Taxpayer's Income Is Excludable From Gross Income

[Third Party Communication: * * *

We are responding to a letter dated December 7, 2015, requesting rulings that Taxpayer's income is excludable from gross income under § 115 of the Internal Revenue Code (Code), and that contributions to Taxpayer are deductible by donors because Taxpayer is a government instrumentality under the terms of § 170. We construe the facts provided as follows.

Pursuant to the new law, County established Taxpayer as its agent to facilitate the effective reclamation, revitalization, and return to economic productivity of abandoned or foreclosed real estate located in County. County can dissolve Taxpayer at any time, in accordance with State law.

Taxpayer's seven-member board of directors must include County's Fiscal Officer, County's Executive, and a member of County's Council. These three county directors confirm two additional directors. One of these directors is recommended by the mayor of City, and the other is recommended by the president of a county township association. The county directors select two additional directors, and by unanimous vote the county directors may remove any of the other directors. Taxpayer's directors do not receive compensation for their services to Taxpayer. A paid, professional staff manages Taxpayer's daily operations.

Taxpayer maintains a conflict of interest policy that supplements State's conflict of interest policy for public officials and employees. Among other things, Taxpayer's policy requires its officers, directors, and employees to sign a written form each year stating that they understand and agree to comply with Taxpayer's conflict of interest policy. State law requires Taxpayer to adhere to State's open meetings and public records requirements. Taxpayer must also provide an annual financial report to State, and the report must be available on Taxpayer's website. Taxpayer also makes available on its website other information such as agenda and minutes of board meetings, as well as descriptions of its programs.

Taxpayer's organizational documents provide that Taxpayer is intended to have the status of an organization whose income is excludable from gross income pursuant to § 115 of the Code, and that its authority and activities are limited accordingly. Further, the organizational documents require written annual statements from Taxpayer's officers and directors confirming that they understand Taxpayer exercises essential governmental functions, and that its income accrues to County. The organizational documents also provide for periodic reviews to ensure Taxpayer is performing essential governmental functions, and that its compensation arrangements are reasonable and the result of arm's length bargaining.

Taxpayer has adopted written policies and procedures governing the acquisition and disposition of residential and commercial properties. The policies and procedures are intended to provide consistency, transparency, standards, and safeguards to prevent abuse.

Taxpayer's funding is derived from several sources. The bulk of the Taxpayer's funding comes from County and State, with County committing a specified percentage of a delinquent tax and assessment collection fund. State has issued Taxpayer several grants to acquire and demolish abandoned residences. Taxpayer has also derived a limited amount of revenue from property sales. State law directs that Taxpayer must use revenue from its activities solely in furtherance of its statutory purposes.

Taxpayer coordinates with multiple county and other government offices to efficiently acquire and dispose of properties. Working with local governments, Taxpayer focuses on demolishing vacant and blighted residential structures in specified areas, and then on finding new owners for the properties so they can be returned to the tax rolls. Taxpayer may also acquire property for commercial or industrial redevelopment. Taxpayer advances its purposes at the local level by offering reimbursement and matching grants to local governments and certain nonprofit organizations to conduct activities that are consistent with Taxpayer's purposes.

Taxpayer's articles of incorporation provide that no part of its net earnings can inure to the benefit of or be distributable to any incorporator, director, trustee, or officer of Taxpayer, or to any private individual. Moreover, pursuant to the articles, upon dissolution, all remaining assets will be distributed to State, a political subdivision of State, or an entity whose income is excludable from gross income under § 115 of the Code.

Section 170(a)(1) provides that there shall be allowed as a deduction any charitable contribution (as defined in § 170(c)) payment of which is made within the taxable year.

Section 170(c)(1) states that, for purposes of § 170, the term charitable contribution means a contribution or gift to or for the use of 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.

Revenue Ruling 77-261,1977-2 C.B. 45, holds that 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 § 115(1), because such investment constitutes an essential governmental function and the income accrues to the state or its political subdivisions.

The ruling explains that the statutory exclusion is not intended to extend 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 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.

Revenue Ruling 90-74, 1990-36 I.R.B. 5, provides that the determination of whether a function is an essential government function depends on the facts and circumstances of each case. The ruling considers a risk-sharing pool created by local governments. Under state law, county governments could form and become members of a non-profit organization to pool their casualty risks. The governing body of each county authorizes it to join, and designate an individual to represent it at meetings and elect the board of directors. The counties pay initial deposits and annual fees based upon size and other determinants of risk. The organization also earns investment income. It reimburses members for casualty losses. If dissolved, it will distribute its assets to its members.

The revenue ruling states that political subdivisions insure against risks from casualties, employee negligence, worker's compensation, and employee health to satisfy government obligations. The private benefit to employees from the insurance is held to be incidental to the public benefit. The revenue ruling finds that pooling casualty risks through a separate organization instead of purchasing commercial insurance fulfills the obligations of the political subdivisions to protect their financial integrity. The revenue ruling further concludes that the income of the organization accrues to political subdivisions because (1) the organization's income does not benefit private interests; (2) the organization's income is used to reimburse counties for their losses and to reduce the annual fees that they would otherwise be required to pay the organization; and (3) the organization's assets were required to be distributed to the counties upon its dissolution.

Revenue Ruling 57-128, 1957-1 C.B. 311, provides that, in cases involving the status of an organization as a wholly owned instrumentality of one or more states or political subdivisions, the following factors are taken into consideration:

Revenue Ruling 69-453, 1969-2 C.B. 182, applies the six factors of Revenue Ruling 57-128 to rule that a soil and water conservation district formed as a private non-stock corporation by private individuals is not an instrumentality of the state. The revenue ruling finds the state has no authority or control over the district's expenditures, has no authority to remove any member of the district's board, and the district funds its operations through fees that it charges landowners for work done for the purpose of soil conservation. Moreover, the revenue ruling notes the state has no claim to the district's assets after the district's dissolution.

Revenue Ruling 65-196, 1965-2 C.B. 388, holds that a sports area commission formed pursuant to an agreement (which was authorized by the enactment of a state law legalizing such agreements) between a city and two villages to erect and operate an athletic stadium is an instrumentality of political subdivisions of the state. The commission is comprised of members appointed by councils of the city and villages as their representatives. Each member is required to be a citizen and resident of the state and may not be a member of the governing body of the city or the villages. The sole source of financing for the commission comes from bonds issued by the city; the city is authorized to issue bonds upon the request of the commission to fund the athletic stadium. The revenue ruling finds the commission is an instrumentality of the city and two villages by whose agreement it was formed because it meets substantially all of the Revenue Ruling 57-128 factors: the commission was created by the city and villages as their instrumentality, and validated by state law; the commission members are delegated certain authority under the terms of the agreement between the city and villages; control and supervision of the assets of the commission are in the hands of the city and villages; there are no private interests involved; and the city, upon the commission's direction, is responsible for the project's finances.

In Year, State amended the law that it and County had used to target problems such as blighted, vacant, and foreclosed properties. The amendments streamlined procedures and gave counties new tools to tackle community ailments worsened by a burgeoning real estate crisis. County created Taxpayer in accordance with the new State law, and it designated Taxpayer to be its agent to carry out the statutory purposes of combating community deterioration by restoring abandoned and blighted property, and promoting economic and housing development in County. Transforming blighted, abandoned or foreclosed property into safe and economically productive property is an essential governmental function for purposes of § 115 of the Code.

County can dissolve Taxpayer at any time, and it controls Taxpayer's board of directors. County is Taxpayer's most consistent source of funding, although Taxpayer obtains substantial funding from State and, to a much lesser extent, from the sale of property Taxpayer acquires in furtherance of its purposes. Taxpayer operates according to State's open meetings and public records rules, is required to submit an annual financial report to State's official auditor, and it must display the report on its website. Taxpayer has taken many additional steps to ensure that private interests do not benefit from Taxpayer's activities more than incidentally. Taxpayer's articles ensure that upon dissolution its assets will be distributed to State, County, another political subdivision of State, or to an entity whose income is excludable from gross income under § 115. Therefore, taxpayer's income accrues to a state or political subdivision of a state.

Issue 2.

The second ruling requested raises the issue of whether Taxpayer is a separate, wholly-owned instrumentality of one or more political subdivisions of State, such that Taxpayer is eligible to receive charitable contributions within the meaning of § 170(c)(1). Section 170(c)(1) generally defines the term "charitable contribution," for purposes of § 170(a)(1), to include a contribution or gift to or for the use of a state or any political subdivision of the state, provided the contribution or gift is made for exclusively public purposes.

Taxpayer is not itself a political subdivision of State. Therefore, contributions to Taxpayer cannot constitute charitable contributions to a political subdivision of State for purposes of § 170(c)(1). However, pursuant to Revenue Ruling 75-359, contributions to Taxpayer may constitute charitable contributions for the use of political subdivisions of State, which are deductible under § 170(a), subject to the limitation of § 170(b)(1)(B), if Taxpayer qualifies as a separate, wholly-owned instrumentality of one or more political subdivisions of State. A determination of whether Taxpayer is a wholly-owned instrumentality of one or more political subdivisions of State is made by applying the factors set forth in Revenue Ruling 57-128.

For the reasons stated above, Taxpayer is a wholly owned instrumentality of one or more political subdivisions of State. Similar to the taxpayer described in Revenue Ruling 65-196, and unlike the one in Revenue Ruling 69-453, Taxpayer is used for a governmental purpose and performs a governmental function; Taxpayer's function is on behalf of County, which is a political subdivision of State; there are not more than incidental private interests involved, and political subdivisions of State have the powers and interests of an owner, with respect to Taxpayer; control and supervision of Taxpayer is vested in public authorities; express statutory authority is necessary for the creation and use of Taxpayer and such authority exists; Taxpayer is not financially autonomous from State and its political subdivisions, but rather relies heavily upon State and its political subdivisions for the funding of its operating expenses. Therefore, in accordance with Revenue Ruling 75-359, we conclude that contributions to Taxpayer constitute charitable contributions (within the meaning of § 170(c)(1)) for the use of political subdivisions of State, that are deductible under § 170(a), subject to the limitation of § 170(b)(1)(B).

Except as expressly provided herein, no opinion is expressed or implied concerning the tax consequences of any aspect of any transaction or item discussed or referenced in this letter, or of any activity or transaction not expressly addressed in this letter.

The rulings contained in this letter are based upon information and representations submitted by Taxpayer and accompanied by a penalty of perjury statement executed by an individual with authority to bind Taxpayer, as specified in Revenue Procedure 2016-1, 2016-1 I.R.B. 1, § 7.01(15)(b), or its successors. This office has not verified any of the material submitted in support of the request for rulings, and such material is subject to verification on examination.

The Associate Office will revoke or modify a letter ruling and apply the revocation retroactively if there has been a misstatement or omission of controlling facts; the facts at the time of the transaction are materially different from the controlling facts on which the ruling was based; or, in the case of a transaction involving a continuing action or series of actions, the controlling facts change during the course of the transaction. See Revenue Procedure 2016-1, § 11.05, or its successors.

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

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

A copy of this ruling letter should be attached to Taxpayer's tax return for the current year. If the return is filed electronically, attach a statement containing the date and control number of the letter ruling.

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

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

Sincerely,