A recent IRS private letter ruling addresses whether a cooperative’s gain on sale of stock resulted in patronage or non-patronage income. This particular ruling follows many others that focus on the reason for acquiring the asset.
In Year 1, CORP 1 was formed when COOP joined with other telephone cooperatives and independent telephone companies to provide interstate connectivity that will carry voice and data statewide. In Year 2 and 3, COOP formed additional companies to supply lower cost telecommunications for its members. In Year 4, these companies were combined to form CORP 2. In year 5, CORP 3 was formed by combining CORP 1 and CORP 2. In Year 6, COOP sold its stock in CORP 3 which will generate gain for the COOP.
The IRS cited the traditional patronage-determination language in Rev. Rul. 69-576:
The classification of an item of income as from either patronage or nonpatronage sources is dependent on the relationship of the activity generating the income to the marketing, purchasing, or service activities of the cooperative. If the income is produced by a transaction which actually facilitates the accomplishment of the cooperative’s marketing, purchasing, or service activities, the income is from patronage sources. However, if the transaction producing the income does not actually facilitate the accomplishment of these activities but merely enhances the overall profitability of the cooperative, being merely incidental to the association’s cooperative operation, the income is from nonpatronage sources.
The IRS found that the reason the cooperative acquired the stock was to promote telecommunications services to its patrons. Thus, the sale of such stock resulted in patronage-sourced income.
COOP’s ownership of stock in CORP 3 was directly related to COOP’s cooperative business. Investing in a corporation to provide better telecommunication service is directly related to the business of a rural cooperative telephone company whose “reason for existence” is to provide telephone service to its patrons. COOP’s sale of its stock in CORP 3 is also directly related to COOP’s cooperative business purpose.
AHC attorney David Cook has obtained many patronage-sourced rulings from the IRS. For more information about patronage-source determinations or IRS private letter rulings, contact David Cook.