Regulated customer fees used for business obligations are gross income

Plain-English summary

An S corporation operating a regulated facility charged clients separate fees to fund legally required future activities and placed the money in interest-bearing accounts subject to varying degrees of agency oversight. The taxpayer argued that the amounts were excluded from gross income because it acted only as a conduit and received no benefit, relying on advertising-fund and cemetery perpetual-care cases. The IRS disagreed because the clients had no interest in the later activities, the taxpayer had no duty to repay them, and the funded work satisfied the taxpayer's own statutory obligations. The taxpayer could also use account funds to buy equipment that it owned. The IRS therefore ruled that both categories of fees must be included in gross income under Section 61.

Ruling snapshot

• Question: Are regulated client fees held for the taxpayer's future mandated activities excluded from gross income?
• Outcome: Denied, the fees are gross income
• Key authorities: IRC § 61; Commissioner v. Glenshaw Glass Co.; Seven-Up Co. v. Commissioner; Commissioner v. Cedar Park Cemetery Ass'n

Full text (IRS public release)

Internal Revenue Service                                      Department of the Treasury
                                                              Washington, DC 20224

Number: 202138001                                             Third Party Communication: None
Release Date: 9/24/2021                                       Date of Communication: Not Applicable
Index Number: 61.00-00
                                                              Person To Contact:
----------------------------------------------                -----------------------, ID No. -----------------
---------------------                                         Telephone Number:
-------------------                                           --------------------
-----------------------------------                           Refer Reply To:
---------------------                                         CC:ITA:B05
---------------------------------------                       PLR-100232-21
                                                              Date:
                                                              August 23, 2021




Legend

Taxpayer            =    ----------------------------------------------------------------------
Parent              =    ----------------------------------------------------
State               =    ----------------
Facility            =    -------------------------------------------------------
Services            =    ---------------------------------
Agency              =    -----------------------------------------------------------------------------------------
                         ---------
Permit              =    -----------------------------------------------------------------------------------------
                         -------------------
Regulations         =    ------------------------------------------------------
Plan                =    -----------------------------------------
Activities          =    ----------------------------------------------------------------------
Other               =    -----------------------------------------------------------------------------------------
Activities               ---------------------------------------------------------------------------
Fees                =    -----------------------------------------------------------------------------------------
                         -----------------------------------------------------------------------------------------
                         -----------------------------------
Other Fees          =    -----------------------------------------------------------------------------------------
                         -----------------------------------------------------------------------------------------
                         -----------------------------------------------------------------------------------------
                         -----------------------------------------------------------------------------------------
                         ----------------------------------------
Account             =    -----------------------------------------------------------------------------------------
                         -------------
Other               =    -----------------------------------------------------------------------------------------
Accounts                 ---------------------------------------
PLR-100232-21                                         2

 Agreement         = -----------------------------------------------------------------------------------------
                     ------------------------------------------------------------------
 Other             = -----------------------------------------------------------------------------------------
 Agreements          -----------------------------------------------------------------------------------------
                     ----------------------------------------------------------------
 Agent             = -----------------------------------------------------------------------------------------
                     ------------
 Fund              = -----------------------------------------------------------------------------------------
                     -----------------------------------------------------------------------------------------
                     -----------------------------------------------------------------------------------------
                     -----------------------------------------------------------------------------------------
                     -----------------------------------------------------------------

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

This letter supersedes our letter dated July 01, 2021, to correct an obvious error.

This letter responds to your letter, dated December 30, 2020, and subsequent
correspondence, submitted on behalf of Taxpayer, requesting a private letter ruling that
Fees and Other Fees charged to fund Activities and Other Activities and held in Account
and Other Accounts are excludible from gross income under § 61 of the Internal
Revenue Code (Code).

FACTS

Taxpayer is an S Corporation that operates Facility in State. Taxpayer is wholly owned
by Parent. State regulates operation of Facility for which Taxpayer maintains Permit
issued by Agency. Taxpayer’s business operations model consists of two stages.
During the first stage, Taxpayer provides Services to its clients. During the second
stage, Taxpayer performs its statutorily mandated obligations of Activities and Other
Activities for which Regulations require Taxpayer to establish a Plan. Taxpayer charges
its clients a standard rate for Services and also collects Fees from its clients to fund
Taxpayer’s obligation to perform Activities and Other Activities. Taxpayer deposits Fees
into Account pursuant to Agreement with State. Agency monitors the balances of,
approves withdrawals from, and conducts periodic audits of Account. Further, funds in
Account must be readily available in the event of an emergency.

Taxpayer enters into Other Agreements with Agency. Other Agreements authorize
Taxpayer to collect Other Fees from clients to cover Activities and Other Activities.
Taxpayer is permitted to increase rate of Other Fees charged to customers. Taxpayer
deposits Other Fees into Other Accounts. Agency does not directly approve
withdrawals from Other Accounts, and the funds held in Other Accounts do not have to
be readily available in the event of an emergency. Agency requires Taxpayer to submit
invoices for funds drawn from Other Accounts, and expenditures must be deemed
reasonable and within the scope of Plan.
PLR-100232-21                                3


Taxpayer deposits Fees and Other Fees with Agent who places funds in an interest-
bearing account. All interest and other earned income is deposited into the respective
Account and Other Accounts. The funds held in Account and Other Accounts are not
considered to be an asset of Taxpayer and will not be available to potential creditors.
After Agency determines that Taxpayer has completed all Activities and Other Activities,
Agent transfers the balances remaining in Account and Other Accounts into Fund.

Taxpayer’s relationship with its clients ends when Taxpayer starts Activities and Other
Activities per Plan. At that time, Taxpayer may withdraw funds from Accounts and
Other Accounts. These funds are used to pay vendors hired by Taxpayer. Taxpayer
does not receive a commission or a mark-up over the invoiced amounts submitted by
vendors. A significant portion of the construction of Facility and work on Activities and
Other Activities is performed by parties related to Taxpayer at rates typically charged by
similar vendors in the local market.

Taxpayer also makes withdrawals from Accounts and Other Accounts to purchase
certain equipment. Taxpayer owns the equipment purchased with the funds from
Accounts and Other Accounts.

Presently, Taxpayer does not recognize income in the year it collects Fees and/or Other
Fees and does not claim a deduction for amounts withdrawn from Account and/or Other
Accounts. Further, Taxpayer presently does not take basis and claim depreciation or
amortization for the equipment purchased with funds withdrawn from Account and/or
Other Accounts.

LAW

Section 61(a) of the Code provides that except as otherwise provided in subtitle A,
gross income means all income from whatever source derived. Specifically, § 61(a)(2)
includes income derived from business in gross income. Gross income is an
undeniable accession to wealth, clearly realized, over which a taxpayer has complete
dominion. Commissioner v. Glenshaw Glass Co., 348 U.S. 426 (1955). As stated by
the Supreme Court in discussing an earlier version of the Section, “[t]he income taxed is
described in sweeping terms and should be broadly construed in accordance with an
obvious purpose to tax income comprehensively.” Commissioner v. Jacobson, 336 U.S.
28, 49 (1949).

If taxpayer receives funds that must be spent in a way regulated by another entity, such
as a government regulator, the taxpayer must recognize amounts received as gross
income under Section 61(a)(2). The determinative factors are the degree of control over
the funds the taxpayer enjoys and the degree to which Taxpayer benefits from the
expenditures of the funds. Mutual Telephone Co. v. United States, 204 F.2d 160, 161-
62 (9th Cir.1953) (increased charges collected by public utility to decrease demand are
income when placed in retirement fund, as directed by regulating Commission); United
PLR-100232-21                                4

States v. Maryland Jockey Club of Baltimore City, 210 F.2d 367, 371-72 (4th Cir.), cert.
denied, 347 U.S. 1014 (1954); Iowa Southern Utilities Co. v. United States, 841 F.2d
1108 (Fed.Cir.1988), aff’g 11 Cl.Ct. 868 (1987); Rev. Rul. 63-182, 1963-2 C.B. 194.

Under the Seven-Up line of cases, when a taxpayer is controlled by another and acts as
an agent, fiduciary, or a conduit, funds that taxpayer received and spent for the benefit
of others are not includible in taxpayer’s gross income under Section 61. Seven-Up Co.
v. Commissioner, 14 T.C. 965 (1950), acq. in result, 1974-2 C.B. 4; Rev. Rul. 74-319,
1974-2 C.B. 15. Cf. Rev. Rul. 74-318, 1974-2 C.B. 14. See also Broadcast
Measurement Bureau, Inc. v. Commissioner, 16 T.C. 988 (1951) (relying on Seven-Up,
the court held that amounts the taxpayer collected from its radio subscribers to conduct
surveys were not includible in the taxpayer’s gross income). However, the tax court has
held that for proceeds held in trust to be excluded from gross income under the trust
fund doctrine, no profit, gain or other benefit must accrue to the taxpayer on account for
their receipt. See Ford Dealers Advertising Fund, Inc. v. Commissioner, 55 T.C. 761
(1971), aff’d, 456 F.2d 255 (5th Cir. 1972), nonacq., 1974-2 C.B. 5; Affiliated Foods, Inc.
v. Commissioner, 154 F.3d 527 (5th Cir. 1998), aff’g and rev’g on other grounds, T.C.
Memo 1996-505 (1996).

In the cemetery perpetual care line of cases, if a taxpayer receives funds and is bound
either by agreements or by statute to pay certain sums into a trust fund, and the
principal and interest do not inure to the benefit of the taxpayer, those funds are not
considered part of the taxpayer’s gross income. See Commissioner v. Cedar Park
Cemetery Ass'n, 183 F.2d 553 (7th Cir. 1950); Los Angeles Cemetery Asso. V.
Commissioner, 2 B.T.A 495 (1925), acq. 1926-1 C.B. 4; American Cemetery Co. v.
United States, 28 F.2d 918 (D. Kan. 1928); Portland Cremation Ass’n v.
Commissioner, 31 F.2d 843 (9th Cir. 1929(, rev’g, 10 B.T.A 65 (1928). However,
where the taxpayer has control and receives benefits from proceeds placed in trust
courts have treated the proceeds as gross income under § 61. See Gracelawn
Memorial Park, Inc. v. United States, 260 F.2d 328 (3rd Cir. 1958), aff’g, 157
F.Supp. 516 (1957); Crystal Lake Cemetery Asso. v. United States, 413 F.2d 617
(8th Cir. 1969), aff’g, 1968 U.S. Dist. LEXIS 11621 (1968)

ANALYSIS

We are adverse to Taxpayer’s request for two reasons. First, Taxpayer asserts that,
under the Seven-Up line of cases and under the cemetery perpetual care line of cases,
Fees and Other Fees collected for Activities and Other Activities and placed in Account
and Other Accounts should not be included in Taxpayer’s gross income because it is
merely a conduit and has no control over the Fees and Other Fees as it is required to
deposit the funds into Account and Other Accounts and to use those funds for a specific
purpose.

We disagree with Taxpayer’s position. The fact that Taxpayer is required to keep
certain amounts in Accounts and Other Accounts to ensure its obligations will be
PLR-100232-21                                  5

satisfied during the second stage of its business operations does not mean that
these amounts are not included in gross income. Unlike the cemetery plot owners
who are concerned not only with the upkeep of their lots, but also with the overall
maintenance of the cemetery grounds, Taxpayer’s clients have no interest in, nor
participate in the Activities and Other Activities’ phase of Taxpayer’s operations.
Commissioner v. Cedar Park Cemetery Ass’n, 183 F.2d 553, 555 (7th Cir. 1950)
Further, Taxpayer has a statutory obligation to perform Activities and Other Activities.
Taxpayer’s obligations are owed to Agency and State, and the clients have no
interest in Taxpayer’s Activities or Other Activities. Further, Taxpayer is under no
obligation to repay the funds to its clients, and all of the Activities and Other Activities
obligations are imposed on the Taxpayer. Therefore, Taxpayer does not act as a mere
conduit.

Second, Taxpayer asserts that, similar to the Seven-Up line of cases and the cemetery
perpetual care line of cases, it does not derive a benefit from Fees or Other Fees.

We disagree with Taxpayer’s position. Unlike the bottlers in Seven-Up and the
taxpayers in the cemetery perpetual care line of cases, Taxpayer has a statutory
obligation to perform Activities and Other Activities. Thus, funding Activities and Other
Activities is Taxpayer’s liability. Using the funds in Account and Other Accounts to
satisfy its liabilities is a benefit to Taxpayer. Moreover, Taxpayer may use the funds in
Account and Other Accounts to purchase equipment for which Taxpayer takes
ownership, thus directly benefiting from the Fees and Other Fees.

CONCLUSION

Therefore, to comply with the requirements of § 61, Taxpayer must include Fees and
Other Fees in gross 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.

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

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
PLR-100232-21                                6


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,



                                      Christina M. Glendening
                                      Senior Counsel, Branch 5
                                      Office of Associate Chief Counsel
                                      (Income Tax & Accounting)




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