PLR 1346006: Port operator income remains excludable after LLC conversion

Plain-English summary

The IRS ruled that a state-created company’s income would remain excludable from gross income after the company converted from a nonprofit corporation to a single-member LLC treated as a corporation for federal tax purposes. The company operated public port and warehouse facilities, and its net revenues and liquidation proceeds would accrue to a state political subdivision. The IRS concluded that these activities constituted an essential governmental function under IRC § 115(1). The ruling was limited to the specific conversion and facts described.

Ruling snapshot

• Question: Will the company’s income remain excludable under IRC § 115(1) after its conversion to a single-member LLC?
• Outcome: Approved
• Key authorities: IRC § 115(1); Rev. Rul. 77-261; Rev. Rul. 90-74

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201346006 Third Party Communication: None
Release Date: 11/15/2013 Date of Communication: Not Applicable
Index Number: 115.00-00
Person To Contact:
----------------------------- ------------------------, ID No. ------------------
------------------------ ----------------------------------------------------
------------------------------------------------- Telephone Number:
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-------------------------------------- Refer Reply To:
CC:TEGE:EOEG:EO
PLR-117177-13
Date:
August 02, 2013

Legend

Company = -------------------------------------------------
Authority = ------------------------------
State = -------------------------------------
Statute = ------------------------------------------------------------------------------------------
Board = ----------------------------------
Date 1 = ------------------
Date 2 = -----------------------
Date 3 = --------------------------
Subsidiary = ----------------------
1
Subsidiary = ------------------------------------------------------
2
Facilities = ----------------------------------------------------------------------------------------------------------
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----------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------
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----------------------------------------------------
X = ----------------------------------------------------------------------------------------------------------
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-----

Dear ---------------:

This letter responds to a letter from your authorized representative dated April 4, 2013,
requesting a ruling that Company’s income is excludable from gross income under
Internal Revenue Code (“IRC”) §115. Company represents the facts as follows.
PLR-117177-13 2

FACTS

Company was formed on Date 1, by Authority, a political subdivision of State, to operate
Facilities as they then existed and have subsequently been expanded. Its articles
provide that it is “to operate, maintain, develop and improve the public terminal and
warehouse facilities of the ports of the [State]” and “to foster the development of the
foreign commerce of the United States and the ports of the [State].” The members of
Company’s board of directors are selected by the Board of Authority, with the executive
director of the Authority serving as a permanent member. Authority’s Board has the
authority to remove and replace any member of Company’s board of directors.
Company’s board of directors appoints all officers of Company.

Upon dissolution of Company all of its net assts shall be distributed to Authority.
Company’s articles further provide that no part of its net earning shall inure to the
benefit of, or be distributable to its directors, officers, or other private persons.

Authority and Company are parties to a service agreement that provides that Company
will manage, operate and conduct the business of the Facilities in accordance with the
policies established by Authority’s Board and the Statute. Pursuant to the agreement
Authority has delegated to Company the authority to establish rates, charges,
regulations, tariffs, practices and requirements concerning the use of the Facilities.
However, Authority retains the right to review and revise all such rates and charges.
Under the agreement all gross revenues collected by Company, less its expenses must
be paid to Authority.

On Date 2, the Internal Revenue Service (“Service”) issued Company a letter ruling
concluding that Company’s income is excludable from gross income under IRC §115.
Company’s activities serve the good of the general public by having central
management for state-owned facilities. On Date 3, the Service issued Company a
subsequent letter ruling concluding that certain changes in Company’s operations would
not affect the ruling contained in the Date 2 letter.

Company plans to convert from a nonprofit, non-stock corporation to a limited liability
company pursuant to the laws of State. Company will be treated as a corporation for
federal tax purposes following the conversion. Authority will hold the sole membership
in Company. The purpose of the conversion is to streamline, modernize and make
more efficient the operations of both entities and to give more oversight and control of
Company’s activities to Authority.

After the conversion, Authority will continue to receive all net revenues attributable to
Company’s operations. Additionally, any liquidation proceeds upon a termination of
Company would be distributed exclusively to Authority.

Company has two wholly-owned subsidiaries, Subsidiary 1 and Subsidiary 2.
Subsidiary 1 owns X, which enables certain cargo to be transported to, from and
between the public terminal and warehouse facilities of the ports of State. Subsidiary 2
has acted as manager of Subsidiary 1 and the operator of X. Both subsidiaries are
PLR-117177-13 3

limited liability companies and are disregarded entities for federal tax purposes. In
connection with the proposed conversion, Subsidiary 2 will merge into Subsidiary 1 and
Subsidiary 1 will take over the duties of Subsidiary 2 to manage and operate X.

LAW AND ANALYSIS

IRC §115(1) provides that gross income does not include income derived from any
public utility or the exercise of any essential governmental function and accruing to a
state or any political subdivision thereof.

Rev. Rul. 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 IRC § 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, holds that the 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.

Company operates, maintains, develops and improves the public terminal and
warehouse facilities of the ports of State. That function constitutes the performance of
an essential governmental function within the meaning of IRC §115(1). See Rev. Rul.
77-261 and Rev. Rul. 90-74.

In addition, all the net revenue of Company accrues to Authority. No private interests
participate in or benefit from the operation of Company, other than incidentally or as
providers of goods or services. Company dedicates its assets and income exclusively
for the benefit of Authority. See Rev. Rul. 90-74.

All of Company’s assets that remain upon dissolution of Company (after providing for all
outstanding obligations) will be distributed to Authority, which is a political subdivision of
the State. See Rev. Rul. 90-74.

Based on the information and representations submitted on behalf of Company, we
conclude that:
PLR-117177-13 4

   The income of Company will derive from the exercise of an essential
   governmental function and will accrue to a state or a political subdivision thereof.
   Company’s income will be excludable from gross income under IRC §115(1)
   upon Company’s conversion under State law to a single-member limited liability
   company that is treated as a corporation for federal income tax purposes.

No opinion is expressed concerning the Federal tax consequences under any IRC
provision other than the one specifically cited above.

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.

This ruling is directed only to the taxpayer requesting it. IRC § 6110(k)(3) provides that
it may not be used or cited as precedent.

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

A copy of this letter must be attached to any income tax return to which it is relevant.
Alternatively, taxpayers filing their returns electronically may satisfy this requirement by
attaching a statement to their return that provides the date and control number of the
letter ruling.

The rulings contained in this letter are based upon information and representations
submitted by the taxpayer and accompanied by a penalty of perjury statement executed
by an appropriate party. While this office has not verified any of the material submitted
in support of the request for rulings, it is subject to verification on examination.

                                   Sincerely,



                                   Kenneth M. Griffin
                                   Chief, EO Branch
                                   (Tax Exempt & Government Entities)

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