Rev. Rul. 2004-52 holds — Internal Revenue Bulletin 2004-22

fees are not interest for federal income tax purposes. Moreover, the ruling holds that credit card annual fees are includible in the gross income by the card issuer when they become due and payable by card holders under the terms of the credit card agreements. See Rev. Rul. 2004-52, page 973.

Rev. Proc. 2004–32 provides automatic procedures for taxpayers to change their method of accounting to a method that complies with Rev. Rul. 2004–52, 2004–22 I.R.B. dated June 1, 2004, or to the Ratable Inclusion Method for Credit Card Annual fees described in this revenue procedure. See Rev. Proc. 2004-32, page 988.

Rev. Proc. 2004-33 provides automatic procedures for taxpayers to change their method of accounting for credit card late fee income to treat these fees as interest that creates or increases the amount of OID on a pool of credit card loans to which the fees relate. This revenue procedure also sets forth the conditions under which the Commissioner will not challenge a taxpayer’s treatment of these fees as interest or as OID on a pool of credit card loans to which the fees relate. See Rev. Proc. 2004-33, page 989.

Section 451.—General Rule for Taxable Year of Inclusion

26 CFR 1.451–1: Taxable year of inclusion. (Also: §§ 61, 446.)

Credit card annual fees. This ruling holds that credit card annual fees are not interest for federal income tax purposes. Moreover, the ruling holds that credit card annual fees are includible in the gross income by the card issuer when they become due and payable by cardholders under the terms of the credit card agreements.

Rev. Rul. 2004–52

ISSUES

(1) Are credit card annual fees interest for federal income tax purposes?

no longer an eligible individual for the purpose of the HSA.

In the arrangements described, the individual does not fail to be an eligible individual under section 223 and may contribute to an HSA. In addition, combinations of these arrangements which are consistent with these requirements would not disqualify an individual from being an eligible individual. For example, if an employer offers a combined post-deductible health FSA and a limited-purpose health FSA, this would not disqualify an otherwise eligible individual from contributing to an HSA.

An individual may not be reimbursed for the same medical expense by more than one plan or arrangement. However, if the individual has available an HSA, a health FSA and an HRA that pay or reimburse the same medical expense, the health FSA or the HRA may pay or reimburse the medical expense, subject to the ordering rules in Notice 2002–45, Part V, so long as the individual certifies to the employer that the expense has not been reimbursed and that the individual will not seek reimbursement under any other plan or arrangement covering that expense (including the HSA).

HOLDINGS

In Situation 1, the individual is covered by an HDHP and by a health FSA and HRA that pay or reimburse medical expenses incurred before the minimum annual deductible under section 223(c)(2)(A)(i) has been satisfied. The health FSA and HRA pay or reimburse medical expenses that are not limited to the exceptions for permitted insurance, permitted coverage or preventive care. As a result, the individual is not an eligible individual for the purpose of making contributions to an HSA. This result is the same if the individual is covered by a health FSA or HRA sponsored by the employer of the individual’s spouse. See, Rev. Rul. 2004–38.

In Situation 2, the individual is covered by an HDHP and by a health FSA and HRA that pay or reimburse medical expenses incurred before the minimum annual deductible under section 223(c)(2)(A)(i) has been satisfied. However, the medical expenses paid or reimbursed by the health FSA and HRA include only vision and dental benefits (which are

permitted coverage) and preventive care. All of these benefits may be covered as a separate health plan, as a separate or optional rider, or as part of the HDHP and whether or not the minimum annual deductible under section 223(c)(2)(A)(i) has been satisfied. The individual is an eligible individual for the purpose of making contributions to an HSA.

In Situation 3, the individual elects to forgo the payment or reimbursement of medical expenses incurred during an HRA coverage period. The suspension of payments and reimbursements by the HRA does not apply to permitted insurance, permitted coverage and preventive care (if otherwise allowed to be paid or reimbursed by the HRA). The individual is an eligible individual for the purpose of making contributions to an HSA until the suspension period ends and the individual is again entitled to receive, from the HRA, payments or reimbursements of section 213(d) medical expenses incurred after the suspension period.

In Situation 4, the health FSA and HRA pay or reimburse medical expenses (including the 20 percent coinsurance not otherwise covered by the HDHP) only after the HDHP’s minimum annual deductible has been satisfied. The individual is an eligible individual for the purpose of making contributions to an HSA.

In Situation 5, the HRA is a retirement HRA that only pays or reimburses medical expenses incurred after the individual retires. The individual is an eligible individual for the purpose of making contributions to an HSA before retirement because the HRA will pay or reimburse only medical expenses incurred after retirement.

Drafting Information

The principal author of this notice is Shoshanna Tanner of the Office of Division Counsel/Associate Chief Counsel (Tax Exempt and Government Entities). For further information regarding this notice, contact Ms. Tanner at (202) 622–6080 (not a toll-free call).

2004-22 I.R.B. 973 June 1, 2004

Notwithstanding the holding of this revenue ruling, Rev. Proc. 2004–32, 2004–22 I.R.B. 988, dated June 1, 2004, this Bulletin, allows card issuers to account for annual fee income using the Ratable Inclusion Method for Credit Card Annual Fees, which is described in section 4 of that revenue procedure. Rev. Proc. 2004–32 also provides automatic consent for a taxpayer described in this revenue ruling to change its method of accounting for annual fee income.

HOLDINGS

(1) Credit card annual fees are not interest for federal income tax purposes.

(2) Credit card annual fees are includible in gross income by the card issuer when they become due and payable by cardholders under the terms of the credit card agreements.

DRAFTING INFORMATION

The principal authors of this revenue ruling are Rebecca E. Asta, Alexa Dubert, and Tina Jannotta of the Office of Chief Counsel (Financial Institutions and Products). For further information regarding this revenue ruling, contact the principal authors at (202) 622–3930 (not a toll-free call).

Section 481.—Adjustments Required by Changes in Method of Accounting

Taxpayers changing a method of accounting for certain transfers to trusts to satisfy contested liabilities under section 461(f) may be required to take into account a positive adjustment under section 481(a) entirely in one year. See Rev. Proc. 2004-31, page 986.

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

26 CFR 1.501(c)(3)–1: Organizations organized and operated for religious, charitable, scientific, testing for public safety, literary, or educational purposes, or for the prevention of cruelty to children or animals. (Also sections 511–513.)

Joint ventures. This ruling illustrates the tax consequences for a section 501(c)(3) organization that enters into a joint venture with a for-profit organization as an insubstantial part of its activities.

(2) When are credit card annual fees includible in gross income by the card issuer?

FACTS

X, a taxpayer that uses an overall accrual method of accounting for federal income tax purposes, issues credit cards. Each card allows the cardholder to access a revolving line of credit to make purchases of goods and services and, if otherwise provided for under the applicable cardholder agreement, to obtain cash advances.

Credit card issuers, including X, charge certain cardholders an annual fee. These credit card issuers make various benefits and services available to their cardholders during the year, regardless of whether the cardholder actually utilizes them. Further, although they provide these benefits and services to cardholders, no part of the annual fee that is charged to any cardholder is for a specific benefit or service provided by a credit card issuer to that cardholder.

Each cardholder’s credit card agreement sets forth the applicable terms and conditions under which X may charge that cardholder an annual fee. X charges some cardholders a nonrefundable annual fee. X charges other cardholders an annual fee that is refundable on a pro rata basis if the cardholder closes the account during the period covered by the fee.

Under the applicable cardholder agreement, no annual fee becomes due and payable until X posts an annual fee charge to the cardholder’s credit card account. X reflects this posting in the cardholder’s credit card statement. X generally posts the full amount of the annual fee in a single charge unless the terms of the agreement require X to post the annual fee charge in installments.

LAW AND ANALYSIS

For federal income tax purposes, interest is an amount that is paid in compensation for the use or forbearance of money. Deputy v. DuPont, 308 U.S. 488 (1940), 1940–1 C.B. 118; Old Colony Railroad Co. v. Commissioner, 284 U.S. 552 (1932), 1932–1 C.B. 274. Neither the label used for the fee nor a taxpayer’s treatment of the fee for financial or regulatory reporting purposes is determinative of the proper federal income tax charac

terization of that fee. See Thor Power Tool Co. v. Commissioner, 439 U.S. 522, 542–43 (1979), 1979–1 C.B. 167, 174–75; Rev. Rul. 72–315, 1972–1 C.B. 49.

The annual fee that credit card issuers, including X, charge any cardholder is not for any specific benefit provided by the credit card issuer to that cardholder. Rather, it is charged for all of the benefits and services that are available to the cardholder under the applicable cardholder agreement. Because cardholders pay annual fees to credit card issuers, including X, in return for all of the benefits and services available under the applicable credit card agreement, annual fees are not compensation for the use or forbearance of money. Thus, X ’s annual fee income is not interest income for federal income tax purposes.

Under § 451(a) of the Internal Revenue Code, the amount of any item of gross income is includible in gross income for the taxable year in which it is received by the taxpayer, unless that amount is to be properly accounted for in a different period under the method of accounting used by the taxpayer in computing taxable income.

Under § 1.451–1(a) of the Income Tax Regulations, income is includible in gross income by a taxpayer that uses an accrual method of accounting when all events have occurred that fix the taxpayer’s right to receive that income and the amount of that income can be determined with reasonable accuracy. See also § 1.446–1(c)(1)(ii)(A). Generally, all the events that fix the right to receive income occur when either the required performance takes place, payment is due, or payment is made, whichever occurs first (the all events test). See Rev. Rul. 2003–10, 2003–1 C.B. 288; Rev. Rul. 80–308, 1980–2 C.B. 162. X is required to include these annual fees in gross income under § 1.451–1(a) when the fee income becomes due and payable under its agreements, because X ’s right to the income is fixed at that point and the amount of the income can be determined with reasonable accuracy. Thus, the all events test is satisfied when X posts an annual fee charge to a cardholder’s credit card account even if X later is required to refund a portion of a previously posted refundable annual fee charge because the cardholder closes the account during the period covered by that fee.

June 1, 2004 974 2004-22 I.R.B.

Rev. Rul. 2004–51

ISSUES

Whether, under the facts described below, an organization continues to qualify for exemption from federal income tax as an organization described in § 501(c)(3) of the Internal Revenue Code when it contributes a portion of its assets to and conducts a portion of its activities through a limited liability company (LLC) formed with a for-profit corporation.
Whether, under the same facts, the organization is subject to unrelated business income tax under § 511 on its distributive share of the LLC’s income.

FACTS

M is a university that has been recognized as exempt from federal income tax under § 501(a) as an organization described in § 501(c)(3). As a part of its educational programs, M offers summer seminars to enhance the skill level of elementary and secondary school teachers.

To expand the reach of its teacher training seminars, M forms a domestic LLC, L, with O, a company that specializes in conducting interactive video training programs. L ’s Articles of Organization and Operating Agreement (“governing documents”) provide that the sole purpose of L is to offer teacher training seminars at offcampus locations using interactive video technology. M and O each hold a 50 percent ownership interest in L, which is proportionate to the value of their respective capital contributions to L . The governing documents provide that all returns of capital, allocations and distributions shall be made in proportion to the members’ respective ownership interests.

The governing documents provide that L will be managed by a governing board comprised of three directors chosen by M and three directors chosen by O . Under the governing documents, L will arrange and conduct all aspects of the video teacher training seminars, including advertising, enrolling participants, arranging for the necessary facilities, distributing the course materials and broadcasting the seminars to various locations. L ’s teacher training seminars will cover the same content covered in the seminars M conducts on M ’s campus. However, school teachers will participate through an interactive video

link at various locations rather than in person. The governing documents grant M the exclusive right to approve the curriculum, training materials, and instructors, and to determine the standards for successful completion of the seminars. The governing documents grant O the exclusive right to select the locations where participants can receive a video link to the seminars and to approve other personnel (such as camera operators) necessary to conduct the video teacher training seminars. All other actions require the mutual consent of M and O .

The governing documents require that the terms of all contracts and transactions entered into by L with M, O and any other parties be at arm’s length and that all contract and transaction prices be at fair market value determined by reference to the prices for comparable goods or services. The governing documents limit L ’s activities to conducting the teacher training seminars and also require that L not engage in any activities that would jeopardize M ’s exemption under § 501(c)(3). L does in fact operate in accordance with the governing documents in all respects.

M ’s participation in L will be an insubstantial part of M ’s activities within the meaning of § 501(c)(3) and § 1.501(c)(3)–1(c)(1) of the Income Tax Regulations.

Because L does not elect under § 301.7701–3(c) of the Procedure and Administration Regulations to be classified as an association, L is classified as a partnership for federal tax purposes pursuant to § 301.7701–3(b).

LAW

Exemption under § 501(c)(3)

Section 501(c)(3) provides, in part, for the exemption from federal income tax of corporations organized and operated exclusively for charitable, scientific, or educational purposes, provided no part of the organization’s net earnings inures to the benefit of any private shareholder or individual.

Section 1.501(c)(3)–1(c)(1) provides that an organization will be regarded as operated exclusively for one or more exempt purposes only if it engages primarily in activities that accomplish one or more of the exempt purposes specified in § 501(c)(3).

Activities that do not further exempt purposes must be an insubstantial part of the organization’s activities. In Better Business Bureau of Washington, D.C. v. United States, 326 U.S. 279, 283 (1945), the Supreme Court held that “the presence of a single . . . [non-exempt] purpose, if substantial in nature, will destroy the exemption regardless of the number or importance of truly . . . [exempt] purposes.”

Section 1.501(c)(3)–1(d)(1)(ii) provides that an organization is not organized or operated exclusively for exempt purposes unless it serves a public rather than a private interest. To meet this requirement, an organization must “establish that it is not organized or operated for the benefit of private interests....”

Section 1.501(c)(3)–1(d)(2) defines the term “charitable” as used in § 501(c)(3) as including the advancement of education.

Section 1.501(c)(3)–1(d)(3)(i) provides, in part, that the term “educational” as used in § 501(c)(3) relates to the instruction or training of the individual for the purpose of improving or developing his capabilities.

Section 1.501(c)(3)–1(d)(3)(ii) provides examples of educational organizations including a college that has a regularly scheduled curriculum, a regular faculty, and a regularly enrolled body of students in attendance at a place where the educational activities are regularly carried on and an organization that presents a course of instruction by means of correspondence or through the utilization of television or radio.

Joint Ventures

Rev. Rul. 98–15, 1998–1 C.B. 718, provides that for purposes of determining exemption under § 501(c)(3), the activities of a partnership, including an LLC treated as a partnership for federal tax purposes, are considered to be the activities of the partners. A § 501(c)(3) organization may form and participate in a partnership and meet the operational test if 1) participation in the partnership furthers a charitable purpose, and 2) the partnership arrangement permits the exempt organization to act exclusively in furtherance of its exempt purpose and only incidentally for the benefit of the for-profit partners.

Redlands Surgical Services, 113 T.C. 47, 92–93 (1999), aff’d 242 F.3d 904 (9th

2004-22 I.R.B. 975 June 1, 2004

§ 501(c)(3), M may be subject to unrelated business income tax under § 511 if L conducts a trade or business that is not substantially related to the exercise or performance of M ’s exempt purposes or functions.

The facts establish that M ’s activities conducted through L constitute a trade or business that is substantially related to the exercise and performance of M ’s exempt purposes and functions. Even though L arranges and conducts all aspects of the teacher training seminars, M alone approves the curriculum, training materials and instructors, and determines the standards for successfully completing the seminars. All contracts and transactions entered into by L are at arm’s length and for fair market value, M ’s and O ’s ownership interests in L are proportional to their respective capital contributions, and all returns of capital, allocations and distributions by L are proportional to M ’s and O ’s ownership interests. The fact that O selects the locations and approves the other personnel necessary to conduct the seminars does not affect whether the seminars are substantially related to M ’s educational purposes. Moreover, the teacher training seminars L conducts using interactive video technology cover the same content as the seminars M conducts on M ’s campus. Finally, L ’s activities have expanded the reach of M ’s teacher training seminars, for example, to individuals who otherwise could not be accommodated at, or conveniently travel to, M ’s campus. Therefore, the manner in which L conducts the teacher training seminars contributes importantly to the accomplishment of M ’s educational purposes, and the activities of L are substantially related to M ’s educational purposes. Section 1.513–1(d)(2). Accordingly, based on all the facts and circumstances, M is not subject to unrelated business income tax under § 511 on its distributive share of L ’s income.

HOLDINGS

M continues to qualify for exemption under § 501(c)(3) when it contributes a portion of its assets to and conducts a portion of its activities through L .
M is not subject to unrelated business income tax under § 511 on its distributive share of L ’s income.

Cir. 2001), provides that a nonprofit organization may form partnerships, or enter into contracts, with private parties to further its charitable purposes on mutually beneficial terms, “so long as the nonprofit organization does not thereby impermissibly serve private interests.” The Tax Court held that the operational standard is not satisfied merely by establishing “whatever charitable benefits [the partnership] may produce,” finding that the nonprofit partner lacked “formal or informal control sufficient to ensure furtherance of charitable purposes.” Affirming the Tax Court, the Ninth Circuit held that ceding “effective control” of partnership activities impermissibly serves private interests. 242 F.3d at 904.

St. David’s Health Care System v. United States, 349 F.3d 232, 236–237 (5th Cir. 2003), held that the determination of whether a nonprofit organization that enters into a partnership operates exclusively for exempt purposes is not limited to “whether the partnership provides some (or even an extensive amount of) charitable services.” The nonprofit partner also must have the “capacity to ensure that the partnership’s operations further charitable purposes.” Id . at 243. “[T]he non-profit should lose its tax-exempt status if it cedes control to the for-profit entity.” Id . at 239.

Tax on Unrelated Business Income

Section 511(a), in part, provides for the imposition of tax on the unrelated business taxable income (as defined in § 512) of organizations described in § 501(c)(3).

Section 512(a)(1) defines “unrelated business taxable income” as the gross income derived by any organization from any unrelated trade or business (as defined in § 513) regularly carried on by it less the deductions allowed, both computed with the modifications provided in § 512(b).

Section 512(c) provides that, if a trade or business regularly carried on by a partnership of which an organization is a member is an unrelated trade or business with respect to the organization, in computing its unrelated business taxable income, the organization shall, subject to the exceptions, additions, and limitations contained in § 512(b), include its share (whether or not distributed) of the gross income of the partnership from the unrelated trade or business and its share of the partner

ship deductions directly connected with the gross income.

Section 513(a) defines the term “unrelated trade or business” as any trade or business the conduct of which is not substantially related (aside from the need of the organization for income or funds or the use it makes of the profits derived) to the exercise or performance by the organization of its charitable, educational, or other purpose or function constituting the basis for its exemption under § 501.

Section 1.513–1(d)(2) provides that a trade or business is “related” to an organization’s exempt purposes only if the conduct of the business activities has a causal relationship to the achievement of exempt purposes (other than through the production of income). A trade or business is “substantially related” for purposes of § 513, only if the causal relationship is a substantial one. Thus, to be substantially related, the activity “must contribute importantly to the accomplishment of [exempt] purposes.” Section 1.513–1(d)(2). Section 513, therefore, focuses on “the manner in which the exempt organization operates its business” to determine whether it contributes importantly to the organization’s charitable or educational function. United States v. American Col- lege of Physicians, 475 U.S. 834, 849 (1986).

ANALYSIS

L is a partnership for federal tax purposes. Therefore, L ’s activities are attributed to M for purposes of determining both whether M operates exclusively for educational purposes and therefore continues to qualify for exemption under § 501(c)(3) and whether M has engaged in an unrelated trade or business and therefore may be subject to the unrelated business income tax on its distributive share of L ’s income.

The activities M is treated as conducting through L are not a substantial part of M ’s activities within the meaning of § 501(c)(3) and § 1.501(c)(3)–1(c)(1). Therefore, based on all the facts and circumstances, M ’s participation in L, taken alone, will not affect M ’s continued qualification for exemption as an organization described in § 501(c)(3).

Although M continues to qualify as an exempt organization described in

June 1, 2004 976 2004-22 I.R.B.

DRAFTING INFORMATION

The principal author of this revenue ruling is Virginia G. Richardson of Exempt Organizations, Tax Exempt and Government Entities Division. For further information regarding this revenue ruling, contact Virginia G. Richardson at (202) 283–8938 (not a toll-free call).

Section 511.—Imposition of Tax on Unrelated Business Income of Charitable, etc., Organizations

Unrelated business income tax consequences for a section 501(c)(3) organization that enters into a joint venture with a for-profit organization as an insubstantial part of its activities. See Rev. Rul. 2004-51, page 974.

Section 512.—Unrelated Business Taxable Income

Section 513.—Unrelated Trade or Business

Section 1272.—Current Inclusion in Income of Original Issue Discount

Section 1361.—S Corpo- ration Defined

26 CFR 1.1361(b): Small business corporation de- fined. (Also: §§ 401, 501, 1362, 7701, 7871, 305.7871–1.)

Indian tribal government. This ruling provides clarification with regard to an Indian tribal government’s ability to qualify as an eligible shareholder under section 1361 of the Code. Specifically, the ruling explains that a federally recognized Indian tribal government does not qualify as a permissible S corporation shareholder under section 1361(b)(1)(B) because it is not treated as an individual subject to individual income taxes under section 1 of the Code. The ruling also explains that a federally recognized Indian Tribe cannot qualify as a permissible S corporation shareholder under section 1361(c)(6) because it is neither a section 501(c)(3) organization, nor a section 401(a) qualified plan, profit-sharing, or stock bonus plan organization.

Rev. Rul. 2004–50

ISSUE

Is a federally recognized Indian tribal government, as described in § 7701(a)(40)(A) of the Internal Revenue Code, an eligible S corporation shareholder under § 1361?

FACTS

X is a federally recognized Indian tribal government (Indian tribal government) and a shareholder in Corporation, a domestic entity, formed in accordance with the laws of State . Corporation wants to make an election to be an S corporation.

LAW AND ANALYSIS

Section 1361(a) provides that for purposes of this title, the term “S corporation” means, with respect to any taxable year, a small business corporation for which an election under § 1362(a) is in effect for the year.

Section 1361(b)(1) provides that for purposes of this subchapter, the term “small business corporation” means a domestic corporation which is not an ineligible corporation and which does not (A) have more than 75 shareholders, (B) have

as a shareholder a person (other than an estate, a trust described in subsection (c)(2), or an organization described in subsection (c)(6)) who is not an individual, (C) have a nonresident alien as a shareholder, and (D) have more than one class of stock.

Section 1361(c)(6) provides that for purposes of subsection (b)(1)(B), an organization which is (A) described in §§ 401(a) or 501(c)(3), and (B) exempt from taxation under § 501(a), may be a shareholder in an S corporation.

Section 401(a) provides the definition of a qualified pension, profit-sharing, and stock bonus plans that qualifies under § 1361(b) as an eligible S corporation shareholder.

Section 501(a) provides that an organization described in subsection (c) or (d) or § 401(a) shall be exempt from taxation under this subtitle unless that exemption is denied under § 502 or § 503.

Section 501(c)(3) describes corporations, and any community chest, fund, or foundation, organized and operated exclusively for religious, charitable, scientific, testing for public safety, literacy, or educational purposes, or to foster national or international amateur sports competition (but only if no part of its activities involve the provision of athletic facilities or equipment), or for the prevention of cruelty to children or animals, no part of the net earnings of which inures to the benefit of any private shareholder or individual, no substantial part of the activities of which is carrying on propaganda, or otherwise attempting, to influence legislation (except as otherwise provided in section (h)), and which does not participate in, or intervene in (including the publishing or distribution of statements), any political campaign on behalf of (or in opposition to) any candidate for public office.

Section 7701(a)(40)(A) states that the term “Indian tribal government” refers to the governing body of any tribe, band, community, village, or group of Indians, or (if applicable) Alaska Natives, which is determined by the Secretary of the Treasury, after consultation with the Secretary of the Interior, to exercise governmental functions.

Section 7871(a) and § 305.7871–1 of the Income Tax Regulations provide that Indian tribal governments will be treated as states for certain enumerated federal tax purposes.

2004-22 I.R.B. 977 June 1, 2004

Section 7871(d) states that, for purposes of § 7871(a), a subdivision of an Indian tribal government shall be treated as a political subdivision of a state if (and only if) the Secretary of the Treasury determines (after consultation with the Secretary of the Interior) that the subdivision has been delegated the right to exercise one or more of the substantial governmental functions of the Indian tribal government.

Rev. Proc. 2002–64, 2002–2 C.B. 717, provides the most recent list of federally recognized tribal governments. In the situation described in this ruling, X is a federally recognized Indian tribal government.

Generally, federal income tax statutes do not tax Indian tribes. See Rev. Rul. 67–284, 1967–2 C.B. 55. An Indian tribe is not subject to federal income tax as an individual under § 1 or as a corporation under § 11. However, colleges and universities formed by Indian tribes are subject to § 511(a)(2)(B) (relating to the taxation of colleges and universities which are agencies or instrumentalities of governments or their political subdivisions) pursuant to § 7871(a)(5). Indian tribes also are subject to certain excise taxes.

Rev. Rul. 60–384, 1960–2 C.B. 172, provides circumstances under which a governmental agency is prohibited from qualifying as a § 501(c)(3) organization. A state or municipality itself will not qualify as an organization described in § 501(c)(3) since its purposes are clearly not exclusively those described in § 501(c)(3). Where a particular branch or department under whose jurisdiction the activity in question is being coordinated is an integral part of a state or municipal government, the provisions of § 501(c)(3) would also not be applicable.

Based on the above law and published guidance, X, an Indian tribal government, is not subject to federal income tax as an individual under § 1. Because an Indian tribal government is not subject to tax as an individual for § 1 purposes, it is not considered an individual under § 1361(b)(1)(B).

In addition, X, an Indian tribal government, does not qualify under the § 1362(c)(6) exception for certain exempt organizations described in § 501(c)(3) or § 401(a). X is not a § 401(a) organization because it is not a qualified pension, profit-sharing, or stock bonus plan. Furthermore, X is not a § 501(c)(3) organization because it is a government and

its purposes are not exclusively those described in § 501(c)(3). Consequently, X is not an eligible S corporation shareholder, and Corporation cannot make an election to be an S corporation.

HOLDING

A federally recognized Indian tribal government is not an eligible S corporation shareholder for purposes of § 1361.

DRAFTING INFORMATION

The principal author of this revenue ruling is Laura C. Nash of the Office of Associate Chief Counsel (Passthroughs and Special Industries). For further information regarding this revenue ruling, contact Ms. Nash at (202) 622–3050 (not a toll-free call).

Section 6501.—Limitations on Assessment and Collection

Ct. D. 2079

SUPREME COURT OF THE

UNITED STATES

No. 02-1389

UNITED STATES v . GALLETTI ET AL.

CERTIORARI TO THE UNITED

STATES COURT OF APPEALS FOR THE NINTH

CIRCUIT

March 23, 2004

Syllabus

“[T]he amount of any tax imposed [by the Internal Revenue Code] shall be assessed within three years after the return was filed.” 26 U.S.C. Sec. 6501(a). If a tax is properly so assessed, the statute of limitations for collecting it is extended by 10 years from the assessment date. Sec. 6502(a). Respondents were general partners of a partnership (hereinafter Partnership) that failed to pay significant federal employment taxes from 1992 to 1995. The Internal Revenue Service (IRS) timely assessed the Partnership, but the taxes were never paid. Respondents later filed for Chapter 13 bankruptcy protection, and the

IRS then filed proof of claims against them for the Partnership’s unpaid employment taxes. Respondents objected, arguing that the timely assessment of the Partnership did not extend the 3-year limitations period against the general partners, who had not been separately assessed within that period. The Bankruptcy Court and the District Court agreed and sustained respondents’ objections. The Ninth Circuit affirmed, holding that since respondents are “taxpayers” under Sec. 7701, which defines “taxpayer” to mean “any person subject to any internal revenue tax,” they are also “taxpayers” under Secs. 6203 and 6501. As such, the court held that the assessment against the Partnership extended the limitations period only with respect to the Partnership.

Held : The proper tax assessment against the Partnership suffices to extend the statute of limitations to collect the tax in a judicial proceeding from the general partners who are liable for the payment of the Partnership’s debts. Pp. 4–9.

(a) Respondents argue that a valid assessment triggering the 10-year increase in the limitations period must name them individually, as they are primarily liable for the tax debt. They claim, first, that they are the relevant taxpayers under Sec. 6203, which requires the assessment to be made by “recording the liability of the taxpayer.” Although the Ninth Circuit correctly concluded that an individual partner can be a “taxpayer,” Sec. 6203 speaks of the taxpayer’s “liability,” which indicates that the relevant taxpayer must be determined. Here, the liability arose from the Partnership’s failure to comply with Sec. 3402(a)(1)’s requirement that an “employer [paying] wages” deduct and withhold employment taxes. And Sec. 3403 makes clear that the “employer” that fails to withhold and submit the requisite employment taxes is the “liable” taxpayer. In this case, the Partnership is the “employer.” Second, respondents claim that they are primarily liable for the tax debt because California law makes them jointly and severally liable for the Partnership’s debts. However, to be primarily liable for this debt, respondents must show that they are the “employer.” And, under California law, a partnership and its general partners are separate entities. Thus respondents cannot argue that, for all intents and purposes, imposing a tax directly on

June 1, 2004 978 2004-22 I.R.B.

Briguglio filed joint petitions for relief under Chapter 13 of the Bankruptcy Code on October 20, 1999, and February 4, 2000, respectively. In the Gallettis’ proceedings, the IRS filed a proof of claim in the amount of $395,179.89 for unpaid employment taxes assessed between January 1994 and July 1995 against the Partnership. In the Briguglios’ proceedings, the IRS filed a proof of claim in the amount of $427,402.74. The proof of claim included secured claims totaling $403,264.06 for unpaid employment taxes assessed between January 1994 and November 1996 against the Partnership.

Respondents objected to the claims on the ground that they were not proven against the estates. Respondents did not dispute that under California law they are jointly and severally liable for the debts of the Partnership. Nor did they dispute that the IRS had properly assessed the taxes against the Partnership within the 3-year statute of limitations, thereby extending the limitations period for collection of the taxes by 10 years. Rather, respondents argued that the timely assessment of the Partnership extended the statute of limitations only against the Partnership. To extend the 3-year statute of limitations against the general partners, respondents argued, the IRS had to separately assess the general partners within the 3-year limitations period. Because it did not, and because the 3-year limitations period had expired, respondents argued that the IRS could no longer collect the debt from them. The Bankruptcy Court and the District Court agreed and sustained respondents’ objections to the claims.

The Court of Appeals for the Ninth Circuit affirmed. The Government argued that the Code does not require that the individual partners be assessed within the 3-year period prescribed by Sec. 6501 and that the IRS made a valid assessment of the taxpayer here because the Partnership is the only relevant “taxpayer.” The Court of Appeals held that since respondents are “taxpayers” under Sec. 7701(a)(14), which defines “taxpayer” to mean “any person subject to any internal revenue tax,” they are also “taxpayers” under Secs. 6203 and 6501. As such, the Court of Appeals held that “[t]he assessment against the Partnership extended the statute of limitations only with respect to the Partnership.” 314 F.3d 336, 340 (2002).

the Partnership is equivalent to imposing a tax directly on the general partners, but must instead prove that the tax liability was imposed both on the Partnership and on respondents as separate “employers.” That respondents are jointly and severally liable for the Partnership’s debts is irrelevant to this determination. Pp. 4–7.

(b) The Code does not require the Government to make separate assessments of a single tax debt against persons or entities secondarily liable for that debt in order for Sec. 6502’s extended limitations period to apply to judicial collection actions against those persons or entities. It is clear that “assessment” refers to little more than the calculation or recording of a tax liability, see, e.g., Sec. 6201, and that it is the tax that is assessed, not the taxpayer, see, e.g., Sec. 6501. The limitations period resulting from a proper assessment governs the time extension for enforcing the tax liability. United States v. Updike, 281 U.S. 489, 495. Once a tax has been properly assessed, nothing in the Code requires the IRS to duplicate its efforts by separately assessing the same tax against individuals or entities who are not the actual taxpayers but are, by reason of state law, liable for the taxpayer’s debt. The assessment’s consequences—the extension of the limitations period for collecting the debt—attach to the debt without reference to the special circumstances of the secondarily liable parties. Here, the tax was properly assessed against the Partnership, thereby extending the limitations period for collecting the debt. The United States now timely seeks to collect that debt in judicial proceedings against respondents. Pp. 7–9.

314 F.3d 336 reversed and remanded. THOMAS, J., delivered the opinion for a unanimous Court.

SUPREME COURT OF THE

UNITED STATES

No. 02-1389

UNITED STATES, PETITIONER v . ABEL COSMO GALLETTI ET AL.

ON WRIT OF CERTIORARI TO THE

UNITED STATES COURT OF APPEALS FOR THE NINTH

CIRCUIT

March 23, 2004

JUSTICE THOMAS delivered the opinion of the Court.

Section 6501(a) of the Internal Revenue Code states that, except as otherwise provided, “the amount of any tax imposed by this title shall be assessed within 3 years after the return was filed . . . and no proceeding in court without assessment for the collection of such tax shall be begun after the expiration of such period.” 26 U.S.C. Sec. 6501(a). If a tax is properly assessed within three years, however, the statute of limitations for the collection of the tax is extended by 10 years from the date of assessment. Sec. 6502(a). We must decide in this case whether, in order for the United States to avail itself of the 10-year increase in the statute of limitations for collection of a tax debt, it must assess the taxes not only against a partnership that is directly liable for the debt, but also against each individual partner who might be jointly and severally liable for the debts of the partnership. Under California law a partnership maintains a separate identity from its general partners, and the partners are only secondarily liable for the tax debts of the partnership, as they are for any debt of the partnership. Because, in this case, the only relevant “taxpayer” for purposes of Secs. 6501–6502 is the partnership, we hold that the proper assessment of the tax against the partnership suffices to extend the statute of limitations for collection of the tax from the general partners who are liable for the payment of the partnership’s debts. The Government’s timely assessment of the tax against the partnership was sufficient to extend the statute of limitations to collect the tax in a judicial proceeding, whether from the partnership itself or from those liable for its debts.

Respondents, Abel Cosmo Galletti, Sarah Galletti, Francesco Briguglio, and Angela Briguglio, were general partners of Marina Cabrillo Company (Partnership). From 1992 to 1995, the Partnership failed to pay significant federal employment tax liabilities that it had incurred. Although the Internal Revenue Service (IRS) timely assessed those taxes against the Partnership in 1994, 1995, and 1996, the Partnership never satisfied the debt.

Respondents Abel and Sarah Galletti and respondents Francesco and Angela

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comply with Sec. 3402(a)(1) of the Code, which requires “every employer making payment of wages” to deduct and withhold employment taxes. Moreover, “[t]he employer shall be liable for the payment of the tax required to be deducted and withheld.” Sec. 3403. When an employer fails to withhold and submit the requisite amount of employment taxes, Sec. 3403 makes clear that the liable taxpayer is the employer. In this case, the “employer” was the Partnership. ³

Respondents also argue that they are primarily liable for the Partnership’s tax debt because, under California law, general partners are jointly and severally liable for the debts of their partnership, Cal. Corp. Code Ann. Sec. 16306 (Supp. 2004). Brief for Respondents 8–16. As our prior discussion demonstrates, however, respondents cannot show that they are primarily liable for the payment of the Partnership’s employment taxes unless they can show that they are the “employer.” However, under California’s partnership principles, a partnership and its general partners are separate entities. See Cal. Corp. Code Ann. Sec. 16201 (Supp. 2004). Thus respondents cannot argue that, for all intents and purposes, imposing a tax directly on the Partnership is equivalent to imposing a tax directly on the general partners. Respondents must instead prove that the tax liability was imposed both on the Partnership and respondents as separate “employers.” The fact that respondents are jointly and severally liable for the debts of the Partnership is irrelevant to this determination.

III

We now turn to the question whether the Government must make separate assessments of a single tax debt against persons or entities secondarily liable for that debt

The Government argued in the alternative that because respondents conceded that they were liable for the Partnership’s employment tax debts as a matter of California law, the Government had a right to payment, which suffices to prove a valid claim in bankruptcy. See 11 U.S.C. Sec. 101(5)(A) (defining “claim” as including a “right to payment, whether or not such right is reduced to judgment, liquidated, unliquidated, fixed, contingent, matured, unmatured, disputed, undisputed, legal, equitable, secured, or unsecured”). The Court of Appeals rejected this argument because, under California law, a creditor must obtain a judgment against a partner before holding that partner liable for the partnership’s debt. Cal. Corp. Code Ann. Sec. 16307(c) (Supp. 2004). At the time the United States filed its proof of claim, it had not obtained a separate judgment against respondents, and the time for obtaining a judgment under the Internal Revenue Code against respondents had expired.

We granted certiorari, 539 U.S. (2003), and now reverse.

Section 6501(a) of the Internal Revenue Code provides that “the amount of any tax imposed [by the Code] shall be assessed within 3 years after the return was filed.” 26 U.S.C. Sec. 6501(a). “The assessment shall be made by recording the liability of the taxpayer in the office of the Secretary [of the Treasury] in accordance with rules or regulations prescribed by the Secretary.” Sec. 6203. Within 60 days of the assessment, the Secretary is required to “give notice to each person liable for the unpaid tax, stating the amount and demanding payment thereof.” Sec. 6303(a). If the tax is properly assessed within 3 years, the limitations period for collection of the tax is extended by 10 years from the date of the assessment. Sec. 6502.

The dispute in this case centers on whether the United States can collect the Partnership’s unpaid employment taxes from respondents in a judicial proceeding occurring more than three years after the tax return was filed but within the 10-year extension to the 3-year limitations period that attached when the tax was timely assessed against the Partnership. ¹ Respondents insist that a valid assessment (that is, one that would trigger the 10-year increase in the statute of limitations) must name them individually. This is so, according to respondents, because they are primarily liable for the tax debt, both because they are “the [relevant] taxpayer[s]” under Sec. 6203 and because they are jointly and severally liable for the tax debts of the partnership. ² We reject both arguments in turn.

Respondents argue, and the Court of Appeals agreed, that each partner is primarily liable for the debt and must be individually assessed because each partner is a separate “taxpayer” under 26 U.S.C. Sec. 6203. The statutory definition of “taxpayer” includes “any person subject to any internal revenue tax,” and “person” includes both “an individual” and a “partnership,” Secs. 7701(a)(14), (a)(1). The Court of Appeals observed that although the Partnership is a “taxpayer,” each individual partner is also a separate “taxpayer.” As such, the Court of Appeals interpreted Sec. 6203’s requirement that the Secretary of the Treasury record “the liability of the taxpayer” to require a separate assessment against each of the general partners.

Although the Court of Appeals correctly concluded that an individual partner can be a “taxpayer,” the inquiry does not end there. Section 6203 speaks of “ the li- ability of the taxpayer” (emphasis added), which indicates that the relevant taxpayer must be determined. The liability in this case arose from the Partnership’s failure to

1 Because the Government is attempting to enforce the Partnership’s tax liabilities against respondents in a judicial proceeding, we do not address whether an assessment only against the Partnership is sufficient for the IRS to commence administrative collection of the Partnership’s tax debts by lien or levy against respondents’ property.

We also decline to address whether an assessment against the partnership suffices to trigger liability against the partners for interest and penalties without separate notice and demand to them.

2 Respondents argue that even if we were to hold that the partners are secondarily liable, the IRS would still be barred from collecting the taxes. Respondents contend that if partners are not “taxpayers” under Sec. 6203, then their liability arises only under state law, and the state 3-year statute of limitations therefore applies. Brief for Respondents 30–34. Respondents have forfeited this argument by failing to raise it in the courts below. Indeed, the closest respondents have come to arguing that the state limitations period applies was in the Court of Appeals, when respondents argued that “under California law, any collections suit filed against a partner to collect a partnership debt is subject to the statute limitation provision which applies to the underlying debt of the partnership.” Brief for Respondents in Nos. 01–55953, 01–55954 (CA9), p. 14. This argument, of course, is contrary to respondents’ position in this Court.

3 Our decision is consistent with this Court’s holding in United States v. Williams, 514 U.S. 527, 532–536 (1995), where we interpreted “taxpayer” under 26 U.S.C. Sec. 6511 more broadly. Here, it is clear that we must interpret “the taxpayer” under Sec. 6203 with reference to the underlying liability.

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The basis of the liability in Updike was a tax imposed on the corporation, and the Court held that the same limitations period applied in a suit to collect the tax from the corporation as in a suit to collect the tax from the derivatively liable transferee. Id ., at 494–496. See also United States v. Wright, 57 F.3d 561, 563 (CA7 1995) (holding that, based on Updike ’s principle of “all-for-one, one-for-all,” the statute of limitations governs the debt as a whole).

Once a tax has been properly assessed, nothing in the Code requires the IRS to duplicate its efforts by separately assessing the same tax against individuals or entities who are not the actual taxpayers but are, by reason of state law, liable for payment of the taxpayer’s debt. The consequences of the assessment—in this case the extension of the statute of limitations for collection of the debt—attach to the tax debt without reference to the special circumstances of the secondarily liable parties.

In this case, the tax was properly assessed against the Partnership, thereby extending the statute of limitations for collection of the debt. The United States now timely seeks to collect that debt in judicial proceedings against respondents. ⁵ We therefore reverse the judgment of the Court of Appeals and remand the case for further proceedings consistent with this opinion.

It is so ordered.

in order for Sec. 6502’s extended statute of limitations to apply to those persons or entities. ⁴ We hold that the Code contains no such requirement. Respondents’ argument that they must be separately assessed turns on a mistaken understanding of the function and nature of an assessment as identical to the initiation of a formal collection action against any person or entity who might be liable for payment of a debt. In its numerous uses throughout the Code, it is clear that the term “assessment” refers to little more than the calculation or recording of a tax liability. See, e.g., 26 U.S.C. Sec. 6201 (assessment authority); Sec. 6203 (method of assessment); Sec. 6204 (supplemental assessments); 26 CFR Sec. 601.103 (2003). See also Black’s Law Dictionary 111 (7th ed. 1999) (defining “assessment” as the “[d]etermination of the [tax] rate or amount of something, such as a tax or damages”). “The Federal tax system is basically one of self-assessment,” whereby each taxpayer computes the tax due and then files the appropriate form of return along with the requisite payment. 26 CFR Sec. 601.103(a) (2003). In most cases, the Secretary accepts the self-assessment and simply records the liability of the taxpayer. Where the taxpayer fails to file the form of return or miscalculates the tax due, as in this case, the Secretary can assess “all taxes (including interest, additional amounts, additions to the tax, and assessable penalties),” 26 U.S.C.

Sec. 6201(a), by “recording the liability of the taxpayer in the office of the Secretary,” Sec. 6203. In other words, where the Secretary rejects the self-assessment of the taxpayer or discovers that the taxpayer has failed to file a return, the Secretary calculates the proper amount of liability and records it in the Government’s books.

To be sure, the assessment of a tax triggers certain consequences. After the amount of liability has been established and recorded, the IRS can employ administrative enforcement methods to collect the tax. Secs. 6321–6327, 6331–6334. The assessment of a tax liability also extends the period during which the Government can collect the tax. But the fact that the act of assessment has consequences does not change the function of the assessment: to calculate and record a tax liability.

Under a proper understanding of the function and nature of an assessment, it is clear that it is the tax that is assessed, not the taxpayer. See Sec. 6501(a) (“the amount of any tax . . . shall be assessed”); Sec. 6502(a) (“[w]here the assessment of any tax”). And in United States v. Updike, 281 U.S. 489 (1930), the Court, interpreting a predecessor to Sec. 6502, held that the limitations period resulting from a proper assessment governs “the extent of time for the enforcement of the tax liability,” id ., at 495. In other words, the Court held that the statute of limitations attached to the debt as a whole.

4 We use the term “secondary liability” to mean liability that is derived from the original or primary liability.

5 The Court of Appeals also held that the claims were barred by California partnership law, which requires a creditor first to obtain a judgment against a partnership before holding the partners liable for the partnership’s debt. 314 F.3d 336, 344 (CA9 2002). When respondents filed for bankruptcy, an automatic stay barred the Government from bringing suit outside the Bankruptcy Court to enforce respondents’ secondary liability. 11 U.S.C. Sec. 362(a)(1). Respondents do not dispute, however, that the adjudication of a disputed claim satisfies California’s requirement that there be a “judgment against a partner.” Cal. Corp. Code Ann. Sec. 16307(c) (Supp. 2004) Moreover, a claim is allowable in bankruptcy “whether or not such right is reduced to judgment.” 11 U.S.C. Sec. 101(5)(A).

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