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

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

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

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.

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)

 

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

 

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

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 15^th 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

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.

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.

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.

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.

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

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

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.

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

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.

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

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

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

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.

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.

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.

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.

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)).

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  and TAM 9726001 . 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 .

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 ).

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).

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

UIL Number: 4941.00-00, 4942.03-05, 4945.00-00
Release Date: 4/25/2014

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.

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.

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).

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.

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.

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

Citations: LTR 201417022

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

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

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.

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.

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).

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).

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

Citations: LTR 201417018

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).

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.

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

FEBRUARY 19, 2014

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

 

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

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

 

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.

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

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

                               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

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.

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.

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.

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.)

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.

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.

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.

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

Judith.a.hagley@usdoj.gov

Appellate.taxcivil@usdoj.gov

Of Counsel:
John W. Vaudreuil
United States Attorney

APRIL 2014

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.

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

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).

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.

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).

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”.

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.

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

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.

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.* * * * *

March 24, 2014
Affected IRM: IRM 4.76.22 and 7.25.14
Expiration Date: March 24, 2015

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

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

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

 

 

UIL: 7805.03-00
Release Date: 3/28/2014

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 = * * *

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).

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.

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).

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

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

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.

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.

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

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

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

“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

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)

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.”

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

Citations: H.R. 4237; Sustainable Water Infrastructure Investment Act of 2014

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.

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

UIL: 501.03-00
Release Date: 3/21/2014

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

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.

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.

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.

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).

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

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

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”).

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).

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.

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

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

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

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

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

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.