Income of States, Municipalities, Etc.; Political Subdivisions (I.R.C. 115)

February 27, 2013

General Discussion:

Section 115 of the Internal Revenue Code of 1986, as amended, provides the following:

Gross income does not include – (1) income derived from any public utility or the exercise of any essential governmental function and accruing to a State or any political subdivision thereof, or the District of Columbia; or (2) income accruing to the government of any possession of the United States, or any political subdivision thereof.

Rev. Rul. 57-128, 1957-1 C.B. 311, provides that the following six factors are considered in determining whether an organization is a wholly owned instrumentality of a political subdivision or a State:

  1. Whether the organization is used for a governmental purpose and performs a governmental function;
  2. Whether the performance of the organization’s functions is on behalf of one or more states or political subdivisions;
  3. Whether there are private interests involved, or whether the states or political subdivisions involved have the powers and interests of an owner;
  4. Whether control or supervision of the organization is vested in public authority or authorities;
  5. Whether express or implied statutory or other authority is necessary or exists for the creation and/or use of the organization; and
  6. The organization’s degree of financial autonomy and the source of its operating expenses.

References:

PLR 201720001 (May 22, 2017):  The entity was established by a county to combat the long-term economic and demographic decline aggravated by a residential foreclosure crisis.

PLR 201714001 (Apr. 10, 2017):  Entity was established by a county to carry out the statutory purposes of combating community deterioration by restoring abandoned and blighted property and promoting economic and housing development in that county.  Entity’s income determined to be derived from its performance of an essential governmental function and accrued to a state or political subdivision and, therefore, was excludable from gross income under I.R.C. 115.  County can dissolve the entity at any time, in accordance with state law.  The board consists of five to nine members.  The board must include the County’s treasurer and two County commissioners.  These directories unanimously select additional directors.  The office of County auditor manages the entity’s daily operations.  See also PLR 201712001 (Dec. 2, 2016)

PLR 201652001 (Sept. 13, 2016):  Taxpayer was established by various political subdivisions of the state (the participating employers) to hold assets to be used to provide self-funded, pooled self-funded or purchased insurance programs for their employees as provided under the plans.  The taxpayer is managed by a nine-member board of trustees.  Each board member is elected by the participating employers.  The plans provide coverage for medical, pharmacy, dental, vision, mental health and disability insurance for the employees of the participating employers.  Each participating employer must be a political subdivision of the state.  IRS concludes that the income of the taxpayer derives from the exercise of an essential governmental function and accrues to a state or a political subdivision thereof.  The taxpayer’s income is excludable from gross income under I.R.C. 115.

PLR 201308010:  The IRS has ruled that the anticipated income of two corporations formed by a mayoral directive to foster economic development qualifies for the exclusion from gross income under section 115 because the income will be derived from the exercise of an essential governmental function and will accrue to a state or a political subdivision.  The letter rulings discusses the factors in Rev. Rul. 57-128 to determine, for employment tax purposes, whether the corporations constitute wholly owned instrumentalities of a political subdivion – the City.

See 1990 Exempt Organization – Continuing Professional Education, Module E. Instrumentalities for a good overview of the status of organizations as instrumentalities of a political subdivision, 501(c)(3) determination for such entities and filing exemptions.

PLR 200406003 (Oct. 31, 2003):  Corporation overseeing and managing hotel is considered an instrumentality of the City for purposes of I.R.C. 141.

PLR 201441003 (Oct. 10, 2014):  Income of trust created to fund costs for health and welfare benefits to city retirees and their dependents was excludable from gross income under Code Sec. 115(1); where it was derived from exercise of essential govt. function and would accrue to state or political subdivision.

Rev. Rul. 77-261, 1977-2 C.B. 45:  Income generated by an investment fund that is established by a state to hold revenues in excess of the amounts needed to meet current expenses is excludable from gross income under I.R.C. 115(1), because such investment constitutes an essential governmental function. The ruling explains that the statutory exclusion is intended to extend not to the income of a state or municipality resulting from its own participation in activities, but rather to the income of an entity engaged in the operation of a public utility or the performance of some governmental function that accrues to either a state or political subdivision of a state. The ruling points out that it may be assumed that Congress did not desire in any way to restrict a state’s participation in enterprises that might be useful in carrying out projects that are desirable from the standpoint of a state government and that are within the ambit of a sovereign to conduct.

Rev. Rul. 90-74, 1990-2 C.B. 34:  Income of an organization formed, funded, and operated by political subdivisions to pool various risks (e.g., casualty, public liability, workers’ compensation, and employees’ health) is excludable from gross income under IRC § 115(1), because the organization is performing an essential governmental function. In Rev. Rul. 90-74, private interests neither materially participate in the organization nor benefit more than incidentally from the organization.

Rev. Proc. 95-48: Exempts an organization that is an affiliate of a governmental unit from the requirement of filing Form 990.  Section 4.02 of that Revenue Procedure provides that an organization is treated as an affiliate of a governmental unit if it is described in I.R.C. 501(c) and it meets the requirements of either Section 4.02(a) or (b).  Section 4.02(a)(i) states that an organization is treated as an affiliate of a governmental unit if it has a ruling or determination from the Service that its income, derived from activities constituting the basis for its exemption under I.R.C. 501(c), is excluded from gross income under I.R.C. 115.

PLR 201442037:  Income derived by authority created by Agency and County to manage water matters is income derived from exercise of essential governmental function and will accrue to state or political subdivision thereof for IRC § 115(1) purposes, and the Authority is a constituted authority for purposes of Treas. Reg. 1.103-1(b).

PLR 201509001 (and PLR 201338029):  Income of state non-profit corporation is derived from the exercise of an essential governmental function and will accrue to state or political subdivision thereof, and is therefore excludable from gross income for purposes of I.R.C. 115(1).

PLR 201528010:  In this one, a state university (with various ‘foundations’ that operate the university departments) and a state-created teaching hospital form a corporation to “provide a more strategically, financially and clinically integrated clinical enterprise, […] and to align the interests of all physicians currently employed by the foundations into a single physician organization.” The corporation will provide clinical services to the hospital’s patients and support the educational mission of the university.  The corporation has two classes of common stock, but the stock have no pecuniary value and do not provide dividends. The university holds one class of shares, the hospital holds the other class of shares. Neither the university nor the hospital may sell or transfer the shares without approval of all shareholders and the corporation’s board of directors. Upon dissolution, assets must be transfer to the state or a section 115 entity. The IRS determines that the corporation is exercising essential governmental functions and that its income from those functions is exempt under section 115.

PLR 201537019:  Multiple employer trust with public agencies as participating employers can be a Section 115 entity with respect to each participating agency.

PLR 201538011:  A city’s trust provides length of service benefits to volunteer fire fighters.  The trust’s income is excludable from gross income for federal income tax purposes.

PLR 201550026:  A trust’s income was derived from the exercise of an essential governmental function and accrued to a state or political subdivision and, therefore, was excludable from gross income under Code Sec. 115. Since the trust’s income was excludable from gross income, it was not required to file an annual income tax return. The trust was established by various political subdivisions of the state (the participating employers), to hold assets used to provide health and welfare benefits to their employees, and some former employees, as provided under the plan.

PLR 201551001 and PLR 201551002 (Sept. 8, 2015):  State nonprofit corporation’s income is excludable from gross income under I.R.C. 115.  The corporation is not required to file annual information returns on Form 990.  The corporation is a 501(c)(6) organization that is exempt under I.R.C. 501(a).  Membership in the corporation (association) is limited to special districts.  The special districts are devoted to providing specific services to citizens of the state, such as irrigation, port, fire, and sanitary services.  Membership is open to any intergovernmental agency, department, council or similar entity created under state statute, or statewide or regional associations of local government or any other public entities that qualify as political subdivisions or municipal, quasi-municipal or public corporations under state statute.  The corporation board consists of representatives from each class of member.  The corporation develops and disseminates information and acts as a clearinghouse for general and specific information to improve efficiency in the provision of all types of public service, cooperates with the state congressional delegation in items of common interest in matters of national legislation, etc.  The corporation will have a separate LLC to assist members with financial matters.  The corporation also has a trust for providing self-insured insurance pools and group purchase of insurance to members.  Corporation is found to be providing services that the members would otherwise perform.  Based generally on the forgoing, the IRS concludes that the corporation derives its income from the exercise of an essential governmental function and the income accrues to a state or political subdivision, and therefore the corporation’s income is excludable under I.R.C. 115.  Under Rev. Proc. 95-48, the corporation does not need to file the Form 990.


Pooled Financing Bonds (I.R.C. 149(f)(4)(A))

February 25, 2013

General Discussion:

An issuer may decide to issue tax-exempt bonds for the purpose of making loans to two or more conduit borrowers.  Borrowers may be governmental entities, section 501(c)(3) organizations or private businesses.  Borrowers are generally interested in these types of financings because the pooling of proceeds may reduce issuance costs and lower interest rates.

Special tax rules may apply when bonds are issued to make loans to two or more conduit borrowers.  The rules result from the concern that tax-exempt bonds not be issued substantially in advance of when the proceeds are actually needed by the borrowers.  Other rules reflect the belief that pooled bond issuers should not unduly benefit from their issuance of the bonds on behalf of the ultimate consumers (the borrowers) of the proceeds.

There are special non-arbitrage limitations, arbitrage limitations, rebate rules and refunding rules for pooled financings.

Non-Arbitrage Limitations:

See I.R.C. 149(f), 149(g), 147(b)

Exceptions to Rebate:

There are certain special rules for pooled financings, including the rules described below.

With respect to the six-month spending exception to rebate, the six-month period for pooled financings begins on the issue date of the pool bonds (not on the date of the loan to the borrower).  Therefore, the gross proceeds are not treated as “spent” for purposes of the spending exception until the gross proceeds are spent for their ultimate purposes (rather than on the making of a loan).  Under Treas. Reg. § 1.148-7(b)(6), the pooled bond issuer may elect (on or before the issue date) to apply the spending requirements separately to each loan to a conduit borrower, as discussed in the next paragraph.  If the election is made and proceeds are loaned to the ultimate borrower, the six-month spending period begins for the loan on the earlier of (1) the date the loan is made or (2) the date 12 months from the issue date of the pooled bonds.

For purposes of the two-year construction spending exception to rebate, special rules provide that the Available Construction Proceeds (ACP) of pooled bonds that are construction issues automatically qualify for the two-year rule.  In other words, under I.R.C. § 148(c)(2), if pooled bonds are issued and part of the issue is used to make or finance loans for construction expenditures, that portion of the bonds is entitled to a two-year temporary period (two-year spending exception) rather than the six month spending exception.  The pooled bond issue may elect to apply the spending exceptions separately to each conduit loan.  If the election is made, then (1) the spending requirements for a loan begin on the earlier of the date the loan is made or the first day following the one-year period beginning on the issue date of the pooled financing issue, and (2) the rebate requirement (and none of the spending exceptions) applies to the gross proceeds on the issue before the date on which the spending requirements begin.  See Treas. Reg. 1.148-7(b)(6)(ii).  If the issuer makes this election, it may make all elections under the two-year rule separately for each loan, and may pay rebate with regard to some conduit loans and the 1.5% penalty for other conduit loans from the same pooled financing issue.  The 1.5% penalty is computed separately for each conduit loan.  If a borrower in the pool fails to meet the expenditure requirements, the issuer must pay rebate in accordance with the general rules of I.R.C. § 148(f)(2), unless it has elected to pay the 1.5% penalty in lieu of rebate.  This election must be made on or before the date the pooled bonds are issued and is irrevocable.  A pooled issue, however, may elect to terminate the 1.5% penalty for a loan rather than for the entire issue.

For purposes of the small issuer exception to rebate, in the context of a pooled financing in which the borrower otherwise meets the small issuer exception, the small issuer exception is available to the proceeds of the pooled issue in the hands of the small borrower.  The pooled financing may mix large and small issuers and treat each borrowing separately for purposes of available rebate exceptions.  A loan to a conduit borrower qualifies for the small issuer exception, however, only if (1) the bonds of the pooled financing are not PABs, (2) none of the loans to conduit borrowers are PABs and (3) the loan to the conduit borrower meets all requirements of the small issuer exception.  The issuer of the pooled financing issue is, however, subject to the rebate requirement for any unloaded gross proceeds.  Also, in determining the $5,000,000 size limitation of a pooled financing issuer, bonds of the pooled financing issue are not counted against the issuer for purposes of applying the small issuer exception to the issuer’s other issues, to the extent that the pooled financing issuer is not an ultimate borrower in the financing and the conduit borrowers are governmental units with general taxing powers and not subordinate to the issuer.  See I.R.C. 148(f)(4)(D)(ii)(II) and Treas. Reg. 1.148-8(d)(1).

Other Matters:

Private activity bond requirements:  I.R.C. § 147 – Maturity limitation

Other general bond requirements:  I.R.C. § 149

Current refundings versus advance refundings

PLR 200315012 regarding multipurpose issues and refundings

TEB enforcement of I.R.C. § 6700 penalties in pooled financing bond cases

References:

Gannett and Jones, Pooled Financings, CPE Exempt Organizations Technical Instruction Program for FY 2000 Training.


Accountable Plans

February 25, 2013

General Discussion:

An accountable plan is an employee reimbursement allowance arrangement or a method for reimbursing employees for business travel expenses that complies with IRS regulations.  The accountable plan also most include a plan by which employees return excess reimbursements (those in excess of allowable amounts) to the employer.  If an employer sets up and maintains an accountable plan, employee travel expenses do not have to be treated as taxable income.

There are certain requirements for accountable plans, including the following:

  1. The expenses must have a business connection (they must have been paid or incurred while performing services as an employee);
  2. The employee must adequately account to the employer for these expenses within a reasonable time; and
  3. The employee must return excess reimbursements or allowances within a reasonable period of time.

(I.R.C. § 62; Treas. Reg. § 1.62-2; IRS Publication 463 (2011); and Jean Murray, Accountable Plan, About.com, available at http://biztaxlaw.about.com/od/glossarya/g/accountableplandef.htm)


Refunding of Conduit Financing Issues

February 22, 2013

General Discussion:

Treas. Reg. 1.150-1(d)(2)(iii) provides the following:

(A) Refunding of a conduit financing issue by a conduit loan refunding issue. Except as provided in paragraph (d)(2)(iii)(B) of this section, the use of the proceeds of an issue that is used to refund an obligation that is a purpose investment (a conduit refunding issue) by the actual issuer of the conduit financing issue determines whether the conduit refunding issue is a refunding of the conduit financing issue (in addition to a refunding of the obligation that is the purpose investment).

Example Applications:

Assume on date X the governmental authority (the “Authority”) issues bonds (the “Authority Bonds”) and uses the proceeds thereof to fund a loan (the “Loan”) to a town (the “Town”).  On the same date, the Town issues its “governmental agency bond” to the Authority to secure the Loan.  Many years later, on date Y, the Town decides to pay off the Loan.  To do so, it issues refunding bonds (the “Refunding Bonds”) and uses the proceeds to redeem the governmental agency bond.

Under Treas. Reg. 1.150-1(d)(2)(iii), when the Town uses proceeds of the Refunding Bonds to redeem the governmental agency bond, the Authority can either (1) use those proceeds to refund its own Authority Bonds or (2) “recycle” those proceeds to make future Loans if certain conditions are satisfied.

Now, assume the Authority Bonds aren’t callable within 90 days and the Authority can’t “recycle” the proceeds.  In this case, the Authority will need to advance refund the Authority Bonds.  This could be a problem if the Authority theretofore already advance refunded the Authority Bonds once.  By permitting the Town to pay off the governmental agency bond with cash only (and not with a Refunding Bond issue), the Authority is protecting its ability to conduct advance refundings of the Authority Bonds.


Convention and Trade Show Facilities

February 6, 2013

General Discussion:

Prior to the Tax Reform Act of 1986, convention and trade show facilities were considered one type of “exempt facility,” together with sports facilities, parking facilities and pollution control facilities.  The authority to issue tax-exempt bonds for such facilities were repealed by the Tax Reform Act of 1986.

“Convention or trade show facilities” means special-purpose buildings or structures, such as meeting halls and display areas that are generally used to house a convention or trade show, including facilities functionally related and subordinate to such facilities such as parking lots or railroad sidings.  A hotel or motel that is available to the general public, whether or not it is intended primarily to house persons attending or participating in a convention or trade show, is neither a convention or trade show facility nor functionally related and subordinate thereto.  See Treas. Reg. 1.103-8(d).


Protected: Audit Considerations for Tax-Exempt Bonds

February 5, 2013

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