PLR 1050017: IRS classified a state-created association as a division, not a political subdivision

Plain-English summary

The IRS considered whether a state-created association administering a no-fault medical compensation plan was a political subdivision of the state. The IRS concluded that the association did not exercise sovereign power because it could collect assessments but did not impose them, and it had no taxing, eminent-domain, or police power. The IRS nevertheless concluded that the association was a division of the state based on its legislative creation, public purpose, state funding, state control, and sovereign immunity. As a division of the state, the association was not required to file federal income tax returns or pay federal income tax on its income.

Ruling snapshot

• Question: Was the state-created association a political subdivision of the state for federal tax purposes?
• Outcome: mixed, the association was not a political subdivision but was a division of the state and received the stated tax treatment.
• Key authorities: IRC § 103; Treas. Reg. § 1.103-1(b); Rev. Ruls. 78-276 and 83-131

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201050017 Third Party Communication: None
Release Date: 12/17/2010 Date of Communication: Not Applicable
Index Number: 103.00-00, 103.02-00
Person To Contact:
-------------------------- ----------------, ID No. -------------
------------------------ Telephone Number:
---------------------------------- ---------------------
--------------------------------------------- Refer Reply To:
CC:FIP:B05
PLR-120169-10
Date:
August 25, 2010

Legend:

X = --

Y = -----

Act = --------------------------------------------------

Association = -----------------------------------------------------

Certain Medical
Services = -----------------------------------------------------

Department = ---------------------------------------------------

Entities = --------------------------------------------------------------------------------

              ---------------------------------------------------------------------------------------------------
                                ---------------------------------------------------------------------------------
                                ----------------

Fund = ---------------------------------------------------------------------------------

Plan = --------------------------------------------------------------------------------

State = ---------
PLR-120169-10 2

Dear --------------

    This letter is in response to your request for a ruling that the Association is a

political subdivision of State.

Facts and Representations:

  Association was created by an act of State’s legislature for the purpose of

administering the Plan. The Plan was established under State law to provide
compensation, irrespective of fault, for Certain Medical Services within State.

   Association is comprised of X directors who are appointed by State’s chief

financial officer. When vacancies occur, recommendations are provided to State’s chief
financial officer by the Entities but the chief financial officer is not bound by any
recommendations. Association is operated pursuant to a plan of operation approved by
the Department. When the Association was formed, State’s legislature funded the Plan
with Y million from the Fund.

   The Plan’s revenues are derived primarily from an assessment imposed under

State law on most State physicians and an assessment levied on certain hospitals per
baby born in the hospital. Under State law, the Department must authorize any
increased assessments. Association may enforce collection of assessments required to
be paid to the Plan. The assessments imposed for the Plan constitute a “tax” under
State law. Funds held by the Association on behalf of the Plan are considered to be
funds of State and Association may only invest Plan funds in certain specified
investments and securities as set forth under the Act. Under State law, Association has
sovereign immunity which is waived only to the extent necessary to pay claims under
the Plan.

Law and Analysis:

    Section 1.103-1(b) of the Income Tax Regulations provides that the term “political

subdivision” denotes any division of any state or local governmental unit which is a
municipal corporation or which has been delegated the right to exercise part of the
sovereign power of the unit. As thus defined, a political subdivision of any state or local
governmental unit may or may not, for purposes of this section, include special
assessment districts so created, such as road, water, sewer, gas, light, reclamation,
drainage, irrigation, levee, school, harbor, port improvement, and similar districts and
divisions of these units. Rev. Rul. 78-276, 1978-2 C.B. 256, states that the term
“political subdivision” has been defined consistently for all Federal income tax purposes
PLR-120169-10 3

as denoting either (1) a division of the State or local government that is a municipal
corporation, or (2) a division of such State or local government that has been delegated
the right to exercise sovereign power.

    We conclude that the Association has not been delegated the right to exercise a

sovereign power. The three generally acknowledged sovereign powers are the power
to tax, the power of eminent domain, and the police power. See Commissioner v.
Estate of Alexander J. Shamberg, 3 T.C. 131 (1944), acq., 1945 C.B. 6, aff’d, 144 F.2d
998 (2d Cir. 1944), cert. denied, 323 U.S. 792 (1945). Although we are not concluding
that the assessments are a tax for Federal tax purposes, if they are a tax, they are not
levied by the Association. Rather, the assessments are set by State law, and the
Department must authorize any increase. Association simply has the power to collect
the assessments, which is not the exercise of a sovereign power. Association has no
other sovereign power.

   Nevertheless, we conclude that the Association is a division of State. In

determining whether Association is a division of State, consideration must be given to
factors that indicate that it will be a governmental rather than a private entity. These
factors include, but are not limited to, its public purpose and attributes, whether its
assets or income will inure to private interests and the degree of its control by State.
See generally Rev. Rul. 83-131, 1983-2 C.B. 184. Here, Association was established
by State’s legislature for a public purpose, and the Plan which it administers was funded
by State with an initial appropriation of Y million. Funds held by the Association on
behalf of the Plan are funds of State under State law. Association has been granted
sovereign immunity under State law. Association’s board of directors is appointed by
State’s chief financial officer. Moreover, Association is operated in accordance with a
plan of operations that was approved by the Department. Cumulatively, the foregoing
factors indicate that Association is a division of State.

Conclusion:

   Based solely on the representations made, we conclude that the Association is a

division of State but is not a political subdivision. As a division of State, Association is
not required to file Federal income tax returns or pay Federal income tax on its income.

   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.

  The ruling contained in this letter is based upon information and representations

submitted by the taxpayer and accompanied by a penalty of perjury statement executed
by an appropriate party. This office has not verified any of the material submitted in
support of the request for ruling; however such material is subject to verification on
examination.
PLR-120169-10 4

   This ruling is directed only to the taxpayer requesting it. Section 6110(k)(3) of

the Internal Revenue Code provides that it may not be used or cited as precedent.

                                  Sincerely,

                                  Associate Chief Counsel
                                  (Financial Institutions & Products)



                                  By:
                                  Timothy L. Jones
                                  Senior Counsel
                                  Branch 5

cc: