Part I. Rulings — Internal Revenue Bulletin 2002-37

Section 61.—Gross Income Defined

26 CFR 1.61–21: Taxation of fringe benefits.

Fringe benefits aircraft valuation for- mula. For purposes of section 1.61–21(g) of the Income Tax Regulations, relating to the rule for valuing non-commercial flights on employer-provided aircraft, the Standard Industry Fare Level (SIFL) cents-permile rates and terminal charge in effect for the second half of 2002 are set forth.

Period During Which the Flight Is Taken

Rev. Rul. 2002–56

For purposes of the taxation of fringe benefits under section 61 of the Internal Revenue Code, section 1.61–21(g) of the Income Tax Regulations provides a rule for valuing noncommercial flights on employerprovided aircraft. Section 1.61–21(g)(5) provides an aircraft valuation formula to determine the value of such flights. The value of a flight is determined under the base aircraft valuation formula (also known as the Standard Industry Fare Level for

Terminal Charge

mula or SIFL) by multiplying the SIFL cents-per-mile rates applicable for the period during which the flight was taken by the appropriate aircraft multiple provided in section 1.61–21(g)(7) and then adding the applicable terminal charge. The SIFL centsper-mile rates in the formula and the terminal charge are calculated by the Department of Transportation and are reviewed semi-annually.

The following chart sets forth the terminal charges and SIFL mileage rates:

SIFL Mileage Rates

7/1/02 - 12/31/02 $38.02 Up to 500 miles = $.2080 per mile

501-1500 miles = $.1586 per mile

Over 1500 miles = $.1524 per mile

Drafting Information

The principal author of this revenue ruling is Kathleen Edmondson of the Office of Division Counsel/Associate Chief Counsel (Tax Exempt and Government Entities). For further information regarding this revenue ruling, contact Ms. Edmondson at (202) 622–6040 (not a toll-free call).

Section 472.—Last-in, First-out Inventories

26 CFR 1.472–1: Last-in, first-out inventories.

LIFO; price indexes; department stores . The July 2002 Bureau of Labor Statistics price indexes are accepted for use by department stores employing the retail inventory and last-in, first-out inventory methods for valuing inventories for tax years ended on, or with reference to, July 31, 2002.

Rev. Rul. 2002–57

The following Department Store Inventory Price Indexes for July, 2002 were issued by the Bureau of Labor Statistics. The

indexes are accepted by the Internal Revenue Service, under § 1.472–1(k) of the Income Tax Regulations and Rev. Proc. 86– 46, 1986–2 C.B. 739, for appropriate application to inventories of department stores employing the retail inventory and last-in, first-out inventory methods for tax years ended on, or with reference to July 31, 2002. The Department Store Inventory Price Indexes are prepared on a national basis and include (a) 23 major groups of departments, (b) three special combinations of the major groups - soft goods, durable goods, and miscellaneous goods, and (c) a store total, which covers all departments, including some not listed separately, except for the following: candy, food, liquor, tobacco, and contract departments.

2002–37 I.R.B. 526 September 16, 2002

BUREAU OF LABOR STATISTICS, DEPARTMENT STORE INVENTORY PRICE INDEXES BY DEPARTMENT GROUPS

(January 1941 = 100, unless otherwise noted)

Percent Change

from July 2001

to July 2002 ¹

Groups

July July 2001 2002

Piece Goods----------------------------------------------------------------------- 495.0 486.4 -1.7
Domestics and Draperies ------------------------------------------------------- 604.1 577.3 -4.4
Women’s and Children’s Shoes ----------------------------------------------- 652.3 607.4 -6.9
Men’s Shoes ---------------------------------------------------------------------- 865.9 906.0 4.6
Infants’ Wear---------------------------------------------------------------------- 593.7 590.9 -0.5
Women’s Underwear ------------------------------------------------------------ 567.1 526.3 -7.2
Women’s Hosiery ---------------------------------------------------------------- 352.6 345.2 -2.1
Women’s and Girls’ Accessories ---------------------------------------------- 542.1 517.0 -4.6
Women’s Outerwear and Girls’ Wear ---------------------------------------- 355.7 342.0 -3.9
Men’s Clothing------------------------------------------------------------------- 577.6 565.1 -2.2
Men’s Furnishings --------------------------------------------------------------- 588.4 573.1 -2.6
Boys’ Clothing and Furnishings----------------------------------------------- 476.0 455.1 -4.4
Jewelry----------------------------------------------------------------------------- 946.5 887.6 -6.2
Notions----------------------------------------------------------------------------- 805.8 795.1 -1.3
Toilet Articles and Drugs ------------------------------------------------------- 972.5 970.8 -0.2
Furniture and Bedding ---------------------------------------------------------- 637.7 627.6 -1.6
Floor Coverings ------------------------------------------------------------------ 628.7 617.6 -1.8
Housewares ----------------------------------------------------------------------- 771.5 752.9 -2.4
Major Appliances ---------------------------------------------------------------- 225.6 221.4 -1.9
Radio and Television ------------------------------------------------------------ 53.9 48.4 -10.2
Recreation and Education ² ---------------------------------------------------- 89.8 86.3 -3.9
Home Improvements ² ---------------------------------------------------------- 125.8 125.8 0.0
Auto Accessories ² --------------------------------------------------------------- 109.4 111.6 2.0

Groups 1–15: Soft Goods------------------------------------------------------------- 575.7 555.9 -3.4 Groups 16–20: Durable Goods------------------------------------------------------- 423.3 409.9 -3.2 Groups 21–23: Misc. Goods ² -------------------------------------------------------- 98.5 96.6 -1.9

Store Total ³ ----------------------------------------------------------------------- 519.5 502.8 -3.2

1 Absence of a minus sign before the percentage change in this column signifies a price increase. 2 Indexes on a January 1986=100 base. 3 The store total index covers all departments, including some not listed separately, except for the following: candy, food, liquor, tobacco, and contract departments.

DRAFTING INFORMATION

The principal author of this revenue ruling is Michael Burkom of the Office of Associate Chief Counsel (Income Tax and Accounting). For further information regarding this revenue ruling, contact Mr. Burkom at (202) 622–7718 (not a tollfree call).

Section 501.—Exemption From Tax on Corporations, Certain Trusts, etc.

26 CFR 1.501(c)(12)–1: Local benevolent life in- surance associations, mutual irrigation and tele- phone companies, and like organizations.

Tax-exempt electric cooperative. A taxexempt electric cooperative’s (1) distribution and sale of propane in tanks to members is not a tax-exempt activity under section 501(c)(12)(A) of the Code and may adversely affect its tax-exempt status under section 501(c)(12); (2) if the taxexempt status of the electric cooperative is not adversely affected; income derived from this activity is unrelated business income and subject to unrelated business income

September 16, 2002 527 2002–37 I.R.B.

members for the sole purpose of meeting losses and expenses. See also § 1.501 (c)(12)–1(a) of the Income Tax Regulations. The 85 percent member income test is computed in each taxable year, and a cooperative may fail the test one year but meet the test in a prior or subsequent tax year. See Rev. Rul. 65–99, 1965–1 C.B. 242.

Section 511(a)(1) imposes a tax on the unrelated business taxable income of organizations described in § 511(a)(2).

Section 511(a)(2) states that all organizations exempt under § 501(c) are subject to the unrelated business income tax (other than § 501(c)(1)).

Section 1.511–2(a)(1)(i) provides, in pertinent part, that § 511(a)(1) applies to any organization exempt under § 501(a) (other than § 501(c)(1)).

ANALYSIS

Organizations exempt under § 501(c)(12) include mutual ditch or irrigation companies and telephone or electric cooperatives. If the organization in question does not furnish any of these services, its activity must be a “like organization” activity. As stated in Rev. Rul. 83–170 and Rev. Rul. 67–265, a “like organization” activity is a public utility type service. A public utility type service is the furnishing or sale of the production, transmission, and distribution of electricity, gas, steam or water, sewage disposal service, or telephone service, traditionally where the rates have been established or approved by a State, a political division, public utility commission, or other similar body of a State, or by any agency or instrumentality of the United States. See Rev. Rul. 83–170 (cable television is a public utility type service because it is regulated by the state); see generally § 168(i)(10). A public utility type service for purposes of § 501(c)(12) also requires an extensive infrastructure, like the delivery of electricity from producers to consumers, the construction of which necessitates large capital investment.

In the factual situation described above, A ’s distribution and sale of tanked propane by trucks is not a public utility type service because the rates charged for tanked propane are not and traditionally have not been regulated (aside from safety regulations) by states or the federal government. Also, the distribution and sale of tanked propane by trucks does not require an extensive infrastructure, unlike the distribu

tax; and (3) the income is treated as nonmember income for purposes of calculating the 85 percent member income test under section 501(c)(12)(A).

Rev. Rul. 2002–54

ISSUES

Whether the distribution and sale of propane in tanks by an electric cooperative to members is a “like organization” activity under § 501(c)(12)(A) of the Internal Revenue Code;
If the distribution and sale of propane in tanks is not a “like organization” activity, how the 85 percent member income test of § 501(c)(12)(A) is applied to income derived from this activity;
If the distribution and sale of propane in tanks is not a “like organization” activity, is it an activity unrelated to the exempt purpose of an electric cooperative and subject to the unrelated income tax described in §§ 511–513?

FACTS

A is a corporation formed for the purpose of providing electricity to members. A operates according to cooperative principles. A is recognized as exempt from federal income tax under § 501(a) as an organization described in § 501(c)(12). Membership in A is available to any person. A ’s members reside in a certain geographic area of State X .

A distributes electricity to members. A also sells propane to members for their personal or business use. Propane in tanks is delivered by truck to the purchasers’ residences or businesses at regular intervals and also on an as needed basis.

In year Y, A ’s income is derived as follows: $95x from sales of electricity to members, $2x from interest income earned on A ’s bank accounts, and $3x from sales of tanked propane to members.

LAW

The Internal Revenue Service (“Service”) position has been that providing light

and water to members on a cooperative basis is a “like organization” activity because it is a public utility type service. See Rev. Rul. 67–265, 1967–2 C.B. 205, up- dating and restating I.T. 1671, C.B. II–1, 158 (1923). Congress in 1980 amended § 501(c)(12) by adding § 501(c)(12)(C), which specifically lists electric cooperatives as organizations within the purview of § 501(c)(12). Pub. L. No. 96–605 § 106(a), 94 Stat. 3524 (1980).

Rev. Rul. 83–170, 1983–2 C.B. 97, affirms the public utility type service rationale described in Rev. Rul. 67–265 and states that the definition of “like organization” includes those cooperatives that are engaged in activities similar in nature to a public utility type service. In the revenue ruling, an organization provides cable television service to its members on a cooperative basis. The revenue ruling compares cable television service to a public utility type service because it is a service regulated by the state. The revenue ruling concludes that the cooperative organization is a “like organization” within the meaning of § 501(c)(12)(A) and qualifies for exemption under § 501(c)(12).

The Service has stated that “like organization” activity does not include activities not similar in nature to a public utility type service. In Rev. Rul. 65–201, 1965–2 C.B. 170, an organization sells electrical material, equipment and supplies, and provides equipment repair services to its members on a cooperative basis. The revenue ruling holds that the organization is not a “like organization” because the activities in question are not similar to public utility type services that are conducted by those organizations listed in § 501(c)(12). See also Consumers Credit Rural Electric Coop. Corp. v. Commissioner, 37 T.C. 136, 143, aff’d 319 F.2d 475 (6th Cir. 1963) (an organization that financed consumer purchases of electrical, water or plumbing appliances was not a “like organization”); New Jersey Automobile Club v. United States, 181 F. Supp. 259 (Cl. Ct. 1960), cert. denied, 366 U.S. 964 (1961) (providing emergency road, travel and bail bond services were not “like organization” activities).

Section 501(c)(12)(A) provides that organizations whose activities are described in this subsection can qualify for exemption only if 85 percent or more of the income consists of amounts collected from

2002–37 I.R.B. 528 September 16, 2002

erative principles. A is recognized as exempt from federal income tax under § 501(a) as an organization described in § 501(c)(12). Membership in A is available to any person. A ’s members reside in a certain geographic area of State X . B is a taxable corporation formed for valid business purposes. A owns 100 percent of the stock of B . B does not operate on a cooperative basis. B is not a member of A . B distributes $5x to A as a dividend (as defined in § 301) to A . B files Forms 1120.

In the year in question, A ’s income is derived as follows: $90x from its members for telephone services, $5x as a dividend received from B, and $5x from interest income earned on A ’s bank accounts.

LAW

Section 501(c)(12)(A) 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 in any year consists of amounts collected from members for the sole purpose of meeting losses and expenses.

A corporation is a separate taxable entity for federal income tax purposes if the corporation is formed for valid business purposes, and is not a sham, an agency or instrumentality. Moline Properties, Inc. v. Commissioner, 319 U.S. 436 (1943); Com- missioner v. Bollinger, 485 U.S. 340 (1988).

ANALYSIS

An organization seeking exemption under § 501(c)(12) must satisfy two requirements. First, it must be a benevolent life insurance association of a purely local character, mutual ditch or irrigation company, mutual or cooperative telephone company or a like organization. Hence, an organization must conduct activities that are permitted under § 501(c)(12) and must be operated on a cooperative basis.

Second, the organization must receive 85 percent or more of its income in any year from members for the sole purpose of meeting losses and expenses incurred from services provided to members. The 85 percent member income test requires that the income be (1) derived from members and (2) used to pay for services listed in

tion of electricity. Hence, distribution and sale of tanked propane by trucks is not a “like organization” activity under § 501(c)(12)(A).

The 85 percent member income test of § 501(c)(12) requires that a § 501(c)(12) cooperative must receive 85 percent or more of its income from members for the sole purpose of meeting losses and expenses in order to qualify for and maintain tax exemption. The 85 percent member income test requires that the income be (1) derived from members and (2) used to pay for services listed in § 501(c)(12). The $3x A derived from distribution and sale of tanked propane by trucks is from members, but is not used for a service listed in § 501(c)(12) because distribution and sale of tanked propane is not a “like organization” activity. Hence, the $3x A derived is treated as nonmember income for purposes of calculating the 85 percent member income test.

The unrelated business income tax provisions, §§ 511 – 513, provide that the income of a cooperative exempt under § 501(c)(12) is subject to unrelated business income tax if the income is derived from an activity unrelated to its exempt purpose. See also Henry E. & Nancy Horton Bartels Trust for the Benefit of the Uni- versity of New Haven v. United States, 209 F.3d 147, 149 (2d Cir. 2000) (stating that an organization exempt from tax under § 501 may be subject to the unrelated business income tax on income it derives from a trade or business unrelated to its exempt purpose). The distribution and sale of tanked propane, as concluded, is not a “like organization” activity within the meaning of § 501(c)(12)(A). A ’s distribution and sale of tanked propane to members is a business, is regularly carried on and is not related to providing electricity to members. See § 1.512(a)–1 (stating the definition for unrelated business taxable income). If A ’s distribution and sale of tanked propane were not insubstantial, it would jeopardize its exempt status under § 501(c)(12). If it were insubstantial, the $3x A derived from distribution and sale of tanked propane would be subject to unrelated business income tax.

HOLDINGS

Distribution and sale of tanked propane by trucks is not a “like organization” activity under § 501(c)(12)(A). The $3x A derived from the distribution and sales of tanked propane to members is non

member income for purposes of calculating the 85 percent member income test. A ’s total income for year Y is $100x, $95x (95 percent) of which is derived from members. $5x (5 percent) of the total income for year Y is derived from nonmembers, $3x (3 percent) from distribution and sale of tanked propane and $2x (2 percent) in interest income. A satisfies the 85 percent member income test for year Y . A ’s distribution and sales of tanked propane is unrelated to its exempt purpose. A ’s exempt status under § 501(c)(12) is not jeopardized if the distribution and sale of tanked propane is insubstantial, but the $3x A derived from the activity is subject to unrelated business income tax.

This revenue ruling deals only with § 501(c)(12). No inference is intended as to any other provision of law, including the definition of utility or public utility under any other provision.

EFFECTIVE DATE

This revenue ruling is effective for taxable years beginning after December 31, 2002.

DRAFTING INFORMATION

The principal author of this revenue ruling is Michael Seto, TE/GE Division, Exempt Organizations. For further information regarding this revenue ruling, contact Michael Seto at (202) 283–9465 (not a tollfree call).

Cooperative exempt from federal in- come tax. A cooperative exempt from federal income tax under section 501(c)(12) of the Code is not required to include income of its subsidiary for purposes of calculating the 85 percent member income test of section 501(c)(12)(A).

Rev. Rul. 2002–55

ISSUE

How the 85 percent member income test of § 501(c)(12)(A) of the Internal Revenue Code is applied in the situation described below.

FACTS

A is a corporation formed for the purpose of providing telephone services to members. A operates according to coop

September 16, 2002 529 2002–37 I.R.B.

question is derived from nonmembers, $5x from B and $5x from A ’s interest bearing bank accounts. A satisfies the 85 percent member income test for the year in question.

HOLDING

A is exempt from federal income tax under § 501(c)(12) for the taxable year in question because more than 85 percent of its income is derived from members.

EFFECTIVE DATE

This revenue ruling is effective for taxable years beginning after December 31, 2002. However, taxpayers may rely on this revenue ruling for prior periods.

DRAFTING INFORMATION

§ 501(c)(12). See § 1.501(c)(12)–1(a) of the Income Tax Regulations and Consumers Credit Rural Electric Cooperative Corp. v. Commissioner, 37 T.C. 136 (1961), aff’d in pertinent part, 319 F.2d 475 (1963).

In order to maintain tax exemption under § 501(c)(12), the cooperative must compute the 85 percent member income test in each taxable year. The cooperative may fail the 85 percent member income test one year but satisfy the test in a prior year or subsequent year. See Rev. Rul. 65–99, 1965–1 C.B. 242. Hence, the 85 percent member income test requires a cooperative exempt under § 501(c)(12) for any taxable year to combine all sources of income not otherwise excludable under § 501(c)(12)(B) or (C) and calculate whether more than 15 percent of that income is derived from nonmembers. The cooperative is not tax exempt in any taxable year if more than 15 percent of its income is derived from nonmembers. A cooperative has the burden of proof to establish that it satisfies the 85 percent member income test for each taxable year. See also Nonprofits’ Insurance Alli- ance of California v. United States, 32 Fed. Cl. 277 (1994) (income tax exemptions are

matters of legislative grace which the courts have consistently strictly construed).

In the situation described, A must establish that not more than 15 percent of its income is derived from nonmember sources for the taxable year in question. Assuming that B is recognized as an entity separate from A for federal income tax purposes under Moline Properties, the income of B is not included for purposes of determining whether A satisfies the 85 percent member income test. However, any payments A received from B are included in the calculation of the 85 percent member income test. Because B is not a member of A, the dividend A receives from B for the year in question is nonmember income for purposes of the 85 percent member income test. Further, even if B were a member of A, the dividend is not member income because it is not payment for the sole purpose of meeting losses and expenses incurred for telephone services provided to B by A .

A ’s total income for the year in question is $100x, $90x (90 percent) of which is derived from members. $10x (10 percent) of the total income for the year in

2002–37 I.R.B. 530 September 16, 2002