IRS approves surrender of tax-exempt status by an electric cooperative

Plain-English summary

The IRS ruled that a mutual or cooperative electric company exempt under IRC § 501(c)(12) could surrender its tax-exempt status and operate as a taxable cooperative by filing a final Form 990 return. The cooperative wanted greater flexibility in arranging financing for capital improvements. The ruling explained that filing the final return would end the organization's status under IRC §§ 501(a) and 501(c)(12), rather than merely causing it to pay tax for a year in which it failed the member-income test. The ruling was based on the stated facts and did not address other Code or regulatory provisions.

Ruling snapshot

• Question: Could the electric cooperative surrender its § 501(c)(12) exemption and become taxable by filing a final Form 990?
• Outcome: Approved
• Key authorities: IRC §§ 501(c)(12), 501(a), and 6043(b); Rev. Rul. 65-99 and Rev. Rul. 67-265

Full text (IRS public release)

DEPARTMENT OF THE TREASURY
INTERNAL REVENUE SERVICE
WASHINGTON, D.C. 20224

TAX EXEMPT AND
GOVERNMENT ENTITIES
DIVISION

Release Number: 201241012
Release Date: 10/12/2012
Date: July 19, 2012

501.12-03

Legend:

Date A:
State B:
U :

Dear

We have considered your ruling request dated March 25, 2011, regarding the tax
consequences of the proposed transaction described below.

You are exempt from federal income tax under section 501(c)(12) of the Code. You are an
electric distribution cooperative incorporated on Date A under the laws of State B. You serve
more than U homes, farms, businesses and industries in various counties in State B.

As a distribution cooperative, you purchase electric power under the all-requirement
contracts with other power cooperatives, and deliver the power to your customers over your
distribution lines. Due to significant economic growth in your service area, you have incurred
substantial additional capital expenditures to serve your customers. You anticipate that further
financings will be necessary to fund additional capital expenditures.

You have expressed concern that your continued operations as a tax-exempt entity will limit
your ability to seek and obtain additional financing to fund your capital improvements. Thus,
because you will need additional flexibility in the forms of financing utilized, you want to
terminate your tax-exempt status under section 501(c)(12) of the Code.

In addition, you have stated that once “the Internal Revenue Service recognizes [your] status
as a taxable cooperative, [you] need to remain taxable until such time as [you] seek and receive
a determination letter from the Service that [you] again qualify as a tax-exempt entity.” You have
noted that “this is important in that the contemplated financing can be adversely affected by
[your] classification as a tax-exempt entity.”

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Under State B’s rural electric cooperative statute, only cooperative, nonprofit, membership
corporations may be organized under that law. However, operation as a nonprofit membership
corporation in State B is not dependent on the corporation’s federal income tax classification.

Further, you have stated that your operation as a nonprofit cooperative does not determine
your status for State B income tax purposes. Under the law of State B, a corporation for income
tax purposes may include a cooperative, even though it is a nonprofit corporation. Therefore,
you have concluded that if your tax-exempt status under section 501(c)(12) is terminated, you
will be a cooperative taxable under both federal law and the law of State B.

You have requested the following ruling:

(1) An organization exempt under section 501(c)(12) of the Internal Revenue Code can
surrender its tax-exempt status and operate as a taxable cooperative through the filing of
a final Form 990 return.

Law:

Section 501(c)(12) of the Code provides for the exemption from federal income tax of
benevolent life insurance associations of a purely local character, mutual ditch or irrigation
companies, mutual or cooperative telephone companies, or like organizations; but only if 85
percent or more of the income consists of amounts collected from members for the sole purpose
of meeting losses and expenses. Mutual and cooperative electric companies are considered to
be “like organizations” for these purposes. Rev. Rul. 67-265, 1967-2 C.B. 205.

Section 6043(b) of the Code provides that an organization which for any of the last five
taxable years preceding liquidation, dissolution, termination, or substantial contraction was
exempt from taxation under section 501(a) shall file a return and other information with respect
to the liquidation, dissolution, termination, or substantial contraction as the Secretary of the
Treasury may prescribe.

Rev. Rul. 65-99, 1965-1 C.B. 252, provides that the 85 percent member income test is
applied on the basis of an annual accounting period. Failure to meet the requirement in a
particular year precludes exemption for that year, but has no effect upon exemption for years in
which the 85 percent test is satisfied. Specifically, if for any year the income received from a
transaction, together with other nonmember income, causes the organization's income from
members for the year to fall below 85 percent, the organization is required to file a corporation
income tax return, Form 1120, for that year.

Rationale:

The income of certain cooperatives, including mutual and cooperative electric companies, is
exempt from federal income tax as long as 85 percent or more of their income consists of
amounts collected from members for the sole purpose of meeting losses and expenses. Section

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501(c)(12). For any year that such an organization does not meet the 85 percent member
income test, it is required to file a Form 1120 and pay income tax. However, it does not thereby
lose its status under §501(c)(12), and its income will again be exempt from federal tax for the
next year that it meets the 85 percent member income test. Rev. Rul. 65-99.

However, in order to obtain your needed financing, you cannot operate as an exempt entity,
whether or not paying federal income tax. Thus, you wish to surrender your tax-exempt status
under §501(c)(12). An organization that no longer wants to be exempt under §501(a) of the
Code files a final return as described in §6043(b). In your case, this means a final Form 990.
Once your final return is filed, you will no longer be described in §501(a) or §501(c)(12).

You have emphasized that you will become taxable under both federal and state law once
you are no longer recognized as tax-exempt under §501(c)(12) of the Code.

Accordingly, based on the above, we rule as follows:

(1) You, as an organization exempt under section 501(c)(12) of the Code, can surrender
your tax-exempt status and operate as a taxable cooperative through the filing of a final
Form 990 return.

This ruling will be made available for public inspection under section 6110 of the Code after
certain deletions of identifying information are made. For details, see 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 Notice 437. If you disagree with our proposed
deletions, you should follow the instructions in Notice 437.

This ruling is directed only to the organization that requested it. Section 6110(k)(3) of the
Code provides that it may not be used or cited by others as precedent.

This ruling is based on the facts as they were presented and on the understanding that there
will be no material changes in these facts. This ruling does not address the applicability of any
section of the Code or regulations to the facts submitted other than with respect to the sections
described. Because it could help resolve questions concerning your federal income tax status,
this ruling should be kept in your permanent records.

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

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In accordance with the Power of Attorney currently on file with the Internal Revenue Service,
we are sending a copy of this letter to your authorized representative.

Sincerely,
Mary J. Salins

Manager, Exempt Organizations
Technical Group 4

Enclosure
Notice 437