23 January 2025 IRS exempts under IRC Section 115(1) income of corporation formed by county and city to oversee climate-related infrastructure projects
In PLR 202443008, the IRS concluded that the income of a state corporation established by a county (County) and city (City) for the purposes of supporting infrastructure projects to mitigate the effects of climate change was excluded from gross income under IRC Section 115(1) and that contributions to the corporation are deductible under IRC Section 170. In PLR 202443008, a state corporation (Authority) was incorporated by County and City — both political subdivisions of the state (State) — and thereby authorized to undertake or support infrastructure projects that mitigate the effects of climate change. The State's formal acceptance of Authority's articles of incorporation resulted in Authority being a "body politic … and instrumentality" of City and County. Authority's articles of incorporation limit its projects, all of which are funded by State, County and federal agencies, to those benefiting City and County. Authority is prohibited from acting in a way that would result in more than incidental benefit to private interests. Furthermore, Authority cannot amend its articles of incorporation or terminate without State, County and City approval. Upon Authority's termination, all of its remaining property would transfer to the City and County. Authority's 12-member board is uncompensated and entirely appointed by County and City. Board members must meet certain requirements, including adhering to rules against having conflicts of interests or taking financial interests in any Authority project. An advisory committee comprised of County and City officers with relevant subject-matter portfolios aids the Board, as does a County employee appointed by County's Executive as the Authority's director. Under IRC Section 115(1), gross income does not include income that (1) derives from the exercise of an essential governmental function, and (2) accrues to a state or its political subdivision. In Revenue Ruling 77-261, the IRS interpreted IRC Section 115(1) to allow income from the temporary investment of cash balances of a state and its participating political subdivisions in a state-established investment fund to be excluded from gross income. While the investment fund was a separate entity from the state and its political subdivisions, the income resulted from an essential government service; because the political subdivisions had an unrestricted right to their proportionate share of the fund's income, that income accrued to them. In Revenue Ruling 90-74, the IRS ruled that income of an organization formed, operated and funded by a state's political subdivisions to pool their casualty risks was excluded from gross income under IRC Section 115(1). While noting that facts and circumstances determine whether a function is an essential government function, the IRS found that the significant involvement of the political subdivisions in the formation and management of the pool and the overall absence of a benefit to private interests evinced an essential government function. For an activity to be an essential government function, the IRS noted, it must not benefit private interests more than incidentally. The IRS concluded that the organization's activities did not benefit private interests more than incidentally. In Revenue Ruling 71-589, the IRS excluded from gross income under IRC Section 115(1) income from property that a decedent had placed in trust for use by a political subdivision as funding for certain enumerated charitable purposes. As the political subdivision accepted and used the gift "for designated purposes ordinarily recognized as municipal functions," the IRS determined that the trust's income accrued to the political subdivision. The IRS concluded that Authority's income was exempt from tax under IRC Section 115(1) because Authority's activities constituted the exercise of an essential function of County and City, as contemplated in Revenue Ruling 77-261. Because Authority was acting in accordance with a state law that specifically authorized its formation and County and City exercised significant control over Authority, it was exercising an essential government function. According to the IRS, City and County's express authorization of Authority's mission, control of its organizing documents, appointment of its board members and director, and oversight of its financial books and records all demonstrated that Authority aided in the exercise of their sovereign powers and an essential government function. The IRS also determined that Authority's activities did not benefit any private interests more than incidentally, because Authority transfers ownership and control over County- and City-funded projects upon completion, adheres to strict rules concerning conflicts of interest and private benefits by insiders, and would transfer all of its property to County or City upon its dissolution. IRC Section 170(a)(1) allows deductions for charitable contributions made within the tax year. For purposes of IRC Section 170, IRC Section 170(c)(1) defines "charitable contribution" as a contribution or gift made for exclusively public purposes for use by (1) a US state, a US possession, or any political subdivision of a US state or possession, or (2) the United States or the District of Columbia. While IRC Section 170(c)(1) does not refer to instrumentalities of a state or political subdivision, the IRS has long considered contributions or gifts to such entities to be "for the use of" of a state or a political subdivision rather than gifts "to" a state or political subdivision. In Revenue Ruling 75-359, the IRS ruled that the 30% limitation on the percentage of a taxpayer's adjusted gross income that is deductible under IRC Section 170(b)(1)(B) applies to a gift "for the use of" a state or political subdivision. Revenue Ruling 57-128 lists six factors to consider in determining if an organization is a wholly owned instrumentality of a state or political subdivision:
Because Authority is not itself a political subdivision of a state, the IRS found that contributions to Authority cannot be considered charitable contributions "to" a political subdivision of a state for purposes of IRC Section 170(c)(1). In determining whether contributions to Authority constitute charitable contributions "for the use of" a political subdivision of a state, subject to the IRC Section 170(b)(1)(B) limitation, the IRS applied the six factors of Revenue Ruling 57-128 to determine that they did constitute deductible charitable contributions, because:
As Authority satisfied all six factors, the IRS found that contributions made to Authority exclusively for a public purpose could be deducted by donors as charitable contributions under IRC Section 170(c)(1). Entities that perform activities for or on behalf of governmental subdivisions should evaluate IRC Section 115(1), the relevant revenue rulings and the PLRs described previously to determine if their income may be excluded from total gross income for federal income tax purposes. Entities hoping to qualify for this income exclusion must serve an essential government function, evidenced by governmental board appointment, governmental funding for projects with community/local benefit (in other words, no private inurement) and articles of incorporation that outline the local government ownership/control. Those entities should also have explicit provisions in their governing documents that (1) prohibit any net earnings or profits from benefiting private interests, (2) demonstrate that their income accrues to the state or political subdivisions, and (3) provide, upon dissolution, for distribution of any remaining assets to the state or a political subdivision thereof. Maintaining thorough documentation to demonstrate that an entity meets these criteria can support a position that its income is excludible from gross income for federal tax purposes. Contributions that are excludible from an entity's gross income under IRC Section 115 aren't necessarily deductible as a charitable contribution under IRC Section 170. For these contributions to be deductible, either the entity would need to be recognized by the IRS as tax-exempt under IRC Section 501(c)(3) or the contribution would need to be "to" or "for the use of" a US state or possession, or a subdivision of a US state or possession. Affiliates of state or political subdivisions, like the state authority described in PLR 202443008, may receive deductible charitable contributions under IRC Section 170(c)(1) only if they qualify as a wholly-owned instrumentality of a state or political subdivision under the six-factor test outlined in Revenue Ruling 57-128. In those cases, contributions are deductible not because they are made to the instrumentalities, but because they are made "for the use of" the state or political subdivision(s) that own and control the instrumentalities. Accordingly, entities that rely on IRC Section 115 to exclude income from gross income for federal tax purposes should ensure they meet Revenue Ruling 57-128's six-factor test in order to receive tax-deductible charitable contributions under IRC Section 170.
Document ID: 2025-0309 | ||||||