As members of the National Association of Housing Cooperatives (NAHC) NYARM has been keeping a watchful eye on their long standing efforts on the issue of IRS Section 277 and its application to cooperatives. They have recently declared victory and we reprint below the bulletin they sent to their membership.
As a result of the efforts of the §277 Challenge Task Force, the IRS has stopped applying §277 to any kind of housing cooperative (previously, after losing the Trump Village case, it had stopped applying §277 only as to certain kinds of limited-equity cooperatives). Thus, the IRS has now essentially accepted the holding of the Tax Court in the Thwaites case. This means that the IRS will not be asserting §277 against any cooperative in a pending audit, in a new audit, or in dealing with refund claims.
Tax attorney Joel E. Miller, who was retained to attempt to achieve this result, commenced a test refund case on behalf of Rutherford Tenants Corp in the U.S. District Court last April. Over the ensuing months, Mr. Miller had many discussions with Assistant US Attorney Glenn Colton, who had been assigned to defend the suit, as well as with Andrew J. Mandell (Assistant District Counsel for the IRS Brooklyn office) and with Shelly Bienenstock (an Appeals officer in the IRS Manhattan office), who are the two local IRS personnel most familiar with the issue. Eventually, the IRS came to accept that such things as a no-proxy rule or a one-person-one-vote rule or limited-equity restrictions are not essential to "operating on a cooperative basis," leading to the conclusion that all kinds of housing cooperatives are covered by Subchapter T and therefore not subject to §277.
The IRS is already rapidly implementing its new position. Mr. Miller recently learned that internal memoranda have been circulated instructing both auditors and appeals officers that, barring exceptional circumstances, they are not to assert §277 against any housing cooperative. Also, a number of accountants representing cooperatives in cases that were being contested by the IRS under §277 have reported that they have just been notified by the IRS either that an examination has been terminated or that a full refund will be allowed.
As indicated above, the IRS has reserved the right to attempt to apply §277 if circumstances – not presently envisioned – should arise in which a failure to do so would in its view lead to an unconscionable result. For that reason, Mr. Miller was told, the IRS was planning no public announcement at the present rime. However, Mr. Miller was able to arrange that, if a cooperative should be confronted by an agent who is asserting §277, the agent should be requested to telephone either Mr. Mandell (516-688-1701) or Mr. Bienenstock (212-298-2444) to be officially informed of the IRS’s present position.
While it is theoretically possible that the IRS might revert to its former position and again seek to apply §277 to housing cooperatives, Mr. Miller, based on numerous conversations with IRS personnel, feels that there is virtually no likelihood that that would ever happen under present law. He also points out that, even thought the Rutherford case will have been concluded (with the cooperative receiving a full refund with interest), nothing would prevent the commencement of a new case if that should prove to be necessary at any time.
Cooperatives must bear in mind, though, that the vanishing of §277 from the scene does not mean that they will never have to pay tax on any of their income. Among other things, a Subchapter T cooperative is not permitted to use "patronage" deductions to offset "non-patronage" income, so that issues may arise as to the classification of income not coming directly from tenant-stockholders. While it seems quite clear that interest earned on reasonable reserves and discharge-of-indebtedness income generated by a workout, for example, are "patronage" income, the classification of many other kinds of income will have to be worked out on a case-by-case basis.