Instrumentality (Rev. Rul. 57-128)

June 13, 2014

Instrumentality:

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.

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;
  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.

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:  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).

Rev. Rul. 75-359: Deductions for contributions and gifts.

GCM 36781:  Whether the entity is conducting a governmental function.

GCM 39683:  Whether the bar association is performing a governmental function.

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”).

 

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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 201735001 (Sept. 6, 2017):  Trust’s income was derived from exercise of an essential governmental function and accrued to a state or political subdivision and, therefore, was excludable from gross income.

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 201718001 (May 8, 2017): An entity’s income was derived from its performance of an essential governmental function and accrued to a county and other political subdivisions and, therefore, was excludable from gross income under Code Sec. 115(1). The entity was established by a county to facilitate the effective reclamation, revitalization, and return to economic productivity of abandoned or foreclosed real estate located in the county. Moreover, because the entity was an instrumentality for purposes of Code Sec. 170(c)(1), contributions to the entity constituted charitable contributions for the use of political subdivisions of the state and was deductible to the extent otherwise allowed by Code Sec. 170.

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.