I.R.S. AGREES AT LAST NOT TO APPLY
SECTION 277 TO HOUSING COOPERATIVES
The Internal Revenue Service will no longer apply Section 277 of the
Internal Revenue Code to housing cooperatives of any kind,
but will instead treat all housing cooperatives as subject
to Subchapter T of the Internal Revenue code. This new policy
comes in response to the efforts of tax attorney Joel E. Miller,
who initiated a refund case to challenge the long-held I.R.S.
position on Section 277 on behalf of the recently formed 277
Challenge Task Force. It brings to a successful close a long
campaign waged in the courts and in Congress to establish
that housing cooperatives are not subject to Section 277 of
the Internal Revenue Code.
For more than a dozen years, CNYC has worked with the National
Association of Housing Cooperatives on this important issue.
In June 1995, Judge Whelan's decision in the long-pending
Trump Village Section 3 case made it clear that Trump was
subject to Subchapter T and not Section 277. However, the
I.R.S. chose a very narrow interpretation of the Trump Case,
and continued to apply Section 277 to housing cooperatives
that did not precisely fit the Trump fact pattern. It focused
particularly on differences in voting procedures.
the September 1996 ruling in Thwaites Terrace House Owners Corp. v.
Commissioner specifically confirmed that all Section 216 housing cooperatives
are within Subchapter T and therefore not subject to Section 277, regardless
of whether shareholders vote by the number of shares that they own or
on a one-person one-vote basis. The amicus curiae brief submitted
by the National Association of housing cooperatives, CNYC and the Federation
of New York Housing Cooperatives in the Thwaites case had urged that position.
But the I.R.S. refused to acquiesce in the Thwaites ruling. It continued
to apply Section 277 to some housing cooperatives. Although housing cooperatives
with new audits could resist by bringing their cases to the tax court
where they could be confident that the Thwaites rule would be applied,
there was no binding precedent in the courts that handled refund claims.
Determined that this issue must be resolved, CNYC called together organizations
representing housing cooperatives in late 1997 to form the 277 Challenge
REFUND TEST CASE
In the aftermath of the Thwaites decision, many housing cooperatives that
had paid taxes based on Section 277 applied for refunds. The Internal
Revenue Service did pay some smaller claims, but continued to apply Section
277 in most cases. At that point, the 277 Challenge Task Force decided
to bring a test case to challenge the I.R.S. position that not all Section
216 cooperatives were within Subchapter T.
Joel E. Miller, the tax attorney who wrote the amicus curiae brief in
Thwaites,agreed to take a refund case through trial on behalf of the organizations
for a fixed fee. The 277 Challenge Task Forced raised the necessary funds
through contributions from the organizations and their member housing
cooperatives and condominiums, as well as many accountants representing
housing cooperatives and several other professionals. The names of contributors
are listed on the letterhead of the Task Force, which you can view by
clicking here (112K file).
I.R.S. CHANGES POLICY
In April of 1998, Mr. Miller commenced a refund case on behalf of a New
York City housing cooperative called Rutherford Tenants Corp. in the U.S.
District Court. Over the ensuing months, Mr. Miller had many discussions
with the Assistant U.S. Attorney assigned to defend the suit, as well
as with I.R.S. personnel familiar with the issue. Eventually, the I.R.S.
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 Section 277.
Once this happened, the I.R.S. began at once to implement its new position.
Mr. Miller was informed that internal memoranda had been circulated instructing
both auditors and appeals officers that, barring exceptional circumstances,
they are not to assert Section 277 against any housing cooperatives.
SUBCHAPTER T RULE APPLIES
IN TAXING HOUSING COOPERATIVES
Mr. Miller cautions cooperatives that Section 277's disappearance from
the scene does not mean that they will never have to pay tax on any of
their income. Although Subchapter T has considerably more flexibility
than Section 277, 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. Accountants and attorneys who work with housing cooperatives
are working together for a better understanding of Subchapter T, and developing
insights that will be shared in future issues of this Newsletter.