Fees vs. Taxes

December 27, 2015

General Resources:

Colorado Union of Taxpayers Foundation v. City of Aspen (http://www.cobar.org/opinions/opinion.cfm?opinionid=9983&courtid=1):  Whether a $0.20 per bag fee imposed by stores is an unvoted tax or fee.  The court of appeals determined that the fee is a fee that does not violate constitutional debt limits because the primary purpose of the fee was to reduce waste, and the majority of the revenues was used to provide reusable bags to residents and visitors.  No part of the balance of the revenues was deposited to the City’s general fund for general governmental use.

Voluntary Closing Agreement Program (VCAP)

April 8, 2015

Scope of the VCAP Program

Under TEB VCAP, an issuer may request a closing agreement with respect to its bonds to resolve violations of sections 103, 54, 1397E, 1400N and related provisions of the Code. TEB VCAP is not available when:

  1. Absent extraordinary circumstances, the violation can be remediated under existing remedial action provisions or tax-exempt bond closing agreement programs contained in regulations or other published guidance.
  2. The bond issue is under examination. A bond issue is generally treated as under examination on the date a letter opening an examination on the bond issue is sent.
  3. The tax-exempt status of the bonds or qualified status of tax credit bonds is at issue in any court proceeding or is being considered by the IRS Office of Appeals.
  4. The Service determines that the violation was due to willful neglect.


Notice 2008-31 provides general information about the TEB VCAP.

I.R.M. 7.2.3 provides administrative information concerning the requirements for submitting the VCAP request.

Form 14429 is the form that is to be submitted as a cover letter to the VCAP request.

Certain Stock Purchases Treated as Asset Acquisitions (I.R.C. 338)

December 14, 2014

See also http://www.alliedbizgroup.com/resources/publications/asset-sale-vs-stock-sale.html.

See also http://www.bizquest.com/resource/basic_deal_structures__stock_purchase_vs_asset_p-23.html.

Instrumentality (Rev. Rul. 57-128)

June 13, 2014


The status of an entity as an “instrumentality” of a state or local governmental unit is relevant for the following purposes:

  • I.R.C. 141:  Private activity bonds test (see Treas. Reg. 1.141-1(b) definition of “governmental person”);
  • I.R.C. 170:  Deductions for contributions and gifts to or for the use of a state, a possession or any political subdivision of the foregoing (see I.R.C. 170(c)(1)) or an instrumentality of a state or an instrumentality of a political subdivision of a state if the contributions are made for exclusively public purposes (see Rev. Rul. 75-359);
  • I.R.C. 3121(b)(7) and 3306(c)(7):  Federal Insurance Contribution Act (FICA) taxes on the wages paid by an employer to employees with respect to employment.

The term “instrumentality” is not defined in the Code or regulations.

Revenue Ruling 57-128 sets forth the following factors to be taken into account in determining whether an entity is an instrumentality of one or more governments:

  1. Whether the organization is used for a governmental purpose and performs a governmental function;
    •  See GCM 39683 relating to a state bar association.  An entity may still be an instrumentality even if it performed private functions in addition to governmental functions.
  2. Whether the performance of the organization’s functions is on behalf of one or more states or political subdivisions;
    • See GCM 39683.  If the activities serve governmental functions as well as private functions, it is not clear whether the performance of those functions is on behalf of the state.
  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;
    • See GCM 39683.  Control of purse strings may be insufficient if the control exists merely to ensure that expenditures are within the purposes of the act creating the entity.  However, appointment by Texas Supreme Court of members of the state bar means power to control is vested in a public authority.
  5. Whether express or implied statutory or other authority is necessary or exists for the creation and/or use of the organization; and
    • Does the entity need statutory authority to conduct its functions?  For example, to reprimand members or bring disbarment proceedings, in the case of GCM 39683 and the state bar.
  6. The organization’s degree of financial autonomy and the source of its operating expenses.

These criteria were developed under I.R.C. 3121(b)(7) and 3306(c)(7) which exclude from the definition of “employment” services performed in the employ of a state, or any political subdivision thereof, or any instrumentality of any one or more of the foregoing which is wholly owned thereby.

The status of an entity as an instrumentality does not automatically mean that the entity is also an on-behalf-of issuer (Click link to view topic) for purposes of I.R.C. 103(c)(1).  On-behalf-of issuer status is tested based on “constituted authority” status under Rev. Rul. 57-187 or on-behalf-of status under Rev. Proc. 63-20.  There are some PLRs in which the entity at issue is both an instrumentality (usually for purposes of proving that the entity is a governmental purpose of the private activity bond test) and an on-behalf-of issuer.

Rulings and Resources:

GCM 36088 (Nov. 18, 1974):  Whether a contribution for exclusively public purposes to a wholly-owned instrumentality of a state or of a political subdivision is a contribution to rather than merely for the use of such state or political subdivision for the purposes of I.R.C. 170(c)(1) and, therefore, is subject to the 50 percent limitation on deductions for contributions by individuals under I.R.C 170(b)(1)(A).  The memorandum distinguishes between wholly owned instrumentalities and integral parts of states or political subdivisions to hold that gifts to the later are gifts “to” the state or political subdivisions.

Rev. Rul. 75-359: Deductions for contributions and gifts.  I think this is the ruling described and revised by GCM 36088.

GCM 36781 (Jul. 6, 1976):  Whether the entity is conducting a governmental function. The entity is an urban league that is organized to aid in the development of a secure and exemplary American democracy by assisting communities to ameliorate conditions and to solve problems arising out of racial inequities within the American community and to work on problems and opportunities in the fields of job development and employment, education and youth incentives, housing, and health and welfare and that is exempt from federal income taxes under the 1954 Code as a 501(c)(3).  GCM concerned the exemption from federal excise taxes on communication services. [Not particularly helpful to common 103-related instrumentality fact patters.]

GCM 39683 (Jun. 14, 1987):  Whether the bar association is performing a governmental function.  Memorandum relates to unemployment tax liability.  Under Section 3306(c)(7), employment does not include services performed in the employ of a state, a political subdivision thereof, or any instrumentality of any one or more of the foregoing which is wholly owned y one or more states or political subdivisions, and any service performed in the employ of any instrumentality of one or more states or political subdivisions to the extent that the instrumentality is, with respect to such services, immune under the Constitution of the Untied States from the tax imposed by Section 3301.  General Counsel concludes that the state bar is not a political subdivision because it does not possess any sovereign powers.   The powers to investigate and prosecute grievance actions and unauthorized practice suits are not traditional governmental powers but rather are customary powers of professional associations.  Then, General Counsel concludes that the bar is not a public corporation in the constitutional sense.  At least part of the purposes, functions and activities of the state bar are private and not governmental in nature, including encouraging cordial intercourse among its members, the protection of the professional interests of the members, etc.

PLR 200026013:  Concerns the status of the Authority as an instrumentality for purposes of I.R.C. 141 private activity bond tests, applying Rev. Rul. 57-128.  Authority is a membership corporation.  Members are all political subdivisions.  Persons serving on the board are required to be officers or employees of the members.  Each member has the power to remove (with or without cause) any of the directors that it appointed.  A removed director’s successor is appointed by the member that removed the director to serve the unexpired term.  The entity’s purpose is to coordinate the operation of electric generation resources.  The entity receives funding from its members.  The entity submits financial reports to its members.  No net earnings of the Authority may be paid or inure to the benefit of any private person.  Upon dissolution, any assets remaining after the entity satisfies its obligations are distributed ratably to its members.

PLR 200225010:  The issue addressed in this ruling is whether an Authority, which is a joint venture between tribes, is an “instrumentality” (within the meaning of Rev. Rul. 57-128) of its governmental/tribal members and therefore a “governmental person” for purposes of the private activity bond tests.

PLR 200510016: Whether (1) the Association’s income is exempt from taxation under I.R.C. 115, (2) the Association is an instrumentality for purposes of I.R.C. 3121(b)(7) and 3306(c)(7), under Rev. Rul. 57-128 and (3) the contributions made to the Association are deductible by the donors as charitable contributions under I.R.C. 170(c)(1).  Association was created by City for the purpose of carrying out the promotion of tourism for the City.  By promoting tourism in the City, the Association will contribute to the economic development of the City through increased tourism and visitation to the City and will increase the expenditure of tourist dollars at local businesses.

PLR 200524015:  That (1) Agency and Agency’s Subsidiary are instrumentalities under Rev. Rul. 57-128 for purposes of the private activity bond tests, (2) income of Agency and Agency’s Subsidiary is excludable from gross income under I.R.C. 115(l) and (3) Agency’s use of bond proceeds will not constitute use meeting either the private business tests of I.R.C. 141(b) or the private loan tests of I.R.C. 141(c).  Agency was formed by governmental entities to perform the functions of, or to carry out the purposes, of its members with a view towards maximizing the efficient acquisition, management and delivery of natural gas supplies and reducing operating costs of its members. (Keyword: Piggybacking Instrumentality.)

PLR 200718002:  A System is an instrumentality of the County under Rev. Rul. 57-128 for purposes of the private activity bond rules of I.R.C. 141 (i.e., the bond-financed facility is therefore used by a governmental person and not a private business user) as well as an on-behalf-of issuer (constituted authority under Rev. Rul. 57-187) of the County for purposes of issuing tax-exempt bonds (i.e., the System could issue tax-exempt bonds on behalf of the County).  County Board created System as a public corporation that will operate as a subsidiary of County to provide health care and related services to the general public and related education and research programs.  System is required to provide services to persons who are indigent.

PLR 200736022: [To come]

PLR 200836005:  Issues include (1) whether the entity’s income is exempt from taxation under I.R.C. 115, (2) whether the entity qualifies as an instrumentality for purposes of making charitable contributions to the entity under I.R.C. 170(c)(1) and (3) whether interest on bonds issued by the entity are excludible from gross income because the entity is a constituted authority under Rev. Rul. 57-187.

PLR 201220005, February 3, 2012:  Public corporation established to support state’s schools for the vision and hearing impaired qualifies as an “instrumentality of the state” contributions to which are deductible under I.R.C. 170(c)(1).

PLR 201308010 (Nov. 20, 2012):  The Internal Revenue Service applies the six factors in Rev. Rul. 57-128 to economic development corporations created by City.  Ruling relates to determining whether services provided to the corporations are “employment” under FICA.

PLR 201411018 (Aug. 9, 2013):  The Internal Revenue Service applies the six factors in Rev. Rul. 57-128 to a state university or community college and concludes that the university/college is an instrumentality of the state for purposes of I.R.C. 141 private activity bond tests and is eligible to receive charitable contributions under I.R.C. 170(c)(1) (“A state, a possession of the United States, or any political subdivision of any of the foregoing, or the United States or the District of Columbia, but only if the contribution or gift is made for exclusively public purposes”).


Debt vs. Equity

April 29, 2013

(This post will be updated from time to time, as needed.  Many of my readers are likely to have more and better insight into specific debt versus equity matters regarding bonds.  If you have any comments, please leave a comment using the “reply” feature below.)

General Information

debt-consolidation-funny-pictureWhether an obligation is considered debt for federal income tax purposes depends on the terms of the obligation instrument and all surrounding facts and circumstances.  In Notice 94-47, the Internal Revenue Service describes several factors listed below that may be considered in making this determination.  No particular factor is conclusive in making a determination of whether the obligation constitutes debt or equity, and the weight given to any factor depends on the facts and circumstances and the overall effect of an instrument’s debt and equity features.

  1. Whether there is an unconditional promise on the part of the issuer to pay a sum certain on demand or at a fixed maturity date that is in the reasonably foreseeable future (“yes” indicates debt);
  2. Whether holders of the instruments possess the right to enforce the payment of principal and interest (“yes” indicates debt);
  3. Whether the rights of the holders of the instruments are subordinate to the rights of general creditors (“no” indicates debt);
  4. Whether the instruments give the holders the right to participate in the management of the issuer (“no” indicates debt);
  5. Whether the issuer is thinly capitalized (“no” indicates debt);
  6. Whether there is identity between holders of the obligations and stockholders of the issuer (“no” indicates debt);
  7. The labels placed upon the instruments by the parties;
  8. Whether the instruments are intended to be treated as debt or equity for non-tax purposes, including regulatory, rating agency or financial accounting purposes.

Notice 94-47 was issued in part to address transactions being completed in which the obligations were structured to look like debt for federal income tax purposes but as equity for regulatory, rating agency or financial accounting purposes (see factor 8 above).  Rev. Rul. 85-119, 1985-2 C.B. 60 was used as authority or guidance in treating such obligations as debt.  The IRS cautions that the ruling should be analyzed narrowly and indicates that it does not feel bound by any arrangements that do not mirror the facts in the ruling.

See also L. Howard Adams, “What Role for Equity in Applying Factors for Distinguishing Debt?,” Tax Notes, March 4, 2013, for a good discussion of factors relevant to determining the debt/equity status of obligations.

Excludable, Includable, Included

January 1, 2013


Statements in transaction documents oftentimes include covenants that are triggered when interest on bonds is no longer excludable from gross income for federal income tax purposes of the registered owners of the bonds.  The covenants may frequently be stated in the inverse – such that the covenant is triggered when interest is included or even includable in gross income.  Is it critical that such covenants be written in terms of interest not being excludable from rather than being included or includable in gross income?


I.R.C. 103(a) states that gross income does not include interest on any State or local bond.  The inverse of this statement would be that interest is included in gross income.  This suggests that the proper phraseology of tax covenants ought to refer to inclusion in gross income.

The use of the term “included” means that interest is actually included in gross income.  This term is appropriate only if there are no other circumstances outside of I.R.C. 103 and 141 to 150 that would not prevent such inclusion.  If there are other circumstances, those circumstances may invalidate the effect of the meaning of the covenant.  For instance, even though an event may have happened that, under I.R.C. 103, causes the inclusion, the default condition technically goes away if, under another provision of the Code, interest is excluded.  Under what circumstances could interest be excluded from gross income for federal income tax purposes outside of the I.R.C. 103 realm?  I.R.C. 149(c) suggests that there are no other sources of exemption.  For bonds issued after 1983, this section of the Code provides that the exemption requirements under Part IV (Tax Exemption Requirements for State and Local Bonds) must be satisfied as a condition to exemption.

Use of the term “includable” suggests that there is some discretion in including the interest.  As discussed above, there are no other actual sources of exemption from federal income tax of interest on State or local bonds.  Therefore, if interest is not excluded under I.R.C. 103, interest is absolutely included (versus “includable”) in gross income.

There does not appear to be a meaningful difference in phrasing a covenant using the term “included” or “excludable.”

Protected: Audit of Village Center Community Development District Bonds

November 3, 2012

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Lease and COP Matters

October 12, 2011

A.  Non-Substitution Clauses in Leases

The following is an excerpt from “Common Questions about Tax-Exempt Leases” published online by Municipal Funding of Zephyrhills, Florida, available at http://municipal-funding.com/tax-exempt_leasing_faq.htm:

A non-substitution clause is a provision in a 103 lease that prevents the government from non-appropriating and then acquiring equipment to perform the same function as the previously leased equipment.

Although non-substitution clauses still appear in 103 leases, the majority view (with which the author agrees) seems to be that having a non-substitution clause in a 103 lease actually damages the lessor’s interest. Here is the rationale: If the non-substitution clause prohibits the government from performing an essential government function, such a clause may be used to show that the lessor, while purporting to recognize the unrestricted right of the government to non-appropriate, nevertheless imposed coercive sanctions on the government in the event that the government exercised such right. The right to non-appropriate becomes illusory.

The non-substitution clause becomes the basis for an argument that the 103 lease creates debt. The government still has to perform the essential government function being served by the equipment. If it is unable to acquire new equipment to perform that function subsequent to a non-appropriation, non-appropriation is not a real option and the lease is essentially a multiyear hell or high-water obligation.

Courts in several states, including Texas, Oregon, Colorado, and Florida, have already found that including a non-substitution clause turns the 103 lease into debt. In each of these cases, because the procedures for incurring debt were not complied with, the 103 lease was void.

In light of this and because experience shows the clause is rarely if ever enforced, it offers no real benefit to lessors. Limiting its reach by the phrase “to the extent permitted by law” may mitigate some of the negative consequences, but it does little to make the provision more helpful.

B. Lessor Entities

For purposes of IRS Form SS-4, Application for Employer Identification Number (EIN), does the lessor entity check the “Corporation” box or the “State/local government” box on line 9a?  Does the lessor entity need to file an income tax return?

Generally, if an entity is separate from (not an “integral part” of) the government, its income will be subject to tax unless an exclusion or exemption applies. If the income is subject to income tax, the entity may need to file a return.  An exclusion in I.R.C. 115, however, excludes from gross income, income (1) derived from any public utility or the exercise of any essential governmental function, and (2) accruing to a state or political subdivision (including the District of Columbia).

The IRS Exempt Organizations training material provides the following discussion:

What activities involve exercise of an “essential governmental function” is generally decided on a case-by-case basis. Factors considered include whether the activity is one traditionally considered “governmental” (as opposed to private or proprietary), whether it involves the exercise of governmental (sovereign) powers, the extent of government control over the activity, and the extent of government financial interest in the activity. Qualifying activities may include public education; investment of public funds, Rev. Rul. 77-261, 1977-2 C.B. 45; operating a municipal insurance pool; operating a public hospital or other public health facilities; or providing public recreation facilities.

Income must be derived from a qualifying activity; it is not enough that it be paid over to or benefit a qualifying activity. For example, that a university uses income derived from operating a commercial television station to conduct educational programs does not render the income excludable; the income must have been derived from educational activities. See Iowa State University of Science & Technology v. United States, 500 F.2d 508 (Ct. Cl. 1974).

The second requirement under IRC 115(1) is that income “accrue to” a state or political subdivision. Income “accrues” where the state or subdivision has an unrestricted right to a proportionate share of the income. Rev. Rul. 77-261, 1977-2 C.B. 45. The “accrual requirement” may also be met by less direct means. What is required is a substantial degree of government dominance over the enterprise. While many organizations that are “instrumentalities” for employment tax purposes (discussed below) will also have income excluded under IRC 115, the two are conceptually distinct. It is therefore conceivable that an “instrumentality” may be subject to income taxation.

If the lessor entity constitutes an entity described in I.R.C. 115, bond counsel will generally identify the lessor entity as a “State/local government” entity on the SS-4 form.  It is not entirely clear whether the lessor or the governmental lessee will need to file a tax return for the lessor.  The IRS Exempt Organizations training material provides the following statement:

Return Requirements. Under Rev. Rul. 78-316, 1978-2 C.B. 304, states and political subdivisions (including their “integral parts”) are generally not required to file income tax returns with respect to activities they directly conduct. Separatelyorganized instrumentalities, however, are subject to the general rule requiring taxable corporations to file returns, regardless of whether they have income or owe tax. Rev. Rul. 77-261, 1977-2 C.B. 45. Specific provisions may require a return even if an entity is an “integral part” of a state or political subdivision. For example, if an entity is an “insurance company” for federal tax purposes, it must file a return even if it is not otherwise considered a taxable corporation. See Rev. Rul. 83-132, 1983-2 C.B. 270.

C.  COP Matters

PLR 200314024:  Bonds are issued “as certificates of participation” in an installment sale agreement with the City in which the City agrees to make payments to purchase the Center from the Corporation.  Payments will equal the interest and principal due on the COPs.

PLR 9123058:  In a COP financing, the underlying lease as well as the COPs were approved under 147(f), not just the COPs.

Political Subdivision; On-Behalf-Of Issuer (I.R.C. 103; Rev. Rul. 57-187; Rev. Rul. 63-20)

June 9, 2009


Section 103(a) of the Code excludes from gross income for federal income tax purposes interest on any “State or local bonds.”  A bond is defined as an “obligation” of any State or political subdivision thereof.  For an obligation to exist for Section 103 purposes, it must be incurred by an issuer (see section B below) pursuant to the exercise of its borrowing power, as opposed to some other power, and the bonds must be valid under state law (see section D below).  The following sections provide a discussion of certain of these requirements.


1. States and Political Subdivisions

  • A political subdivisions, for purposes of Section 103, is a governmental unit to which there has been delegated at least one of the three fundamental sovereign powers of the state.  (See also PLR 201104020)
  • Three generally acknowledged sovereign powers of states are the power to tax, the power of eminent domain and the police power (power to regulate).  See Estate of Alexander J. Shamberg, 3 T.C. 131 (1944).  It is not necessary that all three powers be delegated.  However, possession of only an insubstantial amount of any or all sovereign powers is not sufficient.  “All of the facts and circumstances must be taken into consideration, including the public purposes of the entity and its control by a government.” See Rev. Rul. 77-164.  See, also, Philadelphia National Bank case cited below (the Temple University case).
  • Rev. Rul. 61-181: A Los Angeles authority is delegated certain sovereign powers to furnish mass transportation.
  • PLR 8152063: Entity given power of eminent domain and the right to condemn property to improve health conditions of the state.
  • PLR 9122068:  University has eminent domain and police powers for campus police.
  • PLR 8630027:  District’s powers do not represent substantial powers of taxation or eminent domain.  In effect, here the District (wholly controlled by the non-exempt Corporation) has been delegated no materially greater ‘sovereign powers’ over District land (the Corporation’s inventory) than the Corporation inherently will have if the District is never created.
  • PLR 201104020: The issuer is not a political subdivision because it’s power of eminent domain is limited in that the issuer must seek approval from the City Council before exercising the power.  This was found to be only an insubstantial amount of sovereign power.
  • Rev. Rul. 77-164: A community development authority, created under state laws that empower it to collect service and user fees for the construction, operation and maintenance of community facilities, that lacks the power to tax, the power of eminent domain and control over zoning, police and fire protection, does not qualify as a political subdivision within the meaning of I.R.C. 103.
  • PLR 200238001: A district is governed by property owners and elected officials of the County.  The IRS reviews sovereign powers and then the division test.  The IRS concludes that, because at least five (presumably the majority) trustees of the board “are subject to the control of either the County Judge/Executive, an elected official of the County or the control of the property owners of the District.”  This suggests that, if all trustees were subject to the control of the property owners, that would be sufficient.  There is no sense in this PLR that the property owners cannot be the owner of all of the property within the district.
  • PLR 200017018 (Wholly motivated by a public purpose):  Request for ruling that the Authority is a political subdivision of the state.  The Authority was created under state law by local governmental units A, B and C, to provide for the development of ports for transportation-related commerce.  The Authority is governed by a board of directors appointed by its member governmental units.  Upon dissolution, the Authority’s assets will be distributed to its member governmental units.  “In determining whether an entity is a division of a state or local governmental unit, important considerations are the extent the entity is (1) controlled by the state or local government unit, and (2) motivated by a wholly public purpose. […] Indicia that the Authority is governmentally controlled are: (1) the Authority is governed by a board of directors appointed by its member governmental units A, B and C; (2) the Authority’s net revenues inure to the benefit of the State and its municipalities; and (3) the Authority’s assets will be distributed to its member governmental units upon dissolution.  The Authority is motivated by a wholly public purpose.”  Accordingly, the Authority is a political subdivision for purposes of I.R.C. 103.
  • “Public purpose” in the context of a wholly public purpose:  See Treas. Reg. 1.141-5(d)(4)(ii):  “Essential governmental functions. For purposes of paragraph (d) of this section, improvements to utilities and systems that are owned by a governmental person and that are available for use by the general public (such as sidewalks, streets and street-lights; electric, telephone, and cable television systems; sewage treatment and disposal systems; and municipal water facilities) serve essential governmental functions.  For other types of facilities, the extent to which the service provided by the facility is customarily performed (and financed with governmental bonds) by governments with general taxing powers is a primary factor in determining whether the facility serves an essential governmental function.  For example, parks that are owned by a governmental person and that are available for use by the general public serve an essential governmental function.  Except as otherwise provided in this paragraph (d)(4)(ii), commercial or industrial facilities and improvements to property owned by a nongovernmental person do not serve an essential governmental function.  Permitting installment payments of property taxes or other taxes is not an essential governmental function.”
  • PLR 201735020 (Police Power):  Division established by State as part of State’s public transportation system was held to be a political subdivision.  Division is governed by a board of directors the members of which are appointed by the governing bodies of the counties in the metro area and by the chief executive official of a city.  Board members can be removed for cause by a majority of board members or by the governor of State.  Division has certain powers which the IRS considers to be substantial police powers.  Ruling incorporates the flawed IRS conclusion that a political subdivision must be a division of a state or local government. Specifically, the ruling unduly focuses on the specific public purpose of Division and control by State and certain other governmental entities.
  • PLR 201741010:  Corporation established to provide long-term energy solutions and maximize the value of natural gas located in the state for its residents determined to be a political subdivision under section 103.

2. “On Behalf Of” Issuers: Overview

  • If an entity fails to satisfy the requirements necessary to be treated as a political subdivision, it may still issue tax-exempt obligations if in so doing it is deemed to be acting on behalf of a state or local governmental unit.  See Rev. Rul. 77-164; Philadelphia National Bank v. United States, 666 F.2d 834 (3d Cir. (Pa.) 1981).
  • There are two types of “on behalf of” issuers: (1) entities formed under state law for the express purpose of issuing bonds to effect a public purpose, i.e., constituted authorities; and (2) entities formed under applicable state nonprofit corporation law which comply with the requirements of Rev. Rul. 63-20.  Rev. (Proc. 82-26 sets forth the conditions under which the IRS will grant a favorable advance ruling on whether a nonprofit corporation’s obligations are exempt under Code Section 103(a)(1).)
  • Don’t confuse “on-behalf-of” issuer status (discussed in this posting) with “instrumentality” status (discussed in this posting).  Instrumentality status is only relevant to determining whether the entity is “governmental person” for purposes of the private activity bond test (and for charitable contributions and FICA taxes).
  • For a good overview of “on behalf of” issuers, see George Pitt’s “63-20 Handbook.

2.1. “On Behalf Of” Issuers: Constituted Authorities (Rev. Rul. 57-187)

  • Constituted authorities are entities specifically authorized by state law to issue bonds on behalf of political subdivisions of a state, among other specific powers granted to such entities in order to further public purposes.
  • Alabama board ruling (Rev. Rul. 57-187): Describes that obligations by this entity were deemed issued on behalf of the political subdivision.  Nearly all conduit public authority enabling legislation is based on Rev. Rul. 57-187.
  • There is generally no difference for federal tax purposes between an issuance by the political subdivision and the issuance by an on-behalf-of constituted authority.
  • Statutes can include municipal ordinances enacted under a home rule charter, but do not otherwise include intergovernmental agreements, as described in a private letter ruling of the mid-1980s.  The statutory reference to the “constituted authority” must be fairly specific and, for example, should refer to the authority by name or be otherwise specific to the authority.  One Chicago-based bond counsel firm apparently requested a ruling regarding constituted authority status in a western state which had a liberally-worded statute.  The IRS proposed or even issued an adverse ruling.
  • Rev. Rul. 57-187:  Industrial development boards were authorized by state law for incorporation in municipalities to promote industry and develop trade in Alabama.  In furtherance of those purposes the boards were empowered to acquire, improve, furnish, equip, lease, sell and convey industrial projects and to issue bonds in furtherance of the boards’ purposes.  The boards were controlled by the local municipality’s governing body.  State law provided that bonds were payable solely out of revenues from the boards, sales or lease of projects.  Each board was a public nonprofit corporation whose earnings and property upon dissolution reverted to the municipality in which it was located.  The IRS ruled that bonds issued by the industrial development boards were obligations issued “on behalf of a political subdivision” by a constituted authority.  Characteristics in Rev. Rul. 57-187:  (1) the issuance of the bonds must be authorized by specific statute; (2) the bond issuance must have a public purpose (which includes promotion of trade, industry and economic development); (3) the governing body of the authority must be controlled by the political subdivision; (4) the authority must have the power to acquire, lease and sell property and issue bonds in furtherance of its purposes; (5) earnings cannot inure to the benefit of private persons; (6) upon dissolution, title to all bond financed property must revert to the political subdivision.
  • Rev. Rul. 60-248:  Bonds, notes, and other obligations issued by the New York State Housing Finance Agency, established pursuant to an Act of the New York State Legislature for the purpose of financing the construction of low rent housing facilities, are considered as issued on behalf of the State and the interest received therefrom is exempt from federal income tax.  Agency’s membership consists of the State Commissioner of Housing, the State Director of the Budget, the State Commissioner of Taxation and Finance, and two other members appointed by the Governor. The Governor may remove any member of the Agency for inefficiency, neglect of duty, or misconduct in office. The Agency and its corporate existence are to continue for as long as it shall have bonds, notes, and other obligations outstanding, and until its existence is terminated by law. Upon termination, all its rights and properties shall pass to and be vested in the State of New York.
  • PLR 201104020: Authority was not an on-behalf-of issuer because a majority of the board members was not controlled by the City.
  • PLR 200936012: Corporation’s board is appointed by the County. Corporation meets the requirements of Rev. Rul. 57-187 as an on-behalf-of issuer.
  • TAM 200646017:  Public school academy doesn’t have sovereign powers (though it does meet the division analysis, particularly because of the control element) but is an on-behalf-of issuer of the state because it meets the requirements of Rev. Rul. 57-187.
  • PLR 8912008: University issues bonds on behalf of the state.
  • PLR 8906058:  Authority created under state law to assist with planning and development of the county issues bonds on behalf of the county.
  • PLR 8542104 (Jul. 29, 1985): Authority is created by City ordinance pursuant to a state statute to issue bonds for creation of certain public facilities.  Bonds will be issued on behalf of the City, which approves the Authority’s Articles of Incorporation, provides for perpetual existence and distribution of assets to City in event of dissolution.  The City has the right to appoint and remove Board of Directors.  The City’s home rule status causes the ordinance to be considered state statute for purposes of creation of the Authority.  Authority therefore is a constituted authority. (“Focus on the Family ruling.”)
  • PLR 8507034:  IRS held that a housing finance joint powers board was not a “constituted authority” within the meaning of Treas. Reg. 1.103-1(b) because the statute under which the board was created did not specifically authorize the board to issue obligations on behalf of a state or local governmental unit for a specific purpose.  Instead, the statute generally permitted the board to issue bonds under any law under which the governmental units were independently authorized to issue bonds.
  • PLR 8419029:  Lease purchase financing entered into by entity is considered entered into on behalf of the university even though not all of the entity’s board members are controlled by the university – a majority is sufficient.
  • PLR 8405131:
  • PLR 8232044:
  • PLR 8215025:
  • PLR 8207036:  The IRS rules that an entity organized by more than one municipality does not affect the application of the criteria in Rev. Rul. 57-187.
  • PLR 8139124:  Board is a department of the state responsible for advising the state regarding supervision of aeronautics within the state.  The authorizing act for the board authorizes the board to issue bonds on behalf of the state to finance projects suitable for use by commercial enterprises that provide scheduled air transportation services within the state.  Without any analysis, the Service concludes that the board is an on behalf of issuer of the state.  Side issues in the ruling are the requirement for locating small issue bond facility within the jurisdiction of the issuer where the financed property may travel outside of the jurisdiction.  The project consisted of aircraft.
  • PLR 8125023:  The Authority was established in County Y by an act of the State Legislature (the Act) designed to promote industry and develop trade by inducing manufacturing, industrial, governmental and commercial enterprises to locate in or remain in the State. Pursuant to the Act, the Authority is governed by a board of commissioners appointed by the governing body of County Y.
  • PLR 200022028:  Request for a ruling that (1) income derived from the Corporation as a result from its proposed activities will be excludable under I.R.C. 115, (2) the Bonds to be issued by the Corporation will be considered issued on behalf of the State under I.R.C. 103 and (3) the Corporation is an instrumentality of the State under I.R.C. 141.  Corporation was created by act of the State legislature as a subsidiary of the Authority.  The Corporation has the power to issue bonds on behalf of the State for certain projects.  The Authority was specifically created by the Act as an instrumentality of the State, with the power to perform such governmental functions as issuing bonds.  The Authority was a valid “constituted authority” under Rev. Rul. 57-187.  The members of the Corporation’s board are the members of the Authority’s board.  The Bond proceeds were going to be used by a Company to develop and construct a destination resort on property anchored by a theme park.  As a condition to receiving the ruling regarding on-behalf-of issuer status, the Authority and the Corporation had to amend their bylaws to provide the State with direct control over the Corporation.  The point of this PLR is that there may not be stacking of on-behalf-of issuers.  This concept may be equally applicable to instrumentalities such that stacking of instrumentalities is not valid. (Wir)
  • Advice Memorandum AM-2014-005 (Jun. 18, 2014):  An Indian tribal government that receives an allocation of volume cap to issue tribal economic development bonds may designate an “on behalf of issuer,” within the rules applicable to bonds issued under I.R.C. 103, that is formed under the laws of that tribal government to issue those bonds.  The proceeds of any bonds issued by such an “on behalf of” issuer will be treated as if they were proceeds of bonds issued by the Indian tribal government that received the allocation.  See Notice 2009-51.
  • 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).
  • TAM 200646017, August 1, 2006: Michigan Charter School.  Based on the facts relating to Michigan state law, the charter school is considered an on-behalf-of issuer.

2.2. “On Behalf Of” Issuers: 63-20 Corporations

  • 63-20 Corporations are typically used where applicable state law has not specifically authorized the formation of public corporations which would qualify as constituted authorities under Rev. Rul. 57-187.
  • The criteria required for constituted authorities under Rev. Rul. 57-187 and the five requirements for 63-20 corporations are substantially the same.  The most significant difference is the type of authorizing statute under which each is organized.
  • Rev. Rul. 54-296 (superceded by 63-20): Bonds issued by the nonprofit are deemed as having been issued on behalf of the lessee/user of the facilities during the life of the bonds and would become owner of the facilities thereafter.
  • Rev. Rul. 59-41(superceded by 63-20): Similar to 54-296, but now it was permissible even if the facilities not actually used by the political subdivision so long as the facilities were seen as public in nature (in the sense that the political subdivision might otherwise be required to provide them and could therefore be viewed as having been relieved of a burden rightfully belonging to it, i.e. Water and wastewater facilities).
  • Rev. Rul. 63-20: Involved a nonprofit corporation issuer who was not the owner and operator of the facilities but was to be a conduit.  Must show the following to establish a 63-20 issuer (as clarified by 82-26):
    • Corporation must engage in activities that are essentially public in nature;
      • Activities and purposes of the corporation are those permitted under the nonprofit law of the state; and
      • Property to be provided by the corporation’s bonds must be located in the geographical boundaries of or have a substantial connection with the governmental unit on whose behalf the obligations are issued;
    • Corporation must be a nonprofit, except to the extent of retiring indebtedness (Corporate income must not inure to any private person);
      • Organized under nonprofit laws of the state in which the governmental unit is located; and
      • Articles of Incorporation provide that corporation is one not organized for profit;
    • State or political subdivision must have a beneficial interest in the corporation while the bonds remain outstanding, and upon retirement of the bonds, it must obtain full legal title to the property of the corporation with respect to which the bonds were issued;
      • Refers to interest in the bond-financed property, not in the corporation, and can be established by the following:
        • Purchase option at any time (can be compatible with customary 10 year call protection);
        • Purchase option in event of default;
        • Declaration of beneficial interest (file declaration in real estate records to put the “world” on notice);
        • Governmental unit has exclusive beneficial use equivalent to 95% or more of fair rental value for life of obligations; OR nonprofit has exclusive beneficial use equivalent to 95% or more of fair rental value for life of obligations and governmental unit appoints or approves the appointment of at leat 80% of the members of the governing board of the corporation and the power to remove, for cause, either directly or indirectly or through judicial proceedings, any member of the governing board and appoint a successor; OR Governmental unit has the right at any time to obtain unencumbered fee title and exclusive possession of the property financed by the bonds, and any additions to that property by placing in escrow an amount that will be sufficient to defease the obligations and paying reasonable costs incident to the defeasance (This is described in more detail in 82-26)
      • Full legal title requirement customarily provided for by having the corporation deposit a warranty deed and bill of sale with the bond trustee together with an irrevocable letter of instructions to deliver these documents to the political subdivision when the bonds are retired;
      • Financing of equipment may require statement in indenture by which borrower must maintain, renew, repair and replace the equipment so that fully equipped and operational facility exists at the time of the gift;
      • Full legal title means unencumbered title;
      • No delay in gift;
      • Must have level debt service schedules;
      • Cannot finance working capital or intangible property, because this negates gift effect;
    • Corporation must have been approved by the state, or a political subdivision thereof, either of which must also have approved the specific obligations issued by the corporation;
      • Customarily fulfilled by the adopting of a resolution of the governing body of the political subdivision prior to the issuance declaring the proposed financing by the nonprofit corporation will be beneficial to the political subdivision and agreeing to accept a gift of the bond-financed property (without binding the governing body at the time of such tender to accept the gift).
      • May be necessary to show legal reasoning supporting conclusion that political subdivision has the power to accept gifts of the type proposed to be financed. Do not need to show that the political subdivision could have issud for that purpose or has the power to operate.
    • [Only one “sponsoring” political subdivision.] Some bond counsel may disagree with the authority underlying this requirement;
    • No stacking of “on behalf of” entities.
  • Rev. Rul. 82-26: Clarifies elements of 63-20.
  • PLR 7605210220A (May 21, 1976):  Community Hospital issues bonds on behalf of County to finance improvements to a hospital, and to acquire a hospital facility.  The financing is structured to comply with 63-20, but there are issues regarding fair market value determination and management of the facility that are discussed in the PLR.
  • PLR 7742055 (Jul. 22, 1977):  Proposed notes to be issued by nonprofit 501(c)(3) “Association” for hospital construction are considered issued “on behalf of” the City – a political subdivision.  The Association and the City entered into a lease that provides that title to all buildings and improvements located on the leased land will vest in the City upon completion of their construction or annexation to the property.  The lease also provides that it will terminate immediately upon the repayment of the Notes or the City’s paying the Association all necessary funds to pay or provide for all amounts due under the Notes.  The City’s health officer is an ex-officio member of the Association’s Board of Directors.  The analysis is a type of 63-20 analysis.


IRS PLR 200923005, February 9, 2009:  Authority created by statute to implement solid waste systems that has the power of eminent domain and whose directors are appointed by governor or legislative leaders qualifies as a “political subdivision” under Section 1.103-1(b).

IRS PLR 200837004, September 12, 2008:  (1) Authority is a political subdivision of the State for purposes of Section 103 of the Code, because the Authority has been delegated the right to exercise sovereign power, is controlled by the State and is motivated by a wholly public purpose, and (2) Corporation’s income is excludible from gross income under Section 115(1) of the Code because the Corporation’s income is derived from the exercise of an essential governmental function and will accrue to a state or political subdivision thereof for purposes of Section 115(1).

IRS PLR 201104020, January 28, 2011: An authority created by state statute found (1) not to be a political subdivision because it didn’t possess enough sovereign power and (2) not to be an on-behalf-of issuer under Rev. Rul. 57-187 because the governing body of the entity was not controlled by a political subdivision.


1. Examples in Colorado

School districts.  A school district in Colorado is a “school district, political subdivision and body corporate of the State.”  As an express political subdivision of the State, it is a valid issuer for federal income tax purposes.  Obligations of school districts are valid bonds under state law for federal income tax purposes based on either of the following statutory authorizations:

  1. Pursuant to article 42 (Bonded Indebtedness) of title 22 (Education) of the Colorado Revised Statutes, as amended (“C.R.S.”), a school district may issue general obligation bonds, subject to voter approval of a ballot issue authorizing the bonds;
  2. Pursuant to the Public Securities Refunding Act set forth in article 56 (Public Securities Refunding Act) of title 11 (Financial Institutions), C.R.S., a school district (as “public body” within the meaning of C.R.S. 11-56-103(7)) may issue general obligation bonds to refund outstanding general obligation bonds (principal and interest in arrears or to become due), subject to certain limitations and conditions (e.g.,  the underwriter must provide certain disclosures regarding financial matters, and the refunding bonds must be issued for certain permitted purposes).

Charter schools.  In Colorado, a charter school is typically created as a Colorado nonprofit corporation pursuant to the Charter Schools Act set forth in article 30.5 of title 22, C.R.S., and a charter contract considered and approved by the local board of education of the applicable school district or the state’s chartering institute – the State Board of Education.  A charter school in Colorado usually has no sovereign powers (and is therefore not a political subdivision of the state), and is not established by statute (and is therefore not a constituted authority).  It is not entirely clear whether a charter school, the board of which is not elected or controlled by the state or school district, can nonetheless be considered an on-behalf of issuer.  Some bond counsel have determined that the totality of the circumstances may determine status of the bonds as governmental versus private activity bonds – one significant factor being whether the charter school’s property is transferred to the school district when the charter school is dissolved.

See PLR 201217025 regarding a discussion of a charter school’s obligation to file a Form 990 even though the charter school is also a governmental unit.  The IRS describes certain factors indicating control by a governmental entity.