Thwaites Terrace Case Overcomes
But ruling taxes this cooperative under Subchapter T.
Section 216 housing cooperatives are subject to Subchapter T and not
to Section 277 of the Internal Revenue Code. This definitive ruling was
handed down by Judge John Colvin of the U.S. Tax Court on September 3,
1996, in the matter of Thwaites Terrace House Owners Corp. v. the Commissioner
of Internal Revenue. Judge Colvin had accepted a brief of amicus curiae
prepared by CNYC, the National Association of Housing Cooperatives and
the Federation of New York Housing Cooperatives, which argued that Section
277 does not apply to housing cooperatives.
Subchapter T sections 1381-1388 deal with the taxation of organizations
that operate on a cooperative basis; "patronage" income under
Subchapter T is more broadly defined than is "member" income
under 277. Judge Colvin found that Section 216 housing cooperatives are
subject to Subchapter T, regardless of whether shareowners vote by number
of shares or on a one-unit, one-vote basis, and regardless of whether
patronage dividends have been paid to shareholders. His careful decision
explores the three criteria identified in Puget Sound Plywood v. Commissioner
in 1965 as "the core of economic cooperative theory" and
finds that all are met in this open market New York City cooperative.
The criteria are:
1. Subordination of capital to the needs of the cooperative (shareholders
are identical to patrons and the cooperative operates for the benefit
of its patrons);
2. Democratic control by the members themselves (annual meeting and board
3. Allocating among members all fruits and increases arising from their
cooperative endeavor in proportion to their participation (housing cooperatives
operate at breakeven or use gains to reduce maintenance for subsequent
years; Thwaites had operating losses in the years in question).
In 1972, in Park Place v. the Commissioner, the Tax Court had
held that Park Place was a cooperative under Subchapter T because it was
a Section 216 housing cooperative. Since 1992, three important cases have
affirmed that Subchapter T and Section 277 contain provisions that conflict,
and that "the application of Section 277 to nonexempt cooperatives
would lead to absurd or futile results" (Buckeye Countrymark,
Inc. v Commissioner - 1994).
Thwaites lost this case
Although housing cooperatives nationwide benefit from Judge Colvin's
decision, we note with regret that Thwaites Terrace House Owners Corp.
did not win this case. Similar to the way that Section 277 taxes non-member
income of membership organizations, Subchapter T designates the earnings
of a cooperative as either patronage-sourced or nonpatronage-sourced;
patronage-sourced deductions cannot be used to offset nonpatronage-sourced
income. The Internal Revenue Service had invoked Section 277 to seek back
taxes on interest earned on reserves that were held by Thwaites in savings
and money market accounts and certificates of deposit. Because Thwaites
did not present any evidence that the reserves were integral to the business
of operating the cooperative, Judge Colvin upheld the I.R.S. claim to
taxes – imposed, of course, under Subchapter T.
In the course of his discussion, Judge Colvin did provide guidelines
that should prove helpful to cooperatives and the professionals who guide
them as we all learn more about Subchapter T and how to confirm that reserves
are vital to the way cooperatives are run.
CNYC has been working for more than a decade to affirm that Section 277
does not apply to housing cooperatives. The National Association of Housing
Cooperatives (NAHC) has led and coordinated this crusade. Your contributions
have helped defray the cost of lobbying efforts and court challenges to
the applicability of Section 277 to housing cooperatives. We hesitate
now to declare a complete victory, since, in the short time since the
decision, there has not yet been any indication from the Internal Revenue
Service as to whether it will try to challenge Judge Colvin's decision.
Having "won" this case, the I.R.S. cannot appeal. It remains
to be seen whether it will continue to attempt to tax cooperatives under
Section 277 or if it will strictly examine non-patronage income under
Subchapter T. CNYC will continue to monitor this important issue and keep