons controlling taxable fuels before tax is imposed must be registered with the IRS.13 Additionally, terminal facilities must register with the IRS as a condition of storing untaxed (or undyed) taxable fuels.14 The sale or other transfer of fuel to an unregistered party or removal to an unregistered facility before the fuel breaks bulk results in the imposition of tax on that transaction. If the fuel subsequently is entered into and removed from a registered terminal, a second tax is imposed. Refund claims are allowed to prevent double taxation.

In general, fuel removed from a registered terminal facility is subject to tax without regard to whether the ultimate use of the fuel is taxable (e.g., non-taxable use for heating or on a farm for farming purposes). Exceptions are provided allowing diesel fuel and kerosene to be removed for a non-taxable use if the fuel is indelibly dyed at the time of removal.15

The tax on alternative fuels accounts for a relatively small portion of the tax on motor fuels. The tax is imposed when the fuels are sold for use or used as a fuel in a motor vehicle or motorboat. The person liable for the tax is either the retailer making the sale or, in some cases, the user of the fuel.

Non-taxable uses of fuelIn general, refunds or income tax credits may be claimed for fuels on which tax has been imposed and which ultimately are used for a non-taxable purpose. Present law includes numerous exemptions (including partial exemptions) for specified uses. Because the fuel taxes generally are imposed before the end use of the fuel is known, many of these exemptions are realized through refunds to end users of tax paid by a party that held the fuel earlier in the distribution chain. Non-taxable uses of fuel include: (1) use on a farm for farming purposes; (2) off-highway business use; (3) export; (4) use in a boat engaged in commercial fishing; (5) use in certain intercity and local buses; (6) use in a school bus; (7) exclusive use by a qualified blood collector organization; (8) exclusive use by a nonprofit educational organization; (9) exclusive use by a State; (10) use in an aircraft or vehicle owned by an aircraft museum; and (11) use of diesel fuel other than as a fuel in a propulsion engine of a diesel-powered highway vehicle (e.g., home heating oil).The rules governing how and by whom a refund is claimed differ by type of fuel, by end use, and by dollar amount of the claim. In general, no more than one claim per quarter may be filed. Refund claims may be filed only if prescribed dollar thresholds are satisfied. If the dollar amounts are not satisfied in a calendar year, refunds must be claimed as credits on income tax returns. Unlike income tax refunds, excise tax refunds generally do not bear interest if they are not paid within set periods. The Highway Trust Fund does not reimburse the General Fund for the payments of nontaxable use refunds.16

Fuel excise tax creditsThe Code provided per-gallon tax credits and payments for the following qualified fuels through December 31, 2013: biodiesel (including agri-biodiesel), renewable diesel, and certain alternative fuels.17 If the qualified fuel is part of a qualified fuel mixture, the incentives apply only to the amount of qualified fuel in the mixture.For qualified fuel mixtures, the excise tax credits are taken against the taxes imposed by section 4081 (relating to the taxes on gasoline, diesel fuel, and kerosene). The alternative fuel excise tax credit was taken against the tax imposed by section 4041 (relating to the back-up tax on diesel fuel and alternative fuels). Although taken as credits against excise taxes supporting the Highway Trust Fund, the credits do not reduce the amount of fuel tax transferred to the Highway Trust Fund.18 Similarly, if a person has insufficient excise tax liability to use the credits, the incentive may be taken as a payment.19 The Highway Trust Fund does not reimburse the General Fund for these payments.

Non-fuels excise taxes

Tax on heavy vehicle tiresThe Code imposes a tax on taxable tires sold by the manufacturer, producer or importer of the tire. The rate is 9.45 cents for each 10 pounds of maximum rated load capacity over 3,500 pounds.20 A “taxable tire” is any tire of the type used on highway vehicles if made of rubber (in whole or in part) and if marked according to Federal regulations for highway use.21 “Rubber” includes synthetic and substitute rubber. For biasply tires, and super single tires (other than those designed for steering), the rate of tax is half the regular rate, 4.725 cents for each 10 pounds of maximum rated load capacity over 3,500 pounds.22The tax does not apply to tire carcasses not suitable for commercial use, or to tires for use on qualifying intercity, local and school buses.23 In addition, tires sold for the exclusive use of the Department of Defense or the Coast Guard are not subject to tax.24 Nor does the tax apply to tires of a type used exclusively on mobile machinery vehicles. The Code also provides exemptions for tires that have been exported, sold to a State or local government for its exclusive use, sold to a nonprofit educational organization for its exclusive use, sold to a qualified blood collector organization for its exclusive use in connection with a vehicle the organization certifies will be primarily used in the collection, storage or transportation of blood, or used or sold for use as supplies for vessels.25

Retail sales tax on tractors, heavy trucks, and heavy trailersA 12-percent retail sales tax is imposed on the first retail sale of heavy trucks (over 33,000 pounds), trailers (over 26,000 pounds) and certain highway tractors.26 The taxable weight is the “gross vehicle weight,” which is the maximum total weight of a loaded vehicle (all equipment, fuel body, payload, driver, etc.). The tax is imposed on chassis and bodies. The sale of a truck or trailer is considered a sale of a chassis and a body. However, the price of certain equipment unrelated to the highway transportation function of the vehicle is excluded from the tax base.27Additionally, a credit against the tax is allowed for the amount of tire excise tax imposed on manufacturers of new tires installed on the vehicle.The Code also imposes the 12-percent tax on the price of parts or accessories installed on a taxable vehicle within six months of the date the vehicle was placed in service.28

Annual use tax for heavy vehiclesAn annual use tax is imposed on heavy highway vehicles, at the rates shown below.29 Under 55,000 pounds                No tax

 55,000-75,000 pounds               $100 plus $22 per 1,000 pounds
                                    over 55,000 pounds

 Over 75,000 pounds                 $550

The annual use tax is imposed for a taxable period of July 1 through June 30. Generally, the tax is paid by the person in whose name the vehicle is registered. Exemptions and reduced rates are provided for certain “transit-type buses,” trucks used for fewer than 5,000 miles on public highways (7,500 miles for agricultural vehicles), logging trucks, mobile machinery and qualified blood collector vehicles.

Legislation regarding the Highway Trust Fund balance

In recent years, trends in Highway Trust Fund receipts and spending have resulted in projections of significant shortfalls. As discussed below, several provisions have been enacted transferring money from the General Fund to the Highway Trust Fund to avoid a shortfall.

Public Law No. 111-46, an Act to restore funds to the Highway Trust Fund, provided that out of money in the Treasury not otherwise appropriated, $7 billion was appropriated to the Highway Trust Fund effective August 7, 2009.

The Hiring Incentives to Restore Employment Act (the “HIRE Act”) contained several provisions affecting the Highway Trust Fund.30 From September 30, 1998, the Highway Trust Fund did not earn interest on its unexpended balances. The HIRE Act repealed the requirement that obligations held by the Highway Trust Fund not be interest-bearing. The HIRE Act permits amounts in the Trust Fund to be invested in interest-bearing obligations of the United States and have the interest be credited to, and form a part of, the Highway Trust Fund. Thus, the Highway Trust Fund now accrues interest on its unexpended balances, which serves as a continuing transfer from the General Fund.31 The HIRE Act also provides that out of money in the Treasury not otherwise appropriated, $14,700,000,000 is appropriated to the Highway Trust Fund and $4,800,000,000 is appropriated to the Mass Transit Account in the Highway Trust Fund, and made those amounts available without fiscal year limitation. The HIRE Act also terminated required transfers from the Highway Trust Fund into the general fund for certain repayments and credits, relating to amounts paid in respect of gasoline used on farms, amounts paid in respect of gasoline used for certain non-highway purposes or by local transit systems, amounts relating to fuels not used for taxable purposes, and income tax credits for certain uses of fuels. The HIRE Act provisions generally were effective as of March 18, 2010.

The following table reflects the Congressional Budget Office’s (“CBO”) projections of the Highway Trust Fund’s balance for fiscal years 2013 through 2024.

                Table 1. -- Estimates of Revenue and Outlays for
                 the Highway Trust Fund Fiscal Years 2013-2024
                             [billions of dollars]
 _____________________________________________________________________

 Highway Account

 Start-of-Year Balance

     2013  2014  2015  2016  2017  2018  2019  2020  2021  2022  2023  2024
 ______________________________________________________________________________

       10     4     2     a     a     a     a     a     a     a      a     a

 Revenues & Interestb

     2013  2014  2015  2016  2017  2018  2019  2020  2021  2022  2023  2024
 ______________________________________________________________________________

       32    33    34    34   34     34    34    34    34    34    34    34

 Intragovernmental Transfersc

     2013  2014  2015  2016  2017  2018  2019  2020  2021  2022  2023  2024
 ______________________________________________________________________________

        6    10     0     0     0     0     0     0     0     0     0     0

 Outlays

     2013  2014  2015  2016  2017  2018  2019  2020  2021  2022  2023  2024
 ______________________________________________________________________________

       43    45    45    45    45    46    46    46    47    48    48    49

 End of Year Balance**

     2013  2014  2015  2016  2017  2018  2019  2020  2021  2022  2023  2024
 ______________________________________________________________________________

        4     2     a     a     a     a     a     a     a     a     a     a

 Transit Account

 Start-of-Year Balance

     2013  2014  2015  2016  2017  2018  2019  2020  2021  2022  2023  2024
 ______________________________________________________________________________

        5     2     1     a     a     a     a     a     a     a     a     a

 Revenues and Interestb

     2013  2014  2015  2016  2017  2018  2019  2020  2021  2022  2023  2024
 ______________________________________________________________________________

        5     5     5     5     5     5     5     5     5     5     5     5

 Intragovernmental Transfersc

     2013  2014  2015  2016  2017  2018  2019  2020  2021  2022  2023  2024
 ______________________________________________________________________________

        0     2     0     0     0     0     0     0     0     0     0     0

 Outlaysd

     2013  2014  2015  2016  2017  2018  2019  2020  2021  2022  2023  2024
 ______________________________________________________________________________

        7     8     8     8     8     9     9     9    10    10    10    10

 End-of-Year Balance

     2013  2014  2015  2016  2017  2018  2019  2020  2021  2022  2023  2024
 ______________________________________________________________________________

        2     1     a     a     a     a     a     a     a     a     a     a

 Memorandum

 Cumulative Shortfalla

 Highway Account Shortfall

     2013  2014  2015  2016  2017  2018  2019  2020  2021  2022  2023  2024
 ______________________________________________________________________________

     n.a.  n.a.   -10   -21   -32   -43   -55   -67   -79   -92  -106  -120

 Transit Account Shortfall

     2013  2014  2015  2016  2017  2018  2019  2020  2021  2022  2023  2024
 ______________________________________________________________________________

     n.a.  n.a.    -2    -6    -9   -13   -18   -22   -27   -32   -38   -44
 ______________________________________________________________________________

 Notes: Details may not add to totals because of rounding

 n.a. = not applicable

                              FOOTNOTES TO TABLE 1

      a Under CBO's baseline projections, the highway and transit
 accounts of the Highway Trust Fund will have insufficient revenues to meet
 obligations starting in fiscal year 2015. Under current law, the Highway Trust
 Fund cannot incur negative balances and has no authority to borrow additional
 funds. However, following the rules in the Deficit Control Act of 1985, CBO's
 baseline for highway spending incorporates the assumption that obligations
 incurred by the Highway Trust Fund will be paid in full. The cumulative
 shortfalls shown in this table are estimated on the basis of spending
 consistent with the obligation limitations contained in CBO's April 2014
 baseline for highway and transit spending. The obligation limitations
 contained in CBO's baseline are projected by adjusting the 2014 limitations
 for inflation. The Department of Transportation has indicated that it needs at
 least $4 billion in cash balances available in the highway account and at
 least $1 billion in the transit account to meet obligations as they are due.
 As a result, under CBO's baseline projections, the highway account may have to
 delay some of its payments during the latter half of 2014.

      b Some of the taxes that are credited to the Highway Trust Fund
 are scheduled to expire on September 30, 2016. Those include taxes on certain
 heavy vehicles and tires and all but 4.3 cents of federal taxes levied on
 fuels. However, under the rules governing baseline projections, these
 estimates reflect the assumption that all of the expiring taxes credited to
 the fund continue to be collected.

      c Sections 40201 and 40251 of the Moving Ahead for Progress in
 the 21st Century Act (Public Law 112-140) require certain intragovernmental
 transfers, mostly from the general fund of the Treasury, to the Highway Trust
 Fund.

      d Outlays include amounts "flexed," or transferred, between the
 highway and transit accounts. CBO estimates that those amounts would total
 about $1 billion annually.

                          END OF FOOTNOTES TO TABLE 1

II. SELECTED METHODS FOR INFRASTRUCTURE PROJECT FINANCEA. Public-Private Partnerships

In generalThe Department of Transportation defines public-private partnerships broadly to include “contractual agreements formed between a public agency and private sector entity that allow for greater private sector participation in the delivery of transportation projects.”32 The private sector historically has participated in the design and construction of U.S. highways, most commonly as contractors to the public sector. A public-private partnership, however, generally is understood as shifting more of the economic risks (and attendant rewards) of a transportation project to the private sector than would be the case in a traditional public owner-private contractor relationship. For example, a public-private partnership might contemplate a private firm taking on all the design and construction risks for a new project, or a private firm operating a project for a period of years following construction, and obtaining an economic return based on the relative success of its management. State and local governments have shown increasing interest in public-private partnership arrangements as the cost of infrastructure development and maintenance continues to increase.33

Examples of public-private partnerships34

Some private firms have acquired economic interests in the financing, maintenance, and operation of public highways after they are built.35 Two arrangements, involving the Chicago Skyway and the Indiana Toll Road, illustrate how the public-private partnership concept can be applied to transfers of economic interests in existing highways from the public sector to private firms. The Chicago Skyway and Indiana Toll Road deals are structured as very long-term arrangements: 99 years in the former case, and 75 years in the latter. For tax purposes, each transaction can be seen as comprising three operating relationships, each of which in turn runs for the length of the overall arrangement:

      1. A lease of the existing infrastructure (the highway itself and associated improvements) from the public owner to the private firm;

2. A grant by the public owner to the private firm of a right-of-way on the public lands underlying that infrastructure; and

3. A grant of a franchise from the public entity permitting the private party to collect tolls on the highway.
In return, the private party paid a large up-front amount to the public owner, and agreed to operate and maintain the road, to invest specified amounts in future improvements, and to accept restrictions on the maximum tolls it could charge.36 An umbrella concession agreement sets out the long-term rights and obligations of each party including dispute resolution mechanisms.More specifically, in 2004, the City of Chicago leased the Chicago Skyway, a 7.8 mile toll road south of downtown Chicago that connects two major highways, in the first long-term lease of an existing toll road in the United States. Under the 99-year concession agreement with Skyway Concession Company Holdings LLC, a joint venture between Cintra of Madrid, Spain, and Macquarie of Sydney, Australia,37 the City of Chicago received a $1.8 billion up-front payment in exchange for granting the private concessionaire the exclusive right to use, possess, operate, manage, maintain, rehabilitate, and collect tolls from the Chicago Skyway.

In 2006, the Indiana Finance Authority (“IFA”) entered into a 75-year concession agreement with ITR Concession Company LLC (“ITR”), also a joint venture between Cintra and Macquarie, in respect of the Indiana Toll Road. IFA received a $3.8 billion up-front payment in exchange for granting ITR the exclusive right to operate, manage, maintain, rehabilitate, and collect tolls from the Indiana Toll Road.

Tax treatment of certain public-private partnerships

Overall characterization of arrangementThe parties to the representative public-private partnerships summarized above entered into an umbrella concession agreement that describes the overall business relationship. In general, the deals generally are structured not to constitute partnerships for tax purposes. (If the transaction were characterized as a constructive tax partnership, there would be many adverse consequences for the parties, including the possible application of section 470 which limits deductions allocable to property used by governments and tax-exempt entities as well as differences in the tax depreciation rules for the assets.) Instead, and as described above, the arrangements are intended to be treated for tax purposes as transfers of three separate bundles of property rights from the public owner to the private firm, all in exchange for the lump sum cash payment:

      1. A “lease” of the infrastructure assets;

2. A lease of the land underlying the infrastructure assets (the right of way); and

3. A grant of an intangible “franchise” right to collect tolls.
Under tax principles, the “lease” of the infrastructure assets generally is characterized as an outright purchase of those assets by the private firm for tax purposes because the “lessee” has acquired all the benefits and burdens of ownership of those assets for a term that significantly exceeds their expected remaining useful life.38 Land, by contrast, is deemed for tax purposes to have a perpetual useful life, and as a result the long-term ground lease would be expected to be characterized as such.The concession agreement signed by the parties generally is for a period much longer than the economic useful life of the highway assets, which (along with operating control) is the critical question in determining whether a purported lease should be recharacterized as a purchase of assets for tax purposes. The Bureau of Economic Analysis estimates the service life of highways and streets to be 45 years,39 while the Chicago Skyway and Indiana Toll Road agreements were for terms of 99 years and 75 years, respectively. The private party’s responsibilities under the agreement may include all operations of the toll road, payment of utilities, maintenance, taxes, capital improvements, risk of loss, and liabilities that arise during the term.40 Accordingly, while the facts and circumstances of each transaction will control its tax treatment, these arrangements most likely will be viewed by the parties as a sale and purchase of a trade or business, and the concession agreement can be expected to include a provision describing the intended tax treatment in this manner.41

Allocation of up-front paymentThe large up-front payment made by the private party to the transaction is treated as paid to acquire different bundles of business assets. As a result, the parties must allocate the initial consideration to the following categories: (1) the acquisition of infrastructure assets, such as land improvements, computers, toll booths, and other property used to operate and maintain the highway; (2) a lease of the underlying land; and (3) the acquisition of intangible assets, such as a franchise and license for the right to collect tolls (along with any generally unstated goodwill or going concern value).The tax treatment of the assets in each of these categories varies. The tax allocation of the consideration therefore will determine the timing of the tax deductions associated with the investment. The tax rules provide that the parties must allocate purchase price in accordance with the relative fair market value of the assets acquired.42

Recovery of investment (depreciation and amortization)
Depreciation of tangible infrastructure assets
For Federal income tax purposes, a taxpayer is allowed to recover, through annual depreciation deductions, the cost of certain property used in a trade or business or for the production of income. The amount of the depreciation deduction allowed with respect to tangible property for a taxable year is determined under the modified accelerated cost recovery system (“MACRS”). Under MACRS, different types of property generally are assigned applicable recovery periods and depreciation methods. The MACRS depreciation categories generally are set out in the Internal Revenue Code and Internal Revenue Service guidance.43The MACRS recovery periods applicable to most tangible personal property range from three to 25 years. The depreciation methods generally applicable to tangible personal property are the 200-percent and 150-percent declining balance methods, switching to the straight-line method for the taxable year in which the taxpayer’s depreciation deduction would be maximized. Nonresidential real property and residential rental property are assigned lives of 39 years and 27.5 years, respectively, using the straight-line method.

The most significant tangible infrastructure assets acquired by the private party in a public-private partnership are the highway and any related bridges.44 To the extent the assets are classified as land improvements,45 these assets generally are depreciated under MACRS over a 15-year recovery period using the 150-percent declining balance method. The roadbed underlying the highway, however, is treated as having an indefinite useful life, and therefore its value is not recovered through depreciation at all.46

Other tangible assets that may be acquired include computers, equipment, toll booths, building structures, and other tangible assets associated with operating and maintaining a toll highway. As with the land improvements, these assets generally are recovered through accelerated depreciation under MACRS using various recovery periods, generally five to seven years, or through straight line depreciation over 39 years in the case of certain structures.47

To the extent any of these assets were originally constructed or acquired with proceeds of tax-exempt bonds,48depreciation is calculated under the alternative depreciation system (“ADS”) using the straight-line method generally over longer recovery periods.49 For example, land improvements are recovered over 20 years using the straight-line method if the project is financed with tax-exempt bonds, instead of 15 years under MACRS using the 150-percent declining balance method. The treatment of assets as tax-exempt bond financed property in the hands of the original owner (resulting in use of the longer recovery periods and the straight line method) continues even if the tax-exempt bonds are no longer outstanding or are redeemed.50 Furthermore, any subsequent owners who acquire the property while the tax-exempt bonds are outstanding also are subject to the ADS.51
Amortization of intangible assets
As previously noted, significant value generally is assigned in public-private partnership arrangements to the intangible franchise right; that is, the right of the private party to collect tolls from users of the highway. The taxpayer’s rationale for this allocation likely is that the right to collect tolls is the main revenue source and is the primary economic driver of the transaction.52Under section 197, when a taxpayer acquires an operating business, any value properly attributable to a franchise right is amortizable on a straight-line basis over 15 years.53 Additionally, any value attributable to licenses, permits, and other rights granted by governmental units is subject to 15-year amortization, even if the right is granted for an indefinite period or is reasonably expected to be renewed indefinitely.54 Goodwill and going concern value similarly are amortized on the same schedule. However, interests in land, including leases, easements, grazing rights, and mineral rights granted by a government, may not be amortized over the 15-year period provided in section 197, but instead must be amortized over the period of the grant of the right.55

Some toll road transactions have been reported to include revenue-sharing provisions not unlike royalty payments of a typical business franchise. These revenue-sharing provisions are viewed by some as a method for the public party to share in possible future economic upside from toll collections.56 To the extent payments are made by the private party pursuant to the arrangement, the revenue-sharing payments may be considered “contingent serial payments” and deductible in the year paid or incurred.57 If a payment does not meet the requirements for contingent serial payments, the amount may be treated as contingent purchase price allocated to the franchise and recovered over the remaining life of the franchise intangible asset.58
Recovery of investment in lease of land
The amount of any up-front consideration allocated to the lease of land generally is deductible to the lessee for tax purposes over the term of the lease under section 467. Very generally, those rules take time value of money concepts into account, and effectively convert the lump-sum payment into a constructive loan used to fund a stream of level rent payments.59

B. Tax-Exempt Financing for Transportation Infrastructure

OverviewInterest paid on bonds issued by State and local governments generally is excluded from gross income for Federal income tax purposes. Because of the income exclusion, investors generally are willing to accept a lower rate on tax-exempt bonds than they might otherwise accept on a taxable investment. This, in turn, lowers the borrowing cost for the beneficiaries of such financing.

Bonds issued by State and local governments may be classified as either governmental bonds or private activity bonds. Governmental bonds are bonds the proceeds of which are primarily used to finance governmental functions or which are repaid with governmental funds. Private activity bonds are bonds in which the State or local government serves as a conduit providing financing to nongovernmental persons (e.g., private businesses or individuals). The exclusion from income for State and local bonds does not apply to private activity bonds, unless the bonds are issued for certain permitted purposes (“qualified private activity bonds”) and other requirements of the Code are met.

Like other activities carried out and paid for by State and local governments, the construction, renovation, and operation of governmental transportation infrastructure projects such as public highways or governmental mass commuting systems (e.g., rail and bus) are eligible for financing with the proceeds of governmental bonds. In addition, certain privately-used transportation infrastructure projects may be financed with qualified private activity bonds.

Tax-exempt governmental bonds

In generalPresent law does not limit the types of facilities that can be financed with governmental bonds. Thus, State and local governments can issue tax-exempt, governmental bonds to finance a broad range of transportation infrastructure projects, including highways, railways, airports, etc. However, while the types of projects eligible for governmental bond financing are not circumscribed, present law imposes restrictions on the parties that may benefit from such financing. For example, present law limits the amount of governmental bond proceeds that can be used by nongovernmental persons. Use of bond proceeds by nongovernmental persons in excess of amounts permitted by present law may result in such bonds being treated as taxable private activity bonds, rather than governmental bonds. The Code defines a private activity bond as any bond that satisfies (1) the private business use test and the private security or payment test (“the private business test”); or (2) “the private loan financing test.”60 Generally, private activity bonds are taxable unless issued as qualified private activity bonds.Generally, governmental bonds are not subject to restrictions that apply to bonds used to finance private activities. For example, governmental bonds are not subject to issuance cost, maturity, and annual volume limitations that generally apply to qualified private activity bonds.

Private business testsUnder the private business tests, a bond is a private activity bond if it is part of an issue in which both:

      1. More than 10 percent of the proceeds of the issue (including use of the bond-financed property) are to be used in the trade or business of any person other than a governmental unit (“private business use test”); and

2. More than 10 percent of the payment of principal or interest on the issue is, directly or indirectly, secured by (a) property used or to be used for a private business use or (b) to be derived from payments in respect of property, or borrowed money, used or to be used for a private business use (“private payment test”).61
A bond is not a private activity bond unless both parts of the private business tests (i.e., the private business use test and the private payment test) are met. Thus, a facility that is 100 percent privately used does not cause the bonds financing such facility to be private activity bonds if the bonds are not secured by or paid with private payments. For example, land improvements that benefit a privately-owned factory may be financed with governmental bonds if the debt service on such bonds is not paid by the factory owner or other private parties.In general, for purposes of the private business use test, a broad standard applies under which private business use includes use of bond-financed property by a nongovernmental person as a result of ownership of property, a lease of property, or other actual or beneficial use of property under certain management or incentive payment contracts, output-type contracts, or certain other arrangements in which a nongovernmental person has legal contractual rights to use property.62

A contract between a private management or other service company and a governmental unit to operate bond-financed governmental facilities may result in private business use depending on the terms of the contract.63 In general, a management contract gives rise to private business use if the compensation under the contract is based on net profits. For example, a management contract with respect to a commuter rail facility that compensates the management company based on the profits of such facility would result in private use. The IRS has provided safe harbor guidelines under which certain management contract arrangements are treated as not giving rise to private business use, depending on the term of the contract and the nature of the management compensation arrangement.64 Under these safe harbors, the permitted term of the contract depends on the compensation arrangement. Thus, for example, these safe harbors permit a 15-year contract in which 95 percent of the management compensation consists of periodic fixed fees and a 5-year contract in which 50 percent of the management compensation consists of periodic fixed fees. Contracts for service incidental to the facility’s primary functions, such as janitorial, office equipment repair and similar services, are not considered management contracts.

For purposes of the private payment test, both direct and indirect payments made by any private person treated as using the financed property are taken into account. Payments by a person for the use of proceeds generally do not include payments for ordinary and necessary expenses (within the meaning of section 162) attributable to the operation and maintenance of financed property.65

Private loan financing testA bond issue satisfies the private loan financing test if proceeds exceeding the lesser of $5 million or five percent of such proceeds are used directly or indirectly to finance loans to one or more nongovernmental persons. Private loans include both business and other (e.g., personal) uses and payments by private persons; however, in the case of business uses and payments, all private loans also constitute private business uses and payments that are subject to the private business test.Qualified private activity bonds

Qualified private activity bonds are tax-exempt bonds issued to provide financing for specified privately used facilities. The definition of a qualified private activity bond includes an exempt facility bond, or a qualified mortgage, veterans’ mortgage, small issue, redevelopment, 501(c)(3), or student loan bond.66

To qualify as an exempt facility bond, 95 percent of the net proceeds must be used to finance an eligible facility.67Business facilities eligible for this financing include transportation (i.e., airports, ports, local mass commuting, high-speed intercity rail facilities, and qualified highway or surface freight transfer facilities); privately owned and/or operated public works facilities (i.e., sewage, solid waste disposal, water, local district heating or cooling, and hazardous waste disposal facilities); privately-owned and/or operated residential rental housing; and certain private facilities for the local furnishing of electricity or gas. Bonds issued to finance “environmental enhancements of hydro-electric generating facilities,” qualified public educational facilities, and qualified green building and sustainable design projects also may qualify as exempt facility bonds.

Generally, qualified private activity bonds are subject to a number of restrictions that do not apply to governmental bonds. For example, the aggregate volume of most qualified private activity bonds is restricted by annual State volume limitations (the “State volume cap”).68 For 2014, the State volume limit is the greater of $100 multiplied by the State population, or $296,825,000.69

Qualified private activity bonds also are subject to additional limitations on issuance cost and length of maturity. In general, the interest income from qualified private activity bonds (other than qualified 501(c)(3) bonds) is a preference item for purposes of calculating the alternative minimum tax (“AMT”).70

Rules governing private activity bonds for transportation infrastructure

AirportsExempt facility bonds may be issued to finance airports. Exempt facility bonds for airports are not subject to the State volume cap. However, all tax-exempt-bond-financed airport property must be governmentally owned. Property eligible for this financing includes land, terminals, runways, public parking facilities, and related equipment. Airplanes are not eligible for tax-exempt financing. Additionally, certain real property facilities (and related equipment) are excluded from this financing:

      1. Hotels and other lodging facilities;

2. Retail facilities (including food and beverage facilities) located in a terminal, if the facilities are in excess of a size necessary to serve passengers and employees at the airport;

3. Retail facilities for passengers or the general public (including, but not limited to, rental car lots) located outside the terminal;

4. Office buildings for individuals who are not employees of a governmental unit or of the public airport operating authority; and

5. Industrial parks or manufacturing facilities.
Port facilitiesExempt facility bonds may be issued to finance port (“dock and wharf”) facilities and related storage and training facilities. Facilities that are specifically ineligible for financing with airport bonds may not be financed with port bonds. Further, ships and other vessels are not eligible for private activity tax-exempt bond financing. All property financed with these bonds must be governmentally owned. Exempt facility bonds issued for ports are not subject to the State volume cap.Mass commuting facilitiesExempt facility bond financing for mass commuting facilities is subject to similar restrictions as those which apply to such bonds for airports and ports. All property financed with these bonds must be governmentally owned. Further, “rolling stock” (e.g., buses and rail cars) is not eligible for financing with exempt facility bonds.High-speed intercity rail facilitiesThe definition of an exempt facility bond includes bonds issued to finance high-speed intercity rail facilities.71 A facility qualifies as a high-speed intercity rail facility if it is a facility (other than rolling stock) for fixed guideway rail transportation of passengers and their baggage between metropolitan statistical areas.72 The facilities must use vehicles that are reasonably expected to be capable of attaining a maximum speed in excess of 150 miles per hour between scheduled stops, and the facilities must be made available to members of the general public as passengers.Unlike other bond-financed transportation facilities, high-speed intercity rail facilities may be privately owned. However, if the bonds are to be issued for a nongovernmental owner of the facility, such owner must irrevocably elect not to claim depreciation or credits with respect to the property financed by the net proceeds of the issue.73

The Code imposes a special redemption requirement for these types of bonds. Any proceeds not used within three years of the date of issuance of the bonds must be used within the following six months to redeem such bonds.74

Seventy-five percent of the principal amount of the bonds issued for high-speed rail facilities is exempt from the volume limit.75 If all the property to be financed by the net proceeds of the issue is to be owned by a governmental unit, then such bonds are completely exempt from the volume limit.

Qualified highway or surface freight transfer facility bondsPresent law authorizes the issuance of tax-exempt private activity bonds to finance qualified highway or surface freight transfer facilities. A qualified highway facility or surface freight transfer facility is any surface transportation or international bridge or tunnel project (for which an international entity authorized under Federal or State law is responsible) which receives Federal assistance under title 23 of the United States Code or any facility for the transfer of freight from truck to rail or rail to truck which receives Federal assistance under title 23 or title 49 of the United States Code.Qualified highway or surface freight transfer facility bonds are not subject to the State volume limitations. Rather, the Secretary of Transportation is authorized to allocate a total of $15 billion of issuance authority to qualified highway or surface freight transfer facilities in such manner as the Secretary determines appropriate.76

Similar to the requirement for high-speed intercity rail facilities, the Code imposes a special redemption requirement for qualified highway or surface freight transfer facility bonds. Under present law, the proceeds of qualified highway or surface freight transfer facility bonds must be spent on qualified projects within five years from the date of issuance of such bonds. Proceeds that remain unspent after five years must be used to redeem outstanding bonds.

The qualified highway or surface freight transfer facility bond provision was enacted in 2005 as part of the Safe, Accountable, Flexible, Efficient Transportation Equity Act: A Legacy for Users (“SAFETEA-LU”).77 As reflected in the following chart, as of April 18, 2014, the Department of Transportation has made allocations of approximately $9.8 billion of the $15 billion it is authorized to allocate. Of the $9.8 billion that has been allocated, approximately $4.6 billion of bonds have been issued.78

           Table 2. -- Qualified Highway or Surface Freight
                   Transfer Facility Bond Projects1
 _____________________________________________________________________

 Project                                                     Amount
 _____________________________________________________________________

 Bonds Issued

 Capital Beltway HOT Lanes                                $589,000,000
 North Tarrant Expressway, TX                             $400,000,000
 H 635 (LBJ Freeway), TX                                  $615,000,000
 Denver RTD Eagle Project (East Corridor & Gold Line      $397,835,000
 CenterPoint Intermodal Center, Joliet, Illinois          $225,000,000
 Downtown Tunnel/Midtown Tunnel, Norfolk, VA              $675,004,000
 I-95 HOT/HOV Project                                     $252,648,000
 East End Crossing, Ohio River Bridges                    $676,805,000
 North Tarrant Expressway 3A & 3B                         $274,030,000
 Goethals Bridge                                          $460,915,000
 US 36 Managed Lanes/BRT Phase 2                           $20,360,000

   Subtotal                                             $4,586,597,000

 Allocations

 Knik Arm Crossing, AL                                    $600,000,000
 CenterPoint Intermodal Center, Joliet                    $700,000,000
 I-77 Managed Lanes                                       $350,000,000
 I-4 Ultimate Project                                   $2,000,000,000
 I-69 Section 5                                           $400,000,000
 Portsmouth Bypass, OH                                    $610,000,000
 SH-288                                                   $600,000,000

   Subtotal                                             $5,260,000,000

 Grand Total                                            $9,846,597,000
 _____________________________________________________________________

                              FOOTNOTE TO TABLE 2

      1 As of April 18, 2014. U.S. Department of
 Transportation, Federal Highway Administration, Office of Innovative
 Program Delivery, Tools & Programs: Federal Debt Financing Tools,
 Private Activity Bonds, "Current Status"
 http://www.fhwa.dot.gov/ipd/finance/tools_programs/federal_debt_financing/private_activity_bonds/#current.

                           END OF FOOTNOTE TO TABLE 2

C. Other Methods and Proposals for
Infrastructure Project Finance

1. Overview: tax-credit bonds and direct-pay bondsTax-credit bonds provide tax credits to investors to replace a prescribed portion of the interest cost. The borrowing subsidy generally is measured by reference to the credit rate set by the Treasury Department. Current tax-credit bonds include qualified tax credit bonds, which have certain common general requirements, and include new clean renewable energy bonds, qualified energy conservation bonds, qualified zone academy (“QZABs”), and qualified school construction bonds. The authority to issue two other types of tax-credit bonds, recovery zone economic development bonds and Build America Bonds, expired on January 1, 2011.

General rules applicable to qualified tax-credit bonds79Unlike tax-exempt bonds, qualified tax-credit bonds generally are not interest-bearing obligations. Rather, the taxpayer holding a qualified tax-credit bond on a credit allowance date is entitled to a tax credit. The amount of the credit is determined by multiplying the bond’s credit rate by the face amount on the holder’s bond. The credit rate for an issue of qualified tax credit bonds is determined by the Secretary and is estimated to be a rate that permits issuance of the qualified tax-credit bonds without discount and interest cost to the qualified issuer.80 The credit accrues quarterly and is includible in gross income (as if it were an interest payment on the bond), and can be claimed against regular income tax liability and alternative minimum tax liability. Unused credits may be carried forward to succeeding taxable years. In addition, credits may be separated from the ownership of the underlying bond similar to how interest coupons can be stripped for interest-bearing bonds. Qualified tax-credit bonds are subject to a maximum maturity limitation, a three-year spending requirement, arbitrage restrictions, and IRS reporting requirements.Direct-pay bonds and expired tax-credit bond provisionsThe Code provides that an issuer may elect to issue certain tax credit bonds as “direct-pay bonds.” Instead of a credit to the holder, with a “direct-pay bond” the Federal government pays the issuer a percentage of the interest on the bonds. The following tax credit bonds may be issued as direct-pay bonds: new clean renewable energy bonds, qualified energy conservation bonds, and qualified school construction bonds. QZAB may be issued as direct-pay bonds but such an election is not available regarding any allocation of the national zone academy bond allocation after 2010 or any carryforward of such allocations. The ability to issue Build America Bonds and Recovery Zone bonds, which have direct-pay features, has expired. The Build America Bond program is discussed below.Build America BondsThe Build America Bond program, part of the American Recovery and Reinvestment Act of 2009 (“ARRA”81 ), provided a subsidy to State and local governments to finance capital projects, including the development of surface transportation infrastructure. The authority to issue bonds under the program expired December 31, 2010.Under the Build America Bond program, an issuer could elect to have an otherwise tax-exempt bond, issued prior to January 1, 2011, treated as a “Build America Bond.”82 In general, Build America Bonds are taxable governmental bonds, the interest on which is subsidized by the Federal government by means of a tax credit to the holder (“tax-credit Build America Bonds”) or, in the case of certain qualified bonds, a direct payment to the issuer (“direct-pay Build America Bonds”).83

The holder of a tax-credit Build America Bond accrues a tax credit in the amount of 35 percent of the interest paid on the interest payment dates of the bond during the calendar year.84 The interest payment date is any date on which the holder of record of the Build America Bond is entitled to a payment of interest under such bond.85 The sum of the accrued credits is allowed against regular and alternative minimum tax; unused credits may be carried forward to succeeding taxable years.86 The credit, as well as the interest paid by the issuer, is included in gross income, and the credit may be stripped under rules similar to those provided for qualified tax-credit bonds.87

Although the authority existed to issue Build America Bonds that provided for a tax credit to the bond holder, most Build America Bonds were issued as “direct-pay Build America Bonds.” Under a special rule, in lieu of the tax credit to the holder, the issuer is allowed a refundable credit equal to 35 percent of each interest payment made under such bond.88

2. Tax-credit bonds for infrastructure proposals

S. 1250, the “Transportation and Regional Infrastructure Projects Bonds Act of 2013” or the “TRIP Bonds Act,” was introduced on June 27, 2013. The TRIP Bonds Act creates a new category of qualified tax credit bonds called TRIP bonds. TRIP bonds must meet four requirements: (1) the bond is issued by a State infrastructure bank; (2) bond proceeds must be used for capital improvements to any transportation infrastructure project; (3) projects financed with bond proceeds must comply with a State contribution requirement; and (4) bond proceeds are subject to a five-year spending requirement plus a binding commitment to spend 10 percent of proceeds or commence construction within 12 months of the date of issuance. In addition, the bonds must be designated as TRIP bonds by the State infrastructure bank and issued in registered form, the appropriate State agency relating to the qualified project must utilize updated construction technologies, and the term of the bond cannot exceed 30 years. The credit rate on the bonds is equal to the average market yield on outstanding comparable-term corporate debt (as of the date before the sale of the issue). There is a national limitation on the amount of qualified TRIP bonds that may be issued: $5 billion for the first year, $5 billion for the second year, $10 billion for the third year, $10 billion for the fourth year, and $10 billion for the fifth year. Each calendar year, the national limitation is to be allocated among the States by the Secretary of the Treasury so that each State receives two percent of the national limitation. Unused allocation may be carried forward to succeeding years until used by issuance of TRIP bonds. The TRIP Bonds Act also provides rules for TRIP Bonds Trust Accounts for each State infrastructure bank.

3. National infrastructure bank proposals

As a supplement to existing financing mechanisms for infrastructure, there have been proposals put forth in the last several years to create a “national infrastructure bank” or fund to provide additional financing for infrastructure projects of national and/or regional significance. Such assistance could take the form of loans, loan guarantees or grants. Generally, the proposals initially capitalize the bank with Federal funds. Some proposals would allow the bank to issue debt to provide financing for infrastructure projects. Some of the most recent proposals are briefly described below.

On November 14, 2013, Senator Warner introduced S. 1716, the “Building and Renewing Infrastructure for Development and Growth in Employment Act” or the “BRIDGE Act.” The bill establishes the Infrastructure Financing Authority as a wholly-owned government corporation. The authority is to provide direct loans and loan guarantees for certain transportation, water, and energy infrastructure projects. The projects are required to have reasonably anticipated costs that equal or exceed $50 million ($10 million for rural infrastructure projects).

On January 16, 2014, Senator Bennet introduced S. 1957, the “Partnership to Build America Act of 2014.” The bill establishes the American Infrastructure Fund (“AIF”) as a wholly-owned government corporation. The AIF is authorized to issue up to $50 billion in bonds to provide loans and loan guarantees for certain transportation, energy, water, communications, and educational infrastructure projects, as well as provide equity investments in such projects (not to exceed 20 percent of the total project cost).

As part of the fiscal year 2015 budget proposal, the Administration proposed the creation of a $10 billion national infrastructure bank that would provide loans and loan guarantees for transportation, energy, and water projects.

FOOTNOTES

1 This document may be cited as follows: Joint Committee on Taxation, Overview of Selected Tax Provisions Relating to the Financing of Surface Transportation Infrastructure, (JCX-49-14), May 5, 2014. This document also can be found on our website at www.jct.gov.2 U.S. Department of Transportation, Federal Highway Administration, Office of Innovative Program Delivery, Fact Sheet: Public-Private Partnerships Transportation Finance Innovations,http://www.fhwa.dot.gov/ipd/fact_sheets/p3.htm.

3 Although Build America Bonds could have been issued as traditional tax-credit bonds, affording a tax credit to the bondholder, it is understood generally that this authority was not used and that most, if not all, Build America Bonds were issued as direct-pay bonds.

4 Sec. 9503. All section references are to the Internal Revenue Code of 1986 (“the Code”) unless otherwise indicated.

5 Government Accountability Office, Surface Transportation: Restructured Federal Approach Needed for More Focused, Performance-Based and Sustainable Programs (GAO-08-400), March 2008, p. 6.

6 Ibid. pp. 6-7.

7 This portion of the tax rates was enacted as a deficit reduction measure in 1993. Receipts from it were retained in the General Fund until 1997 legislation provided for their transfer to the Highway Trust Fund.

8 These fuels are subject to an additional 0.1-cent-per-gallon excise tax to fund the Leaking Underground Storage Tank (“LUST”) Trust Fund (secs. 4041(d) and 4081(a)(2)(B)). That tax is imposed as an “add-on” to other existing taxes.

9 Diesel-water emulsions are taxed at 19.7 cents per gallon (sec. 4081(a)(2)(D)).

10 The rate of tax is 24.3 cents per gallon in the case of liquefied natural gas, any liquid fuel (other than ethanol or methanol) derived from coal, and liquid hydrocarbons derived from biomass. Other alternative fuels sold or used as motor fuel are generally taxed at 18.3 cents per gallon. For purposes of this pamphlet “alternative fuel” includes compressed natural gas. The rate for compressed natural gas is 18.3 cents per energy equivalent of a gallon of gasoline. See sec. 4041(a)(2) and (3).

11 Sec. 4081(a)(1).

12 A special rule applies to “two-party exchanges” (sec. 4105). It is common practice for oil companies to serve customers of other oil companies under exchange agreements, e.g., where Company A’s terminal is more conveniently located for wholesale or retail customers of Company B. In such cases, the exchange agreement party (Company B in the example) is treated as owning the fuel when sold to B’s customer if the requirements of section 4105 are met.

13 Sec. 4101.

14 Kerosene or diesel fuel that has been dyed generally indicates that such fuel is destined for a use for which tax is not imposed.

15 See sec. 4082(b). However, such fuel generally is still subject to the LUST Trust Fund tax.

16 The requirement that transfers be made from the Highway Trust Fund to the General Fund to cover amounts paid by the General Fund for nontaxable use refund claims was repealed by section 444(a) of Pub. L. No. 111-147 (the Hiring Incentives to Restore Employment Act, discussed infra).

17 See secs. 40A, 6426, and 6427(e). The tax credit and payment provisions relating to liquified hydrogen expire September 30, 2014.

18 Sec. 9503(b)(1).

19 Sec. 6427(e). These claims for payment may be made on a weekly basis if the claim is for $200 or more (no dollar threshold if filed electronically), and if such claims are not paid within the specified time parameters, the claim is paid with interest. Sec. 6427(i)(3).

20 Sec. 4071(a). In general, these parameters would exclude tires for passenger automobiles and light trucks.

21 Sec. 4072(a). “Tires of the type used on highway vehicles” means tires of the type used on motor vehicles that are highway vehicles, or vehicles of the type used in connection with motor vehicles that are highway vehicles (sec. 4072(c)). However, the term does not include the kind of tires used exclusively on mobile machinery vehicles, as defined in section 4053(8).

22 Sec. 4071(a). The term “biasply tire” means a pneumatic tire on which the ply cords that extend to the beads are laid at alternative angles substantially less than 90 degrees to the centerline of the tread. A “super single tire” means a single tire greater than 13 inches in cross section width designed to replace two tires in a dual fitment. It does not include any tire designed for steering.

23 Sec. 4221(e)(3). A qualifying intercity or local bus is a bus which is used predominantly in furnishing (for compensation) passenger transportation available to the general public on a schedule with a regular route or has a seating capacity of at least 20 adults (not including the driver) (sec. 4221(d)(7)(B)). A school bus is a bus substantially all the use of which is to transport students and employees of schools (sec. 4221(d)(7)(C)).

24 Sec. 4073.

25 See sec. 4221 and Internal Revenue Service, Publication 510, Excise Taxes (Including Fuel Tax Credits and Refunds) (2013) p. 33.

26 Sec. 4051. The tax does not apply to tractors weighing 19,500 pounds or less that, in combination with a trailer or semitrailer, has a gross combined weight of 33,000 pounds or less.

27 Sec. 4053.

28 A vehicle is treated as placed in service on the date on which the owner of the vehicle took actual possession of the vehicle.

29 Sec. 4481.

30 Pub. L. No. 111-147, secs. 441 – 444.

31 See sec. 9602(b)(1) and (b)(3), “. . . It shall be the duty of the Secretary of the Treasury to invest such portion of any Trust Fund established by subchapter A as is not, in his judgment, required to meet current withdrawals. Such investments may be made only in interest-bearing obligations of the United States. . . . The interest . . . on any obligations held in a Trust Fund . . . shall be credited to and form a part of the Trust Fund.”

32 U.S. Department of Transportation, Federal Highway Administration, Innovative Program Delivery (website), “P3 Defined” http://www.fhwa.dot.gov/ipd/p3/defined/index.htm.

33 For background on infrastructure investment, see Congressional Budget Office, Issues and Options in Infrastructure Investment (May 2008) (public-private partnership discussion p. 32).

34 For purposes of discussion, this pamphlet focuses on public-private partnerships involving long-term leases of infrastructure assets by a private party. The Department of Transportation classifies public-private partnerships into six categories. For new facilities, there are three categories: design-build, design-build-operate, and design-build-finance-operate. For existing facilities, there are two categories: operations and maintenance concessions, and long-term leases. In a hybrid situation, involving both an existing facility and the expansion of such facility, there is the lease-develop-operate category in which a private party is grated a long-term lease to operate and expand an existing facility. U.S. Department of Transportation, Federal Highway Administration, Innovative Program Delivery(website), “P3 Defined” http://www.fhwa.dot.gov/ipd/p3/defined/index.htm.

35 For background on public-private partnerships, see CRS Report RL34567, Public-Private Partnerships in Highway and Transit Infrastructure Provision, by William J. Mallett (February 22, 2010); Government Accountability Office, Highway Public-Private Partnerships, More Rigorous Up-front Analysis Could Better Secure Potential Benefits and Protect the Public Interest, GAO-08-44 (Washington, DC: February 2008).

36 See summaries of these arrangements at U.S. Department of Transportation, Federal Highway Administration,Innovative Program Delivery (website) “Case Studies,” http://www.fhwa.dot.gov/ipd/p3/casestudies/index.htm.

37 “Cintra” and “Macquarie” refer to these companies generally. In the case of Skyway Concession Company Holdings LLC, the investment is owned, indirectly, by Cintra Concesiones de Infraestructuras de Transporte, SA and Macquarie Infrastructure Group.

38 To the extent the property under the concession agreement is owned directly or indirectly by non-U.S. persons, the U.S. business operations related to the property generally is subject to net-basis U.S. taxation in the same manner as if the property were owned by U.S. persons. If those U.S. business operations were conducted through a domestic corporation, the corporation would be subject to corporate tax on the income from the operations. Sec. 11. Certain payments (such as dividends) to foreign owners of the corporation would be subject to U.S. withholding tax (subject to reduction or elimination under bilateral income tax treaties). If the U.S. business operations were conducted through a foreign corporation, the corporation would be subject to U.S. tax on its effectively connected income. Sec. 882. Moreover, the foreign corporation could be subject to branch profits tax and branch interest tax on, respectively, dividend-like withdrawals from the U.S. business and certain interest payments allocable to the business. Sec. 884(a), (f). “Earnings stripping” rules also could apply to disallow deductions for certain interest payments to related parties and interest payments on debt guaranteed by related parties.

Finally, the special U.S. tax rules applicable to foreign investment in U.S. real estate (the “FIRPTA” rules of section 897) may affect the U.S. tax treatment of foreign investors. Some advisors have taken the position that the intangible franchise right is an interest in real property for purposes of section 897. Other advisors have taken a contrary view. Treating the franchise right as an interest in real property would make it more likely that a domestic corporation that owned the right would be a U.S. real property holding corporation under section 897(c)(2) and, therefore, that tax under section 897 would be triggered by, for example, a sale of the corporation by foreign investors.

39 U.S. Department of Commerce, Bureau of Economic Analysis, BEA Depreciation Estimates,http://www.bea.gov/national/FA2004/Tablecandtext.pdf.

40 The terms of an agreement will vary depending on the particular arrangement. For example, the private party may not be required to pay certain real estate, sales, and other taxes. This discussion is not intended to be an exhaustive list of responsibilities.

41 For example, Section 2.8 of the Indiana Toll Road Concession and Lease Agreement, (April 12, 2006) states: “This Agreement is intended for U.S. Federal and State income tax purposes to be a sale of the Toll Road Facilities and Toll Road Assets to Concessionaire and the grant to the Concessionaire of an exclusive franchise and license for and during the Term to provide Toll Road Services within the meaning of sections 197(d)(1)(D) and (E) of the Internal Revenue Code of 1986, as amended, and sections 1.197-2(b)(8) and (10) of the Income Tax Regulations thereunder,” http://www.in.gov/ifa/files/4-12-06-Concession-Lease-Agreement.pdf.

42 Section 1060 sets out detailed rules for the allocation of consideration in certain asset acquisitions.

43 Sec. 168. Rev. Proc. 87-56, 1987-2 C.B. 674.

44 In addition to acquired tangible assets, the private party will incur capital improvement costs throughout the lease term. The cost of newly constructed assets will also be recovered through depreciation deductions.

45 Asset class 00.3 of Rev. Proc. 87-56 provides examples of “land improvements” that include sidewalks, roads, canals, waterways, bridges, fencing, and landscaping.

46 Rev. Rul. 88-99, 1988-2 C.B. 3. In a public-private partnership transaction, the roadbed is likely included as part of the right-of-way lease of the underlying land.

47 To the extent several requirements are met (including the property acquired being qualified property, as well as the acquisition date and the original placed in service date being within the requisite timeframe), an additional first-year depreciation deduction is allowed equal to 50 percent of the adjusted basis of qualified property placed in service after December 31, 2011, and before January 1, 2014 (January 1, 2015, for certain longer-lived and transportation property). Sec. 168(k).

48 See discussion of tax-exempt financing below.

49 Secs. 168(g)(1)(C) and 168(g)(5).

50 Treas. Reg. sec. 1.168(i)-4(d)(2)(ii)(B).

51 H.R. Rep. No. 97-760, 516 (1982). State and local governments may redeem outstanding tax-exempt bonds prior to the public-private partnership arrangement so that the acquired assets are not subject to ADS rules. To the extent State and local governments retire tax-exempt bonds and taxable bonds are issued or other taxable debt is incurred to finance the private party payment pursuant to a public-private partnership arrangement, the migration from tax-exempt to taxable financing may result in increased Federal tax receipts.

52 There also may be value in a license by the government for the right of the private party to use the name of the highway.

53 Secs. 197(d)(1)(F) and 197(f)(4). A franchise is defined “an agreement which gives one of the parties to the agreement the right to distribute, sell, or provide goods, services, or facilities, within a specified area.” Sec. 1253(b)(1).

54 Sec. 197(d)(1)(D). Examples include a liquor license, a taxi-cab medallion, an airport landing or take-off right, a regulated airline route, or a television or radio broadcasting license. Renewals of such governmental rights are treated as the acquisition of a new 15-year asset. Treas. Reg. sec. 1.197-2(b)(8). A license, permit, or other right granted by a governmental unit is a franchise if it otherwise meets the definition of a franchise. Treas. Reg. sec. 1.197-2(b)(10). Section 197 intangibles do not include certain rights granted by a government not considered part of the acquisition of a trade or business. Sec. 197(e)(4)(B) and Treas. Reg. sec. 1.197-2(c)(13).

55 Sec. 197(e)(2). Treas. Reg. sec. 1.197-2(c)(3). An interest in land does not include an airport landing or takeoff right, a regulated airline route, or a franchise to provide cable television service. The cost of acquiring a license, permit, or other land improvement right, such as a building construction or use permit, is taken into account in the same manner as the underlying improvement. Treas. Res. Sec. 1.197-2(c)(3).

56 Government Accountability Office, Highway Public-Private Partnerships, More Rigorous Up-front Analysis Could Better Secure Potential Benefits and Protect the Public Interest, GAO-08-44 (Washington, DC: February 2008), p. 44.

57 Sec. 1253(d)(1).

58 Treas. Reg. sec. 1.197-2(f)(2).

59 Sec. 467(a).

60 Sec. 141.

61 The 10-percent private business test is reduced to five percent in the case of private business uses (and payments with respect to such uses) that are unrelated to any governmental use being financed by the issue.

62 Treas. Reg. sec. 1.141-3(b).

63 Treas. Reg. sec. 1.141-3(b)(4).

64 Rev. Proc. 97-13, 1997-1 C.B. 632.

65 Treas. Reg. sec. 1.141-4(c)(3).

66 Sec. 141(e).

67 Sec. 142(a).

68 The following private activity bonds are not subject to the State volume cap: qualified 501(c)(3) bonds; exempt facility bonds for airports, docks and wharves; environmental enhancements for hydroelectric generating facilities; and exempt facility bonds for solid waste disposal facilities that are to be owned by a governmental unit. The State volume cap does not apply to 75 percent of exempt facility bonds issued for high speed intercity rail facilities; 100 percent if the high speed intercity rail facility is to be owned by a governmental unit. Qualified veterans mortgage bonds, qualified public educational facility bonds, qualified green building and sustainable project design bonds, and qualified highway or surface freight transfer facility bonds also are not subject to the State volume cap, but the Code subjects such bonds to volume limitations specific to the category of bonds.

69 Rev. Proc. 2013-35, 2013-47 I.R.B. 537 (November 18, 2013).

70 Sec. 57(a)(5).

71 Sec. 142(a)(11) and sec. 142(i).

72 A metropolitan statistical area for this purpose is defined by reference to section 143(k)(2)(B). Under that provision, the term metropolitan statistical area includes the area defined as such by the Secretary of Commerce.

73 Sec. 142(i)(2).

74 Sec. 142(i)(3).

75 Sec. 146(g)(4).

76 See Department of Transportation, Notice of Solicitation for Requests for Allocations of Tax-exempt Financing and Request for Comments, 71 Fed. Reg. 642 (January 5, 2006) and Internal Revenue Service, Notice 2006-45,Exempt Facility Bonds for Qualified Highway or Surface Freight Transfer Facilities, 2006-20 I.R.B. 891 (May 15, 2006).

77 Section 11143 of Pub. L. No. 109-59.

78 Federal Highway Administration, Innovative Program Delivery (website), Tools & Programs: Federal Debt Financing Tools, Private Activity Bonds,http://www.fhwa.dot.gov/ipd/finance/tools_programs/federal_debt_financing/private_activity_bonds.

79 Separate rules apply in the case of tax-credit bonds which are not qualified tax-credit bonds (e.g., “recovery zone economic development bonds,” and “Build America Bonds”).

80 However, for new clean renewable energy bonds and qualified energy conservation bonds, the applicable credit rate is 70 percent of the otherwise applicable rate.

81 Pub. L. No. 111-5.

82 Sec. 54AA.

83 Tax-credit Build America Bonds may be issued to finance any governmental purpose for which tax-exempt governmental bonds (excluding private activity bonds under section 141) could be issued under section 103. The eligible uses of proceeds and types of financings for direct-pay Build America Bonds are more limited than for tax-credit Build America Bonds. Direct-pay Build America Bonds are to finance only capital expenditures that could have been financed with tax-exempt governmental bonds.

84 Sec. 54AA(a) and (b).

85 Sec. 54AA(e).

86 Sec. 54AA(c).

87 Sec. 54AA(f).

88 Sec. 54AA(g)(1).



EO Update: e-News for Charities & Nonprofits - May 9, 2014

IRS.gov Banner
 
1.  Register for the IRC 501(c)(6) Organizations phone forum

 

Thursday, May 22 – 11 a.m. Eastern Time

Topics include:

  • To file or not to file an application for recognition of exemption
  • Form 1024: Applying for exemption
  • Annual filing requirements for exempt organizations
  • Permitted501(c)(6) purposes and activities

To receive CE credit (and a certificate of completion) you must view the presentation for a minimum of 50 minutes.

Register for this presentation.

2.  IRS to Exempt Organizations as Filing Deadline Nears: Remember to File and Don’t Include SSNs on Form 990

The IRS has a few important reminders as the May 15 filing deadline nears for tax-exempt organizations who operate on a calendar year basis.
The IRS also cautions not to include personally identifiable information – including unnecessary SSNs or other unrequested personal information could lead to identity theft.

Review the following two items:

 

3.  Treasury and the IRS invite public comment on recommendations for 2014–2015 Priority Guidance Plan

Read Notice 2014–18

In addition, review the third quarter update to the IRS/Treasury Priority Guidance Plan.

4.  EO Business Master File Web page link updated

The link for the Exempt Organization Business Master File Extract (EO BMF) is  updated. Users should update bookmarks.

The EO BMF includes cumulative information on exempt organizations.

The data is extracted monthly and is available by state and region. The files are in comma separated value (CSV) format and can be opened by most computer applications including Excel.

The EO BMF is updated the second Monday of every month.

Next anticipated posting date: 05/12/14

5.  Disaster Relief Resources for Charities and Contributors

In the aftermath of a disaster, individuals, employers and corporations often are interested in providing assistance to victims through a charitable organization.

Find specialized disaster relief resources for charities and contributors on IRS.gov. Special tax rules may apply to exempt organizations affected by a federally declared disaster area.

Find IRS News Releases about the most recent disaster declarations and learn which exempt organization requirements may be postponed in a declared disaster on IRS.gov.

See Disaster Relief Resources for Charities and Contributors

6.  Watch new small business health care tax credit YouTube video

Find out how small businesses and tax-exempts that provide health insurance coverage to their employees may qualify for a special tax credit by watching this new YouTube video.

Watch this and other videos on the IRS YouTube Channel

If you have a technical or procedural question relating to Exempt Organizations, visit theCharities and Nonprofits homepage on the IRS.gov Web site.

If you have a specific question about exempt organizations, call EO Customer Account Services at 1-877-829-5500.


Most Future Benefits Guidance Will Come From Chief Counsel.

All technical legal guidance previously issued by the employee plans division within the IRS Tax-Exempt and Government Entities Division will move to the IRS Office of Chief Counsel as part of the TE/GE reorganization, according to Lauson Green, branch 1 chief (qualified plans), TE/GE.

Speaking May 1 in Philadelphia during a conference sponsored by the American Society of Pension Professionals & Actuaries, Green said that transferring legal guidance to the chief counsel’s office might speed up the guidance process by reducing the number of people involved in guidance projects and streamlining the review process.

According to Green, the chief counsel’s office will assume responsibility over legal guidance that will include all substantive projects, annual guidance projects, and private letter rulings. The employee plans division will likely continue issuing more routine guidance like 60-day rollover letter rulings, determination letters, and guidance lacking significant legal analysis, he said.

MAY 2, 2014

by Matthew R. Madara



Draft Version of Simplified Exemption Application Criticized.

Draft Form 1023-EZ, “Streamlined Application for Recognition of Exemption Under Section 501(c)(3) of the Internal Revenue Code,” does not ask for enough information and therefore could hinder the IRS’s ability to ferret out applications filed under false pretenses, according to Arthur Rieman and Jessica Shofler of The Law Firm for Non-Profits P.C.

April 30, 2014

Office of Information and Regulatory Affairs,
Office of Management and Budget
ATTN: Desk Officer for Treasury
New Executive Office Building, Room 10235
Washington, DC 20503

Treasury PRA Clearance Officer
1750 Pennsylvania Ave. NW., Ste 8140
Washington, DC 20220

 

Re: Comment on Draft Form 1023-EZ (OMB Number 1545-0056)

To Whom It May Concern:

This letter is written as a comment to the draft Form 1023-EZ (Rev. 5-2014). The Law Firm for Non-Profits, P.C. has been assisting exempt organizations for more than twenty years and has prepared and submitted hundreds of Forms 1023. We have concerns about the use of the Form 1023-EZ as drafted, which are set forth below along with our recommendations:

Concerns:

  • From our experience, a great many people desire to and do establish 501(c)(3) organizations under false pretenses (e.g., to obtain contributions or avoid taxation). This is borne out by the fact that the Service denies a large number of exemptions for organizations of all sizes on the basis of private inurement.
  • Exemption based on a properly completed Form 1023-EZ will be all-but-automatic. That is, there will be NO SCRUTINY of the applicant other than to ensure that all boxes and blank lines on the application form are properly completed.
  • The narrative portions of Form 1023 enable Exempt Organization Specialists the opportunity to ferret out exemption applications filed under false pretenses. Form 1023-EZ eliminates these narrative portions, eviscerating the Service’s ability to identify such exemption applications and thus deny exemption to those applicants.
  • Rather than requiring applicants to describe their exempt activity, Form 1023-EZ would automatically recognize as exempt any organization whose founder ticks nine boxes “attesting” that he or she complies with certain legal requirements. Signing under penalty of perjury will not stop people from using the Form 1023-EZ under false pretenses. Requiring an applicant to set forth a narrative of the organization’s intentions instead of simply checking boxes increases the likelihood that (1) an applicant understands he or she will be held responsible for the information set forth in the application, and (2) that Exempt Organization Specialists will identify and deny exemption to applicants that file under false pretenses.
  • Form 1023-EZ converts the privilege that is exemption under § 501(c)(3) to something akin to applying for a library card. With its adoption of Form 1023-EZ, the IRS will no longer have the ability to ensure that organizations that claim the privilege of exemption under section 501(c)(3) actually meet that statute’s requirements.
  • An applicant for exemption may use Form 1023-EZ if it attests that its annual revenue during its first three years of operation is not expected to exceed $200,000. The applicant is not required to provide a projected budget with the application. This will lead to abuse in the application process. As there will be no substantive scrutiny of an applicant’s Form 1023-EZ, those filing under false pretenses will certainly claim that their annual expected revenue will not exceed $200,000 in order to avoid the review by an Exempt Organization Specialist that would take place if the applicant instead filed a Form 1023.
  • The Service estimates that 17% of Applicants for exemption under § 501(c)(3) of the Internal Revenue Code will use Form 1023-EZ. The lack of scrutiny afforded organizations that use Form 1023-EZ will incentivize applicants to underestimate their projected revenue in order to use Form 1023-EZ instead of Form 1023. This will result in a far greater percentage of such applicants using Form 1023-EZ, perhaps as much as 50%.
  • The Service vastly overestimates the time it takes to complete Form 1023 and the time it will take to complete Form 1023-EZ, at 101 hours and 14 hours, respectively. Based on our experience, it takes a nonprofessional an average of about 20 hours to complete Form 1023. It will take under an hour for the average person to complete Form 1023-EZ.
  • Form 1023-EZ was developed by the IRS in consultation with Lean Six Sigma consultants. Lean Six Sigma is a methodology used by businesses to manage and improve business processes. Its stated goal is to identify and remove nonessential and non-value added steps in a process. Adoption of Form 1023-EZ by the Service would suggest that review of an applicant’s proposed activities does not add value to the review process.
  • By automatically recognizing as exempt any organization that submits a properly completed Form 1023-EZ, the Service will shift the burden of enforcement almost entirely to the investigation and audit function. This will be a costly mistake. It takes much greater resources to ferret out and stop an organization that is violating the law than it does to review an exemption application and deny exemption.
  • Further, Form 1023-EZ will unleash an unprecedented number of exemption applications — and will in effect encourage individuals to establish unnecessary exempt organizations. In turn this will substantially increase the number of 501(c)(3) organizations. Without a concomitant increase in the exempt organization investigation and audit staff, the Service will not have the resources to effectively monitor and audit 501(c)(3) organizations. In turn, this will lead to increased abuse of exempt organization law, including private inurement and noncharitable activity, by organizations established under false pretenses.

Recommendations:

      1. It may be appropriate for small organizations to submit an abbreviated version of the Form 1023, but the proposed Form 1023-EZ does not include information sufficient for Exempt Organization Specialists to make the exemption determination. The Form 1023-EZ should include information about an applicant’s proposed budget and activities.

2. Where eligibility to file Form 1023-EZ is based on projected annual gross receipts and assets, the projection requirement should be far lower. The Form 1023-EZ is only appropriate for organizations that are similar to those filing the Form 990N-ePostcard. In addition, there must be substantive penalties imposed on organizations that clearly under-project their revenue.

3. It should be made more apparent that the Form 1023-EZ is being filed under penalty of perjury. Filers must be reminded that a fraudulent claim to meeting the Form 1023-EZ’s eligibility requirements is a crime punishable by time in prison.
Thank you in advance for your consideration of this firm’s concerns and recommendations.

                  Very truly yours,
                  Arthur Rieman, Esq.
                  Jessica Shofler, Esq.
                  The Law Firm for Non-Profits, P.C.
                  Studio City, CA

cc:
Rep. Darryl Issa
Rep. Brad Sherman
Rep. Xavier Becerra
Tax Analyst



IRS LTR: Utility's Normalization Calculation Is Proper.

The IRS ruled that the reduction of a public utility’s rate base by its accumulated deferred income tax account without regard to the balances in its net operating loss carryforward account and its minimum tax credit carryforward account meet the requirements of section 168(i)(9).

JANUARY 27, 2014

Citations: LTR 201418024

Third Party Communication: None
Date of Communication: Not Applicable
Person To Contact: * * *, ID No. * * *
Telephone Number: * * *

Index Number: 167.22-01
Release Date: 5/2/2014

Date: January 27, 2014

Refer Reply To: CC:PSI:B06 – PLR-133813-13

LEGEND:Taxpayer = * * *
Parent = * * *
State = * * *
Commission = * * *
Year A = * * *
Year B = * * *
Year C = * * *
Year D = * * *
Year E = * * *
X = * * *
Y = * * *
Date A = * * *
Date B = * * *
Date C = * * *
Date D = * * *
Date E = * * *
Case = * * *
Director = * * *

Dear * * *:

This letter responds to the request, dated July 30, 2013, of Taxpayer for a ruling on whether the Commission’s treatment of Taxpayer’s Accumulated Deferred Income Tax (ADIT) account balance in the context of a rate case is consistent with the requirements of the normalization provisions of the Internal Revenue Code.

The representations set out in your letter follow.

Taxpayer is a regulated public utility incorporated in State. It is wholly owned by Parent. Taxpayer distributes and sells natural gas to customers in State. Taxpayer is subject to the regulatory jurisdiction of Commission with respect to terms and conditions of service and particularly the rates it may charge for the provision of service. Taxpayer takes accelerated depreciation where available and, for the period beginning in Year A and ending in Year E, Taxpayer has, in the aggregate, produced more net operating losses (NOL) than taxable income. After application of the carryback and carryforward rules, Taxpayer represents that it has net operating loss carryforward (NOLC), produced in Year C and Year E, of $X as of the end of Year E. The amount of claimed accelerated depreciation in Year C and Year E exceeded the amount of the NOLCs for those years. In Year D, Taxpayer produced regular taxable income as well as alternative minimum taxable income (AMTI); the regular taxable income was offset by the NOLCs from Year B and year C but could not offset the entire alternative minimum tax (AMT) liability due to the limitation in § 56(d). Taxpayer paid $Y of AMT in Year D and had a minimum tax credit carryforward (MTCC) as of the end of year E of $Y.

On its regulatory books of account, Taxpayer “normalizes” the differences between regulatory depreciation and tax depreciation. This means that, where accelerated depreciation reduces taxable income, the taxes that a taxpayer would have paid if regulatory depreciation (instead of accelerated tax depreciation) were claimed constitute “cost-free capital” to the taxpayer. A taxpayer that normalizes these differences, like Taxpayer, maintains a reserve account showing the amount of tax liability that is deferred as a result of the accelerated depreciation. This reserve is the accumulated deferred income tax (ADIT) account. Taxpayer maintains an ADIT account and also maintains an offsetting series of entries that reflect that portion of those ‘tax losses’ which, while due to accelerated depreciation, did not actually defer tax because of the existence of an NOLC. With respect to the $Y AMT liability from Year D, Taxpayer carried that amount as an offset to the ADIT because the AMT increased the payment of tax.

Taxpayer filed a general rate case on Date A (Case). The test year used in the Case was the 12 month period ending on Date B. In establishing the income tax expense element of its cost of service, the tax benefits attributable to accelerated depreciation were normalized in accordance with Commission policy and were not flowed thru to ratepayers. In establishing the rate base on which Taxpayer was to be allowed to earn a return Commission generally offsets rate base by Taxpayer’s plant based ADIT balance, using a 13-month average of the month-end balances of the relevant accounts. Taxpayer argued that the ADIT balance should be reduced by the amounts that Taxpayer calculates did not actually defer tax due to the presence of NOLCs or the AMT. Commission, in an order issued on Date C, did not use the amounts that Taxpayer calculates did not defer tax due to NOLCs or AMT but only the amount in the ADIT account. Taxpayer filed a petition for reconsideration based on the normalization implications of the order. On Date D, Commission rejected Taxpayer’s request. Taxpayer again requested reconsideration and the Commission denied that request on Date E. Commission asserts that, in setting rates it includes a provision for deferred taxes based on the entire difference between accelerated tax and regulatory depreciation, including situations in which a utility has, such as in this case, an NOLC or AMT. Thus, Commission asserts that it has already recognized the effects of the NOCL in setting rates and there is no need to reduce the ADIT by the other amounts due to NOLCs or AMT.

Taxpayer requests that we rule as follows:

Under the circumstances described above, the reduction of Taxpayer’s rate base by the full amount of its ADIT account without regard to the balances in its NOLC-related account and its MTCC-related account was consistent with the requirements of § 168(i)(9) and § 1.167(l)-1 of the Income Tax regulations.

LAW AND ANALYSIS

Section 168(f)(2) of the Code provides that the depreciation deduction determined under section 168 shall not apply to any public utility property (within the meaning of section 168(i)(10)) if the taxpayer does not use a normalization method of accounting.In order to use a normalization method of accounting, section 168(i)(9)(A)(i) of the Code requires the taxpayer, in computing its tax expense for establishing its cost of service for ratemaking purposes and reflecting operating results in its regulated books of account, to use a method of depreciation with respect to public utility property that is the same as, and a depreciation period for such property that is not shorter than, the method and period used to compute its depreciation expense for such purposes. Under section 168(i)(9)(A)(ii), if the amount allowable as a deduction under section 168 differs from the amount that-would be allowable as a deduction under section 167 using the method, period, first and last year convention, and salvage value used to compute regulated tax expense under section 168(i)(9)(A)(i), the taxpayer must make adjustments to a reserve to reflect the deferral of taxes resulting from such difference.

Section 168(i)(9)(B)(i) of the Code provides that one way the requirements of section 168(i)(9)(A) will not be satisfied is if the taxpayer, for ratemaking purposes, uses a procedure or adjustment which is inconsistent with such requirements. Under section 168(i)(9)(B)(ii), such inconsistent procedures and adjustments include the use of an estimate or projection of the taxpayer’s tax expense, depreciation expense, or reserve for deferred taxes under section 168(i)(9)(A)(ii), unless such estimate or projection is also used, for ratemaking purposes, with respect to all three of these items and with respect to the rate base.

Former section 167(l) of the Code generally provided that public utilities were entitled to use accelerated methods for depreciation if they used a “normalization method of accounting.” A normalization method of accounting was defined in former section 167(l)(3)(G) in a manner consistent with that found in section 168(i)(9)(A). Section 1.167(1)-1(a)(1) of the Income Tax Regulations provides that the normalization requirements for public utility property pertain only to the deferral of federal income tax liability resulting from the use of an accelerated method of depreciation for computing the allowance for depreciation under section 167 and the use of straight-line depreciation for computing tax expense and depreciation expense for purposes of establishing cost of services and for reflecting operating results in regulated books of account. These regulations do not pertain to other book-tax timing differences with respect to state income taxes, F.I.C.A. taxes, construction costs, or any other taxes and items.

Section 1.167(l)-1(h)(1)(i) provides that the reserve established for public utility property should reflect the total amount of the deferral of federal income tax liability resulting from the taxpayer’s use of different depreciation methods for tax and ratemaking purposes.

Section 1.167(1)-1(h)(1)(iii) provides that the amount of federal income tax liability deferred as a result of the use of different depreciation methods for tax and ratemaking purposes is the excess (computed without regard to credits) of the amount the tax liability would have been had the depreciation method for ratemaking purposes been used over the amount of the actual tax liability. This amount shall be taken into account for the taxable year in which the different methods of depreciation are used. If, however, in respect of any taxable year the use of a method of depreciation other than a subsection (1) method for purposes of determining the taxpayer’s reasonable allowance under section 167(a) results in a net operating loss carryover to a year succeeding such taxable year which would not have arisen (or an increase in such carryover which would not have arisen) had the taxpayer determined his reasonable allowance under section 167(a) using a subsection (1) method, then the amount and time of the deferral of tax liability shall be taken into account in such appropriate time and manner as is satisfactory to the district director.

Section 1.167(1)-1(h)(2)(i) provides that the taxpayer must credit this amount of deferred taxes to a reserve for deferred taxes, a depreciation reserve, or other reserve account. This regulation further provides that, with respect to any account, the aggregate amount allocable to deferred tax under section 167(1) shall not be reduced except to reflect the amount for any taxable year by which Federal income taxes are greater by reason of the prior use of different methods of depreciation. That section also notes that the aggregate amount allocable to deferred taxes may be reduced to reflect the amount for any taxable year by which federal income taxes are greater by reason of the prior use of different methods of depreciation under section 1.167(1)-1(h)(1)(i) or to reflect asset retirements or the expiration of the period for depreciation used for determining the allowance for depreciation under section 167(a).

Section 1.167(1)-(h)(6)(i) provides that, notwithstanding the provisions of subparagraph (1) of that paragraph, a taxpayer does not use a normalization method of regulated accounting if, for ratemaking purposes, the amount of the reserve for deferred taxes under section 167(l) which is excluded from the base to which the taxpayer’s rate of return is applied, or which is treated as no-cost capital in those rate cases in which the rate of return is based upon the cost of capital, exceeds the amount of such reserve for deferred taxes for the period used in determining the taxpayer’s expense in computing cost of service in such ratemaking.

Section 1.167(1)-(h)(6)(ii) provides that, for the purpose of determining the maximum amount of the reserve to be excluded from the rate base (or to be included as no-cost capital) under subdivision (i), above, if solely an historical period is used to determine depreciation for Federal income tax expense for ratemaking purposes, then the amount of the reserve account for that period is the amount of the reserve (determined under section 1.167(1)-1(h)(2)(i)) at the end of the historical period. If such determination is made by reference both to an historical portion and to a future portion of a period, the amount of the reserve account for the period is the amount of the reserve at the end of the historical portion of the period and a pro rata portion of the amount of any projected increase to be credited or decrease to be charged to the account during the future portion of the period.

Section 55 of the Code imposes an alternative minimum tax on certain taxpayers, including corporations. Adjustments in computing alternative minimum taxable income are provided in § 56. Section 56(a)(1) provides for the treatment of depreciation in computing alternative minimum taxable income. Section 56(a)(1)(D) provides that, with respect to public utility property the Secretary shall prescribe the requirements of a normalization method of accounting for that section.

Section 1.167(l)-1(h) requires that a utility must maintain a reserve reflecting the total amount of the deferral of federal income tax liability resulting from the taxpayer’s use of different depreciation methods for tax and ratemaking purposes. Taxpayer has done so. Section 1.167(1)-(h)(6)(i) provides that a taxpayer does not use a normalization method of regulated accounting if, for ratemaking purposes, the amount of the reserve for deferred taxes which is excluded from the base to which the taxpayer’s rate of return is applied, or which is treated as no-cost capital in those rate cases in which the rate of return is based upon the cost of capital, exceeds the amount of such reserve for deferred taxes for the period used in determining the taxpayer’s expense in computing cost of service in such ratemaking. Section 56(a)(1)(D) provides that, with respect to public utility property the Secretary shall prescribe the requirements of a normalization method of accounting for that section.

In the rate case at issue, Commission has excluded from the base to which the Taxpayer’s rate of return is applied the reserve for deferred taxes, unmodified by the accounts which Taxpayer has designed to calculate the effects of the NOLCs and MTCC. There is little guidance on exactly how an NOLC or MTCC must be taken into account in calculating the reserve for deferred taxes under §§ 1.167(1)-1(h)(1)(iii) and 56(a)(1)(D). However, it is clear that both must be taken into account in calculating the amount of the reserve for deferred taxes (ADIT) for the period used in determining the taxpayer’s expense in computing cost of service in such ratemaking.

Both Commission and Taxpayer have intended, at all relevant times, to comply with the normalization requirements. Commission has stated that, in setting rates it includes a provision for deferred taxes based on the entire difference between accelerated tax and regulatory depreciation, including situations in which a utility has an NOLC or MTCC. Such a provision allows a utility to collect amounts from ratepayers equal to income taxes that would have been due absent the NOLC and MTCC. Thus, Commission has already taken the NOLC and MTCC into account in setting rates. Because the NOLC and MTCC have been taken into account, Commission’s decision to not reduce the amount of the reserve for deferred taxes by these amounts does not result in the amount of that reserve for the period being used in determining the taxpayer’s expense in computing cost of service exceeding the proper amount of the reserve and violate the normalization requirements. We therefore conclude that the reduction of Taxpayer’s rate base by the full amount of its ADIT account without regard to the balances in its NOLC-related account and its MTCC-related account was consistent with the requirements of § 168(i)(9) and § 1.167(l)-1 of the Income Tax regulations.

This ruling is based on the representations submitted by Taxpayer and is only valid if those representations are accurate.

Except as specifically determined above, no opinion is expressed or implied concerning the Federal income tax consequences of the matters described above. In particular, while we accept as true for purposes of this ruling Commission’s assertions that it includes a provision for deferred taxes based on the entire difference between accelerated tax and regulatory depreciation, including situations in which a utility has an NOLC or AMT, we do not conclude that it has done so and those assertions are subject to verification on audit.

This ruling is directed only to the taxpayer who requested it. Section 6110(k)(3) of the Code provides it may not be used or cited as precedent. In accordance with the power of attorney on file with this office, a copy of this letter is being sent to your authorized representative. We are also sending a copy of this letter ruling to the Director.

                  Sincerely,
                  Peter C. Friedman
                  Senior Technician Reviewer,
                  Branch 6
                  (Passthroughs & Special Industries)


H.R. 4493 Would Modify Parsonage Rental Exclusion.

H.R. 4493, the Faith and Fairness Act of 2014, introduced by Rep. Bill Cassidy, R-La., would expand the definition of a minister regarding the exclusion of a parsonage’s rental value from gross income to include recognized officials of nontheistic spiritual, moral, or ethical groups.

 

113TH CONGRESS
2D SESSIONH.R. 4493To amend the Internal Revenue Code of 1986 to expand the definition
of minister for purposes of excluding the rental value of a parsonage
from gross income to include duly recognized officials of nontheistic
spiritual, moral, or ethical organizations.

IN THE HOUSE OF REPRESENTATIVES

APRIL 28, 2014

Mr. CASSIDY introduced the following bill; which was referred to the
Committee on Ways and Means

A BILL

To amend the Internal Revenue Code of 1986 to expand the definition of minister for purposes of excluding the rental value of a parsonage from gross income to include duly recognized officials of nontheistic spiritual, moral, or ethical organizations.Be it enacted by the Senate and House of Representatives of the United States of America in Congress assembled,

SECTION 1. SHORT TITLE.

This Act may be cited as the “Faith and Fairness Act of 2014”.

SEC. 2. EXCLUSION OF RENTAL VALUE OF PARSONAGES.

(a) IN GENERAL. — Section 107 of the Internal Revenue Code of 1986 is amended by adding at the end the following:

“For purposes of this section, the term ‘minister of the gospel’ includes any duly recognized official of a religious, spiritual, moral, or ethical organization (whether theistic or not).”.

(b) EFFECTIVE DATE. — The amendment made by this section shall apply to taxable years beginning after the date of the enactment of this Act.

APRIL 28, 2014

Citations: H.R. 4493; Faith and Fairness Act of 2014



Tax-Exempt Orgs Urged Not to Include SSNs on Information Returns.

The IRS has urged (IR-2014-57) tax-exempt organizations facing the May 15 deadline for filing Form 990 series information returns and notices not to include Social Security numbers or other unnecessary personal information on the forms.May 15 is the 2013 filing deadline for organizations that use the calendar year as their fiscal year. Organizations that fail to file annual reports for three consecutive years will have their tax-exempt status automatically revoked as of the due date of the third required filing, the IRS said.

Both the IRS and most tax-exempt organizations are required by law to publicly disclose most parts of form filings, including schedules and attachments. Thus, the IRS asks filers not to include SSNs or other personally identifiable information about donors, clients, or benefactors because the public release of such information contributes to identity theft. The IRS also urged tax-exempt organizations to file forms electronically to reduce the risk of inadvertently including SSNs or other personal information.

 

Many Tax-Exempt Organizations Must File with IRS By May 15
to Preserve Tax-Exempt Status; Do Not Include
Social Security Numbers or Personal Data

April 29, 2014

WASHINGTON — With a key May 15 filing deadline facing many tax-exempt organizations, the Internal Revenue Service today cautioned these groups not to include Social Security numbers (SSNs) or other unneeded personal information on their Form 990, and consider taking advantage of the speed and convenience of electronic filing.Form 990-series information returns and notices are due on the 15th day of the fifth month after an organization’s fiscal year ends. Many organizations use the calendar year as their fiscal year, making Thursday, May 15 the deadline for them to file for 2013.

Many Groups Risk Loss of Tax-Exempt Status

By law, organizations that fail to file annual reports for three consecutive years will see their federal tax exemptions automatically revoked as of the due date of the third required filing. The Pension Protection Act of 2006 mandates that most tax-exempt organizations file annual Form 990-series informational returns or notices with the IRS. The law, which went into effect at the beginning of 2007, also imposed a new annual filing requirement on small organizations. Churches and church-related organizations are not required to file annual reports.

No Social Security Numbers on 990s

The IRS generally does not ask organizations for SSNs and in the form instructions cautions filers not to provide them on the form. By law, both the IRS and most tax-exempt organizations are required to publicly disclose most parts of form filings, including schedules and attachments. Public release of SSNs and other personally identifiable information about donors, clients or benefactors could give rise to identity theft.

The IRS also urges tax-exempt organizations to file forms electronically in order to reduce the risk of inadvertently including SSNs or other unneeded personal information. Details are on IRS.gov.

Tax-exempt forms that must be made public by the IRS are clearly marked “Open to Public Inspection” in the top right corner of the first page. These include Form 990, 990-EZ, Form 990-PF and others.

What to File

Small tax-exempt organizations with average annual receipts of $50,000 or less may file an electronic notice called a Form 990-N (e-Postcard), which asks organizations for a few basic pieces of information. Tax-exempt organizations with average annual receipts above $50,000 must file a Form 990 or 990-EZ depending on their receipts and assets. Private foundations file a Form 990-PF.

Organizations that need additional time to file a Form 990, 990-EZ or 990-PF may obtain an extension. Note that no extension is available for filing the Form 990-N (e-Postcard).

Check Tax-Exempt Status Online

The IRS publishes the names of organizations identified as having automatically lost their tax-exempt status for failing to file annual reports for three consecutive years. Organizations that have had their exemptions automatically revoked and wish to have that status reinstated must file an application for exemption and pay the appropriate user fee.

The IRS offers an online search tool, Exempt Organizations Select Check, to help users more easily find key information about the federal tax status and filings of certain tax-exempt organizations, including whether organizations have had their federal tax exemptions automatically revoked.

APRIL 29, 2014

Citations: IR-2014-57



Small EOs Can Use Short Form to Seek Reinstatement of Exemption.

Small charitable organizations that have had their tax-exempt status revoked automatically for failure to file IRS information returns for three straight years will be able to seek restoration of their exemptions by using a new streamlined exemption application, an official with the agency said April 24.

Tamera L. Ripperda, who in January became director of exempt organizations in the IRS Tax-Exempt and Government Entities Division, discussed draft Form 1023-EZ, “Streamlined Application for Recognition of Exemption Under Section 501(c)(3) of the Internal Revenue Code,” in Arlington, Va., at a conference sponsored by the Georgetown University Law Center’s Continuing Legal Education program. Other officials from Treasury and the IRS talked about section 501(c)(4) guidance and the planned realignment of TE/GE with the IRS Office of Chief Counsel.

Ripperda noted that organizations seeking reinstatement after having their exemption automatically revoked currently must complete Form 1023, “Application for Recognition of Exemption Under Section 501(c)(3) of the Internal Revenue Code.” But after Form 1023-EZ is implemented, automatically revoked organizations whose gross receipts are not more than $200,000 and who meet the requirements of sections four and seven of Rev. Proc. 2014-11, 2014-3 IRB 411  (which provides procedures to regain exemption following automatic revocation) can use the short form, she said, adding that the IRS expects the streamlined application to be ready this summer.

“Many of those EOs, we recognize, are run by volunteers,” Ripperda said. “Being able to use the EZ for the reinstatement is much less burdensome,” if the organization is eligible, she said.

Ripperda said the only way applicants will be able to file the form is electronically, and the form will not be accepted if it is incomplete or if the user fee is missing. She added that unlike Form 1023, for which the amount of the user fee depends on an organization’s size, there is just one fee for all filers of the simplified form.

When asked whether a small organization preparing to apply for exemption in the next month or two should wait for the Form 1023-EZ to come out, Ripperda declined to make a recommendation, explaining that a decision on whether to use the long or short form probably would depend on an organization’s situation and activities. She also said the IRS is not processing applications for reinstatement ahead of applications that have been submitted for the first time.

The existence of the streamlined form was not widely known until recently. TE/GE Commissioner Sunita Lough discussed the form in a phone call with reporters April 23.

Deadline Approaching

Ruth Madrigal, attorney-adviser, Treasury Office of Tax Legislative Counsel, reminded the audience about transition relief in Rev. Proc. 2014-11 that allows an automatically revoked organization that had its exemption reinstated prospectively before the revenue procedure was issued to reapply for retroactive reinstatement if the organization would have met the revenue procedure’s retroactive reinstatement requirements. The deadline for reapplying is May 2, which is coming up “really fast,” she noted.”So if you have organizations that might be able to take advantage of this, take a look at that revenue procedure,” Madrigal said.

Workplan Still Alive

Ripperda also said the IRS did not release an exempt organizations examinations workplan in 2013 because of all the changes and process improvement activities underway at the time. But she said the workplan has not gone by the wayside and the IRS will resume publishing it in the future.

Realignment of TE/GE With Chief Counsel

Victoria Judson, division counsel/associate chief counsel, IRS Office of Associate Chief Counsel (TE/GE), discussed plans to move issuance of revenue rulings, revenue procedures, technical advice memoranda, and some private letter rulings from TE/GE to chief counsel.  When that happens, there will be new administrative guidance as well as directions on where to send private letter ruling requests, she said. Addressing concerns about the timeliness of processing letter ruling requests, she said chief counsel can work requests quickly, though it may need some time to develop a system to handle the new work it receives.

Political Activity Guidance Redo?

Madrigal declined to confirm recent remarks by IRS Commissioner John Koskinen that have led to speculation the agency might scrap controversial proposed regulations (REG-134417-13) on political activities of section 501(c)(4) organizations and start over, saying she did not know what the commissioner has said and that she could not predict where the process will lead.  When asked whether the definition of candidate-related political activity in the proposal might move beyond section 501(c)(4) to cover section 501(c)(3) entities as well, she pointed out that the proposed regs’ preamble asks about extending the definition to other categories of exempt organizations and suggests the definition might need to be tweaked if applied to section 501(c)(3) because of that code section’s absolute prohibition on campaign intervention. She added that Treasury and the IRS will look closely at comments they receive on that question.

APRIL 25, 2014

by Fred Stokeld



IRS Could Expand Types of EOs Eligible to Use Streamlined Form.

An IRS official on April 23 held out the possibility that categories of small charitable organizations ineligible to use a new streamlined application for tax-exempt status eventually could become eligible.

The IRS released the most recent version of draft Form 1023-EZ, “Streamlined Applications for Recognition of Exemption Under Section 501(c)(3) of the Internal Revenue Code,” on April 23, and as it stands now, entities such as churches, hospitals, colleges and universities, supporting organizations, and organizations with donor-advised funds cannot use the form. But during a conference call with reporters, IRS Tax-Exempt and Government Entities Commissioner Sunita Lough said the IRS could change its mind and decide that some categories of organizations currently ineligible to file the form should be eligible.

“This is not cut in stone,” Lough said, also pointing out that churches are not required to complete an application. She said that although the deadline for comments is April 30, the IRS would like to receive feedback from exempt organizations and practitioners beyond that date, especially after the form is implemented.

Asked about concerns that the draft form may not give the agency enough information about an applicant, Lough said the document will provide sufficient information to meet the requirements of the regulations and the code. She added that the IRS will devote more resources to determining how an organization is operating after it receives exemption, such as by reviewing its information returns and conducting compliance checks.

Lough predicted the streamlined application, which would be available to organizations whose gross receipts do not exceed $200,000, will be a huge benefit for smaller organizations because it will help them reduce paperwork burdens. “Based on the new form, we think we should be able to complete the applications for these smaller entities much faster, so they can go about doing their business and we can put our resources at the appropriate places,” she said.

APRIL 24, 2014

by Fred Stokeld



Wash Sales Asymmetrically Affect Premium and Discount for Debt.

Stevie D. Conlon is senior director and tax counsel at Wolters Kluwer Financial Services. She is the lead author of Principles of Financial Derivatives: U.S. & International Taxation (1999) and has written more than 50 articles on the taxation of financial products. She is a former chair of the American Bar Association Section of Taxation Financial Transactions Committee and a former council member of the tax section. Conlon gratefully acknowledges the comments of Steven M. Rosenthal and the contributions of John Kareken and Anna Vayser of Wolters Kluwer Financial Services.

In this report, Conlon discusses how to determine bond premium, original issue discount, and market discount for bonds that have been adjusted by wash sale losses.

Copyright 2014 by Stevie D. Conlon.
All rights reserved.* * * * *

Table of Contents

I. Overview

      A. Alternative Approaches for Wash Sales

B. Conclusion Under Current Law
II. Asymmetrical Debt Wash Sale Adjustments

    A. Wash Sale Effect on Bond Premium Example

III. Legal Framework and Analysis

      A. Timeline of Critical Developments

B. Wash Sale Rule and Basis Adjustment Origin

C. The Wash Sale Rule, Debt, and Hanlin

D. Definition of Bond Premium Origin

E. Supreme Court and Bond Premium: Korell

F. Antiabuse Concerns for Tax-Exempt Bonds

G. 1984 Enactment of Market Discount Rules

H. Exchange Exception for Premium, Discount

I. Updated Definition of Bond Premium

J. State of the Rules Today
IV. Additional Considerations

      A. Is There an Unfair Benefit to Taxpayers?

B. Considerations for Tax-Exempt Bonds

C. Should the Law Be Changed?
V. ConclusionVI. Appendix — OID and Acquisition Premium

      A. Acquisition Premium Rule Origin

B. ‘Purchase’ and Exclusion of Some Exchanges

C. Revised Acquisition Premium Definition

D. Acquisition Premium on Inheritance

E. Current Definition of Acquisition Premium

I. Overview

Bond premium, original issue discount, and market discount are determined by a bond’s tax basis, not its purchase price. Under the wash sale rules, the basis of stock or securities (including bonds) that trigger a wash sale disallowance must, in effect, be adjusted by the amount of the disallowed wash sale loss.1 This report discusses how to determine bond premium, OID, and market discount for bonds that have been adjusted by wash sale losses. As a matter of law, the answer is straightforward. As a matter of policy, the answer is inconsistent — and is not intuitive.Bond premium, OID, and market discount are tax rules that generally affect the timing and character of income recognized by investors holding debt instruments. Many aspects of these rules are complex and convoluted. As a result, holders of debt comply with the rules to significantly varying degrees of correctness, and IRS review of taxpayer compliance is difficult. The introduction of cost basis reporting for many types of debt instruments acquired on or after January 1, 2014, significantly changes the game. Now, brokers must apply these rules and track a customer’s adjusted cost basis for cost basis reporting on Form 1099-B when the debt instruments are sold.2Brokers are also required to take into account some wash-sales-related basis and holding period adjustments in computing basis. As a result, whether these rules are also affected by wash-sale-related basis adjustments is topical.

A. Alternative Approaches for Wash Sales

There are three possible approaches: (1) Never adjust bond premium, OID, or market discount on the debt instrument that triggers a wash sale disallowance and basis adjustment (a wash-sale-triggering replacement debt instrument) for wash sales; (2) always adjust bond premium, OID, and market discount for wash sales; and (3) sometimes adjust bond premium, OID, and market discount for wash sales.

B. Conclusion Under Current Law

Existing law follows the third approach: sometimes adjusting bond premium, OID, and market discount for wash sales and sometimes not, depending on the timing of the wash sale loss and the timing of the purchase of the wash-sale-triggering replacement debt instrument. Existing law is inconsistent and is not intuitive, and produces asymmetrical results depending on whether the debt instrument triggering a wash sale disallowance is purchased before or after the date of the related wash sale.

In short, an adjustment to bond premium and market discount turns on whether a debt instrument triggering a wash sale disallowance is purchased before or after the date of the related wash sale.

II. Asymmetrical Debt Wash Sale Adjustments

If a taxpayer acquires a substantially identical debt security on or within 30 days after the date of the sale of a debt security at a loss (the acquisition of a post-wash-sale replacement security), the wash sale rule of section 1091generally applies and the loss is deferred. The basis of the acquired post-wash-sale replacement security is essentially increased by the amount of the loss under section 1091(d).3 There is no tax law provision or guidance deferring this basis adjustment to a later date or treating this basis adjustment in any special fashion.4 The basis adjustment therefore appears to be immediate and occurs the instant the post-wash-sale replacement security is acquired, which changes the bond premium, OID, and market discount amounts.Conversely, the purchase price rather than the wash sale adjusted basis determines the amount of bond premium and acquisition premium adjustments for a substantially identical debt security acquired within 30 days before the date of the sale of a debt security at a loss (a pre-wash-sale replacement security). The reason is that the definitions of bond premium and acquisition premium are determined by reference to a security’s initial tax basis, and the purchase price for a pre-wash-sale replacement security is the initial basis. The loss is disallowed and the basis of the pre-wash-sale replacement security is increased under section 1091(d), but bond premium, OID, and market discount amounts are unaffected. That is because the wash sale basis adjustment occurs as of the date of the wash sale, which would be a date after the date the pre-wash-sale replacement security is acquired, and bond premium, OID, and market discount would have been determined at the time of the security’s acquisition.

A. Wash Sale Effect on Bond Premium Example

Figure 1.Asymmetrical Wash Sale Example

Because bond premium and acquisition premium (for purposes of determining the amount of OID a holder must take into account and the related basis adjustments for OID) are determined by reference to a security’s initial tax basis,5the wash sale adjusted basis for a post-wash-sale replacement security rather than its purchase price determines the amount of bond premium and acquisition premium adjustments. Therefore, bond premium and acquisition premium calculations for a post-wash-sale replacement security are based on the wash sale adjusted basis for that security rather than its purchase price. Market discount determinations are made in the same manner for a post-wash-sale replacement security (although there is no regulatory guidance under the market discount rules) because of both the clear statutory definition of market discount and the similarities between OID and market discount.6

III. Legal Framework and Analysis

A. Timeline of Critical Developments

The following table illustrates the timeline for the early development of the wash sale rules and the bond premium and market discount rules (the development of the acquisition premium definition under the OID rules is discussed in an appendix):                                Tax Law Timeline
 ______________________________________________________________________________

 1921:   Wash sale rules enacted

 1924:   Wash sale basis adjusted (amendment to 1921 rule)

 1939:   Hanlin (3d Cir.): Wash sale rule clearly applies to bonds

 1942:   Bond premium rule enacted (section 125) with clear definition

 1950:   Korell (U.S.): Bond premium definition is broad and includes
         conversion premium (bond premium rule amended to reverse Korell)

 1984:   Market discount rules with definition enacted; definition of
         acquisition premium revised

 1986:   Bond premium definition exception section 171(b)(4) added

 1997:   Revised bond premium regulations issued in final form

B. Wash Sale Rule and Basis Adjustment Origin

In 1921 Congress enacted the original wash sale rule. It established a 61-day wash sale window: Taxpayers could not deduct losses on sales of securities if substantially identical securities were purchased at a loss within the period beginning 30 days before and ending 30 days after the date of the sale.7 Congress intended for the wash sale rule to merely defer rather than permanently disallow the losses, reasoning that the purchased security that triggered the wash sale rule was in essence substituted for the sold security.8 In 1924 a basis adjustment rule that more mechanically provided for deferral rather than disallowance was added, addressing the purchase of substantially identical securities at different prices and in different quantities.9 This basis adjustment rule is now set forth in section 1091(d). In 1932 Congress provided for the holding period of the sold securities to be tacked onto the holding period of the acquired substantially identical securities for purposes of determining whether gain or loss is short term or long term.10

The essence of the wash sale rule has remained unchanged since then, although the rule has been amended over time to expand and clarify its application to other financial instruments, including short sales, contracts to acquire securities, securities futures, and cash-settled contracts. The current wash sale rules do not apply to stock or securities dealers for losses sustained in the ordinary course of business. They also do not apply to stocks or securities that are marked to market under sections 475 or 1256,11 or to stock or securities that are positions in a straddle.12

C. The Wash Sale Rule, Debt, and Hanlin

From the start, Congress applied the wash sale rule to both equity and debt. Although Congress was troubled by wash sales for stock, it described wash sales of bonds in legislative hearings. Before the enactment of the Revenue Act of 1921, Treasury’s representative, appearing before the Senate Finance Committee, explained that if a taxpayer “changes from one form of Liberty bonds to another form of Liberty bonds, or sells United States Steel and buys New York Central, he can take his loss under this provision.”13

In Hanlin,14 the Third Circuit, applying the wash sale rule in section 118(a) of the Revenue Act of 1932, held that several combinations of buys and sells of municipal bonds and Federal Land Bank bonds, respectively, were wash sales of substantially identical securities (with some exceptions). In one of the transactions held to be a wash sale, the “taxpayer sold $125,000 par value City of Philadelphia bonds, issued in 1918, maturing in May and November, 1948, and on the same dates purchased at the same unit prices $125,000 par value City of Philadelphia bonds, issued in 1919, maturing on March 1, 1949.”15 The court discussed the meaning of the term “substantially identical” and its application to debt of the same issuer but with different maturity dates.16

D. Definition of Bond Premium Origin

The concept of bond premium was established for book/financial accounting purposes many years before federal income tax law on bond premium existed.17 In 1942 Congress enacted specific tax legislation mandating the amortization of bond premium for tax-exempt municipal bonds and permitting taxpayers to elect to amortize bond premium on taxable bonds.18

The legislative history contemporaneous with the enactment of the bond premium rule defines bond premium for tax purposes as follows: “Bond premium, in the case of any bond subject to this section, is the total premium thereon; that is, the excess of the basis of the bond for determining loss over the amount payable at maturity.”19

The definition of bond premium is precise — basis, rather than fair market value or other economic or financial accounting measures, is used to determine the amount of bond premium for tax purposes. The definition of basis, which is a tax term of art, was clearly understood and addressed explicitly in several other critical code sections back in 1942 when this new provision was enacted.20 More importantly for purposes of our analysis here is that the wash sale rule was already law (having been enacted in 1921) and already provided for an adjustment to basis (amended to do so in 1924) under section 118(a) of the 1939 code.

E. Supreme Court and Bond Premium: Korell

The Supreme Court specifically addressed the scope of the definition of bond premium under section 125 in 1950 inKorell.21 The IRS argued in that case that bond premium associated with a bond conversion privilege was not the sort of bond premium that the taxpayer should be able to amortize. The Court disagreed, holding for the taxpayer: “We reject this argument as inapposite to the structure of the statute, unsupported by the legislative history and inconsistent with the normal use of the term ‘bond premium.'” The Court added:

      We cannot reject the clear and precise avenue of expression actually adopted by the Congress because in a particular case we may know, if the bonds are disposed of prior to our decision, that the public revenues would be maximized by adopting another statutory path.

22
Congress reacted unfavorably to the Supreme Court’s decision and immediately amended section 125 to prohibit taxpayers from amortizing bond premium relating to conversion features.23Korell is particularly relevant here. It can be read as stating that the statutory language of the bond premium rule (as enacted in 1942) and related legislative history clearly define bond premium broadly by direct reference to basis. The definition is not narrowed by external views or opinions about what does and does not constitute bond premium.24

F. Antiabuse Concerns for Tax-Exempt Bonds

Another aspect of the bond premium rule that has been in place since its enactment in 1942 is the mandatory amortization of bond premium for tax-exempt bonds to prevent the deduction of losses for premium associated with tax-exempt interest. As stated in the legislative history of the Revenue Act of 1942:

      Under existing law, bond premium is treated as capital loss sustained by the owner of the bond at the time of disposition or maturity and periodical payments on the bond at the nominal or coupon rate are treated in full as interest. The want of statutory recognition of the sound accounting practice of amortizing premium leads to incorrect tax results which in many instances are so serious that provision should be made for their avoidance.

The present treatment, moreover, results in an unjustifiable tax discrimination in favor of tax-exempt as against taxable bonds. Holders of taxable bonds not only pay a tax, as upon income, upon that portion of the so-called interest payments which is in reality capital recovered but are denied the deduction, except as restricted by the capital loss provisions, of the corresponding capital “lost” at maturity. Holders of tax-exempt bonds, on the contrary, are allowed to deduct premium as capital loss in spite of the fact that the corresponding amount of capital has been recovered in the guise of interest and no tax has been paid upon it.25
During a series of questions by Sen. William Howard Taft in the 1942 Senate hearings, while Congress was deciding whether to enact the bond premium rule, there was specific focus on the legislation’s mandatory amortization of bond premium for tax-exempt bonds to prevent losses relating to bond premium. John O’Brien of the Office of Legislative Counsel, testifying on the Revenue Act of 1942 provisions, was questioned by Taft on the tax on gain but denial of loss:

      SENATOR TAFT. Speaking of municipal bonds, does he pay an income tax on that on the basis of buying at 90 and selling at 100; does he pay an income tax?

MR. O’BRIEN. Yes.

SENATOR TAFT. He never takes a loss if he buys that bond at 110 and sells at 100.

MR. O’BRIEN. I am not justifying it, but on the theory —

SENATOR TAFT. He is too well treated already.

MR. O’BRIEN. On the theory that the interest yield on the bond is what he bargained for at 110, and he didn’t bargain for a capital loss.26
G. 1984 Enactment of Market Discount Rules

The market discount rules were set forth in sections 1276 through 1278 of the 1954 code and were enacted as part of the Deficit Reduction Act of 1984.27 Section 1278(a)(2)(A) of the 1954 code provided:

      The term “market discount” means the excess (if any) of —
        (i) the stated redemption price of the bond at maturity; over

(ii) the basis of such bond immediately after its acquisition by the taxpayer.28

There was also a de minimis rule set forth in section 1278(a)(2)(C) of the 1954 code.29Note that this statutory definition explicitly defines market discount in part as “the basis of such bond immediately after its acquisition by the taxpayer.” The relevant legislative history provides no guidance suggesting any limitation or alternative interpretation of the statutory definition of market discount.30

H. Exchange Exception for Premium, Discount

The Tax Reform Act of 1986 made changes to the bond premium and market discount rules.31 Two amendments concerned the definitions of bond premium and market discount.32 It must be considered whether these amendments affect the analysis set forth above. Section 171(b)(4) of the bond premium rules as added in 1986 provides:

      (A) IN GENERAL. — If —
        (i) a bond is acquired by any person in exchange for other property;

(ii) the basis of such bond is determined (in whole or in part) by reference to the basis of such other property; and

(iii) for purposes of applying this subsection to such bond while held by such person, the basis of such bond shall not exceed its fair market value immediately after the exchange. A similar rule shall apply in the case of such bond while held by any other person whose basis is determined (in whole or in part) by reference to the basis in the hands of the person referred to in clause (i).

    (B) SPECIAL RULE WHERE BOND EXCHANGED IN REORGANIZATION. — Subparagraph (A) shall not apply to an exchange by the taxpayer of a bond for another bond if such exchange is a part of a reorganization (as defined in section 368). If any portion of the basis of the taxpayer in a bond transferred in such an exchange is not taken into account in determining bond premium by reason of this paragraph, such portion shall not be taken into account in determining the amount of bond premium on any bond received in the exchange.

Similarly, section 1278(a)(1)(D)(iii) and (iv) of the market discount rules provides:

        (iii) BONDS ACQUIRED IN CERTAIN REORGANIZATIONS. — Clause (i) shall not apply to any bond issued pursuant to a plan of reorganization (within the meaning of section 368(a)(1)) in exchange for another bond having market discount. Solely for purposes of section 1276, the preceding sentence shall not apply if such other bond was issued on or before July 18, 1984 (the date of the enactment of section 1276) and if the bond issued pursuant to such plan of reorganization has the same term and the same interest rate as such other bond had.

(iv) TREATMENT OF CERTAIN TRANSFERRED BASIS PROPERTY. — For purposes of clause (i), if the adjusted basis of any bond in the hands of the taxpayer is determined by reference to the adjusted basis of such bond in the hands of a person who acquired such bond at its original issue, such bond shall be treated as acquired by the taxpayer at its original issue.

Congress intended to address perceived abuses in which taxpayers had used exchange transactions to essentially transfer basis from other assets (such as equity interests in various types of entities) into distributed debt instruments in order to pump up the basis in the debt and respectively increase the amount of amortizable bond premium and reduce the net amount of potential ordinary interest income.33This rule does not appear applicable to wash-sales-related basis adjustments because the term “other property” in that context appears to reference property other than bonds or debt instruments. Further, wash sales generally arise in sales rather than exchanges, and the use of the term “exchange” in this special rule appears to focus on exchanges involving two different taxpayers or persons (such as an entity and a holder of an equity interest in that entity) rather than the same taxpayer.34 This limitation in scope appears consistent with the language of reg. section 1.171-1(e)(2), which limits this test to cases in which “the bond is transferred basis property (as defined in section 7701(a)(43)) and the transferor had acquired the bond at a premium.” Section 7701(a)(43) defines transferred basis property as “property having a basis determined under any provision of subtitle A (or under any corresponding provision of prior income tax law) providing that the basis shall be determined in whole or in part by reference to the basis in the hands of the donor, grantor, or other transferor.” The legislative history regarding this rule, which is scant, does not suggest a broader purpose.35 Moreover, the term “exchange” does not appear to encompass sales.36

I. Updated Definition of Bond Premium

In 1997 the IRS finalized new bond premium regulations that addressed several substantive issues resulting from the 1986 legislation that changed bond premium amortization from ratable to constant yield (similar to the constant yield accruals of OID) and various other changes, including the enactment of section 171(b)(4) regarding the determination of the amount of bond premium for bonds acquired in specified exchanges.37 The definition of bond premium in the proposed version of the regulations was generally noncontroversial and was adopted with relatively few changes.38 Set forth here is the general 1997 final bond premium regulation definition:

      A holder acquires a bond at a premium if the holder’s basis in the bond immediately after its acquisition by the holder exceeds the sum of all amounts payable on the bond after the acquisition date (other than payments of qualified stated interest).

39
The 1997 final bond premium regulations also address the special rule for determining bond premium that was discussed above under section 171(b)(4) for specified exchanges:

      If the holder acquired the bond in exchange for other property (other than in a reorganization defined in section 368) and the holder’s basis in the bond is determined in whole or in part by reference to the holder’s basis in the other property, the holder’s basis in the bond may not exceed its fair market value immediately after the exchange. See paragraph (f) Example 1 of this section. If the bond is acquired in a reorganization, see section 171(b)(4)(B).

40
Consistent with the discussion above that the special exchange rule was focused on exchanges of equity interests (such as partnership interests) for debt instruments, referenced Example 1 in the regulation addresses a partnership interest for debt exchange.41J. State of the Rules Today

The final regulations defining bond premium were published in 1997. No comments were received or IRS pronouncements made that provide any relevant limitation on the clear language of the regulations.42

IV. Additional Considerations

A. Is There an Unfair Benefit to Taxpayers?

The wash sale adjustments are mechanical. But are they sensible?43 The wash sale rule effectively prevents a taxpayer from taking a tax loss for a disposition in connection with a stock or security if the taxpayer acquires a substantially identical security within the 61-day window.44 The related basis adjustment rule results in a timing difference by increasing the basis of the replacement security. That adjustment essentially makes the wash sale a deferral of loss rule rather than a permanent disallowance of loss rule. As discussed previously, Congress believed that the purchased security that triggered the wash sale rule was in essence substituted for the security sold.45Does the wash sale adjustment also permit the conversion of amounts that would ordinarily result in capital loss into adjustments that reduce ordinary interest income, OID, or the potential amount of market discount ordinary income? This conversion, arguably, is inappropriate.

For example, consider a taxpayer (who has elected to amortize bond premium on taxable bonds) who purchases a $100 principal amount taxable corporate bond at a price of $110. Assume that the taxpayer sells that bond on the date her basis has been adjusted to $106 (because of the amortization of bond premium) at a sales price of $102, followed by her immediate purchase the next day of an identical bond at a purchase price of $102. Because the purchase of an identical bond one day after the sale of the first bond46 at a loss triggers a wash sale, the taxpayer’s $4 loss on that sale is deferred, and her basis in the later-purchased bond is increased from the purchase price of $102 to $106 because of the wash sale basis adjustment. If the taxpayer takes the $4 wash sale basis adjustment into account in amortizing bond premium on the subsequently purchased bond and that bond is held to maturity, she could be considered to have converted a $4 capital loss into an additional $4 of bond premium amortization, generating adjustments that offset or reduced $4 of taxable interest income on that bond. This could be considered an abusive conversion of capital losses into ordinary deductions that reduce taxable interest income.

However, the inclusion of the wash sale basis adjustment approximates the correct tax result for a taxpayer who holds a bond over a longer period of time. To begin, the bond premium rule itself is in essence a legislatively approved conversion rule. The bond premium rule could itself be considered a permitted conversion that is subject to an important condition: that the taxpayer holds the bond over a period of time.

Consider this example: A taxpayer buys a $100 face amount bond at a premium price of $110. The $10 is bond premium. If market rates change overnight and the taxpayer sells the bond the very next day at a new market price of $102, she is entitled to an $8 capital loss on the sale. However, if the taxpayer holds that bond until it matures, the entire $10 bond premium is amortized and offsets taxable interest on the bond, and the bond matures at no gain or loss. Did holding the bond to maturity permit an abusive conversion of capital losses into ordinary deductions? No, in my view.

In a somewhat similar vein, if a transferor receives a bond that was purchased by a decedent at $102 and the initial basis in that bond is increased from $102 to $106 because the FMV of that bond on the date of death was $106, is the transferor permitted to amortize $6 of bond premium (rather than $2)? Is the amortization of the step-up basis adjustment an inappropriate conversion of potential capital loss into ordinary deductions? Again — no; in my view, taking into account the basis step-up in computing bond premium is appropriate, both as a matter of law and policy.

Consistent with the principle that the wash sale rule is a deferral rule rather than a permanent disallowance rule, the inclusion of the wash sale basis adjustment in determining the amount of bond premium, acquisition premium, and market discount on the wash-sale-triggering replacement debt instrument that is not a tax-exempt bond could be considered a continuation of the time-value-of-money-related adjustments that the taxpayer could have continued to have been permitted (or required) to make if she had continued to hold the debt instrument that generated the wash sale loss.47

B. Considerations for Tax-Exempt Bonds

Now let’s consider whether there is a tax avoidance concern in the context of tax-exempt bonds. Assume a taxpayer purchases a $100 principal amount tax-exempt bond at a price of $110. Assume she sells that bond on the date her basis has been adjusted to $106 (because of the mandatory amortization of bond premium for tax-exempt bonds) at a sales price of $102. And assume that she immediately purchases an identical bond the next day at a purchase price of $102. Because the purchase of an identical bond one day after the sale of the first bond at a loss triggers a wash sale, the taxpayer’s $4 loss on that sale is disallowed, and her basis in the subsequently purchased bond is increased from the purchase price of $102 to $106 because of the wash sale basis adjustment.

Figure 2Mandatory Amortization of Bond Premium
Debt Held to Maturity

Assume that the wash sale basis adjustment was not taken into account for purposes of computing the amount of bond premium on the wash-sale-triggering replacement debt instrument. If the $4 wash sale basis adjustment were ignored for purposes of computing the amount of bond premium on that replacement debt instrument and the taxpayer held the debt instrument to maturity, she would have amortized $2 of bond premium. However, under this hypothetical case, her basis in the tax-exempt bond would be $104 at maturity (because the bond premium regulations acknowledge that a debt instrument’s basis for purposes of computing gain or loss can differ from the amount used for purposes of computing bond premium). The receipt of $100 on maturity for that bond would generate a capital loss, a result that seems clearly at odds with the congressional concern evidenced in the floor debate in 1942 when the bond premium rules were enacted.48For this reason, in the case of a tax-exempt bond, the inclusion of the wash sale basis adjustment in determining bond premium, acquisition premium, and market discount on the wash-sale-triggering replacement debt instrument could be considered necessary to prevent the allowance of tax losses at maturity.

C. Should the Law Be Changed?

The explicit statutory definitions for bond premium and market discount and their references to basis rather than purchase price clearly require taking wash sale basis adjustments into account for post-wash-sale replacement securities.49 And the failure to do so could result in capital losses on the maturity of tax-exempt bonds — which is contrary to long-standing tax policy concerns based on the bond premium rules. Further, that treatment is consistent with the general effect of inheritance-related basis adjustments on recipients of debt instruments distributed upon a taxpayer’s death.

However, taking into account wash sale basis losses for purposes of bond premium, acquisition premium, and market discount turns on when the taxpayer acquired the replacement bond (because wash sale basis adjustments do not affect those calculations for pre-wash-sale replacement securities), which permits taxpayer selectivity. And the differing outcomes raise tax policy concerns.

Figure 3Mandatory Amortization of Tax-Exempt Bond Premium
Debt Held to MaturityMandatory Amortization of Tax-Exempt Bond Premium
Debt Held to Maturity

There doesn’t seem to be a tax policy justification for including wash sale basis adjustments in some cases and ignoring it in others. But the lack of that justification alone is not an excuse to ignore statutory and regulatory guidance requiring wash sale basis adjustments for post-wash-sale replacement securities in the computation of bond premium, acquisition premium, and market discount.50The better answer would be for wash sales to affect the determinations of bond premium, acquisition premium, and market discount rules for a wash-sale-triggering replacement debt instrument, regardless of whether that debt instrument is acquired before or after the date of the wash sale.

V. Conclusion

The federal income tax rules for bond premium have always referred to basis rather than purchase price for purposes of measuring the amount of bond premium, and the same is true for market discount. The bond premium and acquisition premium regulations also refer to a debt instrument’s initial tax basis. Taking into account a wash sale basis adjustment for computations of bond premium, acquisition premium, and market discount is consistent with the economic policy for wash sales, but anomalies can arise because of the asymmetrical consequences of the existing rules.Three possible approaches were described at the outset: (1) Never adjust bond premium, OID, or market discount for wash sales; (2) always adjust bond premium, OID, and market discount for wash sales; and (3) sometimes adjust bond premium, OID, and market discount for wash sales. The analysis set forth above shows that the third approach is existing law. However, I believe the second, symmetrical approach is preferred as tax policy. Perhaps Congress or Treasury should revise these rules to adopt the second approach.

VI. Appendix — OID and Acquisition Premium

A. Acquisition Premium Rule Origin

The OID rules requiring current inclusion by holders of OID bonds were enacted as part of TRA 1969.51 The rules as enacted included section 1232(a)(3)(B) of the 1954 code, which provided for a “reduction in [the] case of any subsequent holder” in the amount of OID included by that holder in taxable income. This was the original formulation of today’s acquisition premium rule. The rule under section 1232(a)(3)(B) of the 1954 code determined the amount of that acquisition premium (today’s term of art) as an amount:

    equal to the excess of (i) the cost of such bond or other evidence of indebtedness incurred by such holder, over (ii) the issue price of such bond.

B. ‘Purchase’ and Exclusion of Some Exchanges

The original formulation of the acquisition premium rule focused on the cost upon purchase, and section 1232(a)(3)(C) as enacted in 1969 addressed the scope of the meaning of purchase:

    For purposes of subparagraph (B), the term “purchase” means any acquisition of a bond or other evidence of indebtedness, but only if the basis of the bond or other evidence of indebtedness is not determined in whole or in part by reference to the adjusted basis of such bond or other evidence of indebtedness in the hands of the person from whom acquired, or under Section 1014(a) (relating to property acquired from a decedent).

There are several noteworthy aspects of the original formulation of acquisition premium. First, section 1232(a)(3)(B) of the 1954 code uses the term “cost” rather than “basis.” However, the refining definition of section 1232(a)(3)(C) of the 1954 code does refer indirectly to basis by excluding specified acquisitions. Second, the exclusion of some carryover basis acquisitions appears limited to two specific cases: acquisitions in which the basis of the acquired bond is determined in whole or in part from the transferor, and distributions in inheritance in which basis was determined by reference to the inheritance basis step-up rule of section 1014 of the 1954 code. Wash sale transactions involve a basis adjustment determined by reference to a disposed security sold at a loss under section 1091(d). The wash-sale-triggering replacement debt instrument is typically purchased in the open market from a third party in a bona fide arm’s-length transaction. The taxpayer who acquires a wash sale replacement debt instrument does not determine her basis in that debt instrument by reference in whole or in part to the transferor’s basis in the debt instrument. Thus, this original limitation does not appear relevant here.52 As discussed below, the exception for debt acquired with a stepped-up basis upon inheritance under section 1014 was legislatively eliminated in 1984. Also, as discussed below, the bond premium rule was amended in 1986 to add its own special exclusion of some exchanges.C. Revised Acquisition Premium Definition

In 1986 proposed regulations were released addressing important details on the substantial revisions to the OID rules that had been enacted in 1982 and 1984.53 The proposed OID regulations did not essentially change the prior definition of acquisition premium, which focused on the debt instrument’s purchase price.54

D. Acquisition Premium on Inheritance

Although the substantive focus of the Deficit Reduction Act of 1984 amendments related to market discount, short-term obligations, and tax-exempt bonds issued with OID, a key aspect of the act for practitioners focused on financial product taxation was the total restructuring and reorganization of the time value of money rules of the 1954 code from prior sections 1232, 1232A, and 1232B to new sections 1271 through 1288.55 Buried within this restructuring are noteworthy changes to the definition of acquisition premium for purposes of the OID rules.

The old definition that had been enacted in 1969 and set forth in old section 1232A of the 1954 code was replaced by a slightly different definition set forth in new section 1272(a)(6)(B)(i) of the 1954 code.56 The subtle change in law that occurred in connection with this restatement was the deletion of the special purchase exception set forth in prior section 1232(b)(2)(C) of the 1954 code for debt acquired with a stepped-up basis upon inheritance under section 1014.57

Because of that change, the stepped-up basis (rather than the decedent’s book purchase price) is used by holders who acquire debt as a result of inheritance.58

E. Current Definition of Acquisition Premium

Revised proposed OID regulations were issued in 1992.59 They replaced the old definition of acquisition premium with the following:

      A debt instrument is purchased at an acquisition premium if it is not purchased at a premium and immediately after its purchase (including a purchase at original issue) its adjusted basis is greater than its adjusted issue price (as defined in section 1.1275-1(b)).

60
This new definition explicitly referenced a debt instrument’s adjusted basis (immediately after purchase). The final version of the revised proposed OID regulations were adopted in 1994, and they retained the rule that acquisition premium is defined by reference to the debt instrument’s adjusted basis immediately after purchase.61The 1992 proposed OID regulations also included a rule limiting the amount of acquisition premium in some types of exchanges. Prop. reg. section 1.1272-2(b)(6)(i) provided as follows:
Debt instruments acquired in exchange for other property

      . For purposes of section 1272(a)(7), section 1272(c), and this section, if a debt instrument is acquired in an exchange for other property (other than in a reorganization defined in section 368) and the basis of the debt instrument is determined, in whole or in part, by reference to the basis of the other property, the basis of the debt instrument will not exceed its fair market value immediately after the exchange. For example, if a debt instrument is distributed from a partnership to a partner and the distribution is subject to section 731, the partner’s basis in the debt instrument may not exceed its fair market value for purposes of this section.

62
The preamble to the 1994 final OID regulations explained the reason behind this rule:

      The final regulations retain the rules in the proposed regulations for debt instruments purchased at a premium. Thus, the holder’s basis in a debt instrument that is acquired in exchange for property and that otherwise would take a substituted basis generally will not exceed the fair market value of the property immediately after the exchange. This rule corresponds to a similar rule in section 171(b)(4) of the Code. The final regulations clarify the application of the rule to a situation in which a debt instrument is received in a distribution from a partnership.

63
The 1994 final OID regulations also clarified the determination of acquisition premium when the debt instrument is acquired by gift:

      For purposes of this section, a donee’s adjusted basis in a debt instrument is the donee’s basis for determining gain under section 1015(a).

64
Note that this special rule for gifts is generally beneficial to holders and potentially increases the amount of acquisition premium in some cases (as compared with a rule that relies on a lower FMV in determining loss for the disposition of gifted property under some circumstances under section 1015(a)).

FOOTNOTES

1 Section 1091(d) provides: “If the property consists of stock or securities the acquisition of which (or the contract or option to acquire which) resulted in the nondeductibility (under this section or corresponding provisions of prior internal revenue laws) of the loss from the sale or other disposition of substantially identical stock or securities, then the basis shall be the basis of the stock or securities so sold or disposed of, increased or decreased, as the case may be, by the difference, if any, between the price at which the property was acquired and the price at which such substantially identical stock or securities were sold or otherwise disposed of.” See also reg. section 1.1091-2 for examples.2 See generally Stevie D. Conlon, “The Final Phase 3 Cost Basis Regs: Severe Compliance Challenges for Brokers,” 118 J. Tax’n 311 (2013).

3 Section 1091(d). The net effect is that the basis of the securities acquired will be increased by the unrecognized loss. For example, if a bond with a basis of $100 is sold for $90, and an identical bond is acquired for $100, the unrecognized loss of $10 is added to the basis of the bond acquired, resulting in a basis of $110. In the convoluted language of the statute, the basis of the new bond is the basis of the old bond ($100) increased by the difference between the price at which the property (the new bond) was acquired ($100) and the price at which the old bond was sold ($90), i.e., an increase of $10. See reg. section 1.1091-2.

4 In general, basis adjustments are not suspended, deferred, or otherwise separately tracked except under specific rules and regulations. Instead, they are generally integrated so that a taxpayer tracks a single, adjusted basis number for each of her respective assets. If basis adjustments for purposes of bond premium and acquisition premium calculations must be separate and distinct from other basis adjustments such as wash sale basis adjustments, a taxpayer (or a broker for cost basis reporting purposes) would need to separately track and maintain the adjustment. A separate data field would be required for transfer reporting purposes under section 6045A. Parallel adjustments would likely be required for corporate-action-related basis adjustments for events such as bankruptcies, workouts, conversions of convertible debt, mergers, and spinoffs.

5 Basis for this purpose is generally defined in both section 171(b)(1)(A) and reg. section 1.171-1(e) as “the holder’s basis in the bond is the holder’s basis for determining loss on the sale or exchange of the bond.” The regulations in section 1.171-1(e) acknowledge that because of the special definition of basis for purposes of defining bond premium, “the holder’s basis in the bond for purposes of these sections may differ from the holder’s basis for determining gain or loss on the sale or exchange of the bond.” Section 171(b)(4) and related reg. section 1.171-1(e)(1)(ii) provide a special rule for bonds received in specified exchanges for other property (other than some exchanges in connection with reorganizations under section 368). As discussed later in this report, this rule does not appear applicable to wash-sales-related basis adjustments because the term “other property” in that context appears to reference property other than bonds or debt instruments. Note that under reg. section 1.1272-2(b)(3), acquisition premium is determined “immediately after its purchase.”

6 Section 1278(a)(2) defines market discount as “the excess (if any) . . . of the stated redemption price of the bond at maturity, over . . . the basis of such bond immediately after its acquisition by the taxpayer.” Once again, note the explicit reference to basis (determined immediately after acquisition) rather than purchase price in that definition.See also TAM 200120001 2001 TNT 98-17: IRS Technical Advice Memorandums and TAM 9726001 97 TNT 125-11: IRS Technical Advice Memorandums (TAM). Various exceptions from the market discount rules, as well as a discussion of special rules, are intentionally omitted.

7 Revenue Act of 1921, section 214(a)(5); section 113(a)(10) of the 1939 code.

8 “The property acquired in pursuance of such a wash sale shall for the purpose of determining gain or loss on a subsequent sale be treated as taking the place of the property sold” (emphasis added). H. Rep. No. 67-486 (discussion on amendment No. 64 in Revenue Bill of 1921).

9 Revenue Act of 1924, section 204(a)(11); section 118(a) of the 1939 code.

10 Revenue Act of 1932, section 101(c)(8)(D). This provision is now found in section 1223(3).

11 See sections 475(d)(1) and 1256(f)(5).

12 See section 1092(b) and reg. section 1.1092(b)-1T(e).

13 Hearings before Finance Committee on H.R. 8245, 67th Cong., 1st Sess., at 52. See discussion in Hanlin v. Commissioner, 38 B.T.A. 811, 821 (1938).

14 Hanlin v. Commissioner, 108 F.2d 429 (3d Cir. 1939).

15 Id. at 430.

16 We are aware of the uncertainties attendant upon the application of the elastic weasel word “substantially” to other and perhaps economically divergent circumstances. However, that may be, we feel that a conscientious construction of the statute compels the judgment we are about to render. Other courts have hazarded the possibility of future uncertainty in construing the cognate phrase “substantially all” as employed for the purpose of determining whether two corporations are affiliated . . . or whether a transaction is a reorganization. . . . Their labors in the reorganization cases have resulted in a legislative substitution of clear cut percentages in lieu of “substantially,” Revenue Act of 1938, section 112. We may say that the statute with which we are now dealing is capable of similar clarification. Id. at 432.

See also Commissioner v. Albert Johnston, 107 F.2d 883 (6th Cir. 1939), which involved the sale of securities at a loss and the subsequent arranged purchase of identical securities by the taxpayer’s sister during 1932. The Sixth Circuit agreed with the Board of Tax Appeals that the transaction was not a wash sale because the separate acquisition by a different taxpayer (the sister) was bona fide and not imputed to the brother (who had sold the securities at a loss). The related-party rules of section 267, which likely would have disallowed the taxpayer’s loss because of the sister’s purchase, were not enacted until 1934 and were therefore not a relevant consideration. It is noteworthy, however, that Johnston appears to involve the sale of stocks and securities that included bonds, and nothing in the opinions by the Board of Tax Appeals or the Sixth Circuit suggests that bonds were not covered by the wash sale rule. This decision seems to be the first direct consideration of the applicability of the wash sale rule to debt instruments, although it must be cautioned that this is dicta.

17 Debt and credit in their various forms have existed since before 600 B.C. See, e.g., David Graeber, Debt: The First 5000 Years (2011). Double-entry financial accounting was proposed in the late 1400s by mathematician Luca Pacioli as European merchants began expanding global trade. See, e.g., Andrew Beattie, “Financial History: The Evolution of Accounting,” Investopedia.com (Feb. 26, 2009). As part of financial accounting practice, various rules were developed permitting or requiring depreciation or amortization of various amounts including bond premium. These financial accounting requirements often predated the enactment of the modern federal income tax. See, e.g., the discussion of purchases of promissory notes, bills of exchange, and certificates of deposit at a premium beginning in 1853 in Humphreyville Copper Co. v. Sterling, 12 F.Cas. 881 (N.D. Ohio 1859).

18 Section 125 of the 1939 code, added by section 126(b) of Revenue Act of 1942.

19 Cited in Rev. Rul. 60-17, 1960-1 C.B. 124.

20 Section 113(a) and (b) of the 1939 code. Note that Congress did not adopt or reference prior financial accounting rules regarding the definition or measurement of bond premium.

21 Commissioner v. Korell, 339 U.S. 619 (1950).

22 Id. at 625.

23 Section 125(b)(1), amended by section 217(a) of the Revenue Act of 1950.

24 See Korell, 339 U.S. at 626, n.9:

    Petitioner cites H.R. Rep. No. 2333, 77th Cong., 2d Sess., 47 (1942), and the statements of John O’Brien, 1 Hearings before Senate Committee on Finance on H.R. 7378, 77th Cong., 2d Sess., 52 (1942), and Randolph Paul, 1 Hearings before House Committee on Ways and Means on Revenue Revision of 1942, 77th Cong., 2d Sess., 90 (1942). None of these can be taken as a clear statement excluding premium reflecting financial inducements other than the interest rate.

25 H. Rep. No. 77-2333 (1942).26 Hearings before the Senate Finance Committee on H.R. 7378, 77th Cong., 2d Sess., vol. 1, at 53 (1942).

27 The market discount rules were enacted under section 41 of the Deficit Reduction Act of 1984.

28 Section 1278(a)(2)(B) of the 1954 code provided the following special definition of market discount for debt instruments issued with OID: “in the case of any bond having original issue discount, for purposes of subparagraph (A), the stated redemption price of such bond at maturity shall be treated as equal to its revised issue price.”

29 “If the market discount is less than -1/4 of 1 percent of the stated redemption price of the bond at maturity multiplied by the number of complete years to maturity (after the taxpayer acquired the bond), then the market discount shall be considered to be zero.” Section 1278(a)(2)(C) of the 1954 code.

30 See, e.g., the definition of market discount in H. Rep. No. 98-432 (1984).

31 Section 1803(a)(11)(A) of TRA 1986.

32 The addition of section 171(b)(4), modifying the definition of bond premium (effective for exchanges after May 6, 1986), was set forth in section 1803(a)(12)(A) of TRA 1986, and the addition of section 1278(a)(1)(C)(iii) and (iv) concerning the definition of market discount was set forth in section 1803(a)(6).

33 See, e.g., the TRA 1986 blue book discussion of the market discount definition change:

      Under the Act, two statutory exceptions are provided. The first exception relates to bonds that are part of an issue that is publicly offered. Because the Act provides that the issue price of publicly offered bonds (other than bonds issued for property) is the price at which a substantial amount of the bonds are sold, the OID provisions are inapplicable to a portion of the OID with respect to bonds acquired on original issue by large investors at “wholesale” prices (at deeper discounts than those available to “retail” customers). Under the Act, market discount is created on original issuance of a bond if the holder has a cost basis determined under section 1012, and such basis is less than the issue price of the bond. The difference between the holder’s issue price and basis is treated as market discount.

The second statutory exception applies to a bond that is issued in exchange for a market discount bond pursuant to a plan of reorganization. This exception is intended to prevent the holder of a market discount bond from eliminating the taint of unaccrued market discount by swapping the bond for a new bond (e.g., in a recapitalization). Solely for purposes of the interest characterization rule, however, this exception is inapplicable to a bond issued in exchange for a pre-enactment market discount bond where term and interest rate of the new bond is identical to that of the old bond.
Joint Committee on Taxation, “Explanation of Technical Corrections to the Tax Reform Act of 1984 and other Recent Tax Legislation” (May 13, 1987).See also David C. Garlock, Federal Income Taxation of Debt Instruments, section 1208: “Although the legislative history does not explain the purpose for this rule, it apparently was designed to prevent taxpayers from converting capital losses on depreciated property into amortizable premium through a tax-free exchange of that asset for property including (or consisting solely of) a bond.”

34 The concept of an exchange, like a sale, in the law generally envisions two different entities (two persons, a person and her corporation, a person and herself as trustee, etc.) exchanging property or engaging in a bargain and sale at arm’s length. Intrataxpayer transactions are generally ignored for tax purposes: “Generally speaking, the language in the Revenue Act [of 1934], just as in any statute, is to be given its ordinary meaning, and the words ‘sale’ and ‘exchange’ are not to be read any differently.” Helvering v. Flaccus Oak Leather Co., 313 U.S. 247, 249 (1941). In a wash sale, there are two sales in the marketplace between the buyer and seller, not an exchange of one security for a substantially identical security, any more than selling one’s old car and buying a new one is an exchange of cars in a legal sense.

35 Garlock, supra note 33, at section 1208.

36 Section 43(a)(1) of the Deficit Reduction Act of 1984 added definitions for substituted basis property, transferred basis property, and exchanged basis property — section 7701(a)(42), (43), and (45), respectively. Substituted basis property is defined as both transferred basis and exchanged basis property. Transferred basis property refers to basis “determined in whole or in part by reference to the basis in the hands of the donor, grantor, or other transferor.” Exchanged basis property refers to basis “determined in whole or in part by reference to other property held at any time by the person for whom the basis is to be determined.” Despite a seemingly broad definition, exchanged basis does not seem to include the fundamentally different concept of sale, which is an arm’s-length market transaction. The JCT explanation of the 1984 act, in discussing the carryover of market discount on exchanged basis property, states: “The amount of accrued market discount with respect to ‘exchanged basis property’ (property received by a taxpayer in a nonrecognition transaction the basis of which is determined in whole or in part by reference to the basis of property that was transferred by the taxpayer in the transaction) includes any accrued market discount to the extent such amount was not previously treated as interest income under the provisions of the Act. For example, on the disposition of stock received upon the conversion of a convertible bond or in a recapitalization in which a bond was exchanged for stock, gain is treated as interest income to the extent of the amount of accrued market discount as of the date of conversion.” JCT, “General Explanation of the Revenue Provisions of the Deficit Reduction Act of 1984” (Dec. 31, 1984). See generally Basis Variations, section I(A)(2), BNA Tax Management Portfolio 560-3d.

37 T.D. 8746 98 TNT 10-65: IRS Final Regulations (RTD).

38 Id. The preamble to the final bond premium regulation provides the following explanation concerning the definition of bond premium:

      Under the proposed regulations, bond premium is defined as the excess of a holder’s basis in a bond over the sum of the remaining amounts payable on the bond other than payments of qualified stated interest. The holder generally determines the amount of bond premium as of the date the holder acquires the bond.

The proposed regulations provide special rules that limit a holder’s basis solely for purposes of determining bond premium. For example, if a bond is convertible into stock of the issuer at the holder’s option, for purposes of determining bond premium, the holder must reduce its basis in the bond by the value of the conversion option. This reduction prevents the holder from inappropriately amortizing the cost of the embedded conversion option.
The final regulations adopt the rules of the proposed regulations for determining the amount of bond premium, if any, on a bond. However, in response to comments, they clarify the determination of basis in the case of a convertible bond acquired in a transferred basis transaction.39 Reg. section 1.171-1(d)(1).

40 Reg. section 1.171-1(e)(1)(ii). There is a special rule in reg. section 1.171-1(e)(1)(iii)(B) for exchanges involving convertible bonds.

41 Reg. section 1.171-1(f), Example 1.

42 T.D. 8746. The preamble states:

      Sections 1.171-1 through 1.171-4 of the Income Tax Regulations were promulgated in 1957 and last amended in 1968. In the Tax Reform Act of 1986, section 171(b) was amended to require that bond premium be amortized by reference to a constant yield. In the Technical and Miscellaneous Revenue Act of 1988, section 171(e) was amended to require that amortizable bond premium be treated as an offset to interest income.

On June 27, 1996, the IRS published a notice of proposed rulemaking in the Federal Register (61 FR 33396) relating to the federal income tax treatment of bond premium and bond issuance premium. A public hearing was not held because no one requested to speak at the hearing that had been scheduled for October 23, 1996. The IRS did receive a few comments on the proposed regulations. The proposed regulations, with certain changes to respond to the comments, are adopted as final regulations.
43 Of course, the rules must be followed regardless of whether they are sensible.44 Section 1091(a).

45 See supra note 8.

46 The identical bond is a post-wash-sale replacement security.

47 This is consistent with the legislative substitution theory of the rule as discussed in note 8, supra. Another potential concern with existing law is that the addition of wash sale basis adjustments can not only increase the amount of acquisition premium or reduce the amount of market discount, but also transform a bond that is putatively acquired at a discount into a bond that is treated as acquired with bond premium (crossing over). A detailed discussion of crossing over is intentionally omitted. However, existing law supports this result.

48 See reg. section 1.171-3(c)(4)(ii)(A) and compare the rule for taxable and tax-exempt bonds. Similarly, failing to take into account a wash sale basis adjustment on a tax-exempt bond issued with OID could result in a basis in excess of the bond’s stated redemption price at maturity if the amount of acquisition premium does not reflect the basis adjustment. Congressional concern regarding the taking of losses of tax-exempt bonds was also addressed in the enactment of section 1288 of the 1954 code as part of the Deficit Reduction Act of 1984. In discussing the reason for the change from prior law, the relevant House report provides:

    Recently, there has been a significant increase in the issuance of zero coupon tax-exempt bonds. The Committee is concerned that taxpayers may acquire these obligations to generate tax losses to shelter income. Although it appears to be the position of the Internal Revenue Service that no loss is allowable based on the linear accrual of tax-exempt OID, some taxpayers have claimed that such losses are allowable. The committee believes that OID on zero coupon municipal bonds should be accrued in the same manner as that provided for OID on obligations issued by corporations and other juridical entities. The committee intends no inference regarding the proper treatment of obligations acquired before the effective date of the bill. Discussion of OID on tax-exempt bonds, new Sec. 1288 in House Ways and Means Committee report on Tax Reform Bill of 1984, House Rept. 98-432 (March 5, 1984).

49 The same is true for acquisition premium based on the definition in reg. section 1.1272-2.50 It could be argued that taking into account the wash sale rules in determining the amount of bond premium, acquisition premium, and market discount is unreasonable. However, federal income tax law generally is based on the letter of the law and regulations. This principle is so firm that even statements in IRS publications are not law and have no legal authority. The intent of tax law provisions and assessments of their reasonableness are relevant only in limited circumstances. In fact, arguments of reasonableness or unreasonableness of law or regulation generally carry little weight. See, e.g., the discussion in Chevron U.S.A. Inc. v. Natural Resources Defense Council Inc., 467 U.S. 837, 842-843 (1984):

    When a court reviews an agency’s construction of the statute which it administers, it is confronted with two questions. First, always, is the question whether Congress has directly spoken to the precise question at issue. If the intent of Congress is clear, that is the end of the matter; for the court, as well as the agency, must give effect to the unambiguously expressed intent of Congress. If, however, the court determines Congress has not directly addressed the precise question at issue, the court does not simply impose its own construction on the statute, as would be necessary in the absence of an administrative interpretation. Rather, if the statute is silent or ambiguous with respect to the specific issue, the question for the court is whether the agency’s answer is based on a permissible construction of the statute.

It could also be argued that the computation of yield, as well as the determination of the amount of bond premium, OID, and market discount should follow financial market and financial accounting methods rather than a different set of tax rules. That argument should be categorically rejected. First, on examination of the tax rules for bond premium, OID, or market discount, one quickly discovers that these guidelines are complex, clearly spelled out statutory rules and regulations. On closer inspection, these tax rules differ in many key details from related financial market and accounting methods for bond premium, OID, and market discount (for example, financial analysts do not generally distinguish between OID and market discount from the perspective of investors in debt instruments). Second, generally, federal income tax rules are different because the goals and objectives of tax accounting methods are fundamentally different from the goals and objectives of financial market practices and financial accounting principles. For an unequivocal statement by the Supreme Court on this, look no further than Thor Power Tool v. Commissioner, 439 U.S. 522 (1979). Thor Power Tool is the landmark case that rejected the use of financial accounting inventory write-downs for tax purposes and specifically rejected the general acceptability of financial accounting principles for federal income tax purposes.51 As part of section 413 of TRA 1969.

52 There is a detailed discussion in H. Rep. No. 91-413, pt. 2 (1969), that also includes discussion of the special definition of purchase with reference to basis and the special rule if basis is determined by reference to the person from whom acquired. However, it does not provide any additional insight.

53 LR-189-84 (regulations proposed Apr. 8, 1986).

54 Id. As set forth in reg. section 1272-1(g)(2)(ii):

      The ratable amount of acquisition premium is equal to —
        A. The excess (if any) of the purchase price over the revised issue price on the date of purchase, divided by

B. The number of days beginning on the date of purchase and ending on the day before the stated maturity date.

55 See introductory language of section 41(a) of the Deficit Reduction Act of 1984.56 And section 1272(b)(4)(B)(i) of the 1954 code for corporate debt instruments issued before July 2, 1982. The 1982 amendments to the OID rules that resulted in the demarcation between pre- and post-July 2, 1982, debt, although generally significant, are irrelevant here.

57 The JCT explanation stated that under prior law, the definition of purchase excluded “the acquisition of a bond the basis of which is determined by reference to the basis of the bond in the hands of the transferor or under section 1014(a) (relating to property acquired from a decedent).” The reason for the 1984 change was the 1982 revision of the OID rules, which “presented a number of technical issues that required legislative solutions.” The revision removed the exclusion so that “the acquisition of a bond from a decedent is treated as a purchase for purposes of the OID provisions, including the rules applicable to stripped bonds and stripped coupons.” JCT, “General Explanation of the Revenue Provisions of the Deficit Reduction Act of 1984” (Dec. 31, 1984).

58 See Garlock, supra note 33, at section 511.01: “Thus, the acquisition premium rules apply to tax-free exchanges of debt instruments, acquisitions by gift or bequest, distributions from partnerships and corporations, etc.”

59 FI-189-84, 57 F.R. 60750 (Dec. 22, 1992 94 TNT 19-6: IRS Final Regulations (RTD)).

60 1992 prop. reg. section 1.1272-2(b)(3).

61 T.D. 8517 at reg. section 1.1272-2(b)(3):

      A debt instrument is purchased at an acquisition premium if its adjusted basis, immediately after its purchase (including a purchase at original issue), is —
        (i) Less than or equal to the sum of all amounts payable on the instrument after the purchase date other than payments of qualified stated interest (as defined in section 1.1273-1(c)); and

(ii) Greater than the instrument’s adjusted issue price (as defined in section 1.1275-1(b)).

62 The 1994 final OID regulations slightly modified this exception:

      (i) Debt instruments acquired in exchange for other property. —
      For purposes of section 1272(a)(7), section 1272(c)(1), and this section, if a debt instrument is acquired in an exchange for other property (other than in a reorganization defined in section 368) and the basis of the debt instrument is determined, in whole or in part, by reference to the basis of the other property, the basis of the debt instrument may not exceed its fair market value immediately after the exchange. For example, if a debt instrument is distributed by a partnership to a partner in a liquidating distribution and the partner’s basis in the debt instrument would otherwise be determined under section 732, the partner’s basis in the debt instrument may not exceed its fair market value for purposes of this section.

Reg. section 1.1272-2(b)(6)(i).63 Preamble, T.D. 8517.

64 Reg. section 1.1272-2(b)(6)(ii).

END OF FOOTNOTES


IRS LTR: IRS Rules on Treatment of Matching Gifts to Charities.

The IRS ruled that matching gifts a foundation makes to public charities will not constitute self-dealing, will be qualifying distributions within the meaning of section 4942(g), and will not be taxable expenditures under section 4945(d).

Contact Person: * * *
Identification Number: * * *
Telephone Number: * * *

UIL Number: 4941.00-00, 4942.03-05, 4945.00-00
Release Date: 4/25/2014

Date: January 30, 2014Employer Identification Number: * * *

LEGEND:

Company = * * *
W = * * *
X = * * *
Y = * * *
Z = * * *
StateA = * * *

Dear * * *:We have considered your ruling request dated November 8, 2013, submitted by your authorized representative, requesting rulings under I.R.C. §§ 4941, 4942 and 4945.

FACTS

You are an organization exempt from taxation under § 501(c)(3) and classified as a private foundation under § 509(a). Company is your sole contributor and you and Company share the same officers and directors.As part of its charitable undertakings, Company had established a matching gifts program under which it matched employees’ and Company board of director members’ contributions in cash and securities to public charities. All full time employees of Company who were on the active payroll were eligible for the company match program. Employees who give monetary contributions to certain charitable organizations have their gifts matched. The limit of the match varies depending on the employees’ positions. The amount that was matched must have been at least $W and non-executive employees have their gifts matched up to $X; executive employees have their gifts matched up to $Y; and directors have their gifts matched up to $Z.

Pursuant to written policies that you submitted as part of this ruling request, an employee’s contribution must meet certain criteria to be eligible for a match payment. The contribution must go to “an organization that is recognized by the Internal Revenue Service as tax exempt, . . . [is] designated a public charity under Section 501(c)(3) of the Internal Revenue Code,” and is not a supporting organization under § 509(a)(3). Therefore, the donee organization could not be a private foundation. Further, a contribution where the employee receives anything in return is not eligible for the match. For example tuition payments, insurance premiums, and membership dues paid by employees to § 501(c)(3) organizations are not eligible. A contribution that an employee is legally required to pay is not eligible. A gift that is used for religious or political purposes is not eligible. Finally, a non-cash gift is not eligible for the match. A Company employee who seeks to have his or her donation matched must submit information about the donation and the recipient charitable organization to Company. Company then uses a third party vendor to verify eligibility. Once verified, the charity receives payment.

Company’s employees are informed of these policies through e-mail and Company’s human resources website. These policies also state that Company in its sole discretion may refuse to match an employee’s gift and may modify or end the gift matching program at any time.

A few months before you submitted your ruling request, Company altered a significant component of its employee gift matching program. Prior to this change, Company paid the matches of employee donations to recipient organizations. However, in all but one state, Company has ceased making these payments. Instead, you have assumed the role of payor in Company’s gift matching program (“foundation match program”), and you now pay the matches to recipient organizations. You stated that, under the foundation match program additional restrictions were imposed by you:

  • The charitable organizations eligible for matching gifts are limited to public charities classified as exempt under § 509(a)(1) or (2). You do not pay organizations classified as private foundations. You do not match any gifts made by participants in the Company match pogrom prior to the termination of the Company match program.
  • You do not match any legal obligation of a participant in the foundation match program, and the participant is required to certify that the participant has no legal obligation to make the contribution.
  • You do not match contributions made to any organization which you control or which is controlled by one or more disqualified persons within the meaning of § 4946.
  • Gifts are made to match the fair market cash value of contributions of securities.

The one state where Company did not change its gift matching policy for employees is StateA. Company maintained its policy there because of a prior agreement with a state agency. This state agency gave Company approval for a corporate acquisition on the condition that Company continue to make charitable contributions to organizations within StateA for a number of years following the transaction. As such, Company continues to be the payor of the gift match payments in StateA.

RULINGS REQUESTED

You requested the following rulings:

      1. That matching gifts made by you under the foundation match program do not constitute self-dealing within the meaning of § 4941.

2. That the matching gifts made under the foundation match program will be “qualifying distributions” within the meaning of § 4942(g).

3. That the matching gifts made under the foundation match program will not be “taxable expenditures” within the meaning of § 4945(d).

LAW

I.R.C. § 170(c)(2)(B) provides the term “charitable contribution” means a contribution or gift to or for the use of a corporation, trust, or community chest, fund, or foundation organized and operated exclusively for religious, charitable, scientific, literary, or educational purposes, or to foster national or international amateur sports competition (but only if no part of its activities involve the provision of athletic facilities or equipment), or for the prevention of cruelty to children or animals.I.R.C. § 501(c)(3) exempts from federal income taxation corporations, and any community chest, fund, or foundation, organized and operated exclusively for religious, charitable, scientific, testing for public safety, literary, or educational purposes, or to foster national or international amateur sports competition (but only if no part of its activities involve the provision of athletic facilities or equipment), or for the prevention of cruelty to children or animals.

I.R.C. § 507(d)(2)(A) defines a substantial contributor as any person who contributed or bequeathed an aggregated amount of more than $5,000 to a private foundation, if such amount is more than 2 percent of the total contributions and bequests received by the foundation before the close of the taxable year of the foundation in which the contribution or bequest is received by the foundation from such person.

I.R.C. § 4941 imposes an excise tax on private foundations and foundation managers for each act of self-dealing and between a private foundation and a disqualified person.

I.R.C. § 4941(d)(1) defines self-dealing to include the furnishing of goods, services, or facilities between a disqualified person and a private foundation, the payment of compensation by a private foundation to a disqualified person, or use of the private foundation’s assets, by or for the benefit of a disqualified person.

I.R.C. § 4942(a) imposes a tax on undistributed income of a private foundation for any taxable year, which has not been distributed by the first day of the second taxable year following such taxable year.

I.R.C. § 4942(g)(1) defines “qualifying distribution” as (A) any amount paid to accomplish one or more purposes described in § 170(c)(2)(B), other than any contribution to (i) an organization controlled by the foundation or one or more disqualified persons, or (ii) a private foundation which is not an operating foundation, except as otherwise provided; (B) any amount paid to acquire an asset used directly in carrying out one or more purposes described in § 170(c)(2)(B).

I.R.C. § 4945(a) imposes a twenty percent tax on each taxable expenditure of a private foundation.

I.R.C. § 4945(d) defines taxable expenditure as any amount paid or incurred by a private foundation as a grant to an organization unless the expenditure meets certain criteria unless the private foundation exercises expenditure responsibility with respect to such grant in accordance with § 4945(h) or an amount paid for any purpose other than one specified in § 170(c)(2)(B).

I.R.C. § 4946(a)(1) provides, in part, that the term ‘disqualified person’ means, with respect to a private foundation, a person who is —

      (A) a substantial contributor to the foundation,

(B) a foundation manager,

(C) an owner of more than 20 percent of —

        (i) the total combined voting power of a corporation,

(ii) the profits interest of a partnership, or

(iii) the beneficial interest of a trust or unincorporated enterprise, which is a substantial contributor to the foundation,

      (D) a member of the family of any individual described in subparagraph (A), (B), or (C),

(E) a corporation of which persons described in subparagraph (A), (B), (C), or (D) own more than 35 percent of the total combined voting power,

(F) a partnership in which persons described in subparagraph (A), (B), (C), or (D) own more than 35 percent of the profits interest,

(G) a trust or estate in which persons described in subparagraph (A), (B), (C), or (D) hold more than 35 percent of the beneficial interest, and
Treas. Reg. § 53.4941(d)-2(f)(2) provides that the fact that a disqualified person receives an incidental or tenuous benefit from the use by a foundation of its income or assets will not, by itself, make such use an act of self-dealing. Thus, the public recognition a person may receive, arising from the charitable activities of a private foundation to which such person is a substantial contributor, does not in itself result in an act of self-dealing since generally the benefit is incidental and tenuous. For example, a grant by a private foundation to a § 509(a)(1), (2), or (3) organization will not be an act of self-dealing merely because one of the § 509(a)(1), (2), or (3) organization’s officers, directors, or trustees is also a manager of or a substantial contributor to the foundation.Treas. Reg. § 53.4941(d)-2(f)(9) Example 2 gives the following situation. Private foundation X established a program to award scholarship grants to the children of employees of corporation M, a substantial contributor to X. After disclosure of the method of carrying out such program, X received a determination letter from the Internal Revenue Service stating that X is exempt under § 501(c)(3), that contributions to X are deductible under § 170, and that X’s scholarship program qualifies under § 4945(g)(1). A scholarship grant to a person not a disqualified person with respect to X paid or incurred by X in accordance with such program shall not be an indirect act of self-dealing between X and M.

Treas. Reg. § 53.4942(a)-3(a)(2) defines the term “qualifying distribution,” in relevant part, to mean any amount (including program related investments and reasonable and necessary administrative expenses) paid to accomplish one or more purposes described in § 170(c)(1) or (2)(B), other than any contribution to a private foundation which is not an operating foundation or to an organization controlled (directly or indirectly) by the contributing private foundation or one or more disqualified persons with respect to such foundation.

Treas. Reg. § 53.4945-5(a)(1) provides that the term “taxable expenditure” includes any amount paid or incurred by a private foundation as a grant to an organization (other than an organization described in § 509(a)(1), (2), or (3)), unless the private foundation exercises expenditure responsibility with respect to such grant.

Rev. Rul. 73-407, 1973-2 C.B. 383, holds that a contribution by a private foundation to a public charity made on the condition that the public charity change its name to that of the foundation’s substantial contributor for at least 100 years does not constitute an act of self-dealing.

Rev. Rul. 77-160, 1977-1 C.B. 351, concerned the issue of whether payment by a private foundation of a disqualified person’s membership church dues constituted an act of self-dealing within the meaning of § 4941(d)(1)(E). The Revenue Ruling found that the payment was not an incidental or tenuous benefit within the meaning of § 53.4941(d)-2(f)(2). The foundation’s payment resulted in a direct economic benefit to the disqualified person. The payment of the membership fee by the foundation was a substitute for an obligation of the disqualified person. As a result of the payment, the disqualified person was entitled to hold office, vote in congregational meetings to elect officers and conduct other business, and otherwise participate in the religious activities of the congregation. Accordingly, the payment of membership dues by the private foundation on behalf of the disqualified person was an act of self-dealing under § 4941(d)(1)(E).

Rev. Rul. 80-310, 1980-2 CB 319, held that the grants of a private foundation to an educational institution for engineering instruction were not an act of self-dealing, even though a corporation, a disqualified person, intended to hire graduates of the engineering program and encourage its employees to participate in the program. The Revenue Ruling stated that because the corporation would compete on an equal basis for program graduates and admission of its own employees to the program, it would receive only an incidental or tenuous benefit.

Rev. Rul. 85-162, 1985-2 C.B. 275, found no self-dealing where a private foundation, with a disqualified person of a bank, made loans to publicly supported organizations for construction projects in disadvantaged areas where the contractors doing the construction might have been ordinary customers of the bank. Any benefit to the bank from the fact that the loan proceeds were paid by the public charities to the contractors who are ordinary customers of the bank was incidental or tenuous.

ANALYSIS

Ruling 1Section 4941(a) imposes an excise tax on each act of self-dealing between a disqualified person and a private foundation. Under § 4946(a)(1)(A), a disqualified person for the purpose of § 4941 means, with respect to a private foundation, a person who is a substantial contributor to the foundation, a foundation manager, an owner of more than 20 percent of (i) the total combined voting power of a corporation which is a substantial contributor to the foundation; a member of the family of any individual described in above, a corporation in which persons described in above or own more than 35 percent of the total combined voting power. Section 507(d)(2)(A) defines a substantial contributor as any person who contributed or bequeathed an aggregated amount of more than $5,000 to a private foundation, if such amount is more than two percent of the total contributions and bequests received by the foundation before the close of the taxable year of the foundation in which the contribution or bequest is received by the foundation from such person. Here Company is your substantial contributor, and you and Company share the same officers and directors.

Section 4941(d)(1)(E) defines self-dealing as any direct or indirect transfer to, or use by or for the benefit of, a “disqualified person” of the income or assets of the private foundation. You have agreed to take over payment ofCompany’s employee gift matching program. Company has a policy whereby employees are informed that certain charitable gifts that they make will be matched, and you then tender the matching payment. If this agreement entails the exchange of money, merchandise or services between you and Company or the use of your assets to benefit company more than incidentally, then it violates the self-dealing prohibition. You have submitted a number of assurances in your ruling request including a representation that you will not match any gifts made by participants in the Company match program prior to the termination of the Company match program and that you are not taking on any obligation of Company or relieving Company of any financial burden. As such, the foundation match program does not involve any exchange of money, merchandise, or services between you and Company.

Nonetheless, Company derives some benefit from your payments from the good will created by this foundation match program. However, this good will is merely incidental benefit for Company. Section 53.4941(d)-2(f)(2) states a private foundation’s use of assets that results in incidental benefit to a disqualified person is not by itself an act of self-dealing. The benefits of increased loyalty and morale for a business have been found to be incidental and tenuous. Example 2 of § 53.4941(d)-2(f)(9) provides a situation where a private foundation’s action, a scholarship program for children of employees of a disqualified person, likely results in increased employee loyalty and good will for the disqualified person. Nonetheless, the situation is not self-dealing. Similarly, the possibilities of an improved workforce or increased customer loyalty were found to be incidental benefits in Rev. Rul. 80-310 (providing that advantages gained by a local employer from the creation of a new education program were incidental and did not create self-dealing) and Rev. Rul. 85-162 (finding that a private foundation’s funding of construction projects resulted in only incidental benefit to a bank, even though the projects might have employed the bank’s customers).

Company is similar to the disqualified person in Rev. Rul. 73-407 who received only incidental benefit from a private foundation’s directive for a public charity to adopt the disqualified person’s name. The disqualified person derived good will from the charity’s name change, but nonetheless the private foundation’s payment was not an act of self-dealing. Further, unlike the disqualified person in Rev. Rul. 77-160 (finding more than incidental benefit when a private foundation paid a disqualified person’s church membership dues and as a result the disqualified gained the right to be an active participant in the church), Company does not receive any tangible right or privilege from your payments. Thus, Company’s receipt of good will does not render your foundation match program payments as acts of self-dealing. Since your gifts under the foundation match program benefit Company only incidentally between you and Company, they are not acts of self-dealing.

Ruling 2

Your payments under Company’s foundation match program are qualifying distributions. Under § 4942(g)(1), the definition of “qualifying distribution” includes any amount paid to accomplish one or more purposes described in § 170(c)(2)(B). Under § 53.4942(a)-3(a)(2) the term “qualifying distribution” does not include a contribution to a private foundation. You have represented that you will make payments only to organizations that have been recognized by the IRS as public charities under §§ 509(a)(1) or (2). With these safeguards, you are ensuring that your payments under the foundation match program are qualifying distributions.

Ruling 3

Under § 53.4945-5(a)(1), a private foundation’s taxable expenditures include amounts to an organization, other than an organization described in § 509(a)(1), (2), or (3), unless the private foundation exercises expenditure responsibility with respect to such grant. Since you have represented that you will give money in the foundation match program solely to organizations that are classified by the IRS as public charities under §§ 509(a)(1) or (2), then your payment will not constitute a taxable expenditure.

RULINGS
      1. Matching gifts made by you under the foundation match program to qualified public charities do not constitute self-dealing within the meaning of § 4941.

2. The matching gifts made under the foundation match program will be “qualifying distributions” within the meaning of § 4942(g).

3. The matching gifts made under the foundation match program will not be “taxable expenditures” within the meaning of § 4945(d).
This ruling will be made available for public inspection under I.R.C. § 6110 after certain deletions of identifying information are made. For details, see enclosed Notice 437, Notice of Intention to Disclose. A copy of this ruling with deletions that we intend to make available for public inspection is attached to Notice 437. If you disagree with our proposed deletions, you should follow the instructions in Notice 437.This ruling is directed only to the organization that requested it. I.R.C. § 6110(k)(3) provides that it may not be used or cited by others as precedent.

This ruling is based on the facts as they were presented and on the understanding that there will be no material changes in these facts. This ruling does not address the applicability of any section of the Code or regulations to the facts submitted other than with respect to the sections described. Because it could help resolve questions concerning your federal income tax status, this ruling should be kept in your permanent records.

If you have any questions about this ruling, please contact the person whose name and telephone number are shown in the heading of this letter.

In accordance with the Power of Attorney currently on file with the Internal Revenue Service, we are sending a copy of this letter to your authorized representative.

                  Sincerely,
                  Ronald Shoemaker
                  Manager, Exempt Organizations
                  Technical Group 2

Enclosure
Notice 437

JANUARY 30, 2014

Citations: LTR 201417022



IRS LTR: Charity's Status Not Affected by Operating Program Abroad.

The IRS ruled that an organization’s tax-exempt status and its classification as a public charity will not be affected when it operates an educational program in foreign countries and that amounts it receives from the program’s manager, a nonprofit controlled by a for-profit company, will not constitute unrelated business taxable income.

Contact Person: * * *

Identification Number: * * *
Telephone Number: * * *

UIL: 501.03-00, 501.03-08, 170.07-02, 509.02-00, 513.00-00
Release Date: 4/25/2014

Date: January 31, 2014Employer Identification Number: * * *

LEGEND:

Company = * * *
Country = * * *
University = * * *
Program1 = * * *
Program2 = * * *
Foundation = * * *
X = * * *

Dear * * *:This is in response to your letter in which you requested certain rulings with respect to §§ 501(c)(3), 170(b)(1)(A)(ii), and 511

BACKGROUND

You are an organization described in § 501(c)(3) and classified as a public charity under §§ 509(a)(1) and 170(b)(1)(A)(ii). You were originally founded by Company, a for-profit company founded in Country, but Company no longer maintains control over you, though its employees do constitute a minority of your board. Your mission is “to contribute to human and economic development by educating and training individuals to be effective knowledge-based leaders in an increasingly interdependent global economy.”In addition to your programming in conjunction with University, one of two primary programs you offer, you also offer independent classes and seminars open to the general public or to organizational clients seeking programs for its employees. Your other primary program is Program1, a three month global business curriculum delivered at your facilities. You are responsible for the admission policy, candidate selection, and tuition collection as well as choosing the instructors and curriculum for the program.

You are now hoping to alter the structure of Program1 such that it will now be Program2. Program2 will be a three-plus month, multi-network program that will be delivered twice a year on campuses in four countries. Program2 will be headquartered and managed by Foundation, a foreign non-profit organization that is controlled by Company.Foundation‘s employees will be mostly employees seconded from Company. Students in Program2 will spend six weeks of the program at your facilities where you will be responsible for the curriculum, the professors, the materials for each course, and the grading of the students for the portion of the overall program that is conducted by you. For these activities Foundation will pay you $x per student that is enrolled in the program. The admission criteria, student selection, and tuition collection will all be handled by Foundation.

RULINGS REQUESTED
      1. Following the operational modifications outlined above, you will continue to be exempt from taxation under § 501(c)(3).

2. Following the operational modifications outlined above, you will continue to qualify as an educational organization under § 170(b)(1)(A)(ii) and therefore a public charity under § 509(a)(1).

3. Following the operational modifications outlined above, amounts received by you from Foundation in connection with Program2 will not constitute unrelated business taxable income under § 511.

LAW

I.R.C. § 170(b)(1)(A)(ii) describes an educational organization that normally maintains a regular faculty and curriculum and normally has a regularly enrolled body of pupils or students in attendance at the place where its educational activities are regularly carried on.I.R.C. § 501(c)(3) provides that organizations may be exempted from tax if they are organized and operated exclusively for religious, charitable, scientific, testing for public safety, literary, or educational purposes and “no part of the net earnings of which inures to the benefit of any private shareholder or individual.”

I.R.C. § 509(a)(1) states that an organization described in 501(c)(3) is a private foundation unless it is described in Section 170(b)(1)(A).

I.R.C. § 511 imposes a tax on unrelated business taxable income of every organization described in § 501(c).

I.R.C. § 512 defines unrelated business taxable income as the gross income derived from any unrelated trade or business that is regularly carried on by an organization.

I.R.C. § 513 defines unrelated trade or business as any trade or business the conduct of which is not substantially related (aside from the need for income or funds or the use made of the profits derived) to the exercise or performance by an organization of its charitable, educational, or other purpose or function constituting the basis for its exemption under § 501.

Treas. Reg. § 1.170-2(b)(3)(i) defines educational organization as one “whose primary function is the presentation of formal instruction and which normally maintains a regular faculty and curriculum and normally has a regularly enrolled body of pupils or students in attendance at the place where its educational activities are regularly carried on.”

Treas. Reg. § 1.501(c)(3)-1(c)(1) states an organization will be regarded as operated exclusively for one or more exempt purposes only if it engages primarily in activities which accomplish one or more of such exempt purposes. An organization will not be so regarded if more than an insubstantial part of its activities is not in furtherance of an exempt purpose.

Treas. Reg. § 1.501(c)(3)-1(d)(3) defines educational as the instruction or training of the individual for the purpose of improving or developing his capabilities, and the instruction of the public on subjects useful to the individual and beneficial to the community.

Treas. Reg. § 1.501(c)(3)-1(d)(3)(ii), Example (1) states that an organization such as a primary or secondary school which has a regularly scheduled curriculum, a regular faculty, and a regularly enrolled body of students in attendance at a place where the educational activities are regularly carried on is an educational organization.

Treas. Reg. § 1.513-1(b) provides that for purposes of § 513 the term trade or business has the same meaning it has in § 162, and generally includes any activity carried on for the production of income from the sale of goods or performance of services. Also, producing or distributing goods or performing services from which a particular amount of gross income is derived do not lose identity as trade or business merely because they are carried on within a larger aggregate of similar activities or within a larger complex of other endeavors which may, or may not, be related to the exempt purposes of the organization.

Treas. Reg. § 1.513-1(c) provides that specific business activities of an exempt organization will ordinarily be deemed to be regularly carried on if they manifest a frequency and continuity, and are pursued in a manner, generally similar to comparable commercial activities of nonexempt organizations.

Treas. Reg. § 1.513-1(d)(2) provides that a trade or business is “related” in the relevant sense only where the conduct of the business activities has causal relationship to the achievement of exempt purpose, and the relationship to be substantial the performance of the trade or business must contribute importantly to the accomplishment of the organization’s exempt purpose.

Treas. Reg. § 1.513-1(d)(3) provides that in determining whether an activity contributes importantly to the accomplishment of an exempt purpose, the size and extent of the activities involved must be considered in relation to the nature and extent of the exempt function which the organization purports to serve.

Revenue Ruling 73-434, 1973-2 C.B. 71, describes an organization whose only activity was the conducting of courses designed to teach young people how to survive in a natural environment. The courses are conducted on an island and most of the classes are conducted out-of-doors rather than in classrooms. A regularly enrolled student body attends the courses. The organization conducts 12 courses a year and each class term lasts for a period of 26 days. The organization has a faculty of full-time instructors who present a course of instruction in survival skills through lectures, demonstrations, and various practical exercises. Instruction is given in such subjects as water survival, seamanship, first aid, fire fighting, climbing, and rescue operations. The organization’s income is from contributions and tuition payments and its expenditures are for the operation of the school. The ruling concludes that this organization is an educational organization described in § 170(b)(1)(A)(ii).

ANALYSIS

RULINGS 1 AND 2In order to be operated for an exempt purpose you must not have as part of your operations a substantial non-exempt purpose. Section 1.501(c)(3)-1(c)(1). Your primary purpose is educational. Education is an exempt purpose and is defined in the Internal Revenue Code as the instruction or training of individuals for the purpose of improving or developing an individual’s capabilities. Section 1.501(c)(3)-1(d)(3). Additionally, the examples in the regulations provide that an educational organization is an organization similar to a primary or secondary school, a college, or a professional or trade school, which has a regularly scheduled curriculum, a regular faculty, and a regularly enrolled body of students in attendance at a place where the educational activities are regularly carried on. Section 1.501(c)(3)-1(d)(3)(ii), Example (1). Your new program, Program2, anticipates continuing your mission for global learning in order to create “knowledge-based” leaders. The program will consist of traditional in-person classes where one of your instructors will teach a curriculum determined by you in order to advance the student’s leadership and management skills. Program2 furthers your educational purpose.

Program2 does not alter your similarity to the organization described in § 1.501(c)(3)-1(d)(3)(ii). Example (1), in that you will continue to be an organization described in § 170(b)(1)(A)(ii). Section 170(b)(1)(A)(ii) requires that an organization be one where its primary function is the presentation of formal instruction and which normally maintains a regular faculty and curriculum and normally has a regularly enrolled body of pupils or students in attendance at the place where its educational activities are regularly carried on. Section 1.170-2(b)(3)(i). In addition to your other educational programs, Program2 will provide formal courses taking place within a classroom with all participants present in a building rented by you. You are in charge of the curriculum, instructors, and grading for the portion ofProgram2 that will occur at your facilities. Additionally, the instructors for your courses are your employees. Also, admission to the program will be open to the general public and students will enroll for the entire program requiring attendance at each session. The fact that the students only participate in your section of the program for six weeks and complete the entire program over four countries does not remove you from being described in § 170(b)(1)(A)(ii). Rev. Rul. 73-434, supra. With the addition of Program2 you will continue to be described within § 170(b)(1)(A)(ii).

RULING 3

Section 512 provides that unrelated taxable income is the gross income from an unrelated trade or business as defined in § 513. Section 513 provides that an unrelated trade or business is any trade or business that is actively carried on and is not substantially related to the exempt purpose of the organization. The regulations under § 513 provide that a trade or business is an activity that is carried on for the production of income and which otherwise possesses the characteristics required to be a “trade or business” under § 162. Section 1.513-1(b). A trade or business does not lose its character as such even if it is an aggregate of some larger activity. Id. A trade or business will be considered to be regularly carried on if it manifests a frequency and continuity, and is pursued in a manner similar to comparable commercial activities of non-exempt organizations. Section 1.513-1(c). Finally, a trade or business will be considered to be substantially related only where the conduct of the business activities has a causal relationship to the achievement of exempt purpose, and for the relationship to be substantial the performance of the trade or business must contribute importantly to the accomplishment of the organization’s exempt purpose. Section 1.513-1(d)(2).

Program2 will be conducted as a portion of a larger program conducted by Foundation. In return for the portion of the program under your control you will be compensated by Foundation per each student that is enrolled in the program. Even if we consider your program to be a regularly carried-on trade or business within the meaning of § 513 you are not conducting an unrelated trade or business since Program2 is substantially related to your educational purpose. Your mission is to provide a global perspective within creating “knowledge-based” leadership. Program2 will further this exempt purpose by providing a traditional educational program with a curriculum designed by you and taught by your instructors. Since Program2 furthers your exempt purpose, the money received in the performance ofProgram2 is not unrelated business taxable income. Sections 1.513-1(d)(2) and (3).

RULING
      1. Following the operational modifications outlined above, you will continue to be exempt from taxation under § 501(c)(3).

2. Following the operational modifications outlined above, you will continue to qualify as an educational organization under § 170(b)(1)(A)(ii) and therefore a public charity under § 509(a)(1).

3. Following the operational modifications outlined above, amounts received by you from Foundation in connection with Program2 will not constitute unrelated business taxable income under § 511.
This ruling will be made available for public inspection under section 6110 of the Code after certain deletions of identifying information are made. For details, see enclosed Notice 437, Notice of Intention to Disclose. A copy of this ruling with deletions that we intend to make available for public inspection is attached to Notice 437. If you disagree with our proposed deletions, you should follow the instructions in Notice 437.This ruling is directed only to the organization that requested it. Section 6110(k)(3) of the Code provides that it may not be used or cited by others as precedent.

This ruling is based on the facts as they were presented and on the understanding that there will be no material changes in these facts. This ruling does not address the applicability of any section of the Code or regulations to the facts submitted other than with respect to the sections described. Specifically, this ruling does not address any private benefit concerns that may be present with your operations. Because it could help resolve questions concerning your federal income tax status, this ruling should be kept in your permanent records.

If you have any questions about this ruling, please contact the person whose name and telephone number are shown in the heading of this letter.

In accordance with the Power of Attorney currently on file with the Internal Revenue Service, we are sending a copy of this letter to your authorized representative.

                  Sincerely,
                  Ronald Shoemaker
                  Manager, Exempt Organizations
                  Technical Group 2

Enclosure
Notice 437

JANUARY 31, 2014

Citations: LTR 201417018



IRS Issues Average Residential Purchase Prices.

The IRS has provided (Rev. Proc. 2014-31) issuers of qualified mortgage bonds and issuers of mortgage credit certificates with nationwide average purchase prices for residences and the average area purchase price safe harbors for residences in statistical areas in each state, the District of Columbia, Puerto Rico, the Northern Mariana Islands, American Samoa, the Virgin Islands, and Guam.According to the revenue procedure, the average nationwide purchase price is $245,500 for new and existing residences.

 

SECTION 1. PURPOSE

This revenue procedure provides issuers of qualified mortgage bonds, as defined in section 143(a) of the Internal Revenue Code, and issuers of mortgage credit certificates, as defined in section 25(c), with (1) the nationwide average purchase price for residences located in the United States, and (2) average area purchase price safe harbors for residences located in statistical areas in each state, the District of Columbia, Puerto Rico, the Northern Mariana Islands, American Samoa, the Virgin Islands, and Guam.

SECTION 2. BACKGROUND

.01 Section 103(a) provides that, except as provided in section 103(b), gross income does not include interest on any state or local bond. Section 103(b)(1) provides that section 103(a) shall not apply to any private activity bond that is not a “qualified bond” within the meaning of section 141. Section 141(e) provides, in part, that the term “qualified bond” means any private activity bond if such bond (1) is a qualified mortgage bond under section 143, (2) meets the volume cap requirements under section 146, and (3) meets the applicable requirements under section 147.

.02 Section 143(a)(1) provides that the term “qualified mortgage bond” means a bond that is issued as part of a qualified mortgage issue. Section 143(a)(2)(A) provides that the term “qualified mortgage issue” means an issue of one or more bonds by a state or political subdivision thereof, but only if: (i) all proceeds of the issue (exclusive of issuance costs and a reasonably required reserve) are to be used to finance owner-occupied residences; (ii) the issue meets the requirements of subsections (c), (d), (e), (f), (g), (h), (i), and (m)(7) of section 143; (iii) the issue does not meet the private business tests of paragraphs (1) and (2) of section 141(b); and (iv) with respect to amounts received more than 10 years after the date of issuance, repayments of $250,000 or more of principal on mortgage financing provided by the issue are used by the close of the first semiannual period beginning after the date the prepayment (or complete repayment) is received to redeem bonds that are part of the issue.

Average Area Purchase Price

.03 Section 143(e)(1) provides that an issue of bonds meets the purchase price requirements of section 143(e) if the acquisition cost of each residence financed by the issue does not exceed 90 percent of the average area purchase price applicable to such residence. Section 143(e)(5) provides that, in the case of a targeted area residence (as defined in section 143(j)), section 143(e)(1) shall be applied by substituting 110 percent for 90 percent.

.04 Section 143(e)(2) provides that the term “average area purchase price” means, with respect to any residence, the average purchase price of single-family residences (in the statistical area in which the residence is located) that were purchased during the most recent 12-month period for which sufficient statistical information is available. Under sections 143(e)(3) and (4), respectively, separate determinations are to be made for new and existing residences, and for two-, three-, and four-family residences.

.05 Section 143(e)(2) provides that the determination of the average area purchase price for a statistical area shall be made as of the date on which the commitment to provide the financing is made or, if earlier, the date of the purchase of the residence.

.06 Section 143(k)(2)(A) provides that the term “statistical area” means (i) a metropolitan statistical area (MSA), and (ii) any county (or the portion thereof) that is not within an MSA. Section 143(k)(2)(C) further provides that if sufficient recent statistical information with respect to a county (or portion thereof) is unavailable, the Secretary may substitute another area for which there is sufficient recent statistical information for such county (or portion thereof). In the case of any portion of a State which is not within a county, section 143(k)(2)(D) provides that the Secretary may designate as a county any area that is the equivalent of a county. Section 6a.103A-1(b)(4)(i) of the Temporary Income Tax Regulations (issued under section 103A of the Internal Revenue Code of 1954, the predecessor of section 143) provides that the term “State” includes a possession of the United States and the District of Columbia.

.07 Section 6a.103A-2(f)(5)(i) provides that an issuer may rely upon the average area purchase price safe harbors published by the Department of the Treasury for the statistical area in which a residence is located. Section 6a.103A-2(f)(5)(i) further provides that an issuer may use an average area purchase price limitation different from the published safe harbor if the issuer has more accurate and comprehensive data for the statistical area.

Qualified Mortgage Credit Certificate Program

.08 Section 25(c) permits a state or political subdivision to establish a qualified mortgage credit certificate program. In general, a qualified mortgage credit certificate program is a program under which the issuing authority elects not to issue an amount of private activity bonds that it may otherwise issue during the calendar year under section 146, and in their place, issues mortgage credit certificates to taxpayers in connection with the acquisition of their principal residences. Section 25(a)(1) provides, in general, that the holder of a mortgage credit certificate may claim a federal income tax credit equal to the product of the credit rate specified in the certificate and the interest paid or accrued during the tax year on the remaining principal of the indebtedness incurred to acquire the residence. Section 25(c)(2)(A)(iii)(III) generally provides that residences acquired in connection with the issuance of mortgage credit certificates must meet the purchase price requirements of section 143(e).

Income Limitations for Qualified Mortgage Bonds and Mortgage Credit Certificates

.09 Section 143(f) imposes limitations on the income of mortgagors for whom financing may be provided by qualified mortgage bonds. In addition, section 25(c)(2)(A)(iii)(IV) provides that holders of mortgage credit certificates must meet the income requirement of section 143(f). Generally, under sections 143(f)(1) and 25(c)(2)(A)(iii)(IV), the income requirement is met only if all owner-financing under a qualified mortgage bond and all mortgage credit certificates issued under a qualified mortgage credit certificate program are provided to mortgagors whose family income is 115 percent or less of the applicable median family income. Section 143(f)(5), however, generally provides for an upward adjustment to the percentage limitation in high housing cost areas. High housing cost areas are defined in section 143(f)(5)(C) as any statistical area for which the housing cost/income ratio is greater than 1.2.

.10 Under section 143(f)(5)(D), the housing cost/income ratio with respect to any statistical area is determined by dividing (a) the applicable housing price ratio for such area by (b) the ratio that the area median gross income for such area bears to the median gross income for the United States. The applicable housing price ratio is the new housing price ratio (new housing average area purchase price divided by the new housing average purchase price for the United States) or the existing housing price ratio (existing housing average area purchase price divided by the existing housing average purchase price for the United States), whichever results in the housing cost/income ratio being closer to 1.

Average Area and Nationwide Purchase Price Limitations

.11 Average area purchase price safe harbors for each state, the District of Columbia, Puerto Rico, the Northern Mariana Islands, American Samoa, the Virgin Islands, and Guam were last published in Rev. Proc. 2013-28, 2013-27 I.R.B. 28.

.12 The nationwide average purchase price limitation was last published in section 4.02 of Rev. Proc. 2013-28. Guidance with respect to the United States and area median gross income figures that are to be used in computing the housing cost/income ratio described in section 143(f)(5) was last published in Rev. Proc. 2014-23, 2014-12 I.R.B. 684.

.13 This revenue procedure uses FHA loan limits for a given statistical area to calculate the average area purchase price safe harbor for that area. FHA sets limits on the dollar value of loans it will insure based on median home prices and conforming loan limits established by the Federal Home Loan Mortgage Corporation. In particular, FHA sets an area’s loan limit at 95 percent of the median home sales price for the area, subject to certain floors and caps measured against conforming loan limits.

.14 To calculate the average area purchase price safe harbors in this revenue procedure, the FHA loan limits are adjusted to take into account the differences between average and median purchase prices. Because FHA loan limits do not differentiate between new and existing residences, this revenue procedure contains a single average area purchase price safe harbor for both new and existing residences in a statistical area. The Treasury Department and the Internal Revenue Service have determined that FHA loan limits provide a reasonable basis for determining average area purchase price safe harbors. If the Treasury Department and the Internal Revenue Service become aware of other sources of average purchase price data, including data that differentiate between new and existing residences, consideration will be given as to whether such data provide a more accurate method for calculating average area purchase price safe harbors.

.15 The average area purchase price safe harbors listed in section 4.01 of this revenue procedure are based on FHA loan limits released December 6, 2013. FHA loan limits are available for statistical areas in each state, the District of Columbia, Puerto Rico, the Northern Mariana Islands, American Samoa, the Virgin Islands, and Guam. See section 3.03 of this revenue procedure with respect to FHA loan limits revised after December 6, 2013.

.16 OMB Bulletin No. 03-04, dated and effective June 6, 2003, revised the definitions of the nation’s metropolitan areas and recognized 49 new metropolitan statistical areas. The OMB bulletin no longer includes primary metropolitan statistical areas.

SECTION 3. APPLICATION

Average Area Purchase Price Safe Harbors

.01 Average area purchase price safe harbors for statistical areas in each state, the District of Columbia, Puerto Rico, the Northern Mariana Islands, American Samoa, the Virgin Islands, and Guam are set forth in section 4.01 of this revenue procedure. Average area purchase price safe harbors are provided for single-family and two to four-family residences. For each type of residence, section 4.01 of this revenue procedure contains a single safe harbor that may be used for both new and existing residences. Issuers of qualified mortgage bonds and issuers of mortgage credit certificates may rely on these safe harbors to satisfy the requirements of sections 143(e) and (f). Section 4.01 of this revenue procedure provides safe harbors for MSAs and for certain counties and county equivalents. If no purchase price safe harbor is available for a statistical area, the safe harbor for “ALL OTHER AREAS” may be used for that statistical area.

.02 If a residence is in an MSA, the safe harbor applicable to it is the limitation of that MSA. If an MSA falls in more than one state, the MSA is listed in section 4.01 of this revenue procedure under each state.

.03 If the FHA revises the FHA loan limit for any statistical area after December 6, 2013, an issuer of qualified mortgage bonds or mortgage credit certificates may use the revised FHA loan limit for that statistical area to compute (as provided in the next sentence) a revised average area purchase price safe harbor for the statistical area provided that the issuer maintains records evidencing the revised FHA loan limit. The revised average area purchase price safe harbor for that statistical area is computed by dividing the revised FHA loan limit by .92.

.04 If, pursuant to section 6a.103A-2(f)(5)(i), an issuer uses more accurate and comprehensive data to determine the average area purchase price for a statistical area, the issuer must make separate average area purchase price determinations for new and existing residences. Moreover, when computing the average area purchase price for a statistical area that is an MSA, as defined in OMB Bulletin No. 03-04, the issuer must make the computation for the entire applicable MSA. When computing the average area purchase price for a statistical area that is not an MSA, the issuer must make the computation for the entire statistical area and may not combine statistical areas. Thus, for example, the issuer may not combine two or more counties.

.05 If an issuer receives a ruling permitting it to rely on an average area purchase price limitation that is higher than the applicable safe harbor in this revenue procedure, the issuer may rely on that higher limitation for the purpose of satisfying the requirements of section 143(e) and (f) for bonds sold, and mortgage credit certificates issued, not more than 30 months following the termination date of the 12-month period used by the issuer to compute the limitation.

Nationwide Average Purchase Price

.06 Section 4.02 of this revenue procedure sets forth a single nationwide average purchase price for purposes of computing the housing cost/income ratio under section 143(f)(5).

.07 Issuers must use the nationwide average purchase price set forth in section 4.02 of this revenue procedure when computing the housing cost/income ratio under section 143(f)(5) regardless of whether they are relying on the average area purchase price safe harbors contained in this revenue procedure or using more accurate and comprehensive data to determine average area purchase prices for new and existing residences for a statistical area that are different from the published safe harbors in this revenue procedure.

.08 If, pursuant to section 6.02 of this revenue procedure, an issuer relies on the average area purchase price safe harbors contained in Rev. Proc. 2013-28, the issuer must use the nationwide average purchase price set forth in section 4.02 of Rev. Proc. 2013-28 in computing the housing cost/income ratio under section 143(f)(5). Likewise, if, pursuant to section 6.05 of this revenue procedure, an issuer relies on the nationwide average purchase price published in Rev. Proc. 2013-28, the issuer may not rely on the average area purchase price safe harbors published in this revenue procedure.

SECTION 4. AVERAGE AREA AND NATIONWIDE AVERAGE PURCHASE PRICES

.01 Average area purchase prices for single-family and two to four-family residences in MSAs, and for certain counties and county equivalents are set forth below. The safe harbor for “ALL OTHER AREAS” (found at the end of the table below) may be used for a statistical area that is not listed below.

          2014 Average Area Purchase Prices for Mortgage Revenue Bonds
 _____________________________________________________________________________

                                 One-Unit  Two-Unit    Three-Unit   Four-Unit
 County Name               State Limit     Limit       Limit        Limit
 _____________________________________________________________________________

 ALEUTIANS WEST CENSUS     AK    $418,750    $536,087    $647,989     $805,272
 ANCHORAGE MUNICIPALITY    AK    $386,250    $494,457    $597,663     $742,772
 BRISTOL BAY BOROUGH       AK    $318,750    $408,043    $493,207     $612,989
 DENALI BOROUGH            AK    $323,750    $414,457    $500,978     $622,609
 FAIRBANKS NORTH STAR      AK    $298,750    $382,446    $462,283     $574,511
 HAINES BOROUGH            AK    $308,750    $395,217    $477,772     $593,750
 JUNEAU CITY AND BOROUGH   AK    $393,750    $504,076    $609,293     $757,228
 KETCHIKAN GATEWAY BOROUGH AK    $350,000    $448,043    $541,576     $673,098
 KODIAK ISLAND BOROUGH     AK    $415,000    $531,250    $642,174     $798,098
 MATANUSKA-SUSITNA BOROUGH AK    $386,250    $494,457    $597,663     $742,772
 NOME CENSUS AREA          AK    $298,750    $382,446    $462,283     $574,511
 NORTH SLOPE BOROUGH       AK    $361,250    $462,446    $559,022     $694,728
 PETERSBURG CENSUS AREA    AK    $361,250    $462,446    $559,022     $694,728
 SITKA CITY AND BOROUGH    AK    $436,250    $558,478    $675,054     $838,967
 VALDEZ-CORDOVA CENSUS     AK    $318,750    $408,043    $493,207     $612,989
 WRANGELL CITY AND BOROUGH AK    $361,250    $462,446    $559,022     $694,728
 YAKUTAT CITY AND BOROUGH  AK    $457,500    $585,652    $707,935     $879,837
 RUSSELL                   AL    $315,000    $403,261    $487,446     $605,761
 COCONINO                  AZ    $393,750    $504,076    $609,293     $757,228
 ALAMEDA                   CA    $679,891    $870,408  $1,052,120   $1,307,527
 ALPINE                    CA    $503,750    $644,891    $779,511     $968,750
 AMADOR                    CA    $361,250    $462,446    $559,022     $694,728
 BUTTE                     CA    $318,750    $408,043    $493,207     $612,989
 CALAVERAS                 CA    $406,250    $520,054    $628,641     $781,250
 CONTRA COSTA              CA    $679,891    $870,408  $1,052,120   $1,307,527
 EL DORADO                 CA    $516,250    $660,870    $798,859     $992,772
 FRESNO                    CA    $306,250    $392,065    $473,913     $588,913
 HUMBOLDT                  CA    $356,250    $456,033    $551,250     $685,109
 INYO                      CA    $401,250    $513,641    $620,924     $771,630
 LOS ANGELES               CA    $679,891    $870,408  $1,052,120   $1,307,527
 MARIN                     CA    $679,891    $870,408  $1,052,120   $1,307,527
 MARIPOSA                  CA    $350,000    $448,043    $541,576     $673,098
 MENDOCINO                 CA    $406,250    $520,054    $628,641     $781,250
 MONO                      CA    $575,000    $736,087    $889,783   $1,105,761
 MONTEREY                  CA    $525,000    $672,065    $812,391   $1,009,620
 NAPA                      CA    $643,750    $824,130    $996,141   $1,237,989
 NEVADA                    CA    $518,750    $664,076    $802,717     $997,609
 ORANGE                    CA    $679,891    $870,408  $1,052,120   $1,307,527
 PLACER                    CA    $516,250    $660,870    $798,859     $992,772
 PLUMAS                    CA    $366,250    $468,859    $566,739     $704,348
 RIVERSIDE                 CA    $386,250    $494,457    $597,663     $742,772
 SACRAMENTO                CA    $516,250    $660,870    $798,859     $992,772
 SAN BENITO                CA    $679,891    $870,408  $1,052,120   $1,307,527
 SAN BERNARDINO            CA    $386,250    $494,457    $597,663     $742,772
 SAN DIEGO                 CA    $593,750    $760,109    $918,804   $1,141,848
 SAN FRANCISCO             CA    $679,891    $870,408  $1,052,120   $1,307,527
 SAN JOAQUIN               CA    $331,250    $424,022    $512,554     $637,011
 SAN LUIS OBISPO           CA    $610,000    $780,924    $943,913   $1,173,098
 SAN MATEO                 CA    $679,891    $870,408  $1,052,120   $1,307,527
 SANTA BARBARA             CA    $679,891    $870,408  $1,052,120   $1,307,527
 SANTA CLARA               CA    $679,891    $870,408  $1,052,120   $1,307,527
 SANTA CRUZ                CA    $679,891    $870,408  $1,052,120   $1,307,527
 SHASTA                    CA    $297,500    $380,815    $460,326     $572,120
 SIERRA                    CA    $331,250    $424,022    $512,554     $637,011
 SOLANO                    CA    $435,000    $556,848    $673,152     $836,522
 SONOMA                    CA    $566,250    $724,891    $876,250   $1,088,967
 STANISLAUS                CA    $300,000    $384,022    $464,239     $576,902
 TUOLUMNE                  CA    $360,000    $460,870    $557,065     $692,283
 VENTURA                   CA    $650,000    $832,120  $1,005,815   $1,250,000
 YOLO                      CA    $516,250    $660,870    $798,859     $992,772
 ADAMS                     CO    $425,000    $544,076    $657,663     $817,283
 ARAPAHOE                  CO    $425,000    $544,076    $657,663     $817,283
 ARCHULETA                 CO    $310,000    $396,848    $479,674     $596,141
 BOULDER                   CO    $443,750    $568,043    $686,685     $853,370
 BROOMFIELD                CO    $425,000    $544,076    $657,663     $817,283
 CHAFFEE                   CO    $298,750    $382,446    $462,283     $574,511
 CLEAR CREEK               CO    $425,000    $544,076    $657,663     $817,283
 DENVER                    CO    $425,000    $544,076    $657,663     $817,283
 DOUGLAS                   CO    $425,000    $544,076    $657,663     $817,283
 EAGLE                     CO    $679,891    $870,408  $1,052,120   $1,307,527
 ELBERT                    CO    $425,000    $544,076    $657,663     $817,283
 GARFIELD                  CO    $679,891    $870,408  $1,052,120   $1,307,527
 GILPIN                    CO    $425,000    $544,076    $657,663     $817,283
 GRAND                     CO    $362,500    $464,076    $560,924     $697,120
 GUNNISON                  CO    $388,750    $497,663    $601,576     $747,609
 HINSDALE                  CO    $465,000    $595,272    $719,565     $894,239
 JEFFERSON                 CO    $425,000    $544,076    $657,663     $817,283
 LA PLATA                  CO    $412,500    $528,043    $638,315     $793,261
 LARIMER                   CO    $300,000    $384,022    $464,239     $576,902
 MESA                      CO    $307,500    $393,641    $475,815     $591,359
 OURAY                     CO    $462,500    $592,065    $715,707     $889,402
 PARK                      CO    $425,000    $544,076    $657,663     $817,283
 PITKIN                    CO    $679,891    $870,408  $1,052,120   $1,307,527
 ROUTT                     CO    $679,891    $870,408  $1,052,120   $1,307,527
 SAN MIGUEL                CO    $679,891    $870,408  $1,052,120   $1,307,527
 SUMMIT                    CO    $679,891    $870,408  $1,052,120   $1,307,527
 FAIRFIELD                 CT    $653,750    $836,902  $1,011,630   $1,257,228
 HARTFORD                  CT    $383,750    $491,250    $593,804     $737,989
 LITCHFIELD                CT    $388,750    $497,663    $601,576     $747,609
 MIDDLESEX                 CT    $383,750    $491,250    $593,804     $737,989
 NEW HAVEN                 CT    $332,500    $425,652    $514,511     $639,402
 NEW LONDON                CT    $305,000    $390,435    $471,957     $586,522
 TOLLAND                   CT    $383,750    $491,250    $593,804     $737,989
 WINDHAM                   CT    $310,000    $396,848    $479,674     $596,141
 COLUMBIA                  DC    $679,891    $870,408  $1,052,120   $1,307,527
 NEW CASTLE                DE    $412,500    $528,043    $638,315     $793,261
 SUSSEX                    DE    $343,750    $440,054    $531,902     $661,033
 BAKER                     FL    $331,250    $424,022    $512,554     $637,011
 BROWARD                   FL    $375,000    $480,054    $580,272     $721,141
 CLAY                      FL    $331,250    $424,022    $512,554     $637,011
 COLLIER                   FL    $487,500    $624,076    $754,348     $937,500
 DUVAL                     FL    $331,250    $424,022    $512,554     $637,011
 LAKE                      FL    $298,750    $382,446    $462,283     $574,511
 MANATEE                   FL    $310,000    $396,848    $479,674     $596,141
 MARTIN                    FL    $343,750    $440,054    $531,902     $661,033
 MIAMI-DADE                FL    $375,000    $480,054    $580,272     $721,141
 MONROE                    FL    $575,000    $736,087    $889,783   $1,105,761
 NASSAU                    FL    $331,250    $424,022    $512,554     $637,011
 OKALOOSA                  FL    $353,750    $452,826    $547,391     $680,272
 ORANGE                    FL    $298,750    $382,446    $462,283     $574,511
 OSCEOLA                   FL    $298,750    $382,446    $462,283     $574,511
 PALM BEACH                FL    $375,000    $480,054    $580,272     $721,141
 SARASOTA                  FL    $310,000    $396,848    $479,674     $596,141
 SEMINOLE                  FL    $298,750    $382,446    $462,283     $574,511
 ST. JOHNS                 FL    $331,250    $424,022    $512,554     $637,011
 ST. LUCIE                 FL    $343,750    $440,054    $531,902     $661,033
 WALTON                    FL    $353,750    $452,826    $547,391     $680,272
 BARROW                    GA    $348,750    $446,467    $539,674     $670,652
 BARTOW                    GA    $348,750    $446,467    $539,674     $670,652
 BUTTS                     GA    $348,750    $446,467    $539,674     $670,652
 CARROLL                   GA    $348,750    $446,467    $539,674     $670,652
 CHATTAHOOCHEE             GA    $315,000    $403,261    $487,446     $605,761
 CHEROKEE                  GA    $348,750    $446,467    $539,674     $670,652
 CLARKE                    GA    $348,750    $446,467    $539,674     $670,652
 CLAYTON                   GA    $348,750    $446,467    $539,674     $670,652
 COBB                      GA    $348,750    $446,467    $539,674     $670,652
 COWETA                    GA    $348,750    $446,467    $539,674     $670,652
 DAWSON                    GA    $348,750    $446,467    $539,674     $670,652
 DEKALB                    GA    $348,750    $446,467    $539,674     $670,652
 DOUGLAS                   GA    $348,750    $446,467    $539,674     $670,652
 FAYETTE                   GA    $348,750    $446,467    $539,674     $670,652
 FORSYTH                   GA    $348,750    $446,467    $539,674     $670,652
 FULTON                    GA    $348,750    $446,467    $539,674     $670,652
 GREENE                    GA    $560,000    $716,902    $866,576   $1,076,957
 GWINNETT                  GA    $348,750    $446,467    $539,674     $670,652
 HARALSON                  GA    $348,750    $446,467    $539,674     $670,652
 HARRIS                    GA    $315,000    $403,261    $487,446     $605,761
 HEARD                     GA    $348,750    $446,467    $539,674     $670,652
 HENRY                     GA    $348,750    $446,467    $539,674     $670,652
 JASPER                    GA    $348,750    $446,467    $539,674     $670,652
 LAMAR                     GA    $348,750    $446,467    $539,674     $670,652
 MADISON                   GA    $348,750    $446,467    $539,674     $670,652
 MARION                    GA    $315,000    $403,261    $487,446     $605,761
 MERIWETHER                GA    $348,750    $446,467    $539,674     $670,652
 MORGAN                    GA    $348,750    $446,467    $539,674     $670,652
 MUSCOGEE                  GA    $315,000    $403,261    $487,446     $605,761
 NEWTON                    GA    $348,750    $446,467    $539,674     $670,652
 OCONEE                    GA    $348,750    $446,467    $539,674     $670,652
 OGLETHORPE                GA    $348,750    $446,467    $539,674     $670,652
 PAULDING                  GA    $348,750    $446,467    $539,674     $670,652
 PICKENS                   GA    $348,750    $446,467    $539,674     $670,652
 PIKE                      GA    $348,750    $446,467    $539,674     $670,652
 ROCKDALE                  GA    $348,750    $446,467    $539,674     $670,652
 SPALDING                  GA    $348,750    $446,467    $539,674     $670,652
 WALTON                    GA    $348,750    $446,467    $539,674     $670,652
 HAWAII                    HI    $400,000    $512,065    $618,967     $769,239
 HONOLULU                  HI    $783,750  $1,003,315  $1,212,826   $1,507,228
 KALAWAO                   HI    $715,000    $915,326  $1,106,413   $1,375,000
 KAUAI                     HI    $775,000    $992,120  $1,199,293   $1,490,380
 MAUI                      HI    $715,000    $915,326  $1,106,413   $1,375,000
 BLAINE                    ID    $679,891    $870,408  $1,052,120   $1,307,527
 CAMAS                     ID    $679,891    $870,408  $1,052,120   $1,307,527
 LINCOLN                   ID    $679,891    $870,408  $1,052,120   $1,307,527
 TETON                     ID    $679,891    $870,408  $1,052,120   $1,307,527
 VALLEY                    ID    $296,250    $379,239    $458,424     $569,728
 BOONE                     IL    $368,750    $472,065    $570,598     $709,130
 COOK                      IL    $397,500    $508,859    $615,109     $764,402
 DEKALB                    IL    $397,500    $508,859    $615,109     $764,402
 DUPAGE                    IL    $397,500    $508,859    $615,109     $764,402
 GRUNDY                    IL    $397,500    $508,859    $615,109     $764,402
 KANE                      IL    $397,500    $508,859    $615,109     $764,402
 KENDALL                   IL    $397,500    $508,859    $615,109     $764,402
 LAKE                      IL    $397,500    $508,859    $615,109     $764,402
 MCHENRY                   IL    $397,500    $508,859    $615,109     $764,402
 WILL                      IL    $397,500    $508,859    $615,109     $764,402
 WINNEBAGO                 IL    $368,750    $472,065    $570,598     $709,130
 JASPER                    IN    $397,500    $508,859    $615,109     $764,402
 LAKE                      IN    $397,500    $508,859    $615,109     $764,402
 NEWTON                    IN    $397,500    $508,859    $615,109     $764,402
 PORTER                    IN    $397,500    $508,859    $615,109     $764,402
 JOHNSON                   KS    $302,500    $387,228    $468,098     $581,739
 LEAVENWORTH               KS    $302,500    $387,228    $468,098     $581,739
 LINN                      KS    $302,500    $387,228    $468,098     $581,739
 MIAMI                     KS    $302,500    $387,228    $468,098     $581,739
 WYANDOTTE                 KS    $302,500    $387,228    $468,098     $581,739
 BARNSTABLE                MA    $441,250    $564,891    $682,826     $848,533
 BRISTOL                   MA    $463,750    $593,696    $717,609     $891,848
 DUKES                     MA    $679,891    $870,408  $1,052,120   $1,307,527
 ESSEX                     MA    $511,250    $654,457    $791,141     $983,152
 HAMPDEN                   MA    $298,750    $382,446    $462,283     $574,511
 HAMPSHIRE                 MA    $298,750    $382,446    $462,283     $574,511
 MIDDLESEX                 MA    $511,250    $654,457    $791,141     $983,152
 NANTUCKET                 MA    $679,891    $870,408  $1,052,120   $1,307,527
 NORFOLK                   MA    $511,250    $654,457    $791,141     $983,152
 PLYMOUTH                  MA    $511,250    $654,457    $791,141     $983,152
 SUFFOLK                   MA    $511,250    $654,457    $791,141     $983,152
 WORCESTER                 MA    $310,000    $396,848    $479,674     $596,141
 ANNE ARUNDEL              MD    $537,500    $688,098    $831,739   $1,033,641
 BALTIMORE                 MD    $537,500    $688,098    $831,739   $1,033,641
 BALTIMORE CITY            MD    $537,500    $688,098    $831,739   $1,033,641
 CALVERT                   MD    $679,891    $870,408  $1,052,120   $1,307,527
 CARROLL                   MD    $537,500    $688,098    $831,739   $1,033,641
 CECIL                     MD    $412,500    $528,043    $638,315     $793,261
 CHARLES                   MD    $679,891    $870,408  $1,052,120   $1,307,527
 FREDERICK                 MD    $679,891    $870,408  $1,052,120   $1,307,527
 HARFORD                   MD    $537,500    $688,098    $831,739   $1,033,641
 HOWARD                    MD    $537,500    $688,098    $831,739   $1,033,641
 KENT                      MD    $316,250    $404,837    $489,348     $608,152
 MONTGOMERY                MD    $679,891    $870,408  $1,052,120   $1,307,527
 PRINCE GEORGE'S           MD    $679,891    $870,408  $1,052,120   $1,307,527
 QUEEN ANNE'S              MD    $537,500    $688,098    $831,739   $1,033,641
 SOMERSET                  MD    $343,750    $440,054    $531,902     $661,033
 ST. MARY'S                MD    $377,500    $483,261    $584,130     $725,978
 TALBOT                    MD    $416,250    $532,880    $644,130     $800,489
 WICOMICO                  MD    $343,750    $440,054    $531,902     $661,033
 WORCESTER                 MD    $343,750    $440,054    $531,902     $661,033
 CUMBERLAND                ME    $308,750    $395,217    $477,772     $593,750
 HANCOCK                   ME    $295,000    $377,663    $456,467     $567,283
 KNOX                      ME    $303,750    $388,859    $470,000     $584,130
 SAGADAHOC                 ME    $308,750    $395,217    $477,772     $593,750
 YORK                      ME    $308,750    $395,217    $477,772     $593,750
 ANOKA                     MN    $346,250    $443,261    $535,815     $665,870
 CARVER                    MN    $346,250    $443,261    $535,815     $665,870
 CHISAGO                   MN    $346,250    $443,261    $535,815     $665,870
 COOK                      MN    $307,500    $393,641    $475,815     $591,359
 DAKOTA                    MN    $346,250    $443,261    $535,815     $665,870
 HENNEPIN                  MN    $346,250    $443,261    $535,815     $665,870
 ISANTI                    MN    $346,250    $443,261    $535,815     $665,870
 LE SUEUR                  MN    $346,250    $443,261    $535,815     $665,870
 MILLE LACS                MN    $346,250    $443,261    $535,815     $665,870
 RAMSEY                    MN    $346,250    $443,261    $535,815     $665,870
 SCOTT                     MN    $346,250    $443,261    $535,815     $665,870
 SHERBURNE                 MN    $346,250    $443,261    $535,815     $665,870
 SIBLEY                    MN    $346,250    $443,261    $535,815     $665,870
 WASHINGTON                MN    $346,250    $443,261    $535,815     $665,870
 WRIGHT                    MN    $346,250    $443,261    $535,815     $665,870
 BATES                     MO    $302,500    $387,228    $468,098     $581,739
 CALDWELL                  MO    $302,500    $387,228    $468,098     $581,739
 CASS                      MO    $302,500    $387,228    $468,098     $581,739
 CLAY                      MO    $302,500    $387,228    $468,098     $581,739
 CLINTON                   MO    $302,500    $387,228    $468,098     $581,739
 JACKSON                   MO    $302,500    $387,228    $468,098     $581,739
 LAFAYETTE                 MO    $302,500    $387,228    $468,098     $581,739
 PLATTE                    MO    $302,500    $387,228    $468,098     $581,739
 RAY                       MO    $302,500    $387,228    $468,098     $581,739
 COPIAH                    MS    $300,000    $384,022    $464,239     $576,902
 HINDS                     MS    $300,000    $384,022    $464,239     $576,902
 MADISON                   MS    $300,000    $384,022    $464,239     $576,902
 RANKIN                    MS    $300,000    $384,022    $464,239     $576,902
 SIMPSON                   MS    $300,000    $384,022    $464,239     $576,902
 YAZOO                     MS    $300,000    $384,022    $464,239     $576,902
 FLATHEAD                  MT    $327,500    $419,239    $506,793     $629,783
 GALLATIN                  MT    $376,250    $481,630    $582,228     $723,533
 JEFFERSON                 MT    $311,250    $398,424    $481,630     $598,533
 LEWIS AND CLARK           MT    $311,250    $398,424    $481,630     $598,533
 MADISON                   MT    $353,750    $452,826    $547,391     $680,272
 MISSOULA                  MT    $307,500    $393,641    $475,815     $591,359
 SWEET GRASS               MT    $315,000    $403,261    $487,446     $605,761
 CAMDEN                    NC    $679,891    $870,408  $1,052,120   $1,307,527
 CHATHAM                   NC    $363,750    $465,652    $562,880     $699,511
 CURRITUCK                 NC    $498,750    $638,478    $771,793     $959,130
 DARE                      NC    $425,000    $544,076    $657,663     $817,283
 DURHAM                    NC    $363,750    $465,652    $562,880     $699,511
 FRANKLIN                  NC    $305,000    $390,435    $471,957     $586,522
 GATES                     NC    $498,750    $638,478    $771,793     $959,130
 HYDE                      NC    $525,000    $672,065    $812,391   $1,009,620
 JOHNSTON                  NC    $305,000    $390,435    $471,957     $586,522
 ORANGE                    NC    $363,750    $465,652    $562,880     $699,511
 PASQUOTANK                NC    $679,891    $870,408  $1,052,120   $1,307,527
 PERQUIMANS                NC    $679,891    $870,408  $1,052,120   $1,307,527
 PERSON                    NC    $363,750    $465,652    $562,880     $699,511
 TYRRELL                   NC    $425,000    $544,076    $657,663     $817,283
 WAKE                      NC    $305,000    $390,435    $471,957     $586,522
 WATAUGA                   NC    $298,750    $382,446    $462,283     $574,511
 BILLINGS                  ND    $331,250    $424,022    $512,554     $637,011
 STARK                     ND    $297,500    $380,815    $460,326     $572,120
 WILLIAMS                  ND    $300,000    $384,022    $464,239     $576,902
 HILLSBOROUGH              NH    $321,250    $411,250    $497,120     $617,772
 ROCKINGHAM                NH    $511,250    $654,457    $791,141     $983,152
 STRAFFORD                 NH    $511,250    $654,457    $791,141     $983,152
 ATLANTIC                  NJ    $343,750    $440,054    $531,902     $661,033
 BERGEN                    NJ    $679,891    $870,408  $1,052,120   $1,307,527
 BURLINGTON                NJ    $412,500    $528,043    $638,315     $793,261
 CAMDEN                    NJ    $412,500    $528,043    $638,315     $793,261
 CAPE MAY                  NJ    $450,000    $576,087    $696,359     $865,380
 ESSEX                     NJ    $679,891    $870,408  $1,052,120   $1,307,527
 GLOUCESTER                NJ    $412,500    $528,043    $638,315     $793,261
 HUDSON                    NJ    $679,891    $870,408  $1,052,120   $1,307,527
 HUNTERDON                 NJ    $679,891    $870,408  $1,052,120   $1,307,527
 MERCER                    NJ    $375,000    $480,054    $580,272     $721,141
 MIDDLESEX                 NJ    $679,891    $870,408  $1,052,120   $1,307,527
 MONMOUTH                  NJ    $679,891    $870,408  $1,052,120   $1,307,527
 MORRIS                    NJ    $679,891    $870,408  $1,052,120   $1,307,527
 OCEAN                     NJ    $679,891    $870,408  $1,052,120   $1,307,527
 PASSAIC                   NJ    $679,891    $870,408  $1,052,120   $1,307,527
 SALEM                     NJ    $412,500    $528,043    $638,315     $793,261
 SOMERSET                  NJ    $679,891    $870,408  $1,052,120   $1,307,527
 SUSSEX                    NJ    $679,891    $870,408  $1,052,120   $1,307,527
 UNION                     NJ    $679,891    $870,408  $1,052,120   $1,307,527
 WARREN                    NJ    $405,000    $518,478    $626,685     $778,859
 LOS ALAMOS                NM    $413,750    $529,674    $640,217     $795,652
 SANTA FE                  NM    $400,000    $512,065    $618,967     $769,239
 TAOS                      NM    $311,250    $398,424    $481,630     $598,533
 CARSON CITY               NV    $311,250    $398,424    $481,630     $598,533
 CLARK                     NV    $312,500    $400,054    $483,587     $600,978
 DOUGLAS                   NV    $381,250    $488,043    $589,946     $733,152
 STOREY                    NV    $353,750    $452,826    $547,391     $680,272
 WASHOE                    NV    $353,750    $452,826    $547,391     $680,272
 ALBANY                    NY    $317,500    $406,467    $491,304     $610,543
 BRONX                     NY    $679,891    $870,408  $1,052,120   $1,307,527
 DUTCHESS                  NY    $679,891    $870,408  $1,052,120   $1,307,527
 KINGS                     NY    $679,891    $870,408  $1,052,120   $1,307,527
 NASSAU                    NY    $679,891    $870,408  $1,052,120   $1,307,527
 NEW YORK                  NY    $679,891    $870,408  $1,052,120   $1,307,527
 ORANGE                    NY    $679,891    $870,408  $1,052,120   $1,307,527
 PUTNAM                    NY    $679,891    $870,408  $1,052,120   $1,307,527
 QUEENS                    NY    $679,891    $870,408  $1,052,120   $1,307,527
 RENSSELAER                NY    $317,500    $406,467    $491,304     $610,543
 RICHMOND                  NY    $679,891    $870,408  $1,052,120   $1,307,527
 ROCKLAND                  NY    $679,891    $870,408  $1,052,120   $1,307,527
 SARATOGA                  NY    $317,500    $406,467    $491,304     $610,543
 SCHENECTADY               NY    $317,500    $406,467    $491,304     $610,543
 SCHOHARIE                 NY    $317,500    $406,467    $491,304     $610,543
 SUFFOLK                   NY    $679,891    $870,408  $1,052,120   $1,307,527
 WESTCHESTER               NY    $679,891    $870,408  $1,052,120   $1,307,527
 DELAWARE                  OH    $337,500    $432,065    $522,228     $649,022
 FAIRFIELD                 OH    $337,500    $432,065    $522,228     $649,022
 FRANKLIN                  OH    $337,500    $432,065    $522,228     $649,022
 HOCKING                   OH    $337,500    $432,065    $522,228     $649,022
 LICKING                   OH    $337,500    $432,065    $522,228     $649,022
 MADISON                   OH    $337,500    $432,065    $522,228     $649,022
 MORROW                    OH    $337,500    $432,065    $522,228     $649,022
 PERRY                     OH    $337,500    $432,065    $522,228     $649,022
 PICKAWAY                  OH    $337,500    $432,065    $522,228     $649,022
 UNION                     OH    $337,500    $432,065    $522,228     $649,022
 BENTON                    OR    $325,000    $416,033    $502,880     $625,000
 CLACKAMAS                 OR    $393,750    $504,076    $609,293     $757,228
 CLATSOP                   OR    $306,250    $392,065    $473,913     $588,913
 COLUMBIA                  OR    $393,750    $504,076    $609,293     $757,228
 CURRY                     OR    $356,250    $456,033    $551,250     $685,109
 DESCHUTES                 OR    $332,500    $425,652    $514,511     $639,402
 HOOD RIVER                OR    $403,750    $516,848    $624,783     $776,467
 JACKSON                   OR    $303,750    $388,859    $470,000     $584,130
 LINCOLN                   OR    $300,000    $384,022    $464,239     $576,902
 MULTNOMAH                 OR    $393,750    $504,076    $609,293     $757,228
 TILLAMOOK                 OR    $312,500    $400,054    $483,587     $600,978
 WASHINGTON                OR    $393,750    $504,076    $609,293     $757,228
 YAMHILL                   OR    $393,750    $504,076    $609,293     $757,228
 BUCKS                     PA    $412,500    $528,043    $638,315     $793,261
 CARBON                    PA    $405,000    $518,478    $626,685     $778,859
 CHESTER                   PA    $412,500    $528,043    $638,315     $793,261
 DELAWARE                  PA    $412,500    $528,043    $638,315     $793,261
 LEHIGH                    PA    $405,000    $518,478    $626,685     $778,859
 MONTGOMERY                PA    $412,500    $528,043    $638,315     $793,261
 NORTHAMPTON               PA    $405,000    $518,478    $626,685     $778,859
 PHILADELPHIA              PA    $412,500    $528,043    $638,315     $793,261
 PIKE                      PA    $679,891    $870,408  $1,052,120   $1,307,527
 BRISTOL                   RI    $463,750    $593,696    $717,609     $891,848
 KENT                      RI    $463,750    $593,696    $717,609     $891,848
 NEWPORT                   RI    $463,750    $593,696    $717,609     $891,848
 PROVIDENCE                RI    $463,750    $593,696    $717,609     $891,848
 WASHINGTON                RI    $463,750    $593,696    $717,609     $891,848
 BEAUFORT                  SC    $381,250    $488,043    $589,946     $733,152
 BERKELEY                  SC    $335,000    $428,859    $518,370     $644,239
 CHARLESTON                SC    $335,000    $428,859    $518,370     $644,239
 DORCHESTER                SC    $335,000    $428,859    $518,370     $644,239
 GEORGETOWN                SC    $356,250    $456,033    $551,250     $685,109
 JASPER                    SC    $381,250    $488,043    $589,946     $733,152
 CANNON                    TN    $427,500    $547,283    $661,522     $822,120
 CHEATHAM                  TN    $427,500    $547,283    $661,522     $822,120
 DAVIDSON                  TN    $427,500    $547,283    $661,522     $822,120
 DICKSON                   TN    $427,500    $547,283    $661,522     $822,120
 HICKMAN                   TN    $427,500    $547,283    $661,522     $822,120
 MACON                     TN    $427,500    $547,283    $661,522     $822,120
 MAURY                     TN    $427,500    $547,283    $661,522     $822,120
 ROBERTSON                 TN    $427,500    $547,283    $661,522     $822,120
 RUTHERFORD                TN    $427,500    $547,283    $661,522     $822,120
 SMITH                     TN    $427,500    $547,283    $661,522     $822,120
 SUMNER                    TN    $427,500    $547,283    $661,522     $822,120
 TROUSDALE                 TN    $427,500    $547,283    $661,522     $822,120
 WILLIAMSON                TN    $427,500    $547,283    $661,522     $822,120
 WILSON                    TN    $427,500    $547,283    $661,522     $822,120
 ATASCOSA                  TX    $343,750    $440,054    $531,902     $661,033
 AUSTIN                    TX    $321,250    $411,250    $497,120     $617,772
 BANDERA                   TX    $343,750    $440,054    $531,902     $661,033
 BASTROP                   TX    $332,500    $425,652    $514,511     $639,402
 BEXAR                     TX    $343,750    $440,054    $531,902     $661,033
 BRAZORIA                  TX    $321,250    $411,250    $497,120     $617,772
 CALDWELL                  TX    $332,500    $425,652    $514,511     $639,402
 CHAMBERS                  TX    $321,250    $411,250    $497,120     $617,772
 COLLIN                    TX    $312,500    $400,054    $483,587     $600,978
 COMAL                     TX    $343,750    $440,054    $531,902     $661,033
 DALLAS                    TX    $312,500    $400,054    $483,587     $600,978
 DENTON                    TX    $312,500    $400,054    $483,587     $600,978
 ELLIS                     TX    $312,500    $400,054    $483,587     $600,978
 FORT BEND                 TX    $321,250    $411,250    $497,120     $617,772
 GALVESTON                 TX    $321,250    $411,250    $497,120     $617,772
 GUADALUPE                 TX    $343,750    $440,054    $531,902     $661,033
 HARRIS                    TX    $321,250    $411,250    $497,120     $617,772
 HAYS                      TX    $332,500    $425,652    $514,511     $639,402
 HOOD                      TX    $312,500    $400,054    $483,587     $600,978
 HUNT                      TX    $312,500    $400,054    $483,587     $600,978
 JOHNSON                   TX    $312,500    $400,054    $483,587     $600,978
 KAUFMAN                   TX    $312,500    $400,054    $483,587     $600,978
 KENDALL                   TX    $343,750    $440,054    $531,902     $661,033
 LIBERTY                   TX    $321,250    $411,250    $497,120     $617,772
 MEDINA                    TX    $343,750    $440,054    $531,902     $661,033
 MONTGOMERY                TX    $321,250    $411,250    $497,120     $617,772
 PARKER                    TX    $312,500    $400,054    $483,587     $600,978
 ROCKWALL                  TX    $312,500    $400,054    $483,587     $600,978
 SOMERVELL                 TX    $312,500    $400,054    $483,587     $600,978
 TARRANT                   TX    $312,500    $400,054    $483,587     $600,978
 TRAVIS                    TX    $332,500    $425,652    $514,511     $639,402
 WALLER                    TX    $321,250    $411,250    $497,120     $617,772
 WILLIAMSON                TX    $332,500    $425,652    $514,511     $639,402
 WILSON                    TX    $343,750    $440,054    $531,902     $661,033
 WISE                      TX    $312,500    $400,054    $483,587     $600,978
 BOX ELDER                 UT    $423,750    $542,446    $655,707     $814,891
 DAGGETT                   UT    $328,750    $420,870    $508,696     $632,228
 DAVIS                     UT    $423,750    $542,446    $655,707     $814,891
 MORGAN                    UT    $423,750    $542,446    $655,707     $814,891
 RICH                      UT    $322,500    $412,826    $499,022     $620,163
 SALT LAKE                 UT    $326,250    $417,663    $504,837     $627,391
 SUMMIT                    UT    $652,500    $835,326  $1,009,728   $1,254,837
 TOOELE                    UT    $326,250    $417,663    $504,837     $627,391
 WASATCH                   UT    $360,000    $460,870    $557,065     $692,283
 WASHINGTON                UT    $302,500    $387,228    $468,098     $581,739
 WEBER                     UT    $423,750    $542,446    $655,707     $814,891
 ALBEMARLE                 VA    $475,000    $608,098    $735,000     $913,478
 ALEXANDRIA CITY           VA    $679,891    $870,408  $1,052,120   $1,307,527
 AMELIA                    VA    $582,500    $745,707    $901,359   $1,120,217
 AMHERST                   VA    $317,500    $406,467    $491,304     $610,543
 APPOMATTOX                VA    $317,500    $406,467    $491,304     $610,543
 ARLINGTON                 VA    $679,891    $870,408  $1,052,120   $1,307,527
 BEDFORD                   VA    $317,500    $406,467    $491,304     $610,543
 BEDFORD CITY              VA    $317,500    $406,467    $491,304     $610,543
 BUCKINGHAM                VA    $475,000    $608,098    $735,000     $913,478
 CAMPBELL                  VA    $317,500    $406,467    $491,304     $610,543
 CAROLINE                  VA    $582,500    $745,707    $901,359   $1,120,217
 CHARLES CITY              VA    $582,500    $745,707    $901,359   $1,120,217
 CHARLOTTESVILLE CITY      VA    $475,000    $608,098    $735,000     $913,478
 CHESAPEAKE CITY           VA    $498,750    $638,478    $771,793     $959,130
 CHESTERFIELD              VA    $582,500    $745,707    $901,359   $1,120,217
 CLARKE                    VA    $679,891    $870,408  $1,052,120   $1,307,527
 COLONIAL HEIGHTS CITY     VA    $582,500    $745,707    $901,359   $1,120,217
 CULPEPER                  VA    $679,891    $870,408  $1,052,120   $1,307,527
 DINWIDDIE                 VA    $582,500    $745,707    $901,359   $1,120,217
 FAIRFAX                   VA    $679,891    $870,408  $1,052,120   $1,307,527
 FAIRFAX CITY              VA    $679,891    $870,408  $1,052,120   $1,307,527
 FALLS CHURCH CITY         VA    $679,891    $870,408  $1,052,120   $1,307,527
 FAUQUIER                  VA    $679,891    $870,408  $1,052,120   $1,307,527
 FLOYD                     VA    $317,500    $406,467    $491,304     $610,543
 FLUVANNA                  VA    $475,000    $608,098    $735,000     $913,478
 FREDERICK                 VA    $295,000    $377,663    $456,467     $567,283
 FREDERICKSBURG CITY       VA    $679,891    $870,408  $1,052,120   $1,307,527
 GILES                     VA    $317,500    $406,467    $491,304     $610,543
 GLOUCESTER                VA    $498,750    $638,478    $771,793     $959,130
 GOOCHLAND                 VA    $582,500    $745,707    $901,359   $1,120,217
 GREENE                    VA    $475,000    $608,098    $735,000     $913,478
 HAMPTON CITY              VA    $498,750    $638,478    $771,793     $959,130
 HANOVER                   VA    $582,500    $745,707    $901,359   $1,120,217
 HARRISONBURG CITY         VA    $301,250    $385,652    $466,141     $579,293
 HENRICO                   VA    $582,500    $745,707    $901,359   $1,120,217
 HOPEWELL CITY             VA    $582,500    $745,707    $901,359   $1,120,217
 ISLE OF WIGHT             VA    $498,750    $638,478    $771,793     $959,130
 JAMES CITY                VA    $498,750    $638,478    $771,793     $959,130
 KING GEORGE               VA    $381,250    $488,043    $589,946     $733,152
 KING WILLIAM              VA    $582,500    $745,707    $901,359   $1,120,217
 LANCASTER                 VA    $481,250    $616,087    $744,674     $925,489
 LOUDOUN                   VA    $679,891    $870,408  $1,052,120   $1,307,527
 LYNCHBURG CITY            VA    $317,500    $406,467    $491,304     $610,543
 MANASSAS CITY             VA    $679,891    $870,408  $1,052,120   $1,307,527
 MANASSAS PARK CITY        VA    $679,891    $870,408  $1,052,120   $1,307,527
 MATHEWS                   VA    $498,750    $638,478    $771,793     $959,130
 MONTGOMERY                VA    $317,500    $406,467    $491,304     $610,543
 NELSON                    VA    $475,000    $608,098    $735,000     $913,478
 NEW KENT                  VA    $582,500    $745,707    $901,359   $1,120,217
 NEWPORT NEWS CITY         VA    $498,750    $638,478    $771,793     $959,130
 NORFOLK CITY              VA    $498,750    $638,478    $771,793     $959,130
 NORTHUMBERLAND            VA    $346,250    $443,261    $535,815     $665,870
 PETERSBURG CITY           VA    $582,500    $745,707    $901,359   $1,120,217
 POQUOSON CITY             VA    $498,750    $638,478    $771,793     $959,130
 PORTSMOUTH CITY           VA    $498,750    $638,478    $771,793     $959,130
 POWHATAN                  VA    $582,500    $745,707    $901,359   $1,120,217
 PRINCE GEORGE             VA    $582,500    $745,707    $901,359   $1,120,217
 PRINCE WILLIAM            VA    $679,891    $870,408  $1,052,120   $1,307,527
 PULASKI                   VA    $317,500    $406,467    $491,304     $610,543
 RADFORD CITY              VA    $317,500    $406,467    $491,304     $610,543
 RAPPAHANNOCK              VA    $679,891    $870,408  $1,052,120   $1,307,527
 RICHMOND CITY             VA    $582,500    $745,707    $901,359   $1,120,217
 ROCKINGHAM                VA    $301,250    $385,652    $466,141     $579,293
 SPOTSYLVANIA              VA    $679,891    $870,408  $1,052,120   $1,307,527
 STAFFORD                  VA    $679,891    $870,408  $1,052,120   $1,307,527
 SUFFOLK CITY              VA    $498,750    $638,478    $771,793     $959,130
 SUSSEX                    VA    $582,500    $745,707    $901,359   $1,120,217
 VIRGINIA BEACH CITY       VA    $498,750    $638,478    $771,793     $959,130
 WARREN                    VA    $679,891    $870,408  $1,052,120   $1,307,527
 WILLIAMSBURG CITY         VA    $498,750    $638,478    $771,793     $959,130
 WINCHESTER CITY           VA    $295,000    $377,663    $456,467     $567,283
 YORK                      VA    $498,750    $638,478    $771,793     $959,130
 BENNINGTON                VT    $301,250    $385,652    $466,141     $579,293
 CHITTENDEN                VT    $372,500    $476,848    $576,413     $716,359
 FRANKLIN                  VT    $372,500    $476,848    $576,413     $716,359
 GRAND ISLE                VT    $372,500    $476,848    $576,413     $716,359
 LAMOILLE                  VT    $300,000    $384,022    $464,239     $576,902
 CHELAN                    WA    $372,500    $476,848    $576,413     $716,359
 CLALLAM                   WA    $417,500    $534,457    $646,033     $802,880
 CLARK                     WA    $393,750    $504,076    $609,293     $757,228
 DOUGLAS                   WA    $372,500    $476,848    $576,413     $716,359
 ISLAND                    WA    $350,000    $448,043    $541,576     $673,098
 JEFFERSON                 WA    $350,000    $448,043    $541,576     $673,098
 KING                      WA    $550,000    $704,076    $851,087   $1,057,717
 KITSAP                    WA    $333,750    $427,228    $516,467     $641,848
 PIERCE                    WA    $550,000    $704,076    $851,087   $1,057,717
 SAN JUAN                  WA    $525,000    $672,065    $812,391   $1,009,620
 SKAGIT                    WA    $342,500    $438,424    $530,000     $658,641
 SKAMANIA                  WA    $393,750    $504,076    $609,293     $757,228
 SNOHOMISH                 WA    $550,000    $704,076    $851,087   $1,057,717
 THURSTON                  WA    $318,750    $408,043    $493,207     $612,989
 WHATCOM                   WA    $331,250    $424,022    $512,554     $637,011
 KENOSHA                   WI    $397,500    $508,859    $615,109     $764,402
 MILWAUKEE                 WI    $313,750    $401,630    $485,489     $603,370
 OZAUKEE                   WI    $313,750    $401,630    $485,489     $603,370
 PIERCE                    WI    $346,250    $443,261    $535,815     $665,870
 ST. CROIX                 WI    $346,250    $443,261    $535,815     $665,870
 WASHINGTON                WI    $313,750    $401,630    $485,489     $603,370
 WAUKESHA                  WI    $313,750    $401,630    $485,489     $603,370
 HAMPSHIRE                 WV    $295,000    $377,663    $456,467     $567,283
 JEFFERSON                 WV    $679,891    $870,408  $1,052,120   $1,307,527
 SUBLETTE                  WY    $312,500    $400,054    $483,587     $600,978
 SWEETWATER                WY    $318,750    $408,043    $493,207     $612,989
 TETON                     WY    $679,891    $870,408  $1,052,120   $1,307,527
 GUAM                      GU    $612,500    $784,130    $947,826   $1,177,880
 NORTHERN ISLANDS          MP    $570,000    $729,674    $882,011   $1,096,141
 ROTA                      MP    $446,250    $571,250    $690,543     $858,152
 SAIPAN                    MP    $575,000    $736,087    $889,783   $1,105,761
 TINIAN                    MP    $578,750    $740,924    $895,598   $1,112,989
 AGUAS BUENAS              PR    $418,750    $536,087    $647,989     $805,272
 AIBONITO                  PR    $418,750    $536,087    $647,989     $805,272
 BARCELONETA               PR    $418,750    $536,087    $647,989     $805,272
 BARRANQUITAS              PR    $418,750    $536,087    $647,989     $805,272
 BAYAMON                   PR    $418,750    $536,087    $647,989     $805,272
 CAGUAS                    PR    $418,750    $536,087    $647,989     $805,272
 CANOVANAS                 PR    $418,750    $536,087    $647,989     $805,272
 CAROLINA                  PR    $418,750    $536,087    $647,989     $805,272
 CATANO                    PR    $418,750    $536,087    $647,989     $805,272
 CAYEY                     PR    $418,750    $536,087    $647,989     $805,272
 CEIBA                     PR    $418,750    $536,087    $647,989     $805,272
 CIALES                    PR    $418,750    $536,087    $647,989     $805,272
 CIDRA                     PR    $418,750    $536,087    $647,989     $805,272
 COMERIO                   PR    $418,750    $536,087    $647,989     $805,272
 COROZAL                   PR    $418,750    $536,087    $647,989     $805,272
 CULEBRA                   PR    $307,500    $393,641    $475,815     $591,359
 DORADO                    PR    $418,750    $536,087    $647,989     $805,272
 FAJARDO                   PR    $418,750    $536,087    $647,989     $805,272
 FLORIDA                   PR    $418,750    $536,087    $647,989     $805,272
 GUAYNABO                  PR    $418,750    $536,087    $647,989     $805,272
 GURABO                    PR    $418,750    $536,087    $647,989     $805,272
 HUMACAO                   PR    $418,750    $536,087    $647,989     $805,272
 JUNCOS                    PR    $418,750    $536,087    $647,989     $805,272
 LAS PIEDRAS               PR    $418,750    $536,087    $647,989     $805,272
 LOIZA                     PR    $418,750    $536,087    $647,989     $805,272
 LUQUILLO                  PR    $418,750    $536,087    $647,989     $805,272
 MANATI                    PR    $418,750    $536,087    $647,989     $805,272
 MAUNABO                   PR    $418,750    $536,087    $647,989     $805,272
 MOROVIS                   PR    $418,750    $536,087    $647,989     $805,272
 NAGUABO                   PR    $418,750    $536,087    $647,989     $805,272
 NARANJITO                 PR    $418,750    $536,087    $647,989     $805,272
 OROCOVIS                  PR    $418,750    $536,087    $647,989     $805,272
 RIO GRANDE                PR    $418,750    $536,087    $647,989     $805,272
 SAN JUAN                  PR    $418,750    $536,087    $647,989     $805,272
 SAN LORENZO               PR    $418,750    $536,087    $647,989     $805,272
 TOA ALTA                  PR    $418,750    $536,087    $647,989     $805,272
 TOA BAJA                  PR    $418,750    $536,087    $647,989     $805,272
 TRUJILLO ALTO             PR    $418,750    $536,087    $647,989     $805,272
 VEGA ALTA                 PR    $418,750    $536,087    $647,989     $805,272
 VEGA BAJA                 PR    $418,750    $536,087    $647,989     $805,272
 YABUCOA                   PR    $418,750    $536,087    $647,989     $805,272
 ST. CROIX ISLAND          VI    $356,250    $456,033    $551,250     $685,109
 ST. JOHN ISLAND           VI    $677,500    $867,337  $1,048,370   $1,302,880
 ST. THOMAS ISLAND         VI    $485,000    $620,870    $750,489     $932,717

 ALL OTHER AREAS (floor):        $294,620    $377,174    $455,897     $566,576

.02 The nationwide average purchase price (for use in the housing cost/income ratio for new and existing residences) is $245,500.

SECTION 5. EFFECT ON OTHER DOCUMENTS

Rev. Proc. 2013-28 is obsolete except as provided in section 6 of this revenue procedure.

SECTION 6. EFFECTIVE DATES

.01 Issuers may rely on this revenue procedure to determine average area purchase price safe harbors for commitments to provide financing or issue mortgage credit certificates that are made, or (if the purchase precedes the commitment) for residences that are purchased, in the period that begins on April 25, 2014, and ends on the date as of which the safe harbors contained in section 4.01 of this revenue procedure are rendered obsolete by a new revenue procedure.

.02 Notwithstanding section 5 of this revenue procedure, issuers may continue to rely on the average area purchase price safe harbors contained in Rev. Proc. 2013-28, with respect to bonds sold, or for mortgage credit certificates issued with respect to bond authority exchanged, before May 25, 2014, if the commitments to provide financing or issue mortgage credit certificates are made on or before June 24, 2014.

.03 Except as provided in section 6.04, issuers must use the nationwide average purchase price limitation contained in this revenue procedure for commitments to provide financing or issue mortgage credit certificates that are made, or (if the purchase precedes the commitment) for residences that are purchased, in the period that begins on April 25, 2014, and ends on the date when the nationwide average purchase price limitation is rendered obsolete by a new revenue procedure.

.04 Notwithstanding sections 5 and 6.03 of this revenue procedure, issuers may continue to rely on the nationwide average purchase price set forth in Rev. Proc. 2013-28 with respect to bonds sold, or for mortgage credit certificates issued with respect to bond authority exchanged, before May 25, 2014, if the commitments to provide financing or issue mortgage credit certificates are made on or before June 24, 2014.

SECTION 7. PAPERWORK REDUCTION ACT

The collection of information contained in this revenue procedure has been reviewed and approved by the Office of Management and Budget in accordance with the Paperwork Reduction Act (44 U.S.C. 3507) under control number 1545-1877.

An agency may not conduct or sponsor, and a person is not required to respond to, a collection of information unless the collection of information displays a valid OMB control number.

This revenue procedure contains a collection of information requirement in section 3.03. The purpose of the collection of information is to verify the applicable FHA loan limit that issuers of qualified mortgage bonds and qualified mortgage certificates have used to calculate the average area purchase price for a given metropolitan statistical area for purposes of section 143(e) and 25(c). The collection of information is required to obtain the benefit of using revisions to FHA loan limits to determine average area purchase prices. The likely respondents are state and local governments.

The estimated total annual reporting and/or recordkeeping burden is: 15 hours.

The estimated annual burden per respondent and/or recordkeeper: 15 minutes.

The estimated number of respondents and/or recordkeepers: 60.

Books or records relating to a collection of information must be retained as long as their contents may become material in the administration of any internal revenue law. Generally tax returns and tax return information are confidential, as required by 26 U.S.C. 6103.

SECTION 8. DRAFTING INFORMATION

The principal authors of this revenue procedure are David White and James Polfer of the Office of Associate Chief Counsel (Financial Institutions & Products). For further information regarding this revenue procedure contact David E. White on (202) 317-4562 (not a toll free call).

APRIL 25, 2014
Citations: Rev. Proc. 2014-31; 2014-20 IRB 1


IRS Hopes to Publish Final Charitable Hospital Regs by Year-End.

The IRS hopes to release final regulations on the requirements of section 501(r) for tax-exempt hospitals by the end of the year, Preston Quesenberry, senior technical reviewer (exempt organizations), IRS Office of Associate Chief Counsel (Tax-Exempt and Government Entities), said April 25.

Quesenberry spoke in Arlington, Va., at a conference sponsored by the Georgetown University Law Center’s Continuing Legal Education program.

The final regulations appear on the third quarter update to the 2013-2014 priority guidance plan. A Treasury official noted in March that exempt hospitals can rely on previously proposed regs (REG-106499-12, REG-130266-11) until the final regs are published.

Section 501(r) was enacted under the Affordable Care Act and contains new rules for tax-exempt hospitals. In late December the IRS published a proposed revenue procedure in Notice 2014-3, 2014-3 IRB 408, designed to help hospitals correct unintended violations of the new rules.

The IRS received only six comments on the notice, and the comment period is closed, Quesenberry said.

The proposed revenue procedure includes a few “very bare-boned” examples, Quesenberry said. One example he cited was that if a hospital fails to adopt a community health needs assessment report that contains all the required elements, the correction could be adopting a corrected report and posting it online.

“The thought was that once both the IRS and the hospitals gain more experience with implementation of the 501(r) requirements and with the type of failures that tend to occur, that we would be able to provide additional examples that could cover more scenarios and situations,” Quesenberry said.

Form 990 Changes for Hospitals

Exempt hospitals will face two significant changes in completing the hospital schedule of their 2013 Form 990 information return, another IRS official said at the conference.According to Garrett Gluth, a tax law specialist (exempt organizations) in the IRS Tax-Exempt and Government Entities Division, organizations filing Schedule H, “Hospitals,” should complete Part V, Section C, which asks for supplementary information to the answers provided in Part V, Section B. That section asks about a hospital’s community health needs assessments, financial assistance policies, emergency medical care policies, and charges to individuals eligible for assistance under the financial assistance policies. Gluth said a hospital should provide the information in Section C separately for each of its facilities, adding that Section C is designed to provide a cleaner way to supplement responses to section B.

The IRS also changed instructions for the community benefit table in line seven of Part I to say that contributions to a hospital that are restricted for a community benefit purpose should be reported as offsetting revenue for the type of community benefit they provide, Gluth said.

“This change provides more complete, accurate reporting and added transparency, treating restricted grants equally with other offsetting revenue on Schedule H, Part I,” Gluth said. “And of course that change doesn’t change a hospital’s actual community benefit, only how those numbers are presented in the two columns of Schedule H, Part I, line seven.”

APRIL 28, 2014

by David van den Berg



EO Update: e-News for Charities & Nonprofits - April 25, 2014.

 

  1.  IRS releases draft of easier to use Form 1023-EZ for charities seeking tax-exempt status

The draft Form 1023-EZ, “Streamlined Application for Recognition of Exemption Under Section 501(c)(3) of the Internal Revenue Code,” announced in the Federal Register March 31, is a shorter and less burdensome version of the Form 1023. Most small exempt organizations will be eligible to use the Form 1023 EZ.

The Office of Management and Budget is accepting comments on the form through April 30. The IRS expects the Form 1023 EZ to be in use by eligible organizations this summer.

  2.  Register for the Form 990 Filing Tips webcast presentation

Thursday, May 8
2 p.m. Eastern Time

Topics include:

  • Preparing the Form 990-series return
  • Managing legal risks more effectively
  • Avoiding penalties
  • Explaining Unrelated Business Income
  • Highlighting online resources
  • Promoting EO resources

To receive CE credit (and a certificate of completion) you must view the presentation for a minimum of 50 minutes.

Register here.

  3.  IRS to amend regulations regarding treatment of U.S. persons owning passive foreign investment company stock through tax-exempt organizations

Read Notice 2014-28 for details.

 

  4.  Register for EO workshop

Register for our upcoming workshop for small and medium-sized
501(c)(3) organizations on:

  • April 30 – Provo, UT
    Hosted by Brigham Young University – Marriott School

 

  5.  Procedural guidance update

IRS Exempt Organizations periodically issues interim guidance to communicate immediate, time-sensitive, or temporary instructions to employees. These instructions are generally incorporated into the Internal Revenue Manual within one year.


IRS Releases Draft Form 1023-EZ.

The IRS has released draft Form 1023-EZ, “Streamlined Application for Recognition of Exemption Under Section 501(c)(3) of the Internal Revenue Code.”

FEBRUARY 19, 2014



Sign Up Now for the 2014 IRS Nationwide Tax Forums and Save Money.

WASHINGTON — The IRS invites enrolled agents, certified public accountants, certified financial planners and other tax professionals to register for the 2014 IRS Nationwide Tax Forums. Those who sign up by the pre-registration date will save $130 per attendee off the on-site price.

The IRS Nationwide Tax Forums are three-day events that provide tax professionals with the most up-to-date information on federal and state tax issues presented by experts from the IRS and its partner organizations through a variety of training seminars and workshops. 2014 Registration Fees, Dates and Locations: The cost of enrollment for those who pre-register is $225 per person, a savings of $130 off the late or on-site registration price of $355. Pre-registration ends two weeks prior to the start of each forum.

                                              Pre-Registration Deadline
 Location                Forum Dates          for $225 rate
 _____________________________________________________________________________

 Chicago                July 1 - 3                  June 17

 San Diego              July 15 - 17                July 1

 New Orleans            July 22 - 24                July 8

 National Harbor, Md.   Aug. 19 - 21                Aug. 5
 (Washington, DC)

 Orlando, Fla.          Aug. 26 - 28                Aug. 12

More than 40 separate seminars and workshops are being offered, and enrolled agents and certified public accountants may earn up to 18 Continuing Professional Education Credits in each location. Additionally, these seminars may qualify for continuing education credit for certified financial planners, pending review and acceptance by the Certified Financial Planner Board.

A few days before the start of each forum, attendees will be able to download, print or to load onto their mobile devices slide presentations of seminars that they are interested in.

National Participating Association Members

Members of the participating associations below qualify for discounted enrollment costs if they meet the pre-registration deadlines above. Members who meet the early registration deadline would pay $215 and should contact their association directly for more information:

  • American Bar Association (ABA)
  • American Institute of Certified Public Accountants (AICPA)
  • National Association of Enrolled Agents (NAEA)
  • National Association of Tax Professionals (NATP)
  • National Society of Accountants (NSA)
  • National Society of Tax Professionals (NSTP)

Exhibit HallIn addition to the seminars, the forums also feature a two-day expo with representatives from tax, financial, and business communities offering their products, services, and expertise designed with the tax professional in mind.

In a survey of 2013 attendees, the forums received an overall 94% percent satisfaction rate. 2014 marks the 24th year that the IRS has hosted these forums to help educate and interact with the tax professional community.

Registration Information

For more information, or to register online, visit www.irstaxforum.com.

April 18, 2014

 



Streamlined Exemption Application Could Pose Compliance Problems.

The IRS has released a draft of a simplified exemption application for charities in an apparent effort to reduce burdens on smaller organizations, but some attorneys worry it could make it more difficult to get charities to comply with the tax laws.

The draft Form 1023-EZ, “Streamlined Application for Recognition of Exemption Under Section 501(c)(3) of the Internal Revenue Code,” accompanied by draft instructions, was announced in the Federal Register March 31.The notice described the draft as a shorter and less burdensome version of the 25-page Form 1023 and estimated it would take 14 hours to complete as opposed to 101 hours for the standard form.

The IRS provided a statement to Tax Analysts April 18 saying the Form 1023-EZ is intended to make applying for tax-exempt status easier and quicker for smaller organizations and that the Service has submitted the latest draft of the form to the Office of Management and Budget.

But attorneys who spoke with Tax Analysts said the brevity of the draft could raise compliance issues. Charles M. Watkins of Webster, Chamberlain & Bean LLP, who recently discovered the draft’s existence and brought it to the attention of other exempt organization practitioners, said it might not give the IRS all the information it needs to determine whether an applicant qualifies for section 501(c)(3) status, adding that it appears an applicant would not even have to show the agency its organizing documents.

“I would be concerned that they’re not getting enough information and some people are going to be recognized as exempt when in fact what they’re actually doing is not an exempt function,” Watkins said.

Benjamin Takis of Tax-Exempt Solutions PLLC said the standard Form 1023 provides applicants with a useful educational tool that a streamlined application may not offer.

“As I work with the organizations and we go through all the parts of the 1023, that’s an opportunity for them to learn about all their compliance responsibilities,” Takis said. He listed the exempt purpose test, the commerciality doctrine, and private benefit and private inurement rules as examples, adding, “In the absence of the Form 1023 and the rigor of that process, I think a lot of new organizations are not going to get that education.”

Watkins also noted that the Form 1023-EZ would be available only to organizations whose gross receipts do not exceed $200,000 and that churches, hospitals, colleges and universities, supporting organizations, organizations with donor-advised funds, and other entities could not use it.

Watkins was puzzled about why the IRS so far appears to have made no mention of the draft. “Nobody [at the IRS] has said a word about it,” he said. “If it’s something you’re doing that actually might help the situation, why wouldn’t you talk about it, especially in the context of a situation where you really do need to rebuild trust with the exempt organizations community?”

Treasury has asked for comments on the draft by April 30.

by Fred Stokeld

APRIL 21, 2014



EO Update: e-News for Charities & Nonprofits - April 17, 2014

  1.  Register for the Form 990 Filing Tips webcast presentationThursday, May 8, 2 pm, ETTopics include:

  • Preparing the Form 990-series return
  • Managing legal risks more effectively
  • Avoiding penalties
  • Explaining Unrelated Business Income
  • Highlighting online resources
  • Promoting EO resources

To receive CE credit (and a certificate of completion) you must view the presentation for a minimum of 50 minutes.

Register here.

  2.  IRS Commissioner speaks at National Press Club

Read the April 2 speech by John A. Koskinen.

  3.  IRS issues guidance on treatment of unrelated business income of state chartered credit

This memo provides directions to examiners in the processing of unrelated business income tax issues of organizations described in section 501(c)(14)(A) of the Internal Revenue Code.

  4.  Don’t include Social Security numbers on publicly disclosed forms

Because the IRS is required to disclose approved exemption applications and information returns, tax-exempt organizations should not include personal information, such as Social Security numbers, on these forms.

  5.  IRS phone forum Q&As/presentations posted

See responses to inquiries from attendees of these recent phone forums:

  • Good Governance Makes Sense for Charitable Organizations
  • ABCs of Charitable Contributions for 501(c)(3) Organizations

Review recently posted phone forum presentations posted on the
IRS Stay Exempt Resource Library page:

  • Charities and Their Volunteers
  • 501(c)(7) Social Clubs: What they need to know to qualify for and maintain tax-exempt status
  • Exempt Organizations and Employment Issues

  6.  Register for EO workshop

Register for our upcoming workshop for small and medium-sized
501(c)(3) organizations on:

  • April 30 – Provo, UT
    Hosted by Brigham Young University – Marriott School

If you have a technical or procedural question relating to Exempt Organizations, visit theCharities and Nonprofits homepage on the IRS.gov Web site.

If you have a specific question about exempt organizations, call EO Customer Account Services at 1-877-829-5500.


Good-Faith Defense Waives Attorney-Client Privilege.

Taxpayers forfeit the protection of attorney-client privilege on tax opinion letters from a law firm if they seek to avoid accuracy-related penalties by asserting affirmative defenses of good faith and state of mind, the Tax Court held April 16.

In AD Investment 2000 Fund LLC v. Commissioner, 142 T.C. No. 13 (2014), Judge James S. Halpern said that “by placing the partnerships’ legal knowledge and understanding into issue in an attempt to establish the partnerships’ reasonable legal beliefs in good faith arrived at (a good-faith and state-of-mind defense), [the taxpayers] forfeit the partnerships’ privilege protecting attorney-client communications relevant to the content and the formation of their legal knowledge, understanding, and beliefs.”

“Read broadly, the opinion suggests that asserting the reasonable belief defense to the substantial understatement penalty or the general reasonable cause and good-faith defense impliedly waives the attorney-client privilege, regardless of whether the taxpayer intends to rely on an opinion or advice of counsel for penalty protection,” said Andrew R. Roberson of McDermott Will & Emery.

“I don’t think the Tax Court had ever articulated [this position] like this before,” said Mark D. Allison of Caplin & Drysdale. “Taxpayers need to appreciate that when they are putting their belief [and] knowledge into play in litigation, it isn’t merely the specific advice or analysis they’re relying on that’s going to be relevant to the court’s analysis.” Any advice or analysis the taxpayers received or prepared, whether or not it supports their position, will come into play, he said.

“Most people probably thought that if you are not relying on particular advice that you would never have to produce it or put it in play,” Allison said. “It was always a risk in the past even if it was never stated quite this clearly.”

In consolidated cases in AD Investment 2000 Fund, the IRS sought to impose penalties on son-of-BOSS partnership tax shelters. The IRS had adjusted partnership items of two partnerships and determined that section 6662 accuracy-related penalties should apply on the underpayments of tax. The IRS sought to compel production of six opinion letters from Brown & Wood LLP telling the taxpayers it was more likely than not that the anticipated tax benefits from the transactions would be upheld for federal income tax purposes.

The taxpayers argued that they were not required to produce the opinions under the attorney-client privilege. The IRS in turn asserted that that privilege was waived by the taxpayers’ affirmative defenses against the penalty that their underpayment was due to their reasonable belief that the tax treatment was proper and their assertion that any underpayment was due to reasonable cause on which they acted in good faith.

Reg. section 1.6662-4(g)(4)(i) provides that the reasonable belief requirement is satisfied if either the taxpayer analyzes the pertinent facts and authorities and relied on the analysis to conclude that there is a greater than 50 percent likelihood that the tax treatment of the item would be upheld if challenged by the IRS (self-determination), or if the taxpayer reasonably relies in good faith on the opinion of a professional tax adviser (reliance on professional advice).

The taxpayers in AD Investment 2000 Fund asserted only self-determination in their defense against the penalty. But the IRS argued that the opinions provided by the law firm were still relevant to that defense, because if the opinions contradict the claimed self-determination, they could show it to be unreasonable, and if they are consistent with the self-determination, they could show that no self-determination was made.

The Tax Court agreed with the IRS and emphasized fairness in compelling disclosure of the opinion letters. If the petitioners are to rely on professional legal knowledge to establish that the partnerships reasonably and in good faith believed that their claimed tax treatment of the items in question was more likely than not the proper treatment, “it is only fair that respondent be allowed to inquire into the bases of that person’s knowledge, understanding, and beliefs including the opinions (if considered),” Halpern said in the opinion for the court.

“Taxpayers and their advisers will need to carefully consider the Tax Court’s analysis when responding to the assertion of penalties, both at the administrative level and in Tax Court filings,” Roberson said.

Allison said it would have been interesting to see what the Tax Court would have decided if the taxpayer asserted that the opinion letters were attorney work product. The differentiation between the attorney work product and attorney-client privileges is important in other cases, he said, noting that the work product privilege allows the court to make selective decisions about producing privileged information.

by Andrew Velarde and Matthew R. Madara



S. 2203 Would Permanently Extend Build America Bonds.

S. 2203, the Bolstering Our Nation’s Deficient Structures (BONDS) Act of 2014, introduced by Sen. Edward J. Markey, D-Mass., would modify and permanently extend the tax treatment for some Build America Bonds.

 

113TH CONGRESS
2D SESSIONS. 2203To amend the Internal Revenue Code of 1986 to permanently extend
the tax treatment for certain build America bonds,
and for other purposes.

IN THE SENATE OF THE UNITED STATES

APRIL 3, 2014

Mr. MARKEY introduced the following bill; which was read twice and
referred to the Committee on Finance

A BILL

To amend the Internal Revenue Code of 1986 to permanently extend the tax treatment for certain build America bonds, and for other purposes.Be it enacted by the Senate and House of Representatives of the United States of America in Congress assembled,

SECTION 1. SHORT TITLE.

This Act may be cited as the “Bolstering Our Nation’s Deficient Structures Act of 2014” or the “BONDS Act”.

SEC. 2. BUILD AMERICA BONDS MADE PERMANENT.

(a) IN GENERAL. — Subparagraph (B) of section 54AA(d)(1) of the Internal Revenue Code of 1986 is amended by inserting “or during a period beginning on or after the date of the enactment of the Bolstering Our Nation’s Deficient Structures Act of 2014,” after “January 1, 2011,”.

(b) REDUCTION IN CREDIT PERCENTAGE TO BONDHOLDERS. — Subsection (b) of section 54AA of such Code is amended to read as follows:

“(b) AMOUNT OF CREDIT. —

“(1) IN GENERAL. — The amount of the credit determined under this subsection with respect to any interest payment date for a build America bond is the applicable percentage of the amount of interest payable by the issuer with respect to such date.

“(2) APPLICABLE PERCENTAGE. — For purposes of paragraph (1), the applicable percentage shall be determined under the following table:

 "In the case of a bond issued           The applicable
 during calendar year:                   percentage is:
 _____________________________________________________________________

 2009 or 2010                            35
 2014                                    31
 2015                                    30
 2016                                    29
 2017 and thereafter                     28.".

(c) SPECIAL RULES. — Subsection (f) of section 54AA of such Code is amended by adding at the end the following new paragraph:

“(3) APPLICATION OF OTHER RULES. —

“(A) IN GENERAL. — Notwithstanding any other provision of law, a build America bond shall be considered a recovery zone economic development bond (as defined in section 1400U-2) for purposes of application of section 1601 of title I of division B of Public Law 111-5 (26 U.S.C. 54C note).

“(B) PUBLIC TRANSPORTATION PROJECTS. — Recipients of any financial assistance authorized under this section that funds public transportation projects, as defined in Title 49, United States Code, must comply with the grant requirements described under section 5309 of such title.”.

(d) EXTENSION OF PAYMENTS TO ISSUERS. —

(1) IN GENERAL. — Section 6431 of such Code is amended —

(A) by inserting “or during a period beginning on or after the date of the enactment of the Bolstering Our Nation’s Deficient Structures Act of 2014,” after “January 1, 2011,” in subsection (a), and

(B) by striking “before January 1, 2011” in subsection (f)(1)(B) and inserting “during a particular period”.

(2) CONFORMING AMENDMENTS. — Subsection (g) of section 54AA of such Code is amended —

(A) by inserting “or during a period beginning on or after the date of the enactment of the Bolstering Our Nation’s Deficient Structures Act of 2014,” after “January 1, 2011,”, and

(B) by striking “QUALIFIED BONDS ISSUED BEFORE 2011” in the heading and inserting “CERTAIN QUALIFIED BONDS”.

(e) REDUCTION IN PERCENTAGE OF PAYMENTS TO ISSUERS. — Subsection (b) of section 6431 of such Code is amended —

(1) by striking “The Secretary” and inserting the following:

“(1) IN GENERAL. — The Secretary”,

(2) by striking “35 percent” and inserting “the applicable percentage”, and

(3) by adding at the end the following new paragraph:

“(2) APPLICABLE PERCENTAGE. — For purposes of this subsection, the term ‘applicable percentage’ means the percentage determined in accordance with the following table:

 "In the case of a qualified bond        The applicable
 issued during calendar year:            percentage is:
 _____________________________________________________________________

 2009 or 2010                            35
 2014                                    31
 2015                                    30
 2016                                    29
 2017 and thereafter                     28.".

(f) CURRENT REFUNDINGS PERMITTED. — Subsection (g) of section 54AA of such Code is amended by adding at the end the following new paragraph:

“(3) TREATMENT OF CURRENT REFUNDING BONDS. —

“(A) IN GENERAL. — For purposes of this subsection, the term ‘qualified bond’ includes any bond (or series of bonds) issued to refund a qualified bond if —

“(i) the average maturity date of the issue of which the refunding bond is a part is not later than the average maturity date of the bonds to be refunded by such issue,

“(ii) the amount of the refunding bond does not exceed the outstanding amount of the refunded bond, and

“(iii) the refunded bond is redeemed not later than 90 days after the date of the issuance of the refunding bond.

“(B) APPLICABLE PERCENTAGE. — In the case of a refunding bond referred to in subparagraph (A), the applicable percentage with respect to such bond under section 6431(b) shall be the lowest percentage specified in paragraph (2) of such section.

“(C) DETERMINATION OF AVERAGE MATURITY. — For purposes of subparagraph (A)(i), average maturity shall be determined in accordance with section 147(b)(2)(A).

“(D) ISSUANCE RESTRICTION NOT APPLICABLE. — Subsection (d)(1)(B) shall not apply to a refunding bond referred to in subparagraph (A).”.

(g) CLARIFICATION RELATED TO LEVEES AND FLOOD CONTROL PROJECTS. — Subparagraph (A) of section 54AA(g)(2) of such Code is amended by inserting “(including capital expenditures for levees and other flood control projects)” after “capital expenditures”.

(h) GROSS-UP OF PAYMENT TO ISSUERS IN CASE OF SEQUESTRATION. — In the case of any payment under section 6431(b) of the Internal Revenue Code of 1986 made after the date of the enactment of this Act to which sequestration applies, the amount of such payment shall be increased to an amount equal to —

(1) such payment (determined before such sequestration), multiplied by

(2) the quotient obtained by dividing 1 by the amount by which 1 exceeds the percentage reduction in such payment pursuant to such sequestration.

For purposes of this subsection, the term ‘sequestration’ means any reduction in direct spending ordered in accordance with a sequestration report prepared by the Director of the Office and Management and Budget pursuant to the Balanced Budget and Emergency Deficit Control Act of 1985 or the Statutory Pay-As-You-Go Act of 2010.

(i) EFFECTIVE DATE. — The amendments made by this section shall apply to obligations issued on or after the date of the enactment of this Act.



TE/GE Memo Limits Types of Cases Transferred for E/O Processing.

The IRS Tax-Exempt and Government Entities Division has issued administrative guidance (TEGE-07-0414-0009) limiting the types of cases and issues that are transferred to the Exempt Organizations Technical Unit for processing, including cases involving optional expedited processing for section 501(c)(4) applications.Generally, some cases, including cases without established precedent, cases with significant regional or national impact, technical advice cases, and technical assistance requests, have been transferred to the technical unit for processing. Also transferred have been cases involving the interpretation of a treaty or international agreement, Canadian Treaty Organization determinations that involve unprecedented or novel issues, and specific cases with potential terrorist connections.

As of April 8, 2014, the guidance limits the transferred case types to applications under section 501(c)(3) from hospitals subject to requirements under section 501(r); some applications under section 501(c)(4) on optional expedited processes; and some technical assistance requests.

April 8, 2014Affected IRM: IRM 7.20.1 & 7.20.4

Expiration Date: April 8, 2015

MEMORANDUM FOR
ALL MANAGERS AND EMPLOYEES IN THE EXEMPT ORGANIZATIONS DETERMINATIONS
UNIT AND EXEMPT ORGANIZATIONS TECHNICAL UNIT

FROM:
Stephen A. Martin
Acting Director, EO Rulings and Agreements

SUBJECT:
Identification of Cases Transferred to EO Technical

The purpose of this memorandum is to provide administrative guidance to the Exempt Organizations Determinations Unit and the Exempt Organizations Technical Unit regarding issues and cases currently transferred to EO Technical as described in IRM sections 7.20.1 and 7.20.4.Pursuant to IRM section 7.20.1, certain cases, including cases without established precedent (set forth in IRM 7.20.1.4.1), cases with significant regional or national impact, technical advice cases, and technical assistance requests, were transferred to EO Technical for processing. In addition, IRM section 7.20.4 requires the transfer of cases involving the interpretation of a treaty or international agreement, Canadian Treaty Organization determinations that involve unprecedented or novel issues, and certain cases with potential terrorist connections (as described in 7.20.4.7.1). However, in the interest of efficient tax administration, effective upon issuance of this memorandum, the types of cases and issues transferred to EO Technical for processing shall be limited to the following:

      (1) Applications under Internal Revenue Code section 501(c)(3) from hospitals subject to requirements under section 501(r). The transfer of these cases will continue until training is completed for EO Determinations personnel on this technical matter. The training is scheduled for summer 2014;

(2) Certain applications under IRC section 501(c)(4), pursuant to the Memorandum issued on December 23, 2013, by the Acting Director, EO, Control No. TEGE-07-1213-24, Expansion of Optional Expedited Process for Certain Exemption Applications under Section 501(c)(4); and

(3) Technical assistance requests, pursuant to the procedures set forth in the Memorandum issued on July 15, 2013, by the Acting Director, EO R&A, Control No: TEGE-07-0713-11, Interim Guidance on Requests for Technical Assistance.
The content of this memorandum will be incorporated in IRM sections 7.20.1 and 7.20.4.Please contact the Senior Manager, Rulings and Agreements, Technical with any questions regarding the application of this memorandum.

cc:
www.irs.gov

Citations: TEGE-07-0414-0009



Government Appeals Decision on Clergy Housing Allowance Exclusion.

The government filed a brief in the Seventh Circuit arguing that a district court erred when it held that section 107(2), which excludes the rental allowance paid to a minister from income, was an unconstitutional violation of the establishment clause, maintaining that the plaintiffs lacked standing and the law is constitutional.

FREEDOM FROM RELIGION FOUNDATION, INCORPORATED,
ANNIE LAURIE GAYLOR AND DAN BARKER,
Plaintiffs-Appellees
v.
JACOB J. LEW, IN HIS OFFICIAL CAPACITY AS SECRETARY OF THE TREASURY,
AND JOHN A. KOSKINEN, IN HIS OFFICIAL CAPACITY AS
COMMISSIONER OF INTERNAL REVENUE,
Defendants-Appellants

IN THE UNITED STATES COURT OF APPEALS
FOR THE SEVENTH CIRCUITON APPEAL FROM THE JUDGMENT AND ORDER OF
THE UNITED STATES DISTRICT COURT
FOR THE WESTERN DISTRICT OF WISCONSIN
(No. 11-cv-0626; Honorable Barbara B. Crabb)

BRIEF FOR THE APPELLANTS

KATHRYN KENEALLY
Assistant Attorney General

TAMARA W. ASHFORD
Principal Deputy Assistant Attorney General

GILBERT S. ROTHENBERG (202) 514-3361
TERESA E. MCLAUGHLIN (202) 514-4342
JUDITH A. HAGLEY (202) 514-8126
Attorneys
Tax Division
Department of Justice
Post Office Box 502
Washington, D.C. 20044

Of Counsel:
JOHN W. VAUDREUIL
United States Attorney

                               TABLE OF CONTENTS

 Table of contents

 Table of authorities

 Glossary

 Statement regarding oral argument

 Statement of jurisdiction

 Statement of the issues

 Statement of the case

         A. Procedural overview

         B. Background: § 107

         C. FFRF

         D. The proceedings below

 Summary of argument

 Argument

      I. Plaintiffs lack standing to sue

         Standard of review

         A. Introduction

         B. Plaintiffs lack standing under Article III

         C. Plaintiffs' lawsuit also runs afoul of other limitations on
            standing

         D. The District Court's standing analysis cannot withstand scrutiny

     II. Section 107(2) does not violate the Establishment Clause

         Standard of review

         A. Introduction

         B. Section 107 is a permissible accommodation of religion

              1. Section 107(2) has a secular legislative purpose

                   a. The history and context of § 107

                   b. The statute's history and context disclose the secular
                      purpose of eliminating discrimination against, and among,
                      ministers and of minimizing interference with a church's
                      internal affairs

                   c. The District Court ignored the statute's history and
                      context

              2. Section 107(2) does not have the primary effect of advancing
                 or inhibiting religion

                   a. Section 107 does not endorse religion, but merely
                      minimizes governmental influence on, and entanglement
                      with, a church's internal affairs

                   b. Section 107(2) does not subsidize religion, as the
                      District Court erroneously concluded

              3. Section 107(2) does not produce excessive entanglement

              4. Texas Monthly is not controlling because it is
                 distinguishable in crucial respects

 Conclusion

 Certificate of compliance

 Certificate of service

 Statutory addendum

 Circuit Rule 30(d) certification

 Appendix table of contents

                              TABLE OF AUTHORITIES

 Cases:

 ACLU v. Alvarez, 679 F.3d 583 (7th Cir. 2012)

 Allen v. Wright, 468 U.S. 737 (1984)

 Am. Fed'n of Gov't Employees v. Cohen, 171 F.3d 460 (7th Cir. 1999)

 Apache Bend Apartments, Ltd. v. United States, 987 F.2d 1174
 (5th Cir. 1993)

 Ariz. Christian School Tuition Org. v. Winn, 131 S. Ct. 1436 (2011)

 Arizonans for Official English v. Arizona, 520 U.S. 43 (1997)

 Bartley v. United States, 123 F.3d 466 (7th Cir. 1997)

 Books v. Elkhart County, Ind., 401 F.3d 857 (7th Cir. 2005)

 Camps Newfound/Owatonna v. Town of Harrison, 520 U.S. 564 (1997)

 City of Milwaukee v. Block, 823 F.2d 1158 (7th Cir. 1987)

 Commissioner v. Kowalski, 434 U.S. 77 (1977)

 Conning v. Busey, 127 F. Supp. 958 (S.D. Ohio 1954)

 Corp. of the Presiding Bishop of the Church of Jesus Christ of Latter-Day
 Saints v. Amos, 483 U.S. 327 (1987)

 Cutter v. Wilkinson, 544 U.S. 709 (2005)

 Doe v. Elmbrook Sch. Dist., 687 F.3d 840 (7th Cir. 2012), petition
 for cert. filed, No. 12-755 (Sup. Ct. Dec. 20, 2012)

 Droz v. Commissioner, 48 F.3d 1120 (9th Cir. 1995)

 FFRF v. Geithner, 715 F. Supp. 2d 1051 (E.D. Cal. 2010)

 FFRF v. Obama, 641 F.3d 803 (7th Cir. 2011)

 FFRF v. Zielke, 845 F.2d 1463 (7th Cir. 1988)

 Finlator v. Powers, 902 F.2d 1158 (4th Cir. 1990)

 Flast v. Cohen, 392 U.S. 83 (1968)

 Flight Attendants Against UAL Offset v. Commissioner, 165 F.3d 572
 (7th Cir. 1999)

 Fulani v. Brady, 935 F.2d 1324 (D.C. Cir. 1991)

 Gillette v. United States, 401 U.S. 437 (1971)

 Heckler v. Mathews, 465 U.S. 728 (1984)

 Hein v. FFRF, 551 U.S. 587 (2007)

 Hernandez v. Commissioner, 490 U.S. 680 (1989)

 Hibbs v. Winn, 542 U.S. 88 (2004)

 Hosanna-Tabor Evangelical Lutheran Church & Sch. v. EEOC,
 132 S. Ct. 694 (2012)

 Immanuel Baptist Church v. Glass, 497 P.2d 757 (Okla. 1972)

 Kaufman v. McCaughtry, 419 F.3d 678 (7th Cir. 2005)

 Larson v. Valente, 456 U.S. 228 (1982)

 Lemon v. Kurtzman, 403 U.S. 602 (1971)

 Lexmark Int'l, Inc. v. Static Control Components, Inc.,
 __ S. Ct. __, 2014 WL 1168967 (Mar. 25, 2014)

 Louisiana v. McAdoo, 234 U.S. 627 (1914)

 Love Church v. Evanston, 896 F.2d 1082 (7th Cir. 1990)

 Lujan v. Defenders of Wildlife, 504 U.S. 555 (1992)

 MacColl v. United States, 91 F. Supp. 721 (N.D. Ill. 1950)

 Marks v. United States, 430 U.S. 188 (1977)

 McCreary County v. ACLU, 545 U.S. 844 (2005)

 McDaniel v. Paty, 435 U.S. 618 (1978)

 Moose Lodge No. 107 v. Irvis, 407 U.S. 163 (1972)

 Moritz v. Commissioner, 469 F.2d 466 (10th Cir. 1972)

 Mueller v. Allen, 463 U.S. 388 (1983)

 Nat'l Taxpayers Union, Inc. v. United States, 68 F.3d 1428
 (D.C. Cir. 1995)

 Raines v. Byrd, 521 U.S. 811 (1997)

 Salazar v. Buono, 130 S. Ct. 1803 (2010)

 Salkov v. Commissioner, 46 T.C. 190 (1966)

 Schleicher v. Salvation Army, 518 F.3d 472 (7th Cir. 2008)

 Sherman v. Koch, 623 F.3d 501 (7th Cir. 2010)

 Templeton v. Commissioner, 719 F.2d 1408 (7th Cir. 1983)

 Texas Monthly, Inc. v. Bullock, 489 U.S. 1 (1989)

 U.S. Catholic Conference, In re, 885 F.2d 1020 (2d Cir. 1989)

 United States v. Felt & Tarrant Mfg. Co., 283 U.S. 269 (1931)

 United States v. Williams, 514 U.S. 527 (1995)

 Valley Forge Christian Coll. v. Ams. United for Separation of Church &
 State, Inc., 454 U.S. 464 (1982)

 Vision Church v. Village of Long Grove, 468 F.3d 975 (7th Cir. 2006)

 Walz v. Tax Commission, 397 U.S. 664 (1970)

 Warnke v. United States, 641 F. Supp. 1083 (E.D. Ky. 1986)

 Warth v. Seldin, 422 U.S. 490 (1975)

 Williamson v. Commissioner, 224 F.2d 377 (8th Cir. 1955)

 Constitution, Statutes, and Regulations:

 U.S. Constitution:

      Amend. I, cl.1

      Amend. V

      Art. III

 Administrative Procedure Act, 5 U.S.C.:

      § 701(a)(1)

      § 702

      § 702(1), (2)

      § 703

      § 704

 Clergy Housing Allowance Clarification Act, Pub. L. No. 107-181,
 116 Stat. 583

 Internal Revenue Code of 1986 (26 U.S.C.):

      § 107

      § 107(1)

      § 107(2)

      § 119

      § 134

      § 162

      § 280A

      § 280A(c)(1)

      § 912

      § 6211

      § 6212

      § 6213(a)

      § 6511

      § 6532(a)(1)

      § 6662(a)

      § 6664(c)(1)

      § 6702

      § 7421(a)

      § 7422

 Revenue Act of 1921, Public L. No. 98, sec. 213(b)(11), 42 Stat. 227

 Revenue Act of 1921, Public L. No. 98, sec. 214(a)(1), 42 Stat. 227

 Section 22(b)(6) of the 1939 Internal Revenue Code, 53 Stat. 10 28 U.S.C.:

      § 1291

      § 1331

      § 1341

      § 1346(a)(1)

      § 1491

      § 2107(b)

      § 2201(a)

 Treas. Reg. § 1.1402(c)-5(c)(2)

 Miscellaneous:

 1 Mertens Law of Fed. Income Taxation § 7:196 (2013)

 148 Cong. Rec. 4670-4671 (Apr. 16, 2002)

 Bittker, Churches, Taxes & the Constitution, 78 Yale L. J. 1285 (1969)

 Brunner, Taxation: Exemption of Parsonage or Residence of Minister,
 Priest, Rabbi or Other Church Personnel, 55 A.L.R.3d 356 (1974)

 Clergy Housing Allowance Clarification Act, H.R. 4156, 107th Cong.
 (as introduced April 10, 2002)

 Fed. R. App. P. 4(a)(1)(B)

 Hearings on Forty Topics Pertaining to the General Revision of the Internal
 Revenue Code (Aug. 1953)

 H.R. Rep. No. 1337 (1954)

 Internal Revenue Manual § 7.25.3.6.5(2) (Feb. 23, 1999)

 Legg, Excluding Parsonages from Taxation: Declaring a Victor in the Duel
 between Caesar & the First Amendment, 10 Georgetown J. of Law & Public
 Policy 269 (2012)

 I.T. 1694, C.B. II-1, at 79 (1923)

 Note, The Parsonage Exclusion under the Endorsement Test,
 13 Va. Tax Rev. 397 (1993)

 O.D. 862, 4 C.B. 85 (1921)

 Savidge, The Parsonage in England (1964)

 S. Rep. No. 1622 (1954)

 Zelinsky, The First Amendment & the Parsonage Allowance, Tax Notes 5
 (Dec. 2013)

                                GLOSSARY
 _____________________________________________________________________

      APA                   Administrative Procedure Act
      The Code              Internal Revenue Code
      Commissioner          Commissioner of Internal Revenue
      FFRF                  Freedom from Religion Foundation, Inc.
      IRS                   Internal Revenue Service
      Plaintiffs            FFRF, Annie Gaylor, and Dan Barker
      Secretary             Secretary of the Treasury

STATEMENT REGARDING ORAL ARGUMENT

In this case, the District Court struck down the longstanding exclusion for a parsonage allowance under § 107(2) of the Internal Revenue Code as a violation of the Establishment Clause, at the behest of plaintiffs, an atheist advocacy organization and two of its members. Issues of great administrative importance regarding the constitutionality of the exclusion and plaintiffs’ standing to sue are presented. Counsel for the appellants respectfully inform the Court that they believe that oral argument is essential to the disposition of this appeal.

STATEMENT OF JURISDICTION

Freedom from Religion Foundation, Inc. (FFRF) and its co-presidents Annie Gaylor and Dan Barker (together, plaintiffs) brought this suit for declaratory and injunctive relief against the Secretary of the Treasury and the Commissioner of Internal Revenue. (Doc1,13.)1 FFRF, a Wisconsin corporation, has its principal place of business in Madison, Wisconsin. (Id.) The gravamen of the complaint was that § 107 of the Internal Revenue Code, which excludes from federal income taxation certain housing benefits provided to ministers, violates the Establishment Clause of the First Amendment to the United States Constitution and the Equal Protection component of the Constitution’s Due Process Clause. Plaintiffs sought (i) a declaration that § 107 is unconstitutional and (ii) an injunction against the continued allowance of the exclusion. Although plaintiffs invoked the District Court’s jurisdiction under 28 U.S.C. § 1331, the Government maintains that the court lacked subject matter jurisdiction. Because they failed to seek the exclusion provided by § 107, plaintiffs lack standing to challenge it. See Argument I, below.The District Court rendered a final judgment on November 26, 2013, disposing of all claims of all parties. (App44-45.) The Government filed its notice of appeal on January 24, 2014, within the 60 days allowed by Fed. R. App. P. 4(a)(1)(B). (Doc58.) See 28 U.S.C. § 2107(b). This Court’s jurisdiction over the appeal rests upon 28 U.S.C. § 1291.

STATEMENT OF THE ISSUES

1. Whether plaintiffs have standing to challenge the constitutionality of the exclusion for a parsonage allowance under § 107(2), when they have neither sought nor been denied the exclusion.2. If plaintiffs have standing, whether § 107(2) violates the Establishment Clause.

STATEMENT OF THE CASE

A. Procedural overviewPlaintiffs brought this suit against the Secretary and the Commissioner, seeking (i) a declaration that § 107 violates the Establishment Clause and (ii) an injunction barring the allowance of the exclusion. Because plaintiffs did not themselves seek the benefits of § 107, the Government moved to dismiss the case, contending that plaintiffs lacked standing. The District Court denied the motion. (A1-20.) The Government later moved for summary judgment, renewing its argument that plaintiffs lacked standing and contending that § 107 does not violate the Establishment Clause. Plaintiffs did not contest the motion insofar as it concerned their standing to challenge the exclusion under § 107(1) for housing furnished in kind. But they opposed the motion insofar as the exclusion under § 107(2) for a cash parsonage allowance was concerned. The court granted the Government summary judgment regarding § 107(1). After concluding that plaintiffs had standing to challenge the latter exclusion (App1-15), the court granted plaintiffs summary judgment sua sponte regarding § 107(2), striking down the statute as unconstitutional (App15-42). The Government now appeals.

B. Background: § 107

Section 107 is one of several statutory exclusions from gross income for employment-connected housing benefits. Taxpayers who are furnished housing by their employers may exclude the value of that housing from their gross income where (among other things) the housing is furnished for the “convenience of the employer.” § 119. Taxpayers who furnish their own housing, but use it for business purposes for the “convenience of [the] employer,” may deduct from income expenses related to that housing. § 280A(c)(1). In addition, certain federal employees may exclude from gross income cash provided to them for housing purposes. § 134 (military housing allowance); § 912 (foreign housing allowance for Foreign Service, the CIA, etc.).

Section 107 provides an analogous exclusion for housing or its cash equivalent provided to a “minister of the gospel” by his employing church.2 Specifically, when furnished or paid to him “as part of his compensation,” a minister’s gross income does not include “(1) the rental value of a home” or “(2) the rental allowance paid to him . . . to the extent used by him to rent or provide a home and to the extent such allowance does not exceed the fair rental value of the home,” plus utilities. § 107.

Section 107 has its origins in the Revenue Act of 1921, which created an exclusion for “[t]he rental value of a dwelling house and appurtenances thereof furnished to a minister of the gospel as part of his compensation.” Pub. L. No. 98, sec. 213(b)(11), 42 Stat. 227, 239. This exclusion was carried forward in successive revenue acts and was incorporated into the Internal Revenue Code of 1939 without substantive change. See Section 22(b)(6) of the 1939 Code, 53 Stat. 10. When the exclusion was reenacted as § 107(1) of the Internal Revenue Code of 1954, the addition of § 107(2) allowed ministers to exclude “rental allowance[s].”

Although the legislative history of the 1921 Revenue Act does not explain why the in-kind exclusion was introduced, the treatment of clergy housing under prior law sheds light on Section 213(b)(11)’s purpose. Immediately before its enactment, the Treasury Department had allowed some employees — but not clergy — to exclude the value of employer-provided housing from income pursuant to the “convenience of the employer” doctrine. See Commissioner v. Kowalski, 434 U.S. 77, 84-90 (1977) (describing history of exclusion for such employer-provided housing). Those benefiting included seamen living aboard ships, workers living in “camps,” cannery workers, and hospital employees. Id. In 1921, the Treasury announced that ministers would be taxed on the fair rental value of parsonages provided as living quarters, O.D. 862, 4 C.B. 85 (1921), even though ministers traditionally resided in parsonages for the church’s convenience (A37-51). Shortly thereafter, Congress changed that treatment by enacting Section 213(b)(11), thereby placing ministers on an equal footing with other employees who already enjoyed an exclusion for housing provided for the employer’s convenience.

When the parsonage exclusion was enacted, churches had differing traditions and practices that influenced how they provided parsonages to their ministers. (A37-65,68-73.) Older or more hierarchical churches tended to furnish church-owned parsonages to ministers; newer churches favored providing ministers cash housing allowances. (Id.) But either way, the minister’s housing was generally used for the church’s religious purposes. (A37-39,41-42,50-51,70-71,73.)

When churches that did not own parsonages provided ministers with cash housing allowances in lieu of in-kind housing, the Treasury ruled that the statutory exclusion was limited to in-kind housing and that housing allowances were includable in gross income. I.T. 1694, C.B. II-1, at 79 (1923). The Treasury noted, however, that the allowance would be deductible by the minister as a business expense, to the extent it was used for “expenses attributable to the portion of the parsonage which is devoted to professional use.” Id. Several courts disagreed. They held that, in order to treat similarly situated ministers equally, cash allowances must also be considered excludable under the statutory parsonage exclusion. E.g., Williamson v. Commissioner, 224 F.2d 377, 380 (8th Cir. 1955); Conning v. Busey, 127 F. Supp. 958 (S.D. Ohio 1954); MacColl v. United States, 91 F. Supp. 721 (N.D. Ill. 1950). Whether paid in cash or in kind, the benefits were considered provided for the church’s “convenience” and therefore excludable.Williamson, 224 F.2d at 380.

In 1954, Congress resolved the dispute by codifying the prevailing judicial view in § 107, which excludes compensatory housing furnished to ministers in cash as well as in kind. In doing so, Congress sought to remove “discrimination” against ministers who were paid cash allowances, as the House and Senate Reports explained. H.R. Rep. No. 1337, at 15 (1954); S. Rep. No. 1622, at 16 (1954).

In 2002, Congress amended § 107(2) to clarify that the exclusion was limited to the fair rental value of the parsonage. Pub. L. No. 107-181, 116 Stat. 583. The bill that introduced the proposed amendment reiterated that one of the purposes of § 107 was to “accommodate the differing governance structures, practices, traditions, and other characteristics of churches through tax policies that strive to be neutral with respect to such differences.” Clergy Housing Allowance Clarification Act, H.R. 4156, 107th Cong. § 2(a)(4) (as introduced April 10, 2002). In addition to preventing discrimination, § 107 was also designed, according to this legislative history, to avoid “intrusive inquiries by the government into the relationship between clergy and their respective churches” entailed by the generally available convenience-of-the-employer doctrine codified elsewhere in the Code. Id. at § 2(a)(5). Section 107 avoids such potential church-state entanglement by eliminating any need for the minister to demonstrate that the parsonage or allowance therefor is being used for the church’s convenience under § 119 or § 280A(c)(1), respectively.

C. FFRF

FFRF is a nonprofit membership corporation that promotes the separation of church and state and educates on matters of “non-theism.” (A3.) Gaylor and Barker, FFRF’s co-presidents, are “nonbeliever[s]” who are “opposed to government preferences and favoritism towards religion.”3 (Doc13 at 3.) FFRF provides Gaylor and Barker (formerly an ordained minister) with housing allowances not exceeding housing-related expenses. Plaintiffs complained that the § 107 exclusion, being limited to “ministers of the gospel,” subsidizes, promotes, and endorses religion in violation of the Establishment Clause. (Doc13 at 5.) Although they complained of unequal treatment, neither Gaylor nor Barker had personally sought or been denied the exclusion before filing suit, either by claiming it on their income tax returns or by filing claims for refund with the IRS challenging the statute as unconstitutional unless it applied to them. (A22-23,30.)

D. The proceedings below

The Government moved to dismiss for lack of subject matter jurisdiction. (Doc12,16-17.) It contended that plaintiffs lacked standing to sue under Article III of the Constitution. The Government contended that there was no injury-in-fact because neither Gaylor nor Barker had personally sought or been denied the exclusion, and it was insufficient merely to allege that it is illegal for third parties to enjoy it. (Doc12 at 17-22.) The Government further contended that entertaining plaintiffs’ claims, and recognizing a waiver of sovereign immunity under the Administrative Procedure Act, 5 U.S.C. § 702, would also be at odds with the highly articulated structure of tax litigation, which generally precludes the issuance of declaratory and injunctive relief and confines disputes regarding tax treatment to deficiency actions and suits for refund brought by the affected taxpayers. (Doc27 at 4-7.)

In response, plaintiffs contended that they had standing to challenge § 107(2). They argued that, having received housing allowances, they were similarly situated to clergy enjoying the exclusion. (Doc20.)

The District Court denied the Government’s motion. (A1-20.) The court considered it “clear” that plaintiffs are not entitled to the exclusion and that there was no reason to require them to undergo the “futile” exercise of seeking the exclusion. (A2.)

The Government moved for summary judgment. (Doc44,54.) Besides renewing its jurisdictional arguments (Doc44 at 5-25), the Government defended the constitutionality of § 107 (Id. at 25-52). It contended that § 107 does not violate the Establishment Clause because it has the secular purpose and effect of eliminating discrimination against, and among, ministers, and of limiting government entanglement with religion. (Doc44 at 3.)

Plaintiffs opposed the motion, but only as it related to § 107(2). They argued that the District Court had jurisdiction and that § 107(2) violates the Establishment Clause. (Doc52.)

The District Court granted the Government summary judgment regarding § 107(1). Respecting § 107(2), however, the court granted summary judgment to plaintiffs sua sponte. (App1-3.) The court reaffirmed its conclusion that plaintiffs had standing to challenge § 107(2), finding it “clear from the face of the statute that plaintiffs are excluded from an exemption granted to others.” (App2.) The court further held that § 107(2) violates the Establishment Clause because it “provides a benefit to religious persons and no one else, even though doing so is not necessary to alleviate a special burden on religious exercise.” (App2.) The court held that the case was controlled by the plurality opinion in Texas Monthly, Inc. v. Bullock, 489 U.S. 1 (1989), striking down a sales tax exemption for religious periodicals. (App2.) The court rejected the Government’s argument that § 107(2) was enacted for the secular purpose of avoiding discrimination among ministers. Although the court observed that other Code provisions provide tax benefits for employer-provided housing, it did not consider whether § 107(2) avoids the potential church-state entanglement posed by ministers being forced to rely upon generally available tax benefits for housing used for an employer’s convenience. (App29-37.)

SUMMARY OF ARGUMENT

Plaintiffs — an advocacy organization promoting atheism and the separation of church and state, and its co-presidents — challenge the constitutionality of § 107(2), a longstanding exclusion for a cash parsonage allowance paid by a church to its minister. Plaintiffs do not themselves seek the exclusion, but only to nullify its enjoyment by ministers who are not parties to this action. The District Court held that plaintiffs had standing to challenge § 107(2) and that the statute violates the Establishment Clause. Both rulings are flawed.1. Under Article III, a plaintiff lacks standing to sue unless he alleges a personal injury fairly traceable to the defendant’s alleged unlawful conduct. A mere interest in a problem or a grievance shared in common with the public does not suffice. Where, as here, a plaintiff alleges an injury from unequal treatment, he lacks standing unless and until he personally seeks and is denied the benefit at issue. Without the personal denial of equal treatment, the plaintiff raises only a generalized grievance, not a case or controversy. Plaintiffs here have not personally asked for the § 107(2) exclusion, nor are they litigating their own tax liabilities. Because they seek only to deprive others of the exclusion, they have suffered no actual personal injury at the hands of the Government.

Prudential concerns and statutory limitations under the APA also counsel dismissal. Congress has erected a highly articulated structure that confines tax litigation to suits by taxpayers contesting their own tax liabilities in Tax Court deficiency actions or suits for refund in the district courts and Court of Federal Claims. Injunctive and declaratory relief is generally precluded where federal taxes are concerned. To recognize a plaintiff’s standing to challenge the tax liability of third parties not before the court would disturb this carefully crafted statutory scheme.

2. If the Court were to reach the merits, it should uphold § 107(2) as constitutional. Section 107(2) has a secular purpose and effect and avoids excessive church-state entanglement. The clergy have long been provided with homes at or near their places of worship and use them in connection with their ministries. Just as it has done for lay employees furnished housing for the employer’s convenience under § 119, Congress has merely exercised the discretion that accompanies its taxing power to exempt the value of such professionally used parsonages from taxation. Extension of this “refusal to tax” to the cash equivalent of in-kind housing under § 107(2) merely “eliminates the discrimination,” in the words of the drafters, that would otherwise exist against ministers, and between churches that have historically provided parsonages in kind and those that do not. Permitting ministers to exclude parsonage allowances under § 107(2), rather than forcing them to rely on the generally available deduction for the business use of the home under § 280A(c)(1), may also prevent more intrusive Government inquiries into the church-minister relationship, and avoid the need to evaluate whether activities in a minister’s home are secular or religious. These statutory purposes comport fully with the restraints of the Establishment Clause.

In striking down the law, the District Court erred. It failed to come to grips with the reasons Congress enacted § 107 in the first place. It also disregarded the fact that the housing exclusions provided to ministers are merely part of a larger Congressional design providing exclusions or deductions for certain employer-provided housing benefits for all taxpayers. Given the unique history and context of § 107(2), the plurality opinion in Texas Monthly by no means “controls” this case, as the District Court erroneously assumed (App19). That case concerned a distinctly different tax exemption that lacks the redeeming features present here.

ARGUMENTI

Plaintiffs lack standing to sue

Standard of review

A plaintiff’s standing to sue presents a question of law reviewable de novo. Love Church v. Evanston, 896 F.2d 1082, 1085 (7th Cir. 1990).A. Introduction

The standing doctrine has both constitutional and prudential aspects. The “core component” of standing, derived directly from the “cases” or “controversies” requirement of Article III of the Constitution, is grounded on the separation of powers. Allen v. Wright, 468 U.S. 737, 750-752 (1984). It requires the plaintiff to “allege personal injury fairly traceable to the defendant’s allegedly unlawful conduct and likely to be redressed by the requested relief.” Id.at 751. The injury, moreover, must be “concrete, particularized, and actual or imminent (instead of conjectural or hypothetical).” Am. Fed’n of Gov’t Employees v. Cohen, 171 F.3d 460, 466 (7th Cir. 1999). “[G]eneralized grievances” “do not present constitutional ‘cases’ or ‘controversies.'” Lexmark Int’l, Inc. v. Static Control Components, Inc., __ S. Ct. __, 2014 WL 1168967, at *6n.3 (Mar. 25, 2014).

In addition to these constitutional requirements, there are also certain prudential limitations on the exercise of federal jurisdiction. This inquiry includes “whether the constitutional or statutory provision” in question “properly can be understood as granting persons in the plaintiff’s position a right to judicial relief.” Warth v. Seldin, 422 U.S. 490, 500 (1975).

In this case, the District Court struck down § 107(2), which has been on the statute books for some 60 years, at the behest of plaintiffs who have not been injured by the statute, though they object to § 107(2) as a matter of principle. There is no dispute that the individual plaintiffs, Gaylor and Barker, have never sought the very tax benefit about which they complain. Nor do they seek to litigate their own tax liabilities.4

The Supreme Court has “always insisted on strict compliance with [the] jurisdictional standing requirement,” because the “‘law of Art. III standing is built on a single basic idea — the idea of separation of powers.'” Raines v. Byrd, 521 U.S. 811, 819-820 (1997) (citation omitted). The Court also has repeatedly “[w]arn[ed] against premature adjudication of constitutional questions.” Arizonans for Official English v. Arizona, 520 U.S. 43, 79 (1997). In our tripartite system of government, a court does not act as a “constitutional check” on a Congressional enactment unless a bona fide dispute involving an actually injured litigant requires the court to pass on the validity of a statute.

As demonstrated below, the District Court’s ruling is at odds with settled law regarding constitutional standing. In contravention of prudential standing limitations, moreover, the ruling also bypasses the proper channels for tax litigation enacted by Congress that confine tax litigation to suits by taxpayers contesting their own tax liabilities, after the taxpayer first seeks the tax benefit in question from the Internal Revenue Service. These restrictions are by no means “arbitrary” rules (A15) that “waste” time (A8). They are critical components of a constitutional design that ensures that courts are the “‘last'” — not the first — “‘resort.'” Allen, 468 U.S. at 752 (citation omitted).

B. Plaintiffs lack standing under Article III

Here, although they contend that they are similarly situated to the ministers who enjoy it, plaintiffs do not seek to enjoy the parsonage exclusion themselves. Instead, they seek to deprive the ministers of the benefit, even though the clergy are not before the court. Because plaintiffs do not seek to improve their own economic situation, the apparent gravamen of their claim is that they have been stigmatized by the Government’s failure to provide them with equal treatment on account of their atheism. The Supreme Court has held, however, that an injury of this type “accords a basis for standing only to ‘those persons who are personally denied equal treatment’ by the challenged discriminatory conduct.” Allen, 468 U.S. at 755 (emphasis added) (quoting Heckler v. Mathews, 465 U.S. 728, 739-740 (1984)). Without the personal denial of equal treatment, the plaintiff raises only a “generally available grievance about government,” which “does not state an Article III case or controversy.” Lujan v. Defenders of Wildlife, 504 U.S. 555, 573-574 (1992). Insisting on a personalized injury, the Supreme Court “has repeatedly held that an asserted right to have the Government act in accordance with law is not sufficient, standing alone, to confer jurisdiction in federal court.” Allen, 468 U.S. at 754.

In Allen, the Supreme Court held that the parents of African-American children lacked standing to sue Treasury officials to challenge the tax-exempt status of racially discriminatory schools, because they had not been “personally denied equal treatment” by the Government, but were merely seeking to litigate another person’s tax liability. 468 U.S. at 754-756. Similarly, in Moose Lodge No. 107 v. Irvis, 407 U.S. 163, 166-167 (1972), the Court held that an African-American plaintiff lacked standing to challenge a racially discriminatory membership policy because he “never sought to become a member.”

In Heckler, by contrast, a widower was found to have standing to challenge a law requiring his spousal Social Security benefits to be offset against his Civil Service pension unless he demonstrated that he had been his late wife’s dependent, where no such showing was required for a widow to escape the offset. The Court stressed, however, that the plaintiff “personally has been denied benefits that similarly situated women receive.” 465 U.S. at 740 & n.9. Given that personal denial, the Court explained, “there can be no doubt about the direct causal relationship between the Government’s alleged deprivation of appellee’s right to equal protection and the personal injury appellee has suffered — denial of Social Security benefits solely on the basis of his gender.” Id.

Applying these principles, the Fifth Circuit, sitting en banc, held that plaintiffs lacked standing to pursue an “injury of unequal treatment,” based on their ineligibility for special transition rules extended to other taxpayers that temporarily preserved certain repealed tax benefits. Apache Bend Apartments, Ltd. v. United States, 987 F.2d 1174, 1177-1178 (5th Cir. 1993). The court held that “plaintiffs have not suffered any direct injury in the sense that they personally asked for and were denied a benefit granted to others.”5 Id. In so ruling, the court distinguished the injury in Heckler, emphasizing that the plaintiff there had constitutional standing because he “specifically sought benefits for himself,” was “personally” denied those benefits, and raised “his equal protection argument in the context of litigating his right to receive Social Security benefits.” Id. at 1178 n.3. Unlike the plaintiff in Heckler, the plaintiffs in Apache Bend“were not personally denied benefits” under the tax provision at issue, and “never even sought such benefits.” Id.Consequently, the asserted harm was no more than a “generalized grievance” that could not support standing. Id. at 1178.

These principles apply no less in the Establishment Clause context. The “Establishment Clause does not exempt clergy or lay persons from Article III’s standing requirements.” In re U.S. Catholic Conference, 885 F.2d 1020, 1024 (2d Cir. 1989). In Winn, for example, the Supreme Court held that the plaintiffs lacked standing to challenge a tax benefit under the Establishment Clause because they had not personally “been denied a benefit on account of their religion,” but were merely complaining in their capacity as taxpayers that the challenged provision unlawfully benefited religious groups. 131 S. Ct. at 1440, 1449. Similarly, in Catholic Conference, certain clergy plaintiffs alleged that the Government’s failure to revoke the tax exemption of the Catholic Church for electioneering against abortion violated the Establishment Clause. The Second Circuit held that the plaintiffs lacked standing because they “do not complain about their own tax status” and had “neither been personally denied equal treatment under the law nor in any way prosecuted by the IRS.” Id. at 1022, 1024-1026. As the court emphasized, it is “not enough to point to an assertedly illegal benefit flowing to a third party that happened to be a religious entity.” Id. at 1025.

As these decisions make clear, a plaintiff alleging unequal treatment lacks the requisite personal injury unless and until the person seeks — and is denied — equal treatment. Until that point, he complains only of a generalized grievance. Put another way, a person does not have standing to ask that another person’s tax benefit be taken away without first seeking and being denied the benefit himself. Any injury would otherwise be too abstract and diffuse.

Although a would-be litigant lacks standing to deprive others of a tax benefit he eschews, he indubitably would have standing, by contrast, to challenge the exaction of an unconstitutional tax from himself, which results in a direct and personal “economic injury.” Hein v. FFRF, 551 U.S. 587, 599 (2007). But in order to have standing to challenge a tax benefit as unconstitutional, the taxpayer must actually seek the tax benefit himself, placing his own liability in suit. E.g., Texas Monthly, 489 U.S. at 8 (recognizing the standing of a general-interest magazine to raise an Establishment Clause challenge to a tax exemption limited to religious periodicals, where it “paid” the tax and sought a “refund”); Droz v. Commissioner, 48 F.3d 1120, 1122 & n. 1 (9th Cir. 1995) (recognizing that taxpayer had standing to raise Establishment Clause challenge to a religious exemption from the self-employment tax under § 1402(g) for sects opposed to certain insurance, where he claimed, and was denied, the exemption); Moritz v. Commissioner, 469 F.2d 466, 467 (10th Cir. 1972) (addressing Equal Protection challenge brought by a single male who claimed a dependent-care expense deduction that the statute limited to married or widowed men, but allowed to women regardless of marital status); Warnke v. United States, 641 F. Supp. 1083 (E.D. Ky. 1986) (addressing Establishment Clause challenge to regulations under § 107 by taxpayer who claimed, and was denied, the § 107(2) exclusion). In these cases, the taxpayers actually sought the tax benefit from the taxing authority and then litigated their own tax liability, either by way of a deficiency proceeding in Tax Court (as in Droz and Moritz) or by filing a refund suit (as in Texas Monthly and Warnke).

So, too, here, Gaylor and Barker could have sought the § 107(2) exclusion by claiming it on their returns and then petitioning the Tax Court if the IRS were to disallow the exclusion. § 6213(a). Alternatively, they could have paid the resulting taxes due, claimed refunds from the IRS, and then sued for refund if their claims were rejected or not acted upon for six months. §§ 6511, 6532(a)(1), 7422; 28 U.S.C. §§ 1346(a)(1), 1491. Either way, plaintiffs would have standing to litigate their entitlement to the exclusion and to raise an Establishment Clause challenge in that regard. But perhaps preferring to wreak a greater impact — wresting the benefit from ministers nationwide — Gaylor and Barker did neither. (A22-23,30.)

Although plaintiffs “identify their injury as the alleged unequal treatment they have received from” the IRS and Treasury (A6), they, in fact, have received no treatment from those agency-defendants. As plaintiffs concede, they have not contacted the IRS or Treasury about their housing allowances. They have neither personally sought nor been denied equal treatment. (A24,27,31.) Without that critical step, plaintiffs’ claim is reduced to the allegation that § 107(2) violates the Establishment Clause. But as the Supreme Court has emphasized — and the District Court ignored — plaintiffs have “no standing to complain simply that their Government is violating the law.” Allen, 468 U.S. at 755.

Plaintiffs’ suit suffers from the same flaw that precluded standing in Allen, Winn, Apache Bend, and Catholic Conference. Plaintiffs contend that the Government violates the Establishment Clause by permitting ministers to claim the § 107(2) exclusion. But just as in those cases, plaintiffs here are not litigating their own tax liabilities. They are merely suing to have the Government act in accordance with their view of the law. Because plaintiffs have not sought, and been denied, the § 107(2) exclusion, they have not suffered an actual, concrete, and particularized injury. Without such an injury, plaintiffs lack Article III standing.

This Court recently made a like point when FFRF sought to challenge the constitutionality of a federal statute creating the National Day of Prayer as violating the Establishment Clause. FFRF v. Obama, 641 F.3d 803 (7th Cir. 2011). The Court held that FFRF lacked standing because — even if the statute violated the Establishment Clause — FFRF was not personally “injure[d]” by the statute, explaining that FFRF’s “offense at the behavior of the government, and a desire to have public officials comply with (plaintiff’s view of) the Constitution, differs from a legal injury.” Id. at 805, 807. A legal injury, the Court emphasized, requires “an invasion of one’s own rights to create standing.” Id. at 806. Similarly, in FFRF v. Zielke, 845 F.2d 1463 (7th Cir. 1988), the Court held that FFRF lacked standing to challenge a Ten Commandments display because FFRF failed to allege an actual, concrete injury. As the Court explained, FFRF’s commitment “to the principle of separation of church and state . . . alone does not satisfy the standing doctrine.” Id. at 1468 n.3. The same is true here.

C. Plaintiffs’ lawsuit also runs afoul of other limitations on standing

Plaintiffs’ complaint also runs afoul of other limitations on standing. To surmount the prudential principles that limit standing in a suit brought (as here) under the APA, plaintiffs must show not only that they fall within the zone of protected interests, but that there is no “evidence that Congress intended to preclude the plaintiff from suing,” such as “‘the structure of the statutory scheme.'” City of Milwaukee v. Block, 823 F.2d 1158, 1166 (7th Cir. 1987) (citation omitted). These limitations counsel against the exercise of jurisdiction and disclose that the APA does not waive sovereign immunity here.

To begin with, although a person who actually claims a tax benefit might arguably fall within the zone of interests protected by the statute conferring it, plaintiffs here fall short. Eschewing any claim to the § 107(2) exclusion they seek to nullify, they likewise cede any claim to being within the statute’s penumbra. To say, moreover, that they fall within the zone of interests protected by the Establishment Clause, merely because of their interest in the separation of church and state, would not meaningfully set them apart from masses of other citizens who also wish the Government to abide by the law.

In any event, the intent of Congress not to allow plaintiffs to contest the tax liability of third parties is manifest. As we explain below, “Congress has created a highly articulated and exclusive structure of federal tax litigation that limits judicial review of tax matters to precisely defined channels.” (Doc27 at 5.) Plaintiffs are attempting to litigate outside of those established channels.

Congress has authorized taxpayers to bring deficiency actions in the Tax Court to obtain review of asserted deficiencies in income, gift, estate and certain excise taxes without first having to pay the amount in dispute. §§ 6211, 6212, 6213(a). Alternatively, Congress has permitted taxpayers to sue for a refund in a federal district court or in the Court of Federal Claims after the taxpayer has duly filed an administrative refund claim and the claim either has been denied or not acted upon for six months. §§ 6511, 6532(a)(1), 7422(a). These remedies are adequate and specific remedies under 5 U.S.C. §§ 703 and 704 that foreclose review under the APA.

Congress has otherwise generally precluded “any person, whether or not such person is the person against whom such tax was assessed,” from maintaining a suit “for the purpose of restraining the assessment or collection of any tax” (§ 7421(a)), and has likewise generally barred declaratory relief in all actions “with respect to Federal taxes” (28 U.S.C. § 2201(a)). To be sure, the Anti-Injunction Act may not apply of its own terms here, because the effect of plaintiffs’ suit would be to increase tax collections. Cf. Hibbs v. Winn, 542 U.S. 88, 104 (2004) (construing Tax Injunction Act, 28 U.S.C. § 1341). Nevertheless, taken as a whole, this concerted structure generally confines tax disputes to challenges by taxpayers in deficiency actions and refund suits. It expressly — or at least impliedly — forecloses review. 5 U.S.C. §§ 701(a)(1), 702(1), (2).

Against this backdrop, “[i]t is well-recognized that the standing inquiry in tax cases is more restrictive than in other cases.” Nat’l Taxpayers Union, Inc. v. United States, 68 F.3d 1428, 1434 (D.C. Cir. 1995). The standing inquiry becomes particularly “restrictive” (id.) where a plaintiff seeks to litigate the tax liability of third parties who are not before the court. In that context, the courts have recognized “the principle that a party may not challenge the tax liability of another.” United States v. Williams, 514 U.S. 527, 539 (1995). As this Court has observed, “[o]rdinarily a person does not have standing to complain about someone else’s receipt of a tax benefit.” Flight Attendants Against UAL Offset v. Commissioner, 165 F.3d 572, 574 (7th Cir. 1999).

These principles apply with special force where, as here, a plaintiff seeks to increase the tax liabilities of third parties who are not before the court. It would be passing strange to allow plaintiffs, who have not sought the exclusion for themselves, to harness the injunctive power of the court to require the IRS to deny the exclusion to other persons. The better view is that Congress intended no such thing. See Louisiana v. McAdoo, 234 U.S. 627, 632 (1914) (declining to adjudicate third-party challenge to favorable tax treatment for another taxpayer, because the maintenance of such actions “would operate to disturb the whole revenue system of the government”).

Tellingly, the Fifth Circuit, sitting en banc, denied standing in a similar situation in Apache Bend. There, as noted above, the plaintiffs challenged preferential transition relief granted to other taxpayers not before the court. But they did not “seek transition relief for themselves” or “to litigate their own tax liability.” 987 F.2d at 1177. Instead, they “asked only that transition relief be denied to the favored taxpayers.” Id. The Fifth Circuit held that prudential concerns counseled dismissal, explaining that “Congress has erected a complex structure to govern the administration and enforcement of tax laws, and has established precise standards and procedures for judicial review of tax matters.” Id.

Those same concerns counsel dismissal here. As the Fifth Circuit pointed out in Apache Bend, the highly articulated structure of federal tax litigation painstakingly designed by Congress counsels dismissal of a case of this ilk. It is unquestionably “evidence that Congress intended to preclude the plaintiff[s] from suing” outside of that structure.Block, 823 F.2d at 1166. By respecting Congress’s structure, the Fifth Circuit declined to expand its judicial power. The District Court should have exercised the same restraint here.

D. The District Court’s standing analysis cannot withstand scrutiny

The District Court relaxed the standing requirements described above because — in its view — those requirements were “arbitrary” (A15) and a “waste” of “time” (A8). The court considered it “clear” that plaintiffs could not qualify for the exclusion and saw “no reason” to put them through the “futile” exercise of seeking the benefits themselves. (A2.) This approach is flawed for several reasons.

1. As we have already explained, a plaintiff making an unequal-treatment claim has not been injured for standing purposes unless he has sought, and been denied, the benefit at issue. The District Court’s contrary ruling is at odds with this established principle. In Heckler, the Supreme Court held that the plaintiff had standing precisely because he “personally has been denied benefits that similarly situated women receive,” and therefore was not merely asserting a generalized grievance. 465 U.S. at 740 n.9. In Allen, by contrast, the Court held that a plaintiff did not have standing to challenge another’s tax liability. It distinguished Heckler on the basis that the plaintiff there was “‘personally denied equal treatment.'” 468 U.S. at 755 (citation omitted). Where, as here, a plaintiff makes an unequal-treatment claim without contesting his own tax liability, the plaintiff, by definition, is attempting to contest the tax liability of another taxpayer. As the courts held in Allen, Winn, Catholic Conference, and Apache Bend, he lacks standing to do so. Far from being an “arbitrary” step, presenting a “formal claim” to the IRS regarding one’s own tax liability (A2,15), and then having that personal claim denied, provides the concrete and personal injury that Article III requires.

There is no basis for the District Court’s attempt to excuse plaintiffs from seeking and being denied the exclusion by the IRS on the theory that it would be “futile.” (A2.) To begin with, the court was speculating in concluding that the IRS would deny such a claim. But in any event, Article III’s standing requirements must be “strict[ly] compli[ed] with,” Raines, 521 U.S. at 819-820. Moreover, there is no “futility” exception in federal tax litigation, as it was long ago established in the analogous situation regarding the requirement of filing an administrative refund claim under § 6511 before suit. United States v. Felt & Tarrant Mfg. Co., 283 U.S. 269, 273 (1931). Applying this fundamental principle, this Court has held that it lacks the “authority to excuse [the taxpayer’s] failure to make a claim as required by section 7422(a), notwithstanding our certainty that the IRS ultimately will reject her claim.” Bartley v. United States, 123 F.3d 466, 469 (7th Cir. 1997). Similarly, here, the court lacked the authority to excuse plaintiffs from personally seeking, and being denied, the § 107(2) exclusion, and to have allowed the plaintiffs to litigate their claims outside the structure that Congress has designed for tax litigation, on grounds of futility.

Other taxpayers whose challenges to the constitutionality of the tax laws have been heard have first sought the tax benefit at issue, even where doing so was arguably futile. For example, in Texas Monthly, a nonreligious magazine sought the exemption provided for “religious” periodicals by paying the tax “under protest” and then suing “to recover those payments in state court.” 489 U.S. at 6. Similarly, in Moritz, the taxpayer claimed the dependent-care expense deduction available to all women regardless of marital status, notwithstanding that he was ineligible for it as an unmarried man, and then brought suit in Tax Court to contest the resulting deficiency determined against him. 469 F.2d at 467. In both cases, seeking the tax benefit may have been futile. But once the benefit was denied, the taxpayer had sustained the requisite injury concerning his own tax liability that gave rise to his standing to sue.

The District Court’s reliance (App7) on Finlator v. Powers, 902 F.2d 1158 (4th Cir. 1990), is misplaced. That decision is both incorrect and distinguishable. There, the court concluded that taxpayers had standing to challenge a state tax exemption, notwithstanding that they had not taken any “minimal steps” to allow the State to “preclude or redress their injuries ab initio,” such as contesting the liability, refusing to pay, paying under protest or suing for refund. Id. at 1161. The court “decline[d] to read such an implicit requirement into” Texas Monthly, “absent a clear statement by the Supreme Court to that effect.” Id. at 1162. This ruling was misconceived. As the court explained inFulani v. Brady, 935 F.2d 1324, 1328 (D.C. Cir. 1991), standing was recognized in Texas Monthly because the plaintiff there “petitioned for a refund of its own taxes,” and therefore “sought to litigate . . . its own liability.” As we have already explained, the Supreme Court has made it clear, in cases such as Heckler and Allen, that the plaintiff must seek from the defendant (and personally be denied) the benefit at issue in order to have standing to litigate an unequal-treatment claim. Moreover, the court in Finlator concluded that there were no “prudential concerns” that militated against finding standing in that state tax case. 902 F.2d at 1162. By contrast, there are prudential concerns that counsel against recognizing standing in this federal tax case. above.

2. The District Court’s conclusion that following the formal rules of standing would be a “waste” of “time” (A8) fails to appreciate the importance of those rules. Article III is “not merely a troublesome hurdle to be overcome if possible so as to reach the ‘merits’ of a lawsuit which a party desires to have adjudicated; it is a part of the basic charter promulgated by the Framers.” Valley Forge Christian Coll. v. Ams. United for Separation of Church & State, Inc., 454 U.S. 464, 476(1982). “In an era of frequent litigation, class actions, sweeping injunctions with prospective effect, and continuing jurisdiction to enforce judicial remedies, courts must be more careful to insist on the formal rules of standing, not less so.” Winn, 131 S. Ct. at 1449 (emphasis added). In its eagerness to entertain the suit, the District Court disregarded these important constitutional principles and erroneously engaged in “premature adjudication of constitutional questions.” Arizonans for Official English, 520 U.S. at 79.

The District Court’s exercise of jurisdiction in this federal tax case, where the plaintiffs did not first present the issue to the IRS, is particularly troubling. Whether the § 107 exclusion extends to atheists presents a question of statutory interpretation of apparent first impression. Notably, this Court has held that “atheism” is a “religion” for “Establishment Clause” purposes. Kaufman v. McCaughtry, 419 F.3d 678, 684 (7th Cir. 2005). Although the District Court had its own views regarding the matter (App8-14), it is the Secretary and the Commissioner, not the courts, who are charged with the responsibility for enforcing the tax laws in the first instance. The court should have allowed them the opportunity to determine whether an atheist could qualify. The court’s arrogation of this Executive Branch prerogative raises serious constitutional concerns.

3. The District Court’s rationales for relaxing the standing requirements are unfounded. The court’s reliance (A7-9) on cases permitting preenforcement challenges is misplaced. “To satisfy the injury-in-fact requirement in a preenforcement action, the plaintiff must show ‘an intention to engage in a course of conduct arguably affected with a constitutional interest, but proscribed by a statute, and [that] there exists a credible threat of prosecution thereunder.'” ACLU v. Alvarez, 679 F.3d 583, 590-591 (7th Cir. 2012) (citation omitted). Plaintiffs cannot satisfy that standard.

To begin with, unlike the situations presented in the cases cited by the District Court (A7-9), no conduct is proscribed by § 107(2), nor do plaintiffs face a “credible threat of prosecution” under it. And the court’s concern that plaintiffs might be “vulnerable to civil sanctions” (A9) for seeking the exclusion does not excuse a taxpayer from seeking a tax benefit from the IRS first.6 A taxpayer whose position has colorable merit need not fear that a penalty will be imposed against him. Moreover, the District Court’s reservations in this regard are fundamentally at odds with its ultimate conclusion that plaintiffs are similarly situated to the ministers reaping the benefit, but for an invidious and unconstitutional restriction (according to the court) that the compensation so excluded be earned in a religious endeavor.

Similarly lacking in merit is the District Court’s suggestion that the plaintiffs would lack “standing to challenge § 107(2) in the context of a proceeding to claim the exemption.” (App6 (citing Templeton v. Commissioner, 719 F.2d 1408 (7th Cir. 1983), among others).) That aspect of Templeton has since been overruled. In Templeton, this Court held that a taxpayer lacked standing to challenge the underinclusiveness of a tax exemption under the Establishment Clause because the injury was not redressable: if the taxpayer did not qualify, the most he could achieve was to deprive the favored class of the benefit, rather than improve his own situation. Id. at 1412. That rationale, however, was later “rejected” by the Supreme Court in Texas Monthly, because it would “‘effectively insulate underinclusive statutes from constitutional challenge.'” 489 U.S. at 8 (citation omitted). But the plaintiff inTexas Monthly had standing to challenge the underinclusive tax exemption at issue there precisely because it had paid the tax and sought a “refund,” thereby presenting a “live controversy” for the Court to adjudicate. Id. The District Court erred in allowing plaintiffs here to bypass that route.

IISection 107(2) does not violate the Establishment Clause

Standard of review

The District Court’s grant of summary judgment to plaintiffs on their Establishment Clause claim is reviewed de novo. Books v. Elkhart County, Ind., 401 F.3d 857, 863 (7th Cir. 2005).A. Introduction

1. The First Amendment states that “Congress shall make no law respecting an establishment of religion, or prohibiting the free exercise thereof.” U.S. Const. amend. I, cl. 1. Generally speaking, the First Amendment’s Free Exercise Clause prohibits Congress from interfering with religious practices and institutions, while the Establishment Clause prohibits Congress from inappropriately advancing religion. Between the “two Religion Clauses,” there is a middle ground — “room for play in the joints” — within which Congress may accommodate religion “without sponsorship and without interference.” Walz v. Tax Commission, 397 U.S. 664, 668-669 (1970).

The Supreme Court has “‘long recognized that the government may (and sometimes must) accommodate religious practices and that it may do so without violating the Establishment Clause.'” Corp. of the Presiding Bishop of the Church of Jesus Christ of Latter-Day Saints v. Amos, 483 U.S. 327, 334 (1987) (citation omitted); see Cutter v. Wilkinson, 544 U.S. 709, 719-720 (2005) (upholding Religious Land Use& Institutionalized Persons Act as a “permissible legislative accommodation of religion,” even though it was not “compelled by the Free Exercise Clause”); Gillette v. United States, 401 U.S. 437, 450 (1971) (upholding religion-specific exemption from military draft).

2. To determine whether the Government’s accommodation of religion is permissible under the Establishment Clause, courts generally apply the three-pronged test set forth by the Supreme Court in Lemon v. Kurtzman, 403 U.S. 602 (1971), which “‘remains the prevailing analytical tool for the analysis of Establishment Clause claims.'” Doe v. Elmbrook Sch. Dist., 687 F.3d 840, 849 (7th Cir. 2012) (en banc) (citation omitted), petition for cert. filed, No. 12-755 (Sup. Ct. Dec. 20, 2012). In order to comport with the Establishment Clause, (i) “the statute must have a secular legislative purpose,” (ii) “its principal or primary effect must be one that neither advances nor inhibits religion,” and (iii) it “must not foster ‘an excessive government entanglement with religion.'” Lemon, 403 U.S. at 612-613 (citation omitted).

A comparison of Amos and Walz (upholding religious exemptions) to Texas Monthly (invalidating such an exemption) illustrates the contours of permissible accommodation of religion. In Amos, the Supreme Court addressed whether the exemption for religious organizations from the prohibition against religious discrimination under Title VII violates the Establishment Clause. The Court upheld the exemption as a permissible accommodation, even though it was not required by the Free Exercise Clause. 483 U.S. at 336. The Court concluded that the exemption satisfied the Lemon test. First, it served the secular purpose of minimizing governmental interference “with the decision-making process in religions.” Id. Second, it did not advance religion but merely removed a regulatory burden imposed thereon. Id. at 338. Third, it avoided excessive entanglement by “effectuat[ing] a more complete separation” of church and state. Id. at 339. The Court expressly rejected the complaint “that [the exemption] singles out religious entities for a benefit.” Id. at 338. As the Court explained, “[w]here, as here, government acts with the proper purpose of lifting a regulation that burdens the exercise of religion, we see no reason to require that the exemption comes packaged with benefits to secular entities.” Id.

In Walz, the Supreme Court held that exempting religious organizations from a generally applicable property tax did not violate the Establishment Clause. The Court emphasized that the tax exemption served the permissible purpose of “sparing the exercise of religion from the burden of property taxation.” 397 U.S. at 673-674. The exemption, moreover, by no means sponsored religion, but “simply abstains from demanding that the church support the state.”Id. at 675. And it “create[d] only a minimal and remote involvement between church and state and far less than taxation of churches.” Id. at 676. Although the Court observed that the property tax exemption was also available to other nonprofit organizations, its conclusion that the exemption was a “permissible state accommodation to religion” did not depend on that fact. Id. at 673. As the Court explained, the Establishment Clause prohibits government “sponsorship” of “religious activity,” and a property-tax exemption — unlike a “direct money subsidy” — does not run afoul of that prohibition because the “government does not transfer part of its revenue to churches.” Id. at 675.

Finally, in Texas Monthly, the Supreme Court addressed a state sales-tax exemption for periodicals distributed by a “religious faith” that promoted the “teachings of the faith.” 489 U.S. at 5-6. A divided majority of the Court held that this differentiation of literature based upon religious content violated either the Establishment Clause (all but White, J.) or the Press Clause of the First Amendment (White, J.). Id. at 17-25 (Brennan, J., joined by Marshall and Stevens, JJ.); Id. at 25-26 (White, J., concurring in the judgment); Id. at 26-29 (Blackmun, J., joined by O’Connor, J., concurring in the judgment). Justice Blackmun’s concurrence provides the rationale for the Court because it provides the narrowest grounds on which the decision is based. See Marks v. United States, 430 U.S. 188, 193 (1977) (observing that”[w]hen a fragmented Court decides a case and no single rationale explaining the result enjoys the assent of five Justices, ‘the holding of the Court may be viewed as that position taken by those Members who concurred in the judgment on the narrowest grounds'”) (citation omitted). Justice Blackmun believed that, although “some forms of accommodating religion are constitutionally permissible” (citing Amos as an example), the Texas sales-tax exemption was not, because it entailed “preferential support for the communication of religious messages” without any secular justification for doing so. 489 U.S. at 28.

3. As demonstrated below, § 107 is a permissible accommodation of religion under Lemon. Like the exemptions inAmos and Walz, § 107 lifts a burden on religious practice by eliminating governmental discrimination against (§ 107(1)) — and between (§ 107(2)) — religions, and by minimizing governmental interference with a church’s internal affairs, without burdening third parties. Unlike the exemption in Texas Monthly, § 107 does not endorse a religious message. It merely adapts the Code’s general exemptions for certain types of employer-provided housing to the unique context of a church and its minister. See Legg, Excluding Parsonages from Taxation: Declaring a Victor in the Duel between Caesar & the First Amendment, 10 Georgetown J. of Law &Public Policy 269, 271 (2012) (concluding that “the parsonage exclusions are constitutional when (necessarily) viewed as one element of a larger congressional plan to extend tax relief to recipients of employer-provided housing as a principal feature of their employment”).

4. Before turning to those arguments, however, we first highlight three aspects of § 107(2) that are crucial to an understanding of its constitutional soundness. First, § 107(2) involves an exemption from tax, rather than the grant of a direct subsidy. As a general rule, the “grant of a tax exemption is not sponsorship” prohibited by the Establishment Clause, despite the “indirect economic benefit” that goes with it. Walz, 397 U.S. at 674-675. Unlike a “direct money subsidy,” the “government does not transfer part of its revenue to churches but simply abstains from demanding that the church support the state.” Id. at 675. Moreover, the Government’s refusal to “impose a tax” on religion does not impose a burden on third parties. Winn, 131 S. Ct. at 1447.

Second, § 107(2) provides an exclusion from gross income for employment benefits provided by a church to its minister. The courts have been particularly solicitous of governmental accommodation regarding the “employment relationship between a religious institution and its ministers.” Hosanna-Tabor Evangelical Lutheran Church & Sch. v. EEOC, 132 S. Ct. 694, 705 (2012). In Hosanna-Tabor, the Supreme Court held that “there is a ministerial exception grounded in the Religion Clauses of the First Amendment” that precludes the government from applying generally applicable anti-discrimination laws to a church’s minister, even though such laws may be applied to the church’s other employees. Id. at 707. As the Court explained, the church-minister relationship concerns “the internal governance of the church,” given that the minister “personif[ies] its beliefs,” and a church’s decisions regarding its ministers “affects the faith and mission of the church itself.” Id. at 706-707. Indeed, this Court refers to the “ministerial exception” as the “internal affairs” doctrine because the exception is designed to prohibit governmental interference “in the internal management of churches.” Schleicher v. Salvation Army, 518 F.3d 472, 474-475 (7th Cir. 2008) (applying doctrine to reject ministers’ claim that church violated minimum-wage laws).

Third, § 107(2) is but a single provision in a larger Congressional scheme that exempts qualifying employer-provided housing from taxation. As noted above (at pp. 3-4), and described more fully below, the Code contains several tax benefits for housing used by a taxpayer in the business or for the convenience of his employer, including §§ 119 and 280A(c)(1). Section 107 merely adapts those provisions to the unique church-minister context, so as to avoid the entanglement problems that could arise if ministers had to rely on those provisions to exclude or deduct the value of church-provided housing. “When viewed in the context of other employer-provided housing provisions — both historic and currently-existing — [ § 107(2)] hardly singles out religion for an exclusive benefit in violation of the Constitution.” Legg, above, at 297.

B. Section 107 is a permissible accommodation of religion

As demonstrated below, § 107(2) does not violate the Establishment Clause because it satisfies each part of theLemon test.
1. Section 107(2) has a secular legislative purpose
In reviewing an Establishment Clause challenge, it is critical to consider the historical context of the statute and the specific sequence of events leading to its passage. See Salazar v. Buono, 130 S. Ct. 1803, 1816 (2010) (reversing determination that law violated Establishment Clause where the “District Court took insufficient account of the context in which the statute was enacted and the reasons for its passage”). The legislative history and context of § 107(2) demonstrates that the manifest purpose of the statute is to achieve parity among clergy and denominations, irrespective of a minister’s housing arrangements, and to avoid interference in a church’s internal affairs.a. The history and context of § 107Church-provided housing is a tradition that dates back at least to the 13th century. Savidge, The Parsonage in England 7-9 (1964). The patterns of housing members of the clergy in America have deep histories in the churches of Western Europe. The most common feature of this long-held tradition is that clergy lived in housing (called a parsonage) on the church grounds or nearby on church-owned property. (A68-69.) The parsonage system provided a critical means for churches to ensure that the spiritual needs of their congregations were met by housing the clergy in a place available to the congregation that could accommodate the church business conducted there. (A73.)In 1921, when Congress first enacted the parsonage exclusion, most religious denominations in the United States furnished parsonages to ministers in kind. (A72.) The denominations that did not do so were generally very small or were newer sects. (A72,76.) The latter denominations found it more convenient or feasible to furnish parsonages for their ministers by providing them with cash in lieu of the use of a church-owned building. (A72,76.)

Whether provided by means of cash or in kind, parsonages are furnished to ministers for the church’s “convenience.” Williamson, 224 F.2d at 380. Since a minister “will personify” his church, Hosanna-Tabor, 132 S. Ct. at 706, his residence is traditionally more than mere housing (A70). It is an extension of the church itself and is typically used for “religious purposes such as a meeting place for various church groups and as a place for providing religious services such as marriage ceremonies and individual counseling.” Immanuel Baptist Church v. Glass, 497 P.2d 757, 760 (Okla. 1972); see Brunner, Taxation: Exemption of Parsonage or Residence of Minister, Priest, Rabbi or Other Church Personnel, 55 A.L.R.3d 356, 404 (1974) (observing that “[m]ost ministerial residences can be expected to be incidentally used to some considerable extent as an office, a study, a place of counseling, a place of small meetings, such as boards or committees, and a place in which to entertain and lodge church visitors and guests”).

Against this historical backdrop, Congress enacted an exclusion from gross income for parsonages in 1921, just eight years after the modern federal income tax was authorized by the 16th Amendment to the Constitution. SeeRevenue Act of 1921, Section 213(b)(11). Section 213(b)(11) — the precursor to § 107(1) — excluded from income “[t]he rental value of a dwelling house and appurtenances thereof furnished to a minister of the gospel as part of his compensation.” 42 Stat. 227, 239. Immediately before the enactment of Section 213(b)(11), the Treasury Department had allowed some employees — but not clergy — to exclude the value of employer-provided housing from income under the “convenience of the employer” doctrine.7 See, above, pp. 5-6. In response, Congress enacted Section 213(b)(11). Ministers were thereby placed on an equal footing with other types of employees who were already enjoying the Treasury’s recognition of an exclusion for housing provided for the employer’s convenience. It also spared them the prospect of undergoing an intrusive inquiry regarding the church’s convenience.

Ministers whose churches chose to furnish them with parsonages by way of providing cash allowances for that purpose sought to exclude the parsonage allowance under Section 213(b)(11). The Treasury determined that Section 213(b)(11) “applies only to cases where a parsonage is furnished to a minister and not to cases where an allowance is made to cover the cost of a parsonage.” I.T. 1694. The Treasury advised, however, that such ministers could deduct their payments for the parsonage to the extent that the parsonage was used for “professional” rather than personal reasons.8 Id.

Several courts, however, rejected the Treasury’s determination and permitted ministers to exclude from income the value of parsonages furnished to them in cash as well as in kind. See, above, p. 7. As the Eighth Circuit explained, when a church provides a minister a parsonage allowance in lieu of a parsonage, it was “manifestly for the convenience of the employer,” and such housing should be excluded from income, whether furnished in cash or in kind. Williamson, 224 F.2d at 380.

In 1954, Congress codified those decisions by enacting § 107(2) as an additional exclusion to the existing one, which was redesignated as § 107(1). The statute as a whole leaves it to churches to determine how to provide parsonages — in cash or in kind — free from any influence from the tax laws. As the House and Senate Reports explained (using identical language), the rationale for the new provision was as follows:

      Under present law, the rental value of a home furnished a minister of the gospel as a part of his salary is not included in his gross income. This is unfair to those ministers who are not furnished a parsonage, but who receive large salaries (which are taxable) to compensate them for expenses they incur in supplying their own home.

Your committee has removed the discrimination in existing law by providing that the present exclusion is to apply to rental allowances paid to ministers to the extent used by them to rent or provide a home.
H.R. Rep. No. 1337, at 15 (emphasis added); S. Rep. No. 1622, at 16 (emphasis added). Congress had been alerted to the discrimination in existing law by officials from various religious denominations who complained that the existing “discriminatory” tax provision benefited some clergy and churches but not others. Hearings on Forty Topics Pertaining to the General Revision of the Internal Revenue Code at 1574-1575 (Aug. 1953) (Statement of Hon. Peter Mack). Section 107(2) was enacted “to equalize the disparate treatment among religious denominations.” Legg, above, at 275.Those purposes of preventing discrimination and preserving neutrality were confirmed in 2002, when Congress amended § 107(2) to clarify that the exclusion is limited to the fair rental value of the parsonage. 116 Stat. 583. The bill introducing the proposed amendment explained that § 107 was designed to “accommodate the differing governance structures, practices, traditions, and other characteristics of churches through tax policies that strive to be neutral with respect to such differences.” H.R. 4156, 107th Cong. § 2(a)(4). The bill further confirmed that § 107 was also intended to minimize “intrusive inquiries by the government” into a church’s internal affairs by obviating the convenience-of-the-employer inquiry required by §§ 119 and 280A(c)(1). Id. at § 2(a)(3), (5).

b. The statute’s history and context disclose the secular purpose of eliminating discrimination against, and among, ministers and of minimizing interference with a church’s internal affairsFar from seeking to provide religion a special benefit, Congress enacted § 107(1) and its statutory predecessors to ensure that ministers received the same tax benefit that similarly situated secular employees had received pursuant to the convenience-of-the-employer doctrine (now codified in § 119). All employees — religious or lay — are entitled to exclude from gross income the value of “lodging furnished to him” by his “employer for the convenience of the employer.” § 119. When the convenience-of-the-employer doctrine was initially developed, the Treasury applied it to many secular employees, but not to ministers. By allowing secular employees, but not ministers, to exclude employer-provided housing from income, the Treasury’s 1921 ruling raised serious constitutional concerns. E.g., McDaniel v. Paty, 435 U.S. 618, 629 (1978) (determining that law permitting all persons, except for “ministers,” to participate in political conventions violated the First Amendment). Congress quickly reacted to that ruling by enacting Section 213(b)(11) of the Revenue Act of 1921, the predecessor of § 107(1). Consequently, § 107(1) simply levels the playing field between ministers and other types of employees. It is manifestly constitutional.9After eliminating discrimination against ministers who were furnished housing in kind by their churches, Congress next eliminated discrimination among ministers. It addressed the problem that some churches furnished parsonages by providing parsonages in kind, while others did so by providing cash for that purpose. Congress enacted § 107(2) to ensure that all ministers who were similarly situated were treated equally by the Government, tax-wise. Because § 107(2) has the permissible secular purpose of avoiding governmental discrimination among religions, it furthers one of the core purposes of the Establishment Clause. See Larson v. Valente, 456 U.S. 228, 246 (1982) (determining that law that applied to some, but not all, religions violated the Establishment Clause by running afoul of the “principle of denominational neutrality”).

Moreover, by enacting § 107(2), Congress removed tax-related impediments to a church’s decision whether to furnish a parsonage to its minister in cash or in kind, thereby avoiding interference in the church’s internal affairs.See H.R. 4156, 107th Cong. § 2(a)(3) (observing that one purpose of § 107 is to “minimize government intrusion into internal church operations and the relationship between a church and its clergy”). “Under the Lemon analysis, it is a permissible legislative purpose to alleviate significant governmental interference with the ability of religious organizations to define and carry out their religious missions.” Amos, 483 U.S. at 335. Section 107(2) allows each church to decide whether and how best to furnish a parsonage to its ministers.

Finally, § 107 also serves the secular purpose of avoiding problems of entanglement between church and state that could result from administering the convenience-of-the-employer doctrine where ministers are concerned. As Congress and the courts have recognized, the minister’s home is used for the “convenience of the employer,” whether the home is owned by the church or its minister. Williamson, 224 F.2d at 380; 148 Cong. Rec. 4671 (Apr. 16, 2002) (observing that § 107 recognizes “that a clergy person’s home is not just shelter, but an essential meeting place for members of the congregation”). By providing an exclusion for housing provided by churches to ministers, regardless of the form in which it is furnished, § 107 avoids the intrusive convenience-of-the-employer inquiry required by § 119 (when taxpayers seek to exclude employer-provided housing) or § 280A(c)(1) (when taxpayers seek to deduct the cost of housing used in the employer’s business). See H.R. 4156, 107th Cong. § 2(a)(5) (observing that one purpose of § 107 is to accommodate the fact that “clergy frequently are required to use their homes for purposes that would otherwise qualify for favorable tax treatment, but which may require more intrusive inquiries by the government into the relationship between clergy and their respective churches with respect to activities that are inherently religious”). Avoiding entanglement is a secular purpose. See Amos, 483 U.S. at 336.

c. The District Court ignored the statute’s history and contextIn concluding that § 107(2) lacked a “secular purpose” (App31), the District Court ignored the statute’s history and context, including Congress’s articulation of its anti-discrimination purpose in the 1954 House and Senate reports quoted above. That primary purpose has been recognized by the courts and commentators. E.g., Warnke, 641 F. Supp. at 1087 (observing that § 107(2) was enacted “to eliminate discrimination”); 1 Mertens Law of Fed. Income Taxation § 7:196 n.71 (2013) (same). For purposes of the first prong of the Lemon test, the District Court should have deferred to Congress’s articulation of its secular purpose, unless it determined that purpose to be a “sham.”McCreary County v. ACLU, 545 U.S. 844, 865 (2005). The District Court did not — and could not — find that Congress’s articulated purpose here was a “sham.”The District Court’s error in disregarding the secular purpose asserted by Congress is magnified by the fact that the law in question is a tax statute. The Supreme Court has emphasized that, even in Establishment Clause cases, “‘[l]egislatures have especially broad latitude in creating classifications and distinctions in tax statutes,'” and that courts must give “substantial deference” to a legislative “judgment” regarding a “tax” provision that is challenged under the Establishment Clause. Mueller v. Allen, 463 U.S. 388, 396 (1983) (citation omitted).

The District Court nevertheless opined that § 107(2) was intended “to assist disadvantaged churches and ministers” and held that doing so could not be considered a secular purpose when like benefits were withheld from secular organizations and employees. (App34.) In so holding, the court lost sight of the fact (i) that Congress created the exclusion for cash parsonage allowances to “remove[ ] the discrimination in existing law” among ministers, H.R. Rep. No. 1337, at 15; S. Rep. No. 1622, at 16, and (ii) that the original parsonage exclusion was intended to alleviate discrimination against ministers, who had not been accorded the favorable treatment extended to other, secular employees who had also been furnished lodging for the employer’s convenience.10

There is no merit to the District Court’s further suggestion (App32) that any concern about discrimination was unfounded because § 119 treats “secular” employees who purchase their own housing differently than secular employees who receive employer-provided housing. Treating secular employees differently does not raise First Amendment concerns, while treating churches and their ministers differently does. The “principle of denominational neutrality,” which applies to legislation that may “effectively” distinguish between “well-established churches” that own parsonages and “churches which are new” that do not, Larson, 456 U.S. at 246 & n.23, has no parallel with regard to secular organizations and their employees.

By enacting § 107(2), Congress intended to lift the burden of discriminatory tax treatment that had been imposed on churches and ministers by allowing all ministers to exclude the value of the parsonage from income, no matter how each church chooses to provide that housing. In providing that equal treatment, the statute by no means “discriminates against those religions that do not have ministers,” as the District Court protested. (App33.) If a religion has no ministers, then, a fortiori, there is no taxation of a minister’s housing that needs to be accommodated.See Legg, above, at 292 (observing that “religions without clergy have no leaders needing the benefit of the exclusion”). Nor does § 107(2) create an “imbalance” between ministers who receive housing in kind and those who receive a housing allowance, as the court posited. (App33.) The fact that a minister who uses his housing allowance to buy a home may also benefit from the Code’s deductions available to homeowners is not a consequence of § 107(2), but flows from the minister’s independent decision to use the housing allowance to purchase, rather than rent, a home.
2. Section 107(2) does not have the primary effect of advancing or inhibiting religion
To determine whether a law has the primary effect of advancing or inhibiting religion, this Court considers whether “‘irrespective of government’s actual purpose,'” the “‘practice under review in fact conveys a message of endorsement or disapproval.'” Sherman, 623 F.3d at 517 (citation omitted). A “reasonable observer” would not “view § 107(2) as an endorsement of religion,” as the District Court assumed. (App37.) To the contrary, a reasonable observer, i.e., one who is familiar with “‘the text, legislative history, and implementation of the statute,'” McCreary, 545 U.S. at 862 (citation omitted), would understand that § 107(2) is a tax exemption, not a subsidy, and that it was designed not only to eliminate discrimination among religions, but also to further separate church and state.a. Section 107 does not endorse religion, but merely minimizes governmental influence on, and entanglement with, a church’s internal affairsIn ruling that § 107(2) lacked a secular effect, the District Court failed to appreciate that § 107(2) minimizes governmental interference with a church’s internal affairs. The limited nature of the exclusion in § 107 — which applies only to ministers and not to all religious employees — confirms that its primary effect is not to advance religion, but to preserve the autonomy of churches. Section 107 preserves the “autonomy” of churches by permitting them to determine how best to furnish parsonages to their ministers (whether with cash or in kind) “under the ecclesiastical doctrine of each church,” free of discriminatory tax laws and without any adverse tax consequences hinging on that determination. Legg, above, at 291. In this regard, the § 107 exclusion is similar to the “ministerial exception,” or “internal-affairs doctrine,” that the courts have applied to generally applicable employment laws. Like that doctrine, which minimizes governmental interference “in the internal management of churches,” Schleicher, 518 F.3d at 475, § 107 minimizes both governmental influence on a church’s decision regarding how to furnish a parsonage, and governmental evaluation of church activities that take place in the parsonage.The effect of the § 107 exclusion must also be judged in the context of other housing-related exclusions and deductions provided in the Code. See Zelinsky, The First Amendment & the Parsonage Allowance, Tax Notes 5-8 (Dec. 2013) (critiquing District Court’s opinion for analyzing “section 107 in isolation from other code provisions,” and explaining how applying § 119 to religious employers creates church-state entanglement problems). Section 107 is “similar to other housing provisions in the Tax Code offered to workers who locate in a particular area for the convenience of their employers, and military personnel who receive a tax exclusion for their housing.” 148 Cong. Rec. 4670 (Apr. 16, 2002). All taxpayers may exclude certain employer-provided housing from income. § 119. Likewise, all taxpayers may deduct the cost of their housing to the extent that it is used for their employer’s business and convenience. § 280A(c)(1); I.T.1694. In addition, certain employees of the federal government are entitled to exclude their housing allowance without first demonstrating that the housing was being used for the employer’s convenience. See § 134 (military members); § 912 (civil servants on foreign postings). Section 107 provides similar tax benefits to ministers, but does so in a way that avoids the intrusive inquiries implicit in the employer’s convenience and business exigency requirements inherent in §§ 119, 162, and 280A(c)(1).

Ministers who are furnished parsonages in kind could rely on the Code’s exclusion for housing furnished “for the convenience of the employer” that “the employee is required to accept . . . on the business premises of his employer as a condition of his employment.” § 119. Similarly, ministers who receive parsonage allowances could rely on the Code’s deduction for housing used for the employer’s business and convenience. §§ 162, 280A(c)(1); I.T. 1694. Ministers’ claims of the exclusion or deduction, as the case may be, would raise questions regarding the church’s “convenience,” the scope of the church’s “business premises,” and the terms of the minister’s employment. It has been argued that the “blanket exclusion” under § 107 “does not ‘prefer’ religion but merely reduces the administrative burden of applying § 119 to clergymen.” Bittker, Churches, Taxes & the Constitution, 78 Yale L. J. 1285, 1292 n.18 (1969);11 see Legg, above, at 292 (explaining that § 107 prevents “entanglement” problems under § 280A(c)(1) by “avoid[ing] the need to have the IRS make case-by-case determinations of whether the parsonage was truly granted ‘for the convenience of the employer’ based on the church’s ecclesiastical doctrine or instead granted as a form of compensation not directly for the benefit of the church”); Note, The Parsonage Exclusion under the Endorsement Test, 13 Va. Tax Rev. 397, 418-419 (1993) (comparing§ 107(2) to § 119). If it were necessary for such questions to be answered, it might “require[e] the Government to distinguish between ‘secular’ and ‘religious’ benefits or services, which may be ‘fraught with the sort of entanglement that the Constitution forbids.'” Hernandez v. Commissioner, 490 U.S. 680, 697 (1989) (citation omitted). By obviating the resolution of such questions, § 107 has a salutary effect. Each prong of § 107 removes the potential for entanglement by eliminating the intrusive inquiries that could arise if ministers were forced to rely upon § 119 or § 280A(c)(1). The statute therefore has an indisputably secular effect.

b. Section 107(2) does not subsidize religion, as the District Court erroneously concludedBesides having a secular effect, § 107(2) does not provide government funding for any religious activity, but only a tax exemption for housing. The Supreme Court has made it clear that the “grant of a tax exemption is not sponsorship since the government does not transfer part of its revenue to churches but simply abstains from demanding that the church support the state.” Walz, 397 U.S. at 675. Indeed, observing the long history in the United States of exempting church property from taxation, the Court concluded that “[n]othing” in the “two centuries of uninterrupted freedom from taxation has given the remotest sign of leading to an established church or religion and on the contrary it has operated affirmatively to help guarantee the free exercise of all forms of religious belief.”Id. at 678.Ignoring the analysis of tax exemptions in Walz, the District Court instead based its decision on the proposition that “‘[e]very tax exemption constitutes a subsidy.'” (App18 (quoting Texas Monthly, 489 U.S. at 14-15).) The court’s reliance on this statement from Texas Monthly is misplaced. The quoted language, endorsed only by Justices Brennan, Marshall, and Stevens, did not overrule the majority opinion in Walz, where the Court held that a “tax exemption” is not a “subsidy,” and does not advance religion because there “is no genuine nexus between tax exemption and establishment of religion.” 397 U.S. at 675. The Supreme Court continues to recognize the ruling inWalz that, for “Establishment Clause” purposes, “there is a constitutionally significant difference between subsidies and tax exemptions.” Camps Newfound/Owatonna v. Town of Harrison, 520 U.S. 564, 590 (1997). In disregarding that critical difference, the District Court erred.
3. Section 107(2) does not produce excessive entanglement
Section 107 does not produce excessive entanglement with religion. Indeed, the District Court did not find otherwise. (App41.) To “constitute excessive entanglement, the government action must involve ‘intrusive government participation in, supervision of, or inquiry into religious affairs.'” Vision Church v. Village of Long Grove, 468 F.3d 975, 995 (7th Cir. 2006) (citation omitted). As a tax exemption, § 107(2) does not raise this concern. As the Court noted in Walz, a tax “exemption creates only a minimal and remote involvement between church and state and far less than taxation of churches.” 397 U.S. at 676.Moreover, by adapting the tax benefits generally available to taxpayers in §§ 119 and 280A(c)(1) to the unique circumstances of ministers, § 107 prevents the entanglement that would ensue if the tax benefit were contingent on whether the minister acts for the “convenience of the employer” in using his home. By making such scrutiny unnecessary, the exclusion provided in § 107(2) avoids entanglement and promotes the statute’s secular purposes.

Because § 107(2) satisfies each part of the Lemon test, it does not violate the Establishment Clause. For the same reasons, § 107(2) does not violate the Equal Protection component of the Fifth Amendment’s Due Process Clause, an issue raised by plaintiffs but not reached by the District Court (App2). See Amos, 483 U.S. at 338-339 & n.16 (rejecting equal-protection claim for the same reasons that the Court rejected Establishment Clause claim).
4. Texas Monthly is not controlling because it is distinguishable in crucial respects
In concluding that § 107(2) violates the Establishment Clause, the District Court relied almost solely on the Texas Monthly plurality opinion. (App19.) Far from being “control[ling]” (id.), Texas Monthly is readily distinguishable.First, in contrast to the situation in Texas Monthly, where only religious publications could avoid the tax on periodical sales, here, all taxpayers are permitted to exclude, or deduct, the costs of housing provided by the employer for its convenience (§ 119) or by the employee for the employer’s convenience (§ 280A(c)(1)). Section 107 provides tax benefits similar to those provided in §§ 119 and 280A(c)(1), but tailors the benefit to avoid entanglement with the church-minister relationship. Section 107’s “exclusions are similar to the property tax exemption at issue in Walzbecause the exclusions flow to ministers as a part of a larger congressional policy of not taxing qualifying employer-provided housing.” Legg, above, at 288. And “[u]nlike Texas Monthly‘s narrowly tailored religious publication exemption, the parsonage exclusions in § 107 are part of a larger scheme that more closely aligns with the employer discrimination exception at issue in Amos.” Id. at 290. When § 107(2) is examined as merely one component of a larger, integrated tax code, Congress has by no means provided a tax benefit to religious organizations and “no one else” (App2), as occurred in Texas Monthly.

Second, unlike § 107(2), which has a long history and effect of eliminating discrimination and minimizing entanglement between church and state, the religion-specific exemption in Texas Monthly lacked any secular purpose or effect. An objective observer could only conclude that the government was endorsing the subject of the tax exemption — the promotion of a religious message. Here, in sharp contrast, by eliminating discrimination and entanglement problems, § 107(2) would be understood by an objective observer to “alleviate a special burden on religious exercise.” (App2.)

Finally, § 107(2) does not require the Government to determine whether “some message or activity is consistent with ‘the teaching of the faith,'” as was true in Texas Monthly, 489 U.S. at 20. To the contrary, it precludes such questions from arising by eliminating inquiries into the extent to which the minister’s home is used for religious rather than secular purposes.

CONCLUSION

The judgment of the District Court, as it relates to § 107(2), should be vacated, and the case remanded with instructions to dismiss for lack of jurisdiction. Alternatively, that aspect of the judgment should be reversed.

                  Respectfully submitted,
                  Kathryn Keneally
                  Assistant Attorney General
                  Tamara W. Ashford
                  Principal Deputy Assistant
                  Attorney General
                  Gilbert S. Rothenberg
                  (202) 514-3361
                  Teresa E. Mclaughlin
                  (202) 514-4342
                  Judith A. Hagley
                  (202) 514-8126
                  Attorneys
                  Tax Division
                  Department of Justice
                  Post Office Box 502
                  Washington, D.C. 20044

Of Counsel:
John W. Vaudreuil
United States Attorney

APRIL 2014

FOOTNOTES

1 “Doc” references are the documents in the original record, as numbered by the Clerk of the District Court. “A” and “App” references are to appellants’ separately bound record appendix and the appendix bound with this brief, respectively. Unless otherwise indicated, all ” § ” references are to the Internal Revenue Code, as currently in effect. Pertinent statutes are set forth in the Statutory Addendum.2 Although § 107 “is phrased in Christian terms” to apply to a “minister of the gospel,” “Congress did not intend to exclude those persons who are the equivalent of ‘ministers’ in other religions.” Salkov v. Commissioner, 46 T.C. 190, 194 apply to a “minister of the (1966) (holding that a Jewish cantor was a “minister of the gospel”). The Commissioner interprets “religion” to include “beliefs (for example, Taoism, Buddhism, and Secular Humanism) that do not posit the existence of a Supreme Being.” Internal Revenue Manual § 7.25.3.6.5(2) (Feb. 23, 1999). Moreover, the employer need not be a church or religious organization, as long as the minister is compensated for ministerial services. Treas. Reg. § 1.1402(c)-5(c)(2) (26 C.F.R.).

3 Although Gaylor and Barker also alleged that they were “federal taxpayers,” they did not attempt to maintain suit as taxpayers under Flast v. Cohen, 392 U.S. 83 (1968). (A5.) In a previous attempt to invalidate § 107 brought by FFRF and others, the district court held that the plaintiffs had standing as taxpayers to sue under the Establishment Clause. FFRF v. Geithner, 715 F. Supp. 2d 1051, 1059-1061 (E.D. Cal. 2010). But after the Supreme Court held that taxpayers lacked standing to challenge tax benefits under the Establishment Clause unless they personally have “been denied a benefit on account of their religion,” Ariz. Christian School Tuition Org. v. Winn, 131 S. Ct. 1436, 1440 (2011), the parties stipulated to dismissal without prejudice. (A29-30.)

4 Because FFRF alleges no injury to itself, its standing depends on that of its members, the individual plaintiffs. The District Court recognized as much. (A4.)

5 The Fifth Circuit framed its decision in terms of prudential standing. It nevertheless observed that its prudential concerns about allowing the plaintiffs to litigate “generalized grievances” outside the normal channels of litigating their own tax liabilities were “closely related to the constitutional requirement of personal ‘injury in fact,’ and the policies underlying both are similar.” 987 F.2d at 1176. Decisions such as Allen and Heckler confirm that the matter likewise affects constitutional standing in the first instance. As the Supreme Court recently opined, “generalized grievances” do not pass muster under Article III. Lexmark, 2014 WL 1168967, at *6 n.3.

6 To be sure, a taxpayer may be liable for a penalty for making a “frivolous” submission to the IRS. § 6702. The accuracy-related penalty under § 6662 with which the court was apparently concerned (A9), however, applies only to underpayments, § 6662(a), not to refund claims, and even then only to positions taken without reasonable cause and good faith, § 6664(c)(1).

7 The convenience-of-the-employer rationale for excluding housing furnished in kind was at first recognized only in Treasury rulings and regulations, but was ultimately codified by Congress in 1954 as § 119. See Kowalski, 434 U.S. 77.

8 Prior to 1976, the costs associated with the business use of the taxpayer’s residence were deductible on the same terms as any other “ordinary and necessary” business expense. E.g., Revenue Act of 1921, § 214(a)(1); § 162. In 1976, however, Congress enacted § 280A, which must be satisfied, in addition to § 162, in order to deduct such expenses. Section 280A(c)(1) requires the residence to be used “for the convenience of [the] employer,” just as the employer-furnished housing must be so used in order to qualify for the coordinate exclusion under § 119.

9 Due to plaintiffs’ uncontested lack of standing, § 107(1) is not even challenged here.

10 Moreover, whether any particular legislator might actually have wished to grant a particular advantage to churches would not have undermined Congress’s legitimate anti-discrimination purpose. See Sherman v. Koch, 623 F.3d 501, 510 (7th Cir. 2010) (observing that “‘what is relevant is the legislative purpose of the statute, not the possibly religious motives of the legislators who enacted the law'”) (citation omitted).

11 Although Professor Bittker adverted only to § 119 at this point, the same logic would also apply to claims of deductions for the minister’s use of the home for church business under § 280A(c)(1), which is likewise infused with the convenience-of-the-employer doctrine.

END OF FOOTNOTES
Citations: Freedom From Religion Foundation Inc. et al. v. Jacob J. Lew et al.; No. 14-1152


IRS LTR: VEBA's Exempt Status Not Affected by Expansion of Its Membership.

The IRS ruled that the tax-exempt status of a voluntary employees’ beneficiary association that provides insurance and other benefits to employees covered under collective bargaining agreements will not be affected when it expands its membership to include employees not subject to the terms of a collective bargaining agreement.

Contact Person: * * *
Identification Number: * * *
Telephone Number: * * *

Uniform Issue List: 501.00-00, 501.09-00, 501.09-02, 501.09-04
Release Date: 4/11/2014

Date: January 17, 2014Employer Identification Number: * * *

LEGEND:Date 1 = * * *
League = * * *
Industry = * * *
Members = * * *
Tri-state Area = * * *
Union = * * *
Workers = * * *

Dear * * *:

We have considered your ruling request dated Date 1 and subsequent amendments, requesting a ruling that the inclusion of certain employees will not adversely affect your status as a tax-exempt Trust under Internal Revenue Code (“I.R.C”) § 501(c)(9).

FACTS

You are a trust, tax-exempt under § 501(c)(9). You fund a voluntary employees’ beneficiary association plan (“VEBA”).You state that you currently provide health coverage to participants, who are covered under collective bargaining agreements (“CBA”), and employed in the Industry.

You propose to add as new participants (“Proposed Participants”) to VEBA. Proposed Participants consist of employees of Members. Members are members of League. You state that Proposed Participants “all share an employment-related common bond with respect to the individuals otherwise covered by the Fund”.

You state that Proposed Participants “consist solely of common law employees who: (1) are not subject to the terms of a collective bargaining agreement (“CBA”) entered into with the [Union]; (2) are employed by organizations whose principals are full or lifetime members of the [ League] who are otherwise bound to a CBA with [ Union] when employing [ Workers]; (3) who work for [League] located only in the [ Tri-state Area].” You state that in other words, the Proposed Participants “will be all non-union common law employees of eligible League organization. They will not include self-employed individuals, sole proprietors, partners, LLC members or any other individuals who are not common law employees of eligible [League] members.”

As a result, Proposed Participants, consist of employees of Members who are not covered under a collective bargaining agreement (Members already has some employees covered under the CBA who are present participants of the VEBA).

Last, you represent that the Proposed Participants will consist only of employees of Members who work in the Tri-state Area. You will monitor closely the non-union participants of VEBA to ensure that, at all times at least 90% of the VEBA’s participants are covered by a CBA with Union in accordance with § 1.419A-2T, Q&A-2.

RULING REQUESTED

You requested the following ruling:That the inclusion of the Proposed Participants located in the Tri-state Area will not adversely impact your exempt status as a VEBA under § 501(c)(9).

LAW

I.R.C. § 501(a) provides that an organization described in subsection (c) or (d) or section 401(a) shall be exempt from taxation under this subtitle (IRC Sections 1 et seq.) unless such exemption is denied under §§ 502 or 503.I.R.C. § 501(c)(9) provides that organizations exempt from income tax under section 501(a) include a VEBA providing for the payment of life, sick, accident, or other benefits to the members of such association or their dependents or designated beneficiaries, if no part of the net earnings of such association inures (other than through such payments) to the benefit of any private shareholder or individual.

Treas. Reg. § 1.501(c)(9)-1 provides that for an organization to be described in § 501(c)(9), it must be an employees’ association; membership in the association must be voluntary; the organization must provide for the payment of life, sick, accident, or other benefits to its members or their dependents, and substantially all of its operations must be in furtherance of providing such benefits; and no part of the net earnings of the organization can inure (other than by payment of permitted benefits) to the benefit of any private shareholder or individual.

Treas. Reg. § 1.501(c)(9)-2(a)(1), provides that the membership of an organization described in § 501(c)(9) must consist of individuals who become entitled to participate by reason of their being employees and whose eligibility for membership is defined by reference to objective standards that constitute an employment-related common bond among such individuals. Typically, those eligible for membership in an organization described in section 501(c)(9) are defined by reference to a common employer (or affiliated employers), to coverage under one or more collective bargaining agreements (with respect to benefits provided by reason of such agreement(s)), to membership in a labor union, or to membership in one or more locals of a national or international labor union. For example, membership in an association might be open to all employees of a particular employer, or to employees in specified job classifications working for certain employers at specified locations and who are entitled to benefits by reason of one or more collective bargaining agreements. In addition, employees of one or more employers engaged in the same line of business in the same geographic locale will be considered to share an employment-related bond for purposes of an organization through which their employers provide benefits. Employees of a labor union also will be considered to share an employment-related common bond with members of the union, and employees of an association will be considered to share an employment-related common bond with members of the association. Whether a group of individuals is defined by reference to a permissible standard or standards is a question to be determined with regard to all the facts and circumstances, taking into account the guidelines set forth in this paragraph. Exemption will not be denied merely because the membership of an association includes some individuals who are not employees (within the meaning of paragraph (b) of this section), provided that such individuals share an employment-related bond with the employee-members. Such individuals may include, for example, the proprietor of a business whose employees are members of the association. For purposes of the preceding two sentences, an association will be considered to be composed of employees if 90 percent of the total membership of the association on one day of each quarter of the association’s taxable year consists of employees (within the meaning of paragraph (b) of this section).

Treas. Reg. § 1.501(c)(9)-2(c)(1) provides, generally, that to be described in section 501(c)(9), there must be an entity, such as a corporation or trust established under applicable local law, having an existence independent of the member-employees or their employer.

Treas. Reg. § 1.509(c)(9)-2(c)(2) provides that generally, membership in an association is voluntary if an affirmative act is required on the part of an employee to become a member rather than the designation as a member due to employee status. However, an association shall be considered voluntary although membership is required of all employees, provided that the employees do not incur a detriment as a result of membership in the association.

Treas. Reg. § 1.501(c)(9)-2(c)(3) provides that a VEBA must be controlled by its membership; by independent trustee(s); or by trustees or other fiduciaries at least some of whom are designated by, or on behalf of, the membership.

Treas. Reg. § 1.501(c)(9)-3(a) provides that the life, sick, accident, or other benefits provided by a VEBA must be payable to its members, their dependents, or their designated beneficiaries.

Treas. Reg. § 1.501(c)(9)-3(b) through (g) detail the types of benefits that a tax-exempt VEBA may provide and who is eligible to receive the benefits.

Treas. Reg. § 1.501(c)(9)-3(c) provides that the term “sick and accident benefits” means amounts furnished to or on behalf of a member or a member’s dependents in the event of illness or personal injury to a member or dependent.

Treas. Reg. § 1.501(c)(9)-4(a) provides that no part of the net earnings of an employees’ association may inure to the benefit of any private shareholder or individual other than through the payment of benefits permitted by § 1.501(c)(9)-3.

Treas. Reg. § 1-419A, Q&A-2(1) provides that for purposes of Q&A-1, a collectively bargained welfare benefit fund is a welfare benefit fund that is maintained pursuant to an agreement which the Secretary of Labor determines to be a collective bargaining agreement and which meets the requirements of the Secretary of the Treasury as set forth in paragraph 2 below.

Treas. Reg. § 1-419A, Q&A-2(2) provides that notwithstanding a determination by the Secretary of Labor that an agreement is a collective bargaining agreement, a welfare benefit fund is considered to be maintained pursuant to a collective bargaining agreement only if the benefits provided through the fund were the subject of arms-length negotiations between employee representatives and one or more employers, and if such agreement between employee representatives and one or more employers satisfies section 7701(a)(46) of the Code. Moreover, the circumstances surrounding a collective bargaining agreement must evidence good faith bargaining between adverse parties over the welfare benefits to be provided through the fund. Finally, a welfare benefit fund is not considered to be maintained pursuant to a collective bargaining agreement unless at least 50 percent of the employees eligible to receive benefits under the fund are covered by the collective bargaining agreement.

Treas. Reg. § 1-419A, Q&A-2(4) provides that notwithstanding the preceding paragraphs and pending the issuance of regulations setting account limits for collectively bargained welfare benefit funds, a welfare benefit fund will not be treated as a collectively bargained welfare benefit fund for purposes of Q&A-1 if and when, after July 1, 1985, the number of employees who are not covered by a collective bargaining agreement and are eligible to receive benefits under the fund increases by reason of an amendment, merger, or other action of the employer or the fund. In addition, pending the issuance of such regulations, for purposes of applying the 50 percent test of paragraph (2) to a welfare benefit fund that is not in existence on July 1, 1985, “90 percent” shall be substituted for “50 percent”.

ANALYSIS

You seek to add to VEBA’s membership Proposed Participants who work only in the Tri-state Area. Section 501(a) exempts from taxation, in pertinent part, organizations described in § 501(c). Section 501(c)(9) describes VEBAs as providing payment of life, sick, accident or other benefits to their members.Treas. Reg. § 1.501(c)(9)-2(a)(1), provides that the membership of an organization described in § 501(c)(9) must consist of individuals who become entitled to participate by reason of their being employees and whose eligibility for membership is defined by reference to objective standards that constitute an employment-related common bond among such individuals. Typically, those eligible for membership in an organization described in section 501(c)(9) includes among others to coverage under one or more collective bargaining agreements (with respect to benefits provided by reason of such agreement(s)).

You were established pursuant to a CBA between the League and Union for the purpose of providing health coverage to participants employed in Industry. Under Treas. Reg. § 1.501(c)(9)-2(a)(1), employees covered under a collective bargaining agreement share an employment-related common bond and are deemed as employees.

Further, exemption will not be denied merely because the membership of an association includes some individuals who are not employees (within the meaning of paragraph (b) of this section), provided that such individuals share an employment-related bond with the employee-members. See Treas. Reg. § 1.501(c)(9)-2(a)(1), Thus, although Proposed Participants are not deemed as employee because they are not covered under a CBA for the purpose of Treas. Reg. § 1.501(c)(9)-2(a)(1), they still share an employment-related common bond with present participants of VEBA (CBA covered employees) because both are employees of Members.

Further, an association will be considered to be composed of employees if 90 percent of the total membership of the association on one day of each quarter of the association’s taxable year consists of employees (within the meaning of paragraph (b) of this section). See Treas. Reg. § 1.501(c)(9)-2(a)(1), Therefore, because 90% of total membership of VEBA on one day of each quarter of VEBA’s taxable year must compose of participants who qualify as employees within the meaning of Treas. Reg. § 1.501(c)(9)-2(a)(1), the addition of Proposed Participants who are not covered under the CBA and who work only in the Tri-state Area to participate in VEBA will not jeopardize your tax-exempt status as an organization described under § 501(c)(9).

You represent that at all times at least 90% of the individuals covered by VEBA are covered by a CBA in accordance with § 1.419A-2T, Q&A-2. Under Treas. Reg. § 1-419A, Q&A-2(4), a welfare benefit fund will not be treated as a collectively bargained welfare benefit fund for purposes of Q&A-1 if and when, after July 1, 1985, the number of employees who are not covered by a collective bargaining agreement and are eligible to receive benefits under the fund increases by reason of an amendment, merger, or other action of the employer or the fund. In addition, pending the issuance of such regulations, for purposes of applying the 50 percent test of paragraph (2) to a welfare benefit fund that is not in existence on July 1, 1985, “90 percent” shall be substituted for “50 percent”. Thus, to continue to meet the employment-related common bond requirement based as a collective bargaining agreement veba as provided under Treas. Reg. § 1.501(c)(9)-2(a)(1), 90% of your participants must consist of employees covered under the Union CBA.

RULING

Based on the information submitted, representations made, and the authorities cited above, we conclude that the inclusion of employees of Members of the League located in the Tri-state Area not covered in the CBA with Unionwill not adversely impact your exempt status as a VEBA under § 501(c)(9).This ruling will be made available for public inspection under § 6110 after certain deletions of identifying information are made. For details, see enclosed Notice 437, Notice of Intention to Disclose. A copy of this ruling with deletions that we intend to make available for public inspection is attached to Notice 437. If you disagree with our proposed deletions, you should follow the instructions in Notice 437.

This ruling is directed only to the organization that requested it. I.R.C. § 6110(k)(3) provides that it may not be used or cited by others as precedent.

This ruling is based on the facts as they were presented and on the understanding that there will be no material changes in these facts. This ruling does not address the applicability of any section of the Code or regulations to the facts submitted other than with respect to the sections described. Because it could help resolve questions concerning your federal income tax status, this ruling should be kept in your permanent records.

If you have any questions about this ruling, please contact the person whose name and telephone number are shown in the heading of this letter.

In accordance with the Power of Attorney currently on file with the Internal Revenue Service, we are sending a copy of this letter to your authorized representative.

                  Sincerely,
                  Ronald Shoemaker
                  Manager, Exempt Organizations
                  Technical Group 2

Enclosure
Notice 437

Citations: LTR 201415008



Camp Tax Reform Proposal Affects Financial Services and Transactions.

Richard Larkins, Alan Munro, and Marc Levy review recent tax reform proposals by House Ways and Means Committee Chair Dave Camp, R-Mich., that would affect the financial services industry and users of financial products.

Richard Larkins and Alan Munro are partners in the capital markets tax practice of EY’s international tax services group, and Marc Levy is a partner and EY global banking and capital markets tax leader in the firm’s financial services office.

In this article, the authors review recent tax reform proposals by House Ways and Means Committee Chair Dave Camp, R-Mich., that would affect the financial services industry and users of financial products.

The views expressed in this article are those of the authors and do not necessarily reflect the views of EY or any other member of EY Global Ltd.

A tax reform proposal (the 2014 proposal) released by House Ways and Means Committee Chair Dave Camp, R-Mich., contains several provisions of interest to financial product users, as well as the financial services industry.

A. Marking to Market Derivatives: General Rule

1. Proposal. Under the 2014 proposal, all taxpayers would generally account for all derivatives on a mark-to-market basis, with any resulting gain or loss treated as ordinary in character.

2. Discussion. Under current tax law, derivatives generally need not be marked to market unless (1) the taxpayer is a dealer of those derivatives; (2) the taxpayer is a trader or dealer in commodities that has elected to mark them to market; or (3) the derivative is a so-called section 1256 contract (a regulated futures contract, foreign currency contract, non-equity option, dealer equity option, or dealer securities futures contract). The gains and losses resulting from that marking are generally ordinary, although they are 60 percent long-term capital and 40 percent short-term capital for some section 1256 contracts.

Camp’s 2013 proposal would largely replace these rules with a requirement to generally account for derivatives annually on a mark-to-market basis, with gain or loss treated as ordinary. Under that proposal, if a taxpayer holds a derivative contract at the beginning of the tax year, proper adjustment is made to any gain or loss later realized on that contract to reflect any gain or loss taken into account by the taxpayer in a prior year. Under the proposal, these mark-to-market rules would apply to all derivatives held by a taxpayer, other than those properly treated as hedging transactions or as part of straddles (as discussed below), even though nonrecognition of gain or loss would have resulted from the application of any other code provision.

The 2013 proposal defines a derivative broadly to include any evidence of an interest in, for example, options, futures, forwards, and swaps. There is no requirement for the underlying property to be publicly traded. The proposed definition of a derivative has a fairly narrow exception for options on real property.

Under the proposal, a derivative generally includes any embedded derivative component of a debt instrument. However, the proposal would exclude most debt instruments with embedded derivatives, so as a practical matter, it would apply only to convertible debt instruments. The proposal is unclear on how the tax rules would apply to the debt instrument once the derivative component had been isolated and subject to mark-to-market accounting.

Although generally similar to the 2013 proposal, the 2014 proposal contains some differences. Notably, a derivative is more narrowly defined as a contract “with respect to,” rather than just evidence of an interest in, specified underlying property. Carved out from the definition of a derivative are the following: the right to the return of the same or substantially identical securities transferred in a securities lending, sale-repurchase, or similar financing transaction; some options received in connection with the performance of services; insurance contracts, annuities, and endowments; derivatives regarding the stock of members of the same worldwide affiliated group; commodities used in the normal course of a trade or business; and American depository receipts for foreign stock.

The 2014 proposal retains the rule that the term “derivative” includes a contract with an embedded derivative component, but it would expand the 2013 proposal’s exception for some debt instruments by excluding from mark-to-market treatment convertible debt instruments, contingent payment debt instruments, integrated debt instruments, variable rate debt instruments, investment units, debt with alternative payment schedules, and other debt instruments to which the section 1275(d) regulations apply. The 2014 proposal also instructs the Treasury secretary to modify regulations under section 1275(d) to provide that convertible debt instruments are treated in a manner similar to contingent payment debt instruments. Thus, unlike the 2013 proposal, the 2014 proposal would not treat convertible debt instruments as having an embedded derivative component and would tax those instruments as contingent payment debt instruments.

3. Implications. While the proposal to mark to market derivatives would be a significant departure from current law, the 2014 proposal’s narrowing of the definition of a derivative is welcome, particularly as it relates to debt instruments. The proposal to tax convertible debt instruments under the contingent payment debt instrument rules would be a big change.

Neither proposal contains a requirement for either the derivative itself or the underlying property to be publicly traded. There is no requirement for there to be underlying property, at least in some cases. This would greatly expand the range of transactions to which the mark-to-market requirements could apply. For example, agreements to buy or sell any stock in a corporation or an interest in a partnership would have to be marked to market. Finally, the mark-to-market rules might apply to many real estate transactions, including leases and sale transactions involving multiple properties.

B. Marking to Market Derivatives: Straddle Rule

1. Proposal. The 2014 proposal contains a special rule regarding a taxpayer’s entry into specified offsetting positions (straddles).

2. Discussion. For purposes of this rule, the term “straddle” means offsetting positions regarding actively traded personal property, and the term “mixed straddle” means a straddle that contains a derivative and at least one offsetting position that would not be marked to market under general rules (for example, common stock).

The 2013 proposal focused on mixed straddles. Thus, if a taxpayer entered into a mixed straddle and, when that occurred, a position had a built-in gain, the gain position would be treated as sold for its fair market value at the time of entering into the mixed straddle. If the position had a built-in loss, however, the position would not be treated as sold at the time of entering into the mixed straddle, and the amount of the built-in loss would not be taken into account in determining the amount that is marked to market during the period of the mixed straddle. Rather, the amount of the loss would be taken into account in determining the amount of gain or loss when the position is disposed of in a transaction in which gain or loss is otherwise recognized. In either case, the mark-to-market and ordinary rules would apply to future gains and losses on both the derivative and the nonderivative positions (except for any deferred built-in loss on the non-mark-to-market position in the mixed straddle).

The 2014 proposal is the same as the 2013 proposal, except it excludes some positions regarding debt subject tosection 860G(a)(1)(B)(i) and straddles consisting of long stock and qualified covered call options.

3. Implications. Both proposals go well beyond current law in triggering the recognition of gain on a financial asset when the taxpayer enters into a risk-reduction transaction for that asset. Under current law, gain recognition is not triggered unless the taxpayer eliminated substantially all its risk of loss and opportunity for gain on the asset. Under either proposal, any substantial diminution of the risk of loss or opportunity for gain would be sufficient to trigger the recognition of gain for tax purposes but would not result in the recognition of loss. Moreover, unlike the existing straddle rules, this one-sided rule would apply to entering into contracts to sell all the stock of a corporate subsidiary. Doing so would trigger the recognition of gain when the contract is executed, and additional gain or loss would need to be determined when the stock is delivered under the contract.

C. Marking to Market Derivatives: Hedging

1. Proposal. Both proposals’ mark-to-market treatment of derivatives (and offsetting positions with built-in gain) would not apply to any derivative that is part of a properly identified hedging transaction. Under the proposals, hedging transactions that are properly identified as such for financial accounting purposes (that is, under generally accepted accounting principles) would be treated as meeting the hedge identification requirement of section 1221.

2. Discussion. Under current law, tax hedging treatment is available only if the risk of being hedged relates to ordinary property held (or to be held) or obligations incurred (or to be incurred) by the taxpayer. Further, for a hedging transaction to unambiguously qualify for ordinary gain or loss treatment, it must be timely identified for federal income tax purposes as a hedging transaction in the taxpayer’s books and records. To be timely, the identification statement must be completed by the end of the day on which the hedging transaction is entered into. Under current Treasury regulations, an identification of the transaction as a hedge for GAAP purposes does not satisfy the requirement to identify the transaction for federal income tax purposes.

As a consequence, many taxpayers are treated as having failed to properly identify their hedging transactions for federal income tax purposes, even though they have completed extensive documentation identifying the transaction as such for GAAP purposes under circumstances in which the transaction is obviously functioning as a hedge. Many taxpayers erroneously rely on their GAAP documentation for federal income tax purposes. This requirement is therefore a trap for the unwary.

Under the 2013 proposal, a hedging transaction would be treated as meeting the hedge identification requirement under section 1221 if the transaction were identified as a hedging transaction for tax purposes (as required under existing law) or if the transaction were treated as a hedging transaction within the meaning of GAAP for purposes of the taxpayer’s audited financial statement. The statement must be certified as being prepared in accordance with GAAP by an independent auditor and must be used for purposes of a statement or report to shareholders, partners, other proprietors, or beneficiaries, or for credit purposes.

The 2014 proposal is the same as the 2013 proposal except that it makes tax hedging treatment more attainable to insurance companies by providing that any bond, debenture, note, certificate, or other evidence of indebtedness held by an insurance company shall be treated as ordinary property for purposes of the tax hedging rules (and thus, potentially eligible for tax hedging treatment). Further, the 2014 proposal broadens the exception from foreign personal holding company income treatment for income arising out of commodity hedging transactions.

3. Implications. The proposals’ hedging exception to marking to market would remove most derivatives used by business taxpayers but would not eliminate the difficulties posed by the adoption of a general mark-to-market system. The proposal to trigger immediate gain (but not loss) recognition if a derivative creates a straddle is particularly troubling. First, many economic exposures involve capital assets, which cannot be the subject of a tax hedge, even if the taxpayer attempts to identify them as such. Second, many U.S. multinationals enter into hedging transactions in their controlled foreign corporations, and the rules under subpart F frequently require careful planning to properly match gain or loss on a hedge with loss or gain on the hedged item. The proposals provide only limited help in addressing these potential mismatches. In the subpart F context, the proposals may worsen the effect of inadvertent errors made by a taxpayer because, under a mark-to-market system, a taxpayer will be unable to control the timing of income. Timing and character mismatches will therefore be even more difficult to avoid.

The extension of tax hedging treatment to debt instruments held by insurance companies to economically hedge their insurance policies is welcome.

The automatic identification system would be a welcome change, but it would not eliminate the need for taxpayers to pay attention to required tax identifications. This is primarily because many exposures that can be hedged for tax purposes cannot be hedged for financial accounting purposes, and therefore will not have been identified as hedges by the taxpayer.

D. Corporate Acquisition Indebtedness: Repeal

1. Proposal. The 2014 proposal would repeal section 279 in its entirety.

2. Discussion. Under current law, if specified conditions are met, a corporation’s interest deduction may be denied for debt issued as consideration for the acquisition of stock in another corporation or of assets of another corporation. The 2013 proposal did not address this.

3. Implications. The repeal of section 279 is a welcome proposal because its many conditions means it rarely applies and is not a large revenue raiser. Thus, repealing this provision is unlikely to have much effect, while it would streamline the code.

E. Inclusion in Income of Market Discount

1. Proposal. The 2014 proposal would require purchasers of bonds at a discount on the secondary market to include the discount in ordinary income over the remaining life of the bond. The proposal would limit market discount inclusion to an amount that approximates increases in interest rates since the loan was originally made by using a maximum accrual rate equal to the greater of (1) the original yield on the bond plus 5 percentage points or (2) the applicable federal rate plus 10 percentage points.

2. Discussion. Under current law, a taxpayer is not generally required to include market discount in income as it accrues but may elect to do so. Gain on the disposition of any market discount bond is treated as ordinary income to the extent of the accrued market discount, which generally accrues ratably unless the taxpayer elects to accrue it based on a constant interest rate. No exception exists for the accrual of market discount on distressed debt when there may be no reasonable expectation of full collection. Nor is there any rule limiting the rate at which market discount accrues to a reasonable market rate of interest.

Under the 2014 proposal, the holder of a market discount bond would include market discount in gross income as it accrues. The amount of the inclusion for any tax year would be computed based on a constant interest rate. For bonds with both market discount and original issue discount, the constant interest rate accrual would be reduced by the OID accrual to avoid double counting.

The 2014 proposal is largely the same as the 2013 proposal regarding market discount, with two exceptions. First, under the 2013 proposal, the capped yield would apply to a hypothetical purchase price, which would result in the bond having the capped yield rather than the actual purchase price. This appeared to be a drafting error. Under the 2014 proposal, the capped yield applies to the adjusted purchase price.

The second difference is that under the 2014 proposal, a holder would treat any loss that results from the disposition of a market discount bond as ordinary (rather than capital) loss to the extent of previously accrued market discount.

3. Implications. While the proposal is welcome in that it would limit the accrual of market discount on severely distressed debt (and thus conform the tax law more closely to the holder’s economic reality of doubtful collectability), taxpayers would be forced to currently include in income market discount as it accrued. That latter aspect of the proposal could significantly affect future years if interest rates rise significantly. Further, the proposal does not solve the overaccrual problem with severely distressed debt when the full recovery of principal is highly uncertain, and quite arguably, zero accrual is the correct answer. It is also unclear from the Camp proposal whether it is intended to supersede any common-law doctrines that permit zero accrual in severely distressed debt cases.

The two changes from 2013 are improvements. The drafting error was fixed, which was expected. Treating loss as ordinary (to the extent of previously accrued market discount) could ease the problem of character whipsaw for a taxpayer that purchased distressed debt and was required to include market discount before selling the debt at a loss.

F. Treatment of Exchanges of Debt Instruments

1. Proposal. Under current law, an issuer can recognize cancellation of debt income (CODI) in a debt-for-debt exchange of publicly traded debt, even though the issuer remains liable for the full amount of the principal. The 2014 proposal would prevent this by generally providing that the issue price of a modified debt instrument cannot be less than that of the debt instrument before modification. This floor on the issue price of the modified debt instrument would be reduced by any amount of principal that is forgiven or by any imputed interest arising from a failure of the new debt to state interest at least at the applicable federal rate.

The 2014 proposal also would generally prevent the holder of a debt instrument from recognizing gain or loss as a result of the modification of the debt.

2. Discussion. If the terms of a debt instrument are altered in a manner that constitutes a significant modification of the instrument (which results in a deemed debt-for-debt exchange of the existing debt instrument for the modified instrument), the tax consequences for both the issuer and holder largely depend on the issue price of the modified debt instrument. In determining the issuer’s CODI, the issuer is treated as having satisfied the existing debt for an amount of money equal to the issue price of the new modified debt. Thus, to the extent the issue price of the modified debt is less than the adjusted issue price of the existing debt, the issuer will recognize CODI (without, of course, receiving any cash with which to pay the tax on that income, since the issuer already received the cash when it incurred the debt). Further, the issue price of the modified debt will also determine whether the issuer has OID and whether the applicable high-yield discount obligation (AHYDO) rules, which can operate to deny or defer interest expense deductions attributable to the OID, would apply. For the holder, the issue price of the modified debt determines its amount realized in the debt-for-debt exchange and thus its gain or loss (although that gain or loss may not be recognized currently under the corporate reorganization provisions). Under current law, the issuer may recognize CODI on restructurings of publicly traded debt when the issuer’s creditworthiness has declined or market rates have increased, even if the principal amount of the debt has not changed. The CODI would generally be offset over time with deductions for OID, but the AHYDO rules or other interest limitations may restrict this.

The 2014 proposal seeks to rectify these results by providing that for an exchange (including by significant modification) by an issuer of a new debt instrument for an existing debt instrument from the same issuer, the issue price of the modified debt instrument shall be the lesser of (1) the adjusted issue price of the existing debt instrument; or (2) the issue price of the modified debt instrument — that is, the principal amount, if there is adequate stated interest or, otherwise, the imputed principal amount — which would be determined under section 1274 if the debt instrument were an instrument to which that section applied.

The 2014 proposal would also change the taxation of holders of debt instruments in actual and deemed debt-for-debt exchanges. This would address the problem that arises if a holder has a low basis in the old debt, and the issue price equals its face amount, as would be the case under current law if the debt is not publicly traded and would often be the case under either proposal regardless of public trading. In that case, absent a special rule, the holder recognizes gain equal to the excess of the face amount over its basis, even though there may be no economic gain. The 2014 proposal would address this problem by providing that an actual or deemed debt exchange is to be treated from the holder’s perspective as a nontaxable transaction with carryover basis, regardless of whether the debt qualified as a corporate security under subchapter C. The 2014 proposal’s treatment of holders in this situation differs from the 2013 proposal, which did not address the problem from the holder’s perspective.

3. Implications. The 2014 proposal would be welcome relief if enacted. From an issuer perspective, it would prevent issuers from realizing phantom CODI from restructurings of their public debt when the principal amount remains the same. Holders would also be prevented from realizing phantom gain from a deemed debt exchange when there was no economic gain.

G. GAAP Income Acceleration

1. Proposal. The 2014 proposal would modify section 451 generally in section 3303 of the 2014 proposal and further expand it for specified debt in section 3413, discussed below, by directing taxpayers to apply the revenue recognition rules under section 451 before the OID rules under section 1272.

2. Discussion. The holder of a debt instrument with OID generally accrues and includes in income (as interest) the OID over the term of the instrument. Under current law, some fees earned by credit card issuers and other financial institutions have been treated as OID income, which allows these institutions to postpone the realization of this income to later years for tax purposes. Under the 2014 proposal, these fees and other amounts received by a taxpayer would not be treated as OID, which would require accrual method taxpayers to include an item of income no later than the tax year in which that item is included for financial statement purposes.

The proper tax treatment of various fees paid by credit card users has been a long-standing issue. The question is whether those fees should be treated as interest, in which case credit card issuers can defer recognition of the fees as OID, or as income currently includable in the year the fees are assessed. For years, authorities addressing the matter were somewhat unclear and incomplete. For example, in Rev. Proc. 2004-33, 2004-1 C.B. 989, the IRS states that it would permit late fees imposed by credit card issuers to be treated as interest if specified conditions were met. The IRS held that over-limit fees were not interest in Rev. Rul. 2007-1, 2007-1 C.B. 265, but took a contrary position in TAM 200533023 under somewhat different facts.

In 2009 the Tax Court held in Capital One Financial Corp. v. Commissioner1 that interchange fees are a form of OID on credit card loans and not a fee for services, meaning that credit card issuers could defer recognition of the fees. The Fourth Circuit affirmed the decision in 2011. After Capital One, the IRS announced that it will no longer challenge the position that interchange fees are OID.

The 2014 proposal would prevent credit card issuers and other financial institutions from treating credit card fees as interest that may be deferred under the OID rules.

3. Implications. The 2014 proposal would essentially overrule Capital One and any other authority supporting the position that credit card fees are OID. The proposal would require credit card issuers and other financial institutions to include fees in income no later than the year in which the fees are included for financial statement purposes, which generally means the year the fees are assessed.

H. FIFO Basis Calculation: Sales of Securities

1. Proposal. The 2014 proposal attempts to simplify tax compliance and administration by requiring the cost basis of a security to be determined on a first-in, first-out basis.

2. Discussion. Under section 1001, the gain or loss recognized on the sale or exchange of property is the difference between the amount realized on the sale and the taxpayer’s adjusted basis, as defined under section 1011. To compute the adjusted basis, a taxpayer must determine the property’s original, unadjusted basis, generally its cost, under section 1012 and make required adjustments. Determining basis is complicated when a taxpayer has acquired stock in a corporation on different dates or at different prices and sells or transfers less than all of the shares of the stock. If a taxpayer does not adequately identify a lot from which the stock is sold or transferred, a FIFO rule applies. If, however, the taxpayer makes an adequate identification of the shares sold, the shares identified are treated as sold.

Under the 2013 proposal, the cost of any specified security sold, exchanged, or otherwise disposed of would be determined using an average basis method. The 2014 proposal would abandon this method and instead proposes that the taxpayer determine basis (and the holding period) on a FIFO basis. As in the 2013 proposal, a specified security includes any share of stock of a corporation, evidence of indebtedness, a commodity, or a contract or derivative regarding that commodity.

3. Implications. As with the 2013 proposal, the 2014 proposal would remove the taxpayers’ ability to identify sold securities with an eye toward reducing tax liability. The 2014 proposal should be seen as an improvement on the 2013 proposal, however, because it eliminates the uncertainty regarding the computation of the taxpayer’s holding period. Holding periods are important for individual taxpayers who can benefit from reduced long-term capital gain rates on securities held longer than 12 months.

I. Wash Sale Rules Extended to Related Parties

1. Proposal. Like the 2013 proposal, the 2014 proposal would expand the current wash sale rules, which prevent a taxpayer from claiming a benefit by selling at a loss and quickly repurchasing the same security.

2. Discussion. Under current section 1091(a), a taxpayer realizing a loss upon the sale or other disposition of stock or securities may not deduct the loss if the wash sale rules apply. The wash sale rules apply if, within a period beginning 30 days before the date of the sale or disposition and ending 30 days after that date, the taxpayer has acquired, or has entered into a contract or option to acquire, substantially identical stock or securities. When a loss is disallowed because of the wash sale rules, the disallowed loss is added to the cost of the new stock or securities to arrive at a new basis for the new stock or securities (except for new stock or securities purchased through an IRA). The effect of this basis increase is that the taxpayer is placed in the same position as if he had never sold the stock or securities.

As written, section 1091(a) only applies when the taxpayer, but not a related party, reacquires (or enters into a contract or option to reacquire) substantially identical stock or securities.

As with the 2013 proposal, the 2014 proposal would modify section 1091 by treating a sale and subsequent repurchase as a wash sale when a related party reacquires the stock or securities sold. For this purpose, a related party is (1) the taxpayer’s spouse; (2) any dependent of the taxpayer or any person for whom the taxpayer is a dependent; (3) any individual, corporation, partnership, trust, or estate that controls or is controlled by the taxpayer or individuals described in (1) or (2); or (4) any IRA, qualified tuition program, employee benefit plan, or deferred compensation plan for individuals described in (1) or (2). The proposal also provides that the Treasury secretary shall issue regulations or other guidance to prevent the avoidance of the purposes of section 1091.

3. Implications. The 2014 proposal would curb what would frequently be a transaction to harvest losses. However, it could also function as a trap for the unwary because it could potentially result in a permanent disallowance of the loss rather than mere deferral of it. Under the proposed modification, the disallowed loss would not increase the security basis of any related party, except for that of a spouse. Moreover, it is unclear how significant the change is, given existing common law doctrine that has attempted to curb several similar situations.

J. Derivative Transactions: Corporation’s Stock

1. Proposal. Under the 2014 proposal, a corporation generally would not recognize income, gains, losses, or deductions for derivatives that relate to the corporation’s own stock, except for some transactions involving the corporation acquiring its own stock and entering into a forward contract regarding that stock.

2. Discussion. Under current section 1032(a), a corporation does not recognize gain or loss on the receipt of money or other property in exchange for its own stock. Further, a corporation does not recognize gain or loss on any lapse or acquisition of an option, or regarding a securities futures contract, to buy or sell its own stock.

The 2014 proposal would modify section 1032(a) so that section 1032 derivative items of a corporation are generally not taken into account in determining the corporation’s tax liability. Section 1032 derivative items include any item of income, gain, loss, or deduction that arises (1) out of rights or obligations under any derivative, to the extent that derivative relates to the corporation’s stock; or (2) under any other contract or position to the extent the item reflects or is determined by reference to changes in the value of the stock or distributions thereon. The term “derivative” is defined by reference to proposed new section 486 and thus includes any option, forward contract, futures contract, short position, swap, or similar position. In conjunction with proposed new section 76, the proposal would require a corporation to recognize income to the extent that a receipt of a contribution of money or property exceeds the value of the stock issued in exchange therefor and to recognize income from the receipt of any premium received for an option on its own stock. Finally, the nonrecognition rule in section 1032(a) would not apply if a corporation acquires its own stock, and the acquisition is part of a plan under which the corporation enters into a forward contract for its stock. In that case, the corporation includes the excess of the amount to be received under the forward contract over the FMV of the stock when the forward is entered into as if the excess were OID on a debt instrument. There is a rebuttable presumption that the stock acquisition forward contract is part of a plan if the forward is entered into within 60 days, beginning 30 days before the corporation acquires the stock.

3. Implications. The 2014 proposal would provide welcome clarity regarding the scope of transactions that qualify for nonrecognition under section 1032. However, the 2014 proposal may impose additional compliance burdens on some corporate taxpayers, depending on how the exception applies to complex financial instruments.

K. Dealers in Tax-Exempt Debt

1. Proposal. Section 3124 of the 2014 proposal would apply to all corporations the rule requiring pro rata allocation of interest expense, which today applies only to specified financial institutions.

2. Discussion. This would repeal the provision currently in effect for dealers in tax-exempt obligations (when the dealer is not otherwise a specified financial institution), allowing for no interest expense disallowance if the debt is not directly traceable to the tax-exempt bonds; and if the average adjusted basis of the dealer’s tax-exempt bonds is 2 percent or less of the average adjusted basis of all assets held by the dealer in the active conduct of its trade or business.

3. Implications. This proposal is likely to dramatically affect the after-tax economics for dealers in tax-exempt bonds.

L. Proposed Excise Tax on Large SIFIs

1. Proposal. Section 7004 of the 2014 proposal includes a groundbreaking excise tax estimated to raise more than $86 billion in revenue over 10 years from fewer than 10 companies.

2. Discussion. The targets of the tax are corporations designated as systemically important financial institutions (SIFIs) under the Dodd-Frank Act (DFA) with greater than $500 billion in total consolidated assets. The term “consolidated assets” is defined by reference to section 165 of the DFA. Although not free from doubt, the regulations under section 165 of the DFA appear to count only the assets underneath the intermediate holding company. For the largest foreign banking organizations operating in the United States, only the U.S. assets would count toward the consolidated assets determination. This would result in none of the non-U.S.-headquartered global systemically important banks operating in the United States being subject to the new excise tax. The 2013 proposal did not include a similar section.

3. Implications. Based on the most recent information published by the Federal Reserve, those intended to be covered would be JP Morgan Chase, Bank of America, Citigroup, Wells Fargo, Goldman Sachs, and Morgan Stanley. The large nonbanks designated by the Financial Stability Oversight Council as SIFIs (GE Capital, AIG, and Prudential) also appear to be covered. The tax, paid quarterly, equals 0.035 percent of the SIFI’s total consolidated assets (as reported to the Federal Reserve) exceeding $500 billion. Under the proposal, the tax would begin to apply in the first quarter of 2015. This new excise tax appears to be deductible for federal income tax purposes. According to the House Ways and Means Committee explanation, the stated rationale for the proposed new tax is to charge the large SIFIs for the “implicit subsidy” allowed to those organizations under the DFA. In a recent press report, however, Camp indicated that at least part of the rationale was based on his sense that most financial institutions will be better off under the overall provisions of the plan and that the excise tax is a way to equalize the effects.

M. Limitation on Deduction for FDIC Premiums

1. Proposal. A percentage of assessments for FDIC insurance would be nondeductible for institutions with total consolidated assets that exceed $10 billion. The percentage of nondeductible assessments would equal the ratio of the total consolidated assets exceeding $10 billion to $40 billion. An institution with total consolidated assets exceeding $50 billion would have total disallowance of the premium amount. The provision would be effective for tax years beginning after 2014.

2. Discussion. Under current law, the premiums paid by banks for FDIC insurance are deductible. The provision is intended to correct for the fact that when the FDIC determines the amount of assessments that are necessary to maintain an adequate balance in the Deposit Insurance Fund, it does so on a pretax basis and does not take into account the deductibility of the premium payments. The tax deductions diminish the general Treasury fund and result in an effective transfer from the U.S. treasury to the Deposit Insurance Fund.

3. Implications. Reputedly targeted at large banks, the threshold for this provision is low enough that it may even trap some of the larger community banks. In conjunction with the proposed excise tax on large financial institutions, this provision likely will be seen as unfair by banks.

FOOTNOTE

1 133 T.C. 136 (2009), aff’d, 659 F.3d 316 (4th Cir. 2011).

by Richard Larkins, Alan Munro, and Marc Levy

Copyright 2014 EY LLP.
All rights reserved.* * * * *



State and Local Tax Burdens Are Falling -- But Not Everywhere.

The burden state and local taxes place on taxpayers has fallen after hitting a national high of more than 10 cents on every dollar earned.

The national average for 2011, the most recent data available, was a tax burden equal to 9.8 percent of income, according to a new report by the Tax Foundation, which looked how much people pay in taxes in relation to how much they take in.

The report estimated the tax burden by determining the amount of all state and local taxes paid per capita (including taxes paid in other states) and dividing that by per capita income in each state. The total burden from year to year is impacted by policy changes but also just by changes in income.The nonpartisan foundation, which supports a simpler tax policy and lower rates, used U.S. Census and other federal data on income per capita and taxes paid in-state and out-of-state.

The decrease to 9.8 percent comes after steady increases in the 2000s. The national burden peaked at 10.2 percent of income as wages fell during the 2008 recession and taxes took a bigger share of incomes. The decrease in 2011 is largely because incomes rose that year for the first time since 2008.

New York, New Jersey and Connecticut remained the top tax burden states, with residents paying 12.6 percent, 12.3 percent and 11.9 percent of their incomes, respectively. South Dakota (7.1 percent), Alaska (7.0 percent) and Wyoming (6.9 percent) are the lowest tax burden states, with Wyoming’s tax burden dropping more than a full percentage point and leaping to 50th from 46th place last year. (Wyoming also enjoyed a boost of nearly $3,000 in per capita income.) Many of the least-burdened states don’t have certain major taxes. For example, Alaska (49th), Nevada (43rd), South Dakota (48th), Texas (47th) and Wyoming all do not tax income.

All states except Maryland and the District of Columbia had a decreases in local and state tax burdens. Maryland’s burden increased by one-tenth of a percent to 10.6 percent of per capita income for taxes. Taxpayers in D.C. have a 9.7 percent burden – a full half of a percent more in income to local taxes than in 2010.

Economist Anirban Basu, CEO of Sage Policy Group in Baltimore, said the data used in the study did not reflect the tightened federal spending marked by sequestration, which began in 2013. In Maryland and D.C., the local economies were relatively strong through 2011 in large measure because federal outlays at that time were still flowing rapidly.

“As opposed to many communities looking to shed tax burdens, there may have been less appetite to do so in Maryland and D.C. because at least those areas were tied to strong economies,” Basu said. “My sense is, when we get to the 2013 data, you’ll see different trends.”

Overall, tax burdens across the country varied by a full 5.7 percentage points from the top of the list to the bottom. But it isn’t necessarily good or bad to have a relatively high or low burden, said Brookings Institution Economic Fellow Benjamin Harris. Rather, the range illustrates the choices citizens have in their level of government and the amount of services provided.

“In a way this is a success of our federalist system,” Harris said. “Oftentimes advocates for lower taxes make the case that fewer taxes stimulates overall economic growth and that simply hasn’t been established. There are a lot of other things at play.”



Examiners Given Guidance on State-Chartered Credit Unions and UBIT.

The IRS’s Tax-Exempt and Government Entities Division, in light of two court decisions, has issued a memorandum (TEGE-04-0314-0005) on how examiners should process unrelated business income tax issues of state-chartered credit unions.The memorandum is limited to UBIT issues identified during the examinations of section 501(c)(14) credit unions and does not apply to section 501(c)(1) federal credit unions, nor any other organization exempt from tax.

Generally, to determine whether an activity of a credit union is substantially related for purposes of UBIT, each activity and all the facts and circumstances surrounding that activity must be examined to determine the activity’s relation to the organization’s exempt purpose. According to the memorandum, two district court decisions have held that activities the IRS has previously regarded as subject to UBIT should not be subject to it.

The government has not appealed these decisions. Consequently, the memorandum provides guidance to examiners working cases involving these, and similar, activities.

March 24, 2014
Affected IRM: IRM 4.76.22 and 7.25.14
Expiration Date: March 24, 2015

MEMORANDUM FOR ALL EXEMPT ORGANIZATIONS EMPLOYEES

FROM:
Tamera L Ripperda
Director, Exempt Organizations

SUBJECT:
Applicability of Unrelated Business Income Tax (UBIT) to State
Chartered Credit Unions Described in IRC § 501(c)(14)(A)

This memorandum provides direction to Exempt Organization examiners in the processing of unrelated business income tax (UBIT) issues of organizations described in section 501(c)(14)(A) of the Internal Revenue Code (IRC).This directive is not an official pronouncement of law, and cannot be used, cited, or relied on as such. In addition, nothing in this directive should be construed as affecting the operation of any other provision of the IRC, regulations, or guidance thereunder.

Background:

There are two types of credit unions:

  • Federal credit unions, which are administered by the National Credit Union Administration and described in IRC § 501(c)(1) as federal instrumentalities.
  • State-chartered credit unions, which are described in IRC § 501(c)(14)(A) and are “without capital stock organized and operated for mutual purposes and without profit.”

Tax-exempt state-chartered credit unions provide savings accounts and loans to their members who may not be served by banks, without profit and for the mutual benefit of their members. Mutuality refers to the fact that a credit union’s members are both borrowers and lenders of the credit union.Under IRC § 511(a)(2)(A), the two types of credit unions are treated differently for UBIT purposes:

  • Federal credit unions described in IRC § 501(c)(1) are not subject to UBIT.
  • State-chartered credit unions described in IRC § 501(c)(14)(A) are subject to UBIT.

Under Treas. Reg. § 1.513-1(d)(2), for the conduct of a trade or business from which gross income is derived to be substantially related to the entity’s exempt purposes, the production or distribution of the goods or the performance of the services from which the gross income is derived must contribute importantly to the accomplishment of those exempt purposes. Whether activities that produce gross income contribute importantly to the accomplishment of any purpose for which an organization is granted exemption depends in each case upon the facts and circumstances involved. To determine whether an activity of a credit union is substantially related for purposes of UBIT, each activity and all the facts and circumstances surrounding that activity must be examined to determine the activity’s relation to the organization’s exempt purpose.Two district court decisions have held that activities the IRS has previously regarded as subject to UBIT should not be subject to UBIT. See Bellco Credit Union v. United States, 735 F.Supp. 2d 1286 (2010), and Community First Credit Union v. United States, No. 08-cv-0057 (E.D. Wis. May 15, 2009), ECF No. 84.

Both Bellco and Community First found that the sale of credit life and credit disability insurance to members was not subject to UBIT. Additionally, Bellco found that the sale of accidental death and dismemberment insurance was not subject to UBIT (excluded from UBI as royalty income). Also, Community First found that the sale of Guaranteed Auto Protection (GAP) insurance was not subject to UBIT.

The government has not appealed these decisions. Consequently, this directive provides guidance to examiners working cases involving these, and similar, activities.

Planning and Examination Guidance:

Examiners examining original or amended Forms 990-T or claims for refund by State-chartered credit unions described in IRC § 501(c)(14)(A) should:

      1. Treat income from the following income-producing activities as substantially related income not subject to UBIT:

      • Sale of checks/fees from a check printing company
      • Debit card program’s interchange fees
      • Credit card program’s interchange fees
      • Interest from credit card loans
      • Sale of collateral protection insurance
      2. Treat income from the marketing of the following insurance products as well as certain ATM fees as subject to UBIT:

      • Automobile warranties
      • Dental insurance
      • Cancer insurance
      • Accidental death and dismemberment insurance
      • Life insurance
      • Health insurance
      • ATM “per-transaction” fees from nonmembers
      3. Treat income from the following products if sold to members as not subject to UBIT:

      • Credit life and credit disability insurance
      • GAP auto insurance
      If these two insurance products are sold to non-members, treat the income from these products as subject to UBIT.

4. Unless there is a royalty arrangement (rather than payments for a credit union’s services), treat all other insurance products including accidental death and dismemberment insurance as generally subject to UBIT.

Scope of the Directive:

This directive is limited to UBIT issues identified during the examinations of section 501(c)(14) credit unions. This directive does not apply to section 501(c)(1) Federal credit unions, nor any other organization exempt from tax.

Internal Revenue Manual section 4.76.22 will be updated to reflect the content of this directive, and IRM section 7.25.14 will be updated to the extent that the information contained herein impacts rulings.

Please contact the 501(c)(14) subject matter expert in EO Technical Group 3 with any questions regarding the application of this directive, or issues relating to income on a product other than those mentioned above.

cc:
www.irs.gov
Victoria A. Judson, Division Counsel/Associate Chief Counsel TE/GE
Kirsten B. Wielobob, Chief, Appeals



Bill Would Permanently Revive the BAB Program.

WASHINGTON — The Build America Bond program would be permanently revived with lower subsidy rates and without issuers being hurt by sequestration cuts, under a bill recently introduced in the Senate.

The subsidy rate would be 31% for BABs issued in calendar year 2014 and lowered by 1% each successive year, remaining at 28% for BABs issued in 2017 and thereafter.

Sen. Edward Markey, a Massachusetts Democrat and member of the Senate Environment and Public Works Committee, introduced the “Bolstering Our Nation’s Deficient Structures Act of 2014” or “BONDS Act,” on Thursday. The bill, S. 2203, has been referred to the Senate Finance Committee.

“The BONDS Act is a win-win-win for cities, states and the entire country,” Markey said in a release. “It encourages investment in Massachusetts’ infrastructure backbone, will put workers back on the job and empowers states and cities to plan for long-term economic growth.”

The BAB program, originally authorized as part of the American Recovery and Reinvestment Act, allowed state and local governments in 2009 and 2010 to issue taxable bonds and receive subsidy payments from the federal government equal to 35% of their interest costs.

From April 2009 through the expiration of the program at the end of 2010, more than $181 billion of BABs were issued to provide financing for new public capital infrastructure projects.

Massachusetts issued close to $5 billion of BABs, $3 billion of which benefited a program that repairs and rebuilds structurally deficient bridges in the commonwealth, according to a summary of the bill.

The subsidy payments for BABs have been reduced as result of congressionally mandated spending cuts known as sequestration. However, under Markey’s bill, issuers would not be hurt by sequestration cuts for any federal subsidy payments made after the date of enactment.

The legislation also would allow qualified BABs to be current refunded.

“In addition to protecting and safeguarding traditional tax-exempt municipal bonds, which will always be the centerpiece of local government financing, Senator Markey is offering communities an attractive and innovative financing tool to build and invest in schools, police and fire stations, roads, bridges, parks and other critical public infrastructure,” said Geoffrey Beckwith, executive director of the Massachusetts Municipal Association.

Markey’s bill is a companion bill to legislation introduced by Rep. Richard Neal, D-Mass., last year called the Build America Bonds Act of 2013. That bill, H.R. 789, has not made it out of committee.

In January of this year, Neal introduced another bill, H.R. 3939, that includes the same BAB provisions as his earlier bill, but would also eliminate the alternative minimum tax for private-activity bonds, exempt water and sewer facility bonds from the annual state volume caps for PABs and create an infrastructure bank.

BY NAOMI JAGODA

APR 7, 2014 2:39pm ET



Grassley Seeks Information on Oversight of Exempt Hospitals.

WASHINGTON — Sen. Chuck Grassley of Iowa is asking the IRS to account for the status of several important oversight measures for nonprofit hospitals enacted in 2010. Grassley co-authored the provisions imposing standards for the tax exemption of nonprofit hospitals for the first time.”These reforms were the culmination of a review of nonprofit hospitals I began in 2005 that revealed that the practices of many nonprofit hospitals were virtually indistinguishable from their for-profit counterparts,” Grassley writes in a letter to IRS Commissioner John Koskinen. “While these new provisions were intended to provide more oversight of nonprofit hospitals, it appears that not all of the requirements have been implemented.”

To date, key legal guidance needed to ensure compliance with the law does not appear to be finalized. The law also requires the IRS and the Department of Health and Human Services to collect information on nonprofit hospitals and report to Congress every year. An annual report should have been issued to Congress for Fiscal Year 2012, but Congress never received any report. Congress has also yet to receive the report for Fiscal Year 2013.

“As a result, Congress still does not have access to the information that was required to be reported by law,” Grassley writes. “This raises serious concerns both about the oversight of nonprofit hospitals and the government’s ability to faithfully execute laws passed by Congress.”

Grassley’s reforms came after oversight and investigative reviews of nonprofit hospitals revealed troubling practices among some nonprofit hospitals, including providing very little charitable patient care or other community benefits; failing to publicize charitable care to patients; charging indigent, uninsured patients more than insured patients; and using very aggressive collection practices. The Government Accountability Office and others, including the former IRS commissioner, have said for a long time that there is often no discernible difference between the operations of taxable and tax-exempt hospitals. Grassley modeled the new accountability measures after principles and polices that the Catholic Health Association has had in place for years.

The text of Grassley’s April 4 letter to the IRS commissioner is available here.

* * * * *April 4, 2014

The Honorable John Koskinen
Commissioner
Internal Revenue Service
U.S. Department of the Treasury
1111 Constitution Avenue, NW
Washington, DC 20224

Dear Commissioner Koskinen:The Patient Protection and Affordable Care Act (PPACA) included several reforms to nonprofit hospitals that were intended to hold them accountable for their tax-exempt status. These reforms were the culmination of a review of nonprofit hospitals I began in 2005 that revealed that the practices of many nonprofit hospitals were virtually indistinguishable from their for-profit counterparts. While these new provisions were intended to provide more oversight of nonprofit hospitals, it appears that not all of the requirements have been implemented.

The reforms in PPACA created new requirements for nonprofit hospitals. These include requiring hospitals to regularly complete a community needs assessment, establish and make public a financial assistance policy, and restricting certain billing and collection procedures used for those who qualify for financial assistance.1 PPACA also created requirements for the Department of the Treasury, the Internal Revenue Service (IRS), and the Department of Health and Human Services (HHS) to ensure nonprofit hospitals comply with the law and provide information to Congress on the effectiveness of the provisions and whether any further legislation may be necessary.2

In June 2012, the Treasury Inspector General for Tax Administration (TIGTA) issued a report finding that much of the legal guidance required to be written by the federal government is still incomplete. While TIGTA found that the IRS had begun implementing the PPACA provisions, it noted that “until guidance is published, the public cannot be assured that the IRS has implemented all controls to ensure compliance with [PPACA] provisions designed to protect those served by tax-exempt hospitals.”3 To date, that guidance does not appear to be finalized.

The PPACA also required the IRS and HHS to collect information on nonprofit hospitals and report to Congress every year. An annual report should have been issued to Congress for Fiscal Year 2012, but Congress never received any report. Congress has also yet to receive the report for Fiscal Year 2013. In TIGTA’s 2012 report, it recommended that the IRS enter into a Memorandum of Understanding (MOU) with HHS in order to better coordinate the collection and sharing of information for the report. The IRS agreed with TIGTA’s recommendation, but the MOU has not been finalized. As a result, Congress still does not have access to the information that was required to be reported by law. This raises serious concerns both about the oversight of nonprofit hospitals and the government’s ability to faithfully execute laws passed by Congress.

In order to review the status of the IRS’s work on nonprofit hospitals, I ask that you please provide the following information:

1) What is the status of the MOU between IRS and HHS?

2) When do you expect the MOU to be finalized?

3) Why hasn’t there been an annual report to Congress regarding nonprofit hospitals, as required by law?

4) What is the status of the annual report? When can Congress expect to receive the Fiscal Year 2013 report?

5) What is the current status of regulations implementing the nonprofit hospital provisions of the PPACA? Please indicate what regulations, if any, are final, proposed, or have yet to be proposed. For any regulations that are not final also indicate where they are in the review process and expected timeline for completion.

6) The PPACA requires the IRS to conduct a review of the community benefit activities of nonprofit hospitals at least once every three years. TIGTA indicated in its June 2012 report the IRS had begun conducting these reviews. How many of the approximately 1,700 nonprofit hospitals has the IRS reviewed to date?

7) What were the results of the IRS’s reviews of nonprofit hospitals? In responding to this question, please provide aggregate data on hospitals found to be in compliance, those found to be out of compliance, and the nature of the noncompliance.
Thank you for your cooperation and attention in this matter. I would appreciate a response by April 18, 2014. If you have any questions, please do not hesitate to contact Chris Conlin of my personal office staff at 202-224-3744 or Tegan Millspaw on my Judiciary Committee staff at 202-224-5225.

                  Sincerely,
                  Charles E. Grassley
                  U.S. Senator
FOOTNOTES

1 P.L. 111-148, § 9007.2 Id.

3 Treasury Inspector General for Tax Administration, “Affordable Care Act: While Much Has Been Accomplished, the Extent of Additional Controls Needed to Implement Tax-Exempt Hospital Provision is Uncertain,” June 21, 2012.

END OF FOOTNOTES


Obama Signs Nonprofits Pension Bill.

President Obama on April 7 signed into law legislation that would give nonprofits the option of a permanent exemption from pension funding requirements.

The measure, the Cooperative and Small Employer Charity Pension Flexibility Act (H.R. 4275), would apply to about 30 pension plans held by more than 127,000 active nonprofit employees, according to a summary  provided by the bill’s sponsors, Rep. Susan W. Brooks, R-Ind., and House Ways and Means Committee member Ron Kind, D-Wis. Congress exempted charity and cooperative pension plans from the Pension Protection Act of 2006, but the exemption is set to expire, the summary says. Many nonprofits are able to provide defined benefit pension plans to their employees only because they can pool their resources with other associations in a multiemployer plan structure, the bill text notes.

The House passed H.R. 4275 March 24. The Senate followed a day later, passing the measure by a voice vote. The measure would reduce revenue by $190 million over 10 years, according to a Joint Committee on Taxation estimate (JCX-24-14).

by Meg Shreve

 



IRS Declines to Limit Retroactive Effect of Revocation of Exemption.

In technical advice, the IRS declined to provide relief from retroactive revocation of an organization’s tax-exempt status. On its exemption application, the organization said it would provide Bible-based financial education. But the IRS subsequently discovered that the organization’s primary activity was promoting and enrolling people in debt management plans for a for-profit entity that processed the debt management plans. The organization also did not offer any educational seminars or workshops even though it had said on its exemption application that it would do so, and it charged fees for services after having said on its exemption application that it would not do that. Also, contrary to what it said on its exemption application, the organization was a direct outgrowth of its founders’ family and marriage counseling organization. The organization did not inform the IRS of these changes in its operations.

Therefore, the IRS concluded that revocation may be retroactive to the year under examination when the agency determined that the organization had made material changes to its operations.

 

UIL: 7805.03-00
Release Date: 3/28/2014

Date: January 3, 2014

Area Director, Area 4 TEGE Appeals,
Philadelphia, PA

Taxpayer’s Name: * * *
Taxpayer’s Address: * * *
Taxpayer’s ID No.: * * *
Year(s) Involved: * * *
Conference Held: * * *

LEGEND:

Taxpayer = * * *

ISSUE

Whether the Commissioner, TE/GE, should exercise discretion to grant the Taxpayer relief under § 7805(b) of the Internal Revenue Code to limit the retroactive effect of revocation of its exempt status under § 501(c)(3).

FACTS

Application for ExemptionTaxpayer applied for tax-exempt status, describing its activities on the Form 1023. It stated it was formed “to meet the needs of persons experiencing financial difficulties by offering Biblical based financial counseling, education, encouragement and empowerment.” Further, its organizing documents provide it is organized and operated exclusively for religious purposes within the meaning of § 501(c)(3). It was founded by two persons who are both clinical psychologists and licensed family and marriage counselors (“Founders”). Its Board of Directors consisted of one of the founders serving as Chairman and President, the other founder as Vice President, and three other individuals; none of the directors were to be compensated.

To achieve its objectives, Taxpayer stated the following programs would form the basis of its services:

      (1)

Telephone Counseling

       — Provide telephone financial counseling for those individuals who are unable to physically access its facilities.

(2) Face-to-Face Counseling — Provide face-to-face financial counseling for those seeking assistance with restoration of credit, financial management, debt management, and debt elimination. This will be accomplished within the context and with the partnership of the local church.

(3) Seminars — Provide seminars and workshops that disseminate information about financial management, budgeting, stewardship and Biblical financial principles, primarily through the local church.

(4) Resource Support — Produce and make available to clients, resources that support its efforts to fulfill its mission. These products will be made available to its clients as they interface with its programs.

(5) Media Ministry — Produce and broadcast various media programs such as radio, television, and Internet communications that fulfill its mission and purpose.
Taxpayer’s financial support, listed in order of size, was to consist of (1) Donations, and (2) a third party organization will provide debt management services. It described its fundraising program as “Initial start-up and seed monies will be acquired from individual donors. Monies acquired from seminars and workshops will be based upon free will offerings. Products will be provided for a suggested donation.”Taxpayer answered “No” when asked if it was the outgrowth of (or successor to) another organization, or had a special relationship with another organization by reason of interlocking directorates or other factors. Taxpayer also answered “No” when asked if recipients are required to pay for Taxpayer’s benefits, services, or products.

Based on these representations, the Service issued a favorable determination letter and classified Taxpayer as a public charity.

Examination

The examination found that Taxpayer’s primary activity was enrolling individuals in debt management plans (“DMP”) in return for fees from debtors and fair share payments from its creditors. Taxpayer’s phone counselors enrolled callers; it did not process the DMP applications itself, but rather forwarded completed DMP packages to a for-profit company for processing. Taxpayer’s DMP agreement required clients to make a monthly “suggested donation” of $29, in addition to payments to creditors. DMP clients made payments directly to the for-profit company. The for-profit company disbursed the payments to creditors, and on a weekly basis, paid Taxpayer for its portion of the “fair share” payments and monthly DMP client’s suggested donation. The examination revealed that 99 percent of Taxpayer’s revenue came from DMP activity.

Taxpayer’s training manual instructed counselors and administrators to aggressively pursue potential clients. It provided a specific script to keep the conversations short, but to collect all the information required by the creditors for DMP enrollment. The manual appears to instruct the counselors to do one thing — sell DMPs to potential clients.

Taxpayer acknowledged that it did not conduct any educational seminars or workshops, through the local church or elsewhere, during the tax years under exam. Taxpayer spent less than $800 on educational activities during the years under exam. The only “resources” that it made available to its clients consisted of a PowerPoint presentation on subjects of money management and finding meaningful employment posted on its website. It did not produce or broadcast any educational programs for a “media ministry.”

The examination revealed that Taxpayer had been conducting transactions with several related for-profit businesses and exempt entities. Such relationships were not disclosed during the application process, including the fact that Taxpayer was an outgrowth of the founders’ family and marriage counseling organization. The Founders received compensation from Taxpayer and the related organizations. However, Taxpayer had no written employment agreements with Founders, and did not offer evidence of the hours each Founder devoted to his position at Taxpayer. Furthermore, Taxpayer paid one of the related organizations rent during one of the exam years.

Taxpayer did not report any of these changes in operation to the Service.

Taxpayer appealed the proposed revocation. Appeals sustained the revocation. Following the appeals process, the National Office received this request for relief from retroactive revocation as a mandatory TAM.

Legal Standard:

Section 7805(b)(8) provides that the Secretary may prescribe the extent, if any, to which any ruling (including any judicial decision or any administrative determination other than by regulation) relating to the internal revenue laws shall be applied without retroactive effect.

Section 1.501(a)-1(a)(2) of the Income Tax Regulations states that an organization that the Commissioner has determined to be exempt under § 501(a) may rely upon such determination so long as there are no substantial changes in the organization’s character, purposes, or methods of operation, and subject to the Commissioner’s inherent power to revoke rulings because of a change in the law or regulations, or for other good cause.

Section 301.7805-1(b) of the Procedure and Administration Regulations grants the Commissioner authority to prescribe the extent to which any ruling issued by his authorization shall be applied without retroactive effect.

Section 4.04 of Rev. Proc. 2013-5, 2013-1 I.R.B.170, states that all requests for relief under § 7805(b) must be made through a request for technical advice (TAM). Section 19.04 states further that when, during the course of an examination by EO Examinations or consideration by the Appeals Area Director, a taxpayer is informed of a proposed revocation, a request to limit the retroactive application of the revocation must itself be made in the form of a request for a TAM and should discuss the items listed in § 18.06 of Rev. Proc. 2013-5, as they relate to the taxpayer’s situation.

Section 18 of Rev. Proc. 2013-5 lists the criteria necessary for granting § 7805(b) relief as well as the effect of such relief. Section 18.06 states, in part, that a TAM that revokes a determination letter is not applied retroactively if:

      (1) there has been no misstatement or omission of material facts;

(2) the facts at the time of the transaction are not materially different from the facts on which the determination letter was based;

(3) there has been no change in the applicable law; and

(4) the taxpayer directly involved in the determination letter acted in good faith in relying on the determination letter, and the retroactive revocation would be to the taxpayer’s detriment.
Rev. Proc. 2013-9, 2013-2 I.R.B. 255, sets forth procedures for issuing determination letters (from EO Determinations) and rulings (on applications for recognition of exempt status by EO Technical) on the exempt status of organizations under § 501. These procedures also apply to revocation or modification of determination letters or rulings.Section 12.01 of Rev. Proc. 2013-9 states, in part, that the revocation or modification of a determination letter or ruling recognizing exemption may be retroactive if the organization omitted or misstated a material fact, or operated in a manner materially different from that originally represented. In certain cases an organization may seek relief from retroactive revocation or modification of a determination or ruling under § 7805(b) using the procedures set forth in Rev. Proc. 2013-5, §§ 18 and 19.

Section 12.01(1) of Rev. Proc. 2013-9 states that where there is a material change inconsistent with exemption in the character, purpose, or method of operation of an organization, revocation or modification will ordinarily take effect as of the date of such material change.

In Automobile Club of Michigan v. Commissioner, 353 U.S. 180, 184 (1957), the Supreme Court held that the Commissioner has broad discretion to revoke a ruling retroactively. It further held that a retroactive ruling “may not be disturbed unless . . . the Commissioner abused his discretion vested in him . . .” Id.

In Stevens Bros. Foundation, Inc. v. Commissioner, 324 F.2d 633, 641 (1963), the court found the Foundation’s efforts “far from convincing” to demonstrate that its information reports were adequate and sufficient to apprise the Commissioner of its entry into the business activities which led to denial of its tax-exempt status. Shortly after receiving its tax-exempt ruling, the Foundation contracted with a for-profit company, but failed to disclose this fact to the Commissioner on its Forms 990. The court upheld the Service’s retroactive revocation.

In Variety Club Tent No. 6 Charities, Inc. v. Commissioner, 74 T.C.M. (CCH) 1485 (1997), the court held that petitioner “operated in a manner materially different from that originally represented.” The organization represented in its exemption application and articles of incorporation that no part of its net income would inure to the benefit of any private shareholder or individual. But the court found instances of inurement over several years, and upheld the Service’s retroactive revocation for such years.

ANALYSIS

During the years under examination, Taxpayer’s operations were materially different from the description it provided in its exemption application. See Variety Club Tent No. 6 Charities, T.C. Memo 1997-575; Rev. Proc. 2013-9, § 12.01; Rev. Proc. 2013-5 at § 18.06 (no misstatement or omission of material facts or materially different facts). In its application, Taxpayer described multiple plans for Bible-based financial education through in-person counseling, seminars and workshops, resource support, and public media. However, the examination established that Taxpayer’s primary activity was promoting, marketing, and enrolling individuals in DMPs for the for-profit entity that processed the DMPs. It also failed to offer any educational seminars or workshops, or media activities, as it had represented in its Form 1023. Contrary to Taxpayer’s representation in its Form 1023, the examination also established that Taxpayer charged customers fees for its services, including a monthly service fee for DMPs. Furthermore, despite representing its source of revenue would be derived from “donations”, Taxpayer did not receive public support nor public donations. Taxpayer also represented in its Form 1023 that it was not the outgrowth of another organization; however, the exam revealed it was a direct outgrowth of the founders’ family and marriage counseling organization. Contrary to Taxpayer’s representations, the examination revealed that it had several business relationships with other related entities that it did not disclose. Taxpayer did not apprise the Service of these material changes in its operations. See Stevens Bros. Foundation, 324 F.2d at 641 (failure to adequately and sufficiently inform the Service of material changes in operations).Therefore, revocation may be retroactive to the year under examination when the Service determined Taxpayer had made material changes in its operations. See Automobile Club of Michigan, 353 U.S. at 184 (Commissioner has broad discretion to revoke a ruling retroactively); Rev. Proc. 2013-9, section 12.01(1) (revocation ordinarily applies as of the date of the material changes in operations).

CONCLUSION

The Commissioner, TEGE, has declined to exercise discretion to limit the retroactive effect of revocation of exempt status under § 501(c)(3). Revocation is effective as of * * *.

Citations: TAM 201413013



Court Holds Document's Privilege Was Waived in Exempt Status Suit.

A U.S. district court denied a foundation’s motion to preclude the use of an allegedly privileged document in a suit challenging the revocation of its tax-exempt status, finding that attorney-client privilege was waived by the inadvertent disclosure of the document and the privilege holders’ failure to act promptly to assert the privilege.

 

EDUCATIONAL ASSISTANCE FOUNDATION
FOR THE DESCENDANTS OF HUNGARIAN IMMIGRANTS
IN THE PERFORMING ARTS, INC.,
Plaintiff,
v.
UNITED STATES OF AMERICA,
Defendant.

UNITED STATES DISTRICT COURT
FOR THE DISTRICT OF COLUMBIA

MEMORANDUM OPINION

The plaintiff, Educational Assistance Foundation for the Descendants of Hungarian Immigrants in the Performing Arts, Inc. (“Foundation”), challenges the Internal Revenue Service’s (“IRS”) decision to revoke its status as a tax-exempt organization under 26 U.S.C. § 501(c)(3) (2006). Amended Complaint for Declaratory Judgment (“Am. Compl.”) ¶¶ 1, 12, 27-31. In reaching its decision to revoke the Foundation’s tax-exempt status, the IRS relied in part upon a document that the Foundation asserts is protected by attorney-client privilege. Plaintiff’s Motion to Preclude the Government From Introducing Privileged Letter From Barrett Weinberger to Attorney Stephen Bolden and the Entire Administrative Record, and For Related Relief (“Pl.’s Mot.”) at 3-4; United States’ Memorandum Regarding Allegedly Privileged Document (“Def.’s Opp’n”) at 2. The Foundation’s motion to preclude the introduction of the allegedly privileged document in these proceedings and a related motion to intervene are currently before the Court. For the reasons set forth below, the Court concludes that it must deny the motion to preclude the introduction of the contested document and deny the motion to intervene as moot.1

I. BACKGROUND

Effective December 24, 2003, the IRS recognized the Foundation as a tax-exempt organization under 26 U.S.C. § 501(c)(3) “created to assist the educational development of descendants of Hungarian [i]mmigrants who had a particular interest and talent in the arts.” Pl.’s Mot. at 5; see also Def.’s Opp’n at 5. The Foundation is funded entirely with a charitable bequest by the Estate of Julius Schaller. Pl.’s Mot. at 5; Def.’s Opp’n at 5. Prior to his death, Julius Schaller engaged attorney Gary B. Freedman to draft his will. Pl.’s Mot. at 5. The will drafted by Freedman was subsequently executed, and Schaller later died on December 28, 2003. Id.In 2005, the co-executors of Schaller’s will, Barrett Weinberger and Frances Odza, along with the will’s beneficiaries, retained attorney Stephen R. Bolden to bring suit against Freedman for malpractice in drafting Schaller’s will. Id. at 6; Def.’s Opp’n at 6. A December 18, 2005 letter from Barrett Weinberger to Stephen Bolden is at the center of the dispute before the Court. In it, Weinberger describes the relationship between the Estate of Julius Schaller and the Foundation. See Pl.’s Mot., Exhibit (“Ex.”) 2 (December 18, 2005 Letter from Barrett Weinberger to Stephen R. Bolden (“Weinberger-Bolden Letter”)).

In March 2007, the IRS initiated an audit of the Foundation. See Pl.’s Mot., Ex. 8 (Case Chronology) at 2.2 The IRS subsequently commenced a criminal investigation of Barrett Weinberger, Pl.’s Mot. at 8 n.4; Def.’s Opp’n at 7, and, in January 2008, conducted an audit of the Schaller Estate’s tax return, Pl.’s Mot. at 7. On April 20, 2009, the IRS sent an Information Document Request to the Foundation in connection with the ongoing investigation. See Pl.’s Mot., Ex. 6 (April 20, 2009 Information Document Request (“April 20 Request”)). In addition to asking for further documentation from the Foundation, the IRS enclosed several documents, including the Weinberger-Bolden Letter, with the following instructions:

    Enclosed with this [Information Document Request] are records received from another IRS operating division with regards to the arrangement between the Estate of Julius Schaller and The Educational Assistance Foundation For Descendants of Hungarian Immigrants in the Performing Arts, Inc. Such records are being provided to you for comment so they can be included in the administrative record. If you have any comments on such records, please respond in writing.

Id. at 6. Barrett Weinberger responded in a letter dated April 29, 2009, with the following:

      I am in receipt of your Information Document Requests #4, #5, and #6 (Form 4564) addressed to the Educational Assistance Foundation for Descendants of Hungarian Immigrants in the Performing Arts, Inc.

While I remain committed to my previous promise to cooperate as fully as possible with your ongoing audit, due to the ongoing and concurrent criminal investigation (from which you obtained some of the records on which you have asked me to comment) and on the advice of my counsel, I cannot presently provide you with any testimony, comment on any documents, nor address any of your inquiries.
Pl.’s Mot., Ex. 9 (April 29, 2009 Letter from Barrett Weinberger to IRS) at 2. In June 2009, the IRS discontinued the criminal investigation of Weinberger. See Pl.’s Mot., Ex. 8 (Case Chronology) at 32.The audit of the Foundation continued, however, culminating in a November 13, 2009 letter to the Foundation proposing the revocation of its tax-exempt status and enclosing a Report of Examination detailing the agency’s reasoning for the proposed revocation. Pl.’s Mot., Ex. 7 (November 13, 2009 Proposed Revocation (“Proposed Revocation”)) at 2. The Weinberger-Bolden Letter is referenced and quoted in the Proposed Revocation. Id. at 14-15. By letter dated January 11, 2010, Weinberger, on behalf of the Foundation, submitted a protest to the Proposed Revocation. Pl.’s Mot., Ex. 10 (January 11, 2010 Protest (“Protest”)) at 3. The Protest raised the following concerns about the records relied upon by the IRS in reaching its decision:

    The letter referenced in the [Proposed Revocation] is problematic in this investigation and action for it is clearly and facially protected from review by the attorney-client privilege. The letter is a correspondence from the undersigned, individually, to Stephen [R.] Bolden, Esq., a partner of the law firm of Fell and Spalding. Mr. Bolden represented the plaintiffs in their claim against Gary Freedman. While it is unclear how this letter found its way into the administrative file for this matter, it is clear that it should be excised and not relied upon.

Id. at 7. A footnote immediately following the quoted passage states that “[i]n an August 17, 2007 Information Document Request . . . from [IRS agent] Andrew Hay to the Taxpayer, Mr. Hay indicates that this letter was obtained ‘from another IRS operating division[,]’ yet requested comment on its contents.”3 Id. at 7 n.5. Aside from disputing the summary of the letter’s contents as “taken out of context and poorly summarized for the purpose of connoting a malicious intent” and as “impl[ying] inappropriate conduct,” these are the sole references to the Weinberger-Bolden Letter in the Foundation’s Protest. Id. at 7, 8-9. The IRS ultimately issued a final revocation of the Foundation’s tax-exempt status. Def.’s Opp’n at 6; see also Pl.’s Mot. at 4.The concurrent audit of the Schaller Estate’s tax return resulted in an assessment for additional taxes and penalties based on the IRS’ disallowance of the Estate’s charitable contribution to the Foundation. Pl.’s Mot. at 7. On December 19, 2008, the Estate filed a petition with the United States Tax Court challenging the assessment. Def.’s Opp’n, Ex. F (Notification of Receipt of Petition and Petition); see also Pl.’s Mot. at 7. During discovery in the litigation before the Tax Court, the IRS produced portions of its criminal investigation file created during the investigation of Barrett Weinberger. Pl.’s Mot. at 7-8. After discovering the Weinberger-Bolden Letter in the file, counsel for the Estate of Julius Schaller sent a letter to the IRS on December 1, 2010, asserting that the letter was a privileged communication and “request[ing] the IRS immediately segregate [the Weinberger-Bolden Letter] from the rest of its files, and return all copies of said document to [the Estate] as soon as possible.” Id. at 8; Pl.’s Mot., Ex. 3 (December 1, 2010 Letter from Ian Comisky to IRS (“Comisky-IRS Letter”)). The Estate also asked the IRS to “advise [it] as to any use that the IRS has made of this document to date, and the manner in which this document came into your possession.” Pl.’s Mot. at 8; Pl.’s Mot., Ex. 3 (Comisky-IRS Letter). The IRS did not respond to the Estate’s letter, Pl.’s Mot. at 8; Def.’s Opp’n at 17, and the Estate subsequently filed a motion with the Tax Court to preclude the IRS from using the Weinberger-Bolden Letter in those proceedings, Pl.’s Mot. at 8. However, the motion was not resolved before the Tax Court litigation was stayed pending resolution of this case. See id. at 6 n.2.

This case was initiated by the Foundation on August 30, 2011. Following the parties’ settlement of issues raised by the United States in a motion to dismiss, the parties filed a joint statement on August 2, 2012, in advance of the initial scheduling conference that was conducted in this case. Joint Report by the Parties, ECF No. 26. In the joint statement, the Foundation stated that it “believes that the administrative record in this matter contains information protected by the attorney-client privilege, and that the IRS used privileged information in making its determination to revoke [the Foundation’s] tax exempt status.” Id. at 6. The Foundation further indicated its intent to file a motion “challenging the use of information protected by the attorney-client privilege during its audit of [the Foundation]” and asserted its position that the administrative record compiled by the IRS should not be filed on the public docket until this motion is resolved by the Court. Id. During the initial scheduling hearing in this case, the Foundation again raised a concern about the inclusion of what it believed were privileged documents in the administrative record. SeeTranscript of August 9, 2012 Initial Scheduling Conference at 4:2-6:1, ECF No. 34. Before the Foundation filed its motion, the United States filed the administrative record containing the Weinberger-Bolden Letter and a memorandum quoting portions of the letter, and the Foundation moved to seal the administrative record and to strike the memorandum from the docket. See Plaintiff’s Motion to Seal Administrative Record and for Related Relief at 1, ECF No. 35; Plaintiff’s Motion to Strike the United States’ Memorandum Regarding Scope of Review in 26 U.S.C. § 7428 Declaratory Judgment Action and for Related Relief at 1, ECF No. 39. The Court granted both motions and ordered both the administrative record and the United States’ memorandum referring to the Weinberger-Bolden Letter stricken from the record. See ECF Nos. 37, 40, 41.

The Foundation subsequently filed the motion currently before the Court challenging the inclusion of the Weinberger-Bolden Letter in the administrative record and its use by the IRS. As its explanation for how it acquired the Weinberger-Bolden Letter, the United States submitted with its opposition to the Foundation’s motion an affidavit from Shaun Thurston, a Special Agent with the IRS Criminal Investigation Division. Def.’s Opp’n, Ex. 1 (Thurston Affidavit) ¶ 1. In it, Thurston avers

      [a]lthough I am not absolutely certain, to the best of my recollection the [Weinberger-Bolden Letter] was provided to me under IRS Summons by the accountant who had been retained with respect to the filing of the federal estate tax return for the Estate of Julius Schaller. That accountant was Craig Cohen. . . .

To the best of my recollection, the [Weinberger-Bolden Letter] was provided to me by Mr. Cohen intentionally, and not inadvertently.
Id. ¶¶ 4-5. In response to Agent Thurston’s representations, the Foundation submitted affidavits from Barrett Weinberger and Craig Cohen. Pl.’s Reply, Ex. 1 (Weinberger Affidavit), Ex. 2 (Cohen Affidavit). In his affidavit, Weinberger asserts that he has never intentionally disclosed the Weinberger-Bolden Letter to any third party and never provided a copy of the letter to Craig Cohen. Pl.’s Reply, Ex. 1 (Weinberger Affidavit) ¶¶ 12, 14. For his part, Cohen states that while he did provide Thurston with documents in response to a summons,

    I have . . . reviewed my files relating to the Estate of Julius Schaller, including copies of the documents my firm provided to IRS Special Agent Thurston. The [Weinberger-Bolden Letter] is not in our files. At no time did I (or anyone else at my firm) ever provide a copy of the [Weinberger-Bolden Letter] to IRS Special Agent Thurston.

Pl.’s Reply, Ex. 2 (Cohen Affidavit) ¶¶ 4, 6.Simultaneously with the filing of the Foundation’s reply brief, Barrett Weinberger and Frances Odza, as co-executors of the Estate of Julius Schaller, and the entire class of beneficiaries of the Estate of Julius Schaller moved to intervene in this litigation in order to assert attorney-client privilege with respect to the Weinberger-Bolden Letter. Mot. Intervene at 1. The Court now turns to the parties’ arguments regarding the acquisition and use of the letter.

II. ANALYSIS

A. Standing to Assert the Attorney-Client PrivilegeAs an initial matter, the United States argues that the Foundation lacks standing to assert the attorney-client privilege as to the Weinberger-Bolden Letter because the privilege is held by Weinberger, Frances Odza, and the beneficiaries of the Estate of Julius Schaller.4 Def.’s Opp’n at 13-14. The Foundation argues in response that Barrett Weinberger, who serves as the president and director of the Foundation, can properly assert the privilege here because Stephen Bolden represented him in the malpractice litigation regarding the Schaller will. Pl.’s Reply at 11. Nonetheless, Weinberger, Odza, and the beneficiaries of the Schaller Estate have moved to intervene in order to assert the privilege in the event that the Court disagrees with the Foundation’s arguments on this point, Pl.’s Reply at 11-12; Mot. Intervene at 1, and have adopted the Foundation’s arguments regarding the Weinberger-Bolden Letter as their own,5 Intervene Reply at 2 n.2.

As explained below, the Court finds that the actions taken to assert the privilege of the Weinberger-Bolden Letter and to recover it from the IRS after discovery of its disclosure were inadequate to protect any privilege with respect to the document and that the privilege has therefore been waived. It is undisputed that Barrett Weinberger learned that the IRS had acquired the Weinberger-Bolden Letter in April 2009. Whether he learned this information while he was acting in the capacity of president of the Foundation rather than as a beneficiary of the Estate of Julius Schaller (and thus the client of Stephen Bolden), Weinberger may not willfully ignore his knowledge that this document was disclosed simply because he learned of the disclosure while acting on behalf of the Foundation. Such indifference to the disclosure of the letter is inconsistent with the principle that “the confidentiality of communications covered by the privilege must be jealously guarded by the holder of the privilege lest it be waived.” In re Sealed Case, 877 F.2d 976, 980 (D.C. Cir. 1989). Armed with knowledge of the disclosure, Weinberger had the ability to act to preserve the privilege, yet, he did not. Consequently, the Court need not determine whether the Foundation can raise the privilege because regardless of who holds the privilege, the actions taken by any of the parties involved here were insufficient to preserve it. The motion to intervene by the co-executors and beneficiaries of the Schaller Estate is thus denied as moot.

B. Acquisition of the Weinberger-Bolden Letter

As noted previously, the parties offer differing theories as to how the IRS acquired a copy of the Weinberger-Bolden Letter. Both the Foundation and the United States agree that the letter was likely obtained during the criminal investigation of Barrett Weinberger, see Pl.’s Mot. at 12; Def.’s Opp’n at 7, consistent with the IRS’ initial representations to the Foundation regarding the source of the letter, Pl.’s Mot., Ex. 6 (April 20 Request) at 6 (identifying the records enclosed with the Information Document Request, including the Weinberger-Bolden Letter, as “received from another IRS operating division”). Relying on IRS Special Agent Shaun Thurston’s affidavit, the United States contends that the Weinberger-Bolden Letter “was voluntarily and intentionally provided to it, most likely by the accountant retained to prepare the Schaller Estate’s estate tax return.” Def.’s Opp’n at 7 (citing Def.’s Opp’n, Ex. 1 (Thurston Affidavit) ¶¶ 4-5). However, as the Foundation correctly points out, see Pl.’s Reply at 7, Thurston does not possess personal knowledge of the source of the letter, averring that while “to the best of [his] recollection,” the Weinberger-Bolden Letter was intentionally provided to him by Craig Cohen, he is “not absolutely certain” about how he received it, Def.’s Opp’n, Ex. 1 (Thurston Affidavit) ¶¶ 4-5.

In addition to disputing that Craig Cohen intentionally provided the Weinberger-Bolden Letter to Thurston, Pl.’s Reply at 8 (citing Pl.’s Reply, Ex. 1 (Weinberger Affidavit) ¶¶ 12, 14, Ex. 2 (Cohen Affidavit) ¶ 6), the Foundation asserts that the IRS obtained the letter improperly, see Pl.’s Mot. at 12 n.9; Pl.’s Reply at 8-11. In support of its contention that the IRS illegally acquired the Weinberger-Bolden Letter, the Foundation points to “[t]he conflicting positions taken by the government in its responses” regarding how the IRS acquired the letter, Pl.’s Reply at 8 & n.5, the United States’ inability to conclusively state how the IRS obtained the letter, id. at 10, and the United States’ failure to produce a case chronology log for the criminal investigation of Barrett Weinberger, id. at 10-11, as suggestive of wrongdoing. As to the argument that the alleged inconsistency in the United States’ explanations regarding the acquisition of the letter supports the position that it was improperly obtained, the Court first notes that it discerns no inconsistency in the representations provided by the United States to this Court or the Tax Court, which uniformly maintain that the document was either intentionally or inadvertently provided to the IRS during the criminal investigation of Barrett Weinberger. See Pl.’s Mot. at 11 (quoting counsel for the United States during the initial scheduling hearing in this case as stating that “we believe the document they are referring to was actually submitted to the Internal Revenue Service”); id. at 12 (quoting counsel for the United States during a motion hearing in this case as stating that “[w]e believe it was obtained as part of the . . . criminal investigation . . . of Mr. Weinberger”); Pl.’s Reply at 7 (citing Thurston’s affidavit, which states that he believes the letter was provided to him by Craig Cohen during the criminal investigation of Barrett Weinberger); Pl.’s Reply at 8 n.5 (stating that during briefing on this issue before the Tax Court, the United States represented that the Weinberger-Bolden Letter “was freely provided to Special Agent Thurston and was either a voluntary disclosure or an inadvertent disclosure,” but not identifying that Thurston allegedly received the document from Cohen) (emphasis removed). While the United States’ representations include varying levels of detail regarding the acquisition of the letter, they all reflect the general contention that the Weinberger-Bolden Letter was either intentionally or inadvertently provided to Shaun Thurston during the criminal investigation of Barrett Weinberger.

Most importantly though, like the deficiency identified by the Foundation in Thurston’s affidavit, the Foundation similarly can produce no individual with personal knowledge that the IRS improperly obtained the Weinberger-Bolden Letter and the documents submitted to the Court with its motion provide no evidence whatsoever of such wrongdoing.6 Absent evidence demonstrating the contrary, courts generally accord agencies the presumption of administrative regularity and good faith. FTC v. Owens-Corning Fiberglas Corp., 626 F.2d 966, 975 (D.C. Cir. 1980) (citations omitted). The Court will not impute wrongdoing to the IRS based on nothing more than the Foundation’s speculation that IRS agents acted improperly, particularly when human error appears to be at least an equally plausible explanation for how the IRS acquired the Weinberger-Bolden Letter. See United Mine Workers of Am. Int’l Union v. Arch Mineral Corp., 145 F.R.D. 3, 6 (D.D.C. 1992) (declining to infer wrongdoing in the acquisition of allegedly privileged documents because the party asserting the privilege produced no evidence to support its allegations).

Having rejected the Foundation’s assertion that the Weinberger-Bolden Letter was improperly acquired by the IRS, the Court concludes that the letter was either intentionally or inadvertently disclosed to the IRS. As noted previously, the parties have produced contradictory evidence regarding whether the disclosure of the letter was made by Craig Cohen. And as to the possibility that the Weinberger-Bolden Letter was inadvertently produced, neither party has proffered evidence on this point. Indeed, the very nature of inadvertent production would in all likelihood result in the individual who accidentally disclosed the document not having a current recollection of disclosure. The Court need not resolve this remaining dispute, however, because, even if the disclosure was inadvertent, the Court finds that the privilege has been waived, as explained below.

C. Waiver of the Privilege

With respect to disclosure of a communication covered by the attorney-client privilege, Federal Rule of Evidence 502 provides that

      [w]hen made in a federal proceeding or to a federal office or agency, the disclosure does not operate as a waiver in a federal or state proceeding if:

(1) the disclosure is inadvertent;

(2) the holder of the privilege or protection took reasonable steps to prevent disclosure; and

(3) the holder promptly took reasonable steps to rectify the error, including (if applicable) following Federal Rule of Civil Procedure 26(b)(5)(B).
Fed. R. Evid. 502(b). The party asserting the privilege, even if disclosure of the communication was inadvertent, bears the burden of establishing each of these three elements. Williams v. District of Columbia, 806 F. Supp. 2d 44, 48 (D.D.C. 2011) (citations omitted). The Advisory Committee Notes for Rule 502(b) set forth several non-dispositive factors often used to evaluate whether an inadvertent disclosure has effected a waiver of the privilege, including “the reasonableness of precautions taken, the time taken to rectify the error, the scope of discovery, the extent of disclosure and the overriding issue of fairness.” Fed. R. Evid. 502 advisory committee’s note (2007).The Foundation argues at the outset that Rule 502 does not apply because Federal Rule of Evidence 101 states that the Rules “apply to proceedings in United States courts,” and when the Foundation first learned that the IRS possessed the Weinberger-Bolden Letter, “there was no litigation, only an administrative audit by the IRS of the Foundation” and thus there was “no ‘proceeding’ in any United States court at that time.” Pl.’s Reply at 17. The plain language of Rule 502, however, expressly contemplates an inadvertent disclosure of a communication “to a federal office or agency,” and sets forth the circumstances under which “the disclosure does not operate as a waiver in a federal or state proceeding.” Fed. R. Evid. 502(b). Moreover, the Advisory Committee Notes specifically state that Rule 502(b) “applies to inadvertent disclosures made to a federal office or agency, including but not limited to an office or agency that is acting in the course of its regulatory, investigative or enforcement authority,” Fed. R. Evid. 502 advisory committee’s note (2007), and courts have used Rule 502(b) to determine whether disclosure to an agency prior to litigation waives any privilege asserted regarding a document in subsequent litigation, see SEC v. Welliver, No. 11-CV-3076 (RHK/SER), 2012 WL 8015672, at *6-8 (D. Minn. Oct. 26, 2012) (assessing whether attorney-client privilege was waived by inadvertent disclosure of documents during pre-litigation investigation by the Securities and Exchange Commission). Rule 502 therefore applies in this proceeding to determine whether the prior inadvertent disclosure of the Weinberger-Bolden Letter to the IRS precludes the assertion of any claim of privilege concerning the letter.

Alternatively, the Foundation contends that even if Rule 502(b) applies, it has taken adequate steps to assert the privilege and redress the disclosure of the Weinberger-Bolden Letter by raising the issue in its January 11, 2010 Protest to the Proposed Revocation and in motions it has filed with this Court and the Tax Court. Pl.’s Reply at 17. The Court disagrees that these half-hearted and untimely attempts to assert the privilege are sufficient to preserve any claim of privilege as to the document. Barrett Weinberger first learned that the IRS possessed a copy of the Weinberger-Bolden Letter when it enclosed a copy of the letter in its April 20, 2009 Information Document Request, but took no action whatsoever to assert the privilege until January 11, 2010, over eight months later. Even then, the Foundation did not make any attempt to recover the Weinberger-Bolden Letter, but merely asserted its position that the document was protected by the privilege and thus “should be excised and not relied upon.” Pl.’s Mot., Ex. 10 (Protest) at 7. Neither the Foundation nor the Schaller Estate beneficiaries demanded the return of the document until December 1, 2010, nearly two years after Weinberger learned that the IRS possessed it. Such an inordinate delay in action to recover the document is inconsistent with the confidentiality objective which underlies the attorney-client privilege. See United States v. Ary, 518 F.3d 775, 784 (10th Cir. 2008) (reasoning that expeditious claims of privilege serve the purposes of the attorney-client privilege by preserving the confidentiality of the allegedly privileged communication); United States v. de la Jara, 973 F.2d 746, 750 (9th Cir. 1992) (concluding that the defendant’s delay in seeking recovery of privileged communication “allowed ‘the mantle of confidentiality which once protected the document[ ]’ to be ‘irretrievably breached,’ thereby waiving his privilege”); see also In re Sealed Case, 877 F.2d at 979-80 (“[I]f a client wishes to preserve the privilege, it must treat the confidentiality of attorney-client communications like jewels — if not crown jewels.”). Indeed, much shorter delays in seeking recovery of privileged documents have been deemed to waive the privilege. See, e.g., Ary, 518 F.3d at 785 (finding assertion of privilege six weeks after learning of disclosure to be untimely); Murray v. Gemplus Int’l, S.A., 217 F.R.D. 362, 366 (E.D. Pa. 2003) (finding eleven week delay to be incompatible with maintaining privileged character of communications); see also Amobi v. D.C. Dep’t of Corrs., 262 F.R.D. 45, 55 (D.D.C. 2009) (commenting that it was a “debatable proposition” that attempting to rectify an inadvertent disclosure fifty-five days after discovery qualified as sufficiently prompt to protect attorney-client privilege but finding privilege waived on different ground in any event).

On this point, the Foundation contends that Weinberger’s failure to assert the privilege with respect to the Weinberger-Bolden Letter in response to the April 20, 2009 Information Document Request did not effect a waiver because he did not comment on it and instead, on the advice of counsel, invoked his Fifth Amendment right against self-incrimination due to the ongoing criminal investigation. Pl.’s Reply at 12-13. The Foundation offers no explanation, however, for Weinberger’s continuing failure to act after June 2009 when the criminal investigation was discontinued. While the record is unclear regarding when Weinberger learned that the IRS had decided not to prosecute him, Weinberger’s assertion of the privilege in the Foundation’s January 11, 2010 Protest indicates that he knew he was no longer under investigation by that point. Yet, nearly a year elapsed before anyone affiliated with the Foundation or the Estate of Julius Schaller made any attempt to actually recover the document. While the concurrent criminal investigation may have excused Weinberger’s failure to act immediately in response to the Information Document Request, it cannot absolve him of his obligation to act for the entire period of time at issue here.

Even if the Court could find that the Foundation or the beneficiaries of the Schaller Estate made timely efforts to recover the Weinberger-Bolden Letter, the intermittent nature of these efforts also weighs in favor of a finding that the privilege was waived. While the Foundation and the beneficiaries of the Schaller Estate have raised the claim of privilege on several occasions since learning of the disclosure of the Weinberger-Bolden Letter in April 2009, long periods of inaction have followed most of the attempts to recover the document. For example, when the IRS failed to respond to the December 1, 2010 letter requesting the segregation and return of all copies of the Weinberger-Bolden Letter, the Foundation identifies no further efforts to assert the privilege or recover the document until the issue was raised in a motion before the Tax Court one year later. See Pl.’s Mot. at 8; Pl.’s Mot., Ex. 4 (December 7, 2011 Order) at 2. Isolated efforts to recover privileged communications do not absolve the party asserting privilege of any further action, but rather put the privilege holder on notice that further action is required. See Williams, 806 F. Supp. 2d at 52 (rejecting alleged privilege holder’s argument that its notification of the inadvertent disclosure and demand for return of the document was sufficient to preclude a finding of waiver under Rule 502(b) because privilege holder took no further steps to recover the document after receiving no response); IMC Chems. v. Niro, Inc., No. 98-2348-JTM, 2000 WL 1466495, at *27 (D. Kan. July 19, 2000) (finding four letters, two of which specifically demanded return of the documents, to be insufficiently persistent to maintain privilege). Here, the IRS consistently ignored the Foundation’s and the Estate’s occasional efforts to retrieve the Weinberger-Bolden Letter. Instead of taking additional steps to recover the letter, the alleged privilege holders allowed the letter to remain with the IRS with full knowledge that the agency continued to use it without limitation. As another court put it, “[t]hat is not how one protects privileged documents.” IMC Chems., 2000 WL 1466495, at *27.

The Foundation claims that “[t]here were no other avenues that Mr. Weinberger, the beneficiaries, the Foundation, or the Estate could have pursued in order to claim this document is privileged and has been wrongfully obtained and used by the government,” other than raising the issue in the litigation pending before this Court and the Tax Court. Pl.’s Reply at 15-17. To be sure, seeking judicial intervention is a powerful way to assert a privilege and seek to recover a privileged communication that has been inadvertently disclosed. Cf. Bowles v. Nat’l Ass’n of Home Builders, Inc., 224 F.R.D. 246, 254-57 (D.D.C. 2004) (holding that failure to seek judicial intervention for fifteen months even though privilege holder repeatedly asserted privilege in correspondence fatally undermined privilege claim). However, the fact that the Foundation and the Estate did seek judicial intervention on two occasions does not excuse their failure to take other steps to protect the privilege, such as engaging in a consistent course of correspondence with the IRS demanding the return of the Weinberger-Bolden Letter. The Court discerns no reason why more persistent and prompt efforts could not have been taken to recover the document, even when litigation was not pending.

This Circuit’s opinion in SEC v. Lavin, 111 F.3d 921 (D.C. Cir. 1997), does not change the result here. Lavininvolved an assertion of the marital privilege as to conversations recorded on tapes in the possession of Jack Lavin’s employer. 111 F.3d at 923-24. In reversing the district court’s finding that the Lavins had waived any privilege in the conversations by failing to promptly assert the privilege and take adequate steps to recover possession of the tapes, the Circuit declined to find an affirmative duty to preemptively assert the privilege when “there was no event that should have triggered their assertion of the privilege,” instead finding it sufficient that the Lavins claimed the privilege once they learned that the Federal Reserve Bank of New York sought production of the tapes. Id. at 931. The Circuit also rejected the district court’s emphasis on the Lavins’ failure to obtain physical possession of the tapes as “irrelevant” because “any access [to the tapes] was encumbered by the Lavins’ assertion of the privilege.” Id. at 931-32. Lavin, however, pre-dates the 2007 revisions to Rule 502 which addressed waiver by inadvertent disclosure. Moreover, the Lavins made far more significant efforts to preserve their privilege, including securing an agreement to maintain confidentiality of the tapes with the possessor of the tapes and immediately asserting the privilege upon learning that the tapes had been requested by the Federal Reserve Bank,id. at 931-32, in contrast to the two discontinuous attempts to assert privilege and protect the confidentiality of the Weinberger-Bolden Letter.

The Foundation further argues that no additional actions should be required of it because “[t]he IRS was aware that the Foundation was not represented by counsel [during the Foundation audit], and it is the IRS [that] should have strictly adhered to its ethical obligations and notified the Foundation, the Estate, and its beneficiaries that a privileged communication had been obtained.” Pl.’s Reply at 13-14. Whether an attorney’s failure to return an allegedly privileged document upon learning of its inadvertent disclosure constitutes an ethical breach has no bearing on this Court’s assessment of whether the privilege holder acted reasonably to rectify the inadvertent disclosure of the Weinberger-Bolden Letter under Rule 502(b), which puts this burden squarely on the shoulders of the privilege holder, not the recipient of a potentially privileged communication. Additionally, the Court notes that while the Foundation was not represented by counsel during its audit by the IRS, the record indicates that Barrett Weinberger holds a juris doctor and was a practicing attorney from 1983 to 1995. See Pl.’s Mot., Ex. 10 (Protest) at 6. The Court thus presumes that Weinberger has some familiarity with the attorney-client privilege and accordingly finds the Foundation’s suggestion that its pro se status imparts some additional obligations on IRS counsel unpersuasive. Cf. Richards v. Duke Univ., 480 F. Supp. 2d 222, 234 (D.D.C. 2007) (holding that pro se plaintiff who is an attorney is “presumed to have a knowledge of the legal system” and thus is not given great latitude normally afforded to pro se litigants).

In addition to the delay in asserting the privilege in the Weinberger-Bolden Letter and seeking its recovery, the Court finds that other factors weigh in favor of finding that the privilege has been waived. The proceedings between the IRS, the Foundation, and the Estate of Julius Schaller did not involve thousands of documents, but rather a relatively small set of records that could be easily reviewed and controlled. Fairness and the extent of the disclosure here also support a finding of waiver. The IRS has possessed and relied on the Weinberger-Bolden Letter since 2009 in reaching decisions in three separate investigations regarding the relationship between the Estate of Julius Schaller and the Foundation. And its ongoing use of the document was well-known to all interested parties. To expunge this document now would require a wholesale rewriting of history between the IRS, the Foundation, and the Schaller Estate. As this Circuit opined with respect to a similar request, “it would be unfair and unrealistic now to permit the privilege’s assertion as to th[is] document[ ] which ha[s] been thoroughly examined and used by the Government for several years” because “the disclosure cannot be cured simply by a return of the document[ ].” In re Grand Jury Investigation of Ocean Transp., 604 F.2d 672, 675 (D.C. Cir. 1979); see also Ary, 518 F.3d at 784 (noting that a consequence of failing to expeditiously assert a privilege is that a government investigation “may irreparably rely on the protected information, thereby tainting the investigation,” resulting in waiver). Here too, the Court finds that “[t]he privilege has been permanently destroyed.” In re Grand Jury Investigation of Ocean Transp., 604 F.2d at 675.

III. CONCLUSION

For the foregoing reasons, the Court concludes that any attorney-client privilege that would otherwise protect the Weinberger-Bolden Letter has been waived through the document’s inadvertent disclosure and the failure of the alleged privilege holders to take appropriate steps to promptly assert the privilege and aggressively seek to recover the letter. Accordingly, the Court must deny the Foundation’s motion regarding the United States’ use of the Weinberger-Bolden Letter in these proceedings and its inclusion of the letter in the administrative record, and deny the motion to intervene as moot.SO ORDERED this 27th day of March, 2014.7

                  Reggie B. Walton
                  United States District Judge
FOOTNOTES

1 In addition to the documents already referenced, the Court considered the following filings in reaching its decision: (1) the Plaintiff’s Reply Memorandum in Support of Its Motion to Preclude the Government from Introducing Privileged Letter from Barrett Weinberger to Attorney Stephen Bolden and the Entire Administrative Record, and for Related Relief (“Pl.’s Reply”), (2) the Motion to Intervene Filed by Barrett Weinberger and Frances Odza, Co-Executors of the Estate of Julius Schaller, and the Entire Class of Beneficiaries of the Estate of Julius Schaller (“Mot. Intervene”), (3) the Supplement to Motion to Intervene Filed by Barrett Weinberger and Frances Odza, Co-Executors of the Estate of Julius Schaller, and the Entire Class of Beneficiaries of the Estate of Julius Schaller (“Intervene Supp.”), (4) the United States’ Opposition to Motion to Intervene by Barrett Weinberger, Frances Odza, and the Beneficiaries of the Estate of Julius Schaller (“Intervene Opp’n”), and (5) the Reply Brief in Support of Motion to Intervene Filed by Barrett Weinberger and Frances Odza, Co-Executors of the Estate of Julius Schaller, and the Entire Class of Beneficiaries of the Estate of Julius Schaller (“Intervene Reply”).2 For ease of reference, the Court has assigned page numbers to each of the parties’ exhibits beginning in each case with the exhibit cover page followed by the order of the pages as submitted to the Court.

3 Although the Foundation’s Protest lists the date of the Information Document Request which referenced the Weinberger-Bolden Letter as August 17, 2007, all other references to this Information Document Request have indicated that it was dated April 20, 2009. Accordingly, the Court assumes that designating the date of the Information Document Request as August 17, 2007 in the Foundation’s Protest is a typographical error.

4 The United States also argues that the Foundation has not established that the Weinberger-Bolden Letter is a privileged communication. Def.’s Opp’n at 9-13. Because the Court determines that any privilege as to the document was waived, it will assume without deciding that the Weinberger-Bolden Letter would otherwise be protected by attorney-client privilege if not for its inadvertent disclosure.

5 The only argument regarding the Weinberger-Bolden Letter advanced solely by the movants is that Barrett Weinberger “did not have the authority to unilaterally waive the privilege on behalf of the entire class of beneficiaries of the Estate of Julius Schaller.” Intervene Reply at 5-6. Relying on In re Teleglobe Communications Corp., 493 F.3d 345 (3d Cir. 2007), and Magnetar Technologies, Corp. v. Six Flags Theme Park Inc., 886 F. Supp. 2d 466 (D. Del. 2012), the movants argue that waiver of a joint-client privilege requires the consent of all joint-clients and that the United States has not shown that all of the Estate beneficiaries consented to waive a claim of privilege in regard to the Weinberger-Bolden Letter. Intervene Reply at 5-6. The movants’ reliance on this line of authority is misplaced, however, because the requirement of universal consent applies when one client seeks to intentionally waive the privilege. By contrast, the question before the Court here is whether the attorney-client privilege was unintentionallywaived by the inadvertent disclosure of the Weinberger-Bolden Letter.

6 In a footnote in its reply brief, the Foundation suggests that discovery should be conducted regarding “the Special Agent’s report and chronology as to when he obtained the [Weinberger-Bolden Letter]; who the Special Agent consulted with at IRS counsel before providing the letter to the revenue agent handling the Foundation audit; and who the revenue agent consulted with before employing the [Weinberger-Bolden Letter] and using it to support the revocation of the Foundation’s tax exempt status.” Pl.’s Reply at 11 n.6. To be sure, “[a] claim of privilege must be ‘presented to a district court with appropriate deliberation and precision’ before a court can rule on the issue.” SEC v. Lavin, 111 F.3d 921, 928 (D.C. Cir. 1997) (citation omitted). Neither party suggests here that the record is insufficiently developed to permit the Court to rule on this issue based on the filings submitted to the Court and the attached exhibits, many of which were culled from an administrative record with which both parties are already familiar. Moreover, the discovery contemplated by the Foundation is focused primarily on the use of the Weinberger-Bolden Letter by the IRS rather than the letter’s acquisition and thus would be of little assistance in reaching a determination on the issues at hand. Accordingly, the Court declines to permit discovery on the issues raised by the Foundation prior to ruling on the Foundation’s motion.

7 An Order consistent with this Memorandum Opinion will be issued contemporaneously.

Citations: Educational Assistance Foundation for the Descendants of Hungarian Immigrants in the Performing Arts Inc. v. United States; No. 1:11-cv-01573



Bond Issuers Encouraged to Request Refunding Guidance.

Issuers should let the IRS know if refunding guidance is needed on Build America Bonds and whether a lack of clarity in section 54AA has a negative effect on bond issuance, James Polfer, branch 5 chief, IRS Office of Associate Chief Counsel (Financial Institutions and Products), said March 27.

When it is unclear whether an issuer can currently refund, it would be helpful for the IRS to know, Polfer said at the National Association of Bond Lawyers’ Tax and Securities Law Institute in Boston.

“We are aware that in many of these one-off bond programs that it is ambiguous whether or not you can currently refund, so generally requests for guidance about currently refunding a specific program helps us to know that the ambiguity has a real-world effect,” said Polfer.

Some attendees indicated that guidance is needed. “We don’t have guidance on what to do or how to refund a Build America Bond,” said Brent L. Feller of Chapman and Cutler LLP.

Polfer noted that the IRS has issued guidance on current refunding for other types of bonds, most recently in Notice 2014-9, 2014-5 IRB 455, which was released in January and provides that issuers can currently refund a recovery zone facility bond on a tax-exempt basis.

A recovery zone facility bond was an American Recovery and Reinvestment Act of 2009 bond that had to be issued in 2009 or 2010 for recovery zone property in the recovery zone. The bonds were tax-exempt private activity bonds, and the notice provides criteria for currently refunding them. The notice expressly states that it does not apply to Build America Bonds; recovery zone economic development bonds were a taxable variety of those bonds.

The notice provides that if an issuer met the criteria to issue the bonds in 2009 and 2010 and if the current refunding bonds are not in an amount greater than the refunded bonds, a current refunding is available. The values of the refunding and refunded bonds are measured by looking at the issue price of the refunded bonds versus the outstanding principal amount of the refunded bonds. But if the refunded bonds have more than the de minimis original issue discount, the present value must be used to determine the maximum issue price of the current refunding issue. Under the guidance, the current refunding bonds must meet the criteria as well.

Feller noted that the IRS has issued similar notices before: In 2012 a notice was issued regarding Gulf Opportunity Zone Bonds (Notice 2012-3, 2012-3 IRB 289), and in 2003 there was a notice on refunding of New York Liberty Bonds (Notice 2003-40, 2003-2 C.B. 10).

Polfer said the recovery zone facility bond and Liberty Zone Bond notices came about because issuers requested the guidance. “It was pointed out to us that it was not only an ambiguous provision and in the abstract was unclear, but this ambiguity has real-world effects and was holding up actual issuances,” he said.

Feller noted that in the president’s fiscal 2015 budget proposal, there is a measure providing for current refunding for bonds that don’t have a statutory framework for refunding.

“This seems to be a goal of the executive branch to provide guidance on current refunding of [American Recovery and Reinvestment Act] bonds,” said Feller.

Polfer agreed with Feller’s point and added, “It’s good to point out that this has been discussed in a number of budget proposals now and reflects a uniform view in tax administration about the policy advantages for current refunding, both to save interest rates for the reissuer and also to lower the subsidy.”

However, Polfer added, “The fact that this has been memorialized in budget proposals also reflects a view that a widespread, all-encompassing piece of administrative guidance stating that current refundings will be allowed absent a statutory provision that says otherwise is probably beyond the authority of Treasury.”

Polfer said that because comprehensive current refunding guidance is probably beyond Treasury’s power, the result has been piecemeal guidance. “The three notices we put out do reflect the view that it is an advantage to refund these, both from the administration standpoint and the issuer standpoint,” he said. “And we also encourage that if there are any suggestions, comments, or views about the ability to currently refund other programs, we would definitely like to hear that.”

by William R. Davis



Bond Provisions in Camp Draft Warrant Attention.

It’s important to pay close attention to the tax-exempt bond provisions in the tax reform discussion draft  of House Ways and Means Committee Chair Dave Camp, R-Mich., because even if they are unlikely to pass anytime soon, they will likely be used as revenue raisers for future tax proposals, a Treasury official said March 27.

“While it is indicated in the press that the Camp reform bill is likely to go nowhere, I would encourage you to look at some of the provisions to view it as a scorecard of revenue offsets that can be used for other tax proposals,” Vicky Tsilas, attorney-adviser, Treasury Office of Tax Legislative Counsel, said at the National Association of Bond Lawyers’ Tax and Securities Law Institute in Boston. “I would not look at some of those proposals and discount them as not happening.”

Several proposals, many contrary to President Obama’s fiscal 2015 budget, could affect the bond market, including terminating the tax exemption for private activity bonds and advanced refunding bonds, repealing tax credit bonds, and repealing the alternative minimum tax, Tsilas said.

Perry Israel of the Law Office of Perry Israel agreed that the draft’s provisions could end up in other bills. In the 1980s, there were tax reform bills almost every year, and many of the provisions in those bills made it into the Tax Reform Act of 1986, he said. “What you are seeing here are markers that we could very well be talking about in the very near future, so don’t ignore them,” Israel said.

Israel said the Joint Committee on Taxation estimates that the cost of tax-exempt bonds over a five-year period is about $190 billion. Some argue that the estimate is incorrect, but regardless, it’s a large tax expenditure, Israel said. “Tax-exempt bonds are going to consistently be viewed as being a way to give rise to revenue to pay for other things in tax reform,” he said.

Democrats, including Senate Budget Committee Chair Patty Murray, D-Wash., have shown an interest in culling revenue raisers from Camp’s draft, but Republicans have said they remain committed to keeping those provisions intact as part of a comprehensive tax reform effort.

Also on Capitol Hill, discussions have resumed about national infrastructure banks, Tsilas said. The Partnership to Build America Act of 2014 (S. 1957) would create a $50 billion bank with taxable bonds. The administration’s budget includes a proposal for a national infrastructure bank to invest in a broad range of infrastructure projects. Those measures could have significant effects on the tax-exempt bond market, she said.

Tsilas also highlighted a proposal in the administration’s budget for providing a permanent America Fast Forward bond program with expanded eligible uses compared with Build America Bonds. Under the proposal, the bonds would have a 28 percent rate versus 35 percent for Build America Bonds.

Beyond Build America Bonds’ financings for governmental projects, America Fast Forward bonds could be used for current re-fundings of prior capital projects, short-term governmental working capital financings, financing of section 501(c)(3) projects, and all the qualified private activity bond categories.

by William R. Davis



IRS Releases Publication Providing Guidance for Religious Groups.

The IRS has released Publication 1828 (rev. Nov. 2013), Tax Guide for Churches and Religious Organizations, explaining benefits and responsibilities under the federal tax system for churches and religious organizations to encourage voluntary compliance.



Senate Finance Committee Passes Extenders Bill.

On Thursday, April 3, 2014, the Senate Finance Committee passed an $85 billion tax extenders package that includes two years of extensions, including several related to bonds. The bill would provide $400 million of volume per year for the qualified zone academy bond program, and require that those bonds be issued as tax-credit and not direct-pay bonds. It also included an extension for empowerment zone tax incentives, including empowerment zone facility bonds. The bill now goes to the full Senate for vote. More information on the Finance Committee action is available here.



IRS LTR: Churches Aren't Required to Apply for Exempt Status.

The IRS advised that although there is no application requirement for a church to operate as a tax-exempt organization, many churches seek recognition of tax-exempt status because it assures church leaders, members, and contributors that the IRS recognizes the church as exempt and that it qualifies for tax-related benefits.

Person to Contact and ID Number: * * *
Contact Telephone Number: * * *
Uniform Issue List 508.02-00
Release Date: 3/28/2014
Date: December 23, 2013
The Honorable Jim Cooper
House of Representatives
Washington, D.C. 20515
Attention: * * *

Dear Mr. Cooper:

I am responding to your inquiry dated July 30, 2013, on behalf of your constituents and the tax-exempt organizations they represent. You asked questions about the policy of U.S. Citizenship and Immigration Services that requires religious organizations to provide a determination letter from us with an application for an R-1 (Temporary Religious Worker) visa that the organization is tax-exempt under section 501(c)(3) of the Internal Revenue Code (IRC), even if that religious organization is otherwise not required to have a determination letter. Specifically, you requested information on the application requirements for places of worship.

I apologize for the delay in responding to your inquiry.By law, churches, their integrated auxiliaries, and conventions or associations of churches are not required to apply with us to operate as tax-exempt organizations. The law also excludes churches from the requirement to file federal annual returns. Churches are excluded from Federal Unemployment Tax (FUTA) liability, but generally are liable for Federal Insurance Contributions Act (FICA) taxes. State and local governments have various exemptions for churches.

Although there is no requirement to do so, many churches seek recognition of tax-exempt status from us because such recognition assures church leaders, members, and contributors that we recognize the church as exempt, and it qualifies for related tax benefits. For example, contributors to a church we recognize as tax exempt would know that their contributions generally are tax-deductible. To get such recognition, the church must file a Form 1023, Application for Recognition of Exemption Under Section 501(c)(3) of the Internal Revenue Code, and pay the user fee. When we do formally recognize a church’s exempt status, we provide a determination letter to that organization.

Your constituents can find more information about religious organizations and federal tax exemption on our website, www.irs.gov/Charities-&-Non-Profits and clicking on “Churches & Religious Organizations” in the left column. Additionally, your constituents can find information regarding applying for a determination letter of tax-exempt status on our website, www.irs.gov/Charities-&-Non-Profits and clicking in “How to Apply to Be Tax-Exempt.”

This letter is for informational purposes only and provides general statements of well-defined law. It is not a ruling and taxpayers cannot rely on it as such.(Rev. Proc. 2013-1, 2013-1 I.R.B. 1; Rev. Proc. 2013-4, 2013-1 I.R.B. 126). We will make this letter available for public inspection after deleting names, addresses and other identifying information, as appropriate, under the Freedom of Information Act (Announcement 2000-2, 2000-2 I.R.B. 295). I have enclosed a copy of this letter with the proposed deletions.

I hope this information is helpful. If you have any questions, please contact me at * * * or * * * (Identification Number * * *) at * * *.

Enclosure



IRS LTR: IRS Discusses Income Exclusion Relating to Public Utilities.

The IRS advised that income from any public utility or the exercise of any essential governmental function that otherwise qualifies for exclusion under section 115 will not cease to qualify for that treatment merely because the entity earning the income is a co-owner of an electric generating facility as long as certain requirements are met.

UIL: 115.00-00
Release Date: 3/28/2014
Date: June 25, 2012
Refer Reply To:
CC:TEGE:EOEG:E0 – GENIN-113227-12

Dear * * *:

This letter responds to your request for information dated February 29, 2012. You requested information about whether the income an entity derives from any public utility or the exercise of any essential governmental function can qualify for exclusion from gross income under section 115 of the Internal Revenue Code (the “Code”) if the entity and a nongovernmental entity each own an undivided interest in an electric generating facility under a structure that would not result in private business use of the entity’s interest by the nongovernmental co-owner under the tax-exempt bond rules.

Section 115(1) of the Code provides that gross income does not include income derived from any public utility or the exercise of any essential governmental function and accruing to a State or any political subdivision thereof or the District of Columbia.

Section 115(1) of the Code applies not to the income of a State or political subdivision resulting from its own direct participation in industry, but rather to income of a separate entity engaged in the operation of a public utility or the performance of some governmental function that accrues to a State or political subdivision. See Rev. Rul. 77-261, 1977-2 C.B. 45. Rev. Rul. 77-261 concludes that income of a State investment fund “accrues” to the State and the participating political subdivisions because the State and the political subdivisions have an unrestricted right to receive in their own right their proportionate share of the investment fund’s income as it is earned. Rev. Rul. 90-74, 1990-2 C.B. 34, concludes that income of an organization formed by political subdivisions to pool their casualty risks “accrues” to the member political subdivisions because the organization’s income is used to reimburse casualty losses incurred by the members or to reduce the annual fees that they otherwise would be required to pay to the organization, and upon dissolution the organization will distribute its assets to its member political subdivisions.

Section 141 of the Code defines obligations of a State or political subdivision thereof that are “private activity bonds.” It distinguishes between government use and private business use of bond-financed facilities. The Treasury Regulations under Section 141 describe circumstances in which a governmental entity’s undivided ownership interest in an electric generating facility is not treated as used by the other, nongovernmental owner of the facility and, therefore, the bonds are not private activity bonds. Example 1 of section 1.141-7(i) of the Treasury Regulations involves a facility that is owned under a co-ownership structure involving both governmental and nongovernmental co-owners, and concludes that this arrangement does not result in “private business use” by the nongovernmental co-owner of the governmental co-owner’s tax-exempt bond financed portion of the facility. This example describes the ownership structure as joint ownership as tenants in common, with each of the participants sharing in the ownership, output, and operating expenses of the facility in proportion to its contribution to the cost of the facility. The governmental entity funded its portion of the cost of the facility using tax-exempt bond proceeds and the nongovernmental entity used its own funds to pay its share of the facility’s costs.

Co-ownership of an electric generating facility that is structured in the manner described in Example 1 of section 1.141-7(i) of the Treasury Regulations will not prevent the income of a governmental co-owner of the facility from accruing to a State or a political subdivision. Thus, income derived from any public utility or the exercise of any essential governmental function that otherwise qualifies for exclusion from gross income under section 115 will not cease to qualify for such treatment merely because the entity earning the income is a co-owner of an electric generating facility if the co-ownership arrangement is structured in accordance with Example 1 of section 1.141-7(i) of the Treasury Regulations.

This letter has called your attention to certain general principles of the law. It is intended for informational purposes only and does not constitute a ruling. See Rev. Proc. 2012-1, I.R.B. 2012-1 (Jan. 3, 2012). If you have any additional questions, please contact me at * * *.

                    Sincerely,
                    Sylvia F. Hunt
                    Assistant Branch Chief,
                    Exempt Organizations Branch
                  (Tax Exempt & Government Entities)


Tax-Exempt Bond Group Not Affected by TE/GE Reorganization.

The tax-exempt bond group of the IRS Tax-Exempt and Government Entities Division will be unaffected by the recently announced TE/GE reorganization, Rebecca Harrigal, director of tax-exempt bonds at TE/GE, said March 27.

Responding to an audience question at the National Association of Bond Lawyers’ Tax and Securities Law Institute in Boston about whether counsel functions will be moved from the tax-exempt bond (TEB) group of TE/GE, Harrigal said there will be no change in the TEB group because TEB uses the chief counsel financial institutions and products (FIP) branch 5 and the chief counsel TE/GE as TEB Counsel.

The IRS announced March 20 that it will move some legal functions, including those responsible for issuing published guidance, from the TE/GE Division to the IRS Office of Chief Counsel.

“FIP Branch 5 will do the revenue rulings, letter rulings, and TAMs [technical advice memoranda],” Harrigal said. “They have always done that and there is no change there.”

According to Harrigal, TEB uses TE/GE as their field counsel, by helping prep TAMs, among other functions. “We have within TEB some subject matter experts, and in 2009 we had a significant hiring where we brought in a lot of attorneys, but they have never supplanted what the FIP and TE/GE counsel does for us,” Harrigal said. “So there will be no change in TEB’s operations.”

Closing Agreements

Harrigal said that under her leadership, TEB now has a closing agreement team that is designed to ensure consistency and enforceability and to be proactive in the closing agreement area. Closing agreements are how TEB resolves a vast majority of their cases, she said.According to Harrigal, the closing agreement team looks at all the nonstandard closing agreements for consistency and enforceability. “If there are terms in there that are new, we have a procedure and administration person look at it as a member of the closing agreement team. Because we have them as an ad hoc member, there isn’t the lengthy coordination process we would normally face.

“We found that it is working very quickly and we are turning these closing agreements around very quickly,” Harrigal said.

The group also creates standard closing agreement terms, Harrigal said, “so when a closing comes in we can pop those terms in [the agreement] so [the field agents] don’t reinvent the wheel.”

The closing agreement team is also trying to be proactive with the market, Harrigal said. If the team is seeing matters that will be a problem for a significant number of issuers, they will look at consistent resolutions they can put in place before the issuers start getting into problems.

The closing agreement team will consist of members of the field office, FIP branch 5, and IRS Office of Associate Chief Counsel (Procedure and Administration).

Currently, the closing agreement team will not negotiate nor sign off on closing agreements, although this could potentially change as the team develops over time, Harrigal said.

by William R. Davis



H.R. 4237 Would Lift Cap on Water Facility Bonds.

H.R. 4237, the Sustainable Water Infrastructure Investment Act of 2014, introduced by Rep. John J. Duncan Jr., R-Tenn., would exclude bonds for water and sewage facilities from the volume cap on private activity bonds.

Citations: H.R. 4237; Sustainable Water Infrastructure Investment Act of 2014

113TH CONGRESS
2D SESSIONH.R. 4237

To amend the Internal Revenue Code of 1986 to provide that the volume
cap for private activity bonds shall not apply to bonds for facilities
for furnishing of water and sewage facilities.

IN THE HOUSE OF REPRESENTATIVES

MARCH 13, 2014

Mr. DUNCAN of Tennessee (for himself and Mr. PASCRELL) introduced the
following bill; which was referred to the Committee on Ways and Means

A BILL

To amend the Internal Revenue Code of 1986 to provide that the volume cap for private activity bonds shall not apply to bonds for facilities for furnishing of water and sewage facilities.Be it enacted by the Senate and House of Representatives of the United States of America in Congress assembled,

SECTION 1. SHORT TITLE.

This Act may be cited as the “Sustainable Water Infrastructure Investment Act of 2014”.

SEC. 2. FINDINGS AND PURPOSE.

(a) FINDINGS. — Congress finds the following:

(1) Our Nation’s water and wastewater systems are among the best in the world, providing safe drinking water and sanitation to our citizens.

(2) In addition to protecting the health of our citizens, community water systems are essential to our local economies, enabling industries to achieve growth and productivity that make America strong and prosperous.

(3) Regulated under title XIV of the Public Health Service Act (42 U.S.C. 300f et seq.; commonly known as the “Safe Drinking Water Act”) and the Federal Water Pollution Control Act (33 U.S.C. 1251 et seq.), community drinking water systems and wastewater collection and treatment facilities are critical elements in the Nation’s infrastructure.

(4) Water and wastewater infrastructure is comprised of a mixture of old and new technology. In many local communities across the Nation, the old infrastructure has deteriorated to critical conditions and is very costly to replace. Recent government studies have estimated costs of $500,000,000,000 to $800,000,000,000 over the next 20 years for maintaining and improving the existing inventory, building new infrastructure, and meeting new water quality standards.

(5) The historical approach of funding infrastructure is insufficient to meet the investment needs of the future.

(6) The Federal partnership with State and local communities has played a pivotal role in improving the Nation’s water quality and drinking water supplies. Federal assistance under this partnership has been the linchpin of these improvements.

(7) In light of constrained Federal budgets, the availability of exempt-facility financing represents an important financing tool to help close the gap between funds currently being invested and water infrastructure needs, preserving the Federal partnership.

(8) Providing alternative financing solutions, such as tax-exempt securities, encourages investment in water and wastewater infrastructure that in turn creates local jobs and protects the health of our citizens.

(9) Federally mandated State volume cap restrictions in conjunction with other priorities have limited the use of tax-exempt securities on water and wastewater infrastructure investment.

(10) Removal of State volume caps for water and wastewater infrastructure will accelerate and increase overall investment in the Nation’s critical water infrastructure; facilitate increased use of innovative infrastructure delivery methods supporting sustainable water systems through public-private partnerships that optimize design, financing, construction, and long-term management, maintenance and viability; and provide for more effective risk management of complex water infrastructure projects by municipal utility and private sector partners.

(b) PURPOSE. — The purpose of this Act is to provide alternative financing for long-term infrastructure capital investment programs, and to restore the Nation’s safe drinking water and wastewater infrastructure capability and protect the health of our citizens.

SEC. 3. EXEMPT-FACILITY BONDS FOR SEWAGE AND WATER SUPPLY FACILITIES.

(a) BONDS FOR WATER AND SEWAGE FACILITIES EXEMPT FROM VOLUME CAP ON PRIVATE ACTIVITY BONDS. — Paragraph (3) of section 146(g) of the Internal Revenue Code of 1986 is amended by inserting “(4), (5),” after “(2),”.

(b) CONFORMING CHANGE. — Paragraphs (2) and (3)(B) of section 146(k) of the Internal Revenue Code of 1986 are both amended by striking “(4), (5), (6),” and inserting “(6)”.

(c) EFFECTIVE DATE. — The amendments made by this section shall apply to obligations issued after the date of the enactment of this Act.



IRS LTR: Healthcare Organization Is Denied Exemption.

The IRS denied tax-exempt status to an organization established to be the successor organization to two tax-exempt healthcare organizations that plan to merge, concluding that the organization operates primarily for the benefit of its member-enrollees rather than for the community.
Citations: LTR 201412018

Contact Person: * * *
Identification Number: * * *
Contact Number: * * *

UIL: 501.03-00
Release Date: 3/21/2014

Date: December 11, 2013Employer Identification Number: * * *

Form Required To Be Filed: * * *

Tax Years: * * *

Dear * * *:This is our final determination that you do not qualify for exemption from Federal income tax as an organization described in Internal Revenue Code section 501(c)(3). Recently, we sent you a letter in response to your application that proposed an adverse determination. The letter explained the facts, law and rationale, and gave you 30 days to file a protest. Since we did not receive a protest within the requisite 30 days, the proposed adverse determination is now final.

Because you do not qualify for exemption as an organization described in Code section 501(c)(3), donors may not deduct contributions to you under Code section 170. You must file Federal income tax returns on the form and for the years listed above within 30 days of this letter, unless you request an extension of time to file. File the returns in accordance with their instructions, and do not send them to this office. Failure to file the returns timely may result in a penalty.

We will make this letter and our proposed adverse determination letter available for public inspection under Code section 6110, after deleting certain identifying information. Please read the enclosed Notice 437, Notice of Intention to Disclose, and review the two attached letters that show our proposed deletions. If you disagree with our proposed deletions, follow the instructions in Notice 437. If you agree with our deletions, you do not need to take any further action.

If you have any questions about this letter, please contact the person whose name and telephone number are shown in the heading of this letter. If you have any questions about your Federal income tax status and responsibilities, please contact IRS Customer Service at 1-800-829-1040 or the IRS Customer Service number for businesses, 1-800-829-4933. The IRS Customer Service number for people with hearing impairments is 1-800-829-4059.

                  Sincerely,
                  Karen Schiller
                  Acting Director,
                  Exempt Organizations
                  Rulings and Agreements

Enclosure
Notice 437
Redacted Proposed Adverse Determination Letter
Redacted Final Adverse Determination Letter

* * * * *

Contact Person: * * *
Identification Number: * * *
Contact Number: * * *
FAX Number: * * *

501.03-00

Date: October 30, 2013Employer Identification Number: * * *

LEGEND:Organization 1 = * * *
Organization 2 = * * *
System = * * *
Institute = * * *
Foundation = * * *

Dear * * *:

We have considered your application for recognition of exemption from federal income tax under section 501(a) of the Internal Revenue Code. Based on the information provided, we have concluded that you do not qualify for exemption under § 501(c)(3) of the Code. The basis for our conclusion is set forth below.

FACTS

You were formed as a nonprofit membership corporation under state law. You will be the successor to the planned merger between two related healthcare organizations, Organization 1 and Organization 2.Organization 1 is a nonprofit membership corporation. Its members consist of persons who hold insurance contracts directly with Organization 1 or through their employer-subscribers. Organization 1 does not have any corporate members. Organization 1 is recognized by the IRS as an organization described in § 501(c)(4) of the Code. It controls, directly and indirectly, a number of exempt and non-exempt organizations, and serves as the parent of a large integrated healthcare system known as System. The organizations in System include healthcare providers, clinics, and hospitals. Organization 1 is governed by a * * *-member board of directors. * * * directors are elected by Organization 1‘s subscribers or subscribers of plans administered by Organization 1 * * * directors are selected from the directors of Organization 2; and directors are healthcare providers. Organization 1 is licensed to operate an HMO. It offers a number of arranger-type HMO plans to various groups, including small and large employers, individual enrollees, and Medicare and Medicaid beneficiaries. Currently, Organization 1 has approximately * * * enrollees.

Organization 2 is a nonprofit membership corporation. Its members consist of Associate Members (persons holding insurance contracts with Organization 2 or through their employer-subscribers) and one Corporate Member,Organization 1. Organization 2 is recognized by the IRS as an organization described in § 501(c)(3) of the Code. It is governed by a * * * member board of directors. * * * directors are enrollees in Organization 2‘s HMO plan (or in another plan administered by System); one director is the Chair of the Organization 1 board of directors; and one director is a physician appointed by the president of Organization 2. Organization 2 operates a “staff model” HMO and physician clinics, providing healthcare services directly by its employed healthcare providers through clinics and hospitals that are part of System. Organization 2‘s enrollees consist of individuals and Medicare beneficiaries.

Organization 1 and Organization 2 plan to merge and transfer to you all of their assets and operations. As a result, you will carry on the activities and HMO plans that Organization 1 and Organization 2 currently carry on as separate organizations. Following the planned merger, you will continue to offer a variety of insurance plans, including traditional HMO plans, plans providing access to out of network providers, tiered network plans, Medicaid, Medicare Cost and Advantage plans, and dental plans. In addition, as a result of the planned merger, you will replace Organization 1 as the parent of System and thereby control the entities comprising the System.

Your bylaws state that you will have one class of members. A member is a contract holder who holds a health maintenance contract with you for medical services, or a contract holder who receives healthcare services through employer-insured contracts that either you or a related organization administer. Thus, a member of the corporation is also an “enrollee” in one of your healthcare plans. (Hereafter, such an individual is referred to as a “Member-Enrollee.”)

Your bylaws state that a * * *-person board of directors governs you. * * * of the directors must be Member-Enrollees. Your bylaws expressly state that all such directors must be covered under an HMO contract or insurance contract that either you or a related organization issue, or under an employer-issued contract that either you or a related organization administer. No more than one Member-Enrollee director may be from any one employer group, unless that group exceeds 1/7 of the total enrollment. For each additional 1/7, there may be an additional director from that group, up to a maximum of three. In addition, a Member-Enrollee director cannot be a person:

    * * *

The other two directors must be healthcare providers, one physician elected by your Medical Board of Governors, and one of your employee-physicians appointed by your president.As a result of the merger, you expect to have total assets of approximately $* * * million, of which $* * * million, or * * * percent, will consist of accumulated surplus. This surplus is not dedicated to any sort of research, charity care, or educational program. You have not described any tax-exempt programs for which you intend to use this surplus.

For the first full year of operation following the merger, you expect that your revenues will be:

For the first full year of operation, you expect that enrollment in your various health plans will be:

You expect that enrollment in your traditional HMO plans will account for approximately * * * of your * * * subscribers (or * * * percent) and $* * * million of your $* * * billion of revenue (or * * * percent). You estimate that the open access, tiered network, and consumer directed plans will account for approximately * * * of your * * * subscribers (or * * * percent) and $* * * of your $* * * of revenue (or * * * percent).Following the planned merger, you expect to pay approximately $* * * (or * * * percent of your total expected healthcare expenditures of $* * *) as direct contractual fee for service payments to non-employee healthcare providers for services rendered to enrollees in your plans.

Organization 1 and Organization 2 currently have financial assistance programs under which they serve those unable to pay. Persons checking in to one of the organizations’ clinics are provided with an information sheet referring to, among other things, the financial assistance program and may fill out an application. Individuals and families who are at or below the federal poverty level are eligible for completely subsidized care, with decreasing subsidies as income rises up to 300 percent of the federal poverty level. You state that in * * *, under these programs, Organization 1 and Organization 2 together provided a total of approximately $* * * million in uncompensated care. You state that, after the merger, you will continue to follow these same programs and that you expect to provide the same amounts of uncompensated care as Organization 1 and Organization 2 provided previously. At this same level, these benefits will constitute approximately * * * percent of your expected total revenues.

You state that you will also continue a premium subsidy plan that is currently operated by Organization 1 andOrganization 2 for Medicare Advantage plan enrollees who meet certain eligibility criteria. As of January * * *, approximately * * * individuals were enrolled in this plan. At this same level, this enrollment will represent approximately * * * percent of your total expected enrollment.

Currently, Organization 2‘s physician employees provide some direct clinical teaching to medical students and interns at various healthcare facilities in System, and your dentist employees conduct a small training program by collaborating with a university to provide clinical rotations for two residents each year. After the merger, you will continue these programs. These student medical and dental education programs are conducted principally byInstitute, a § 501(c)(3) organization that is currently controlled by Organization 1. Institute provides training for more than * * * medical residents each year and conducts a variety of continuing medical education programs. After the planned merger, Institute will remain a separate organization that you will control.

Currently, Organization 1, through Organization 2, controls Foundation, a § 501(c)(3) organization that focuses primarily on scientific and medical research. Organization 1 and Organization 2 have funded Foundation in the amount of approximately $* * * per year. Following the planned merger, you will control Foundation and intend to continue to fund it at approximately the same level, which would represent approximately * * * percent of your expected total revenues.

LAW

Section 501(c)(3) of the Code exempts from federal income tax corporations organized and operated exclusively for charitable, educational, scientific, and other purposes, provided that no part of their net earnings inures to the benefit of any private shareholder or individual.Section 1.501(c)(3)-1(a)(1) of the Income Tax Regulations (regulations) provides that, in order to be exempt as an organization described in section 501(c)(3), an organization must be both organized and operated exclusively for one or more of the purposes specified. If an organization fails to meet either the organizational test or the operational test, it is not exempt.

Section 1.501(c)(3)-1(c)(1) of the regulations provides that an organization will be regarded as “operated exclusively” for one or more exempt purposes only if it engages primarily in activities that accomplish one or more of the exempt purposes specified in section 501(c)(3). An organization will not be so regarded if more than an insubstantial part of its activities is not in furtherance of an exempt purpose.

In Better Business Bureau of Washington D.C., Inc. v. U.S., 326 U.S. 279 (1945), the Supreme Court held that the presence of a single non-exempt purpose, if substantial in nature, will destroy the exemption regardless of the number or importance of truly exempt purposes. The Court found that a trade association had an “underlying commercial motive” that distinguished its educational program from that carried out by a university, and therefore, the association did not qualify for exemption.

In BSW Group, Incorporated v. Commissioner, 70 T.C. 352 (1978), the Tax Court considered the qualification for exemption under § 501(c)(3) of an organization formed to provide consulting services for a fee to nonprofit and tax exempt organizations in the areas of health and health delivery systems, housing, vocational skills, and cooperative management. In concluding that the organization did not qualify for exemption, the court noted that:
[T]he critical inquiry is whether petitioner’s primary purpose for engaging in its sole activity is an exempt purpose, or whether its primary purpose is the nonexempt one of operating a commercial business producing net profits for petitioner. . . . Factors such as the particular manner in which an organization’s activities are conducted, the commercial hue of those activities, and the existence and amount of annual or accumulated profits are relevant evidence of a forbidden predominant purpose.
Id. at 357.Section 1.501(c)(3)-1(d)(2) of the regulations states, in part, that the term “charitable” in section 501(c)(3) of the Code includes relief of the poor and distressed or of the underprivileged; advancement of religion; advancement of education or science; lessening of the burdens of government; and promotion of social welfare by organizations designed to accomplish any of the above purposes. In addition, the promotion of health has long been recognized as a charitable purpose under common law. See Restatement (Second) of Trusts, §§ 368, 372 (1959).

An organization that promotes health primarily for the benefit of the community as a whole can qualify as charitable. In Rev. Rul. 69-545, 1969-2 C.B. 117, the Service found that a non-profit hospital was described in section 501(c)(3) of the Code when it: (1) provided hospital care for all those persons in the community able to pay the cost thereof either directly or through third party reimbursement; (2) operated an emergency room open to all persons; (3) used its surplus funds to improve the quality of patient care, expand its facilities, and advance its medical training, education, and research programs; (4) was controlled by a board of trustees that was composed of independent civic leaders; and (5) maintained an open medical staff, with privileges available to all qualified physicians.

Three court cases have considered whether an HMO qualifies for exemption under § 501(c)(3): Sound Health Association v. Commissioner, 71 T.C. 158, 177-181 (1978), Geisinger Health Plan v. Commissioner, 985 F.2d 1210, 1219 (3d Cir. 1993), and IHC Health Plans Inc. v. Commissioner, 325 F.3d 1188, 1197 (10th Cir. 2003). All three cases applied the “community benefit” standard for tax-exempt hospitals, using the specific factors set forth in Revenue Ruling 69-545.

In Sound Health, the Tax Court determined that an organization qualified under § 501(c)(3) of the Code where it provided HMO services combined with direct healthcare services. The organization provided services to both subscribers and members of the general public and also operated an outpatient clinic that treated all emergency patients, regardless of subscriber status or ability to pay. The court found that these characteristics, which were similar to those identified in the exempt hospital in Rev. Rul. 69-545, showed that it was operated for charitable purposes.

In Geisinger, the court held that a pre-paid healthcare organization that arranges for the provision of healthcare services only for its members benefits its members rather than the community as a whole. Under the community benefit standard, the organization must benefit the community as a whole to establish the charitable purpose of promoting health for purposes of § 501(c)(3).

IHC involved an operator of health maintenance organizations and insurance providers that served approximately one-quarter of Utah’s residents and approximately one-half of its Medicaid population. The court held that these organizations, Health Plans, Care, and Group, failed to meet the community benefit standard to qualify for exemption under § 501(c)(3) because their activities were focused on arranging for healthcare services for their members in exchange for a fee. The court said that providing healthcare products or services to all in the community is necessary but not sufficient to meet the community benefit standard. Rather, the organization must provide some additional benefit that likely would not be provided in the community but for the tax exemption, and that this public benefit must be the primary purpose for which the organization operates.

Not every activity that promotes health generally furthers exclusively charitable purposes under § 501(c)(3). For example, a hospital does not primarily further a charitable purpose solely by offering healthcare services to the public in exchange for a fee. See Rev. Rul. 69-545, supra. As IHC noted, “engaging in an activity that promotes health, standing alone, offers an insufficient indicium of an organization’s purpose,” as “[n]umerous for-profit enterprises offer products or services that promote health.” 325 F.3d at 1197. Thus, a health maintenance organization that is operated primarily for the purpose of benefiting its paying subscribers does not qualify for exemption solely because the community also derives health benefits from its activities. See, generally, Geisingerand IHC.

To qualify as an organization described in § 501(c)(3), a healthcare organization must make its services available to all in the community plus provide additional community or public benefits. IHC, 325 F.3d at 1198. The additional benefits must give rise to a strong inference that the public benefit is the primary purpose for which the organization operates. Id. The Court of Appeals in IHC identified five factors drawn from relevant case law to determine whether a healthcare organization is operating primarily for the benefit of the community. These factors are enumerated below along with the IHC court’s application of each factor to the facts of that case.

    (1) The size of the class eligible to benefit

The Court of Appeals noted that membership was a precondition to the ability of individuals to qualify for healthcare benefits under its plans, and that a large, diverse enrollment is not indicative per se of the organization’s purpose. Citing Geisinger, the court stated:“The community benefited is, in fact, limited to those who belong to [the HMO] since the requirement of subscribership remains a condition precedent to any service. Absent any additional indicia of a charitable purpose, this self-imposed precondition suggests that [the HMO] is primarily benefitting itself (and, perhaps, secondarily benefitting the community) by promoting subscribership throughout the areas it serves.”
985 F.2d at 1219. Further, while the absence of a large class of potential beneficiaries may preclude tax-exempt status, its presence standing alone provides little insight into the organization’s purpose. Offering products and services to a broad segment of the population is as consistent with self-promotion and profit maximization as it is with any “charitable” purpose.
325 F.3d at 1201.

    (2) Free or below-cost products or services

The Tax Court determined that the organizations provided “virtually no free or below-cost health-care services. [Footnote omitted]. All enrollees must pay a premium in order to receive benefits. [Footnote omitted.]” Id. at 1200. Further, the Court did not consider the organization’s “adjusted community rating system, which likely allowed its enrollees to obtain medical care at a lower cost than might otherwise have been available. [Citations omitted],” as evidence of the organizations’ purpose. Id. Furthermore the court noted that a minimal degree of free services is inconsequential, stating:
As the Eighth Circuit has noted, “a ‘charitable’ hospital may impose charges or fees for services rendered, and indeed its charity record may be comparatively low depending upon all the facts . . . but a serious question is raised where its charitable operation is virtually inconsequential. [Citations omitted.]
Id., n. 27.

    (3) Treatment of persons participating in governmental programs such as Medicare or Medicaid

The organizations provided healthcare services to Medicaid beneficiaries; however, the Court of Appeals noted that:
The relevant inquiry, however, is not “whether [petitioner] benefited the community at all . . . [but] whether it primarily benefited the community, as an entity must in order to qualify for tax-exempt status.” Geisinger I, 985 F.2d at 1219.
Id. at 1201, n. 29.

    (4) Use of surplus funds for research or educational programs

In IHC, none of the organizations conducted research or offered free education programs to the public.

    (5) Composition of the board of trustees

Prior to 1996, the bylaws of one of the IHC organizations provided that employer subscribers represented a plurality of the board. In 1996, the organization amended its bylaws to require that a majority of board members be disinterested and broadly representative of the community. The Court of Appeals did not consider the board composition, either before or after the amendment, as a factor. However, it stated that:
Even if we were to conclude petitioners’ board broadly represents the community, the dearth of actual community benefit in this case rebuts any inference we might otherwise draw.
Id. at 1201.In general, maintaining a board that is representative of the community is a significant factor indicating that an organization will be operated for the benefit of the community as a whole, though it is not essential. See Rev. Rul. 69-545, supra; Sound Health; Geisinger; IHC. For example, in Sound Health, the organization’s board was elected by its member-subscribers and was found to qualify under § 501(c)(3). However, that organization demonstrated other significant factors showing that it was operated for the benefit of the community, such as that initially over 2 percent of its patients would be charity care patients. Sound Health, 71 T.C. at 171. The organization in Sound Health also maintained a significant public health program and subsidized dues program. Id. at 166.

ANALYSIS

You do not meet the community benefit standard because you primarily operate to benefit your Member-Enrollees and not the community as a whole. Thus, you are not described in § 501(c)(3) of the Code. You propose to merge a “staff model” HMO described in § 501(c)(3) with a much larger “arranger” HMO described in § 501(c)(4). You will be the successor to the planned merger of the two organizations. Organization 2, the “staff model” HMO, has approximately * * * members, while Organization 1, the “arranger” HMO, has over * * * enrollees. You expect to have total annual healthcare expenditures of $* * *, of which $* * * billion (or about * * * percent) will consist of direct contractual fee for service payments to non-employee healthcare providers for services rendered to your Member-Enrollees. Therefore, your primary purpose is to operate a § 501(c)(4) arranger HMO, with your direct healthcare services representing a minority of your activities.The IHC court said, “In this case, we deal with organizations that do not provide health-care services directly. Rather, petitioners furnish group insurance entitling enrollees to services of participating hospitals and physicians.” 325 F.3d at 1199. The court reasoned that this is not an inherently charitable activity, and that “the commercial nature of this activity inspire[s] doubt as to the entity’s charitable purpose.” Id. Although you will also operate a “staff model” component, your § 501(c)(4) arranger activities supply the bulk of your revenue. Therefore, as your primary activity is commercial rather than charitable, you are not operated exclusively for § 501(c)(3) purposes.

Additionally, IHC lists several factors used to determine whether a healthcare organization is operating primarily for the benefit of the community. Based on the information you provided, several of these factors suggest that you do not operate primarily for the benefit of the community. Namely, the size of the class eligible to benefit from your activities is not sufficient, you do not provide sufficient free or below-cost services, and you do not use your substantial surplus funds to provide meaningful research and educational programs. Each factor is analyzed below.

    (1) The size of the class eligible to benefit

You are similar to IHC because you limit your healthcare benefits only to persons who are enrolled in one of your plans, a precondition of which is the payment of the required premiums. Although you provide healthcare benefits to some under your financial assistance policy, these benefits are minimal in relation to the total premiums you receive.

    (2) Free or below-cost products or services

Your financial assistance program is expected to result in about $* * * of uncompensated care, which is minimal in relation to your expected operating revenues of $* * * billion, representing only about * * * percent of revenues. In addition, your premium subsidy plan for Medicare Advantage plan enrollees is minimal, serving only * * * persons out of your expected * * * total enrollees, or less than * * *. These programs are unlike the programs described inSound Health, where significant indicia of community benefit outweighed the negative factor that its board was elected by its member-subscribers.

    (3) Use of surplus funds for research or educational programs

You do not use ample surplus funds for research or educational programs to further a § 501(c)(3) purpose. For example, Foundation, a related organization in System that you will control as a result of the proposed merger, will continue to conduct scientific and medical research. You intend to continue to fund this organization in the same amount as your two predecessors, about $* * * per year. At this level, your expected funding will represent only * * * percent of your expected total revenues of $* * *.In addition, as a result of the merger, you expect to have an accumulated surplus of $* * * million, which will represent about * * * percent of your total assets. This surplus is not dedicated to any sort of research, charity care, or educational program. You have not described any tax-exempt programs for which you intend to use this surplus. Maintaining a large surplus such as this is contrary to one of the factors in the community benefit standard established in Rev. Rul. 69-545, supra. See IHC, 325 F.3d at 1196.

Therefore, you will not operate for the primary purpose of providing healthcare services for the benefit of the community. Rather, the evidence shows that you will be controlled by, and operate primarily for the benefit of, your Member-Enrollees. Consequently, you do not qualify as an organization described in § 501(c)(3).

CONCLUSION

For the reasons set forth above, you do not qualify for exemption as an organization described in § 501(c)(3) of the Code and you must file federal income tax returns.You have the right to file a protest if you believe this determination is incorrect. To protest, you must submit a statement of your views and fully explain your reasoning. You must submit the statement, signed by one of your officers, within 30 days from the date of this letter. We will consider your statement and decide if the information affects our determination.

Your protest statement should be accompanied by the following declaration:
Under penalties of perjury, I declare that I have examined this protest statement, including accompanying documents, and, to the best of my knowledge and belief, the statement contains all the relevant facts, and such facts are true, correct, and complete.
You also have a right to request a conference to discuss your protest. This request should be made when you file your protest statement. An attorney, certified public accountant, or an individual enrolled to practice before the Internal Revenue Service may represent you. If you want representation during the conference procedures, you must file a proper power of attorney, Form 2848, Power of Attorney and Declaration of Representative, if you have not already done so. For more information about representation, see Publication 947, Practice before the IRS and Power of Attorney. All forms and publications mentioned in this letter can be found at www.irs.gov, Forms and Publications.If you do not file a protest within 30 days, you will not be able to file a suit for declaratory judgment in court because the Internal Revenue Service (IRS) will consider the failure to protest as a failure to exhaust available administrative remedies. Code § 7428(b)(2) provides, in part, that a declaratory judgment or decree shall not be issued in any proceeding unless the Tax Court, the United States Court of Federal Claims, or the District Court of the United States for the District of Columbia determines that the organization involved has exhausted all of the administrative remedies available to it within the IRS.

If you do not intend to protest this determination, you do not need to take any further action. If we do not hear from you within 30 days, we will issue a final adverse determination letter. That letter will provide information about filing tax returns and other matters.

Please send your protest statement, Form 2848 and any supporting documents to this address:

    * * *

You may also fax your statement using the fax number shown in the heading of this letter. If you fax your statement, please call the person identified in the heading of this letter to confirm that he or she received your fax.If you have any questions, please contact the person whose name and telephone number are shown in the heading of this letter.

Thank you for your cooperation. We have sent a copy of this letter to your representative as indicated in your power of attorney.

                  Sincerely,
                  Karen Schiller,
                  Acting Director,
                  Exempt Organizations
                  Rulings & Agreements


IRS LTR: Management Contract Will Not Result in Private Business Use.

The IRS ruled that an amended management contract under which a bond issuer — which issued bonds to finance an electric distribution system — will pay the manager of the project annual fees will not result in private business use of a hotel.

Citations: LTR 201412011

Third Party Communication: None
Date of Communication: Not Applicable
Person To Contact: * * *, ID No. * * *
Telephone Number: * * *

Index Number: 141.00-00, 141.07-00
Release Date: 3/21/2014

Date: December 23, 2013Refer Reply To: CC:FIP:B05 – PLR-147299-13

LEGEND:

Act = * * *
Authority = * * *
Amended Agreement = * * *
Board = * * *
Department = * * *
Electric Company = * * *
Existing Agreement = * * *
Manager = * * *
Operator = * * *
Service Area = * * *
State = * * *
Storm Event = * * *
Adjustment Factor = * * *
Bonds = * * *
Year 1 = * * *
Year 2 = * * *
Year 3 = * * *
a = * * *
b = * * *
c = * * *
d = * * *
x = * * *
y = * * *
z = * * *

Dear * * *:This responds to Authority’s request for a ruling that the Amended Agreement described below will not result in private business use of the Bonds under § 141(b) of the Internal Revenue Code (the “Code”).

FACTS AND REPRESENTATIONS

You make the following representations. Authority owns all of the stock of Electric Company, a governmental person. Electric Company owns and controls an electric transmission system and an electric distribution system (collectively referred to herein as the “T&D Systems”), and has the right to provide retail electric service to customers in the Service Area. Proceeds of the Bonds were used to finance the T&D Systems.Electric Company and Manager entered into the Existing Agreement in December of Year 1. Pursuant to the Existing Agreement, effective January 1 of Year 2, Manager is required to operate and maintain the T&D Systems in accordance with policies established by Authority and Electric Company. To this end, Manager formed Operator as a wholly-owned subsidiary to provide substantially all of the management and operations services required under the Existing Agreement. In Year 1, Authority sought a letter ruling relating to the consequences, under Code Section 141(b), of the Existing Agreement in relation to interest on then-outstanding Bonds of Authority. A favorable ruling letter was subsequently issued.

Authority and Manager now propose to enter into the Amended Agreement in order to implement the requirements of the Act and to modify certain provisions of the Existing Agreement to improve service and reliability of the T&D Systems at rates set at the lowest level consistent with sound fiscal operating practices. The Act was enacted in response to operational difficulties encountered by the Electric Company and its current service provider in restoring service on the T&D Systems as a result of damage inflicted by the Storm Event and to a range of criticisms relating to, among other matters, storm preparedness, limited accountability, disconnected management, planning and operational policies and a lack of oversight and transparency in the ratemaking process. The Act imposes additional regulatory oversight and requirements on Electric Company and mandates additional duties for any service provider operating the T&D Systems.

The Act also establishes a separate office in Department responsible for reviewing and making recommendations regarding the operations and terms and conditions of service of, and rates and budgets established by, Authority and/or its service provider.

The Amended Agreement has a term that does not exceed 12 years. The Amended Agreement provides that in the event that Manager achieves the level of performance with respect to criteria set forth in the Amended Agreement during the initial term, the parties will negotiate in good faith an extension of the term of the Amended Agreement to 20 years from the original service commencement date on terms and conditions substantially similar to those set forth in the Amended Agreement. The Amended Agreement may be immediately terminated prior to the end of the term by either party due to specified events of default.

None of the voting power of the governing body of Electric Company is vested in Manager and its directors, officers, shareholders, and employees. There are no overlapping board members between Manager and either Authority or Electric Company. Authority represents that it is not a related party, as defined in § 1.150-1(b) of the Income Tax Regulations, to either Manager or Operator.

The Act requires that a service provider prepare and maintain an emergency response plan to assure the reasonably prompt restoration of service in the case of an emergency event. Implementation of the Act further necessitates the transfer of significant operational duties and enables Manager to independently set a wide range of operational policies. Under the Amended Agreement, Electric Company will no longer have a contractual right to approve subcontractors (subject to certain limitations) and a joint operating committee will no longer exist. Manager must nonetheless operate the T&D Systems in a manner Standards”. Also, it cannot transmit or distribute electric energy using the T&D Systems other than power and energy obtained by, on behalf of, or with the approval of Electric Company, nor can it use the T&D Systems to serve any person other than Electric Company and its customers in the Service Area.

Manager will receive the following (collectively referred to herein as the “Services Fee”) under the Amended Agreement: the Fixed Direct Fee; the Incentive Compensation Component; and the Reimbursement of Pass-through Expenditures.

Fixed Direct Fee. Each contract year, Manager will be paid a stated amount (the”Fixed Direct Fee”) in 12 equal monthly installments. The Fixed Direct Fee, expressed in Year 1 dollars, is $a annually, subject to a one time increase after Year 3 to $b annually thereafter. In each contract year, the Fixed Direct Fee will be adjusted by the Adjustment Factor, which is based on the Consumer Price Index, except that if the Adjustment Factor is negative, the Fixed Direct Fee will be the same as in the previous contract year.

Annual Incentive Compensation Component. In any contract year, Manager also will be eligible to receive a payment referred to as the “Incentive Compensation Component”, which will be based on neither gross revenues nor net profits of the T&D Systems. This amount will be paid from an incentive compensation pool established by Electric Company. The Electric Company will credit to the compensation pool an incentive compensation, expressed in Year 1 dollars, of $c, an amount that will increase to $d beginning with the Year 3 contract year. The Incentive Compensation Component may be earned by Manager based on favorable performance measured against certain performance goals outlined in the Amended Agreement. The Incentive Compensation Component earned by Manager for any year will be adjusted downward if the Manager fails to achieve stated minimums described in the Amended Agreement.

The performance goals consist of four categories: cost management performance, customer satisfaction performance, technical and regulatory performance, and financial performance. In general, Manager attains these goals by (1) close adherence to the capital and operating budgets approved for each contract year; (2) achieving high levels of end-use customer satisfaction; (3) providing safe, reliable power supply in a way that complies with regulation; and (4) meeting Electric Company’s financial needs. These performance goals, and their assigned weightings, are largely the same as under the Existing Agreement, although some of the earlier “Performance Metrics”, defined below, have been consolidated. The Performance Metrics will be adjusted to account for the impact of a new outage management system which, if implemented by Manager, can be expected to improve outage identification capabilities.

The performance categories are subdivided into actual performance metrics (the “Performance Metrics”). The cost management performance category, which has the greatest potential effect on the Incentive Compensation Component, contains two Performance Metrics, one for the approved operating budget and the other for the approved capital budget. These Performance Metrics are satisfied if operating costs and capital costs in any contract year do not exceed x% of the separately approved budget levels for that year. If, in any year, Manager does not achieve the expected performance level for both of the cost management Performance Metrics, Manager will not be eligible to receive any incentive compensation for that year. If Manager does not achieve the expected performance level for the same cost management Performance Metric for two consecutive years, Manager will not be eligible to receive any incentive compensation for the second year. If, in any contract year, Manager achieves the expected performance level for only one of the cost management Performance Metrics, Manager will be eligible for a maximum of y% of the Incentive Compensation Component for that year.

For any contract year, Manager’s level of performance in each performance category will be measured based on actual results achieved for that year. The performance categories other than the cost management performance category are weighted according to relative importance based on the assignment of points referred to as “base points”. The weighted percentages determine the share of the incentive compensation pool that may be allocated to a performance category.

Commencing with the third contract year, the annual incentive compensation for a performance category for any contract year will be reduced by (i) y% if Manager has failed to achieve a stated minimum performance level for the same Performance Metric in that performance category in the then-current contract year and any one of the two preceding contract years, or (ii) z% if Manager has failed to achieve the minimum performance level for two or more of the same Performance Metrics in that performance category in the then-current contract year and any one of the two preceding contract years.

Also commencing with the third contract year, a failure of satisfactory performance by Manager with respect to certain Performance Metrics relating to customer satisfaction and service interruptions in the then-current contract year and any one of the two preceding contract years will result in (a) forfeiture of z% of the Incentive Compensation Component for that contract year, and (b) payment to Electric Company of a penalty equal to a certain percentage of the Fixed Direct Fee for that year.

Reimbursement of Pass-through Expenditures. The Amended Agreement identifies and includes a number of Pass-through Expenditures. The term “Pass-through Expenditures” is generally defined to mean those expenditures incurred by Operator in the course of providing operations services, including capital improvements. Specifically included are wages, salaries, benefits, and other labor costs of the general workforce (chiefly management, professional, and union personnel employed by Operator); costs incurred by Operator for all materials, supplies, vehicles, purchased services; subcontractor costs, costs and fees incurred or payable with respect to leases, permits, and similar instruments; costs incurred in connection with various potential claims; certain costs related to storm events and non-storm emergencies; various taxes; costs of compliance with Department and other regulatory requirements to which Manager or Authority is subject, including as provided in the Act; initial and ongoing costs necessary to achieve efficiency savings for the benefit of Service Area customers; certain demonstrated transition costs; costs incurred in connection with an advisory committee formed under the Amended Agreement to provide advice on clean and renewable energy programs and to arrange periodic public meetings for the purpose of developing and providing input and recommendations to Manager on demand reduction goals, renewable program goals established under various State initiatives by Department for utilities and similar matters; costs incurred in connection with branding and customer and public communications; long range planning costs; and demonstrated transition costs incurred to achieve efficiency savings and costs of providing operations services related thereto on an ongoing basis. Pass-through Expenditures do not include amounts paid by Manager to or for individuals who are part of senior management and who are employed by Manager.

Manager will be reimbursed by Electric Company for the Pass-through Expenditures at its cost of service without mark-up, multiplier, or other adjustment. However, the costs to Manager, if any, of transactions with affiliates under which an affiliate agrees to provide an operations service as a shared service will be at Manager’s total costs (defined as all costs of the affiliate providing the relevant service calculated using (i) a fully allocated cost methodology in compliance with the relevant rules, regulations or orders of the Board, or (ii) such other cost allocation methodology as may be required by other applicable regulatory requirements in lieu of the foregoing) incurred in connection with such transaction (including reasonable and demonstrated costs incurred which are necessary to integrate Operator with such affiliate), but will not include in any event a profit or mark-up component for the affiliate. Transactions with an affiliate under which the affiliate agrees to provide a service relating to the T&D Systems not included in the immediately preceding sentence, which must be approved by Electric Company, may include profit or mark-up paid or payable to the affiliate.

The Amended Agreement covers additional categories of costs and capital investments which will or may be paid to or through Manager or made by or for Manager and calls attention to ancillary agreements under which payments will be made to an affiliate of Manager. The additional categories of costs involve major storm and non-storm emergency expenditures in circumstances beyond the reasonable control of Manager. The permitted capital investments would involve investments in such things as energy efficiency, demand response, renewable energy, energy storage, distributed generation, and electric vehicle charging stations, and can be made only if authorized by Electric Company in its sole discretion. The ancillary agreements, each among Authority, Electric Company and an affiliate of Manager, provide for fuel management and power supply management services. Such costs, investments and agreements all involve circumstances or activities in respect of which Manager (or an affiliate) will take on responsibilities or assume a role engendered by uncontrollable events or otherwise far removed from the regular, day-to-day operation and management of the T&D Systems and related services. Based on all the facts and circumstances, we conclude that they need not be taken into account in our evaluation of the Amended Agreement for purposes of Code Section 141(b).

LAW AND ANALYSIS

Section 103(a) provides that gross income does not include interest on any state or local bond. Section 103(b)(1) provides that this exclusion does not apply to any private activity bond unless, among other requirements, it is a qualified bond (within the meaning of § 141). Section 141(a) provides that a bond is a private activity bond if the bond satisfies the private business use test and the private security or payment test of § 141(b).Under §§ 141(b)(1) and 141(b)(6)(A), the private business use test is met if more than 10 percent of the proceeds are used, directly or indirectly, in a trade or business carried on by any person other than a governmental unit. Under § 141(b)(6)(B), any activity carried on by a person other than a natural person is treated as a trade or business.

Section 1.141-3(b)(1) provides that both actual and beneficial use by a nongovernmental person may be treated as private business use. In most cases, the private business use test is met only if a nongovernmental person has special legal entitlements to use the financed property under an arrangement with the issuer. In general, a nongovernmental person is treated as a private business user of proceeds and financed property as a result of ownership; actual or beneficial use of property as pursuant to a lease, or a management or incentive payment contract; or certain other arrangements such as a take or pay or other output-type contract.

Section 1.141-3(b)(4)(i) provides that a management contract with respect to financed property may result in private business use of that property based on all of the facts and circumstances. A management contract with respect to financed property generally results in private business use of that property if the contract provides for compensation for services rendered with compensation based, in whole or in part, on a share of net profits from the operation of the facility.

Section 1.141-3(b)(4)(ii) defines a management contract as a management, service, or incentive payment contract between a governmental person and a service provider under which the service provider provides services involving all, a portion of, or any function of, a facility. Under § 1.141-3(b)(4)(iii)(C), a contract to provide for the operation of a facility or system of facilities that consists predominantly of public utility property, if the only compensation is the reimbursement of actual and direct expenses of the service provider and reasonable administrative overhead expenses of the service provider, is generally not treated as a management contract that gives rise to private business use. Similarly, § 1.141-3(b)(4)(iii)(D) provides that a contract to provide for services generally does not give rise to private business use if the only compensation is the reimbursement of the service provider for actual and direct expenses paid by the service provider to unrelated third parties.

Revenue Procedure 97-13, 1997-1 C.B. 632, as modified by Revenue Procedure 2001-39, 2001-2 C.B. 38 (“Rev. Proc. 97-13”), sets forth operating guidelines for contracts to manage bond-financed facilities which, if satisfied, allow management services to be provided under the contract without causing the facilities to be treated as used in a private business use under § 141(b). Rev. Proc. 97-13 requires that management contracts conform to guidelines relating to (1) compensation arrangements, (2) contract term, and (3) any circumstances substantially limiting the qualified user’s ability to exercise its rights. Section 5.02(1) of Rev. Proc. 97-13 provides that reimbursement of the service provider for actual and direct expenses paid by the service provider to unrelated third parties is not by itself treated as compensation.

Section 5.02(1) of Rev. Proc. 97-13 also provides in part that the contract must provide for reasonable compensation for services rendered with no compensation based, in whole or in part, on a share of net profits from the operation of the managed facility. For this purpose, § 5.02(3) of Rev. Proc. 97-13 provides that a productivity reward equal to a stated dollar amount based on increases or decreases in gross revenues (or adjusted gross revenues), or reductions in total expenses (but not both increases in gross revenues (or adjusted gross revenues) and reductions in total expenses) in any annual period during the term of the contract generally does not cause the compensation to be based on a share of net profits.

Section 5.03 of Rev. Proc. 97-13 sets forth permissible compensation arrangements. Section 5.03(2) provides an arrangement under which at least 80 percent of the services for each annual period during the term of the contract must be based on a periodic fixed fee. The arrangement provided in § 5.03(2) also contains a term limit under which the term of the contract, including all renewal arrangements, must not exceed the lesser of 80 percent of the reasonably expected useful life of the financed property and 10 years. Section 5.03(3) of Rev. Proc. 97-13 provides that if all of the financed property subject to the contract is a facility consisting of predominantly public utility property (as defined in § 168(i)(10)), then 20 years is substituted for 10 years in applying § 5.03(2).

Section 3.05 of Rev. Proc. 97-13 defines a periodic fixed fee to mean a stated dollar amount for services rendered for a specified period of time. The stated dollar amount may automatically increase according to a specified, objective, external standard that is not linked to the output or efficiency of a facility. For example, the Consumer Price Index and similar external indices that track increases in prices in an area or increases in revenues or costs in an industry are external standards.

Section 5.04(1) of Rev. Proc. 97-13 provides that the service provider must not have any role or relationship with the qualified user that, in effect, substantially limits the qualified user’s ability to exercise its rights, including cancellation rights, under the contract, based on all of the facts and circumstances. Section 5.04(2) provides this requirement is satisfied if (a) Not more than 20 percent of the voting power of the governing body of the qualified user in the aggregate is vested in the service provider and its directors, officers, shareholders, and employees; (b) Overlapping board members do not include the chief executive officers of the service providers or its governing body or the qualified user or its governing body; and (c) The qualified user and the service provider under the contract are not related parties, as defined in § 1.150-1(b).

The Amended Agreement must meet all requirements of section 5 of Rev. Proc. 97-13 for that contract to be deemed under that revenue procedure not to result in private business use of the T&D Systems by Manager. If any requirement is not met, then pursuant to § 1.141-3(b)(4)(i), whether the Amended Agreement results in private business use depends on all of the facts and circumstances. In determining whether the facts and circumstances indicate private business use, the principles set forth in Rev. Proc. 97-13 are useful reference points.

Whether Manager’s compensation meets the requirements of Rev. Proc. 97-13 first requires an analysis of the amounts paid to Manager under the Amended Agreement, which are: (1) the Fixed Direct Fee; (2) the Incentive Compensation Component; and (3) Reimbursement of Pass-through Expenditures.

The Fixed Direct Fee does not meet the requirements of section 5.03(2) of Rev. Proc. 97-13, since it is not a periodic fixed fee. It is subject to reductions because of poor performance. These reductions are not specified, objective, and external within the meaning of section 3.05 of Rev. Proc. 97-13. Nevertheless, based on all of the facts and circumstances, we conclude that the Fixed Direct Fee does not cause the Amended Agreement to result in private business use of the T&D Systems for purposes of § 141. A reduction based on poor performance will not be based on a change of net profits. In addition, the Fixed Direct Fee, after a reduction, will remain a stated amount for the particular annual period.

Based on all of the facts and circumstances, we also conclude that the Incentive Compensation Component of the Services Fee does not cause the Amended Agreement to result in private business use of the T&D Systems. Although the various performance categories that make up the Performance Metrics provide incentives to reduce expenses, none of the performance categories are based on gross revenues or net profits of the T&D Systems.

Manager also will be reimbursed by Electric Company for the Pass-through Expenditures. The reimbursements for Pass-through Expenditures, with the exception of the charges from its affiliates, are reimbursements for actual and direct expenses without markup, multiplier, or other adjustment or profit. The charges from affiliates relating to shared services may include costs using a fully allocated cost methodology in compliance with applicable regulatory requirements. The allocated costs under such a methodology will not, however, be based on, or include a share of the T&D Systems’ net profits. The charges in respect of affiliate transactions not involving shared services will also not be based on, or include a share of the T&D Systems’ net profits. In addition, the latter transactions must be approved by Electric Company. We conclude that under the facts and circumstances, the reimbursements for Pass-through Expenditures do not cause the Amended Agreement to result in private business use.

Finally, neither the length of the Amended Agreement nor any relationship between Manager and Authority or Electric Company will result in private business use of the T&D Systems. The term of the Amended Agreement will not exceed the 20-year term allowable under § 5.03(3) of Rev. Proc. 97-13. Pursuant to § 5.04(2), Manager will have no role or relationship with Authority or Electric Company that will substantially limit Electric Company’s ability to exercise its rights under the Amended Agreement.

CONCLUSION

Based on the facts and circumstances represented, we conclude that the Amended Agreement does not result in private business use of the Bonds within the meaning of § 141(b).Except as expressly provided herein, no opinion is expressed or implied concerning the tax consequences of any transaction or item discussed or referenced in this letter.

This ruling is directed only to the taxpayer who requested it. Section 6110(k)(3) provides that it may not be used or cited as precedent.

In accordance with a Power of Attorney on file with this office, a copy of this letter is being sent to the authorized representative of Authority.

The ruling contained in this letter is based upon information and representations submitted by Authority and accompanied by a penalty of perjury statement executed by an appropriate party. While this office has not verified any of the materials submitted in support of the request for a ruling, it is subject to verification upon examination.

                  Sincerely,
                  Associate Chief Counsel
                  (Financial Institutions and
                  Products)
                  By: Timothy L. Jones
                  Senior Counsel
                  Branch 5


IRS LTR: Lawsuit Settlement Liabilities Were Deductible Business Expenses.

The IRS ruled that liabilities, including legal fees and other expenses, incurred by a corporation to settle a lawsuit stemming from alleged securities law violations are deductible as ordinary and necessary business expenses under section 162 because the acts that gave rise to the litigation were performed in the ordinary conduct of business.

 

Third Party Communication: None
Date of Communication: Not Applicable
Person To Contact: * * *
Telephone Number: * * *

Index Number: 162.00-00
Release Date: 3/21/2014

Date: December 13, 2013

Refer Reply To: CC:ITA:B03 – PLR-121178-13

TY: * * *

LEGEND:

Taxpayer = * * *
Target = * * *
Date 1 = * * *
Year 1 = * * *
Date 2 = * * *
Date 3 = * * *
Year 2 = * * *
Year 3 = * * *
Amount 1 = * * *

Dear * * *:This is in response to your request for a ruling that the liabilities incurred to settle a lawsuit, including legal fees and other expenses attributable to the lawsuit, are deductible as ordinary and necessary business expenses under section 162 of the Internal Revenue Code. We conclude that Taxpayer’s payment of these liabilities is deductible as ordinary and necessary business expenses under section 162.

FACTS

On Date 1, * * *, Taxpayer and Target, publicly traded corporations, entered into a merger agreement under which Taxpayer agreed to acquire Target in a stock-for-stock transaction. The merger closed on Date 2, * * *.In * * *, litigation was filed against Taxpayer, Target, and other defendants for alleged securities law violations relating to Target’s and Taxpayer’s alleged misrepresentations and omissions made prior to Date 2, * * *, in disclosures required by federal securities laws, e.g., * * *. The alleged misrepresentations and omissions related to undisclosed * * * incurred by Target and * * * in * * *. The plaintiffs also alleged that Taxpayer’s board of directors was aware of material facts regarding the * * *. * * *. The plaintiffs’ claims were based on Taxpayer stock other than stock acquired in the merger. All plaintiffs were holders of Taxpayer securities at some time during the period beginning * * * after Taxpayer and Target entered into the merger agreement and ending * * * after the merger closed. The eventual settlement was paid not only to plaintiffs who held Taxpayer securities at the time of the merger, but also to plaintiffs who acquired Taxpayer securities after the merger. None of the settlement was allocated to stock acquired from the exchange of Target stock in the merger.

The plaintiffs claimed that the alleged misrepresentations and omissions were material facts affecting the post-merger price of Taxpayer stock. The plaintiffs did not question the validity of the merger, request rescission of the merger, or seek to adjust the consideration in the merger. Thus, their claimed damages were measured by drops in Taxpayer’s stock price after * * * disclosures that occurred after Date 2, * * *.

In * * *, Taxpayer paid Amount 1 to the plaintiffs to settle all of the plaintiffs’ claims.

LAW & ANALYSIS

Under section 162(a) of the Internal Revenue Code, there shall be allowed as a deduction all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on a trade or business.In order to be deductible under section 162, an expenditure must be (i) paid or incurred during the taxable year; (ii) sustained in carrying on a trade or business; (iii) an expense; (iv) a necessary expense; and (v) an ordinary expense. Commissioner v. Lincoln Savings and Loan Association, 403 U.S. 345, 352 (1971).

Section 263(a) prohibits a deduction for capital expenditures. Under section 263(a), an expense must be capitalized if incurred for new buildings, permanent improvements, or betterments made to increase the value of any property or estate. Treasury Regulation section 1.263(a)-4(c)(1) provides, in part, that a taxpayer must capitalize an amount paid to another party to acquire any intangible from that party in a purchase or similar transaction. For these purposes, an intangible includes an ownership interest in a corporation, partnership, trust, estate, limited liability company or other entity. Treas. Reg. § 1.263(a)-4(c)(1)(i). In addition, a taxpayer must capitalize amounts paid to facilitate (i.e., investigate or otherwise pursue) the acquisition of an intangible. See Treas. Reg. § 1.263(a)-4(b)(1)(iv); Treas. Reg. § 1.263(a)-4(e)(1)(i).

Under § 1.263(a)-5, a taxpayer must capitalize an amount paid to facilitate a business acquisition or reorganization transaction described in § 1.263(a)-5(a), which includes a merger. In general, an amount is paid to facilitate a transaction described in § 1.263(a)-5(a) if the amount is paid in the process of investigating or otherwise pursuing the transaction. Facilitative costs are generally for services provided to the taxpayer in the process of an acquisition or reorganization. Whether an amount is paid in the process of investigating or otherwise pursuing the transaction is determined based on all of the facts and circumstances. See § 1.263(a)-5(b)(1).

Generally, amounts paid in settlement of lawsuits are currently deductible if the acts which gave rise to the litigation were performed in the ordinary conduct of the taxpayer’s business. See, e.g., Federation Bank & Trust Co. v. Commissioner, 27 T.C. 960 (1957) (allowing petitioner to deduct amounts paid in settlement of legal proceedings charging petitioner with mismanagement in the liquidation of assets). Similarly, amounts paid for legal expenses in connection with litigation are allowed as deductible business expenses where such litigation is directly connected to, or proximately results from, the conduct of a taxpayer’s business. See, e.g., Howard v. Commissioner, 22 B.T.A. 375 (1931) (legal fees incurred by taxpayer to settle a shareholder’s claim of misrepresentation in the conduct of business are deductible business expenses).

If litigation arises from a capital transaction, the settlement costs and legal fees associated with such litigation are characterized as acquisition costs and must be capitalized under section 263(a). See Woodward v. Commissioner, 397 U.S. 572, 575 (1970) (holding litigation costs incurred by corporation in appraisal proceedings mandated by state law to determine the value of dissenter’s shares were part of the cost of acquiring those shares).

However, business expenses are not converted into capital expenditures solely because they have some connection to a capital transaction. In determining whether litigation costs are deductible expenses or capital expenditures, the courts and the Service have looked to the “origin of the claim” to which the settlement or other litigation costs relate. See Woodward, 397 U.S. at 577; United States v. Gilmore, 372 U.S. 39, 47 (1963). Under the origin of the claim test, the character of a particular expenditure is determined by the transaction or activity from which the taxable event proximately resulted. Gilmore, 372 U.S. at 47. The purpose, consequence, or result of the expenditure is irrelevant in determining the origin of the claim, and therefore, the character of the litigation cost for tax purposes. McKeague v. Commissioner, 12 Cl. Ct. 671, (1987), aff’d without opinion, 852 F.2d 1294 (Fed. Cir. 1988).

In the present case, the issue is whether Taxpayer’s payment to settle its lawsuit, as well as legal and other expenses attributable to its lawsuit, may be deducted under section 162 as an ordinary and necessary business expense or must be capitalized under section 263(a). Under the origin of the claim test, the inquiry is whether the claims in the litigation had their origin in the conduct of the taxpayer’s ordinary and necessary business activities or whether the claims were rooted in a capital transaction.

Here, while the facts of the case involve a capital transaction, the plaintiffs’ claims were that the alleged misrepresentations and omissions harmed the value of their investment in post-merger Taxpayer. The plaintiffs did not challenge the validity of the merger or the price of the merger. Further, none of the plaintiffs’ claims were based upon Taxpayer stock received in exchange for shares of Target, and some of the plaintiffs acquired shares on the open market after the merger. The origin of the claim here is in the manner and extent to which Taxpayer’s board of directors provided information to shareholders in securities filings concerning Target’s * * *. Thus, the amounts paid to settle the claims did not facilitate the transaction within the meaning of § 1.263(a)-5. Further, the amounts are not otherwise part of the price paid for Target.

RULING

We conclude that Taxpayer’s payment of liabilities incurred to settle the securities lawsuit, including any legal fees and other expenses attributable to the lawsuit and settlement thereof, are deductible as ordinary and necessary business expenses under section 162.Except as expressly provided herein, no opinion is expressed or implied concerning the tax consequences of any aspect of any transaction or item discussed or referenced in this letter.

This ruling is directed only to the taxpayer requesting it. Section 6110(k)(3) of the Code provides that it may not be used or cited as precedent.

A copy of this letter must be attached to any income tax return to which it is relevant. Alternatively, taxpayers filing their returns electronically may satisfy this requirement by attaching a statement to their return that provides the date and control number of the letter ruling.

The ruling contained in this letter is based upon information and representations submitted by Taxpayer and accompanied by a penalty of perjury statement executed by an appropriate party. While this office has not verified any of the material submitted in support of the request for rulings, it is subject to verification on examination.

                  Sincerely,
                  Robert M. Casey
                  Senior Technician Reviewer,
                  Branch 3
                    (Income Tax & Accounting)

 

Citations: LTR 201412002



IRS Issues TE/GE Memo on Processing Some Pending Exempt Organization Applications.

The IRS Tax-Exempt and Government Entities Division has issued a memorandum (TEGE-07-0314-0003) to provide guidance to its determination and technical units on determining the effective date of exemption of some organizations that have failed to file annual information returns for three consecutive years while their application for tax-exempt status is pending.

 

March 14, 2014Affected IRM: IRM 7.20.2

Expiration Date: March 14, 2015

MEMORANDUM FOR
EXEMPT ORGANIZATIONS DETERMINATIONS UNIT AND
EXEMPT ORGANIZATIONS TECHNICAL UNIT

FROM:
Stephen A. Martin
Acting Director,
Exempt Organizations Rulings and Agreements

SUBJECT:
Processing Guidelines for Certain Pending Applications of
Exempt Organizations that Fail to File Annual Information
Returns for Three Consecutive Years

This memorandum provides direction to the Exempt Organizations Determinations Unit (“EOD”) and Exempt Organizations Technical Unit (“EOT”) in determining the effective date of exemption of certain organizations seeking tax-exempt status under IRC section 501(a) that have failed to file annual information returns for three consecutive years while their application is pending.Under IRC section 6033(j), if a tax-exempt organization that is required to file an annual information return under IRC sections 6033(a) or (i) fails to file such return for three consecutive years, such organization’s status as an organization exempt from tax under IRC section 501(a) shall be considered revoked on and after the date set by the Secretary for the filing of the third return.

Due to excess inventory, EOD and EOT have applications from organizations that may have failed to file annual information returns for three consecutive years while their applications have been pending. In such circumstances, the exempt status of these organizations may be revoked before they have received a ruling from EOD or EOT. These applications are treated as requests for reinstatement. If an organization is eventually granted a favorable ruling, determination of the effective date of the tax-exemption of such organization requires additional time and resources on the part of the organization and the IRS. Many of the organizations are operated by volunteers and thus may face challenges in meeting or understanding their filing requirements before receiving a ruling from the IRS.

Accordingly, effective upon issuance of this memoradum, if a specialist is working an application of an organization that (i) filed its application for exemption with the IRS prior to the due date of filing its Form 990-N, 990-EZ, 990, or 990-PF for the third tax year after its formation date, and (ii) he/she has determined that the organization should receive a favorable determination with regard to the exempt status of the organization, then take the following steps:

      1. Check IDRS to see if the organization has filed a Form 990-N, 990-EZ, 990 or 990-PF at least once in the last three years. If it has, grant exemption effective as of the appropriate date under our normal procedures (e.g., formation date or post-mark date).

2. If not, the following must be done:

        a. Update status to IDRS code “97” effective the due date of the third return and wait for the organization to be listed on the revocation list. It will take three weeks on average to be on the revocation list.

b. Input IDRS transaction code “TC 590.”

c. Send e-mail to the Correspondence Unit (*TE/GE-EO-Correspondence Unit)

          i. with the heading “NO GAP CASE — REINSTATEMENT DATE CORRECTION” and

ii. in the body of the e-mail include the following statement: “We are processing the application of [Name of Organization], [EIN], as a no-gap reinstatement case. The reinstatement date of the organization on the auto-revocation list should be [Effective date of revocation from step a.].”

        d. Grant exemption effective as of the date the specialist would have otherwise granted recognition on the determination letter and Form 8670 as if there was no automatic revocation (e.g., formation date or post-mark date).

e. Add the following “no gap” addendum to the letter:

You formed [Date 1] and filed your Form [Application number], Application for Recognition of Exemption under Section 501(a), on[DATE 2]. You failed to file a required annual return or notice (Form 990, Form 990-EZ, Form 990-PF or Form 990-N) for three consecutive years after you were formed and while your application was pending. As a result, your tax-exempt status was automatically revoked on [Date 3], the due date of your third year return or notice. We are treating your Form [Application number] as an application for reinstatement and are recognizing your exemption as reinstated on the same day it was automatically revoked. As a result, you are recognized as tax-exempt continuously from the effective date of exemption as reflected at the top of this letter.

Any questions are to be directed to Jon Waddell, Manager, Rulings and Agreements, Determinations, Area 2.The contents of the memorandum will be incorporated into IRM 7.20.2.

cc:
www.irs.gov



IRS to Look for Governmental Entities Disaggregating to Avoid ALE Status.

For governmental entities seeking to apply reasonable controlled group rules as required by the employer healthcare mandate, the IRS will be most concerned with whether they are disaggregating to avoid being considered an applicable large employer, according to Stephen Tackney, deputy associate chief counsel (employee benefits), IRS Office of Associate Chief Counsel (Tax-Exempt and Government Entities).

Final regulations on the Affordable Care Act’s employer shared responsibility provisions released in February require that all employees of a controlled group be taken into account when determining whether the members of the controlled group or affiliated service group together are an applicable large employer. However, state or local governmental entities are left to apply a reasonable, good-faith interpretation of the controlled group rules.

If the entity is being reasonable and not just trying to avoid the section 4980H penalty through an unreasonable attempt to separate government purposes, the IRS is unlikely to take issue with that approach, Tackney said on a March 25 webcast sponsored by the American Bar Association’s Joint Committee on Employee Benefits and the American College of Employee Benefits Counsel. He added that entities may want to look to ownership standards for tax-exempt entities for additional insight.

It will take some time before the IRS can provide more guidance on this issue, Tackney said. Before officials can write the aggregation rules, they must have a definition of a government entity that would carry over for that purpose, he said.

Kathryn Johnson, senior attorney, IRS Office of Associate Chief Counsel (TE/GE), said it is possible for an employee to qualify for the section 36B premium tax credit without subjecting an employer to an assessable payment under section 4980H(b). The section 4980H regs include some affordability safe harbors that aren’t tied directly to section 36B and instead allow employers to look at other data they have access to, she said. Therefore, it’s possible that an employer could offer coverage that is affordable within one of those safe harbors even if the employee gets a premium tax credit from purchasing insurance on an exchange, she said.

Tackney said that one example is when an employer bases affordability on information from a Form W-2 but the employee has other things, such as losses or alimony payments, that lower his income to the point of qualifying for a credit.

Regarding the relationship between the three-month limited assessment period in the final regs and the one-month orientation period allowed under the 90-day rule of section 2708, Tackney said the orientation period does not count as part of the waiting period in cases when an individual must make it through orientation before beginning his job. He said the “first day of the fourth month” requirement in the three-month rule could basically be equated with the 90-day waiting period.

by Jaime Arora



EO Update: e-News for Charities & Nonprofits - March 20, 2014

1.  IRS phone forum scheduled March 27:
Veterans Organizations: Help from the IRS on Key Rules

 

This phone forum, which begins at 2 p.m. EDT, will cover the following topics:

  • Exemption Requirements
  • Exempt Activities
  • Unrelated Business Income (including gaming)
  • Recordkeeping
  • Employment Issues
  • Group Rulings
  • Filing Requirements

Go here to register for this event.

More information: Publication 3386: Veterans’ Organizations Tax Guide

  2.  Changes made to EO Select Check

Exempt Organizations Select Check, the on-line tool that allows users to search for an exempt organization and check certain information about its federal tax status and filings, has been updated.

The changes include:

  • Wording changes throughout the application, most notably changing Tax Deductible Contributions to Tax Deductible Charitable Contribution wherever it appeared
  • Adding the reinstatement date column
  • Removing federal government from the dropdown list of deductibility status codes and removing its explanation from the help text in the Pub 78 section
  • Adding 00 to the dropdown list of exemption types and adding its explanation to the help text in the revocation section
  • Removing 501(c)(1) (Federal Credit Unions) from the dropdown list of exemption types and removing its explanation from the help text in the revocation section

  3.  Exempt Organizations Business Master File Extract page updated

The EO BMF page, which was recently updated, includes cumulative information on exempt organizations. The data are available monthly by state and region.
In addition to the page’s new look:

  • Files are now in comma separated value format, which can be opened by most computer applications including Excel
  • Data is displayed via a map versus by list of states

See the updated documentation guide for further information about the data, including a crosswalk, which shows the changes from one document to another (generally showing where the field was in the first document and where it is in the second document).

  4.  Register for EO workshop

Register for our upcoming workshop for small and medium-sized
501(c)(3) organizations on:

  • April 30 – Provo, UT
    Hosted by Brigham Young University – Marriott School

  5.  Revenue Procedure 2014-22 posted

This revenue procedure revokes Revenue Procedure 79–6, which is inconsistent with the redesigned Form 990. Organizations may no longer use Department of Labor forms to report information requested on the Form 990.

  6.  IRS phone forum Q&As/presentations posted

See responses to inquiries from attendees of these recent phone forums:

Review recently posted phone forum presentations posted on the
IRS Stay Exempt Resource Library page:

Periodically review the phone forums page for registration information on upcoming presentations.


Comments Requested on Bond Tax Credit Form.

The IRS has requested comments on Form 1097-BTC, “Bond Tax Credit”; comments are due by May 19, 2014.


IRS to Extend Deadline for Submitting Section 403(b) Preapproved Plans.

The IRS is leaning toward extending the April 30 deadline for plan sponsors to submit a section 403(b) preapproved plan, according to Jason Levine, manager of employee plans rulings and agreements in the IRS Tax-Exempt and Government Entities Division.

Levine, speaking March 20 at the annual Washington Nonprofit Legal and Tax Conference in Arlington, Va., said the IRS received a lot of comments on Rev. Proc. 2013-22, 2013-18 IRB 985, seeking an extension of the deadline to allow plan sponsors more time to submit plans. “We expect there will be something coming out soon about extending the deadline,” Levine said.

An IRS official in July 2013 said the agency had little flexibility to change the deadline because of time constraints with reviews of defined contribution plans.

Rev. Proc. 2013-22, issued in March 2013, established the section 403(b) preapproved plan program after years of delays. The draft revenue procedure was first announced in 2009 (Announcement 2009-34, 2009-18 IRB 916). The program’s goal is to promote compliance with the section 403(b) regulations that impose a written plan document requirement on plan sponsors.

After the plan submission deadline, “there will be a period of time, probably a year or so,” in which the IRS will review the plans and issue letters, according to Levine. The IRS will then establish a timeline for employers to come in and adopt the plans, he said.

Once employers are able to adopt plans, they will have a “fair amount of time, probably at least a year,” to review the plans and adopt the one they want, Levine said.

by Matthew R. Madara



CRS Discusses Proposals for Financing Local Water Infrastructure Projects.

Local communities in the near term must rely on existing programs, tax-exempt governmental bonds, and tax-exempt private activity bonds to finance their water infrastructure needs because none of the recently proposed financing options are likely to be enacted and implemented quickly, the Congressional Research Service said in a March 17 report.

Legislative Options for Financing Water Infrastructure

Claudia Copeland
Specialist in Resources and Environmental PolicySteven Maguire
Section Research Manager

William J. Mallett
Specialist in Transportation Policy

March 17, 2014

Congressional Research Service
7-5700
www.crs.gov
R42467

SummaryThis report addresses several options being considered by Congress to address the financing needs of local communities for wastewater and drinking water infrastructure projects and to decrease or close the gap between available funds and projected needs. Some of the options exist and are well established, but they are under discussion for expansion or modification. Other innovative policy options for water infrastructure have recently been proposed, especially to supplement or complement existing financing tools. Some are intended to provide robust, long-term revenue to support existing financing programs and mechanisms. Some are intended to encourage private participation in financing of drinking water and wastewater projects.

Six options that are reflected in recent legislative proposals, including their budgetary implications, are discussed.

  • Increase funding for the State Revolving Fund (SRF) programs in the Clean Water Act (H.R. 1877 in the 113thCongress) and the Safe Drinking Water Act (H.R. 5320 in the 111th Congress),
  • Create a federal water infrastructure trust fund (H.R. 3582 and H.R. 1877 in the 113th Congress),
  • Create a “Water Infrastructure Finance and Innovation Act” Program, or WIFIA (S. 601 and S. 335 in the 113thCongress),
  • Create a national infrastructure bank (H.R. 2084, H.R. 2553, S. 1716, H.R. 505, and H.R. 3939 in the 113thCongress),
  • Lift private activity bond restrictions on water infrastructure projects (included in the Administration’s FY2015 budget request and H.R. 3939 and H.R. 4237 in the 113th Congress), and
  • Reinstate authority for the issuance of Build America Bonds (included in the Administration’s FY2015 budget request and H.R. 535, H.R. 789, and H.R. 3939 in the 113th Congress).

A number of these issues and options were examined in hearings by House and Senate committees in the 112thCongress. Legislation to create a WIFIA pilot program (S. 601) has been passed by the Senate and is being considered by a House-Senate conference committee.Consensus exists among many stakeholders — state and local governments, equipment manufacturers and construction companies, and environmental advocates — on the need for more investment in water infrastructure. There is no consensus supporting a preferred option or policy, and many advocate a combination that will expand the financing “toolbox” for projects. Some of the options discussed in this report may be helpful, but there is no single method that will address needs fully or close the financing gap completely. For example, some may be helpful to projects in large urban or multi-jurisdictional areas, while others may be more beneficial in smaller communities. It is unlikely that any of the recently proposed options could be up and running quickly, meaning that, at least for the near term, communities will continue to rely on the existing SRF programs, tax-exempt governmental bonds, and tax-exempt private activity bonds to finance their water infrastructure needs.

                                Contents

 Introduction

 Six Policy Options

      Increase Funding for the SRF Programs

      Create a Federal Water Infrastructure Trust Fund

      Create a "Water Infrastructure Finance and Innovation Act"
      Program (WIFIA)

      Create a National Infrastructure Bank

      Lift Private Activity Bond Restrictions on Water Infrastructure
      Projects

           Background on Private Activity Bonds

           Current Proposals

      Reinstate Authority for Issuance of Build America Bonds (BABs)

 Conclusion

 Figures

 Figure 1. SRF Appropriations, FY2006-FY2015 Request

 Contacts

 Author Contact Information

Introduction

This report examines several legislative options to help finance water infrastructure that currently are receiving attention in Congress. The options discussed here are intended to address capital needs for building and upgrading wastewater and drinking water treatment systems and improving water quality in order to meet requirements under federal law. At issue for Congress is whether the federal government should assist water infrastructure projects and, if so, what form or forms of assistance should be provided.

Localities are primarily responsible for providing water infrastructure services. According to the most recent estimates by states and the Environmental Protection Agency (EPA), funding needs for such facilities total $676 billion over the next 20 years.1

Some analysts and stakeholders take issue with such estimates. Some say that EPA’s needs estimates are too low because they do not fully reflect types of projects not currently eligible for federal assistance, such as repair and replacement of aging systems, or needs that currently are not well met by existing programs, such as security-related projects; on-site treatment systems in small, dispersed communities; and projects that include mixed elements such as developing and treating new water supply, especially in rural areas. Other estimates much larger than EPA’s have been made by a number of groups. For example, the American Water Works Association estimated that investment needs for “buried drinking water infrastructure” total more than $1 trillion over the next 25 years.2

However, assessing “need” is complicated by differences in purpose, criteria, and timing, among other issues. One of the major difficulties is defining what constitutes a “need,” a relative concept that is likely to generate a good deal of disagreement. In the infrastructure context, funding needs estimates try to identify the level of investment that is required to meet a defined level of quality or service, but this depiction of need is essentially an engineering concept. It differs from economists’ conception that the appropriate level of new infrastructure investment, or the optimal stock of public capital (infrastructure) for society, is determined by calculating the amount of infrastructure for which social marginal benefits just equal marginal costs.3

Whether the estimates made by states and EPA understate or overstate capital needs, communities face formidable challenges in providing adequate and reliable water infrastructure services. Congress is considering ways to help meet those challenges.

Capital investments in water infrastructure are necessary to maintain high quality service that protects public health and the environment. Capital facilities are a major investment for water and wastewater utilities. Almost all capital projects are debt-financed (not financed on a pay-as-you-go basis from ongoing revenues to the utility). The principal financing tool that local governments use is issuance of tax-exempt municipal bonds — at least 70% of U.S. water utilities rely on municipal bonds and other debt to some degree to finance capital investments. In 2011, bonds issued for water, sewer, and sanitation projects totaled $29.6 billion, of which $14.2 billion was new-money financing and the remainder was for refunding to refinance prior governmental bonds.4 Beyond municipal bonds, federal assistance through grants and loans is available for some projects, but is insufficient to meet all needs. Finally, public-private partnerships, or P3s, which are long-term contractual arrangements between a public utility and a private company, provide limited capital financing. While they are increasingly used in transportation and some other infrastructure sectors, P3s are uncommon in the water sector, especially P3s that involve private sector debt or equity investment in a project; most P3s for water infrastructure involve contract operations for operation and maintenance.

Six Policy Options

This report addresses several financing options intended to address overall needs and decrease or close the funding gap. Some of the options exist and are well established, but they are under discussion for extension or modification. Other innovative policy options have recently been proposed in connection with water infrastructure, especially to supplement or complement existing financing tools. Some are intended to encourage private participation in financing of drinking water and wastewater projects. Some are intended to provide robust, long-term revenue to support existing financing programs and mechanisms. This report analyzes six policy options, including their budgetary implications, related to financing water infrastructure that are reflected in recent legislation.5

  • Increase funding for the State Revolving Fund (SRF) programs in the Clean Water Act (CWA) and the Safe Drinking Water Act (SDWA). Some propose increasing federal appropriations for these existing programs, under which federal capitalization grants are provided to states for the purpose of making loans to communities for water infrastructure and other eligible projects.
  • Create a federal water infrastructure trust fund. Establishing such a fund could help to provide a dedicated source of federal funding for water infrastructure.
  • Create a “Water Infrastructure Finance and Innovation Act” Program (WIFIA). Modeled after the existing Transportation Infrastructure Finance and Innovation Act (TIFIA) program, a WIFIA program would provide federal credit assistance in the form of direct loans and loan guarantees to finance water infrastructure projects.
  • Create a national infrastructure bank. This federal entity would provide low-interest loans, loan guarantees, and other types of credit assistance to stimulate investments by states, localities, and the private sector in a variety of infrastructure projects.
  • Lift private activity bond restrictions on water infrastructure projects. This proposal would eliminate the limit on the amount of tax-exempt private activity bonds issued by states and localities to provide financing for privately owned water infrastructure facilities.
  • Reinstate authority for the issuance of Build America Bonds (BABs). BABs are taxable bonds for which the U.S. Treasury pays a direct subsidy of the interest costs to the issuer (a state or local government), thus helping finance capital projects with lower borrowing costs.

In the 112th Congress, a number of these issues and options were examined in hearings by the House Transportation and Infrastructure Subcommittee on Water Resources and Environment (on February 28 and March 21, 2012) and by the Senate Environment and Public Works Subcommittee on Water and Wildlife (December 13, 2011, and February 28, 2012). The House subcommittee held a subsequent hearing on March 13, 2013.Increase Funding for the SRF Programs

The most prominent source of federal financial assistance for municipal water infrastructure projects is the SRF programs, which can assist a variety of types of projects, including building new and improving existing wastewater treatment and drinking water treatment facilities needed to comply with standards and requirements of the CWA and SDWA. Clean water and drinking water SRFs have been set up in all 50 states, and the programs are widely supported. The programs’ principal strengths are that they are well established; project selection criteria are well known; states have considerable flexibility in selecting which projects to assist; and operations and procedures are familiar to stakeholders.

Established by Congress in the 1987 CWA amendments (P.L. 100-4), the clean water SRF program provides seed money to states in the form of capitalization grants, which are matched by states at least by 20%. A state, in turn, uses the combined federal-state monies to provide various types of assistance, including making low- or no-interest loans, refinancing, purchasing or guaranteeing local debt, and purchasing bond insurance. Loan recipients repay assistance to the state, under terms set by the state. In 1996, Congress enacted a similar drinking water SRF program in the SDWA (P.L. 104-182). At the federal level, the SRF programs are administered by EPA, but actual implementation is done by states.

Both programs allow federal, state, and local agencies to leverage limited dollars. According to EPA, because of the funds’ revolving nature, the federal investment can result in the construction of up to four times as many projects over a 20-year period as a one-time grant. Further, to the extent that a state uses monies in its SRF to secure bonds and then lends proceeds from the bonds for SRF-eligible activities, loan funding is increased. This financing technique, called leveraging, is used by 28 states and provides funding that exceeds the contribution from federal capitalization grants. In total, leveraged bonds and state contributions have comprised 52% of total SRF investment, while federal capitalization grants have comprised 48%.

From the federal budgetary perspective, the SRF programs are grants, and federal appropriations are fully scored; none of the funds provided to states as capitalization grants are returned to the U.S. Treasury. However, from the local government or utility’s perspective, SRFs are loans, which are repaid to states and are intended to be sources of long-term assistance for water infrastructure projects.

Although the SRF programs are considered to be highly successful in addressing water quality problems, there are several concerns and criticisms of them.

First, although the SRF is a loan program, some communities have long favored grants, which the CWA (but not the SDWA) previously provided. The cost burden per customer of capital projects tends to be greater in small communities, and rural and disadvantaged communities prefer grants because many of them lack the tax base needed to repay a loan. Congress has responded to this concern in several ways, including providing earmarked grants in appropriations acts until recently and authorizing a separate CWA grant program for “wet weather” projects to address sewer overflow problems (although it never received appropriations). Further, Congress specified in recent appropriations acts (such as EPA’s FY2012 appropriation, P.L. 112-74) that states shall use a portion of both programs’ capitalization grants to provide subsidy in the form of principal forgiveness, negative interest loans, or grants.6 Critics of the latter point out that, to the extent SRF assistance is partially subsidized and not fully repaid, the corpus of the state’s loan fund is diminished, along with its capacity to make future loans.

Second, the potential for leveraging to increase overall funding is limited, because nearly half of the states do not use that financing technique.

Third, some stakeholders — especially large cities — contend that the SRF programs favor small and medium communities. According to this view, the programs do not benefit large projects, because in many cases assistance to individual projects is limited to $20 million. However, the general validity of that concern is unclear, because where limits are imposed, this results from state policies, not federal. Neither the CWA nor the SDWA requires a state to limit SRF assistance, and states establish their own criteria for selecting projects, which are identified annually in Intended Use Plans (IUPs). In order to extend aid to more communities, some states may adopt dollar limits by rule or practice, but this is not universally the case.

Fourth, the CWA restricts SRF assistance to municipal, intermunicipal, interstate, and state agencies, thus barring private utilities from the program. Some in the private sector contend that this restriction provides an advantage to publicly owned utilities. Several legislative proposals to allow clean water SRFs to assist non-public entities have been considered, but none has been enacted. Modifying the CWA in that manner would conform the clean water program to its counterpart in the Safe Drinking Water Act. However, critics of providing federal assistance to private utilities contend that the credit subsidies have the potential of offering windfalls to those companies.

Fifth, some are critical that Congress imposes restrictions on states’ use of SRF capitalization grants in order to achieve broad policy objectives beyond clean and safe water. Examples include Buy America or Davis-Bacon prevailing wage requirements. According to this view, by mandating that all funded projects meet certain non-water quality requirements, or that states use a minimum percentage of funds for “green” infrastructure such as energy efficiency projects (a requirement in recent appropriations acts), Congress adds to projects costs and limits state flexibility.

Perhaps the most critical concern is the fact that federal capitalization grants are entirely subject to appropriations, which generally have been flat or declining for more than a decade, as shown in Figure 1. The FY2009 exception to this trend reflects temporary funding under the American Recovery and Reinvestment Act of 2009 (ARRA, P.L. 111-5). The President’s FY2013 budget request for capitalization grants for the two SRF programs was 15% below the $2.38 billion total appropriated in FY2012. The FY2014 request for the two programs totals $1.9 billion and is nearly 20% below the FY2012-appropriated amount.

Figure 1. SRF Appropriations, FY2006-FY2015 Request(millions of dollars)

Source: Compiled by Congressional Research Service from appropriations acts and FY2015 Budget Justification for EPA.Notes: FY2009 funding included supplemental appropriations under the American Recovery and Reinvestment Act of $4.0 billion for the clean water SRF and $2.0 billion for the drinking water SRF.

Securing SRF appropriations is likely to be more difficult in future years, under general deficit reduction pressures and specific discretionary spending caps imposed by the debt agreement embodied in the Budget Control Act of 2011 (BCA, P.L. 112-25), as amended by the American Taxpayer Relief Act of 2012 (ATRA, P.L. 112-240).7 In a multi-step process, the statute set caps on discretionary budget authority (appropriations) that began in FY2012 and an automatic spending reduction process that began in FY2013, which together will reduce the deficit by roughly $2.1 trillion over the FY2012-FY2021 period. The spending caps will affect appropriators’ decisions concerning discretionary spending on clean water and drinking water SRF capitalization grants. Further, the BCA requires that if the appropriations process does not result in spending levels that adhere to the BCA cap levels and the cap levels are breached, a specified enforcement process follows.8 In FY2013, the automatic spending reduction was carried out through an across-the-board sequester (cancellation) of previously authorized budgetary resources. Failure to achieve the FY2013 BCA limits did, in fact, trigger the automatic spending reduction process beginning on March 1, 2013. The Office of Management and Budget (OMB) estimated that the FY2013 sequester would reduce non-exempt defense discretionary spending by 7.8% relative to the cap levels and non-defense discretionary spending (such as for clean water and drinking water SRF capitalization grants) by 5.0% relative to the cap levels.9

Moreover, while the BCA caps represent the upper limit of spending that will meet the act’s deficit reduction targets, some Members of Congress favor even lower levels of spending than the BCA allows and redistributing reductions in order to protect some accounts, especially defense. The FY2014 budget resolution adopted by the House in March 2013 (H.Con.Res. 25) proposed to cut nondefense discretionary spending more than $1 trillion below the level established in the BCA and to remove defense discretionary spending from possible sequestration, meaning that nondefense discretionary programs would be affected to a greater degree. Overall, no matter how much support there may be for more SRF spending, Congress faces many competing needs, priorities, and difficult choices.

Authorization of appropriations for clean water SRF capitalization grants expired in FY1994 and for drinking water SRF capitalization grants in FY2003. Congress has considered water infrastructure funding issues several times since the 107th Congress, but no legislation other than appropriations has been enacted. Recent proposals have included provisions for more robustly funded SRFs. In the 113th Congress, H.R. 1877 would reauthorize the clean water SRF program at a total of $13.8 billion over five years, as would bills that were passed by the House in the 111th (H.R. 1262) and 110th Congresses (H.R. 720). Regarding the drinking water SRF, in the 111th Congress, the House passed a bill to reauthorize that program at a total of $4.8 billion over three years (H.R. 5320). Also in the 111th Congress, a bill to reauthorize both SRF programs was reported in the Senate (S. 1005); it included $20.0 billion for the clean water SRF program and $14.7 billion for the drinking water SRF program, each for five years.

Legislation reported by congressional committees typically is “scored” by the Congressional Budget Office (CBO) for the effects on discretionary and mandatory, or direct, spending and by the Joint Committee on Taxation (JCT) for effects on revenues. Discretionary spending is the part of federal spending that lawmakers generally control through annual appropriation acts. In general, legislation that authorizes future appropriations for discretionary programs, by itself, does not increase federal deficits or decrease surpluses. Any subsequent discretionary appropriation to fund the authorized activity would affect the federal budget and would be subject to spending limits under a budget resolution or the BCA.

Enacting legislation that only authorizes future discretionary appropriations would not result in an increase in CBO’s projection of federal deficit under its baseline assumptions and would not implicate pay-as-you-go rules or the Statutory Pay-As-You-Go Act (P.L. 111-139), or PAYGO, which generally require that direct spending and revenue legislation not increase the federal deficit or that the spending be offset. However, authorizing legislation that affects direct spending or federal revenues is subject to budgetary rules. Direct spending is provided in or controlled by authorizing laws, generally continues without any annual legislative action, and includes spending authority provided for in such programs as Medicare and unemployment compensation. Direct spending also includes many offsetting collections, such as Medicare premiums, which are treated as negative spending instead of as revenues.

Perspective on how the SRF provisions of H.R. 1877 or similar legislation in the 113th Congress likely would be scored is provided by CBO’s report on H.R. 1262 in the 111th Congress, which similarly authorized appropriations totaling $13.8 billion for clean water SRF capitalization grants. The CBO report stated that certain provisions of the bill would affect direct spending and revenues, and it cited the JCT’s estimates that by increasing funds available under the clean water SRF, H.R. 1262 would result in some states leveraging SRF grants by issuing additional tax-exempt bonds to finance water infrastructure projects. The JCT estimated that those additional bonds would result in reductions in federal revenue totaling $700 million over 10 years.10 To offset the reduced revenue, H.R. 1262 included offsetting receipts resulting from an increase in per-ton duties imposed on vessels arriving at U.S. ports from foreign ports. These receipts would offset direct spending. H.R. 1877 in the 113th Congress includes similar offsetting receipts. The significance of needing to include the offsetting receipts in the legislation is that, if states were to increase leveraging and issue more tax-exempt bonds — such as might occur if the state volume cap on private activity bonds were lifted (see discussion below) — additional offsetting receipts likely would be required in SRF reauthorization legislation.

Create a Federal Water Infrastructure Trust Fund

One of the most common criticisms of the SRF programs, that capitalization grants are subject to annual appropriations, is the focus of proposals to create a federal water infrastructure trust fund modeled after existing mechanisms for other types of infrastructure such as the airport and airways trust fund and the highway trust fund. A trust fund supported by dedicated revenues would be intended to provide sustainable and reliable long-term financing of water infrastructure projects. Proponents contend that trust fund expenditures would not impact the federal deficit (assuming that revenues are at least as large as program spending), because they would be drawn from collections that are dedicated by law for specified purposes. Whether the mechanism is created as a trust fund per se is not the critical issue,11 but, rather, the critical issue is creation of a dedicated revenue and how it is recorded in the budget.

This idea is not new: Legislation was introduced in the House in 1993 to support clean water infrastructure by creating a fund that would accrue $6 billion annually in revenues through a combination of user fees and excise taxes. In 1996 EPA issued a report, requested by Congress, on alternative financing options for water infrastructure, including a trust fund, and a 2009 Government Accountability Office (GAO) report, also requested by Congress, similarly assessed options to generate revenue for a clean water trust fund.12 Legislation has been introduced in several congresses (H.R. 3582 and H.R. 1877 in the 113th Congress). Issues associated with alternative financing options have been explored by the House Transportation and Infrastructure Water Resources and Environment Subcommittee in several hearings since 2005.

These proposals would create a dedicated revenue source that would be counted as an offsetting receipt or collection and would be recorded in the budget as reducing or netting out outlays for water infrastructure projects.13Proponents contend that the proposal would be deficit-neutral (again assuming that new revenue sources match or exceed program outlays) and would be a consistent and protected source of revenue to help states replace, repair, and rehabilitate critical water infrastructure facilities.14 Both the 1996 EPA and 2009 GAO reports identified a number of issues that need to be addressed in establishing a clean water trust fund, including how it should be administered, whether it would be used to fund the clean water SRF or a separate program, what type(s) of financial assistance should be provided for projects (grants or loans), and what activities should be eligible for funding. These design issues are necessary, but they are relatively straightforward to resolve legislatively.

The most difficult issues conceptually and politically concern how to generate the revenues. Clean water lacks as clear a basis for charging or taxing a set of users as exists for either the highway or aviation trust funds. As GAO observed, “each funding option poses various implementation challenges, including defining the products or activities to be taxed, establishing a collection and enforcement framework, and obtaining stakeholder support.”15Consensus on these issues has been elusive. Revenue options proposed in the past include excise taxes on water-based beverages, pharmaceutical products, and items disposed in wastewater (such as cosmetics and toilet paper); fees on industrial discharge of toxic pollutants; or an excise tax on the active ingredients of pesticides and fertilizers. In the 113th Congress, H.R. 3582 would support a trust fund through revenue from voluntary labeling of consumer products. The trust fund would be used to fund CWA SRF capitalization grants and an innovative financing program for CWA projects to be modeled after the TIFIA program (see “Create a “Water Infrastructure Finance and Innovation Act” Program (WIFIA)” below). Another current proposal, in Title IV of H.R. 1877, proposes a $10 billion per year fund, but it defers identifying potential funding mechanisms and funding sources, pending a study by CBO.

From a budgetary perspective, there are no hurdles to enacting legislation to collect revenues for a water infrastructure trust fund. That is, assuming that the policy issues of who or what to tax and at what levels are resolved, budget rules do not prohibit enacting a measure to collect new revenues. However, most programs with dedicated revenues, including most trust funds, are not set up to be spent without authorization or appropriation by Congress, making it difficult to assure that all revenues and interest will be spent each year for water infrastructure purposes. Accomplishing the objectives laid out by proponents of the clean water trust fund would involve complicated steps: creating dedicated revenue that is classified in the budget so that it will net out the outlays, preventing spending on the program from being reduced by the congressional authorization and appropriation process, and setting up the program to ensure that it does not count against congressional budget rules such as PAYGO and discretionary spending caps.

In the past, Congress has sought to create a mechanism to guarantee spending for some existing infrastructure trust funds. For example, since 2000, legislation authorizing appropriations from the Airport and Airway Trust Fund included a provision making it out of order in the House or Senate to consider legislation that fails to use all aviation trust fund receipts and interest annually. The 2012 FAA reauthorization act, P.L. 112-95, modified this guarantee to restrict the amount made available for each fiscal year to 90% of the receipts of the aviation trust fund plus interest credited for the respective year as estimated by the Secretary of the Treasury.16 Further, since 1998, House rules effectively created funding guarantees for transportation activities within the highway and mass transit categories by making any legislation that would cause spending to be less than the amount authorized subject to a point of order. This rule, in clause 3 of Rule XXI, was amended at the beginning of the 112th Congress to allow an appropriations measure to reduce spending for highway and mass transit activities below the authorized level, as long as those funds were not made available for a purpose not authorized in the surface transportation act.17 These two examples illustrate the difficulty of assuring that trust fund revenues that are subject to appropriations are spent fully. Moreover, spending guarantees can still be trumped by broader budget policy goals (such as deficit reduction) or by the spending priorities of appropriators — that is, points of order can be waived.

Conceptually, creating a mechanism to protect spending could be done by amending the Balanced Budget and Emergency Deficit Control Act of 1985 to create a separate budget category for water infrastructure programs. Funding from within this category could not be used to, in effect, offset increased spending elsewhere in the budget, thereby removing any incentive for restraining the spending of available trust fund revenues. However, this option reduces the appropriations committees’ influence on spending, which they could be expected to vigorously resist, and also would involve amending the Budget Act, thus requiring the acquiescence of the House and Senate budget committees.

Create a “Water Infrastructure Finance and Innovation Act” Program (WIFIA)

One option for supporting investment in water infrastructure is the creation of a program modeled on the Transportation Infrastructure Finance and Innovation Act (TIFIA) Program. As the name suggests, only transportation projects are eligible for TIFIA assistance, but operation of the TIFIA program over the past 15 years has generated interest in creating a similar program for water infrastructure, a so-called Water Infrastructure Finance and Innovation Act (WIFIA) Program.18

TIFIA, enacted in 1998 as part of the Transportation Equity Act for the 21st Century (TEA-21; P.L. 105-178), was reauthorized in July 2012 in the Moving Ahead for Progress in the 21st Century Act (MAP-21; P.L. 112-141). TIFIA provides federal credit assistance up to a maximum of 49% of project costs in the form of secured loans, loan guarantees, and lines of credit (23 U.S.C. 601 et seq.).

Transportation projects costing at least $50 million (or at least $25 million in rural areas) are eligible for TIFIA financing.19 Projects must also have a dedicated revenue stream to be eligible for credit assistance. TIFIA can provide senior or subordinated debt. With the enactment of MAP-21, funding authorized for the TIFIA program has increased from $122 million annually to $750 million in FY2013 and $1 billion in FY2014.

Prior to the enactment of MAP-21, a project seeking TIFIA assistance had to satisfy a number of eligibility criteria such as project cost and planning requirements. Projects were then selected by the Department of Transportation (DOT) from among those eligible based on eight weighted factors: private participation (20%); environmental impact (20%); national or regional significance (20%); project acceleration (12.5%); creditworthiness (12.5%); use of new technologies (5%); reduced federal grant assistance (5%); and consumption of budget authority (5%). MAP-21 eliminates these selection criteria and now provides TIFIA assistance purely on a project’s eligibility. One of the key eligibility criteria is the creditworthiness of the project. To be eligible, a project’s senior debt obligations and the federal credit instrument must receive an investment-grade rating from at least one nationally recognized credit agency. The TIFIA assistance must also be determined to have several beneficial effects: fostering a public-private partnership, if appropriate; enabling the project to proceed more quickly; and reducing the contribution of federal grant funding. Other eligibility criteria include satisfying planning and environmental review requirements and being ready to contract out construction within 90 days after the obligation of assistance.

Since the beginning of the program in 1998, TIFIA has provided assistance to 35 projects, mostly in the form of direct loans. Loan amounts ranged from $40 million to $900 million. Total credit assistance provided over the life of the program amounts to $11.8 billion, as of September 2013. The amount of credit assistance is much larger than the appropriated amount over this period because the appropriated funds need only cover the subsidy cost of the program (this point is discussed further below). Projects involving TIFIA financing amount to $46 billion in total costs.20 TIFIA typically provides financing to fill a gap in a much larger financial package that sometimes involves private equity and private debt. For example, the $2.6 billion IH-635 Managed Lanes project in Dallas, TX, is being financed with $615 million in private activity bonds, a $664 million equity contribution from the private sector partner, $17 million in toll revenues, $490 million in public funds, and an $850 million TIFIA loan.21

In the 113th Congress, two bills to create a WIFIA program have been introduced. The first, S. 335, would empower the Administrator of the Environmental Protection Agency (EPA) to provide credit assistance to drinking water and wastewater infrastructure projects, much like TIFIA is able to do for transportation projects. WIFIA credit assistance (loans or loan guarantees) would be available directly to sponsors of projects or to state infrastructure financing authorities for a group of projects that are combined for the purpose of receiving credit assistance. The Administrator of EPA would select projects for assistance based on a number of criteria such as creditworthiness; the need for federal assistance; the contribution of non-federal assistance, including from the private sector; and the extent to which the project is of national or regional significance. Credit assistance provided through the program would have to be for projects (individual or grouped by an SRF) totaling not less than $20 million.

A second measure is S. 601, the Water Resources Development Act of 2013 (WRDA), which the Senate passed on May 15, 2013. Title X of the bill authorizes a five-year WIFIA pilot program. Under the bill, EPA would be authorized to provide credit assistance for drinking water and wastewater projects, and the U.S. Army Corps of Engineers would be authorized to provide similar assistance for water resource projects, such as flood control or hurricane and storm damage reduction. Each agency would be authorized $50 million annually to provide this assistance. Like S. 335, projects would have to be $20 million or larger in costs to be eligible for credit assistance.

The House also has passed WRDA legislation, H.R. 3080, but this bill does not include a WIFIA provision. A House-Senate conference committee has been meeting to resolve differences between the two bills.22

From the federal perspective, an advantage of TIFIA is that it can provide a large amount of credit assistance relative to the amount of budget authority provided. The volume of loans and other types of credit assistance that TIFIA can provide is determined by the size of congressional appropriations and calculation of the subsidy cost.23The subsidy cost largely determines the amount of money that can be made available to project sponsors.24Currently in the TIFIA program, the average project subsidy cost is approximately 10%. Of the $122 million annual appropriation for TIFIA in FY2012, DOT was able to use approximately $110 million to cover loan subsidy costs. The rest went for administrative costs and other deductions. DOT estimated that $110 million would support about $1.1 billion in TIFIA credit assistance ($110 million divided by 10% equals $1.1 billion).25 Proponents of a WIFIA argue that loans for water projects could be even less risky than transportation projects, because water rates are an established repayment mechanism, thus the subsidy cost would be lower and the amount of credit assistance higher (per dollar of budget authority).26 However, analysts note that, even with stable rate mechanisms, some communities and water utilities have recently experienced problems with borrowing and bond repayments, so repayment of a WIFIA loan is not a certainty.27

One of the main benefits of the TIFIA program is that it provides capital at a low cost to the borrower. Moreover, TIFIA financing is often characterized as patient capital because loan repayment does not need to begin until five years after substantial completion of a project, the loan can be for up to 35 years from substantial completion, and the amortization schedule can be flexible. The WIFIA legislation likewise is intended to provide these benefits. As total TIFIA assistance cannot exceed 49% of project costs, it is intended to encourage non-federal and private sector financing. The WIFIA bills, with similar 49% caps on assistance, would likely encourage some non-federal financing, including from the private sector, but how much is unclear.

Another possible benefit of a WIFIA program is that it is intended to not duplicate existing water infrastructure financing tools. Many argue that the SRF program is useful primarily for smaller communities and smaller projects, as discussed previously. This might argue for expanding the SRF program, while keeping the WIFIA solely for larger projects. Arguably, then, the $20 million minimum threshold for credit assistance contained in S. 335 and S. 601 could be about the right level so as not to duplicate assistance from SRFs.28 Both bills, however, also provide access to WIFIA financing for smaller projects by grouping, or aggregating, them through a SRF to meet the $20 million threshold. One possible downside of providing smaller projects access to WIFIA financing, grouped or not, is the time and expense of administering the program.

A WIFIA may shift some decision making for financing water infrastructure projects from the state and local level to the federal level, specifically to the EPA (or the Army Corps, under S. 601), a change that concerns some stakeholders. Prior to the enactment of MAP-21, authority to make TIFIA loans and to provide other credit assistance was vested in DOT. MAP-21 makes DOT’s role more administrative, predominantly by making the program based on eligibility. Among other things it is hoped that this will speed the delivery of credit assistance.

Another benefit of the TIFIA program from the federal perspective is that it potentially limits the federal government’s exposure to default by relying on market discipline through creditworthiness standards and the encouragement of private capital investment. On the other hand, the Congressional Budget Office argues that the federal government underestimates the cost of providing credit assistance under programs like TIFIA.29 This is because it excludes “the cost of market risk — the compensation that investors require for the uncertainty of expected but risky cash flows. The reason is that the FCRA [Federal Credit Reform Act] requires analysts to calculate present values by discounting expected cash flows at the interest rate on risk-free Treasury securities (the rate at which the government borrows money). In contrast, private financial institutions use risk-adjusted discount rates to calculate present values.”30

Enacting a WIFIA program raises another federal budgetary and revenue issue. The initial CBO cost estimate for S. 601, as approved by the Environment and Public Works Committee, concluded that the WIFIA provisions would cost $260 million over five years. In addition, it would result in certain revenue loss to the U.S. Treasury, thus, pay-as-you-go procedures would apply to the bill. CBO cited the Joint Committee on Taxation’s (JCT) estimate that enactment of the bill would reduce revenues by $135 million over 10 years, because states would be expected to issue tax-exempt bonds in order to acquire additional funds not covered by WIFIA assistance.31 To avoid the pay-as-you-go problem in the bill, the committee added a provision to S. 601 to prohibit recipients of WIFIA assistance from issuing tax-exempt bonds for the non-WIFIA portions of project costs (Section 10009(a)(5) of S. 601). CBO re-estimated the bill and concluded that, because the change would make the WIFIA program less attractive to entities, most of whom rely on tax-exempt bonds for project financing, the cost of the bill would be $200 million less over five years but would have no impact on revenues, because the demand for federal credit would be lower without the option of using tax-exempt financing.32 Thus, the apparent solution to one problem in the legislation — potential revenue loss — raises a different kind of problem for entities seeking WIFIA credit assistance.

Create a National Infrastructure Bank

Another idea for improving the nation’s investment in infrastructure is the creation of a national infrastructure bank.33An infrastructure bank is a government-established entity that provides credit assistance to sponsors of infrastructure projects. An infrastructure bank can take many different forms, such as an independent federal agency, a federal corporation, a government-sponsored enterprise, or a private-sector, non-profit corporation. Under most infrastructure bank proposals, the bank would be authorized to help finance the construction or reconstruction of infrastructure in several areas including energy, water and wastewater, telecommunications, and transportation.

According to proponents, a national infrastructure bank would provide several major benefits for infrastructure projects, including water and wastewater capital projects. An infrastructure bank might help facilitate water infrastructure projects by providing large amounts of financing on advantageous terms, including low interest rates and long maturities. This might encourage investment that would otherwise not take place, particularly in large, expensive projects whose costs are borne locally but whose benefits are regional or national in scope. On the other hand, an infrastructure bank may not be the lowest-cost means of achieving that goal. The Congressional Budget Office has pointed out that a special entity that issues its own debt would not be able to match the lower interest and issuance costs of the U.S. Treasury.34

Whether providing financing on advantageous terms by a national infrastructure bank would lead to an increase in the total amount of capital devoted to infrastructure investment is unclear. Another purported advantage of certain types of infrastructure banks is access to private capital, such as pension funds and international investors. These entities, which are generally not subject to U.S. taxes, may be uninterested in purchasing the tax-exempt bonds that are traditionally a major source of project finance, but might be willing to make equity or debt investments in infrastructure in cooperation with a national infrastructure bank. If this shift were to occur, however, it could be to the detriment of existing investment, as the additional investment in infrastructure may be drawn from a relatively fixed amount of available investment funds.

Another putative benefit of a national infrastructure bank is that it might improve project selection. A frequent criticism of current public infrastructure project selection is that it is often based on factors such as geographic equity and political favoritism instead of the demonstrable merits of the projects themselves.35 In many cases, funding goes to projects that are presumed to be the most important, without a rigorous study of the costs and benefits. Proponents of an infrastructure bank assert that it would select projects based on economic analyses of all costs and benefits.36

Selecting projects through an infrastructure bank has possible disadvantages as well as advantages. First, it would most likely direct financing to projects that are the most viable financially rather than those with the greatest social benefits. Unless there were set-asides for particular types of projects, water and wastewater projects would be in competition with infrastructure projects across a wide spectrum of sectors. Second, financing projects through an infrastructure bank might serve to exclude small urban and rural areas because infrastructure banks would likely focus on large, expensive projects that tend to be located in major urban centers. This may be true even without a minimum project cost threshold set in law. A third possible disadvantage is that a national infrastructure bank may shift some decision making from the state and local level to the federal level.

Once established, a national infrastructure bank might help accelerate worthwhile infrastructure projects by bearing more of the financial risk. Large projects are often slowed by funding and financing problems given the degree of risk. These large projects might also be too large for financing from a state infrastructure bank or from a state revolving loan fund. Moreover, even with a combination of grants, municipal bonds, and private equity, mega-projects often need another source of funding to complete a financial package. Financing is also sometimes needed to bridge the gap between construction and when the project generates revenues. Although a national infrastructure bank might help accelerate projects over the long term, it will likely take several years for a bank to be fully functioning after enactment.

One attraction of national infrastructure bank proposals is the potential to encourage significant non-federal infrastructure investment over the long term for a relatively small amount of federal budget authority. Ignoring administrative costs, an appropriation of $10 billion for the infrastructure bank could provide $100 billion of credit assistance if the subsidy cost were similar to that of the TIFIA program (see above).37

The federal government already has a number of programs to support water and wastewater infrastructure projects. But a national infrastructure bank could provide assistance to infrastructure projects that are currently too large to be financed using existing mechanisms. The creation of an infrastructure bank might provide another mechanism for financing drinking water and wastewater projects, but would set those projects in competition with projects in energy, transportation, and telecommunications. A national infrastructure bank is probably most like the existing TIFIA program.38 Hence, the creation of both a national infrastructure bank and a WIFIA would likely be duplicative.

Bills to establish a national infrastructure bank or a bank-like entity have been introduced in the 113th Congress — the Partnership to Build America Act of 2013 (H.R. 2084); the Building and Renewing Infrastructure for Development and Growth in Employment Act (the BRIDGE Act, S. 1716); the National Infrastructure Development Bank Act of 2013 (H.R. 2553); provisions of the Balancing Act (§§ 765-779 of H.R. 505); and provisions of the Invest in the United States Act of 2014 (title I of H.R. 3939).39

H.R. 2084 would create a wholly owned government corporation called the American Infrastructure Fund (AIF). It would be headed by an 11-member board of trustees whose mission would be to operate the AIF to be a low cost provider of bond guarantees, loans, and equity investments to state and local governments and non-profit infrastructure providers for non-profit infrastructure projects. The board would only consider projects put forth by state and local governments to assist transportation, energy, water, communications, or educational facilities. At least 25% of its assistance is to be provided to projects for which at least 20% of the project financing comes from private debt or equity. The bank would be initially capitalized with proceeds from $50 billion in American Infrastructure Bonds to be issued by the U.S. Treasury. Proponents estimate that the AIF would leverage the $50 billion at a 15:1 ratio to provide up to $750 billion in assistance.40

The proposed BRIDGE Act, S. 1716, would establish a government-owned Infrastructure Financing Authority (IFA) to facilitate investments in transportation, water, and energy infrastructure projects at least $50 million in size, or $10 million in size in rural areas. The authority would provide loans and loan guarantees and would receive initial seed funding of up to $10 billion, which supporters say could incentivize private sector investment and make possible up to $300 billion in total project investment.41 IFA funding would be limited to 49% of a project’s costs.

H.R. 2553 would create the National Infrastructure Development Bank (NIDB), governed by five presidentially appointed directors. The NIDB would be able to issue public benefit bonds (PBBs) to help finance infrastructure, mainly through loans and loan guarantees. The NIDB would also be able to make grants. Funded projects could include transportation, telecommunications, energy, and environmental infrastructure. The bank would be capitalized by Congress with $5 billion annually for five years. The total $25 billion appropriation would be 10% of the total subscribed capital of the bank. Up to 90% of the subscribed capital would be callable by the Treasury Secretary. The total outstanding bonds issued by the NIDB would not be allowed to exceed 250% of the subscribed capital. Among the criteria for evaluating projects for assistance from the NIDB would be the extent to which assistance will maximize private investment in the project while providing a public benefit.

The wholly owned government corporation created by the infrastructure bank provisions of H.R. 505 and H.R. 3939 would be called the American Infrastructure Financing Authority (AIFA). AIFA would be governed by seven presidentially appointed board members. AIFA would be authorized to provide loans and loan guarantees to eligible transportation, water, and energy infrastructure projects. To be eligible for assistance a project would have to cost at least $100 million, or at least $25 million in rural areas. The bank would be capitalized with a $10 billion appropriation.

Lift Private Activity Bond Restrictions on Water Infrastructure Projects

Water infrastructure can be owned and operated by the private sector, a governmental entity, or through a so-called partnership between a government and a private entity. A partnership could involve a private entity investing in water infrastructure and receiving a market rate of return on that investment. This investment could be an equity share (part ownership) or some other agreement that provides a stream of revenue generated by the facility. Or, the partnership could be the government issuing tax-exempt debt on behalf of the private entity with so-called “private activity bonds.”

Among the options to modify the existing framework for federal assistance for investment in water infrastructure, one option for greater federal involvement includes expanding the availability of tax-exempt financing to private entities, for example, private activity bonds.

Background on Private Activity Bonds

Generally, under current law, privately owned water furnishing and water treatment facilities are not eligible for tax-exempt financing. The tax code, however, does provide that privately owned water furnishing facilities that (1) are operated by a governmental unit or (2) charge rates that are approved by a political subdivision of the host community, can issue qualified private activity bonds (PABs) which are tax-exempt.42 Most qualified PABs, including bonds for water furnishing and water treatment facilities, are subject to a state volume limit.43 In 2013, the volume cap is the greater of $95 multiplied by the state population, or $291,875,000.

The opportunity to use bonds whose interest payments are exempt from federal income taxation confers a considerable subsidy to bond issuers and to investors who buy the bonds. The FY2014 budget estimates that the federal tax expenditure for “water, sewage, and hazardous waste disposal facilities” will be $3.21 billion over the 2014 to 2018 budget window.44

The private activity bond volume limit noted above originated in the Deficit Reduction Act of 1984 (P.L. 98-369). The limit was implemented because “Congress was extremely concerned with the volume of tax-exempt bonds used to finance private activities.”45 The limit and the list of qualified activities were both modified again under the Tax Reform Act of 1986 (TRA 1986, P.L. 99-514). At the time of the TRA 1986 modifications, the Joint Committee on Taxation identified the following specific concerns about tax-exempt bonds issued for private activities:46

  • the bonds represent “an inefficient allocation of capital”;
  • the bonds “increase the cost of financing traditional governmental activities”;
  • the bonds allow “higher-income persons to avoid taxes by means of tax-exempt investments”; and
  • the bonds contribute to “mounting [federal] revenue losses.”

The inefficient allocation of capital arises from the economic fact that additional investment in tax-favored private activities will necessarily come from investment in other public projects. For example, if bonds issued for water infrastructure did not receive special tax treatment, some portion of the bond funds could be used for other government projects such as schools or other public infrastructure.The greater volume of tax-exempt private activity bonds then leads to the second Joint Committee on Taxation concern listed above, higher cost of financing traditional government activities. Investors have limited resources; thus, when the supply of tax-exempt bond investments increases, issuers must raise interest rates to lure them into investing in existing government activities. In economic terms, issuers raising interest rates to attract investors is analogous to a retailer lowering prices to attract customers. The higher interest rates make borrowing more expensive for issuers.

The final two points are less important from an economic efficiency perspective but do cause some to question the efficacy of using tax-exempt bonds to deliver a federal subsidy. Tax-exempt interest is worth more to taxpayers in higher brackets; thus, the tax benefit flows to higher income taxpayers, which leads to a less progressive income tax regime.

The revenue loss generated by tax-exempt bonds also expands the deficit.47 A persistent budget deficit ultimately leads to generally higher interest rates as the government competes with private entities for scarce investment dollars. Higher interest rates further increase the cost of all debt-financed state and local government projects.

Current Proposals

The implicit assumption of several current proposals is that the current cap is binding, preventing the investment in needed water infrastructure projects. Proponents argue that the opportunity for more private entities to meet the requirements for tax-exempt bond financing may induce additional infrastructure investment. What is unclear is how much new investment will be undertaken with PABs if these restrictions were relaxed. Underlying the estimates of potential new investment is demand for new water infrastructure. Following is a discussion of the current use of PABs for water infrastructure.

Demand for the use of PAB capacity for water infrastructure has been relatively low. The Internal Revenue Service (IRS) reports that for the 2008 tax year, new money bonds (in contrast to refunding bonds) were issued for 88 private water furnishing, sewage, and solid waste disposal facilities projects accounting for roughly $2.6 billion of the $50.9 billion of volume capacity available.48 For comparison, other private activities subject to the cap consumed $12.3 billion: residential rental facilities ($4.6 billion), mortgage bonds ($5.1 billion), small issue bonds ( $1.2 billion), and student loan bonds ($1.4 billion). The remainder of the cap space was used for other projects, carried forward to the following year, or abandoned.

The IRS data also provide information on the issuance by state. In 2008, 22 states did not commit any volume capacity to water, sewage, and solid waste disposal. In contrast, two states, California (16 projects) and Texas (17 projects), combined for 33 of the projects and $1.1 billion of the issuance. The limited number of states using PABs may reflect lack of demand for privately owned water infrastructure or may reflect the relative size of water projects limiting the use of PABs. The average PAB amount issued for water, sewer, and solid waste was $29.3 million, whereas the average PAB new money issuance was smaller at $21.4 million. The remainder includes mortgage revenue bonds, which typically have a smaller average issue size.

Private entities also invest in water infrastructure beyond the partnership with governments through PABs. For example, the largest investor-owned U.S. water and wastewater utility company, American Water, reported investing $1 billion in water infrastructure capital in 2008.49 In its 2010 Annual Report, American Water reported $766 million of capital investment.50 Private entities like American Water use a mix of current revenue and debt, including PABs, corporate debt, and equity investment, to finance this capital spending.

The President’s FY2015 budget request (like the FY2013 and 2014 requests) supports eliminating the volume cap for PABs for water infrastructure. Treasury estimates that this proposal would result in loss of $201 million in revenue between 2015 and 2024.51

Two bills in the 113th Congress propose to permanently exclude water infrastructure from the volume cap. These bills are H.R. 3939 (section 204) and H.R. 4237.52 As the data above suggest, excluding PABs for water infrastructure from state volume caps would likely generate marginally more investment in water infrastructure. The private entities that already have used PABs in conjunction with other financial tools would likely increase the use of PABs. What is unclear, however, is if the expanded use of PABs would necessarily reflect substantially new infrastructure investment or just change the mix of financing tools employed for already planned projects. If the latter, then the potential revenue loss may not achieve the intended policy objective of increasing investment in water infrastructure.

The proposed PAB expansion may also be a limited success as many communities have chosen government provision of water infrastructure. In 2011, over $29 billion in governmental bonds were issued for 1,244 water, sewer, and sanitation projects.53 More than $14 billion of these bonds were new money bonds. By comparison, for 2010, $40.4 billion was issued for 1,546 water, sewer, and sanitation projects, and $24 billion of the total was new money financing. The reliance on government provision may reflect market conditions that make private provision infeasible or public preference for government owned and operated water infrastructure.

Reinstate Authority for Issuance of Build America Bonds (BABs)

Another option under discussion to modify the existing framework for federal assistance for water infrastructure investment is to expand or extend the use of Build America Bonds (BABs). BABs were created by the American Recovery and Reinvestment Act of 2009 (ARRA).54 The volume of BABs was not limited and the purpose was constrained only by the requirement that “the interest on such obligation would (but for this section) be excludible from gross income under section 103.”55 Thus, BABs could have been issued for any purpose that would have been eligible for traditional tax-exempt bond financing other than private activity bonds, thus they did not allow for private sector participation (unlike PABs). The authority to issue BABs expired on December 31, 2010.

BABs are modeled after the “taxable bond option,” which was first considered in the late 1960s. In 1976, the following was posited by the then president of the Federal Reserve Bank in Boston, Frank E. Morris:

      The taxable bond option is a tool to improve the efficiency of our financial markets and, at the same time, to reduce substantially the element of inequity in our income tax system which stems from tax exemption [on municipal bonds]. It will reduce the interest costs on municipal borrowings, but the benefits will accrue proportionally as much to cities with strong credit ratings as to those with serious financial problems.

56
One benefit of the BAB program was that it tapped into a broader market for investors without regard to tax liability (such as pension funds, which typically do not invest in tax-exempt bonds). Traditional tax-exempt bonds have a narrow class of investors, generally consisting of individuals and mutual funds. BABs offered an issuer a credit equal to 35% of the interest rate established between the buyer and issuer of the bond.57 The Treasury Department estimated that the $181 billion in BABs issued from April 2009 through December 2010 will allow state and local governments to save an estimated $20 billion in borrowing costs, in present value savings, as compared to issuing traditional tax-exempt bonds.58One option would be to extend BABs to investment in privately owned water infrastructure. Many of the disadvantages cited for PABs identified earlier could be avoided, such as the windfall gain for high-income investors and the economic inefficiency of using a third party to deliver a federal subsidy.59 The FY2015 budget suggests that the BAB program potentially “. . . has a more streamlined tax compliance framework focusing directly on governmental issuers who benefit from the subsidy, as compared with tax-exempt bonds and tax credit bonds, which involve investors as tax intermediaries.”60 In the case of PAB-like arrangements, the partner government or water authority would “issue” bonds at the low rate and pass through the value of the subsidy to the private entity. The private entity would own and operate the water infrastructure.

In the 113th Congress, H.R. 535, H.R. 789, and H.R. 3939 (section 202) have been introduced to extend and expand a modified version of BABs. The President’s FY2015 budget (like the FY2013 and FY2014 budgets) proposes to reinstate BABs — now to be called America Fast Forward Bonds — at a 28% credit rate. In addition, the President’s FY2015 Budget proposes expanding the eligible uses to Section 501(c)(3) nonprofit entities such as hospitals and universities.

According to CBO, the interest subsidy of BABs would be recorded in the federal budget as outlays, like other payments to state and local governments. At the same time, by substituting taxable for tax-exempt bonds, the program would increase taxable interest income. The Joint Committee on Taxation analyzed a similar proposal in the President’s FY2012 budget and estimated that it would boost outlays by $76 billion over 10 years and raise revenues by $70 billion, with a net effect of increasing the cumulative deficit by $6 billion.61

Conclusion

Consensus exists among many stakeholders — state and local governments; equipment manufacturers, construction companies, and engineers; and environmental advocates — on the need for more investment in water infrastructure. Many in these varied groups support one or more options for doing so. There is no consensus supporting a preferred option or policy, and many advocate a combination that will expand the financing “toolbox” for projects. Some of the options discussed in this report may be helpful in addressing financing problems, but there is no single method or “silver bullet” that will address needs fully or close the financing gap completely. For example, some such as a WIFIA or a national infrastructure bank may be helpful to projects in large urban or multi-jurisdictional areas, while others such as expanded SRF programs may be more beneficial in smaller communities. It is unlikely that any of the recently proposed options such as a WIFIA or a trust fund could be enacted and up and running quickly, meaning that, at least for the near term, communities will continue to rely on the existing SRF programs, tax-exempt governmental bonds, and available tax-exempt private activity bonds to finance their water infrastructure needs.

The Obama Administration’s views on some of these issues are largely unknown for now, except for supporting the SRFs, excluding water infrastructure PABs from the state volume cap, and reinstating Build America Bonds, as reflected in its budget requests.

Author Contact Information

Claudia Copeland
Specialist in Resources and Environmental Policy
[email protected], 7-7227
William J. Mallett
Specialist in Transportation Policy
[email protected], 7-2216

Steven Maguire
Section Research Manager
[email protected], 7-7841

FOOTNOTES

1 EPA’s most recent estimate of capital needs for wastewater infrastructure was published in 2010. See U.S. Environmental Protection Agency, Clean Watersheds Needs Survey 2008, Report to Congress, EPA-832-R-10-002, May 2010. The most recent EPA needs estimate for drinking water infrastructure was issued in 2013. See U.S. Environmental Protection Agency, Drinking Water Infrastructure Needs Survey and Assessment, EPA-816-R-13-006, April 2013.2 American Water Works Association, Buried No Longer: Confronting America’s Water Infrastructure Challenge, March 2012, http://www.awwa.org/files/GovtPublicAffairs/GADocuments/BuriedNoLongerCompleteFinal.pdf.

3 For additional discussion, see CRS Report RL31116, Water Infrastructure Needs and Investment: Review and Analysis of Key Issues, by Claudia Copeland and Mary Tiemann, and CRS Report R42018, The Role of Public Works Infrastructure in Economic Recovery, by Claudia Copeland, Linda Levine, and William J. Mallett.

4 Thomson-Reuters, The Bond Buyer 2012 Yearbook, p. 159.

5 This report does not address certain other concepts that have been suggested from time to time to help localities meet financial challenges through better planning and prioritization of water infrastructure. For example, EPA encourages localities to improve management of their infrastructure assets in order to extend current life and reduce need for new infrastructure. Likewise, EPA and municipalities have discussed ways, and EPA issued a policy framework in June 2012, to integrate infrastructure planning and permitting, in order to prioritize investments.

6 The SDWA already allows but does not require states to provide subsidized assistance from drinking water SRFs.

7 For full discussion, see CRS Report R42506, The Budget Control Act of 2011: The Effects on Spending and the Budget Deficit, by Mindy R. Levit and Marc Labonte.

8 In addition to the deficit reduction achieved through the statutory caps on discretionary spending, the BCA put in place an automatic process in the event a special joint committee failed to reach an agreement on spending reductions. The BCA “Super Committee” announced in November 2011 that it had failed to reach such an agreement. As a result, an automatic spending reduction process was triggered unless Congress and the President act to eliminate or change the process. The automatic spending reductions affecting defense and non-defense discretionary accounts take place via a sequestration process in FY2013 and a reduction in the original BCA caps in FY2014 and beyond. Although some discretionary programs are exempt from the sequester process in FY2013, the SRF programs are not. Ibid.

9 Office of Management and Budget, Report to the Congress on the Joint Committee Sequestration for FY2013, March 1, 2013.

10 See U.S. Congress, House Committee on Transportation and Infrastructure, Water Quality Investment Act of 2009, report to accompany H.R. 1262, 111th Congress, 1st session, H.Rept. 111-26, pp. 49-54. Similarly, the JCT estimated that H.R. 5320 in the 111th Congress, authorizing capitalization grants for the drinking water SRF program, would reduce federal revenues by $337 million over 10 years by increasing the use of tax-exempt bonds by states. Pay-as-you-go procedures would apply because enacting the legislation would affect revenues. See U.S. Congress, House Committee on Energy and Commerce, Assistance, Quality, and Affordability Act of 2010, report to accompany H.R. 5320, 111th Cong., 2nd sess., July 1, 2010, H.Rept. 111-524, pp. 20-21.

11 Whether a particular fund is designated in law as a trust fund is, in many cases, arbitrary. In the federal budget, there is no substantive difference between a trust fund (such as the Highway Trust Fund) and a special fund (e.g., the Nuclear Waste Disposal Fund) or a revolving fund (such as the Postal Service Fund). All receive collections that are dedicated by law for specific purposes. Office of Management and Budget, “Budget of the United States Government: Analytical Perspectives, Supplemental Materials Fiscal Year 2013,” p. 455.

12 U.S. Environmental Protection Agency, Alternative Funding Study: Water Quality Fees and Debt Financing Issues, Final Report to Congress, June 1996; and U.S. Government Accountability Office, Clean Water Infrastructure, A Variety of Issues Need to Be Considered When Designing a Clean Water Trust Fund, GAO-09-657, May 2009. Hereinafter, 2009 GAO Report.

13 Offsetting collections are usually authorized to be spent for specified purposes and generally are available for use when collected, without further action by the Congress. Offsetting receipts may or may not be designated for a specific purpose. If designated for a particular purpose, in some cases the offsetting receipts may be spent without further action by Congress. When not so designated, offsetting receipts are credited to the general fund. See “Analytical Perspectives on the FY2014 Budget, Offsetting Collections and Offsetting Receipts,”http://www.whitehouse.gov/sites/default/files/omb/budget/fy2014/assets/receipts.pdf.

14 Rep. Earl Blumenauer, “The Water Trust Fund Act of 2013,”http://blumenauer.house.gov/uploads/Water%20Trust%20Fund%20One%20Pager3.pdf.

15 2009 GAO report, p. 13.

16 This restriction in the bill was described in the House Transportation Committee’s report, H.Rept. 112-29, pt. 1, as necessary to “mitigate the effect of over-optimistic revenue projections in the future.” The 90% restriction would provide room for error in revenue estimates. Once the actual level of revenues for the trust fund is known, an adjustment would be made in the amount actually made available from the trust fund for that year, according to the committee’s report.

17 See CRS Report R41926, House Rules Changes Affecting the Congressional Budget Process Made at the Beginning of the 112th Congress, by Bill Heniff Jr.

18 For example, see American Water Works Association, Water Environment Federation and Association of Metropolitan Water Agencies, “A Cost Effective Approach to Increasing Investment in Water Infrastructure, The Water Infrastructure Financing Innovations Authority (WIFIA),”http://www.awwa.org/portals/0/files/legreg/documents/wifia.pdf.

19 The threshold for Intelligent Transportation Systems projects is $15 million.

20 Federal Highway Administration, “Projects and Project Profiles: TIFIA Portfolio,”http://www.fhwa.dot.gov/ipd/tifia/projects_project_profiles/tifia_portfolio.htm.

21 Federal Highway Administration, “TIFIA Project Profiles: IH 635 Managed Lanes,”http://www.fhwa.dot.gov/ipd/project_profiles/tx_lbj635.htm.

22 For additional discussion, see CRS Report R43315, Water Infrastructure Financing: Proposals to Create a Water Infrastructure Finance and Innovation Act (WIFIA) Program, by Claudia Copeland.

23 According to the Federal Credit Reform Act of 1990, the subsidy cost is the “estimated long-term cost to the Government of a direct loan or loan guarantee, calculated on a net present value basis, excluding administrative costs” (104 Stat. 1388-610). The Federal Credit Reform Act of 1990 was enacted as part of the Omnibus Budget Reconciliation Act of 1990 (P.L. 101-508).

24 Douglas J. Elliott, Budgeting for Credit Programs: A Primer, Center for Federal Financial Institutions, April 2004, at http://www.coffi.org/pubs/Budgeting%20Primer.pdf.

25 Department of Transportation, “Letters of Interest for Credit Assistance Under the Transportation Infrastructure Finance and Innovation Act (TIFIA) Program,” 76 Federal Register 68257-68260, November 3, 2011,http://www.fhwa.dot.gov/ipd/pdfs/tifia/NOFA_Published_110311.pdf.

26 U.S. Congress, House Committee on Transportation and Infrastructure, Subcommittee on Water Resources and Environment, Testimony of Aurel Arndt, Hearing on Innovative Funding of Water Infrastructure of the United States, 112th Cong., 2nd sess., February 28, 2012,http://republicans.transportation.house.gov/Media/file/TestimonyWater/2012-02-28-Arndt.pdf.

27 LaShell Stratton-Childers, “Navigating a Rough Terrain,” Water Environment and Technology, January 2012, pp. 24-29. This article describes the November 2011 bankruptcy filing by Jefferson County, AL, in part resulting from the county’s inability to cover debts for wastewater system upgrades.

28 U.S. Congress, House Committee on Transportation and Infrastructure, Subcommittee on Water Resources and Environment, Testimony of Aurel Arndt, Hearing on Innovative Funding of Water Infrastructure of the United States, 112th Cong., 2nd sess., February 28, 2012,http://republicans.transportation.house.gov/Media/file/TestimonyWater/2012-02-28-Arndt.pdf.

29 For more on this topic generally, see Congressional Budget Office, Fair-Value Accounting for Federal Credit Programs, Issue Brief, March 2012, http://www.cbo.gov/sites/default/files/cbofiles/attachments/03-05-FairValue_Brief.pdf.

30 Congressional Budget Office, “Estimating the Value of Subsidies for Federal Loans and Loan Guarantees,” August 2004, p. 2, http://www.cbo.gov/ftpdocs/57xx/doc5751/08-19-CreditSubsidies.pdf.

31 Congressional Budget Office, Cost Estimate for S. 601, Water Resources Development Act of 2013, April 9, 2013, p. 6.

32 Congressional Budget Office, Cost Estimate for S. 601, Water Resources Development Act of 2013, April 17, 2013, p. 7.

33 For more on this topic, see CRS Report R43308, Infrastructure Banks and Debt Finance to Support SurfaceTransportation Investment, by William J. Mallett and Steven Maguire, and CRS Report R42115, National Infrastructure Bank: Overview and Current Legislation, by William J. Mallett, Steven Maguire, and Kevin R. Kosar.

34 Congressional Budget Office, “Issues and Options in Infrastructure Investment,” May 2008, p. 28, athttp://www.cbo.gov/ftpdocs/91xx/doc9135/05-16-Infrastructure.pdf.

35 Everett Ehrlich, A National Infrastructure Bank: A Road Guide to the Destination, Policy Memo, Progressive Policy Institute, October 2010, at http://www.progressivefix.com/wp-content/uploads/2010/09/09.2010-Ehrlich_A-National-Infrastructure-Bank.pdf.

36 The extent to which this would be done varies depending on the specific proposal. If Congress were to direct the bank to consider factors such as job creation and poverty reduction, then those requirements might constrain its ability to assist the most economically viable projects.

37 As noted earlier, according to the Federal Credit Reform Act of 1990 the subsidy cost is the “estimated long-term cost to the Government of a direct loan or loan guarantee, calculated on a net present value basis, excluding administrative costs” (104 Stat. 1388-610).

38 U.S. Congress, House Committee on Transportation and Infrastructure, Subcommittee on Highways and Transit,Testimony of Geoffrey S. Yarema, Hearing on National Infrastructure Bank: More Bureaucracy and More Red Tape,112th Cong., 1st sess., October 12, 2011.

39 Another infrastructure bank bill introduced in the 113th Congress is the American Infrastructure Investment Fund Act of 2013 (S. 387). It would create a fund within the Department of Transportation to support transportation projects.

40 Rep. John Delaney, Information on Rep. Delaney’s Infrastructure Bill, May 6, 2013,http://delaney.house.gov/information-on-congressman-delaneys-infrastructure-bill.

41 Senator Mark Warner, “Senator Warner Leads Bipartisan Group in Introducing Infrastructure Legislation,” Nov. 14, 2013, http://www.warner.senate.gov/public/index.cfm/pressreleases?ContentRecord_id=8627b0e2-cdd5-4fba-baa0-35cc2cd6f6bf.

42 Sections 142(a)(4), 142(a)(5), 142(e), and 146 of the Internal Revenue Code (I.R.C.).

43 Two types of private activity bonds are outside the annual volume limit, those issued by 501(c)(3) organizations like hospitals and those issued by private universities. For more on private activity bonds, see CRS Report RL31457, Private Activity Bonds: An Introduction, by Steven Maguire.

44 Office of Management and Budget, “Budget of the United States Government: Analytical Perspectives, Fiscal Year 2014,” Table 16-1.

45 U.S. Congress, Joint Committee on Taxation, General Explanation of the Revenue Provisions of the Deficit Reduction Act of 1984, 98th Cong., 2nd sess. (Washington: GPO, 1984), p. 930.

46 U.S. Congress, Joint Committee on Taxation, General Explanation of the Tax Reform Act of 1986, 100th Cong., 1st sess. (Washington: GPO, 1987), p. 1151.

47 The Joint Committee on Taxation estimated that a provision in highway program legislation approved by the Senate on March 14, 2012, the Moving Ahead for Progress in the 21st Century Act or MAP-21 (S. 1813), which proposed to lift the volume cap on water infrastructure projects for 6 years, would reduce revenues to the Treasury by $95 million over 6 years, and by $305 million over 11 years. See http://www.jct.gov/publications.html?func=startdown&id=4404. This provision was not included in the enacted surface transportation reauthorization bill (P.L. 112-141).

48 Internal Revenue Service, “Tax-Exempt Bonds, 2008,” Statistics of Income Bulletin, winter 2011, Table 10, p. 147 and Community Development Finance Agencies, 2008 National Volume Cap Report, available athttp://www.cdfa.net/cdfa/volumecap.nsf/index.html.

49 American Water, 2008 Annual Report, p. 48.

50 American Water, 2010 Annual Report, p. 41.

51 The Bush Administration also proposed a permanent exemption for water and sewage facilities as part of several budget requests.

52 In the 112th Congress, H.R. 1802 and S. 939 proposed to permanently exclude water infrastructure from the volume cap. In March 2012, the Senate passed surface transportation legislation (S. 1813) that included a provision to lift the volume cap for six years, but this provision was not included in the enacted bill (P.L. 112-141).

53 Thomson-Reuters, The Bond Buyer 2012 Yearbook, p. 159.

54 For more, see CRS Report R40523, Tax Credit Bonds: Overview and Analysis, by Steven Maguire.

55 26 U.S.C. § 54AA(d)(1)(A). BAB proceeds that use the direct payment options are to be used only for capital expenditures.

56 Frank E. Morris, “The Taxable Bond Option,” National Tax Journal, vol. 29, no. 3, September 1976, p. 356.

57 Note that the issuer credit is an outlay of the federal government. This simple example does not consider issuance and underwriter fees.

58 U.S. Department of the Treasury, “Treasury Analysis of Build America Bonds Issuance and Savings,” May 16, 2011, p. 11, http://www.treasury.gov/initiatives/recovery/Documents/BABs%20Report.pdf.

59 Researchers have determined that the federal government subsidy for BABs “. . . disadvantages individual U.S. taxpayers, who are the main holders of municipal bonds, and benefits new entrants in the municipal bond market.” New entrants would include international investors and pension funds. See Ang, Andrew, Vineer Bhansali, and Yuhan Xing, “Build America Bonds,” National Bureau of Economic Research, Working Paper 16008, May 2010.

60 U.S. Department of the Treasury, “General Explanations of the Administration’s Fiscal Year 2015 Revenue Proposals,” March 2014, p. 125.

61 U.S. Congressional Budget Office, Preliminary Analysis of the President’s Budget for 2012, March 18, 2011, p. 7.

END OF FOOTNOTES


IRS Announces Realignment of Some Legal Resources in TE/GE.

The IRS announced in a March 20 statement that it will realign some legal resources within its Tax-Exempt and Government Entities Division, moving technical law specialists and support staff responsible for published guidance, some private letter ruling requests, and technical advice from TE/GE to the IRS Office of Chief Counsel (TE/GE).

According to the statement, TE/GE is one of the few places in the IRS where guidance, letter rulings, and technical advice are worked on outside of the chief counsel office. The change will bring TE/GE in alignment with the other three IRS business operating divisions, which use the chief counsel office for their guidance and legal work.

IRS officials said they hope to have the realignment, which will help ensure consistency and efficiency, completed by October 1. The organizational shift will have little impact on practitioners and organizations that interact with this area, the IRS said. However, the IRS may have to revise some administrative guidance, such as revenue procedures and addresses on where to send letter ruling requests.

IRS Statement

IRS officials announced today a realignment of certain legal resources within the Tax Exempt and Governmental Entities (TE/GE) division. Under the change, technical law specialists and support staff, responsible for published guidance (including revenue rulings, revenue procedures), certain private letter ruling requests and technical advice, will be shifted from TE/GE to the IRS Office of Chief Counsel (TEGE). TE/GE is one of the few places in the IRS where published guidance, private letter rulings and technical advice memoranda are worked on outside of Chief Counsel. This change will bring TE/GE in alignment with the other three IRS business operating divisions, which use Counsel for their guidance and legal work.

The decision to make this shift will help ensure consistency and efficiency.

The potentially affected employees and their managers were notified today by TE/GE leadership.

The National Treasury Employees Union (NTEU) has been notified. The specific details of the realignment are still being worked out. IRS officials hope to have these details resolved and the realignment complete by Oct. 1.

We believe this organizational shift will have relatively little impact on practitioners and organizations who interact with this area. The IRS may, however, have to revise some administrative guidance, such as revenue procedures and addresses on where to send private letter ruling requests. The details on these procedural changes will be worked out.

 



IRS Announces Shake-Ups in Chief Counsel's Office and TE/GE.

The IRS announced March 20 that in an effort to “help ensure consistency and efficiency,” it will be moving some legal functions, including those responsible for issuing published guidance, from the Tax-Exempt and Government Entities Division to the IRS Office of Chief Counsel.

The rulings and agreements function and technical guidance function will move to the Office of Chief Counsel, the IRS said. Those functions are responsible for issuing revenue rulings and private letter rulings, among other duties.

Marcus S. Owens of Caplin & Drysdale told Tax Analysts the IRS has perceived a need for realignment for procedural and staffing reasons. “This is going to require a wholesale reordering with how the work is done, and in particular how the issues are identified that need to go to chief counsel,” for in depth review he said.

It’s important to know how transparent the ruling process will be after realignment, Owens said, asking, “Is the taxpayer going to know his or her case is being coordinated with chief counsel, are they going to know what chief counsel says, are they going to have an ability to weigh in on that discussion to make sure that chief counsel fully understands all the facts?”

Starting in the 1980s, the IRS underwent a realignment in which the technical legal rulings functions were transferred to the chief counsel’s office. TE/GE did not exist as a division at that time, but since its inception it has retained its legal rulings function. It was only a matter of time before TE/GE transferred its rulings function to the chief counsel’s office, Owens said.

Owens wondered how the facts of taxpayers’ cases would be communicated to the offices having a role in resolving tough, unprecedented cases under the new alignment. If chief counsel is going to have a role in deciding the cases, will it “get to hear from the taxpayer directly, or is everything going to be filtered through the IRS?” he asked. “I think that’s going to be a critical issue for the Service.”

“In some respects, the processing of applications is what the service center does, but every now and again, things will turn up in application for exemption that are of critical importance” either for tax administration or beyond the tax system, said Owens. “For example, the rise of politically active [section] 501(c)(4)s couldn’t be handled by routine rubber stamping; there are proposed regulations out on those now.” (REG-134417-13) Owens also cited racially discriminatory private schools and the mail-order ministries of the 1970’s.

The “unanswered questions” are whether the new system “will facilitate the surfacing of those issues and the resolution of them” in a way that is nuanced, legally appropriate, and transparent, he said.

Moving to Cincinnati

Also announced March 20 was that the IRS would be relocating its exempt organizations headquarters from Washington to Cincinnati. Tamera Ripperda, the new director of exempt organizations in TE/GE, said the move is one of several steps the IRS is taking to improve efficiency.Speaking at the annual Washington Nonprofit Legal and Tax Conference in Arlington, Va., she said the IRS is committed to strengthening and improving its services to tax-exempt organizations, and to getting exemption applications processed more quickly. Ripperda, whose appointment was announced in December and who has been at the IRS since 1988, said the principal reason for the move to Cincinnati is that that is where most IRS exempt organizations employees are located.

Ripperda did not address the role of the Cincinnati office in the IRS exemption applications scandal, in which questions arose regarding that office’s communications with Washington and its involvement in much of the controversial activity surrounding conservative groups’ applications for section 501(c)(4) status, including what was causing the applications’ delays.

Ripperda told conferees that the IRS is working to reduce the backlog of exemption applications, which is a challenge because the agency on average receives about 60,000 applications a year, and that number is rising just as IRS resources have been decreasing. One reason for the applications’ increase has been requests for reinstatement of exempt status from organizations that had their exemptions revoked automatically because they failed to file information returns for three straight years, she said.

To address the problem, the IRS in January published Rev. Proc. 2014-11, 2014-3 IRB 411, which contains several processes for seeking reinstatement. Ripperda said the IRS believes the revenue procedure will help reduce a significant portion of reinstatement applications.

The IRS is aggressively pursuing a “first-in, first review” approach through which exemption applications that have been in inventory the longest will be assigned for processing before others, regardless of whether they can be processed quickly or will need more work, according to Ripperda. As a result of that and other streamlining processes, most of the cases that had been open for more than a year at the beginning of 2014 have been closed, and the IRS plans to close almost all the rest of them by the end of June, she said.

Ripperda said that nearly 90 percent of the section 501(c)(4) applications that were eligible for expedited processing after last May’s disclosure of mishandled applications by the IRS have been closed.

The IRS is considering establishing a streamlined application process for organizations seeking section 501(c)(3)status, Ripperda said, adding that the process could be used by small organizations whose applications suggest a much lower risk of noncompliance. She reported that initial results from the IRS’s interactive Form 1023 exemption application for charities have been promising, with more complete applications being submitted.

The IRS has added a box to the “Where’s My Application?” page on its website that shows the average date of applications that are being worked on. Ripperda emphasized that it is an average date and that the IRS is working on applications that it has received before that date and applications received after that date.

There have been many recent personnel changes in the exempt organizations function of the IRS, Ripperda said. Nanette Downing, director of exempt organizations examinations at the agency, next week will assume a position involving governmental entities and shared services, Ripperda said, adding that Steve Martin will be the acting director of rulings and agreements at TE/GE.

Martin will take the place of Holly Paz, who stepped down last June.

Also at the March 20 conference were Janine Cook, IRS deputy division counsel and deputy associate chief counsel (tax-exempt and government entities), and Ruth Madrigal, an attorney-adviser in the Treasury Office of Tax Legislative Counsel. Madrigal declined to speculate on when the controversial proposed regulations on political activities of social welfare organizations will be finalized, though she said Treasury and the IRS intend to hold a public hearing on the proposal. Cook noted that the IRS and Treasury have received a lot of comments on the proposed regs — more than 160,000, according to the latest count — that will have to be reviewed before final regs can be released.

Madrigal reiterated that tax-exempt hospitals may rely on proposed regulations (REG-130266-11, REG-106499-12) on the hospital requirements under section 501(r) until final regulations are published, but she added that contrary to some news reports, they are not required to do so, though they must comply with the statute. She said Treasury and the IRS are “a lot further along” in working on the regs, adding that there probably will be a “fairly generous” transition period when the final regs come out to give hospitals time to adjust to them.

by William R. Davis and Fred Stokeld



IRS Explains Sandwich Lease Prohibition in Rehab Tax Credit Safe Harbor.

The prohibition on so-called sandwich leases contained in the safe harbor revenue procedure for section 47 historic rehabilitation tax credit deals applies even when the leaseback is for less than all of the building, Joseph Worst, branch 3 attorney, IRS Office of Associate Chief Counsel (Passthroughs and Special Industries), said March 20.

Section 4.02(2)(c) of Rev. Proc. 2014-12 provides that “a sublease agreement of the building from the master tenant partnership back to the developer partnership or to the principal . . . will be deemed unreasonable unless the sublease is mandated by a third party unrelated to the principal.” The guidance adds that “the terms of a sublease agreement of the building by the master tenant partnership to any person will be deemed unreasonable unless the duration of the sublease is shorter than the duration of the head lease.” (The revised Rev. Proc. 2014-12, 2014-3 IRB 1 was issued January 8. The original Rev. Proc. 2014-12, 2014-3 IRB 415 was issued December 30.)

Speaking on his own behalf at an Institute for Professional and Executive Development conference in Washington cosponsored by Nixon Peabody LLP and CohnReznick LLP, Worst said the government tried to draw a bright line in the guidance where sandwich leases were concerned. “Even if the lease of the building is of less than half the building . . . you can’t do that, whether it’s all of the building or less than all of the building,” he said. “That being said, I would say that if the partners can show that there are actual economics to the deal, you might not be in the safe harbor, but I don’t think Exam would try to audit that kind of a case as long as there are economics.”

The revenue procedure came about because the decision against the taxpayer in the Historic Boardwalk Hall case scared investors off of deals involving the section 47 historic rehab tax credit. (Historic Boardwalk Hall LLC v. Commissioner, No. 11-1832 (3d Cir. 2012).)

Forrest Milder of Nixon Peabody said the facts in Historic Boardwalk were worse for the taxpayer because the investor didn’t care if the deal went well or not. The investor was entitled to get a certain amount of cash and tax credits no matter how successful or unsuccessful the project.

The Third Circuit determined that the investor in Historic Boardwalk wasn’t a bona fide partner. “Historic Boardwalk Hall bears a lot of resemblance to the transactions that we typically do. It’s just that this one was really, really locked up,” Milder said.

In a February 14 letter responding to an inquiry from Connecticut Gov. Dan Malloy (D), Mark Mazur, Treasury assistant secretary for tax policy, wrote that Treasury officials “are confident that the safe harbor described in the revenue procedure will facilitate the resumption of” projects that utilize the section 47 historic rehabilitation tax credit.

Milder wasn’t as optimistic about the impact of the guidance. “There are pending audits right now. Many of the large investors have one or more audits pending,” he said. “Notwithstanding that there is a safe harbor, it can be hard to go to your boss and say, ‘We should do more of these.'”

Craig Gerson, attorney-adviser in the Treasury Office of Tax Legislative Counsel, speaking on his own behalf, said that the historic rehabilitation industry “has a leg up now because they have a safe harbor set of rules that they can look to.” He added, “I don’t know what to tell investors in this area aside from this is just the world that we occupy. When you do deals that have a tax element, there’s a level of subjective risk involved, and your deals have less subjective risk than most, which should make you more likely to do the deals.”

Separate Agreements

Milder explained that probably 95 percent of section 47 historic rehab tax credit deals involve an element called a lease passthrough structure, in which the tax credit gets passed to the master tenant while the depreciation deductions stay with the property owner.Section 4.01 of the safe harbor provides that an investor can’t invest in both the master tenant partnership and the developer partnership “other than through an indirect interest” unless there’s “a separately negotiated, distinct economic arrangement.”

Milder said that there’s been a lot of discussion about how this provision affects the new markets tax credit world, where investors typically make both investments — one on the historic master tenant side and one ultimately on the developer/landlord side — together. “How can they demonstrate that there were two separate arm’s-length investments?” he asked. “People are very interested in this whole separateness concept.”

“What the rev. proc. requires is simply that they are two separate economic deals,” Gerson said. While the parties may see the project as a dual investment opportunity, “we want the investment for each component of it to be separately determined.” He likened the requirement to an individual trading in his old car for a new car. The government wants the sale of the old car to be a separate negotiation from the purchase of the new car.

Investor’s Partnership Interest

The rehab tax credit safe harbor requires a minimum partner interest of 1 percent for the principal and 5 percent for the investor. It also states — albeit in a convoluted way — that the investor’s interest can’t flip to less than 5 percent of what it was in its highest year, Milder said.Section 4.02(2)(b) of the guidance provides that the investor’s interest “must constitute a bona fide equity investment with a reasonably anticipated value commensurate with the investor’s overall percentage interest in the partnership, separate from any federal, state, and local tax deductions, allowances, credits, and other tax attributes to be allocated by the partnership to the investor.”

Milder said that when practitioners first read this they were concerned that the government was requiring that the investor show profit motive because the value of the interest didn’t take into account tax benefits.

“We understand that the credits and other tax attributes are a key part of the deal and that partners may not have a profit potential without taking them into account,” Gerson said. “What we’re really after there is that we don’t want [the value of the investor’s interest] to be winnowed down through the use of unreasonable fees or lease terms orany of the myriad other artificialities that we saw at use in, for example, Historic Boardwalk.”

Gerson added that the requirement in section 4.02(2)(b) couples with the requirement in section 4.02(2)(c), which provides that “the value of the investor’s partnership interest may not be reduced through fees, . . . lease terms, or other arrangements that are unreasonable . . . and may not be reduced by disproportionate rights to distributions or by issuances of interests in the partnership . . . for less than fair market value consideration.”

“If you comply with (2)(c), you should generally get to (2)(b) in a fairly natural way,” Gerson said.

Milder said most people who do historic rehab tax credit transactions are used to the notion of a cash-on-cash return where — if it’s 3 percent on an investment of $1 million, the investor would get back $30,000 per year. He said such a return has the potential to look like interest.

“I would not say that a 3 percent preferred yield could not be within the parameters of the safe harbor,” Gerson said. “But the 3 percent yield in Historic Boardwalk was not contingent upon the partnership’s net income, gain, or loss. It was, in fact, substantially fixed in amount. So the preferred yield should be contingent upon income — the performance of the partnership. And if I’m sitting in your shoes, the safer route is probably what I would call a common interest rather than a preference.”

Worst said that the Service didn’t include a bright-line rule providing that — for example — the investor receive a 3 percent return on its investment because “there’s a myriad of different kinds of investments out there, and some may be able to get 3 percent and some may not. And I don’t think we wanted to exclude those deals that could not.”

“A lot of people have taken the safe harbor as a wonderful thing perhaps for poorer projects,” Milder said, given that the revenue procedure doesn’t have a profit motive requirement.

Gerson said the lack of a profit motive requirement was by design because the government wanted the safe harbor to be as objective as possible. “Pinning our safe harbor on something as subjective as taxpayer intent does not make for easy living for either taxpayers or examiners,” he said. “We’ve tried to structure a safe harbor in which we require that people are all acting at arm’s-length with each other, and I think that the profit motive will take care of itself through there.”

Milder said Faith Colson, branch 1 senior counsel, IRS Office of Associate Chief Counsel (Passthroughs and Special Industries), refers to the requirement in section 4.02(2)(c) as the “no monkey business” test. Milder said a cottage industry has sprung up in the marketplace to produce reports establishing that development and other fees are reasonable.

“Those of us rendering tax opinions read these reports and are not quite sure what to make of them” given that, among other things, it’s hard to find comparables, Milder said.

Gerson said taxpayers that commission such reports aren’t necessarily any better off than taxpayers that don’t. “Your ability to rely on the safe harbor is as good as the strength of your report,” he said. “At the end of the day, people will have to make their own determinations on this.” Gerson said that the most useful guidepost is to ask whether the fee strips out the upside or downside potential of the deal.

by Amy S. Elliott



IRS Bars Appraisers From Valuing Facade Easements for 5 Years.

The IRS has announced (IR-2014-31) that its Office of Professional Responsibility has entered into a settlement agreement with a group of appraisers from the same firm accused of aiding in the understatement of federal tax liabilities by overvaluing facade easements for charitable donation purposes.

In settling the case, the appraisers admitted to violating sections of Circular 230 related to due diligence and document accuracy and agreed to a five-year suspension of valuing facade easements and performing any appraisal services that could subject them to penalties under the code.

IRS Bars Appraisers from Valuing Facade Easements for
Federal Tax Purposes for Five Years

March 19, 2014

WASHINGTON — The Internal Revenue Service today announced its Office of Professional Responsibility (OPR) has entered into a settlement agreement with a group of appraisers from the same firm accused of aiding in the understatement of federal tax liabilities by overvaluing facade easements for charitable donation purposes.Under the settlement agreement, the appraisers admitted to violating relevant sections of Circular 230 related to due diligence and submitting accurate documents to the government.

The appraisers agreed to a five-year suspension of valuing facade easements and undertaking any appraisal services that could subject them to penalties under the Internal Revenue Code. The appraisers also agreed to abide by all applicable provisions of Circular 230.

“Appraisers need to understand that they are subject to Circular 230, and must exercise due diligence in the preparation of documents relating to federal tax matters,” said Karen L. Hawkins, Director of OPR. “Taxpayers expect advice rendered with competence and diligence that goes beyond the mere mechanical application of a rule of thumb based on conjecture and unsupported conclusions.”

Failure to comply with terms of the settlement would result in the appraiser’s disqualification, which would include a ban from presenting any evidence or testimony in administrative proceedings before the Department of the Treasury, and renders any appraisal given after disqualification without probative effect.

The appraisers prepared reports valuing facade easements donated over several tax years. On behalf of each donating taxpayer, an appraiser completed Part III, Declaration of Appraiser, of Form 8283, Noncash Charitable Contributions, certifying that the appraiser did not fraudulently or falsely overstate the value of such facade easement. In valuing the facade easements, the appraisers applied a flat percentage diminution, generally 15 percent, to the fair market values of the underlying properties prior to the easement’s donation.

Specifically, the appraisers admitted violating Circular 230, Section 10.22(a)(1), for failing to exercise due diligence in the preparation of documents relating to IRS matters, and Section 10.22(a)(2) for failing to determine the correctness of written representations made to the Department of the Treasury.

OPR’s settlement agreement with the appraisers includes a disclosure authorization that allows this press release.

 



Comments Sought on Environmental Remediation Trust Regs.

The IRS has requested public comment on information collections under final regulations (T.D. 8668) undersection 7701 on the classification of environmental cleanup trusts; comments are due by May 12, 2014.
Citations: 79 F.R. 13740


IRS LTR: Organization Is Instrumentality of State and May Receive Contributions.

The IRS ruled that a member institution of a state board that approves operating and capital budgets of each institution in the state’s university and community college system is an instrumentality of the state and may receive charitable contributions under section 170(c)(1).

Index Number: 501.03-26
Release Date: 3/14/2014
Date: August 9, 2013

Refer Reply To: CC:TEGE:EOEG:E0 – PLR-127207-12

Dear * * *:
This is in reply to your letter dated June 18, 2012, requesting a ruling on behalf of Organization. You requested a ruling that Organization is an instrumentality of State and is eligible to receive charitable contributions under Section 170(c)(1) of the Internal Revenue Code (“Code”).

FACTS AND REPRESENTATIONS

State Board was established in Year 1 by act of State legislature; the act was codified at Statute. State Board is an integral part of State. The government, management and control of the State university and community college system are vested in State Board. State Board approves the operating and capital budgets of each of the institutions in the State university and community college system. Organization is a member institution of the State Board and serves a governmental purpose of educating the citizens of the State. Organization was established as an instrumentality of State operating as a public institution of higher learning. The purpose of Organization is to support educational excellence in State. Organization represents that contributions made to it are for exclusively public purposes.
Organization is governed by State Board composed of x members (including four ex officio members who shall be the Governor, the Commissioners of Education and Agriculture, and the Executive Director of Commission. A majority of the members of the State Board are appointed by the Governor of State.

Organization is attached for administrative purposes to Commission, which establishes a formula for distribution of public funds through which Organization receives State operating and capital appropriations. State exercises oversight of Organization’s finances through Commission.

LAW

Revenue Ruling 57-128, 1957-1 C.B. 311, sets forth the factors to be taken into account in determining whether an entity is an instrumentality of one or more governmental units: (1) whether the organization is used for a governmental purpose and performs a governmental function; (2) whether performance of its function is on behalf of one or more states or political subdivisions; (3) whether there are any private interests involved, or whether the states or political subdivisions have the power and interests of an owner; (4) whether control and supervision of the organization is vested in a public authority or authorities; (5) whether express or implied statutory or other authority is necessary for the creation and/or use of the organization, and whether this authority exists; and (6) the degree of financial autonomy of the entity and the source of its operating expenses. Each of these factors must be evaluated in order to determine if Organization is an instrumentality of the State.
Section 170(a)(1) allows, subject to certain limitations, a deduction for charitable contributions as defined in section 170(c), payment of which is made within the taxable year. Section 170(c)(1) includes in the definition of “charitable contribution” a contribution or gift made for exclusively public purposes to or for the use of a state, a possession of the United States, a political subdivision of either a state or possession of the United States, the United States, or the District of Columbia. Entities eligible to receive tax deductible contributions include not only governmental units described in section 170(c)(1), but also wholly owned instrumentalities of states and political subdivisions.

ANALYSIS

Organization satisfies the first factor listed in Rev. Rul. 57-128, which requires it to have a governmental purpose and perform a governmental function. The purpose of Organization is to support education in State.
Organization satisfies the second factor, as it performs its function on behalf of State Board. State Board is established pursuant to Statute. State Board is an integral part of State. Organization therefore performs its function on behalf of State.

Organization satisfies the third factor, because no private interests are involved and the State has the power and interest of an owner. Organization is controlled by State Board, an integral part of the State. State Board approves the operating and capital budgets of Organization.

Organization satisfies the fourth factor. Organization is governed by State Board. State Board was created by act of State legislature. Control and supervision of Organization is therefore vested in a public authority.

Organization satisfies the fifth factor, because State Board was created by an act of the State legislature. Organization is a member institution of State Board and provides educational benefits to the people of State. Thus, statutory authority is necessary for the Organization to provide educational services to State.

Organization satisfies the sixth factor, which considers the source of operating expenses as well as the degree of financial autonomy. Organization’s source of operating funds is from money, services and property from Commission. Organization is statutorily limited to specific purposes.. State indirectly controls Organization’s finances because State controls State Board. A majority of State Board members are appointed by the Governor. Committee requires Organization to maintain financial records consistent with the requirements of Committee.

Organization satisfies all factors enumerated in Revenue Ruling 57-128. Accordingly, Organization is an instrumentality of State and is eligible to receive charitable contributions under Section 170(c)(1) of the Code.

Except as expressly provided herein, no opinion is expressed or implied concerning the tax consequences of any aspect of any transaction or item discussed or referenced in this letter.

This ruling is directed only to the taxpayer requesting it. Section 6110(k)(3) provides that it may not be used or cited as precedent.

A copy of this letter must be attached to any income tax return to which it is relevant. Alternatively, taxpayers filing their returns electronically may satisfy this requirement by attaching a statement to their return that provides the date and control number of this letter.

The rulings contained in this letter are based upon information and representations submitted by the taxpayer. While this office has not verified any of the material submitted in support of the request for rulings, it is subject to verification on examination.

Sincerely,

Casey A. Lothamer
Senior Technician Reviewer
(Exempt Organizations Branch)
(Tax Exempt & Government Entities)

AUGUST 9, 2013
Citations: LTR 201411018



Camp's Proposed Deduction Floor Troubles Charities.

A proposed 2 percent floor for charitable deductions in the tax reform plan introduced by House Ways and Means Committee Chair Dave Camp, R-Mich., has charity groups fearing it could cause donations to drop.

For the last five years, federal budget season has been a time of unease for organizations that promote charities and charitable donations, as each year the Obama administration has proposed capping the deduction for charitable contributions at 28 percent for upper-income taxpayers.

Now those groups must contend with another plan to limit the deduction that has been proposed as part of tax reform.

The Tax Reform Act of 2014, released on February 26 as a discussion draft by House Ways and Means Committee Chair Dave Camp, R-Mich., proposes a 2 percent floor on the deduction as well as several other provisions pertaining to charitable giving.

Although the charitable giving community has reacted favorably to some of the proposals, the proposed floor is prompting worry among some groups and outright opposition from others.

The provision would allow taxpayers to deduct their contributions to charity only to the extent the donations exceed 2 percent of the taxpayers’ adjusted gross income, according to a Ways and Means staff summary.  The reduction would apply first to contributions subject to the 25 percent of AGI limitation, then to qualified conservation contributions, and finally to contributions subject to the 40 percent limitation, the summary explains.

Because charitable giving is linked to the economy’s health, the Camp proposal safeguards and encourages donations to charities, according to the bill’s executive summary, which predicts charitable giving would rise by $2.2 billion a year because of the charitable reforms under the plan. Because 95 percent of Americans would no longer have to itemize, they would enjoy lower taxes without the complexity of itemizing, while the remaining 5 percent who would continue itemizing could still claim the charitable deduction if their donations were more than 2 percent of their income, the executive summary says.

The executive summary also notes that, unlike the Obama administration’s budget proposals, the plan would not cap the amount of the deduction, and it would extend the deadline for making deductible contributions in a tax year to April 15 of the following tax year.

But some observers predict that the impact on the deduction and on charitable giving would be significant. David L. Thompson of the National Council of Nonprofits cited a Congressional Budget Office study that predicted charitable donations would decrease under a 2 percent floor. He also challenged the reality of Ways and Means’ estimate of $2.2 billion more in charitable giving, calling it a guess.

Charities depend on charitable giving to carry out the work they do, which is why the deduction should not be tweaked or played with, Thompson said. Limiting the tax break, he said, is “a bullet point on a list of issues in Washington; in the real world, it’s scaring donors, it’s changing the relationship between the community of nonprofits and government.”

Sue Santa of the Council on Foundations (COF) said her group’s initial reaction is concern, though she added that the COF is still studying the proposed 2 percent floor to figure out what it would mean. She said the Camp plan is more complex than the Obama administration’s proposed 28 percent cap because the reform bill as a whole would cause far more individuals to use the standard deduction.

Other Provisions of Note

The Camp plan also would require all tax-exempt organizations that file Form 990, “Return of Organization Exempt From Income Tax,” and related returns to do so electronically. Under current law, e-filing is required only if an organization files at least 250 returns (such as Form W-2 or Form 1099) a year.Santa said the COF supports the concept of mandatory e-filing but added that smaller organizations may need more time and resources before they can file that way. It is important that information that foundations and charities share with the IRS, such as investment data, can be transferred to an electronic filing medium, she added.

“We don’t doubt this is achievable; we just want to be sure that this is implemented in a reasonable way so that the foundations and charities can conform,” Santa said.

A provision long favored by the philanthropic community would replace the 2 percent excise tax on the net investment income of private foundations (which can drop to 1 percent if a foundation makes greater distributions) with a single flat rate of 1 percent. Santa said her organization is delighted the provision is part of Camp’s package, saying that the two-tier system actually creates a disincentive for foundations to distribute more funds in especially difficult times because it makes it more difficult for them to continue to qualify for the lower rate in subsequent years.

Santa also supports extending to April 15 the deadline for making charitable donations for the prior year. “We’re really encouraged by any provision that might increase the amount of charitable giving,” she said.

What They’d Like to See

Asked what is not in the tax reform plan that should be, Thompson said his organization would like to make permanent the charitable giving extenders that now have to be renewed every year, especially the tax break for food inventory donations. Renewing the extenders in December and making them retroactive does not help people waiting for food donations, he said.”You can’t retroactively give a truckload of bananas in December that rotted in January,” Thompson remarked.

Santa said her organization would like to see the provision permitting tax-free charitable distributions from IRAs expanded and made permanent.

MARCH 14, 2014
by Fred Stokeld


Camp Reform Draft Might Spell Trouble for Student Loan Exemptions.

The tax reform draft of House Ways and Means Committee Chair Dave Camp, R-Mich., proposes to eliminate tax breaks for student loans, and student loan relief advocates are concerned about the potential regressive effects of eliminating the breaks, as well as the potential retroactive application of such a move.

With House Ways and Means Committee member Kevin Brady, R-Texas, saying February 25 that the “student loan crisis” is a hindrance on “the future growth of the country” that must be rectified, student loan relief advocates were likely disappointed the next day to discover that committee Chair Dave Camp, R-Mich., was proposing to eliminate tax breaks for student loans in his tax reform discussion draft.

The Camp draft proposes to eliminate the student loan interest deduction and the exclusion of discharge of student loan indebtedness, among other student tax benefits. Advocates for student loan relief who were contacted by Tax Analysts are concerned about the potential regressive effects of eliminating the breaks, as well as the potential retroactive application of such a move.

“This is baffling to me,” Isaac Bowers of public service lawyers group Equal Justice Works said of Camp’s student loan proposals. “The [Congressional Budget Office] projects that the Department of Education is going to make about $174 billion in profits through 2023, so I just don’t see a huge need to cut back on these education provisions that by and large help middle- and lower-class Americans.”

Under current law, gross income generally includes the taxpayer’s discharge of indebtedness, with some exceptions. Camp’s bill would eliminate section 108(f), which exempts from cancellation of indebtedness income student loans discharged after the individual worked for a predetermined period of time in professions involving education or other public benefits.

Congress in 1984 codified under section 108(f) temporary tax provisions that had been enacted in 1976 and 1978, because it believed that the tax break served an important purpose in encouraging doctors, nurses, and teachers to serve in rural and low-income areas. Concerned that the rule would apply too broadly, Congress tightened the exclusion to only loans canceled on the condition of performance of services for a specified, broad class of employers.

In 1984 the Joint Committee on Taxation estimated that section 108(f) would reduce budget receipts by less than $5 million per year. According to a JCT analysis of Camp’s reform draft, eliminating the exclusion for discharge of student loan indebtedness is expected to increase revenues by $1.1 billion from 2014 through 2023.

The repeal of section 108(f) would mean large tax bills for the many recent college graduates taking advantage of one of the many loan forgiveness programs. Under the proposal, they would have to include the amount of the discharged loan in gross income.

Two popular programs under section 108(f) are the teacher loan forgiveness and public service loan forgiveness (PSLF) programs.

The teacher loan forgiveness program applies to borrowers who are employed as full-time teachers for five consecutive years in elementary and secondary schools that serve low-income families, after which they may be eligible to have up to $17,500 in student loan debt forgiven. PSLF borrowers must make 120 payments while employed by some public interest employers, including state and local governments, the federal government, and nonprofit organizations, after which the remaining balance of their federal direct student loans may be forgiven.

Bowers said that if discharge of indebtedness under PSLF becomes taxable, it will prevent many people from being able to use the program.

Someone who begins with $80,000 in federal loans and takes a public service job making about $40,000 a year could end up with a $93,000 tax bill once the loan is forgiven, assuming a 3 percent annual salary raise, Bowers said. “Basically nobody would do that unless the amount they borrowed was low enough compared to their discretionary income so they would pay it off by the time of forgiveness,” he said.

“People would have to do some fine-grain calculations over a long period of time to figure out if this would work for them,” Bowers said. “And people’s circumstances change.”

Income-based repayment (IBR) and “pay as you earn” programs are not exempt from cancellation of indebtedness income, Bowers said, adding, “If the same thing happens to PSLF, many people will find that this is not a program that will help them, but in fact will hurt them.”

Bowers said the purpose of PSLF was to allow people to take lower-paying public service jobs and manage their student debt. If section 108(f) is repealed, they’ll just end up owing a huge amount to Treasury and “a lot of people are going to be dissuaded from doing public service work,” Bowers said, adding, “People are going to look at this and say, ‘I’m better off going to the private sector.'”

Retroactive?

John Buckley, former chief tax counsel for House Ways and Means Democrats and a member of Tax Analysts’ board of directors, said he is concerned about the retroactive application of Camp’s proposed repeal of the student loan indebtedness exclusion.
Under the draft bill, the repeal of section 108(f) would apply to all amounts discharged after December 31, 2014, regardless of when the loan or discharge agreement was entered into by the taxpayer.

Buckley said that although the effective date is not explicitly retroactive because it applies only to future discharges, it would have a retroactive effect “because people who are currently doing something to do loan discharge will find their expectations substantially disturbed.” He added that it would be unfair to have program participants change their plans midstream.

But Buckley is hopeful that if Congress passes the bill, it will exempt existing contracts, despite the current proposal’s retroactive effect. “Quite often, when Congress passes something like this, they exempt existing contracts,” he said.

“In a commercial setting, [Congress] would generally exempt existing contracts. This is the result of a sense of fairness,” Buckley added. “If you are changing the tax treatment of a contract, it is almost always prospective. You don’t disturb existing contracts.”

Obama Proposal

The Obama administration’s fiscal 2015 budget plan proposes a broadening of section 108(f) to exclude from gross income those amounts forgiven at the end of the repayment period for some borrowers using the income-based or income-contingent repayment (ICR) options. The proposal would be effective for loans forgiven after December 31, 2014.
Under IBR and ICR, loans are discharged after the taxpayer makes payments contingent on income for 25 years.

The Obama administration reasoned that individuals meeting the forgiveness requirements will have had low incomes relative to their debt burden and that for many of those individuals, paying the tax on the forgiven amounts will be difficult.

However, the Obama budget also proposes limiting the PSLF amount to $57,500, the undergraduate loan limit. Bowers said that proposal would almost certainly make PSLF untenable for professionals such as doctors, lawyers, and teachers who get advanced degrees and often incur debt in excess of the proposed cap.

New Bill of Hope?

On January 15, Rep. Frederica S. Wilson, D-Fla., introduced a bill that would exempt student loan forgiveness under the IBR and pay as you earn programs from cancellation of indebtedness income.
The Student Loan Borrowers’ Bill of Rights Act of 2013 (H.R. 3892 ) would amend section 108(f) to include all student loan discharges, regardless of circumstances surrounding them. The bill is currently pending before four House committees, including Ways and Means.

Bowers expressed support for Wilson’s bill, saying, “This is the way we think things should be going.”

Bowers added that nobody wants to be on IBR for 25 years but that people will be because of the high unemployment rate and inability of people to find jobs that will help them pay off their loans. And under current law, “those people are going to potentially face a humungous tax bill,” he said.

MARCH 13, 2014
by William R. Davis


Credit Union Group Urges Preservation of Tax Exemption.

The tax-exempt status of federal credit unions should be preserved because ending it would cost jobs, likely cause banks to raise costs for their customers, and be inconsistent with tax reform efforts, the National Association of Federal Credit Unions said in a March 11 letter to House Ways and Means Committee Chair Dave Camp, R-Mich.

March 11, 2014

The Honorable Dave Camp
Chairman
Committee on Ways and Means
1102 Longworth House Office Building
United States House of Representatives
Washington, D.C. 20515

Dear Chairman Camp:

On behalf of the National Association of Federal Credit Unions (NAFCU), the only trade association that exclusively represents the interests of our nation’s federal credit unions, I write to thank you once again for your continued support of credit unions and their 97 million members and to respond to the tired attacks that the banking trades continue to make against credit unions.

In the American Bankers Association’s own words, “A specific tax imposed on a single industry sector is wholly inconsistent with the fundamental purpose of tax reform — to broaden the tax base, lower rates, simplify the code, and reduce economic distortions that impede growth.” Yet time and time again they continue to attack credit unions and ask for them to be taxed. Credit unions serve a unique purpose and despite what the bankers claim, there remain significant regulatory and statutory differences between not-for-profit member-owned credit unions and other types of financial institutions — including limits on who they can serve and their ability to raise capital. Taxing credit unions would penalize the members they serve and be wholly inconsistent with the fundamental purpose of tax reform.

As we have communicated to you before, the cumulative benefit credit unions provide the greater economy totals over $17 billion a year according to an independent study released by NAFCU just last month. As the study also shows, altering the tax status of credit unions would have a devastating impact not only on credit union members across the country, but also on consumers and small businesses in general. Eliminating the credit union tax exemption would result in the loss of 150,000 jobs a year, a shrinking of the GDP and a net loss of revenue to the federal government. You can read the study at: www.nafcu.org/cutaxexemption. A summary of the results of the study is enclosed with this letter.

While the banking trades claim credit unions threaten the business done by other financial institutions, this is simply untrue. What they did not tell you is that a 2011 study commissioned by the Small Business Administration’s Office of Advocacy found that bank business lending was largely unaffected by changes in credit unions’ business lending, and credit unions’ business lending can actually help offset declines in bank business lending during a recession (James A. Wilcox, The Increasing Importance of Credit Unions in Small Business Lending, Small Business Research Summary, SBA Office of Advocacy, No. 387 (Sept. 2011)). The study shows that during the 2007-2010 financial crisis, banks’ small business lending decreased, while credit union business lending increased in terms of the percentage of their assets both before and during the crisis. Clearly, credit unions were making loans when banks did not want to.

Furthermore, the banking trades claim that credit unions have unfair advantages and should be taxed. If credit unions have such an extraordinary advantage, why aren’t banks lining up to convert to credit unions? What the bankers forgot to mention in their attack is that nearly 1/3 of banks are Subchapter S corporations and pay no corporate income tax. Yes, they pay other taxes, but so do credit unions and their over 97 million member-owners who pay personal income taxes on the dividends they get from their credit union. Credit unions actually pay many taxes, such as payroll taxes and state and local taxes. Next time a banker complains to you about credit unions, we would urge you to ask them if they have looked at converting to one.

As you know, during the financial crisis credit unions continued to lend to consumers and small businesses that were left behind by our nation’s mega-banks. Credit unions didn’t participate in the TARP bailout and are proud of their continued service to Main Street America. Perhaps if the banking trades put the same focus on serving their customers that they seem to put on credit unions, the banks they represent would not have needed such a massive bailout.

In other countries where the tax exemption has been eliminated for credit unions, the number of credit unions has declined dramatically. Even the bankers have admitted in previous correspondence to you that new taxes on financial institutions would amount to a levy on lending, savings, credit and other financial services to the American consumer and our nation’s small businesses and would adversely impact economic growth and job creation. If the credit union tax exemption was removed, many credit unions would convert to banks or just go away. Without credit unions, which serve to provide checks and balances in the marketplace, for-profit banks would likely increase rates and fees on consumers.

Thank you once again for your support of credit unions and for the opportunity to respond to these attacks against our industry. If my colleagues or I can be of assistance to you, or if you have any questions regarding this issue, please feel free to contact me or NAFCU’s Vice President of Legislative Affairs Brad Thaler at (703) 842-2204.

Sincerely,

B. Dan Berger
President and CEO
National Association of Federal
Credit Unions
Arlington, VA
cc:
Members of the House Ways and Means Committee



Bond Lawyers Request Meeting With Treasury to Discuss Proposed Issue Price Definition.

Allen Robertson of the National Association of Bond Lawyers has requested a meeting with Treasury and the IRS to discuss the definition of issue price and other aspects of proposed regulations (REG-148659-07) on arbitrage investment restrictions applicable to tax-exempt bonds.

March 7, 2014

Vicky Tsilas
Associate Tax Legislative Counsel
Office of the Tax Legislative Counsel
Department of the Treasury
1500 Pennsylvania Avenue, NW Room 3044
Washington DC 20220

James Polfer
Branch V Chief, Financial Institutions and Products
Internal Revenue Service
1111 Constitution Ave NW
Washington, DC 20224-0001

Dear Ms. Tsilas and Mr. Polfer:
As you know, NABL submitted comments on the proposed arbitrage regulations published in the Federal Register on September 16, 2013 and testified at the hearing held on February 5, 2014. NABL actually submitted two sets of comments to the proposed regulations. One set commented on the proposed changes to the definition of issue price and the other set commented on the other aspects of the proposed regulations. The division of our comments reflects our view that the definition of issue price is of critical importance.

In light of the importance of the definition of issue price, I would like to offer to meet with you and other staff at the Department of the Treasury and the Internal Revenue Service at your convenience to discuss our comments further or to discuss any other aspect of the proposed regulations. I would bring with me a small group of NABL members who worked on our comments.

If NABL can provide further assistance, please do not hesitate to contact Bill Daly in our Washington, D.C. office at (202) 503-3300 or [email protected].

Sincerely,

Allen K. Robertson



IRS LTR: State Law Precludes Charitable Contribution Deductions for Easements, Tax Court Holds.

Citations: Patrick J. Wachter et ux. et al. v. Commissioner; 142 T.C. No. 7; Nos. 9213-11, 9219-11

The Tax Court held that two couples weren’t entitled to charitable contribution deductions for the bargain sale of easements, finding that the easements weren’t qualified real property interests because a state law that restricted easements to 99 years prevented the granting of the easements in perpetuity as required under section 170(h).
Two related couples, Patrick and Louise Wachter and Michael and Kelly Wachter, claimed on their joint returns charitable contribution deductions for cash donations and the bargain sale of easements by partnerships in which they held interests. The IRS disallowed the deductions and determined deficiencies against them. The couples petitioned the Tax Court for redeterminations, and their cases were consolidated. The IRS sought partial summary judgment on the question of whether a North Dakota state law that limited the duration of easements to 99 years prevented the couple from claiming the deductions for the easements. The IRS also sought partial summary judgment regarding whether the couples met contemporaneous written acknowledgment requirements for the cash donations.

Judge Ronald L. Buch, writing for the Tax Court, agreed with the IRS that the state law precluded the couple’s claims regarding the easement donations. Section 170(h)(2)(C) states that a qualified real property interest must include a restriction granted in perpetuity. The court found that since North Dakota law limited the term of easements to a maximum of 99 years, the conservation easements were not granted in perpetuity and did not meet the requirements for deductibility. Buch rejected the couples’ claim that the possibility of reversion of the property interest to them, the partnership, or their successors in interest was so remote that it did not prevent the easements from being perpetual. The court found that the possibility of reversion was not remote because the state law made it inevitable that the property would revert back to them, and it granted the IRS partial summary judgment on the issue.

However, the Tax Court denied summary judgment regarding the cash charitable contribution deductions. Buch found that issues of material fact remained in dispute regarding whether the couples could meet the contemporaneous written acknowledgment requirement for the donations and whether they expected or received any benefit in exchange for the donations.

 

PATRICK J. WACHTER AND LOUISE M. WACHTER,
Petitioners
v.
COMMISSIONER OF INTERNAL REVENUE,
Respondent
UNITED STATES TAX COURT

Filed March 11, 2014

For 2004 through 2006 Ps reported charitable contributions that flowed to them from a partnership and an LLC, both of which were treated as partnerships for tax purposes. For each year the LLC reported charitable contributions of cash and the partnership reported bargain sales of conservation easements as charitable contributions of property. R issued notices of deficiency to Ps disallowing all of the charitable contribution deductions and determining accuracy-related penalties. R filed a motion for partial summary judgment asserting that Ps did not satisfy the “contemporaneous written acknowledgment” requirement for the cash contributions. For the property contributions, respondent asserted that the easements were not granted in perpetuity as a result of a North Dakota State law that limits the duration of a real property easement.
Held: North Dakota State law limits the duration of an easement to not more than 99 years, thus precluding a North Dakota conservation easement from qualifying as granted “in perpetuity” under I.R.C. sec. 170(h)(2)(C) and (5)(A).

Held, further, material facts remain in dispute regarding whether Ps satisfied the “contemporaneous written acknowledgment” requirement of I.R.C. sec. 170(f)(8) and sec. 1.170A-13(f)(15), Income Tax Regs., and thus summary judgment is not appropriate on this issue.
Jon J. Jensen, for petitioners.
David L. Zoss and Christina L. Cook, for respondent.

BUCH, Judge: These cases are before the Court on respondent’s motion for partial summary judgment. The issues for decision are:

(1) whether a State law that limits the duration of an easement to not more than 99 years precludes petitioners’ conservation easements from qualifying as granted “in perpetuity” under section 170(h)(2)(C) or (5)(A).1 We hold that it does; and

(2) whether the documents petitioners provided to the IRS satisfy the “contemporaneous written acknowledgment” requirement of section 170(f)(8) and section 1.170A-13(f)(15), Income Tax Regs. We hold that material facts remain in dispute and thus summary judgment is not appropriate for this issue.
FINDINGS OF FACT

The transactions at issue involve members of the Wachter family and entities that they controlled. Michael and Kelly Wachter filed joint income tax returns for all the years in issue: 2004 through 2006. The same is true for Patrick and Louise Wachter. During the years in issue, Michael, Patrick, and Louise each held varying interests in two entities: WW Ranch, a partnership, and Wind River Properties LLC (Wind River), a limited liability company that is treated as a partnership for tax purposes. Wind River at times operated under the name Windsor Storage. For convenience, we will refer to the petitioners individually by their given names or to Michael, Patrick, and Louise (as owners of WW Ranch and Wind River) collectively as the Wachters.
Farm and Ranch Lands Protection Program

Section 2503 of the Farm Security and Rural Investment Act of 2002, Pub. L. No. 107-171, 116 Stat. at 267, authorized the Secretary of Agriculture to purchase conservation easements in order to protect topsoil by limiting nonagricultural uses of certain lands and authorized funding for such purchases. The United States, acting through the Commodity Credit Corporation (CCC), entered into cooperative agreements in order to implement the Farm and Ranch Lands Protection Program and used the Natural Resources Conservation Service (NRCS) of the Department of Agriculture to administer the program. The parties provided to the Court a copy of a 2003 cooperative agreement between the CCC and the American Foundation for Wildlife (AFW) with an attachment referencing land owned by WW Ranch. The cooperative agreement listed the requirements for such an easement, including that the easement “[r]un with the land in perpetuity or a minimum of thirty years, where State law prohibits a permanent easement.” As a part of the cooperative agreement, the NRCS listed its prerequisites for easement purchases before the Federal Government would release the Federal funds to reimburse AFW for up to 50% of the easement purchase price. The cooperative agreement included a provision whereby a landowner could donate up to 25% of the appraised fair market value of the easement and that such a donation may be considered as part of AFW’s contribution to the purchase price. However, in order for the landowner’s donation to be considered part of AFW’s contribution, AFW was required to get a current appraisal of the contribution. In the event the landowner made such a donation, NRCS required a copy of the landowner’s IRS Form 8283, Noncash Charitable Contributions, before the NRCS would release the federal funds.

Cash Contributions

On its returns for the years in issue, Wind River reported the following cash charitable contributions, which it allocated amongst its members:

2004 $170,000
2005 171,150
2006 144,500

On behalf of Wind River, Michael and Patrick signed an agreement dated February 26, 2004, with North Dakota Natural Resource Trust (NRT) agreeing to donate $170,000 by March 1, 2004. Michael signed a check dated February 26, 2004, from Windsor Storage payable to NRT for $170,000. NRT provided a letter dated March 23, 2004, to Michael and Patrick “dba WW Ranch” acknowledging the cash gift and stating that NRT provided no goods or services in exchange for the donation.

Michael signed a check dated March 23, 2005, from Windsor Storage payable to NRT for $171,150. The Wachters provided the IRS with a letter from NRT dated March 21, 2005, to Windsor Storage acknowledging the cash gift and stating that NRT provided no goods or services in exchange for the donation. The only copy of this letter in the record is unsigned.

Someone prepared a check dated May 9, 2006, from Windsor Storage payable to NRT for $144,500. The only copy of this check in the record is unsigned, but the parties do not appear to dispute that the payment was made. NRT provided a letter dated May 10, 2006, to Windsor Storage acknowledging the cash gift and stating that NRT provided no goods or services in exchange for the donation.

Bargain Sale Charitable Contributions

On its partnership returns for the years in issue, WW Ranch reported bargain sales of conservation easements as charitable contributions as follows:

2004 $349,000
2005 247,550
2006 162,500

For each year, the parties to the transaction obtained two appraisals of the property that was to be contributed. Each appraisal valued the property according to a different land use, and the Wachters used the difference in appraised values to determine the value of the conservation easement and thus the amounts of their charitable contributions.

NRT obtained an appraisal of WW Ranch’s sections 5 and 6 parcel2 as of April 30, 2003, determining a value of $31,000 for use as agricultural property. A second appraisal dated May 14, 2003, was prepared for the sections 5 and 6 parcel, determining a value of $1,400,000 for use as “rural residential sites”. On March 8, 2004, WW Ranch sold a conservation easement on its sections 5 and 6 parcel to AFW for $1,020,000 (of which $170,000 was supplied by NRT). The Wachters subtracted the sale price of $1,020,000 from the difference in value of the two appraisals of $1,369,000 to arrive at their charitable contribution deduction of $349,000.

NRT obtained two appraisals of WW Ranch’s section 8 parcel as of February 21, 2005, one for use as agricultural property determining a value of $10,000 and one for “full developmental value” determining a value of $915,000. On March 24, 2005, WW Ranch sold a conservation easement on the section 8 parcel to AFW for $657,450 (of which $171,150 was supplied by NRT). The Wachters subtracted the sale price of $657,450 from the difference in value of the two appraisals of $905,000 to arrive at their charitable contribution deduction of $247,550.

NRT obtained two appraisals of WW Ranch’s sections 16 and 18 parcels as of August 25, 2005, one subject to a proposed conservation easement determining a value of $46,000 and one for rural residential development determining a value of $696,000. On May 11, 2006, WW Ranch sold a conservation easement on its section 16 and 18 parcels to AFW for $487,500 (of which $144,500 was supplied by NRT). The Wachters subtracted the sale price of $487,500 from the difference in value of the two appraisals of $650,000 to arrive at their charitable contribution deduction of $162,500.

Individual Reporting

Patrick and Louise reported charitable contributions on their joint Federal income tax returns as follows:

2004 Cash — Wind River $85,000
Noncash — WW Ranch 174,500

2005 Cash 85,575
Noncash 123,775

2006 Cash 72,250
Noncash 81,250

Michael and Kelly reported charitable contributions on their joint Federal income tax returns as follows:

2004 Cash — Wind River $85,000
Noncash — WW Ranch 174,500

2005 Cash 85,575
Noncash 123,775

2006 Cash 72,250
Noncash 81,250

On April 8, 2011, respondent issued notices of deficiency to both couples disallowing the charitable contribution deductions related to WW Ranch and Wind River and determining accuracy-related penalties under section 6662. Each couple timely filed a petition disputing their notice of deficiency, and the Court consolidated the cases for trial, briefing, and opinion. Respondent filed a motion for partial summary judgment and a memorandum of facts and law in support of his motion for partial summary judgment, the Wachters filed a response, and respondent filed a reply.

OPINION

Either party may move for summary judgment regarding all or any part of the legal issues in controversy. See Rule 121(a). We may grant summary judgment only if there are no genuine disputes of fact. See Rule 121(b); Naftel v. Commissioner, 85 T.C. 527, 529 (1985). Respondent, as the moving party, bears the burden of proving that no genuine dispute exists as to any material fact and that respondent is entitled to judgment as a matter of law. See Sundstrand Corp. v. Commissioner, 98 T.C. 518, 520 (1992), aff’d, 17 F.3d 965 (7th Cir. 1994). In deciding whether to grant summary judgment, the factual materials and the inferences drawn from them must be considered in the light most favorable to the nonmoving party. See FPL Grp., Inc. v. Commissioner, 115 T.C. 554, 559 (2000); Bond v. Commissioner, 100 T.C. 32, 36 (1993); Naftel v. Commissioner, 85 T.C. at 529. When a motion for summary judgment is made and properly supported, the nonmoving party may not rest on mere allegations or denials but must set forth specific facts showing that there is a genuine dispute for trial. See Celotex Corp. v. Catrett, 477 U.S. 317, 324 (1986); Sundstrand Corp. v. Commissioner, 98 T.C. at 520; see also Rule 121(d). Respondent filed the motion for partial summary judgment; therefore we construe all factual disputes and draw all inferences in favor of the Wachters.
A deduction is allowed for any charitable contribution for which payment is made within the taxable year if the contribution is verified under regulations prescribed by the Secretary. Sec. 170(a)(1). The Wachters claimed charitable contribution deductions for both cash and noncash contributions for each year. We discuss each in turn.

Noncash Contributions

Generally, a charitable contribution deduction is not allowed for a charitable gift of property consisting of less than the donor’s entire interest in that property. Sec. 170(f)(3)(A). However, there is an exception for a “qualified conservation contribution.” Sec. 170(f)(3)(B)(iii). A contribution of real property is a qualified conservation contribution if (1) the real property is a “qualified real property interest”, (2) the contributee is a “qualified organization”, and (3) the contribution is “exclusively for conservation purposes.” Sec. 170(h)(1); see also sec. 1.170A1-4(a), Income Tax Regs. For the purposes of the motion for partial summary judgment, respondent argues that the State law restricting easements to 99 years prevents the conservation easements from being qualified real property interests and prevents the conservation easements from being exclusively for conservation purposes.

North Dakota Law

We look to State law to determine the nature of property rights, whereas Federal law determines the appropriate tax treatment of those rights. United States v. Nat’l Bank of Commerce, 472 U.S. 713, 722 (1985); see also 61 York Acquisition, LLC v. Commissioner, T.C. Memo. 2013-266, at *8.

Beginning in 1915, the United States signed several treaties agreeing to protect migratory birds and their habitats. See North Dakota v. United States, 460 U.S. 300, 309-310 n.12 (1983), aff’g 650 F.2d 911 (8th Cir. 1981). Between 1931 and 1977 the United States acquired easements covering nearly 1 million acres of land in North Dakota for use as migratory bird refuges. Id. at 304-305. However, cooperation between the Federal Government and the State of North Dakota broke down such that in 1977 the State enacted a law, which it amended in 1979 and 1981, (1) requiring approval for all wetland acquisitions first by the board of county commissioners and only then by the governor, (2) allowing the landowner to negotiate the terms of the easement and “drain any after expanded wetland or water area in excess of the legal description”, and (3) restricting all easements to a maximum of 99 years. Id. at 306-308 (quoting N.D. Cent. Code sec. 20.1-02-18.2 (1981)).

The United States brought a declaratory judgment action in the U.S. District Court for the District of North Dakota, seeking judgment that, inter alia, the State law was hostile to Federal law in certain respects and could not be applied. Id. at 309. The District Court granted the United States summary judgment, and the United States Court of Appeals for the Eighth Circuit affirmed. Id. at 309. The Supreme Court determined that because of the migratory bird treaties and the “‘certainty and finality’ that we have regarded as ‘critical when * * * federal officials carrying out the mandate of Congress irrevocably commit scarce funds'”, the North Dakota statute was hostile to Federal interests and may not be applied to the easements for which the Federal Government had already received consent. Id. at 320 (quoting United States v. Little Lake Misere, 412 U.S. 580, 596 (1973)).

The Supreme Court in North Dakota v. United States invalidated the 99-year restriction only insofar as it related to easements on wetlands for which the Federal Government had already received consent. The Supreme Court did not invalidate the 99-year restriction in all situations in which the Federal Government is a party, directly or indirectly, to an easement purchase.

For the years in issue, N. D. Cent. Code sec. 47-05-02.1 (1999 & Supp. 2013) provided in pertinent part:
Real property easements * * * which become binding after July 1, 1977, shall be subject to the requirements of this section. These requirements are deemed a part of any agreement for such interests in real property whether or not printed in a document of agreement.
* * * * * * *

2. The duration of the easement * * * on the use of real property must be specifically set out, and in no case may the duration of any interest in real property regulated by this section exceed ninety-nine years. * * *

Both parties allege that the State law at issue here is unique because this is the only State that has a law that provides for a maximum duration that may not be overcome by agreement. The parties agree that, by operation of State law, the easements at issue will expire 99 years after they were conveyed. The parties do not draw a distinction where the donee of the easement is the Federal Government or an entity acting on behalf of the Federal Government. Nor do we see a distinction.
Respondent asserts that the State law restriction prevents the easements from being granted in perpetuity, which in turn prevents them from being both qualified real property interests under section 170(h)(2) and contributions exclusively for conservation purposes under section 170(h)(5). Petitioners, however, assert that the 99-year limitation should be considered the equivalent of a remote future event or the retention of a negligible interest because at present the remainder is “essentially valueless.” There are two separate and distinct perpetuity requirements, and the failure to satisfy either of them will prevent the easements from being qualified conservation contributions. See Belk v. Commissioner, 140 T.C. 1, 12 (2013).

Qualified Real Property Interest

Under section 170(h)(2)(C), a qualified real property interest means “a restriction (granted in perpetuity) on the use which may be made of the real property.” The Wachters assert that the possibility that the land would revert back to them, WW Ranch, or their successors in interest is the equivalent of a remote future event that will not prevent the easements from being perpetual. Section 1.170A-14(g)(3), Income Tax Regs., provides:
(3) Remote future event. — A deduction shall not be disallowed under section 170(f)(3)(B)(iii) and this section merely because the interest which passes to, or is vested in, the donee organization may be defeated by the performance of some act or the happening of some event, if on the date of the gift it appears that the possibility that such act or event will occur is so remote as to be negligible. * * *

This Court has construed “so remote as to be negligible” as “‘a chance which persons generally would disregard as so highly improbable that it might be ignored with reasonable safety in undertaking a serious business transaction'”, 885 Inv. Co. v. Commissioner, 95 T.C. 156, 161 (1990) (quoting United States v. Dean, 224 F.2d 26, 29 (1st Cir. 1955)), or “‘a chance which every dictate of reason would justify an intelligent person in disregarding as so highly improbable and remote as to be lacking in reason and substance'”, Graev v. Commissioner, 140 T.C. __, __ (slip op. at 27-28) (June 24, 2013) (quoting Briggs v. Commissioner, 72 T.C. 646, 657 (1979), aff’d without published opinion, 665 F.2d 1051 (9th Cir. 1981)). “[A] conservation easement fails to be ‘in perpetuity’ * * * if, on the date of the donation, the possibility that the charity may be divested of its interest in the easement is not so remote as to be negligible.” Id. at __ (slip op. at 27).
“Remote” has various commonly accepted meanings. For example, remote can mean “far distant in space”, “secluded”, “distant in time”, “distant in relationship”, or “slight or faint; unlikely”. Webster’s New Universal Unabridged Dictionary 1630 (2d ed. 2003). As is relevant here, “remote” could refer to a temporal sense (distant, remote in time) or in a probable sense (unlikely, a remote possibility). Id.; see also The American Heritage Dictionary of the English Language 1476 (4th ed. 2000). Both the regulation and our caselaw focus on the term “remote” in terms of likelihood.

As used in the regulation and as interpreted by our caselaw, the event is not remote. On the dates of the donations it was not only possible, it was inevitable that AFW would be divested of its interests in the easements by operation of North Dakota law. Therefore, the easements were not restrictions granted in perpetuity and were thus not qualified conservation contributions.3 As a result, we will grant respondent’s motion for partial summary judgment insofar as the State law prevents a charitable contribution deduction for a conservation easement conveyed under the State law.4

Cash Contributions

For any cash charitable contribution of $250 or more, the taxpayer must obtain a contemporaneous written acknowledgment from the donee. Sec. 170(f)(8)(A). Section 170(f)(8)(B) provides that the contemporaneous written acknowledgment must include the following:
(B) Content of acknowledgment. — An acknowledgment meets the requirements of this subparagraph if it includes the following information:

(i) The amount of cash and a description (but not value) of any property other than cash contributed.
(ii) Whether the donee organization provided any goods or services in consideration, in whole or in part, for any property described in clause (i).

(iii) A description and good faith estimate of the value of any goods or services referred to in clause (ii) or, if such goods or services consist solely of intangible religious benefits, a statement to that effect.

Section 170(f)(8)(C) provides that a written acknowledgment is contemporaneous when the taxpayer obtains it on or before the earlier of: (1) the date the taxpayer files a return for the taxable year of contribution or (2) the due date, including extensions, for filing that return.
Respondent asserts that none of the letters the Wachters provided to the IRS constitutes a valid contemporaneous written acknowledgment. Respondent asserts (1) that none of the letters was addressed to Wind River, the entity that made the cash contributions, (2) NRT provided goods or services to the Wachters each year that were not mentioned in the letters,5 and (3) the values of the goods or services were not mentioned in the letters. Further, respondent asserts the 2005 letter fails to qualify as a contemporaneous written acknowledgment because the letter is unsigned and it predates the check by two days.6

With respect to the assertion that the Wachters received some benefit that was not disclosed or valued in the letters, respondent has not proven on this record that the Wachters expected or received a benefit in exchange for their cash donations. If a taxpayer receives or expects to receive a benefit that is not disclosed in the contemporaneous written acknowledgment, the entire cash contribution deduction is disallowed. See Addis v. Commissioner, 118 T.C. 528 (2002), aff’d, 374 F.3d 881 (9th Cir. 2004); see also Viralam v. Commissioner, 136 T.C. 151, 170-171 (2011); Averyt v. Commissioner, T.C. Memo. 2012-198. Because the receipt of an expected or actual benefit is a material fact that remains in dispute, summary judgment is not proper on this issue.

The Wachters assert that the checks and letters for each year as well as the 2004 agreement can be taken together to meet the requirements of a contemporaneous written acknowledgment. In Irby v. Commissioner, 139 T.C. 371, 389 (2012), the Court held that a series of documents may constitute a contemporaneous written acknowledgment, and the Wachters may yet be able to authenticate disputed documents and provide additional documents to supplement those they have included with the stipulation of facts. Because we must construe all factual inferences in favor of the nonmoving party, we must deny summary judgment regarding the cash charitable contribution deductions.
CONCLUSION

We conclude that respondent is entitled to partial summary judgment disallowing the charitable contribution deductions for the bargain sales of the conservation easements because North Dakota law prohibits real property easements from being granted in perpetuity. Thus a conservation easement conveyed subject to the statute cannot result in a charitable contribution deduction under section 170(f)(3)(B)(iii). However, because material facts remain in dispute as to whether the Wachters expected to receive or actually received goods or services in exchange for their cash contributions and the Wachters may yet be able to supplement the record to meet all of the requirements of a contemporaneous written acknowledgment, we will deny the motion for partial summary judgment on the issue of the cash contributions.
To reflect the foregoing,

An appropriate order will be issued.
FOOTNOTES

1 Unless otherwise indicated, all section references are to the Internal Revenue Code (Code) in effect for the years in issue, and all Rule references are to the Tax Court Rules of Practice and Procedure.
2 Each parcel at issue is located in one or more sections of Township 140 North, Range 81 West of Morton County, North Dakota. The parties refer to the properties at issue as the “sections 5 and 6 parcel”, the “section 8 parcel”, and the “sections 16 and 18 parcels”, and we adopt their terminology.

3 We note that, in isolated situations, a long-term lease may be treated as the equivalent of a fee simple interest. See, e.g., secs. 1.1031(a)-1(c), 1.1033(g)-1(b)(4), Income Tax Regs. But unlike section 170(h)(2)(C), those isolated situations address exchanges for “like” or “similar” property and do not involve an express statutory requirement that an interest be “in perpetuity”.

4 We express no opinion on petitioners’ argument that at present the remainder is essentially valueless; to do so would require that we resolve a question of fact regarding value.

5 At minimum, respondent asserts that the goods or services provided were the appraisals NRT obtained and the partial funding it supplied for the bargain sales.

6 Respondent also contests the authenticity of this document.



IRS Formalizes Decision to Stop Using Labor Department Forms for Parts of Exempt Org Returns.

The IRS has revoked (Rev. Proc. 2014-22, 2014-11 IRB 646) a 1979 revenue procedure (Rev. Proc. 79-6) that provided for the use of some Labor Department forms in the place of some portions of the Form 990 exempt organization annual information return.

The use of these Labor Department forms is no longer appropriate, and the Form 990 and instructions were revised for tax years beginning in 2008 to no longer permit their use, the IRS stated.

Citations: Rev. Proc. 2014-22; 2014-11 IRB 646
26 CFR 601.602: Tax Forms and instructions.

(Also part I, section 6033; 1.6033-2)

Revenue Procedure 79-6, 1979-1 C.B. 485, provided for the use of certain United States Department of Labor forms in place of certain portions of the Form 990, Return of Organization Exempt from Income Tax. The Internal Revenue Service determined that the use of these Department of Labor forms is no longer appropriate, and the Form 990 and Instructions were revised for tax years beginning in 2008 to no longer permit their use. Requiring uniform filing of financial data of all exempt organizations improves transparency by making it easier for the public and the IRS to compare the financial data of organizations. In addition, requiring organizations that must e-file to provide financial information electronically, rather than in a separate attachment, improves tax administration. Accordingly, Revenue Procedure 79-6 is hereby revoked.

DRAFTING INFORMATION

The principal author of this revenue procedure is Melinda Williams of the Exempt Organizations, Tax Exempt and Government Entities Division. For further information regarding this ruling, contact Ms. Williams at 202-317-8532 (not a toll free Number).



BDA: Chairman Camp's Tax Reform Draft - Analysis of Bond Provisions and Politics.

We wanted to provide an overview prepared for BDA by Urban, Swirski & Associates of the politics and next steps surrounding the release last week of Ways and Means Committee Chairman Dave Camp’s tax reform proposal.  Note that the proposal is simply a “draft,” and not a bill, and is not expected to be considered for passage by the Ways and Means Committee at this time.  However, any of the items within the proposal could appear in future tax legislation or proposals designed to raise revenue for either spending cuts or to balance the budget.

Also, the following is a revised summary of the proposal that provides a few additional details regarding the bill’s provisions that would affect municipal bonds:

New Surtax for High Earners Includes Tax Exempt Bond Interest

Essentially, a 10 percent “surtax” on municipal bonds.  Create new 10 and 25 percent individual tax brackets, plus a 10 percent “surtax” on top of the 25 percent tax bracket that applies to a modified adjusted gross income (MAGI) above $400,000 for singles and $450,000 for married couples that would, among other deductions and exemptions, apply to interest on tax exempt bonds – both new issues and outstanding bonds.

Treatment of Deductible Interest Expense and Tax-Exempt Interest Income

The proposal repeals the special treatment for bank-qualified bonds, eliminating tax relief needed for banks to be able to, economically, purchase tax-exempt bonds from small issuers.  This provision could create challenges for BDA’s effort to raise from $10 million to $30 million issuance dollar limits that can qualify as bank-qualified bonds.

Related provisions establish somewhat less flexible tax rules for corporate investors in tax-exempt bonds than those applicable under current law.  Corporations would now be included in rules that currently apply to financial institutions and dealers in tax-exempt obligations.  These rules disallow an interest deduction for investment interest based upon the percentage of the taxpayer’s assets comprised of tax-exempt obligations.  Moreover, for individual investors in tax-exempt bonds, the proposal would permanently reduce any deductions for investment-interest by the amount of tax-exempt interest received.

Repeal of Interest Exclusions for Tax-Preferred Bonds and Advance Refundings

Repeal the interest exclusion for future issuances of private activity bonds.

Repeal the interest exclusion for future issuances of advance refunding bonds.

Generally repeal tax credit bond programs, such as Qualified Zone Academy Bond, Clean Renewable Energy Bond and other programs.  Bondholders and issuers would continue receiving tax credits and payments for tax credit bonds already issued, but no new bonds could be issued (this particularly would affect QZABs as other tax credit bond programs are generally already cancelled).

Repeal the exclusion for interest on United States savings bonds used to pay qualified higher education expenses.

Modify the Tax Treatment of “Market Discount” and Bond Premium

Similar to prior Ways and Means proposals and last year’s Administration buget, the proposal would require purchasers of bonds at a discount on the secondary market to include the discount in taxable income over the post-purchase life of the bond, rather than only upon retirement of the bond or resale of the bond by the purchaser.  Any loss that results from the retirement or resale of such a bond would be treated as an ordinary (rather than capital) loss to the extent of previously accrued market discount. The provision would limit taxable secondary market discount to an amount that approximates increases in interest rates since the loan was originally made: the greater of (1) the original yield on the bond plus 5 percentage points, or (2) the applicable Federal rate plus 10 percentage points.

Modify bond premium amortization deductions to be allowed as above-the-line deductions (without regard to whether a taxpayer itemizes deductions); this is primarily a conforming change given the new tax regime established by the bill.

Repeal Tax-Favored Treatment for Specialized Local Infrastructure Programs

Repeal the 4% Low Income Housing Tax Credit and make a variety of changes to the program — beyond the private activity bond repeal.

Repeal a number of expired programs, underscoring the Chairman’s apparent desire to update the Code and also prevent extension or expansion of the programs, including:

Enterprise Communities and Empowerment Zones and the associated special tax benefits (including access to expanded tax-exempt bond eligility and QZABs).

Liberty Zone and GO Zone designations and the associated special tax benefits (including access to QZABs).

DC Zone tax benefits (including access to expanded tax-exempt bond eligibility and QZABs).

Favorable tax treatment for renewal communities, including access to QZABs.

Conclusion

The changes in treatment of bonds should be viewed in the context of other provisions overhauling the tax code and affecting the financial services sector, taxpayers and investors, including favorable treatment for capital gains and dividends, taxing those provisions as ordinary income with 40 percent excluded from taxation; and, a highly controversial quarterly tax of 3.5 basis points on banks and insurance companies with over $500 billion in assets.  In addition, state and local governments will be pulled in many directions given the multitude of provisions that affect them in the draft – not the least of which is the repeal of the state and local tax deduction.



Airport Operators Worry Tax Overhaul Would Ground Improvement Plans.

Local Governments Fear Plan to Tax Bond Interest Threatens Road Funding

In addition to worrying road builders, state highway officials and transit agencies, House Ways and Means Chairman Dave Camp’s tax overhaul plan has struck a nerve with airport operators.

The Airports Council International – North America is lobbying against Camp’s proposal to end the tax exemption for interest earned on private-activity bonds, which are a popular tool for funding such projects as airport terminal upgrades. Private activity bonds allow tax-exempt municipal bonds to be sold to finance projects by private businesses. They are frequently used in public-private partnerships .

Kevin M. Burke, the airports council’s president and CEO, said ending the tax exemption for private activity bonds “creates a major disincentive for airports seeking to secure cost-effective funding for necessary capital improvement and infrastructure projects.”

“As municipal issuers of private activity bonds, it is incredibly disappointing to our airport members that the House Ways and Means Committee effectively seeks to make this source of funding unnecessarily expensive and likely prohibitive in the long run,” Burke said.

U.S. airports face growing competition from modern overseas airports for lucrative international traffic. Airport operators were already concerned about a law last year (PL 113-9) that redirected funds from the Airport Improvement Program to avoid air-traffic-controller furloughs (PL 113-9) stemming from the budget sequester. President Barack Obama described that action as “earning our seed corn.”

Burke said U.S. airports face $71 billion in capital needs over the next five years, much of which will be financed with municipal bonds.

“Given that we already have limited ability locally to raise funding, we cannot afford the higher interest rates that would result from such drastic changes to the municipal bond market,” Burke said.

By Nathan Hurst

Roll Call Staff

March 4, 2014, 3:05 p.m.

[email protected] | @nathanhurst



Obama Again Proposes 28% Cap, AFF Bonds in Fiscal 2015 Budget.

WASHINGTON — President’s Obama $3.9 trillion fiscal 2015 budget, released Tuesday, proposed capping the value of the tax exemption for municipal bond interest at 28%, which market participants complain would amount to an unprecedented tax on municipal bonds.

The 28% cap, which he has offered in previous budgets, is similar to the 25% cap on the value of the muni exemption proposed by Rep. Dave Camp, R-Mich., in his draft tax reform legislation last week.

The proposal drew disappointment from market participants. “I think something is being lost here,” said Susan Collet, senior vice president of government relations for the Bond Dealers of America. “These tax-exempt bonds are standing behind public infrastructure we can all feel good about.”

“Municipal bonds play a key role in funding state and local infrastructure projects like hospitals and schools, which are essential to creating jobs and growing our economy,” said Michael Decker managing director and co-head of municipal securities for the Securities Industry and Financial Markets Association. “Taxing municipal bonds is counter-productive to the goal of economic growth, as the tax could raise capital costs for state and local governments and discourage investment in job-creating infrastructure projects.”

While neither Obama’s budget nor Camp’s tax-reform draft plan are likely to be enacted this year, market participants are troubled by the similar treatment of the muni exemption in the proposals.

The muni exemption is “out there as a target” for tax reform, said Utah Treasurer Richard Ellis, who is president of the National Association of State Treasurers.

“This will be a continuing issue for years to come,” said Chuck Samuels, an attorney at Mintz Levin and counsel to the National Association of Health & Higher Education Facilities Authorities.

The president’s budget also would in put in place the so-called Buffett Rule, requiring high-income households to pay at least 30% of their income, after charitable giving, in taxes.

Obama also re-proposed an America Fast Forward Bond program, which would build on the Build America Bond program. AFF bonds would be direct-pay bonds with a 28% subsidy rate that could be used for the same kinds of projects financed by BABs but also for projects that could be financed with qualified private activity bonds.

“The president’s America Fast Forward Bonds program might be an option for attracting private investment in infrastructure,” said Large Public Power Council Chairman Bill Gaines in a statement. “However, it should not be a replacement for the stable and mature municipal bond market.”

Ellis said that the 28% subsidy rate for AFF bonds as opposed to the higher 35% subsidy rate for BABs could make AFF bonds less attractive for issuers.

The budget would shield AFF bond subsidy payments from sequestration cuts, but does not seem to do the same for payments for outstanding BABs.

Bill Daly, director of governmental affairs for the National Association of Bond Lawyers, said that he thinks the Obama administration recognized that if it wants issuers to accept direct-pay bonds, they had to address the sequestration issue. It is “unfortunate” the budget did not address sequestration for BAB payments, he said.

Obama’s proposed budget would boost private investment in infrastructure through a Rebuild America Partnership, establishing an independent National Infrastructure Bank to leverage private and public capital to support infrastructure projects of national and regional significance.

Camp was critical of Obama’s budget, saying it “adds more complexity to the tax code and increases taxes for more Washington spending.”

While Camp’s proposal would end the tax-exemption for private activity bonds after 2014, Obama’s budget eases several current restrictions for PABs. The president would eliminate state volume caps for PABs used for water furnishing and sewage facilities. “These bonds are intended to complement Environmental Protection Agency and local efforts to finance water quality improvement projects in the United States,” Treasury Department officials said in their green book explanation of the president’s tax proposals.

Obama would also allow tax-exempt PABs to be issued to finance airports, docks, wharves and mass commuting facilities even if they are not owned by a governmental unit. “The administration has consistently emphasized the importance of infrastructure investment and the role that private capital can play in enhancing such investment,” Treasury officials said.

The president’s budget would except tax-exempt private activity bonds used for research facilities from the more than 10% private use restriction as long as they were owned by a state, locality or nonprofit entity and the issuer is permitted to enter into a bona fide arm’s length contractual arrangement with a private business sponsor of the research for sharing the economic benefits from any resulting products. Under current tax law PABs are not “qualified” and therefore tax-exempt if more than 10% of the proceeds are for private use and more than 10% of the debt service is paid or secured by private business or property and they do not fall into one of several specific categories.

Obama would also repeal the five percent unrelated or disproportionate private business test use test to simplify the private business limits on tax-exempt PABs. Under current law, the 10% business use test is reduced to 5% if the private use is unrelated or disproportionate to the governmental use of a project. Treasury officials said in the green book that this test “requires difficult factual determinations regarding the relationship of private business use to governmental use in financed projects” and is “difficult to apply, particularly in governmental bond issues that finance multiple projects.”

Obama also would increase to 35% from 25% the land acquisition restriction on certain PABs. Current law generally restricts bonds from being tax-exempt PABs if it is part of an issue where 25% or more of the net proceeds are to be used for the acquisition of land. Treasury officials said the 25% restriction must be eased because land costs have increased steadily over the years.

In addition, the president would repeal to $150 million limit on the volume of outstanding, non-hospital tax-exempt 501(c)(3) bonds. This restriction was created by the 1986 Tax Reform Act but repealed in 1997 with respect to bonds issued after Aug. 5, 1997, if at least 95% of the net proceeds were used to finance capital expenditures incurred after that date. As a result, the limitation continues to apply to bonds where more than five percent of the net proceeds are used to finance or refinance working capital or capital expenditures incurred on or before Aug. 5, 1997. “Repealing the limitation would enable nonprofit universities to utilize tax-exempt financing on a basis comparable to public universities,” Treasury officials said in the green book.

Obama would repeal the purchase price and refinancing limitations on single-family mortgage revenue bonds. Under current law these bonds can only be used when a mortgagor’s income is generally not more than 115% of applicable median family income. The limit is higher in certain high-cost areas. Treasury officials said these targeting requirements “are complex and excessive” and the restriction against refinancing “limits the availability of this lower cost borrowing subsidy as a tool to address needs for affordable mortgage loan refinancing within a needy class of existing low- and moderate-income homeowners.”

The budget would put Indian tribal governments on a par with state and local governments and eliminate the restriction that tribal bonds only be used for projects with an “essential government function.” Tribal governments could issue private-activity bonds under volume caps.

The community development block grant program would receive $2.8 billion in budget authority, which is $230 million less than the enacted level for the current fiscal year. But the budget also proposes reforms designed to improve the program’s performance.

The budget proposes $1.8 billion for the clean and drinking water state revolving loan funds, which is $581 million below the enacted level for fiscal 2014. The reduction was proposed to focus on communities that most need assistance.

BY NAOMI JAGODA

MAR 4, 2014 5:02pm ET

Lynn Hume and Kyle Glazier contributed to this story.



Delay of Withholding Tax on Equity-Linked Instruments Pleases Practitioners.

The section 871(m) withholding tax will not apply to equity-linked securities (ELIs) until 90 days after the proposed regulations are finalized, the IRS announced March 4. Practitioners welcomed the last-minute change from the original March 5 application date.

The section 871(m) withholding tax will not apply to equity-linked securities (ELIs) until 90 days after the proposed regulations are finalized, the IRS announced March 4. Practitioners welcomed the last-minute change from the original March 5 application date.

Responding to taxpayer concerns about uncertainty surrounding the proposed section 871(m) specified ELI rules (REG-120282-10  ), Treasury issued Notice 2014-14, 2014-13 IRB 1 , that amends prop. reg. section 1.871-15(e) to limit the specified ELI definition to ELIs issued on or 90 days after the date of the final regs’ publication.

Erika W. Nijenhuis of Cleary Gottlieb Steen & Hamilton LLP approved of the extension, telling Tax Analysts, “It will remove a cloud of uncertainty from convertible bonds, structured notes, and options issued or traded prior to issuance of the final regulations, just as that cloud was about to descend on the market.”

Jeffrey D. Hochberg of Sullivan Cromwell agreed, saying, “The Treasury Department and IRS should be commended for their willingness to take into account the real-world practical problems that the securities industry was facing under the section 871(m) proposed regulations.”

Before Notice 2014-14, payments on specified ELIs would be subject to withholding on payments on or after January 1, 2016, for all specified ELIs acquired by the long party beginning March 5, 2014.

Opportunity to Improve

Hochberg hopes the extra time will allow Treasury and the IRS to address some issues taxpayers have with the proposed regulations, including structuring a withholding regime that works for complex instruments and clarifying delta computations.

David P. Hariton of Sullivan & Cromwell said, “The securities industry is very appreciative of the grandfathering relief, and we hope to engage in a constructive dialogue with Treasury and the IRS on a going-forward basis to help them implement the proposed regulations in the most efficacious manner.”

The proposed regulations, issued December 4, 2013, adopted a delta test to determine whether section 871(m) dividend equivalent withholding requirements apply to ELIs. Some examples of ELIs are convertible bonds and options. The proposed regulations scrapped prior regulations that established a seven-factor test for determining whether the section 871(m) withholding tax would apply.

An issue that must be addressed is with delta computation in the case of a structured note that includes synthetic leverage or other complex terms, Hochberg said. If the March 4 notice were not released, issuers would have had to issue instruments and report delta to holders without knowing how to compute it on these complex instruments, he said.

Perhaps most importantly, the regulators can reduce some of the uncertainty regarding how withholding would apply to structured notes under the proposed regulations, Hochberg said. Under the proposed regulations, an issuer of an ELI might be required to make withholding payments to the IRS when the underlying pays dividends, even though payments under the note may not be made until maturity, Hochberg said.

“This could result in the issuer bearing the cost of the tax because it would have no payment upon which to withhold, particularly if the foreign holder transfers the note to a U.S. holder before any payment is made on the note,” Hochberg said.

“There was a significant amount of concern that without an extension of the grandfather date, issuers might be reluctant to issue structured notes because of this [factor], which in turn could impair a major capital funding source of financial institutions,” Hochberg said, adding that structured notes also represent a significant amount of the capital markets.

“The extension of the grandfather date will allow [the IRS] to address these unresolved issues before the new withholding regime is in effect, and will give the securities industry the necessary time to build the necessary systems to implement this new withholding regime,” Hochberg said.

by William R. Davis



Obama Budget Would Cap Deductions for Municipal Bond Interest.

President Obama’s proposed 28 percent cap on the value of itemized deductions, included in his $3.9 trillion fiscal 2015 budget plan released March 4, would apply to the deduction for municipal bond interest.

President Obama’s proposed 28 percent cap on the value of itemized deductions, included in his $3.9 trillion fiscal 2015 budget plan released March 4, would apply to the deduction for municipal bond interest.

Obama’s budget would place a 28 percent cap on the value of itemized deductions and other tax preferences for high-income taxpayers in the 33 percent, 35 percent, and 39.6 percent brackets. It would apply to all itemized deductions, tax-exempt interest, and tax exclusions for retirement contributions.

Mike Nicholas, CEO of the Bond Dealers of America, said that research shows that the policy will result in increased taxes, borrowing costs, and infrastructure costs.

“We know that the president is highly committed to infrastructure given recent pledges to fix the nation’s crumbling roads, rails, and bridges,” Nicholas said. “Yet we are disappointed that . . . the administration continues to propose a 28 percent limit on the municipal tax exemption.”

House Ways and Means Committee Chair Dave Camp, R-Mich., in his comprehensive tax code overhaul released February 26 proposed a 10 percent surtax on municipal bond interest and other sources of income for high-income earners. Some state and local groups said his plan would also result in higher capital costs and could cause higher property or income taxes.

The president’s budget also would create America Fast Forward bonds, modeled after the now-expired Build America Bonds program. The taxable, direct-pay municipal bonds would include private-activity bonds and relax some limitations on how state and local governments can use municipal bonds.

The president proposed boosting private investment for the purpose of infrastructure investment with the creation of an independent national infrastructure bank, an idea that has been floated for nearly three decades. The budget proposal says the entity would have the “ability to leverage private and public capital to support infrastructure projects of national and regional significance.”

by Jennifer DePaul



EO Update: e-News for Charities and Nonprofits - March 4, 2014.

1.  What if the IRS needs more information on your application?

New sample questions will help you know what to expect.

2.  Review Revenue Procedure 2014-19

Revenue Procedure 2014-19 clarifies that EO Determination letters continue to be eligible for expedited handling under section 9 of Revenue Procedure 2014-4.

3.  Register for EO workshops

Register for our upcoming workshops for small and medium-sized

501(c)(3) organizations on:

March 12 and 13 – Kansas City, MO

Hosted by University of Missouri -Kansas City-Midwest Center for Nonprofit Leadership/Bloch School of Management

March 19 and 20 – Phoenix, AZ

Hosted by ASU – Lodestar Center for Philanthropy & Nonprofit Innovation

April 30 – Provo, UT

Hosted by Brigham Young University – Marriott School

4.  IRS offers Health Care Tax Tips to help individuals understand tax provisions in the Affordable Care Act

The IRS is offering educational Health Care Tax Tips to help individuals understand how the Affordable Care Act may affect their taxes.

The IRS has designed the Health Care Tax Tips to help people understand what they need to know for the federal individual income tax returns they are filing this year, as well as for future tax returns. This includes information on the Premium Tax Credit and making health care coverage choices.

Read the news release.

5.  IRS releases the “Dirty Dozen” Tax Scams for 2014

This annual list of tax scams reminds taxpayers to use caution during tax season to protect themselves against a wide range of schemes ranging from identity theft to return preparer fraud.

6.  Charities and Their Volunteers phone forum presentation posted

Check out this new presentation. Soon all EO phone forums will be posted as Adobe Captivate (an electronic learning tool) presentations on the IRS Stay Exempt Resource Library page. Captivate combines presenter audio and Microsoft PowerPoint to create a more entertaining and informative presentation.

Also, periodically review the phone forums page for registration information on upcoming presentations.

7.  Interactive Form 1023 updated

The form, which incorporates changes suggested by the public, includes updated user fees.

Copyright Notice

This is a work of the U.S. Government and is not subject to copyright protection in the United States. IRS Exempt Organizations encourages readers to reuse these articles in their own organization publications and websites and thereby help disseminate the information beyond the scope of EO Update’s subscribers.

If you have a technical or procedural question relating to Exempt Organizations, visit the Charities and Nonprofits homepage on the IRS.gov Web site.

If you have a specific question about exempt organizations, call EO Customer Account Services at 1-877-829-5500.



Proposal to Reduce Value of Charitable Deductions Resurfaces in Obama Budget.

The Obama administration is again proposing to reduce the value of the deduction for charitable contributions and other itemized deductions for upper-income taxpayers.

The Obama administration is again proposing to reduce the value of the deduction for charitable contributions and other itemized deductions for upper-income taxpayers.

The proposal, included in the budget blueprint  the administration released March 4, would reduce the value of itemized deductions to 28 percent for taxpayers in the 33 percent, 35 percent, or 39.6 percent tax brackets. The cap, which has never gone far in Congress, has been proposed by the administration for six straight years.

As they have in the past, groups representing charities expressed unhappiness at the proposal’s return, saying it could cause charitable giving to drop. “Capping the charitable deduction at 28 percent could cost the nonprofit sector up to $9 billion a year, dealing a big blow to our charities and our economy,” Sandra Swirski, executive director of the Alliance for Charitable Reform, said in a statement . “The charitable deduction is a lifeline, not a loophole, and we strongly urge the President to reevaluate his stance on cutting the deduction,” Swirski said.

The Council on Foundations (COF) also voiced its displeasure. “Since 2009, President Obama has proposed a 28 percent cap on itemized deductions, including the charitable deduction,” COF President and CEO Vikki Spruill said in a statement. “Both the Council and nonprofit sector have repeatedly expressed disappointment with this approach because the charitable deduction is a proven way to strengthen communities. Capping it would have a cascading impact on nonprofits and philanthropic organizations across the country. If donors have less incentive to give, donations will decline by billions of dollars — cutting a lifeline for millions of Americans.”

The budget plan also would establish a “Fair Share Tax” — also known as the “Buffett rule” — on upper-income taxpayers. Although the tax would allow for a charitable deduction, Swirski noted, the tax break also would be capped at 28 percent.

“While the so-called Buffett Rule does recognize the unique nature of the charitable deduction, it still caps that deduction, which will ultimately result in decreased charitable giving,” Swirski said.

The 28 percent cap is the second major proposal to limit the charitable deduction to be made in the past week. The tax reform package  introduced February 26 by House Ways and Means Committee Chair Dave Camp, R-Mich., includes a 2 percent adjusted gross income floor on charitable giving. Tim Delaney, president and CEO of the National Council of Nonprofits, said that idea “could have devastating real-world consequences by diminishing charitable resources for communities.”

Another provision that has been proposed before would replace the two rates of tax on the investment income of private foundations with a single rate of 1.35 percent. Swirski said that her organization supports a single rate but that a flat 1 percent rate, as Camp has proposed in his tax reform plan, would be better than 1.35 percent. Spruill also expressed support for a flat 1 percent rate.

The American opportunity tax credit, which is designed to help families afford college, would become permanent under the budget proposal. The provision also appeared in last year’s budget plan. Other provisions in the plan that have come up before would prohibit charitable deductions for contributions of conservation easements on golf courses and curb excessive deductions for contributions of historic preservation easements. There also is a provision to make permanent incentives for donating conservation easements.

Spruill said that proposed new penalties for failure to file IRS information returns electronically could disadvantage small nonprofits and that COF “will assess how this will impact the foundation community.”

by Fred Stokeld



IRS LTR: Association's Exemption Not Affected by Transactions with For-Profit Sub.

Citations: LTR 201409009

The IRS ruled that the transfer of cash from a nonprofit association that operates a cemetery to a for-profit subsidiary and other transactions involved in preparing to own and operate a funeral home will not affect the association’s tax-exempt status and will not result in unrelated business taxable income.

UIL: 501.13-00, 512.00-00, 512.10-00

Release Date: 2/28/2014

Date: December 4, 2013

Dear * * *:

We have considered your ruling request dated August 22, 2013, requesting rulings under §§ 501(c)(13) and 512 of the Internal Revenue Code.

FACTS

You (Taxpayer) are a non-profit association that operates a cemetery. You are recognized as exempt from federal income tax under § 501(c)(13).

You intend to create a wholly owned, for-profit subsidiary corporation, which will be formed as a Subchapter C corporation, for the purpose of owning and operating a funeral home (Subsidiary). As part of this plan, you propose to enter into the following transactions:

In exchange for 100% of the Subsidiary’s stock, you will transfer at least $x of cash and a nonexclusive license to use your name and address.

You will lease approximately 1,250 square feet of your existing building for arrangements and administrative offices for a fair market value rental rate which will be determined by you and the Subsidiary through an arm’s length negotiation. The employees that engage in the operations and marketing of the funeral home will be employees solely of the Subsidiary.

To the extent that any of the Subsidiary’s employees perform services related to your operations, you will reimburse the Subsidiary for the cost of such services on a fair market value basis. Likewise, you may perform certain administrative services for the Subsidiary (e.g., accounting, billing and collection services). However, in the event that you render these services, the Subsidiary will compensate you for such services on a fair market value basis.

The Subsidiary’s Board of Directors will consist of no less than six members. Under no circumstances will the Subsidiary’s Board of Directors include an individual that is then currently serving as one of your Trustees or employees or any other person directly involved in your day-to-day operations of your cemetery business. The Subsidiary will keep its own books and records separate from you.

The business purpose of the transaction is to provide for your customer’s needs in one location in an effort to better serve your customers.

RULINGS REQUESTED

1. The transfer of cash and contributed assets by the Taxpayer to the Subsidiary, ownership of the Subsidiary’s stock, the lease of the Taxpayer’s land to the Subsidiary, the provision of services to the Subsidiary by the Taxpayer and to the Taxpayer by the Subsidiary in exchange for fair compensation, and the receipt of dividends by the Taxpayer from the Subsidiary will not adversely affect the Taxpayer’s status as a tax exempt organization under § 501(c)(13).

2. Based on the facts presented, the Taxpayer will not be deemed to be engaged in the day-to-day management of the Subsidiary.

3. The dividends you receive from the Subsidiary will not constitute unrelated business taxable income to the Taxpayer pursuant to § 512(a)(1) by virtue of § 512(b)(1).

LAW

I.R.C. § 501(c)(13) provides an exemption from federal income tax for cemetery companies owned and operated exclusively for the benefit of their members or which are not operated for profit; and any corporation chartered solely for the purpose of the disposal of bodies by burial or cremation which is not permitted by its charter to engage in any business not necessarily incidental to that purpose, provided no part of the organization’s net earnings inures to the benefit of any private shareholder or individual.

I.R.C. § 511 imposes a tax on the unrelated business taxable income of organizations exempt under § 501(c).

I.R.C. § 512(a)(1) defines “unrelated business taxable income” as the gross income an organization derives from any unrelated trade or business (defined in § 513) it regularly carries on, less allowable deductions, with certain modifications.

I.R.C. § 512(b)(1) excludes dividends received by the tax-exempt organization from the computation of unrelated business taxable income under § 512(a)(1).

Rev. Rul. 64-109, 1964-1 C.B. 190, held that a cemetery may not, consistent with § 501(c)(13), engage in activities not necessarily incidental to its burial purpose. The ruling concluded that, because operating a mortuary is not necessary to procuring, selling, holding, and using land solely as a burial ground, an organization that engaged in such a business was subject to loss of its exempt status.

Rev. Rul. 76-91, 1976-1 C.B. 150, held that an organization will not jeopardize its exemption under § 501(c)(3), even though it deals with related parties in a commercial context, as long as the dealings are at arm’s length and prices are set by qualified and independent appraisers.

In Restland Memorial Park v. United States, 371 F. Supp. 164 (N.D. Tex. 1974), aff’d, 509 F.2d 187 (5th Cir. 1974), a cemetery’s net earnings were found to inure to private individuals, precluding exemption under § 501(c)(13), where it allowed a related for-profit mortuary to benefit from its efforts without compensation. There, an individual who controlled the cemetery also owned a for-profit funeral home located on the cemetery grounds. The funeral home was managed and controlled by the same individual who controlled the cemetery and used the cemetery’s name in joint advertising campaigns. The court held that inurement occurred, inter alia, through the funeral home’s “trade of goodwill” originally built up by the non-profit cemetery; the joint operation had entwined the cemetery’s goodwill with that of the funeral home and related for-profit operations, for the benefit of the for-profit operations.

For federal income tax purposes, a parent corporation and its subsidiaries are separate taxable entities so long as the purposes for which the subsidiary is incorporated are the equivalent of business activities, or the subsidiary subsequently carries on business activities. Moline Properties, Inc. v. Commissioner, 319 U.S. 436 (1943); Britt v. United States, 431 F.2d 227 (5th Cir. 1970). That is, where a corporation is organized with a bona fide intention that it will have some real and substantial business function, its existence may not generally be disregarded for tax purposes. However, where the parent corporation so controls the affairs of the subsidiary that it is merely an instrumentality of the parent, the corporate entity of the subsidiary may be disregarded. Krivo Industrial Supply Co. v. National Distillers and Chemical Corp., 483 F.2d 1098 (5th Cir. 1973).

ANALYSIS

1. Tax-Exempt Status under 501(c)(13)

Section 501(c)(13) prohibits cemetery companies from engaging in any business incident to the purpose of the disposal of bodies by burial or cremation and from allowing its net earnings to inure to the benefit of any private shareholder or individual. You intend to form the Subsidiary for the substantial business purpose of operating a funeral home. Accordingly, the Subsidiary’s business activities will threaten your exempt status if those activities are attributable to you. However, your proposed facts are distinguishable from both Restland Memorial Park v. United States and Rev. Rul. 64-109. First, in Restland Memorial Park, the individual that controlled the cemetery also owned the for-profit funeral home that did business with the cemetery. In this case, the Subsidiary is completely independent from you, and no common ownership or control exists between you and the Subsidiary. Second, the organization in Rev. Rul. 64-109 directly operated a mortuary. Here, the independently operated Subsidiary, not you, will operate the funeral home. Therefore, the proposed transaction will not adversely affect your tax-exempt status under § 501(c)(13).

2. Day-to-Day Management of the Subsidiary

The information and representations presented indicate that you will not control and will not be involved in the day-to-day management of the Subsidiary. The Subsidiary will have its own board of directors and keep its own books and records. You state that, under no circumstances, will the Subsidiary’s board consist of any of your current Trustees or any employee involved in your day-to-day operations. The Subsidiary’s employees will engage solely in the operations and marketing of the funeral home. Nonetheless, the Subsidiary’s employees may perform services related to your operations, and your employees may perform certain administrative duties for the Subsidiary (e.g., accounting, billing and collection services). In this case, you state that reimbursement will be based on the fair market value of the services rendered. See Rev. Rul. 76-91.

3. Unrelated Business Taxable Income

Section 511 imposes a tax on the unrelated business taxable income of organizations exempt under § 501(c). Section 512(a)(1) defines “unrelated business taxable income” as the gross income an organization derives from any unrelated trade or business (defined in § 513) it regularly carries on, less allowable deductions, with certain modifications describe in § 512(b). Specifically, § 512(b)(1) excludes all dividends received by tax-exempt organizations. Accordingly, any dividends you receive from the Subsidiary will be excluded from calculation of UBTI.

CONCLUSION

Based on the foregoing, we rule as follows.

1. The transfer of cash and contributed assets by the Taxpayer to the Subsidiary, ownership of the Subsidiary’s stock, the lease of the Taxpayer’s land to the Subsidiary, the provision of services to the Subsidiary by the Taxpayer and to the Taxpayer by the Subsidiary in exchange for fair compensation, and the receipt of dividends by the Taxpayer from the Subsidiary will not adversely affect the Taxpayer’s status as a tax exempt organization under § 501(c)(13).

2. Based on the facts presented, the Taxpayer will not be deemed to be engaged in the day-to-day management of the Subsidiary.

3. The dividends you receive from the Subsidiary will be excluded from the calculation unrelated business taxable income under § 512(a)(1) by reason of § 512(b)(1).

This ruling will be made available for public inspection under section 6110 of the Code after certain deletions of identifying information are made. For details, see enclosed Notice 437, Notice of Intention to Disclose. A copy of this ruling with deletions that we intend to make available for public inspection is attached to Notice 437. If you disagree with our proposed deletions, you should follow the instructions in Notice 437.

This ruling is directed only to the organization that requested it. Section 6110(k)(3) of the Code provides that it may not be used or cited by others as precedent.

This ruling is based on the facts as they were presented and on the understanding that there will be no material changes in these facts. This ruling does not address the applicability of any section of the Code or regulations to the facts submitted other than with respect to the sections described. Because it could help resolve questions concerning your federal income tax status, this ruling should be kept in your permanent records.

If you have any questions about this ruling, please contact the person whose name and telephone number are shown in the heading of this letter.

In accordance with the Power of Attorney currently on file with the Internal Revenue Service, we are sending a copy of this letter to your authorized representative.

Sincerely,

Theodore Lieber

Manager, Exempt Organizations

Technical Group 3

Enclosure

Notice 437



Camp's Plan Spells Trouble for Munis in Future Tax Reform Efforts.

WASHINGTON — Don’t dismiss Rep. Dave Camp’s draft tax plan as a non-starter. It’s going to be a foundation for tax reform and most of the bond proposals it contains have already been made and will continue to be made by lawmakers, administration officials, deficit reduction groups, and tax experts.

This was the warning issued on Thursday by several long-time municipal bond market players who participated in the development of the 1986 Tax Reform Act that imposed the biggest restrictions ever made on munis.

The plan by the chairman of the House Ways and Means Committee chair, released Wednesday, would hit munis from all angles. The Michigan Republican would end the tax exemption after 2014 for both private-activity bonds, which are used for charitable and other public projects that have some private involvement, and advance refundings, which state and local governments use to obtain interest rate savings. He would do away with bank-qualified bonds, which help small localities access the bond market through local banks, and he would adopt or revise tax provisions to discourage banks, insurance companies and other financial institutions from buying municipal bonds.

Camp also would dampen retail investor demand for munis by limiting the value of tax exemption to 25% for the wealthy. That proposal is not unlike the 28% cap that President Obama has proposed in his last two budget requests.

Camp threw down his marker on PABs Wednesday, saying in a summary of his plan, “Taxpayers across the country should be not forced to subsidize borrowing by state and local governments that provide a direct benefit to private individuals and entities.”

Toby Rittner, president and chief executive officer at the Council of Development Finance Agencies, said “this is about the worst case scenario for the private-activity bond industry” and that many local development corporations will go out of business if they can’t issue tax-exempt PABs.

But Rittner added, “We don’t see any traction for it.” And several market participants echoed him, saying they were not worried because it was not going to go anywhere.

Ben Watkins, Florida’s bond finance director and chairman of the Government Finance Officers Association’s debt management committee, said Camp’s plan puts the muni exemption “on the radar screen” to become under “a constant long-term threat.” But he said, “I don’t think you’ll see as loud a call to arms” as with previous threats, though it doesn’t mean muni issuers ” care any less.”

Sen. Chuck Schumer, D-N.Y. called the plan “dead on arrival” and Camp, who is term-limited and must step down as committee chairman at year’s end, couldn’t even get his Republican colleagues behind the plan while Senate leaders said there will be no tax reform this year.

But Frank Shafroth, director of the Center for State and Local Leadership at George Mason University who represented issuers in the 1986 tax reform debates, said Camp’s plan plays to those such as President Obama who want tax simplification and Republicans who want lower tax rates.

“For the first time, you actually have a foundation for the committees to use and for the next Congress,” Shafroth said. “It’s going to be used to raise enormous amounts of money between now and November. But if you’re serious about reducing income tax rates, these are the kinds of cuts that will be required.”

At least two major deficit reduction groups, one of which was presidential, issued reports in 2010 that recommended eliminating tax exemption for either all munis or PABs, said Shafroth and Howard Gleckman, a resident fellow at the Tax Policy Center. State and local officials should notice: “There’s a pattern here and the pattern’s pretty consistent,” Gleckman said.

In order for tax reform to be distributionally neutral and to lower rates for the wealthy, you have to cut tax preferences, Gleckman said, adding, “There are only so many targets of opportunity and state and local finance is one of them.” He said he thinks the tax-exemption for munis, PABs and the state and local tax deduction will continue to be targets for revenue raising.

“We take [Camp’s] package very seriously,” said Michael Decker, co-head of municipal securities for the Securities Industry and Financial Markets Association.

Shafroth, Decker, and Micah Green, a partner at Patton Boggs, pointed out that several tax reform plans were floated from 1983 through 1985, some of which have eliminated tax-exempt PABs and advance refundings. The resulting 1986 Tax Reform Act was less harsh, creating volume caps for PABs and limiting those kinds of bonds that could be tax-exempt. The act also restricted issuers of governmental bonds to two advance refundings.

Green, Decker, and John Buckley, former chief tax counsel for the Democrats on the House Ways and Means Committee, each said Camp has proposed muni bond curbs are carefully analyzed and scored revenue raisers that can be used anytime in the future.

“Any revenue opportunity articulated by a tax-writing committee chairman, whether or not it’s enacted, becomes a revenue raiser on the shelf that can be pulled off and used anytime in the future,” said Green.

“Now that the details are out, the various provisions could be picked up by other legislators as revenue raisers or offsets that can be moved separately,” said Decker. “That risk grows when the provisions have the support of the House Ways and Means Committee chairman.”

“In the long run, this could be seen as a menu” of revenue increases for deficit reduction, said Buckley.

Bill Daly, director of governmental affairs for the National Association of Bond Lawyers, said that if muni issuers and other market participants don’t explain how Camp’s proposals would hurt the muni market, “these could gain some traction.”

“It is incumbent on the tax-exempt bond community to make the case that the current tax treatment of munis has economic benefits,” said Decker.

Meanwhile, state treasurers said it has “strong concerns” about some provisions of Camp’s plan. “The proposals in this discussion draft do not respect the authority of a sovereign state and changes the tax treatment of these bonds that have existed for over 100 years,” said Utah Treasurer Richard Ellis, the president of the National Association of State Treasurers. He was particularly concerned about the 25% limitation, also called a 10% surtax on muni bond interest earned by individuals with modified adjusted gross incomes of more than $400,000 and couples with more than $450,000.

U.S. Conference of Mayors chief executive officer and executive director Tom Cochran said the 10% surtax “is an all out attack on local governments and our ability to raise funds for local investments in highways, bridges,” and other projects that is “economically ill-informed.”

BY NAOMI JAGODA and LYNN HUME

FEB 27, 2014 5:09pm ET



Camp Would Repeal Tax-Exemption for New PABs, Advance Refunding Bonds.

WASHINGTON — House Ways and Means Committee chairman Dave Camp’s draft tax reform plan, released Wednesday, would terminate the tax exemption for private-activity bonds and advanced refunding bonds issued after 2014.

The proposed plan, which the Michigan Republican is calling “a discussion draft,” would also put an end to traditional and direct-pay tax-credit bond rules after the date of enactment, although there is no current authority for direct-pay bonds.

As expected, the plan would create three individual income brackets — 10%, 25% and 35% — and would tax a portion of muni bond interest, which is currently tax-exempt, for those in the highest bracket. The surtax would, apply to individuals with incomes of $400,000 or more and couples with $450,000 or more of income as well as all munis they hold, whether new or outstanding. It would essentially cap at 25% the value of tax exemption for those in the 35% tax bracket, sources said. The surtax would be unprecedented and would likely dampen demand for muni bonds and raise borrowing costs for state and local governments, market participants said.

Also as predicted, the draft would require systemically important financial institutions, such as banks, with total consolidated assets of more than $500 billion, to pay an excise tax equal to 0.035 percent of those assets. Federal bank regulators in 2013 reported eight holding companies with assets that large, many of which have companies that are major underwriters of munis. The holding companies are JPMorgan, Chase & Co., Bank of America Corp., Citigroup, Inc., Wells Fargo & Co., Goldman Sachs Group, Inc,. Morgan Stanley, American International Group, Inc. and General Electric Capital Corp.

The excise tax could discourage big banks from holding municipal bonds and is likely to become a priority issue for lobbying by dealer and bank groups, according to market participants.

The plan would also repeal the alternative minimum tax, which currently applies to PABs, which would benefit PABs that are currently outstanding. In addition, it would eliminate the deduction for state and local taxes, which state and local groups are likely to strongly oppose.

Camp is also proposing to dedicate $126.5 billion to the Highway Trust Fund to fully fund highway and infrastructure investment through the HTF for the next eight years.

It is doubtful that the draft plan will move forward because Camp still needs support from colleagues and Senate Democratic and Republican leaders have said tax reform will not likely happen this year. House Speaker John Boehner even declined to endorse it, stressing it is a “discussion draft.”

But tax experts and lobbyists warned these are, in essence “trial balloons.”

“This will start a dialogue,” said Micah Green, a partner at Patton Boggs. “If people don’t express their opinion, there’s a risk some of these provisions will be viewed as viable.”

The proposal to prohibit new PABs and advance refundings from being issued as tax exempt upset many market participants.

Green said muni market participants will have to begin a discussion with lawmakers and administration officials over whether PABs are used solely for private businesses, as the summary of Camp’s plan suggests, or are instead issued for public projects with private involvement.

John Murphy, executive director of the National Association of Local Finance Housing Agencies, called Camp’s draft plan “is a disaster for affordable housing”

“These are not businesses being given an advantage. Single-family housing bonds (PABs) are used to help first-time homebuyers” and multifamily housing bonds benefit renters, he said.

Chuck Samuels, an attorney at Mintz Levin and counsel to the National Association of Health & Higher Education Facilities Authorities, said, “It appears that Camp is willing to strip charities of their ability to access reasonably-priced capital. This is particularly surprising from a conservative Republican who believes the charitable sector can often function more efficiently than the governmental sector.”

Green said doing away with tax exemption for new advance refundings could dramatically change market practices. Historically, issuers issue bonds that can be called in 10 years, knowing that if interest rates drop before then, they can advance refund those bonds.

“If issuers can’t do advance refundings, they’re much more exposed to market interest rate movements,” Green said. They may have to structure bonds with earlier call dates, which investors may not want, or they have to address interest rate risk by increasing activity in derivatives market, he said.

Michael Decker, the Securities Industry and Financial Markets Association managing director and co-head of munis, said, Camp’s proposal “Specifically targets municipal products.”

“The 10% tax on municipal bond interest would be unprecedented. It would the first time in the history of the federal income tax system that the U.S. taxed the interest from municipal bonds, absent a tax violation,” he said.

Decker noted that the Supreme Court, in a 1988 case, South Carolina v. Baker, ruled Congress has the constitutional authority to tax or not tax municipal bond interest, but added, “It would be interesting to see whether the current high court would agree with that.”

He said the 10% surtax will dampen the demand for muni bonds and increase yields. “The tax is really going to be borne by state and local governments through higher borrowing costs. They are ultimately going to pay the costs.” Decker also noted that the 10% surtax “would apply, not just to new issues, but to outstanding munis” as well.

Decker also said in a release issued by SIFMA that the 10% surtax, and the elimination of tax exemption for new PABs and advance refunding bonds “could result in increases in state and local property and income taxes.”

“State and local capital investment in projects like hospitals, schools and roads creates jobs and enhances economic productivity,” he said in the release.

Decker also told The Bond Buyer that the excise or asset tax on systemically important financial institutions is “a very negative proposal that really is a strong discouragement to banks to lend and hold assets such as municipal bonds.” If Camp’s plan prevails, the excise tax would come at a time when banks have increasingly become buyers of munis, he noted.

Columbia, South Carolina Mayor Steve Benjamin, the new chair of the Municipal Bonds for America coalition, which consists of state and local officials and broker-dealers, said in a release, “We oppose proposals, whether from Congress or the White House, that cut, cap or limit the tax exemption for municipal bonds, including private-activity bonds, and significantly limit our ability to borrow at affordable rates and invest in America’s future competitiveness.”

“Congress and the administration have a decision to make: is America just going to survive or are we going to thrive?” Benjamin asked. He noted tax exemption is a “100-year old covenant” and that PABs “are a valuable, trusted and efficient tool that provides access to capital for nonprofits, affordable housing, hospitals, energy providers, manufacturers, and many other job generating, private sector investment catalyzing projects.”

BY NAOMI JAGODA and LYNN HUME

FEB 26, 2014 5:10pm ET



Camp Draft Would End State and Local Income Tax Deduction, Bond Exclusion.

One of the largest federal tax expenditures — the deduction for state and local income taxes — would be eliminated under the proposal from House Ways and Means Committee Chair Dave Camp, R-Mich., to overhaul the tax code, which was released February 26.

One of the largest federal tax expenditures — the deduction for state and local income taxes — would be eliminated under the proposal  from House Ways and Means Committee Chair Dave Camp, R-Mich., to overhaul the tax code, which was released February 26.

The option to deduct sales taxes in lieu of income taxes was one of 55 federal tax expenditures that expired at the end of 2013. The state and local income tax deduction is forecast to cost approximately $277 billion between 2013 and 2017, according to a Joint Committee on Taxation score of the Camp plan (JCX-20-14 ).

“This deduction redistributes wealth to big-government, high-tax states from small-government, low-tax states,” Camp’s plan says.

Experts said that repeal of the state and local tax deduction would put increasing pressure on state governments to keep their taxes low, especially in already high-tax states like California and New York.

“That’s been something that states easily rally around, and they will fight it to the death,” Tax Foundation Chief Economist Will McBride said. “Every indication of history says that there will be a lot of pushback on this.”

Verenda Smith, deputy director of the Federation of Tax Administrators, wasn’t surprised by Camp’s proposal to eliminate the state and local tax deduction, because it’s not a new idea. She said it would be a “pretty heavy lift” to accomplish and that Congress should not mess with state tax codes.

Camp’s long-awaited comprehensive tax reform proposal is the culmination of three years of work. At its core, he said, the discussion draft would produce a “fairer and simpler” U.S. tax code. “We close a lot of loopholes; we got a lot of the junk out of the code,” Camp said at a February 26 press conference on Capitol Hill. “Our plan repeals 228 sections of the tax code. And we cut the size of the income tax code by roughly 25 percent.”

Camp proposes “flattening the code” so that it would include only a top income tax rate of 25 percent for both individual and corporate filers and a 10 percent introductory bracket for individual filers.

Jeff Saviano of EY said trimming the tax code by 25 percent would be a massive shift and would place a burden on states to fully adopt the plan or not. States would have to decide whether they would benefit more from adopting the proposed new tax code or from taking subsequent legislative action to lower tax rates, he said.

Bond Provisions

Camp calls for a 10 percent surtax on some sources of income — including municipal bond interest that’s now tax exempt — for single filers earning more than $400,000 and joint filers earning more than $450,000. Under current law, the tax-exempt interest on municipal bonds is forecast to total approximately $191 billion between 2013 and 2017, according to the JCT.

Camp’s plan also would eliminate the alternative minimum tax, the tax exemption for private activity bonds, and advance refunding bonds issued after 2014. Private activity bonds are primarily used to finance airport, hospital, university, water and sewer, and housing projects.

The plan would eliminate banks’ ability to deduct all of the interest expenses associated with the acquisition of municipal bonds — the so-called bank qualified bonds of small issuers. Recently, banks have been active in purchasing municipal bonds directly, which saves money for issuers and small 501(c)(3) organizations, according to Linda B. Schakel of Ballard Spahr LLP.

It would also do away with the 2 percent de minimis rule, which allows corporations to have up to 2 percent of their assets in tax-exempt bonds without losing any portion of their interest expense deduction.

Camp’s proposals to significantly alter the treatment of tax-exempt municipal bonds and repeal the exemption for private activity bonds could reduce the appeal of buying government debt altogether.

Generally, a reduction in overall tax rates makes tax-exempt bonds less attractive, said Howard Gleckman, resident fellow with the Urban-Brookings Tax Policy Center. The exclusion for tax-exempt bonds is worth less to investors, he added.

Practitioners React

State and local groups and practitioners were alarmed by the proposals, saying they will increase financing costs.

“These new taxes would be borne ultimately by states and localities in the form of higher capital costs, and could result in increases in state and local property and income taxes,” said Michael Decker of the Securities Industry and Financial Markets Association.

“State and local capital investment in projects like hospitals, schools, and roads creates jobs and enhances economic productivity,” Decker said. “Taken together, these proposals would have the effect of raising capital costs for state and local governments and discouraging investment in much-needed infrastructure.”

Susan Collet, senior vice president of government relations with Bond Dealers of America, likened the 10 percent surtax to the 28 percent cap on municipal bond interest proposal that has appeared in President Obama’s annual budget. “It will raise costs and have a similar impact on borrowing costs because issuers will have to increase their yield to compensate for that class of investor,” she said.

Collet said she is also alarmed by the proposal to eliminate advance refunding bonds because they allow state and local governments to take advantage of current interest rates. “The combination of those three proposals creates a very difficult environment for borrowing for critical infrastructure at affordable rates,” she said.

Schakel said Camp’s plan changes the landscape for the municipal bond market.

“It has a lot of repercussions. . . . This is going to be hard for people to figure out where to put their money,” Schakel said. “In some ways this is a zero sum game: If they don’t provide the subsidy through the tax code, you will still have to find the funds somewhere else.”

Charles A. Samuels of Mintz Levin Cohn Ferris Glovsky and Popeo PC said the proposal to eliminate the exclusion for private activity bond income would have a “devastating” impact on nonprofits, particularly in the health and education sectors.

Still, Samuels wasn’t surprised that Camp took a swipe at private activity bonds because of a congressional hearing last March that had many House Ways and Means Committee members questioning the need to maintain federal support for them.

Changes to Rate Structures, Depreciation Provisions

Camp’s plan also includes sweeping changes to personal and corporate income tax rate structures. Coupled with the rate changes are significant changes to permitted income tax deductions. Changes in the determination of federal adjusted gross income would affect states that have a floating conformity date to the current-year Internal Revenue Code.

Camp proposes several changes to the calculation of a taxpayer’s taxable base. Among them is the repeal of the modified accelerated cost recovery system for taking depreciation deductions. In place of MACRS, Camp would institute the alternative depreciation system, requiring shorter recovery periods using the straight-line depreciation method. The proposal would permit taxpayers to elect to take an additional depreciation deduction to account for the effects of inflation on depreciable personal property.

The proposal also would eliminate several depreciation provisions without replacing them, including bonus depreciation, the special recovery periods for Indian reservation property, the special allowance for second-generation biofuel plant property, the special allowance for some reuse and recycling property, and the special allowance for qualified disaster assistance property.

Also, Camp’s proposal would change current rules that permit the deduction of research and experimental expenditures. Instead of allowing corporations to take a current-year deduction for those expenses, the proposal would require the amortization of those deductions over five years.

by Jennifer DePaul and David Sawyer



SIFMA Raises Concerns over Muni Bond Provisions in House Republican Tax Reform Proposal.

SIFMA Raises Concerns over Muni Bond Provisions in House Republican Tax Reform Proposal

Washington, D.C., February 26, 2014– SIFMA today released the following statement from Michael Decker, managing director and co-head of municipal securities, on municipal bond provisions in the House Republican Tax Reform Proposal:

“We are disappointed that the tax reform proposal includes a 10-percent tax on otherwise tax-exempt interest income and would prohibit private-activity bonds and advance refunding bonds. These new taxes would be borne ultimately by states and localities in the form of higher capital costs, and could result in increases in state and local property and income taxes. State and local capital investment in projects like hospitals, schools and roads creates jobs and enhances economic productivity. Taken together, these proposals would have the effect of raising capital costs for state and local governments and discouraging investment in much-needed infrastructure.”

Release Date: February 26, 2014

Contact: Carol Danko, 202.962.7390,  [email protected]



BDA CEO Mike Nicholas Interviewed on Bloomberg TV.

Bloomberg TV interviewed BDA’s CEO, Mike Nicholas on the tax overhaul and how it would affect municipal bonds.

http://www.bdamerica.org/?news_info=bda-ceo-mike-nicholas-interviewed-on-bloomberg-tv



Energy Grant Program Participants May Not Claim Tax Credits for Payments Reduced by Sequestration.

Treasury Assistant Secretary for Legislative Affairs Alastair Fitzpayne informed lawmakers that participants in an American Recovery and Reinvestment Act grant program may not claim any amount of investment or production tax credit for property for which they have received program payments even if the payments were reduced by sequestration.

February 18, 2014

The Honorable Juan Vargas

U.S. House of Representatives

Washington, DC 20515

Dear Representative Vargas:

Thank you for your letter regarding section 1603 of the American Recovery and Reinvestment Tax Act of 2009 (Section 1603 Program) and sequestration. You requested that we consider providing participants of the Section 1603 Program the option of claiming an investment tax credit (ITC) under section 48 of the Internal Revenue Code (IRC) for the amount by which sequestration will reduce any payment they receive under the Section 1603 Program.

As you know, the Section 1603 Program allows a person that places a specified energy property in service to receive a cash payment in lieu of the ITC or the production tax credit (PTC) under section 45 of the IRC. The amount of the tax credit and the amount of the payment are equal to 10 or 30 percent of the basis of the property, depending on the type of property. Payments made under the Section 1603 Program are subject to sequestration, and thus were reduced by 8.7 percent in Fiscal Year 2013 and are being reduced by 7.2 percent in Fiscal Year 2014. Section 48(d) provides that any property for which a Section 1603 payment has already been made will not also receive an ITC or PTC. Thus, Section 1603 Program participants may not claim any amount of ITC or PTC for property for which they have received payments under the Section 1603 Program, regardless of whether the payment amount has been reduced by sequestration. If a Section 1603 Program participant has not yet received a payment — for example, if the participant has not yet placed its property in service — the participant may choose to instead claim the ITC or PTC for the property.

If you have additional questions on this topic, please feel free to contact me or have your staff contact the Office of Legislative Affairs at (202) 622-1900.

Sincerely,

Alastair M. Fitzpayne

Assistant Secretary for Legislative

Affairs

Identical letter sent to:

The Honorable Paul Cook

The Honorable Susan Davis

* * * * *

February 18, 2014

The Honorable Paul Cook

U.S. House of Representatives

Washington, DC 20515

Dear Representative Cook:

Thank you for your letter regarding section 1603 of the American Recovery and Reinvestment Tax Act of 2009 (Section 1603 Program) and sequestration. You requested that we consider providing participants of the Section 1603 Program the option of claiming an investment tax credit (ITC) under section 48 of the Internal Revenue Code (IRC) for the amount by which sequestration will reduce any payment they receive under the Section 1603 Program.

As you know, the Section 1603 Program allows a person that places a specified energy property in service to receive a cash payment in lieu of the ITC or the production tax credit (PTC) under section 45 of the IRC. The amount of the tax credit and the amount of the payment are equal to 10 or 30 percent of the basis of the property, depending on the type of property. Payments made under the Section 1603 Program are subject to sequestration, and thus were reduced by 8.7 percent in Fiscal Year 2013 and are being reduced by 7.2 percent in Fiscal Year 2014. Section 48(d) provides that any property for which a Section 1603 payment has already been made will not also receive an ITC or PTC. Thus, Section 1603 Program participants may not claim any amount of ITC or PTC for property for which they have received payments under the Section 1603 Program, regardless of whether the payment amount has been reduced by sequestration. If a Section 1603 Program participant has not yet received a payment — for example, if the participant has not yet placed its property in service — the participant may choose to instead claim the ITC or PTC for the property.

If you have additional questions on this topic, please feel free to contact me or have your staff contact the Office of Legislative Affairs at (202) 622-1900.

Sincerely,

Alastair M. Fitzpayne

Assistant Secretary for Legislative

Affairs

Identical letter sent to:

The Honorable Juan Vargas

The Honorable Susan Davis

* * * * *

February 18, 2014

The Honorable Susan Davis

U.S. House of Representatives

Washington, DC 20515

Dear Representative Davis:

Thank you for your letter regarding section 1603 of the American Recovery and Reinvestment Tax Act of 2009 (Section 1603 Program) and sequestration. You requested that we consider providing participants of the Section 1603 Program the option of claiming an investment tax credit (ITC) under section 48 of the Internal Revenue Code (IRC) for the amount by which sequestration will reduce any payment they receive under the Section 1603 Program.

As you know, the Section 1603 Program allows a person that places a specified energy property in service to receive a cash payment in lieu of the ITC or the production tax credit (PTC) under section 45 of the IRC. The amount of the tax credit and the amount of the payment are equal to 10 or 30 percent of the basis of the property, depending on the type of property. Payments made under the Section 1603 Program are subject to sequestration, and thus were reduced by 8.7 percent in Fiscal Year 2013 and are being reduced by 7.2 percent in Fiscal Year 2014. Section 48(d) provides that any property for which a Section 1603 payment has already been made will not also receive an ITC or PTC. Thus, Section 1603 Program participants may not claim any amount of ITC or PTC for property for which they have received payments under the Section 1603 Program, regardless of whether the payment amount has been reduced by sequestration. If a Section 1603 Program participant has not yet received a payment — for example, if the participant has not yet placed its property in service — the participant may choose to instead claim the ITC or PTC for the property.

If you have additional questions on this topic, please feel free to contact me or have your staff contact the Office of Legislative Affairs at (202) 622-1900.

Sincerely,

Alastair M. Fitzpayne

Assistant Secretary for Legislative

Affairs

Identical letter sent to:

The Honorable Juan Vargas

The Honorable Paul Cook



Muni Tax Break Would Be Curbed Under House Republican’s Revamp.

The tax break for some investors in the $3.7 trillion municipal bond market would be curbed under changes proposed by the top House tax writer, a shift that may diminish the appeal of buying local-government debt.

A plan released today by House Ways and Means Committee Chairman Dave Camp, a Michigan Republican, would tax some municipal-bond income for the highest earners as part of broader changes that would lower rates. It would also eliminate the exemption for debt sold by localities to finance private projects.

A change to the tax treatment of state and local debt could reduce the value of the securities, which sell for higher prices than other bonds because investors aren’t taxed on the income. That pushes down the borrowing costs for states and cities, which have argued against taxing the debt that they sell to pay for schools, roads and other public works.

The Camp proposal is the latest challenge to the century-old tax exemption, which was targeted in tax plans previously released by President Barack Obama and his deficit-cutting commission. None of those plans have advanced, and Camp’s effort faces a challenge in the divided Congress ahead of elections in November.

This week, Senate Minority Leader Mitch McConnell, a Kentucky Republican, and Majority Leader Harry Reid, a Nevada Democrat, said they saw little chance that major tax changes would be enacted this year.

Starting Point

The proposal may be the starting point for changes next year, said Susan Collet, a lobbyist with Bond Dealers of America, a Washington-based trade group that represents securities firms and opposes changes to munis’ treatment.

“There’s no chance of near-term passage,” she said. “There are going to be a lot of shifting dynamics in the next Congress. But this is something that they will be able to grab.”

Camp’s changes would limit tax-exempt interest for the highest earners, those making more than $400,000 for individuals and $450,000 for couples, according to a description released by his office. It would also eliminate the exemption for new private activity bonds, a type of municipal debt typically sold by public authorities on behalf of a company.

Vikram Rai, a Citigroup Inc. analyst, said the proposal has had little influence in the municipal market, where prices have gained amid a dearth of issues by local governments. He said that could change if it looks like efforts to tax munis are gaining traction.

‘Distant Threat’

“The muni market doesn’t need this kind of uncertainty,” Rai said. “It seems like a fairly distant threat as of now, but if it does become more imminent, we will see a negative impact on the market.”

The tax benefits of munis cost the Treasury about $39 billion in the most recent budget year, according to the Office of Management and Budget. The size of the break has made it a potential source of revenue for lawmakers looking to reduce the size of the deficit or find revenue to offset the cost of tax cuts.

The president’s deficit-reduction commission in 2010 proposed scrapping the muni tax break, and Obama has since proposed limiting the ability of high-income earners to benefit.

Both proposals have drawn criticism from groups representing state and local governments, which say taxing bondholders would raise costs because investors would demand higher yields.

Collet, the lobbyist from the dealers group, said taxing even some of that income may worry investors.

Any change would “put a cloud over the exemption,” she said. “What that means is that state and local governments would have to offer a higher yield to make up for that tax.”

By William Selway February 26, 2014

To contact the reporter on this story: William Selway in Washington at [email protected]

To contact the editor responsible for this story: Jodi Schneider at [email protected]



ICBA Requests Change to Capital Conservation Buffer Rules for Subchapter S Banks.

The capital conservation buffer rules disadvantage community banks against larger financial institutions and tax-exempt credit unions and should be modified to allow subchapter S corporation banks to cover their income tax liabilities out of their profits, the Independent Community Bankers of America said in a February 19 letter.

February 19, 2014

The Honorable Thomas J. Curry

Comptroller of the Currency

Office of the Comptroller of the Currency

400 7th Street, SW

Washington, DC 20219

The Honorable Janet L. Yellen

Chair

Board of Governors of the Federal Reserve System

20th Street and Constitution Avenue, NW

Washington, DC 20551

The Honorable Martin J. Gruenberg

Chairman

Federal Deposit Insurance Corporation

550 17th Street, NW

Washington, DC 20429

Re: Implementation of the Capital Conservation Buffer

Dear Ladies and Gentlemen:

The Independent Community Bankers of America (ICBA)1 would like to express its continued concern about the implementation of the new Basel III capital conservation buffer rules for community banks in the United States. Specifically, the unique detrimental impact the buffer will have on the nation’s 2,000 banks structured as Subchapter S corporations is an immediate concern that needs to be remedied.

The community bank model is unique and represents a critical provider of banking services to many rural and underserved communities across the country. The continued progression of harmful bank regulation like the buffer is an immediate threat to the ability of many community banks to operate without undergoing a change in corporate structure, capital adequacy level, or business model. I urge you to revisit the recent decision by your agency to subject community banks to the buffer and work with the other regulatory agencies to develop a common sense solution that does not bring disproportionate harm to the nation’s community banks.

The buffer forces community banks to compete at a great disadvantage against the largest too-big-to-fail financial institutions and tax-exempt credit unions. These subsidized financial institutions operate at reduced funding costs when compared to community banks either because they are flagged as critical to the stability of the global financial system and therefore too big to fail or they are not subject to taxation on income. Community banks operate with the understanding that losses are privatized, income taxes must be paid, and regulatory capital levels must be maintained at healthy levels all while providing critical access to financial services in local communities.

Notably, the buffer brings considerable harm to community banks organized as Subchapter S corporations under the Internal Revenue Code. These institutions are legally structured as corporations but are pass-through entities for income taxation. Bank profits are automatically taxed at the individual shareholder level. The buffer’s prohibition or limitations on the payment of dividends to shareholders in certain situations presents the real fear that a shareholder may be subject to income tax on community bank taxable earnings that cannot be distributed to cover the associated tax obligation due. The potential for this scenario will severely hamper future capital formation at Subchapter S community banks as shareholders will contemplate the risk of not being able to cover their income tax liabilities. Additionally, differences in regulatory, accounting, and taxable income amplify the negative impact of the buffer by penalizing certain high-quality assets like mortgage servicing rights. The tax reporting requirements for these assets when coupled with the buffer serve to decrease the marketability and succession planning of a Subchapter S community bank when trying to raise capital.

Ironically, the capital conservation buffer punishes the banks that are the most efficient users of regulatory capital and are most appropriately designed to maintain and rebuild common equity tier 1 retained earnings in times of severe economic stress. Subchapter S banks already face extreme capital raising restrictions in the number and type of shareholders they can have under the Internal Revenue Code. The buffer further jeopardizes capital raising options, is counterproductive, and undermines the goal of safety and soundness of the bank. The capital conservation buffer unfairly devalues many community bank franchises at a key point in the nation’s financial and economic recovery. Rapid consolidation of the banking sector will harm both consumer and business borrowers, especially in small, rural, and underserved communities.

Basel III was never intended to trip up small community banks and was created to apply to the largest, most complex, internationally active banks. ICBA requests that the capital conservation buffer be remedied to at least allow the income tax liability of Subchapter S corporation banks to be met on its profits just as C corporation banks are able to cover their tax liabilities directly out of income. ICBA requests that the capital conservation buffer be modified for community banks to allow them to distribute at least 35% of their reported net income for a reporting period. While not a perfect alternative, this solution allows community banks including Subchapter S community banks to be able to provide some level of relief to their shareholders when taxes are due.

ICBA appreciates your attention to this immediate concern and the harm that will be experienced without your further action. If you have any questions or would like additional information, please do not hesitate to contact me at (202) 659-8111.

Sincerely,

Camden R. Fine

President and CEO

Independent Community Bankers of

America

Washington, DC

FOOTNOTE

1 The Independent Community Bankers of America®, the nation’s voice for nearly 7,000 community banks of all sizes and charter types, is dedicated exclusively to representing the interests of the community banking industry and its membership through effective advocacy, best-in-class education and high-quality products and services.

With nearly 5,000 members, representing more than 24,000 locations nationwide and employing more than 300,000 Americans, ICBA members hold more than $1.2 trillion in assets, $1 trillion in deposits, and $750 billion in loans to consumers, small businesses and the agricultural community. For more information, visit ICBA’s website at www.icba.org.



JCT Releases Technical Explanation of Camp Exempt Group Reform Proposals.

The Joint Committee on Taxation has released a report dated February 26 providing a technical explanation of exempt organization reform proposals included in the Tax Reform Act of 2014 discussion draft, by House Ways and Means Committee Chair Dave Camp, R-Mich.

TECHNICAL EXPLANATION OF THE TAX REFORM ACT OF 2014,

A DISCUSSION DRAFT OF THE CHAIRMAN OF

THE HOUSE COMMITTEE ON WAYS AND MEANS

TO REFORM THE INTERNAL REVENUE CODE:

TITLE V — TAX EXEMPT ENTITIES

Prepared by the Staff

of the

JOINT COMMITTEE ON TAXATION

February 26, 2014

JCX-16-14

CONTENTS

INTRODUCTION

TITLE V — TAX EXEMPT ENTITIES

A. Unrelated Business Income Tax

1. Clarification of unrelated business income tax treatment

of entities exempt from tax under section 501(a) (sec.

5001 of the discussion draft and sec. 511 of the Code)

2. Name and logo royalties treated as unrelated business

taxable income (sec. 5002 of the discussion draft and

secs. 512 and 513 of the Code)

3. Unrelated business taxable income separately computed

for each trade or business (sec. 5003 of the discussion

draft and sec. 512 of the Code)

4. Exclusion of research income from unrelated business

taxable income limited to publicly available research

(sec. 5004 of the discussion draft and sec. 512(b)(9) of

the Code)

5. Parity of charitable contribution limitation between

trusts and corporations for purposes of computing

unrelated business taxable income (sec. 5005 of the

discussion draft and sec. 512(b)(11) of the Code)

6. Increase in specific deduction against unrelated

business taxable income (sec. 5006 of the discussion

draft and sec. 512(b)(12) of the Code)

7. Repeal of exclusion from unrelated business taxable

income of gain or loss from the disposition of

distressed property (sec. 5007 of the discussion draft

and sec. 512(b)(16) of the Code)

8. Modify rules concerning qualified sponsorship payments

(sec. 5008 of the discussion draft and sec. 513(i) of

the Code)

B. Penalties

1. Increase in information return penalties (sec. 5101 of

the discussion draft and sec. 6652(c) of the Code)

2. Manager-level accuracy-related penalty on underpayment

of unrelated business income tax (sec. 5102 of the

discussion draft and secs. 6662 and 6662A of the Code)

C. Excise Taxes

1. Modification of taxes on excess benefit transactions

(intermediate sanctions) (sec. 5201 of the discussion

draft and sec. 4958 of the Code)

2. Modification of taxes on self-dealing (sec. 5202 of the

discussion draft and sec. 4941 of the Code)

3. Excise tax on failure to distribute within five years a

contribution to a donor advised fund (sec. 5203 of the

discussion draft and new sec. 4968 of the Code)

4. Simplification of excise tax on private foundation

investment income (sec. 5204 of the discussion draft and

sec. 4940 of the Code)

5. Repeal of exception for private operating foundation

failure to distribute income (sec. 5205 of the

discussion draft and sec. 4942 of the Code)

6. Excise tax based on investment income of private

colleges and universities (sec. 5206 of the discussion

draft and new sec. 4969 of the Code)

D. Requirements for Organizations Exempt From Tax

1. Repeal of tax-exempt status for professional sports

leagues (sec. 5301 of the discussion draft and sec.

501(c)(6) of the Code)

2. Repeal of exemption from tax for certain insurance

companies and CO-OP health insurance issuers (sec. 5302

of the discussion draft and sec. 501 of the Code)

3. In-State requirement for certain tax-exempt workmen’s

compensation insurance organizations (sec. 5303 of the

discussion draft and sec. 501(c)(27) of the Code)

4. Repeal of Type II and Type III supporting organizations

(sec. 5304 of the discussion draft and sec. 509(a)(3) of

the Code)

INTRODUCTION

This document1 provides a technical explanation of Title V of the Tax Reform Act of 2014, a discussion draft2 prepared by the Chairman of the House Committee on Ways and Means that proposes to reform the Internal Revenue Code. Title V of the proposal addresses tax reform of tax exempt entities.

TITLE V — TAX EXEMPT ENTITIES

A. Unrelated Business Income Tax

PRESENT LAW

Tax exemption for certain organizations

Section 501(a) exempts certain organizations from Federal income tax. Such organizations include: (1) tax-exempt organizations described in section 501(c) (including among others section 501(c)(3) charitable organizations and section 501(c)(4) social welfare organizations); (2) religious and apostolic organizations described in section 501(d); and (3) trusts forming part of a pension, profit-sharing, or stock bonus plan of an employer described in section 401(a).

Section 115 excludes from gross income certain income of entities that perform an essential government function. The exemption applies to: (1) income derived from any public utility or the exercise of any essential governmental function and accruing to a State or any political subdivision thereof, or the District of Columbia; or (2) income accruing to the government of any possession of the United States, or any political subdivision thereof.

Unrelated business income tax, in general

An exempt organization generally may have revenue from four sources: contributions, gifts, and grants; trade or business income that is related to exempt activities (e.g., program service revenue); investment income; and trade or business income that is not related to exempt activities. The Federal income tax exemption generally extends to the first three categories, and does not extend to an organization’s unrelated trade or business income. In some cases, however, the investment income of an organization is taxed as if it were unrelated trade or business income.3

The unrelated business income tax (“UBIT”) generally applies to income derived from a trade or business regularly carried on by the organization that is not substantially related to the performance of the organization’s tax-exempt functions.4 An organization that is subject to UBIT and that has $1,000 or more of gross unrelated business taxable income must report that income on Form 990-T (Exempt Organization Business Income Tax Return).

Most exempt organizations may operate an unrelated trade or business so long as the organization remains primarily engaged in activities that further its exempt purposes. Therefore, an organization may engage in a substantial amount of unrelated business activity without jeopardizing exempt status. A section 501(c)(3) (charitable) organization, however, may not operate an unrelated trade or business as a substantial part of its activities.5 Therefore, the unrelated trade or business activity of a section 501(c)(3) organization must be insubstantial.

Organizations subject to tax on unrelated business income

Most exempt organizations are subject to the tax on unrelated business income. Specifically, organizations subject to the unrelated business income tax generally include: (1) organizations exempt from tax under section 501(a), including organizations described in section 501(c) (except for U.S. instrumentalities and certain charitable trusts);6 (2) qualified pension, profit-sharing, and stock bonus plans described in section 401(a);7 and (3) certain State colleges and universities.8

Exclusions from Unrelated Business Taxable Income

In general

Certain types of income are specifically exempt from unrelated business taxable income, such as dividends, interest, royalties, and certain rents,9 unless derived from debt-financed property or from certain 50-percent controlled subsidiaries.10 Other exemptions from UBIT are provided for activities in which substantially all the work is performed by volunteers, for income from the sale of donated goods, and for certain activities carried on for the convenience of members, students, patients, officers, or employees of a charitable organization. In addition, special UBIT provisions exempt from tax activities of trade shows and State fairs, income from bingo games, and income from the distribution of low-cost items incidental to the solicitation of charitable contributions. Organizations liable for tax on unrelated business taxable income may be liable for alternative minimum tax determined after taking into account adjustments and tax preference items.

Research income

Certain income derived from research activities of exempt organizations is excluded from unrelated business taxable income. For example, income derived from research performed for the United States, a State, and certain agencies and subdivisions is excluded.11 Income from research performed by a college, university or hospital for any person also is excluded.12 Finally, if an organization is operated primarily for purposes of carrying on fundamental research the results of which are freely available to the general public, all income derived by research performed by such organization for any person, not just income derived from research available to the general public, is excluded.13

Gain or loss from disposition of real property acquired from financial institutions in conservatorship or receivership

Section 512(b)(16) provides an exclusion from unrelated business taxable income for income from sales of property held for sale in the ordinary course of a trade or business by excluding gains and losses from the sale, exchange, or other disposition of certain real property and mortgages acquired from financial institutions that are in conservatorship or receivership. The exclusion is limited to properties designated by the taxpayer within nine months of acquisition as property held for sale, except that not more than one-half of property acquired in a single transaction may be so designated. The disposition generally must occur within 30 months of the date of acquisition.

Specific deduction against unrelated business taxable income

In computing unrelated business taxable income, an exempt organization may take a specific deduction of $1,000. This specific deduction may not be used to create a net operating loss that will be carried back or forward to another year.14

In the case of a diocese, province or religious order, or a convention or association of churches, a specific deduction is allowed with respect to each parish, individual church, district, or other local unit. The specific deduction is equal to the lower of $1,000 or the gross income derived from any unrelated trade or business regularly carried on by the local unit.15

Deduction against unrelated business taxable income for charitable contributions

In computing unrelated business taxable income, an exempt organization may deduct certain charitable contributions made to other organizations (generally, contributions that satisfy the requirements of section 170), whether or not directly connected with the carrying on of the trade or business. For most organizations subject to that tax on unrelated business income — i.e., those described in section 511(a) — the charitable contribution deduction is limited to 10 percent of the unrelated business taxable income, computed without regard to the deduction of charitable contributions.16 A separate rule applies in determining the charitable contribution deduction for charitable trusts described in section 511(b).17 For such trusts, the charitable contribution percentage limitations under section 170(b)(1)(A) and 170(b)(1)(B) generally apply in determining the trust’s charitable contribution deduction, but with the percentage limits being determined with respect to the trust’s unrelated business taxable income instead of its adjusted gross income.18

Qualified sponsorship payments

Under section 513(i), the activity of soliciting or receiving qualified sponsorship payments by a tax-exempt organization is not an unrelated trade or business. As a result, such payments are exempt from UBIT.

“Qualified sponsorship payments” are defined as any payment made by a person engaged in a trade or business with respect to which the person will receive no substantial return benefit other than the use or acknowledgment of the name or logo (or product lines) of the person’s trade or business in connection with the organization’s activities.19 Such a use or acknowledgment does not include advertising of such person’s products or services — meaning qualitative or comparative language, price information or other indications of savings or value, or an endorsement or other inducement to purchase, sell, or use such products or services.20 Thus, for example, if, in return for receiving a sponsorship payment, an organization promises to use the sponsor’s name or logo in acknowledging the sponsor’s support for an educational or fundraising event conducted by the organization, such payment will not be subject to UBIT. In contrast, if the organization provides advertising of a sponsor’s products, the payment made to the organization by the sponsor in order to receive such advertising will be subject to UBIT (provided that the other requirements for UBIT liability are satisfied).

The term “qualified sponsorship payment” does not include any payments where the amount of such payment is contingent, by contract or otherwise, upon the level of attendance at an event, broadcast ratings, or other factors indicating the degree of public exposure to an activity.21 The term also excludes payments that entitle the payor to the use or acknowledgment of the payor’s trade or business name or logo (or product lines) in tax-exempt organization periodicals.22 Such payments are outside the qualified sponsorship payment provision’s safe-harbor exclusion, and, therefore, are governed by generally applicable rules that determine whether the payment is subject to UBIT. Thus, for example, payments that entitle the payor to a depiction of the payor’s name or logo in a tax-exempt organization periodical may or may not be subject to UBIT depending on the application of rules regarding periodical advertising and nontaxable donor recognition. For this purpose, the term “periodical” means regularly scheduled and printed material published by (or on behalf of) the payee organization that is not related to and primarily distributed in connection with a specific event conducted by the payee organization. In addition, the safe-harbor exclusion for qualified sponsorship payments does not apply to payments made in connection with “qualified convention or trade show activities,” as defined in section 513(d)(3).23

To the extent that a portion of a payment would (if made as a separate payment) be a qualified sponsorship payment, such portion of the payment is treated as a separate payment.24

Operation of multiple unrelated trades or businesses

An organization determines its unrelated business taxable income by subtracting from its gross unrelated business income deductions directly connected with the unrelated trade or business.25 Under regulations, in determining unrelated business taxable income, an organization that operates multiple unrelated trades or businesses aggregates income from all such activities and subtracts from the aggregate gross income the aggregate of deductions.26 As a result, an organization may use a loss from one unrelated trade or business to offset gain from another, thereby reducing total unrelated business taxable income.

1. Clarification of unrelated business income tax treatment of entities exempt from tax under section 501(a) (sec. 5001 of the discussion draft and sec. 511 of the Code)

Description of Proposal

The proposal clarifies that an organization does not fail to be subject to tax on its unrelated business income as an organization exempt from tax under section 501(a) solely because the organization also is exempt, or excludes amounts from gross income, by reason of another provision of the Code. For example, if an organization is described in section 401(a) (and thus is exempt from tax under section 501(a)) and its income also is described in section 115 (relating to the exclusion from gross income of certain income derived from the exercise of an essential governmental function), its governmental status under section 115 does not cause it to be exempt from tax on its unrelated business income.

Effective Date

The proposal is effective for taxable years beginning after December 31, 2014.

2. Name and logo royalties treated as unrelated business taxable income (sec. 5002 of the discussion draft and secs. 512 and 513 of the Code)

Description of Proposal

The proposal modifies the UBIT treatment of the licensing of an organization’s name or logo generally to subject royalty income derived from such a license to UBIT. Specifically, the proposal amends section 513 (regarding unrelated trades or businesses) to provide that any sale or licensing by an organization of any name or logo of the organization (including any trademark or copyright related to a name or logo) is treated as an unrelated trade or business that is regularly carried on by the organization. In addition, the proposal amends section 512 (regarding unrelated business taxable income) to provide that income derived from any such licensing of a name or logo of the organization is included in the organization’s gross unrelated business taxable income, notwithstanding the provisions of section 512 that otherwise exclude certain types of passive income (including royalties) from unrelated business taxable income.27

Effective Date

The proposal is effective for taxable years beginning after December 31, 2014.

3. Unrelated business taxable income separately computed for each trade or business (sec. 5003 of the discussion draft and sec. 512 of the Code)

Description of Proposal

For an organization with more than one unrelated trade or business, the proposal requires that unrelated business taxable income first be computed separately with respect to each trade or business and without regard to the specific deduction generally allowed under section 512(b)(12). The organization’s unrelated business taxable income for a taxable year is the sum of the amounts (not less than zero) computed for each separate unrelated trade or business, less the specific deduction allowed under section 512(b)(12). A net operating loss deduction is allowed only with respect to a trade or business from which the loss arose.

The result of the proposal is that a loss from one trade or business for a taxable year may not be used to offset gain from a different unrelated trade or business for the same taxable year. The proposal generally does not, however, prevent an organization from using a loss from one taxable year to offset gain from the same unrelated trade or business activity in another taxable year, where appropriate.

Effective Date

The proposal generally is effective for taxable years beginning after December 31, 2014.

Special transition rules apply for net operating loss carryforwards and carrybacks. In the case of a net operating loss arising in a taxable year beginning before January 1, 2015, and carried over to a year beginning on or after such date, the new rule that allows a net operating loss deduction only with respect to the trade or business from which the loss arose shall not apply. In the case of a net operating loss arising in a taxable year beginning after December 31, 2014, and carried back to a taxable year beginning on or before such date, the net operating loss deduction is allowed only with respect to the trade or business from which the loss arose.

4. Exclusion of research income from unrelated business taxable income limited to publicly available research (sec. 5004 of the discussion draft and sec. 512(b)(9) of the Code)

Description of Proposal

The proposal modifies the exclusion of income from research performed by an organization operated primarily for purposes of carrying on fundamental research the results of which are freely available to the general public (section 512(b)(9)). Under the proposal, the organization may exclude from unrelated business taxable income under section 512(b)(9) only income from such fundamental research the results of which are freely available to the general public.

Effective Date

The proposal is effective for taxable years beginning after December 31, 2014.

5. Parity of charitable contribution limitation between trusts and corporations for purposes of computing unrelated business taxable income (sec. 5005 of the discussion draft and sec. 512(b)(11) of the Code)

Description of Proposal

The proposal modifies the charitable deduction percentage limit that applies under section 512(b)(11) in determining the charitable contribution deduction a charitable trust described in section 511(b) may take in computing its unrelated business taxable income to align with the limit that applies to a corporation. Under the proposal, the trust’s charitable contribution deduction is limited to 10 percent of its unrelated business taxable income computed without regard to the deduction for charitable contributions. The percentage limits of sections 170(b)(1)(A) and 170(b)(1)(B) no longer apply.

Effective Date

The proposal is effective for taxable years beginning after December 31, 2014.

6. Increase in specific deduction against unrelated business taxable income (sec. 5006 of the discussion draft and sec. 512(b)(12) of the Code)

Description of Proposal

The proposal increases the specific deduction described in section 512(b)(12) from $1,000 to $10,000 (or, in the case of a diocese, province or religious order, or a convention or association of churches, the lower of $10,000 or the gross income derived from any unrelated trade or business regularly carried on by each parish, individual church, district or other local unit).

Effective Date

The proposal is effective for taxable years beginning after December 31, 2014.

7. Repeal of exclusion from unrelated business taxable income of gain or loss from the disposition of distressed property (sec. 5007 of the discussion draft and sec. 512(b)(16) of the Code)

Description of Proposal

The proposal repeals the exclusion from unrelated business taxable income of gain or loss from the disposition of real property acquired from financial institutions in conservatorship or receivership (section 512(b)(16)).

Effective Date

The proposal is effective for property acquired after December 31, 2014.

8. Modify rules concerning qualified sponsorship payments (sec. 5008 of the discussion draft and sec. 513(i) of the Code)

Description of Proposal

The proposal modifies the definition of “qualified sponsorship payment” to exclude from the permitted substantial return benefit the use or acknowledgment of the sponsor’s product lines. In other words, if in exchange for a payment from a sponsor the exempt organization uses or acknowledges the sponsor’s product lines, the payment is not a qualified sponsorship payment. The proposal makes a conforming change (regarding the use or acknowledgment of product lines) to the exclusion from the qualified sponsorship payment safe-harbor for periodicals.

The proposal includes a special rule for an event with respect to which an organization receives an aggregate amount of sponsorship payments greater than $25,000. A payment with respect to such an event is not a qualified sponsorship payment unless any use or acknowledgment of the sponsor’s name or logo only appears with, and in substantially the same manner as, the names of a significant portion of the other donors to the organization with respect to such event. A significant portion of the donors to the organization with respect to an event is determined by taking into account both the total number of donors to the event and the amounts contributed to the event by such donors, but in no event shall fewer than two other donors be treated as a significant portion of other donors.

Effective Date

The proposal is effective for taxable years beginning after December 31, 2014.

B. Penalties

1. Increase in information return penalties (sec. 5101 of the discussion draft and sec. 6652(c) of the Code)

Present Law

In general

The Code imposes penalties in the event an exempt organization fails to make certain required disclosures or file required information returns.28 The penalties are not imposed if it is shown that a failure was due to reasonable cause.29 In certain situations, a penalty may also be imposed against certain persons who fail to make such a filing. Solely for this purpose, the term “person” means an officer, director, trustee, employee, or other individual who is under a duty to perform the act in respect to which the failure occurs.30

Failure to file an exempt organization or political organization annual information return (secs. 6652(c)(1)(A) and (B))

In the event of a failure by an exempt organization or political organization to file a return required under section 6033(a)(1) or 6012(a)(6), respectively, or a failure to include any of the information required to be shown on such a return or to show the correct information, section 6652(c)(1)(A) imposes a penalty on the exempt organization of $20 for each day during which the failure continues. The maximum penalty with respect to any one return is limited to the lesser of $10,000 or five percent of the gross receipts of the organization for the year. For organizations with gross receipts exceeding $1 million for the year, the daily penalty amount is increased from $20 to $100, and the maximum penalty is $50,000.

In the event an organization is subject to a penalty under section 6652(c)(1)(A) (described in the preceding paragraph), the Secretary may make a written demand on the organization specifying a reasonable future date by which the return shall be filed or the information furnished. If any person fails to comply with such a demand on or before the date specified in the demand, section 6652(c)(1)(B) imposes a penalty of $10 for each day after the expiration of the time specified in the demand during which the failure continues. The maximum penalty that may be imposed on all persons with respect to any one return is limited to $5,000.

Failure to make annual returns available for public inspection (sec. 6652(c)(1)(C))

Section 6104(d) generally requires certain organizations exempt from tax to make available for public inspection their three most recent annual information returns (Forms 990) and application for tax exemption. Section 527(j) requires certain political organizations to make disclosures of expenditures and contributions. In the event of a failure to comply with section 6104(d) with respect to an annual information return or the disclosure requirements of section 527(j), section 6652(c)(1)(C) imposes on any person failing to meet the requirements a penalty of $20 for each day during which the failure continues. The maximum penalty on all persons for failures with respect to any one return or report is limited to $10,000.

Failure to make application for exemption or notice of status available for public inspection (sec. 6652(c)(1)(D))

In the event of a failure to comply with 6104(d) with respect to any exempt status application materials or notice materials (as defined in section 6104(d)), section 6652(c)(1)(D) imposes on any person failing to meet the requirements a penalty of $20 for each day during which the failure continues.

Charitable trust returns; exempt organizations liquidating, dissolving, or terminating (sec. 6652(c)(2))

In the case of a failure to file a return required under section 6034(b) (relating to certain trusts other than split-interest trusts) or 6043(b) (relating to terminations, etc. of exempt organizations), section 6652(c)(2)(A) imposes a penalty on the organization or trust failing to file equal to $10 per day for each day during which the failure continues (up to a maximum of $5,000 per return).

In the event a penalty is imposed on the organization or trust under section 6652(c)(2)(A), the Secretary may make a written demand on the organization or trust specifying a reasonable future date by which a filing shall be made. If any person fails to comply with such a demand on or before the date specified in the demand, section 6652(c)(2)(B) imposes a penalty of $10 for each day after the expiration of the time specified in the demand during with the failure continues. The maximum penalty that may be imposed on all persons with respect to any one return is limited to $5,000.

In the case of a failure to file a return under section 6034(a) by a charitable split-interest trust, section 6652(c)(2)(C) provides that the penalties generally applicable to the failure to file an exempt organization return (under section 6652(c)(2)(A)) will apply, except that, in general (1) the five-percent limitation shall not apply, and (2) the increase in the penalty from $20 to $100 (and the maximum penalty from $10,000 to $50,000) shall apply to trusts with gross income in excess of $250,000. In addition to any penalty on the trust, if the person required to file the return knowingly fails to file it, the above penalty also is imposed on the person, who is personally liable for the penalty.

Failure to file a reportable transaction disclosure (sec. 6652(c)(3))

Section 6033(a)(2) generally requires an exempt organization to file a disclosure if it is a party to any prohibited tax shelter transaction within the meaning of section 4965(e) . In the case of a failure to file such a disclosure, section 6652(c)(3)(A) imposes a penalty on the organization (or, in some cases, on an entity manager) of $100 for each day during which the failure continues (up to a maximum of $50,000 per return).

In the event a penalty is imposed under section 6652(c)(3)(A), the Secretary may make a written demand on an entity or manager specifying a reasonable future date by which a filing shall be made. If any entity or manager fails to comply with such a demand on or before the date specified in the demand, section 6652(c)(3)(B) imposes a penalty of $100 for each day after the expiration of the time specified in the demand during with the failure continues. The maximum penalty that may be imposed on all entities and managers with respect to any one disclosure is limited to $10,000.

Description of Proposal

As described below, the proposal doubles each of the daily penalty amounts described above.

Failure to file an exempt organization or political organization annual information return (secs. 6652(c)(1)(A) and (B))

The proposal increases the daily penalties under section 6652(c)(1)(A) from $20 to $40 and from $100 to $200. The daily penalty on managers under section 6652(c)(1)(B) is increased from $10 to $20.

Failure to make annual returns available for public inspection (sec. 6652(c)(1)(C))

The proposal increases the daily penalty under section 6652(c)(1)(C) from $20 to $40.

Failure to make application for exemption or notice of status available for public inspection (sec. 6652(c)(1)(D))

The proposal increases the daily penalty under section 6652(c)(1)(D) from $20 to $40.

Charitable trust returns; exempt organizations liquidating, dissolving, or terminating (sec. 6652(c)(2))

The proposal increases the daily penalties under sections 6652(c)(2)(A), (B), and (C)(ii) from $10 to $20 and from $100 to $200.

Failure to file a reportable transaction disclosure (sec. 6652(c)(3))

The proposal increases the daily penalties under sections 6652(c)(3)(A) and (B) from $100 to $200.

Effective Date

The proposal is effective for information returns required to be filed on or after January 1, 2015.

2. Manager-level accuracy-related penalty on underpayment of unrelated business income tax (sec. 5102 of the discussion draft and secs. 6662 and 6662A of the Code)

Present Law

General accuracy-related penalty (sec. 6662)

An accuracy-related penalty under section 6662 applies to the portion of any underpayment that is attributable to (1) negligence, (2) any substantial understatement of income tax, (3) any substantial valuation misstatement, (4) any substantial overstatement of pension liabilities, or (5) any substantial estate or gift tax valuation understatement. If the correct income tax liability exceeds that reported by the taxpayer by the greater of 10 percent of the correct tax or $5,000 (or, in the case of corporations, by the lesser of (a) 10 percent of the correct tax (or $10,000 if greater) or (b) $10 million), then a substantial understatement exists and a penalty may be imposed equal to 20 percent of the underpayment of tax attributable to the understatement.31 Except in the case of tax shelters,32 the amount of any understatement is reduced by any portion attributable to an item if (1) the treatment of the item is supported by substantial authority, or (2) facts relevant to the tax treatment of the item were adequately disclosed and there was a reasonable basis for its tax treatment. The Secretary may prescribe a list of positions that the Secretary believes do not meet the requirements for substantial authority under this provision.

The section 6662 penalty generally is abated (even with respect to tax shelters) in cases in which the taxpayer can demonstrate that there was “reasonable cause” for the underpayment and that the taxpayer acted in good faith.33 The relevant regulations provide that reasonable cause exists where the taxpayer “reasonably relies in good faith on [a professional] tax advisor’s analysis of the pertinent facts and authorities [that] . . . unambiguously states that the tax advisor concludes that there is a greater than 50-percent likelihood that the tax treatment of the item will be upheld if challenged” by the IRS.34

With certain exceptions, section 6662 does not apply to any portion of an underpayment that is attributable to a reportable transaction understatement on which a penalty is imposed under section 6662A (discussed below).35

Accuracy-related penalty on understatements with respect to reportable transactions (sec. 6662A)

A separate accuracy-related penalty under section 6662A applies to “listed transactions” and to other “reportable transactions” with a significant tax avoidance purpose. The penalty rate and defenses available to avoid the penalty vary depending on whether the transaction was adequately disclosed.

Regulations under section 6011 require a taxpayer to disclose with its tax return certain information with respect to each “reportable transaction” in which the taxpayer participates.36 A reportable transaction is defined as one that the Secretary determines is required to be disclosed because it is determined to have a potential for tax avoidance or evasion.37 There are five categories of reportable transactions: listed transactions, confidential transactions, transactions with contractual protection, certain loss transactions and transactions of interest.38 Transactions falling under the first and last categories of reportable transactions are transactions that are described in publications issued by the Treasury Department and identified as one of these types of transaction. A listed transaction is defined as a reportable transaction that is the same as, or substantially similar39 to, a transaction specifically identified by the Secretary as a tax avoidance transaction for purposes of the reporting disclosure requirements.40

Description of Proposal

In the case of a substantial understatement of income tax under section 6662 that is attributable to the unrelated business income tax of an organization imposed under section 511, the proposal imposes a new penalty on any manager of such organization. The tax equals five percent of the underpayment attributable to such understatement. For this purpose, the term “manager” includes any officer, director, trustee, employee, or other individual who is under a duty to perform an act in respect of which the underpayment occurs. If more than one person is liable for the manager-level penalty with respect to an understatement, all such persons are jointly and severally liable with respect to such understatement. The maximum amount of manager-level penalty that may be imposed with respect to an understatement is $20,000.

In the case of any portion of a reportable understatement of unrelated business income tax of an organization imposed under section 511 to which the accuracy-related penalty under section 6662A (relating to reportable transactions) applies, the proposal imposes a new penalty on any manager of such organization. The penalty equals 10 percent of the portion of the underpayment to which the reportable transaction understatement relates. For this purpose, the term “manager” includes any officer, director, trustee, employee, or other individual who is under a duty to perform an act in respect of which the underpayment occurs. If more than one person is liable for the manager-level penalty with respect to a reportable transaction understatement, all such persons are jointly and severally liable with respect to such understatement. The maximum amount of manager-level penalty that may be imposed with respect to a reportable transaction understatement is $40,000.

The proposal includes a conforming change regarding the coordination of penalties under sections 6662 and 6662A (i.e., the rule under which section 6662 generally does not apply to any portion of an underpayment which is attributable to a reportable transaction understatement on which a penalty is imposed under present law). The conforming change is intended to clarify that this coordination rule of present law also applies to the new manager penalties added by the proposal.

Effective Date

The proposal is effective for taxable years beginning after December 31, 2014.

C. Excise Taxes

1. Modification of taxes on excess benefit transactions (intermediate sanctions) (sec. 5201 of the discussion draft and sec. 4958 of the Code)

Present Law

Excess benefit transactions (“intermediate sanctions”)

The Code imposes excise taxes on excess benefit transactions between disqualified persons and charitable organizations (other than private foundations) or social welfare organizations (as described in section 501(c)(4)).41 The excess benefit transaction tax commonly is referred to as “intermediate sanctions.”42 An excess benefit transaction generally is a transaction in which an economic benefit is provided, directly or indirectly, by a charitable or social welfare organization to or for the use of a disqualified person if the value of the economic benefit provided exceeds the value of the consideration (including the performance of services) received for providing such benefit. The excise tax is imposed on any such excess.

Disqualified persons

Disqualified persons generally include: (1) persons who were, at any time during the five-year period ending on the date of the transaction, in a position to exercise substantial influence over the affairs of the organization (including officers and directors); (2) a member of the family of such a person; and (3) certain 35-percent or more controlled entities.43

Special rules apply with respect to charities that are sponsoring organizations of donor advised funds. For such organizations, the term “disqualified person” also includes: (1) donors and certain other persons appointed by a donor to provide advice with respect to the fund (donor advisors); (2) investment advisors; and (3) members of the family and certain 35-percent or more controlled entities of a person described in (1) or (2).44 An investment advisor is a person (other than an employee of the sponsoring organization) compensated by the organization for managing the investment of, or providing investment advice with respect to, assets maintained in donor advised funds owned by the organization.45

Rebuttable presumption of reasonableness

Under the intermediate sanctions regulations, in certain cases an exempt organization may avail itself of a rebuttable presumption with respect to compensation arrangements and property transfers. Payments under a compensation arrangement are presumed to be reasonable, and a transfer of property, or the right to use property, is presumed to be at fair market value, if: (1) the arrangement or terms of transfer are approved in advance by an authorized body of the organization (as defined below) composed entirely of individuals who do not have a conflict of interest with respect to the arrangement or transfer; (2) the authorized body obtained and relied upon appropriate data as to comparability prior to making its determination; and (3) the authorized body adequately documented the basis for its determination concurrently with making that determination.46 If these requirements are satisfied, the IRS may overcome the presumption of reasonableness if it develops sufficient contrary evidence to rebut the probative value of the comparability data relied upon by the authorized body.47

An authorized body is defined as: (1) the governing body of the organization; (2) a committee of the governing body, which may be composed of any individuals permitted under State law to serve on such a committee, to the extent that the committee is permitted by State law to act on behalf of the governing body; or (3) to the extent permitted by State law, other parties authorized by the governing body of the organization to act on its behalf by following procedures specified by the governing body in approving compensation arrangements or property transfers.48

In general, an authorized body has appropriate data as to comparability if, given the knowledge and expertise of its members, it has information sufficient to determine whether the arrangement is reasonable in its entirety or the transfer is at fair market value.49 In the case of compensation, relevant information includes, but is not limited to, compensation levels paid by similarly situated organizations, both taxable and tax-exempt, for functionally comparable positions; the availability of similar services in the geographic area of the applicable tax-exempt organization; current compensation surveys compiled by independent firms; and actual written offers from similar institutions competing for the services of the disqualified person. In the case of property, relevant information includes, but is not limited to, current independent appraisals of the value of all property to be transferred, and offers received as part of an open and competitive bidding process. For organizations with annual gross receipts (including contributions) of less than $1 million, the authorized body is considered to have appropriate data as to comparability if it has data on compensation paid by three comparable organizations in the same or similar communities for similar services. There is no inference with respect to whether circumstances falling outside this safe harbor will meet the requirement with respect to the collection of appropriate data.50

In general, for a decision to be documented adequately, the written or electronic records of the authorized body must note: (1) the terms of the transaction that was approved and the date it was approved; (2) the members of the authorized body who were present during debate on the transaction that was approved and those who voted on it; (3) the comparability data obtained and relied upon by the authorized body and how the data was obtained; and (4) any actions taken with respect to consideration of the transaction by anyone who is otherwise a member of the authorized body but who had a conflict of interest with respect to the transaction.51

Amount of the excise tax

The excess benefit tax is imposed on the disqualified person and, in certain cases, on the organization’s managers, but is not imposed on the exempt organization.

 

An initial tax of 25 percent of the excess benefit amount is imposed on the disqualified person that receives the excess benefit. An additional tax on the disqualified person of 200 percent of the excess benefit applies if the violation is not corrected. A tax of 10 percent of the excess benefit (not to exceed $20,000 with respect to any excess benefit transaction) is imposed on an organization manager who knowingly participated in the excess benefit transaction, if the manager’s participation was willful and not due to reasonable cause, and if the initial tax was imposed on the disqualified person.52 If more than one person is liable for the tax on disqualified persons or on management, all such persons are jointly and severally liable for the tax.53

Standard for knowing violations

A manager participates in a transaction knowingly only if the manager: (1) has actual knowledge of sufficient facts indicating that, based solely upon those facts, such transaction would be an excess benefit transaction; (2) is aware that such a transaction under these circumstances may violate the provisions of Federal tax law governing excess benefit transactions; and (3) negligently fails to make reasonable attempts to ascertain whether the transaction is an excess benefit transaction, or the manager is in fact aware that it is such a transaction.54 The burden of proof in a Tax Court proceeding as to whether an organization manager (or foundation manager) acted knowingly is on the Secretary.55

Knowing does not mean having a reason to know.56 However, evidence tending to show that an organization manager has reason to know of a particular fact or particular rule is relevant in determining whether the manager had actual knowledge of such a fact or rule. Thus, for example, evidence tending to show that a manager has reason to know of sufficient facts indicating that, based solely upon such facts, a transaction would be an excess benefit transaction is relevant in determining whether the manager has actual knowledge of such facts.57

Participation by an organization manager is willful if it is voluntary, conscious, and intentional. No motive to avoid the restrictions of the law or the incurrence of any tax is necessary to make the participation willful. Participation by an organization manager is not willful if the manager does not know that the transaction in which the manager is participating is an excess benefit transaction.58 An organization manager’s participation is due to reasonable cause if the manager has exercised responsibility on behalf of the organization with ordinary business care and prudence.59

Special rules

An organization manager’s reliance on professional advice generally means that the manager has not knowingly participated in an excess benefit transaction. Under Treasury regulations, an organization manager’s participation in a transaction ordinarily is not considered knowing, even though the transaction subsequently is held to be an excess benefit transaction, to the extent that, after full disclosure of the factual situation to an appropriate professional, the organization manager relies on a reasoned written opinion of that professional with respect to elements of the transaction within the professional’s expertise. A written opinion is considered as reasoned even though it reaches a conclusion that is subsequently determined to be incorrect so long as the opinion addresses itself to the facts and the applicable standards. A written opinion is not considered to be reasoned if it does nothing more than recite the facts and express a conclusion. The absence of a written opinion of an appropriate professional with respect to a transaction does not, by itself, give rise to any inference that an organization manager participated in the transaction knowingly.

Appropriate professionals on whose written opinion an organization manager may rely, are: (1) legal counsel, including in-house counsel; (2) certified public accountants or accounting firms with expertise regarding the relevant tax law matters; and (3) independent valuation experts who hold themselves out to the public as appraisers or compensation consultants, perform the relevant valuations on a regular basis, are qualified to make valuations of the type of property or services involved, and include in the written opinion a certification that the three preceding requirements are met.60

An organization manager’s participation in a transaction ordinarily is not considered knowing even though the transaction subsequently is held to be an excess benefit transaction, if an appropriate authorized body that approved the transaction meets the requirements of the rebuttable presumption of reasonableness with respect to the transaction.61

Description of Proposal

Entity-level tax in the event of an excess benefit transaction

Under the proposal, if an initial tax is imposed on a disqualified person under the intermediate sanctions rules,62 the organization is subject to an excise tax equal to 10 percent of the excess benefit. No tax on the organization is imposed if the organization: (1) establishes that the minimum standards of due diligence (described below) were met with respect to the transaction; or (2) establishes to the satisfaction of the Secretary that other reasonable procedures were used to ensure that no excess benefit was provided.

Eliminate rebuttable presumption and establish due diligence procedures

The proposal eliminates the rebuttable presumption of reasonableness contained in the intermediate sanctions regulations. Under the proposal, the procedures that presently provide an organization with a presumption of reasonableness (i.e., advance approval by an authorized body, reliance upon data as to comparability, and adequate and concurrent documentation) generally will establish instead that an organization has performed the minimum standards of due diligence with respect to an arrangement or transfer involving a disqualified person. Satisfaction of these minimum standards will not result in a presumption of reasonableness with respect to the transaction.

Eliminate certain special rules for knowing behavior by organization managers

The proposal eliminates the special rule that provides that an organization manager’s participation ordinarily is not “knowing” for purposes of the intermediate sanctions excise taxes if the manager relied on professional advice. Although the proposal eliminates the special rule, whether an organization manager relies on professional advice is a relevant consideration in determining the manager knowingly participated in an excess benefit transaction.

The proposal also eliminates the special regulatory rule that provides that an organization manager ordinarily does not act knowingly for purposes of the excess benefit transaction excise tax if the organization has met the requirements of the rebuttable presumption procedure.

Treat investment advisors and athletic coaches as disqualified persons

The proposal modifies the definition of a disqualified person for purposes of the intermediate sanctions rules. First, a person who performs services as an athletic coach for the organization is treated as a disqualified person with respect to the organization. Second, the proposal (1) expands to all organizations that are subject to the intermediate sanctions rules the present-law rule that treats investment advisors to donor advised funds as disqualified persons, and (2) modifies the definition of investment advisor for this purpose. For all applicable tax-exempt organizations (including sponsoring organizations of donor advised funds), the term investment advisor means, with respect to an organization, any person compensated by the organization, and who is primarily responsible, for managing the investment of, or providing investment advice with respect to, assets of the organization.63 For a sponsoring organization of a donor advised fund, the term investment advisor also includes any person who is an investment advisor with respect to a sponsoring organization under present law, i.e., a person (other than an employee of the organization) compensated by such organization for managing the investment of, or providing investment advice with respect to, assets maintained in donor advised funds owned by the sponsoring organization.

Application of intermediate sanctions rules to section 501(c)(5) and section 501(c)(6) organizations

The proposal extends application of the section 4958 intermediate sanctions rules to tax-exempt organizations described in sections 501(c)(5) (labor and certain other organizations) and 501(c)(6) (business leagues and certain other organizations).

Effective Date

The proposal is effective for taxable years beginning after December 31, 2014.

2. Modification of taxes on self-dealing (sec. 5202 of the discussion draft and sec. 4941 of the Code)

Present Law

Self-dealing involving private foundations, in general

Excise taxes are imposed on acts of self-dealing between a disqualified person (as defined in section 4946) and a private foundation.64 In general, self-dealing transactions are any direct or indirect: (1) sale or exchange, or leasing, of property between a private foundation and a disqualified person, including transfers of property subject to a mortgage or lien that the private foundation assumes or that was put on the property by the disqualified person within 10 years of the transfer; (2) lending of money or other extension of credit between a private foundation and a disqualified person, except for no-interest loans by a disqualified person, the proceeds of which are used exclusively for charitable purposes; (3) the furnishing of goods, services, or facilities between a private foundation and a disqualified person, unless the goods, services, or facilities are (i) functionally related to the foundation’s exempt purposes and are provided to or by the foundation on the same basis as provided by the foundation or disqualified person to the general public, (ii) reasonable and necessary to performing exempt purposes and not excessive, or (iii) provided by disqualified person without charge; (4) the transfer to, or use by or for the benefit of, a disqualified person of the income or assets of the private foundation, unless the use or benefit is de minimis; and (5) certain payments of money or property to a government official. Leases provided by a disqualified person without charge to a private foundation, even if the foundation pays for maintenance, are permitted.

An initial tax of 10 percent of the amount involved with respect to an act of self-dealing is imposed on any disqualified person (other than a foundation manager acting only as such) who participates in the act of self-dealing. If such a tax is imposed, a five-percent tax of the amount involved is imposed on a foundation manager who participated in the act of self-dealing knowing it was such an act (and such participation was not willful and was due to reasonable cause) up to $20,000 per act. Such initial taxes may not be abated.65 Such initial taxes are imposed for each year in the taxable period, which begins on the date the act of self-dealing occurs and ends on the earliest of the date of mailing of a notice of deficiency for the tax, the date on which the tax is assessed, or the date on which correction of the act of self-dealing is completed. A government official (as defined in section 4946(c)) is subject to such initial tax only if the official participates in the act of self-dealing knowing it is such an act. If the act of self-dealing is not corrected, a tax of 200 percent of the amount involved is imposed on the disqualified person and a tax of 50 percent of the amount involved (up to $20,000 per act) is imposed on a foundation manager who refused to agree to correcting the act of self-dealing. Such additional taxes are subject to abatement.66

Standard for knowing violations

A foundation manager participates in a transaction knowingly only if the manager: (1) has actual knowledge of sufficient facts indicating that, based solely upon those facts, such transaction would be an act of self-dealing; (2) is aware that such an act under these circumstances may violate the provisions of Federal tax law governing self-dealing; and (3) negligently fails to make reasonable attempts to ascertain whether the transaction is an act of self-dealing, or the manager is in fact aware that it is such an act.67 The burden of proof in a Tax Court proceeding as to whether a foundation manager acted knowingly is on the Secretary.68

Knowing does not mean having a reason to know.69 However, evidence tending to show that a person has reason to know of a particular fact or rule is relevant in determining whether he had actual knowledge of such a fact or rule. Thus, for example, evidence tending to show that a person has reason to know of sufficient facts indicating that, based solely upon such facts, a transaction would be an act of self-dealing is relevant in determining whether the person has actual knowledge of such facts.70

Participation by a foundation manager is willful if it is voluntary, conscious, and intentional. No motive to avoid the restrictions of the law or the incurrence of any tax is necessary to make the participation willful. Participation by a foundation manager is not willful if the manager does not know that the transaction in which the manager is participating is an act of self-dealing.71 A foundation manager’s participation is due to reasonable cause if the manager has exercised responsibility on behalf of the organization with ordinary business care and prudence.72

Special rules

A foundation manager’s reliance on advice of legal counsel generally means that the manager has not knowingly participated in an act of self-dealing. Under Treasury regulations, a foundation manager’s participation in a transaction ordinarily is not considered knowing, even though the transaction subsequently is held to be an act of self-dealing, to the extent that, after full disclosure of the factual situation to legal counsel (including in-house counsel), the manager relies on a reasoned written legal opinion that an act is not an act of self-dealing. A written opinion is considered as reasoned even though it reaches a conclusion that is subsequently determined to be incorrect so long as the opinion addresses itself to the facts and the applicable law. A written opinion is not considered to be reasoned if it does nothing more than recite the facts and express a conclusion. The absence of advice of counsel with respect to a transaction does not, by itself, give rise to any inference that a foundation manager participated in the transaction knowingly.73

Description of Proposal

Entity level tax on private foundations

Under the proposal, if an initial tax is imposed on a disqualified person under the self-dealing rules74 the organization is subject to an excise tax equal to 2.5 percent (10 percent in the case of a payment of compensation) of the amount involved with respect to the act of self-dealing for each year (or part thereof) in the taxable period.

Eliminate special rule for knowing behavior by foundation managers

The proposal eliminates the special rule that provides that a foundation manager’s participation ordinarily is not “knowing” for purposes of the self-dealing excise taxes if the manager relied on advice of counsel. Although the proposal eliminates the special rule, whether a foundation manager relies on advice of counsel is a relevant consideration in determining whether the manager knowingly participated in an act of self-dealing.

Effective Date

The proposal is effective for taxable years beginning after December 31, 2014.

3. Excise tax on failure to distribute within five years a contribution to a donor advised fund (sec. 5203 of the discussion draft and new sec. 4968 of the Code)

Present Law

Overview

Some charitable organizations (including community foundations) establish accounts to which donors may contribute and thereafter provide nonbinding advice or recommendations with regard to distributions from the fund or the investment of assets in the fund. Such accounts are commonly referred to as “donor advised funds.” Donors who make contributions to charities for maintenance in a donor advised fund generally claim a charitable contribution deduction at the time of the contribution.75 Although sponsoring charities frequently permit donors (or other persons appointed by donors) to provide nonbinding recommendations concerning the distribution or investment of assets in a donor advised fund, sponsoring charities generally must have legal ownership and control of such assets following the contribution. If the sponsoring charity does not have such control (or permits a donor to exercise control over amounts contributed), the donor’s contributions may not qualify for a charitable deduction, and, in the case of a community foundation, the contribution may be treated as being subject to a material restriction or condition by the donor.

Statutory definition of a donor advised fund

The Code defines a “donor advised fund” as a fund or account that is: (1) separately identified by reference to contributions of a donor or donors; (2) owned and controlled by a sponsoring organization; and (3) with respect to which a donor (or any person appointed or designated by such donor (a “donor advisor”)) has, or reasonably expects to have, advisory privileges with respect to the distribution or investment of amounts held in the separately identified fund or account by reason of the donor’s status as a donor. All three prongs of the definition must be met in order for a fund or account to be treated as a donor advised fund.76

A “sponsoring organization” is an organization that: (1) is described in section 170(c)77 (other than a governmental entity described in section 170(c)(1), and without regard to any requirement that the organization be organized in the United States78); (2) is not a private foundation (as defined in section 509(a)); and (3) maintains one or more donor advised funds.79

Excess business holdings

The excess business holdings rules of section 4943 are applied to donor advised funds.80 In applying such rules, the term disqualified person means, with respect to a donor advised fund, a donor, donor advisor, a member of the family of a donor or donor advisor, or a 35 percent controlled entity of any such person.81

Excess benefit transactions, taxable distributions, and more than incidental benefit

Excess benefit transactions

Under section 4958, an excise tax is imposed in the event of an excess benefit transaction between a disqualified person (generally, an organization insider) and an applicable tax-exempt organization. An excess benefit transaction generally is a transaction in which an economic benefit is provided by an organization to or for the use of a disqualified person if the value of the economic benefit provided exceeds the value of consideration received in exchange for the benefit.82 Applicable tax-exempt organizations include section 501(c)(3) public charities and organizations described in section 501(c)(4) (generally, social welfare organizations) or 501(c)(29) (qualified nonprofit health insurance issuers).83

Section 4958 includes special excess benefit transaction rules for donor advised funds. Any grant, loan, compensation, or other similar payment from a donor advised fund to a person that with respect to such fund is a donor, donor advisor, or a person related84 to a donor or donor advisor automatically is treated as an excess benefit transaction under section 4958, with the entire amount paid to any such person treated as the amount of the excess benefit.85 Any amount repaid as a result of correcting an excess benefit transaction shall not be held in any donor advised fund.

In general, donors and donor advisors with respect to a donor advised fund (as well as persons related to a donor or donor advisor) are treated as disqualified persons under section 4958 with respect to transactions with such donor advised fund (though not necessarily with respect to transactions with the sponsoring organization more generally).86 An investment advisor (as well as persons related to the investment advisor) also is treated as a disqualified person under section 4958 with respect to the sponsoring organization.87 The term “investment advisor” means, with respect to any sponsoring organization, any person (other than an employee of the sponsoring organization) who is compensated by the sponsoring organization for managing the investment of, or providing investment advice with respect to, assets maintained in donor advised funds (including pools of assets all or part of which are attributed to donor advised funds) owned by the sponsoring organization.88

Taxable distributions

Certain distributions from a donor advised fund are subject to tax.89 A “taxable distribution” is any distribution from a donor advised fund to: (1) any natural person; or (2) to any other person for any purpose other than one specified in section 170(c)(2)(B) (generally, a charitable purpose) or, if for a charitable purpose, the sponsoring organization does not exercise expenditure responsibility with respect to the distribution in accordance with section 4945(h).90 The expenditure responsibility rules generally require that an organization exert all reasonable efforts and establish adequate procedures to see that the distribution is spent solely for the purposes for which it was made, to obtain full and complete reports from the distributee on how the funds are spent, and to make full and detailed reports with respect to such expenditures to the Secretary. A taxable distribution does not in any case include a distribution to (1) an organization described in section 170(b)(1)(A) (other than to a disqualified supporting organization); (2) the sponsoring organization of such donor advised fund; or (3) to another donor advised fund.91

In the event of a taxable distribution, an excise tax equal to 20 percent of the amount of the distribution is imposed against the sponsoring organization. In addition, an excise tax equal to five percent of the amount of the distribution is imposed against any manager of the sponsoring organization (defined in a manner similar to the term “foundation manager” under section 4945) who knowingly approved the distribution, not to exceed $10,000 with respect to any one taxable distribution. The taxes on taxable distributions are subject to abatement under generally applicable rules.92

More than incidental benefit

If a donor, a donor advisor, or a person related to a donor or donor advisor of a donor advised fund provides advice as to a distribution that results in any such person receiving, directly or indirectly, a more than incidental benefit, an excise tax equal to 125 percent of the amount of such benefit is imposed against the person who advised as to the distribution, and against the recipient of the benefit. Persons subject to the tax are jointly and severally liable for the tax. In addition, if a manager of the sponsoring organization (defined in a manner similar to the term “foundation manager” under section 4945) agreed to the making of the distribution, knowing that the distribution would confer a more than incidental benefit on a donor, a donor advisor, or a person related to a donor or donor advisor, the manager is subject to an excise tax equal to 10 percent of the amount of such benefit, not to exceed $10,000. The taxes on more than incidental benefit are subject to abatement under generally applicable rules.93

Reporting and disclosure

Each sponsoring organization must disclose on its information return: (1) the total number of donor advised funds it owns; (2) the aggregate value of assets held in those funds at the end of the organization’s taxable year; and (3) the aggregate contributions to and grants made from those funds during the year.94 In addition, when seeking recognition of its tax-exempt status, a sponsoring organization must disclose whether it intends to maintain donor advised funds.95

Description of Proposal

The proposal generally requires that contributions to donor advised funds be distributed for charitable purposes within a specified time period and imposes an excise tax in the event of a failure to make timely distributions. Specifically, in the case of a contribution that is held in a donor advised fund, the proposal imposes a tax equal to 20 percent of so much of the contribution as has not been distributed by the sponsoring organization in an eligible distribution before the beginning of the sixth (or any succeeding) taxable year beginning after the taxable year during which such contribution is made.96

An eligible distribution is a distribution to an organization described in section 170(b)(1)(A) (generally, to a public charity), other than a supporting organization described in section 509(a)(3) or another donor advised fund described in section 4966(d)(2). Distributions are treated as made from contributions (and any earnings attributable thereto) on a first-in, first-out basis.

The tax imposed by the proposal must be paid by the sponsoring organization.

Effective Date

The proposal generally is effective for contributions made after December 31, 2014. In the case of a contribution made before January 1, 2015, any portion of which (including any earnings attributable thereto) is held in a donor advised fund as of such date, such portion is treated as having been contributed on such date.

4. Simplification of excise tax on private foundation investment income (sec. 5204 of the discussion draft and sec. 4940 of the Code)

Present Law

Excise tax on the net investment income of private foundations

Under section 4940(a), private foundations that are recognized as exempt from Federal income tax under section 501(a) (other than exempt operating foundations) are subject to a two-percent excise tax on their net investment income. Net investment income generally includes interest, dividends, rents, royalties (and income from similar sources), and capital gain net income, and is reduced by expenses incurred to earn this income. The two-percent rate of tax is reduced to one-percent in any year in which a foundation exceeds the average historical level of its charitable distributions. Specifically, the excise tax rate is reduced if the foundation’s qualifying distributions (generally, amounts paid to accomplish exempt purposes)97 equal or exceed the sum of (1) the amount of the foundation’s assets for the taxable year multiplied by the average percentage of the foundation’s qualifying distributions over the five taxable years immediately preceding the taxable year in question, and (2) one percent of the net investment income of the foundation for the taxable year.98 In addition, the foundation cannot have been subject to tax in any of the five preceding years for failure to meet minimum qualifying distribution requirements in section 4942.

Private foundations that are not exempt from tax under section 501(a), such as certain charitable trusts, are subject to an excise tax under section 4940(b). The tax is equal to the excess of the sum of the excise tax that would have been imposed under section 4940(a) if the foundation were tax exempt and the amount of the tax on unrelated business income that would have been imposed if the foundation were tax exempt, over the income tax imposed on the foundation under subtitle A of the Code.

Private foundations are required to make a minimum amount of qualifying distributions each year to avoid tax under section 4942. The minimum amount of qualifying distributions a foundation has to make to avoid tax under section 4942 is reduced by the amount of section 4940 excise taxes paid.99

Exempt operating foundations

Exempt operating foundations are exempt from the tax on the net investment income of private foundations.100 Exempt operating foundations generally include organizations such as museums or libraries that devote their assets to operating charitable programs but have difficulty meeting the “public support” tests necessary not to be classified as a private foundation. To be an exempt operating foundation, an organization must: (1) be an operating foundation (as defined in section 4942(j)(3)); (2) be publicly supported for at least 10 taxable years; (3) have a governing body no more than 25 percent of whom are disqualified persons and that is broadly representative of the general public; and (4) have no officers who are disqualified persons.101

Description of Proposal

The proposal replaces the two rates of excise tax on tax-exempt private foundations with a single rate of tax of one percent. Thus, under the proposal, a tax-exempt private foundation generally is subject to an excise tax of one percent on its net investment income. A taxable private foundation is subject to an excise tax equal to the excess (if any) of the sum of the one-percent net investment income excise tax and the amount of the tax on unrelated business income (both calculated as if the foundation were tax-exempt), over the income tax imposed on the foundation. The proposal repeals the special reduced excise tax rate for private foundations that exceed their historical level of qualifying distributions.

The proposal also repeals the exception for exempt operating foundations from the tax on the net investment income of private foundations.

Effective Date

The proposal is effective for taxable years beginning after December 31, 2014.

5. Repeal of exception for private operating foundation failure to distribute income (sec. 5205 of the discussion draft and sec. 4942 of the Code)

Present Law

Public charities and private foundations

An organization qualifying for tax-exempt status under section 501(c)(3) is further classified as either a public charity or a private foundation. An organization may qualify as a public charity in several ways.102 Certain organizations are classified as public charities per se, regardless of their sources of support. These include churches, certain schools, hospitals and other medical organizations, certain organizations providing assistance to colleges and universities, and governmental units.103 Other organizations qualify as public charities because they are broadly publicly supported. First, a charity may qualify as publicly supported if at least one-third of its total support is from gifts, grants or other contributions from governmental units or the general public.104 Alternatively, it may qualify as publicly supported if it receives more than one-third of its total support from a combination of gifts, grants, and contributions from governmental units and the public plus revenue arising from activities related to its exempt purposes (e.g., fee for service income). In addition, this category of public charity must not rely excessively on endowment income as a source of support.105 A supporting organization, i.e., an organization that provides support to another section 501(c)(3) entity that is not a private foundation and meets certain other requirements of the Code, also is classified as a public charity.106

A section 501(c)(3) organization that does not fit within any of the above categories is a private foundation. In general, private foundations receive funding from a limited number of sources (e.g., an individual, a family, or a corporation).

The deduction for charitable contributions to private foundations is in some instances less generous than the deduction for charitable contributions to public charities. In addition, private foundations are subject to a number of operational rules and restrictions that do not apply to public charities.107

Tax on failure to distribute income by private nonoperating foundations

Private nonoperating foundations are required to pay out a minimum amount each year as qualifying distributions.108 In general, a qualifying distribution is an amount paid to accomplish one or more of the organization’s exempt purposes, including reasonable and necessary administrative expenses.109 Failure to pay out the minimum required amount results in an initial excise tax on the foundation of 30 percent of the undistributed amount. An additional tax of 100 percent of the undistributed amount applies if an initial tax is imposed and the required distributions have not been made by the end of the applicable taxable period.110 A foundation may include as a qualifying distribution the salaries, occupancy expenses, travel costs, and other reasonable and necessary administrative expenses that the foundation incurs in operating a grant program. A qualifying distribution also includes any amount paid to acquire an asset used (or held for use) directly in carrying out one or more of the organization’s exempt purposes and certain amounts set aside for exempt purposes.111

Private operating foundations

The tax on failure to distribute income does not apply to the undistributed income of a private foundation for any taxable year for which it is an operating foundation.112 Private operating foundations generally operate their own charitable programs directly, rather than serving primarily as a grantmaking entity.

Private operating foundations must satisfy several tests designed to distinguish them from nonoperating (grantmaking) foundations. First, an operating foundation generally must make qualifying distributions for the direct conduct of activities that are related to its exempt purpose (as opposed to making such distributions in the form of grants to other charities) equal to 85 percent of the lesser of its adjusted net income or its minimum investment return, each as defined under section 4942.113 In addition, an operating foundation must satisfy one of the following three alternative tests: (1) an asset test, under which substantially more than half of the organization’s assets (generally, 65 percent) are devoted to the direct conduct of exempt activities or to functionally related businesses; (2) an endowment test, under which the organization normally makes qualifying distributions for the direct conduct of activities related to its exempt purpose in an amount not less than two-thirds of its minimum investment return; or (3) a support test, under which the organization must meet certain measures to show that it receives public support.114

Description of Proposal

The proposal repeals the exception for private operating foundations from the excise tax on a private foundation’s failure to distribute income under section 4942, thereby extending the excise tax to private operating foundations.115

Effective Date

The proposal is effective for taxable years beginning after December 31, 2014.

6. Excise tax based on investment income of private colleges and universities (sec. 5206 of the discussion draft and new sec. 4969 of the Code)

Present Law

Public charities and private foundations

An organization qualifying for tax-exempt status under section 501(c)(3) is further classified as either a public charity or a private foundation. An organization may qualify as a public charity in several ways.116 Certain organizations are classified as public charities per se, regardless of their sources of support. These include churches, certain schools, hospitals and other medical organizations, certain organizations providing assistance to colleges and universities, and governmental units.117 Other organizations qualify as public charities because they are broadly publicly supported. First, a charity may qualify as publicly supported if at least one-third of its total support is from gifts, grants or other contributions from governmental units or the general public.118 Alternatively, it may qualify as publicly supported if it receives more than one-third of its total support from a combination of gifts, grants, and contributions from governmental units and the public plus revenue arising from activities related to its exempt purposes (e.g., fee for service income). In addition, this category of public charity must not rely excessively on endowment income as a source of support.119 A supporting organization, i.e., an organization that provides support to another section 501(c)(3) entity that is not a private foundation and meets the requirements of the Code, also is classified as a public charity.120

A section 501(c)(3) organization that does not fit within any of the above categories is a private foundation. In general, private foundations receive funding from a limited number of sources (e.g., an individual, a family, or a corporation).

The deduction for charitable contributions to private foundations is in some instances less generous than the deduction for charitable contributions to public charities. In addition, private foundations are subject to a number of operational rules and restrictions that do not apply to public charities.121

Excise tax on investment income of private foundations

Under section 4940(a), private foundations that are recognized as exempt from Federal income tax under section 501(a) (other than exempt operating foundations)122 are subject to a two-percent excise tax on their net investment income. Net investment income generally includes interest, dividends, rents, royalties (and income from similar sources), and capital gain net income, and is reduced by expenses incurred to earn this income. The two-percent rate of tax is reduced to one-percent in any year in which a foundation exceeds the average historical level of its charitable distributions. Specifically, the excise tax rate is reduced if the foundation’s qualifying distributions (generally, amounts paid to accomplish exempt purposes)123 equal or exceed the sum of (1) the amount of the foundation’s assets for the taxable year multiplied by the average percentage of the foundation’s qualifying distributions over the five taxable years immediately preceding the taxable year in question, and (2) one percent of the net investment income of the foundation for the taxable year.124 In addition, the foundation cannot have been subject to tax in any of the five preceding years for failure to meet minimum qualifying distribution requirements in section 4942.125

Private foundations that are not exempt from tax under section 501(a), such as certain charitable trusts, are subject to an excise tax under section 4940(b). The tax is equal to the excess of the sum of the excise tax that would have been imposed under section 4940(a) if the foundation were tax exempt and the amount of the tax on unrelated business income that would have been imposed if the foundation were tax exempt, over the income tax imposed on the foundation under subtitle A of the Code.

Private foundations are required to make a minimum amount of qualifying distributions each year to avoid tax under section 4942. The minimum amount of qualifying distributions a foundation has to make to avoid tax under section 4942 is reduced by the amount of section 4940 excise taxes paid.126

Private colleges and universities

Private colleges and universities generally are treated as public charities rather than private foundations127 and thus are not subject to the private foundation excise tax on net investment income.

Description of Proposal

The proposal imposes an excise tax on an applicable educational institution for each taxable year equal to one percent of the net investment income of the institution for the taxable year. Net investment income is determined using rules similar to the rules of section 4940(c) (relating to the net investment income of a private foundation).

For purposes of the proposal, an applicable educational institution is an institution: (1) that is an eligible education institution as described in section 25A of the Code (as amended by a separate proposal)128; (2) that is not described in the first section of section 511(a)(2)(B) of the Code (generally describing State colleges and universities); and (3) the aggregate fair market value of the assets of which at the end of the preceding taxable year (other than those assets which are used, or held for use, directly in carrying out the institution’s exempt purpose) is at least $100,000 per student. For this purpose, the number of students of an institution is based on the daily average number of full-time students attending the institution, with part-time students being taken into account on a full-time student equivalent basis.

Effective Date

The proposal is effective for taxable years beginning after December 31, 2014.

D. Requirements for Organizations Exempt From Tax

1. Repeal of tax-exempt status for professional sports leagues (sec. 5301 of the discussion draft and sec. 501(c)(6) of the Code)

Present Law

Tax exemption for section 501(c)(6) organizations

Section 501(c)(6) provides tax exempt status for business leagues and certain other organizations not organized for profit, no part of the net earnings of which inures to the benefit of any private shareholder or individual. A business league is an association of persons having some common business interest, the purpose of which is to promote such common interest and not to engage in a regular business of a kind ordinarily carried on for profit.129 Such an organization may not have as its primary activity performing “particular services” for members.130 Contributions to these types of organizations are not deductible as charitable contributions; however, they may be deductible as trade or business expenses if ordinary and necessary in the conduct of the taxpayer’s business. Many organizations known as “trade associations” may qualify for exempt status under this provision.

Professional sports leagues

Since 1966, section 501(c)(6) has included language exempting from tax “professional football leagues (whether or not administering a pension fund for football players).” The Internal Revenue Service has interpreted this language as applying not only to professional football leagues, but to all professional sports leagues.131

Description of Proposal

The proposal strikes from section 501(c)(6) the phrase “professional football leagues (whether or not administering a pension fund for football players).” In addition, the proposal amends section 501(c)(6) to provide affirmatively that section 501(c)(6) “shall not apply to any professional sports league (whether or not administering a pension fund for players).”

Effective Date

The proposal is effective for taxable years beginning after December 31, 2014.

2. Repeal of exemption from tax for certain insurance companies and CO-OP health insurance issuers (sec. 5302 of the discussion draft and sec. 501 of the Code)

Present Law

Section 501(c)(15) exempts from tax: (1) stock property and casualty insurance companies with gross receipts that do not exceed $600,000, more than 50 percent of which consist of premiums; and (2) mutual property and casualty insurance companies with gross receipts that do not exceed $150,000, more than 35 percent of which consist of premiums.

Qualified nonprofit health insurance issuers (within the meaning of section 1322 of the Patient Protection and Affordable Care Act) that have received a loan or grant under the CO-OP program under such section are exempt from tax under section 501(c)(29) of the Code.

Description of Proposal

The provision strikes sections 501(c)(15) and 501(c)(29). Organizations in existence prior to the effective date are provided transition relief as follows. Organizations are given a fresh start with respect to changes in accounting methods resulting from the change from tax-exempt to taxable status. No adjustment is made under section 481 on account of an accounting method change. The basis of assets of such organizations is equal, for purposes of determining gain or loss, to the amount of the assets’ fair market value on the first day of the organization’s taxable year beginning after the effective date.

Effective Date

The provision applies to taxable years beginning after December 31, 2014.

3. In-State requirement for certain tax-exempt workmen’s compensation insurance organizations (sec. 5303 of the discussion draft and sec. 501(c)(27) of the Code)

Present Law

Workers’ compensation reinsurance organizations

Section 501(c)(27)(A) provides tax-exempt status to any membership organization that is established by a State before June 1, 1996, exclusively to reimburse its members for workers’ compensation insurance losses, and that satisfies certain other conditions. A State must require that the membership of the organization consist of all persons who issue insurance covering workers’ compensation losses in such State, and all persons and governmental entities who self-insure against such losses. In addition, the organization must operate as a nonprofit organization by returning surplus income to members or to workers’ compensation policyholders on a periodic basis and by reducing initial premiums in anticipation of investment income.

State workmen’s compensation act companies

Section 501(c)(27)(B) provides tax-exempt status for any organization that is created by State law, and organized and operated exclusively to provide workmen’s compensation insurance and related coverage that is incidental to workmen’s compensation insurance, and that meets certain additional requirements. The workmen’s compensation insurance must be required by State law, or be insurance with respect to which State law provides significant disincentives if it is not purchased by an employer (such as loss of exclusive remedy or forfeiture of affirmative defenses such as contributory negligence). The organization must provide workmen’s compensation to any employer in the State (for employees in the State or temporarily assigned out-of-State) seeking such insurance and meeting other reasonable requirements. The State must either extend its full faith and credit to the initial debt of the organization or provide the initial operating capital of such organization. For this purpose, the initial operating capital can be provided by providing the proceeds of bonds issued by a State authority; the bonds may be repaid through exercise of the State’s taxing authority, for example. For periods after the date of enactment (August 5, 1997), either the assets of the organization must revert to the State upon dissolution, or State law must not permit the dissolution of the organization absent an act of the State legislature. Should dissolution of the organization become permissible under applicable State law, then the requirement that the assets of the organization revert to the State upon dissolution applies. Finally, the majority of the board of directors (or comparable oversight body) of the organization must be appointed by an official of the executive branch of the State or by the State legislature, or by both.

Description of Proposal

The proposal amends section 501(c)(27)(B) to limit tax-exempt status under that subparagraph to organizations that offer no insurance other than workmen’s compensation insurance offered to any employer in the State (for employees in the State or temporarily assigned out-of-State).

Effective Date

The proposal is effective for policies issued, and renewals, after December 31, 2014.

4. Repeal of Type II and Type III supporting organizations (sec. 5304 of the discussion draft and sec. 509(a)(3) of the Code)

Present Law

Requirements for section 501(c)(3) tax-exempt status

Charitable organizations, i.e., organizations described in section 501(c)(3), generally are exempt from Federal income tax and are eligible to receive tax deductible contributions. A charitable organization must operate primarily in pursuance of one or more tax-exempt purposes constituting the basis of its tax exemption.132 In order to qualify as operating primarily for a purpose described in section 501(c)(3), an organization must satisfy the following operational requirements: (1) its net earnings may not inure to the benefit of any person in a position to influence the activities of the organization; (2) it must operate to provide a public benefit, not a private benefit;133 (3) it may not be operated primarily to conduct an unrelated trade or business;134 (4) it may not engage in substantial legislative lobbying; and (5) it may not participate or intervene in any political campaign.

Classification of section 501(c)(3) organizations

In general

Section 501(c)(3) organizations are classified either as “public charities” or “private foundations.” 135 Private foundations generally are defined under section 509(a) as all organizations described in section 501(c)(3) other than an organization granted public charity status by reason of: (1) being a specified type of organization (i.e., churches, educational institutions, hospitals and certain other medical organizations, certain organizations providing assistance to colleges and universities, or a governmental unit); (2) receiving a substantial part of its support from governmental units or direct or indirect contributions from the general public; or (3) providing support to another section 501(c)(3) entity that is not a private foundation. In contrast to public charities, private foundations generally are funded from a limited number of sources (e.g., an individual, family, or corporation). Donors to private foundations and persons related to such donors together often control the operations of private foundations.

Because private foundations receive support from, and typically are controlled by, a small number of supporters, private foundations are subject to a number of anti-abuse rules and excise taxes not applicable to public charities.136 Public charities also have certain advantages over private foundations regarding the deductibility of contributions.

Supporting organizations (section 509(a)(3))

The Code provides that certain “supporting organizations” (in general, organizations that provide support to another section 501(c)(3) organization that is not a private foundation) are classified as public charities rather than private foundations.137 To qualify as a supporting organization, an organization must meet all three of the following tests: (1) it must be organized and at all times operated exclusively for the benefit of, to perform the functions of, or to carry out the purposes of one or more “publicly supported organizations”138 (the “organizational and operational tests”);139 (2) it must be operated, supervised, or controlled by or in connection with one or more publicly supported organizations (the “relationship test”);140 and (3) it must not be controlled directly or indirectly by one or more disqualified persons (as defined in section 4946) other than foundation managers and other than one or more publicly supported organizations (the “lack of outside control test”).141

To satisfy the relationship test, a supporting organization must hold one of three statutorily described close relationships with the supported organization. The organization must be: (1) operated, supervised, or controlled by a publicly supported organization (commonly referred to as “Type I” supporting organizations); (2) supervised or controlled in connection with a publicly supported organization (“Type II” supporting organizations); or (3) operated in connection with a publicly supported organization (“Type III” supporting organizations).142

 

Type I supporting organizations

In the case of supporting organizations that are operated, supervised, or controlled by one or more publicly supported organizations (Type I supporting organizations), one or more supported organizations must exercise a substantial degree of direction over the policies, programs, and activities of the supporting organization.143 The relationship between the Type I supporting organization and the supported organization generally is comparable to that of a parent and subsidiary. The requisite relationship may be established by the fact that a majority of the officers, directors, or trustees of the supporting organization are appointed or elected by the governing body, members of the governing body, officers acting in their official capacity, or the membership of one or more publicly supported organizations.144

Type II supporting organizations

Type II supporting organizations are supervised or controlled in connection with one or more publicly supported organizations. Rather than the parent-subsidiary relationship characteristic of Type I organizations, the relationship between a Type II organization and its supported organizations is more analogous to a brother-sister relationship. In order to satisfy the Type II relationship requirement, generally there must be common supervision or control by the persons supervising or controlling both the supporting organization and the publicly supported organizations.145 An organization generally is not considered to be “supervised or controlled in connection with” a publicly supported organization merely because the supporting organization makes payments to the publicly supported organization, even if the obligation to make payments is enforceable under state law.146

Type III supporting organizations

Type III supporting organizations are “operated in connection with” one or more publicly supported organizations. To satisfy the “operated in connection with” relationship, Treasury regulations require that the supporting organization be responsive to, and significantly involved in the operations of, the publicly supported organization. This relationship is deemed to exist where the supporting organization satisfies a notification requirement, a “responsiveness test,” and an “integral part test.” 147 An organization is not operated in connection with one or more supported organizations if it supports any supported organization organized outside of the United States.148

To satisfy the notification requirement for a taxable year, a Type III supporting organization must provide the following documents to each of its supported organizations: (1) a written notice to a principal officer of the supported organization describing the type and amount of all support the supporting organization provided during the supporting organization’s preceding taxable year; (2) a copy of the supporting organization’s most recently filed Form 990 (or other annual information return); and (3) a copy of the supporting organization’s current governing documents, unless such documents have been previously provided and not subsequently amended.149 The notification documents for a taxable year must be provided by the last day of the fifth calendar month following the close of the taxable year.150

In general, the responsiveness test requires that the Type III supporting organization be responsive to the needs or demands of the publicly supported organizations. 151 A supporting organization generally satisfies the test by demonstrating that: (1)(a) one or more of its officers, directors, or trustees are elected or appointed by the officers, directors, trustees, or membership of the supported organization; (b) one or more members of the governing bodies of the publicly supported organizations are also officers, directors, or trustees of, or hold other important offices in, the supporting organization; or (c) the officers, directors, or trustees of the supporting organization maintain a close continuous working relationship with the officers, directors, or trustees of the publicly supported organizations;152 and (2) by reason of such arrangement, the officers, directors, or trustees of the supported organization have a significant voice in the investment policies of the supporting organization, the timing and manner of making grants, the selection of grant recipients by the supporting organization, and otherwise directing the use of the income or assets of the supporting organization.153

For purposes of the integral part test, Type III supporting organizations are further classified as “functionally integrated” or “non-functionally integrated.”

Functionally integrated Type III supporting organizations. — To satisfy the integral part test as a functionally integrated Type III supporting organization, an organization must establish that: (1)(a) substantially all of its activities directly further the exempt purposes of one or more supported organizations by performing the functions of, or carrying out the purposes of, such organizations; and (b) these activities, but for the involvement of the supporting organization, normally would be engaged in by the publicly supported organizations themselves;154 (2) it is the parent of each of its supported organizations;155 or (3) it supports a governmental organization.156

Non-functionally integrated Type III supporting organizations. — To satisfy the integral part test as a non-functionally integrated Type III supporting organization, an organization generally must satisfy a distribution requirement and an attentiveness requirement.157 An organization satisfies the distribution requirement for a taxable year if it distributes to or for the use of one or more supported organizations an amount equal to or greater than the supporting organization’s distributable amount for the taxable year.158 The distributable amount generally is the greater of 85 percent of the supporting organization’s adjusted net income or 3.5 percent of the organization’s non-exempt use assets for the immediately preceding tax year.159 An organization satisfies the attentiveness requirement if: (1) it distributes to its supported organization at least 10 percent of the supported organization’s total support; (2) the amount of support received from the supporting organization is necessary to avoid the interruption of the carrying on of a particular function or activity of the supported organization; or (3) based on facts and circumstances, the amount of support received from the supporting organization is a sufficient part of a supported organization’s total support to ensure attentiveness.160

Description of Proposal

The proposal limits supporting organization status to organizations that are operated, supervised, or controlled by one or more publicly supported organizations (present law Type I supporting organizations). An organization may no longer satisfy the relationship test by being supervised or controlled in connection with one or more publicly supported organizations (Type II supporting organizations) or by being operated in connection with one or more publicly supported organizations (Type III supporting organizations).

Effective Date

The proposal generally is effective on the date of enactment. For Type II and Type III supporting organizations recognized as of the date of enactment as exempt from tax under section 501(a) as an organization described in section 501(c)(3), the proposal is effective for taxable years beginning after December 31, 2015.

FOOTNOTES

1 This document may be cited as follows: Joint Committee on Taxation, Technical Explanation of the Tax Reform Act of 2014, A Discussion Draft of the Chairman of the House Committee on Ways and Means to Reform the Internal Revenue Code: Title V — Tax Exempt Entities (JCX-16-14), February 26, 2014. This document can also be found on our website at www.jct.gov.

2 Statutory draft version Camp_041.XML.

3 This is the case for social clubs (sec. 501(c)(7)), voluntary employees’ beneficiary associations (sec. 501(c)(9)), and organizations and trusts described in sections 501(c)(17) and 501(c)(20). Sec. 512(a)(3).

4 Secs. 511-514.

5 Treas. Reg. sec. 1.501(c)(3)-1(e).

6 Sec. 511(a)(2)(A).

7 Sec. 511(a)(2)(A).

8 Sec. 511(a)(2)(B).

9 Secs. 511-514.

10 Sec. 512(b)(13).

11 Sec. 512(b)(7).

12 Sec. 512(b)(8).

13 Sec. 512(b)(9).

14 Sec. 512(b)(12).

15 Ibid.

16 Sec. 512(b)(10).

17 For purposes of the trust’s charitable contribution deduction, a distribution by the trust is treated as a gift or contribution. Sec. 512(b)(11).

18 Sec. 512(b)(11).

19 Sec. 513(i)(2)(A).

20 Sec. 513(i)(2)(A).

21 Sec. 513(i)(2)(B)(i).

22 Sec. 513(i)(2)(B)(ii).

23 Sec. 513(i)(2)(B)(ii).

24 Sec. 513(i)(3).

25 Sec. 512(a).

26 Treas. Reg. sec. 1.512(a)-1(a).

27 Specifically, the proposal references sections 512(b)(1), (2), (3) and (5).

28 Sec. 6652.

29 Sec. 6652(c)(4).

30 Sec. 6652(c)(5)(C).

31 Sec. 6662.

32 A tax shelter is defined for this purpose as a partnership or other entity, an investment plan or arrangement, or any other plan or arrangement if a significant purpose of such partnership, other entity, plan, or arrangement is the avoidance or evasion of Federal income tax. Sec. 6662(d)(2)(C).

33 Sec. 6664(c).

34 Treas. Reg. sec. 1.6662-4(g)(4)(i)(B). See also Treas. Reg. sec. 1.6664-4(c).

35 Sec. 6662(b) (flush language).

36 Treas. Reg. sec. 1.6011-4.

37 Sec. 6707A(c)(1).

38 Treas. Reg. sec. 1.6011-4(b)(2)-(6).

39 The regulations clarify that the term “substantially similar” includes any transaction that is expected to obtain the same or similar types of tax consequences and that is either factually similar or based on the same or similar tax strategy. Further, the term must be broadly construed in favor of disclosure. Treas. Reg. sec. 1.6011-4(c)(4).

40 Sec. 6707A(c)(2).

41 Sec. 4958.

42 The excess benefit transaction rules were enacted in 1996 to provide a sanction short of revocation of tax exemption, an “intermediate” sanction, for abusive self-dealing transactions (i.e., private inurement) between an organization insider and the organization. Prior to enactment of the excess benefit transaction rules, there was no sanction in the Code on organization insiders or disqualified persons for engaging in self-dealing transactions with respect to a public charity.

43 Sec. 4958(f)(1).

44 Secs. 4958(f)(1)(E) and (F).

45 Sec. 4958(f)(8).

46 Treas. Reg. sec. 53.4958-6(a). See also H. Rep. No. 506, 104th Congress, 2d Sess. 1996, pp. 53, 56-7.

47 Treas. Reg. sec. 53.4958-6(b).

48 Treas. Reg. sec. 53.4958-6(c)(1)(i).

49 Treas. Reg. sec. 53.4958-6(c)(2)(i).

50 Treas. Reg. sec. 53.4958-6(c)(2)(ii).

51 Treas. Reg. sec. 53.4958-6(c)(3).

52 Sec. 4958(d)(2). Taxes imposed may be abated if certain conditions are met. Secs. 4961 and 4962.

53 Sec. 4958(d)(1).

54 Treas. Reg. sec. 53.4958-1(d)(4)(i).

55 Sec. 7454(b).

56 Treas. Reg. sec. 53.4958-1(d)(4)(ii).

57 Ibid.

58 Treas. Reg. sec. 53.4958-1(d)(5).

59 Treas. Reg. sec. 53.4958-1(d)(6).

60 Treas. Reg. sec. 53.4958-1(d)(4)(iii).

61 Treas. Reg. sec. 53.4958-1(d)(4)(iv).

62 Sec. 4958(a)(1).

63 Under the proposal, the existing rules that treat as disqualified persons certain family members and 35-percent controlled entities of investment advisors to sponsoring organizations of donor advised funds will apply more broadly to investment advisors that are disqualified persons with respect to any organization subject to the intermediate sanctions rules.

64 Sec. 4941. In general, a private foundation is a section 501(c)(3) organization (generally, a charitable organization) that does not meet the requirements of section 509(a) for being treated more favorably as a public charity.

65 Sec. 4962(b).

66 Sec. 4961.

67 Treas. Reg. sec. 53.4941(a)-1(b)(3).

68 Sec. 7454(b).

69 Treas. Reg. sec. 53.4941(a)-1(b)(3).

70 Ibid.

71 Treas. Reg. sec. 53.4941(a)-1(b)(4).

72 Treas. Reg. sec. 53.4941(a)-1(b)(5).

73 Treas. Reg. sec. 53.4941(a)-1(b)(6).

74 Sec. 4941(a)(1).

75 Contributions to a sponsoring organization for maintenance in a donor advised fund are not eligible for a charitable deduction for income tax purposes if the sponsoring organization is a veterans’ organization described in section 170(c)(3), a fraternal society described in section 170(c)(4), or a cemetery company described in section 170(c)(5); for gift tax purposes if the sponsoring organization is a fraternal society described in section 2522(a)(3) or a veterans’ organization described in section 2522(a)(4); or for estate tax purposes if the sponsoring organization is a fraternal society described in section 2055(a)(3) or a veterans’ organization described in section 2055(a)(4). In addition, contributions to a sponsoring organization for maintenance in a donor advised fund are not eligible for a charitable deduction for income, gift, or estate tax purposes if the sponsoring organization is a Type III supporting organization (other than a functionally integrated Type III supporting organization). In addition to satisfying generally applicable substantiation requirements under section 170(f), a donor must obtain, with respect to each charitable contribution to a sponsoring organization to be maintained in a donor advised fund, a contemporaneous written acknowledgment from the sponsoring organization providing that the sponsoring organization has exclusive legal control over the assets contributed.

76 See sec. 4966(d)(2)(A). A donor advised fund does not include a fund or account that makes distributions only to a single identified organization or governmental entity. A donor advised fund also does not include certain funds or accounts with respect to which a donor or donor advisor provides advice as to which individuals receive grants for travel, study, or other similar purposes. In addition, the Secretary may exempt a fund or account from treatment as a donor advised fund if such fund or account is advised by a committee not directly or indirectly controlled by a donor, donor advisor, or persons related to a donor or donor advisor. The Secretary also may exempt a fund or account from treatment as a donor advised fund if such fund or account benefits a single identified charitable purpose. Secs. 4966(d)(2)(B) and (C).

77 Section 170(c) describes organizations to which charitable contributions that are deductible for income tax purposes can be made.

78 See sec. 170(c)(2)(A).

79 Sec. 4966(d)(1).

80 Sec. 4943(e).

81 Sec. 4943(e)(2).

82 Sec. 4958(c).

83 Sec. 4958(e).

84 For this purpose, a person is treated as related to another person if such person bears a relationship to such other person similar to the relationships described in sections 4958(f)(1)(B) and 4958(f)(1)(C).

85 Sec. 4958(c)(2).

86 Sec. 4958(f)(1)(E).

87 Sec. 4958(f)(1)(F).

88 Sec. 4958(f)(8).

89 Sec. 4966.

90 Sec. 4966(c)(1).

91 Sec. 4966(c)(2).

92 Secs. 4966(a) and (b).

93 See generally sec. 4967.

94 Sec. 6033(k).

95 Sec. 508(f).

96 For example, if such a contribution remains undistributed as of the beginning of the seventh taxable year following the year in which the contributions is made, a tax will be imposed for both the sixth and seventh taxable years following the contribution year.

97 Sec. 4942(g).

98 Sec. 4940(e).

99 Sec. 4942(d)(2).

100 Sec. 4940(d)(1).

101 Sec. 4940(d)(2).

102 The Code does not expressly define the term “public charity,” but rather provides exceptions to those entities that are treated as private foundations.

103 Sec. 509(a)(1) (referring to sections 170(b)(1)(A)(i) through (iv) for a description of these organizations).

104 Treas. Reg. sec. 1.170A-9(f)(2). Failing this mechanical test, the organization may qualify as a public charity if it passes a “facts and circumstances” test. Treas. Reg. sec. 1.170A-9(f)(3).

105 To meet this requirement, the organization must normally receive more than one-third of its support from a combination of (1) gifts, grants, contributions, or membership fees and (2) certain gross receipts from admissions, sales of merchandise, performance of services, and furnishing of facilities in connection with activities that are related to the organization’s exempt purposes. Sec. 509(a)(2)(A). In addition, the organization must not normally receive more than one-third of its public support in each taxable year from the sum of (1) gross investment income and (2) the excess of unrelated business taxable income as determined under section 512 over the amount of unrelated business income tax imposed by section 511. Sec. 509(a)(2)(B).

106 Sec. 509(a)(3). Supporting organizations are further classified as Type I, II, or III depending on the relationship they have with the organizations they support. Supporting organizations must support public charities listed in one of the other categories (i.e., per se public charities, broadly supported public charities, or revenue generating public charities), and they are not permitted to support other supporting organizations or testing for public safety organizations.

Organizations organized and operated exclusively for testing for public safety also are classified as public charities. Sec. 509(a)(4). Such organizations, however, are not eligible to receive deductible charitable contributions under section 170.

107 Unlike public charities, private foundations are subject to tax on their net investment income at a rate of two percent (one percent in some cases). Sec. 4940. Private foundations also are subject to more restrictions on their activities than are public charities. For example, private foundations are prohibited from engaging in self-dealing transactions (sec. 4941), are required to make a minimum amount of charitable distributions each year, (sec. 4942), are limited in the extent to which they may control a business (sec. 4943), may not make speculative investments (sec. 4944), and may not make certain expenditures (sec. 4945). Violations of these rules result in excise taxes on the foundation and, in some cases, may result in excise taxes on the managers of the foundation.

108 Sec. 4942.

109 Sec. 4942(g)(1)(A).

110 Sec. 4942(a) and (b). Taxes imposed may be abated if certain conditions are met. Secs. 4961 and 4962.

111 Sec. 4942(g)(1)(B) and 4942(g)(2). In general, an organization is permitted to adjust the distributable amount in those cases where distributions during the five preceding years have exceeded the payout requirements. Sec. 4942(i).

112 Sec. 4942(a)(1).

113 Sec. 4942(j)(3)(A); Treas. Reg. sec. 53.4942(b)-1(c).

114 Sec. 4942(j)(3)(B).

115 The proposal does not modify the rules for deducting charitable contributions to private operating foundations. As a conforming amendment to the Code, the proposal moves the definition of an operating foundation from section 4942 to section 170(b)(1).

116 The Code does not expressly define the term “public charity,” but rather provides exceptions to those entities that are treated as private foundations.

117 Sec. 509(a)(1) (referring to sections 170(b)(1)(A)(i) through (iv) for a description of these organizations).

118 Treas. Reg. sec. 1.170A-9(f)(2). Failing this mechanical test, the organization may qualify as a public charity if it passes a “facts and circumstances” test. Treas. Reg. sec. 1.170A-9(f)(3).

119 To meet this requirement, the organization must normally receive more than one-third of its support from a combination of (1) gifts, grants, contributions, or membership fees and (2) certain gross receipts from admissions, sales of merchandise, performance of services, and furnishing of facilities in connection with activities that are related to the organization’s exempt purposes. Sec. 509(a)(2)(A). In addition, the organization must not normally receive more than one-third of its public support in each taxable year from the sum of (1) gross investment income and (2) the excess of unrelated business taxable income as determined under section 512 over the amount of unrelated business income tax imposed by section 511. Sec. 509(a)(2)(B).

120 Sec. 509(a)(3). Supporting organizations are further classified as Type I, II, or III depending on the relationship they have with the organizations they support. Supporting organizations must support public charities listed in one of the other categories (i.e., per se public charities, broadly supported public charities, or revenue generating public charities), and they are not permitted to support other supporting organizations or testing for public safety organizations.

Organizations organized and operated exclusively for testing for public safety also are classified as public charities. Sec. 509(a)(4). Such organizations, however, are not eligible to receive deductible charitable contributions under section 170.

121 Unlike public charities, private foundations are subject to tax on their net investment income at a rate of two percent (one percent in some cases). Sec. 4940. Private foundations also are subject to more restrictions on their activities than are public charities. For example, private foundations are prohibited from engaging in self-dealing transactions (sec. 4941), are required to make a minimum amount of charitable distributions each year, (sec. 4942), are limited in the extent to which they may control a business (sec. 4943), may not make speculative investments (sec. 4944), and may not make certain expenditures (sec. 4945). Violations of these rules result in excise taxes on the foundation and, in some cases, may result in excise taxes on the managers of the foundation.

122 Exempt operating foundations are exempt from the section 4940 tax. Sec. 4940(d)(1). Exempt operating foundations generally include organizations such as museums or libraries that devote their assets to operating charitable programs but have difficulty meeting the “public support” tests necessary not to be classified as a private foundation. To be an exempt operating foundation, an organization must: (1) be an operating foundation (as defined in section 4942(j)(3)); (2) be publicly supported for at least 10 taxable years; (3) have a governing body no more than 25 percent of whom are disqualified persons and that is broadly representative of the general public; and (4) have no officers who are disqualified persons. Sec. 4940(d)(2).

123 Sec. 4942(g).

124 Sec. 4940(e).

125 Under a separate proposal, the private foundation excise tax would be simplified by replacing the two-tier rate structure with a single-rate tax set at one percent.

126 Sec. 4942(d)(2).

127 Secs. 509(a)(1) and 170(b)(1)(A)(ii).

128 Section 25A, as amended by a separate proposal, defines an eligible educational institution as an institution (1) which is described in section 481 of the Higher Education Act of 1965 (20 U.S.C. 1088), as in effect on August 5, 1977, and (2) which is eligible to participate in a program under title IV of such Act.

129 Treas. Reg. sec. 1.501(c)(6)-1.

130 Treas. Reg. sec. 1.501(c)(6)-1.

131 See General Counsel Memorandum 38179, November 29, 1979 (“We continue to believe that professional sports leagues, including football leagues, do not qualify for exemption if the ordinary standards of section 501(c)(6) are applied. However, while the answer is far from clear, we have concluded upon reflection that the specific exemption of football leagues in 1966 can be viewed as providing support for recognition of exemption of all professional sports leagues as a unique category of organizations under section 501(c)(6). Since other professional sports leagues are indistinguishable in any meaningful way from football leagues, we think it is fair to conclude that by formally blessing the exemption it knew football leagues had historically enjoyed, Congress implicitly recognized a unique historical category of exemption under section 501(c)(6). The specific enumeration of football leagues can be viewed as merely exemplary of the category thus recognized, and as necessitated only by the problem of insuring that football’s pension and merger arrangement would not endanger its exemption”).

132 Treas. Reg. sec. 1.501(c)(3)-1(c)(1). The Code specifies such purposes as religious, charitable, scientific, testing for public safety, literary, or educational purposes, or to foster international amateur sports competition, or for the prevention of cruelty to children or animals. In general, an organization is organized and operated for charitable purposes if it provides relief for the poor and distressed or the underprivileged. Treas. Reg. sec. 1.501(c)(3)-1(d)(2).

133 Treas. Reg. sec. 1.501(c)(3)-1(d)(1)(ii).

134 Treas. Reg. sec. 1.501(c)(3)-1(e)(1). Conducting a certain level of unrelated trade or business activity will not jeopardize tax-exempt status.

135 Sec. 509(a). Private foundations are either private operating foundations or private non-operating foundations. In general, private operating foundations operate their own charitable programs in contrast to private non-operating foundations, which generally are grant-making organizations. Most private foundations are non-operating foundations.

136 Secs. 4940 – 4945.

137 Sec. 509(a)(3).

138 In general, supported organizations of a supporting organization must be publicly supported charities described in sections 509(a)(1) or (a)(2).

139 Sec. 509(a)(3)(A).

140 Sec. 509(a)(3)(B).

141 Sec. 509(a)(3)(C).

142 Treas. Reg. sec. 1.509(a)-4(f)(2).

143 Treas. Reg. sec. 1.509(a)-4(g)(1)(i).

144 Ibid.

145 Treas. Reg. sec. 1.509(a)-4(h)(1).

146 Treas. Reg. sec. 1.509(a)-4(h)(2).

147 Treas. Reg. sec. 1.509(a)-4(i)(1).

148 Treas. Reg. sec. 1.509(a)-4(i)(10).

149 Treas. Reg. sec. 1.509(a)-4(i)(2)(i).

150 Treas. Reg. sec. 1.509(a)-4(i)(2)(iii).

151 Treas. Reg. sec. 1.509(a)-4(i)(3)(i).

152 Treas. Reg. sec. 1.509(a)-4(i)(3)(ii).

153 Treas. Reg. sec. 1.509(a)-4(i)(3)(iii). For an organization that was supporting or benefiting one or more publicly supported organizations before November 20, 1970, additional facts and circumstances, such as an historic and continuing relationship between organizations, also may be taken into consideration to establish compliance with either of the responsiveness tests. Treas. Reg. sec. 1.509(a)-4(i)(3)(v).

154 Treas. Reg. secs. 1.509(a)-4(i)(4)(i)(A) & -4(i)(4)(ii).

155 Treas. Reg. secs. 1.509(a)-4(i)(4)(i)(B) & -4(i)(4)(iii).

156 Treas. Reg. sec. 1.509(a)-4(i)(4)(i)(C). Regulations describing this means of satisfying the integral support test have been reserved. Treas. Reg. sec. 1.509(a)-4(i)(4)(iv).

157 Treas. Reg. sec. 1.509(a)-4(i)(5)(i)(A). Special rules exist for certain pre-November 20, 1970 trusts. See Treas. Reg. secs. 1.509(a)-4(i)(5)(i)(B) & -4(i)(9).

158 Treas. Reg. sec. 1.509(a)-4(i)(5)(ii).

159 Treas. Reg. secs. 1.509(a)-4T(i)(5)(ii)(B) & (C).

160 Treas. Reg. sec. 1.509(a)-4(i)(5)(iii)(B).

Citations: JCX-16-14



Obama Administration Opposes Barring IRS From Changing Tax-Exemption Requirements.

The Obama administration strongly opposes H.R. 3865, which would temporarily prevent the IRS from changing tax-exemption requirements for social welfare groups, because it could interfere with tax administration and with providing clarity for applicants, the White House said in a February 25 statement of administration policy.

H.R. 3865 — Temporary Prohibition on IRS from Modifying

Tax-Exemption Requirements for Social Welfare Organizations

(Rep. Camp, R-Michigan, and 66 cosponsors)

STATEMENT OF ADMINISTRATION POLICY

February 25, 2014

(House Rules)

The Administration strongly opposes H.R. 3865, which would prohibit the Department of the Treasury and the Internal Revenue Service (IRS) from clarifying the standards that organizations must satisfy to qualify for tax-exempt status. Under current law, organizations qualify as tax-exempt organizations “operated exclusively for the promotion of social welfare” if they are primarily engaged in promoting in some way the common good and general welfare of the people. The relevant Treasury and IRS rules have been in place since 1959 and are broadly recognized as unclear. The proposed legislation would prevent any revisions or clarifications to those rules. Thus, it could prevent the IRS from administering the tax code more effectively and from providing greater clarity to organizations seeking tax-exempt status.

H.R. 3865 would prevent Treasury and the IRS from issuing, for one year from the date of enactment, any generally applicable guidance relating to the standards for tax-exemption under section 501(c)(4) as a social welfare organization. In addition, H.R. 3865 would require the IRS to continue to use the standard and definitions in effect on January 1, 2010, to determine whether an organization qualifies for tax-exempt status under section 501(c)(4). The lack of clarity of these standards has resulted in confusion and difficulty administering the Code, as well as delays in the processing of applications for tax-exempt status. The Treasury Inspector General for Tax Administration and the National Taxpayer Advocate, among others, have recommended clarifying the current rules.

Consistent with these recommendations, Treasury and the IRS recently issued a notice of proposed rulemaking (NPRM) that provides guidance on the definition of candidate-related political activity for purposes of determining the “primary activity” of a social welfare organization and solicits public comment on a number of related issues. This NPRM is the first step in a standard rulemaking process intended to clarify the rules and to provide greater certainty for organizations seeking tax-exempt status. The notice and comment process allows for all concerned parties to provide input and comments before any changes to the rules are effected. Treasury and the IRS will carefully consider any and all such comments before issuing any further guidance, and they will follow standard agency rulemaking procedures.

For the reasons described above, the Administration strongly opposes the proposed legislation. If the President were presented with H.R. 3865, his senior advisors would recommend that he veto the bill.



IRS Publishes Population Figures for Housing Credit, Private Bond Purposes.

The IRS has published (Notice 2014-12, 2014-9 IRB 606) the 2014 resident population figures for the 50 states, the District of Columbia, Puerto Rico, and the U.S. possessions for use in determining the state housing credit ceiling under section 42(h) and the private activity bond volume cap under section 146. The notice also details the private activity bond volume limit under section 142(k)(5).

2014 Calendar Year Resident Population Figures

This notice advises State and local housing credit agencies that allocate low-income housing tax credits under § 42 of the Internal Revenue Code, and States and other issuers of tax-exempt private activity bonds under § 141, of the population figures to use in calculating: (1) the 2014 calendar year population-based component of the State housing credit ceiling (Credit Ceiling) under § 42(h)(3)(C)(ii); (2) the 2014 calendar year volume cap (Volume Cap) under § 146; and (3) the 2014 volume limit (Volume Limit) under § 142(k)(5).

Generally, § 146(j) requires determining the population figures for the population-based component of both the Credit Ceiling and the Volume Cap for any calendar year on the basis of the most recent census estimate of the resident population of a State (or issuing authority) released by the U.S. Census Bureau before the beginning of the calendar year. Similarly, § 142(k)(5) bases the Volume Limit on the State population.

Sections 42(h)(3)(H) and 146(d)(2) require adjusting for inflation the population-based component of the Credit Ceiling and the Volume Cap. The adjustments for the 2014 calendar year are in Rev. Proc. 2013-35, 2013-47 I.R.B. 537. Section 3.08 of Rev. Proc. 2013-35 provides that, for calendar year 2014, the amount for calculating the Credit Ceiling under § 42(h)(3)(C)(ii) is the greater of $2.30 multiplied by the State population, or $2,635,000. Further, section 3.19 of Rev. Proc. 2013-35 provides that the amount for calculating the Volume Cap under § 146(d)(1) for calendar year 2014 is the greater of $100 multiplied by the State population, or $296,825,000.

For the 50 states, the District of Columbia, and Puerto Rico, the population figures for calculating the Credit Ceiling, the Volume Cap, and the Volume Limit for the 2014 calendar year are the resident population estimates released electronically by the U.S. Census Bureau on December 30, 2013, in Press Release CB13-tps111. For American Samoa, Guam, the Northern Mariana Islands, and the U.S. Virgin Islands, the population figures for the 2014 calendar year are the 2013 mid-year population figures in the U.S. Census Bureau’s International Data Base (IDB). The U.S. Census Bureau electronically announced an update of the IDB on June 27, 2012, in Press Release CB12-118.

For convenience, these figures are reprinted below.

Resident Population Figures

______________________________________________________________________

 

Alabama                                      4,833,722

Alaska                                         735,132

American Samoa                                  54,719

Arizona                                      6,626,624

Arkansas                                     2,959,373

California                                  38,332,521

Colorado                                     5,268,367

Connecticut                                  3,596,080

Delaware                                       925,749

District of Columbia                           646,449

Florida                                     19,552,860

Georgia                                      9,992,167

Guam                                            160,378

Hawaii                                       1,404,054

Idaho                                        1,612,136

Illinois                                    12,882,135

Indiana                                       6,570,902

Iowa                                         3,090,416

Kansas                                       2,893,957

Kentucky                                     4,395,295

Louisiana                                    4,625,470

Maine                                        1,328,302

Maryland                                     5,928,814

Massachusetts                                6,692,824

Michigan                                     9,895,622

Minnesota                                    5,420,380

Mississippi                                  2,991,207

Missouri                                     6,044,171

Montana                                      1,015,165

Nebraska                                     1,868,516

Nevada                                       2,790,136

New Hampshire                                1,323,459

New Jersey                                   8,899,339

New Mexico                                    2,085,287

New York                                    19,651,127

North Carolina                               9,848,060

North Dakota                                   723,393

Northern Mariana Islands                      51,170

Ohio                                        11,570,808

Oklahoma                                     3,850,568

Oregon                                       3,930,065

Pennsylvania                                 12,773,801

Puerto Rico                                  3,615,086

Rhode Island                                 1,051,511

South Carolina                               4,774,839

South Dakota                                   844,877

Tennessee                                    6,495,978

Texas                                       26,448,193

Utah                                         2,900,872

Vermont                                        626,630

Virginia                                     8,260,405

Virgin Islands, U.S.                     104,737

Washington                                   6,971,406

West Virginia                                1,854,304

Wisconsin                                    5,742,713

Wyoming                                        582,658

The principal authors of this notice are Jian H. Grant, Office of the Associate Chief Counsel (Passthroughs and Special Industries), and Timothy L. Jones, Office of the Associate Chief Counsel (Financial Institutions and Products). For further information regarding this notice, please contact Ms. Grant at (202) 317-4137 (not a toll-free number).

Citations: Notice 2014-12; 2014-9 IRB 606



IRS Corrects TE/GE Ruling Procedures.

The IRS has corrected (Rev. Proc. 2014-19) the procedures (Rev. Proc. 2014-4) for furnishing ruling letters, information letters, and other guidance on matters regarding sections of the code under the jurisdiction of the Tax-Exempt and Government Entities Division commissioner.

Rev. Proc. 2014-4 contains errors in sections 2.06 and 9.03(3) regarding the expedited handling of exempt organization determination letter requests. Effective January 2, 2014, Rev. Proc. 2014-19 corrects those errors to clarify that EO determination letters are still eligible for expedited handling under section 9 of Rev. Proc. 2014-4.

Part III — Administrative, Procedural, and Miscellaneous

26 CFR 601.201: Rulings and determination letters.

SECTION 1. BACKGROUND

.01 Revenue Procedure 2014-4 as published on January 2, 2014 (2014-1 I.R.B. 125) contains unintentional errors in sections 2.06 and 9.03(3). The errors are:

1. Section 2.06 of Rev. Proc. 2014-4 should have stated that section 9.03(3) has been modified only with respect to EP determination letter requests and not EO determination letter requests, and

2. Section 9.03(3) of Rev. Proc. 2014-4 should have stated that only EP Determination Letter requests (and not EO determination letter requests) are not eligible for expedited handling, and

3. All references in Section 9.03(3) of Rev. Proc. 2014-4 to “letter ruling” should have also included references to “determination letter.”

SECTION 2. MODIFICATIONS TO REVENUE PROCEDURE 2014-4

.01 Section 2.06 of Rev. Proc. 2014-4 is modified to add “EP” before “determination letter requests are not eligible for expedited handling.”

.02 The second sentence of the first paragraph of Section 9.03(3) of Rev. Proc. 2014-4 is modified to add “EP” before “Determination Letter requests are not eligible for expedited handling.”

.03 Section 9.03(3) of Rev. Proc. 2014-4 is modified to add the phrase “or EO determination letter” after all references to the phrase “letter ruling” in this Section.

SECTION 3. EFFECTIVE DATE

.01 The modification in this revenue procedure will be treated as in effect as of the effective date of Rev. Proc. 2014-4, January 2, 2014.

SECTION 4. EFFECT ON OTHER DOCUMENTS

.01 This Rev. Proc. modifies Rev. Proc. 2014-4 to ensure that EO Determination Letters remain eligible for expedited handling under Section 9.03(3) of Rev. Proc. 2014-4.

SECTION 5. DRAFTING INFORMATION

The principal author of this Revenue Procedure is Dave Rifkin of Exempt Organizations, Tax Exempt and Government Entities Division. For further information regarding this Revenue Procedure, contact Dave Rifkin at (202) 317-8525 (not a toll-free call).

Citations: Rev. Proc. 2014-19; 2014-10 IRB 1



Why is the U.S. Olympic Committee Tax Exempt?

Every two years, I sit in front of my TV watching the Olympics. Like clockwork, in the midst of some competition I can’t understand, my mind wanders to tax wonkdom and I ask myself: Why is the U.S. Olympic Committee a tax exempt organization?

The law says tax exempt status is granted to groups that “foster national or international amateur sports competition.” But do the hyper-marketed modern games even remotely fit the ideal of amateur sports? Sure, some athletes who represent the U.S. are amateurs but a great many others are highly paid professionals or marketing magnets. Snowboarder Shaun White–who won no medals– makes a reported $8 million-a-year in endorsements.

And then there is USOC itself. By almost any standard, it is a commercial enterprise. It exists primarily to help organize a bi-annual made-for-TV entertainment extravaganza.  Yes, it provides some support for athletes (though surprisingly little). But its real business is marketing itself and playing its part in a two-week orgy of athletic commercialization.

USOC’s total revenue for 2012 (the last publicly available data) was $353 million. Of that, $263 million, or nearly 75 percent, was generated by broadcast rights, trademark income, and licensing agreements, according to its financial statement. About $46 million came from (mostly corporate) contributions.

How did the committee spend that money in 2012? Its total expenses were $249 million. Nearly $21 million went to fundraising, $17 million to sales and marketing,  $3 million to public relations, and $14 million to administrative and general expenses.

Of what was left, about $74 million went to “member support,” or to fund individual National Governing Bodies such as the US Ski & Snowboard Association, USA Track & Field, US Speedskating and the like.

How much went to direct support for athletes? It’s hard to tell but according to one estimate, it was less than 6 percent of total USOC spending. Top ranked athletes get monthly stipends ranging from $400 to $2,000. Others get nothing. Athletes have access to Olympic training centers though most have to pay to use and stay at them and therefor don’t. A watchdog group called the U.S. Athletic Trust has a nice explanation here, though it reported on USOC expenses from 2009-2011.

About $24 million went to support U.S. Paralympics, and $4 million to sports science and sports medicine.

And USOC paid its senior staff handsomely. A dozen of its top executives made $250,000 or more in 2012, and its CEO, Scott Blackmun, received $965,000. After all that, it still had nearly $100 million in surplus revenue.

To be fair, USOC isn’t the only sports behemoth to enjoy tax-exempt status. The National Football League, the National Hockey League, the Professional  Golfers Association, and other big-bucks professional sports leagues are also tax-exempt–though under a different code subsection than USOC.  Last year, Sen. Tom Coburn (R-OK) introduced a bill to take away the tax-exemption for the pro outfits. It has gone nowhere.

USOC is somehow different, perhaps because it so successfully clings to the myth of the amateur athlete who competes for the love of sport, and not the big bucks.

But reading through its financials, USOC sure looks like a business. Yes, it probably does foster enough international amateur competition to satisfy the law, but I’m still left with the question I had as I tried to figure out what the heck slopestyle is: Why does the government grant tax-exempt status to businesses like USOC?

Howard Gleckman | Posted on February 13, 2014, 4:13 pm



Credit Union Federal Tax Exemption Study.

Benefits of the Credit Union Federal Tax Exemption

With debate about comprehensive tax reform heating up in Washington, NAFCU commissioned a study to take a look at the benefits of the credit union federal income tax exemption to consumers, businesses and the U.S. economy. Download the 2014 study and key findings at the links to the right.

Background

The 1934 Federal Credit Union Act (FCUA) states that credit unions receive a federal income tax exemption because “credit unions are mutual or cooperative organizations operated entirely by and for their members.” In 1998, as part of the findings of the Credit Union Membership Access Act (P.L. 105-219), Congress reaffirmed that exemption. Still, credit unions do pay many taxes and fees, including payroll and property taxes. It is also important to note that share dividends paid to credit union members are taxed at the membership level. Critics argue that credit unions today are no different than banks.

However, the defining characteristics of a credit union, no matter what the size, remain the same today as they did in 1934—credit unions are not-for-profit cooperatives that serve defined fields of membership, generally have volunteer boards of directors and cannot issue capital stock. Credit unions are restricted in where they can invest their members’ deposits and are subject to stringent capital requirements. A credit union’s shareholders are its members and each member has one vote, regardless of the amount on deposit, while a bank has stockholders.

Download 2014 Key Findings

http://www.nafcu.org/WorkArea/DownloadAsset.aspx?id=28446

A convenient two-page document to print and share with your elected officials.

Download 2014 Full Study

http://www.nafcu.org/WorkArea/DownloadAsset.aspx?id=28447





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