Mitchell-Lama co-op wins battle with IRS over non-member income.

It's been many years since the Internal Revenue Service tried to impose a tax bill for non-member income on the limited equity Mitchell-Lama co-op, Trump Village III. But on June 22nd, the long wait was over and a U.S. Tax Court judge rendered his decision in favor of the co-op and said the interest income on the building's bank accounts is not non-membership income.

The ruling hinged on the co-op's argument that it be treated as a matter of law as a Subchapter T corporation and is not subject to Section 277 rules. Even if it fell under Section 277, its attorneys argued, there was no tax deficiency.

Judge Laurence J. Whalen pointed to a recent ruling in Buckeye Countrymark, where Congress did not intend section 277 to apply to non-exempt cooperatives subject to tax under subchapter T.

The court found that Trump Village met three guiding principles of cooperatives, as set forth in Puget Sound Plywood, a 1965 case. These three rules are the subordination of capital; democratic control by worker members; and the vesting in and allocation among worker-members of all fruits arising from their cooperative endeavor. The court rejected the IRS arguments.

Richard Siegler, the Stroock Stroock & Lavan partner who represented Trump Village Section 3, agreed they won but wondered about the implications for other co-ops.

"While helpful for the petitioner, it leaves a great deal of uncertainty," said Siegler of the decision, which ruled there was no tax liability for interest income. The IRS had told Tramp Village it was deficient for more than half a million dollars over four years in the early 1980s.

Siegler is unsure, however, if the case may have turned on the Mitchell-Lama facts, that include a one-vote per unit rule. Most market rate co-ops vote and pay costs based on share allocations. "I can't tell what it will do for the private co-ops that fall under the Business Corporation Law," Siegler added.

Attorney Edward T. Braverman, who heads his own eponymous firm, said the court never made any comment about the other two issues that were raised once they decided it fell under the Subchapter T. "They are sort of saying section 277 doesn't apply, but they didn't treat the general argument of 277 not applying to regular co-ops," Braverman said. "And they didn't look at the issue of whether or not the interest income was truly membership income."

Siegler explained that while the Trump Village case obtained widespread interest, it will not answer all the questions because it depends on what the IRS does. "It depends on how much they want to fight," said Siegler. The case also does not resolve what the state or city will do, and both had been hard at the heels of buildings being audited by the IRS.

Mark B. Shernicoff, CPA, a partner with Zucker & Shernicoff and treasurer of the Council of New York Cooperatives, said the Trump Village 3 decision is better than an adverse decision, but agrees it is unclear as to whether it will apply to all Section 216 co-ops that fall under Subchapter T, or whether it only applies to those Section 216 co-ops that are structured with one-man one-vote, "which many of the market rate co-ops don't have."

Shernicoff said he is still optimistic because there is nothing that precludes a favorable outcome for market rate co-ops. "I still think there's hope," he said.

Where the IRS has determined a tax liability from his clients, Shernicoff has recommended they pay and then file a claim for a refund. "If we had an issue with the state, we were able to get the state cases on indefinite hold and recommended to our clients not to pay. The city was only pursuing on a follow-up," he added.

Among those hoping for a refund is P. Leonard Jones, manager of Trump Village Section IV and president of the New York Association of Realty Managers. He said he was very happy about the decision and hoped the IRS does not appeal.

"We are one of the few housing companies that made the decision to pay the tax bill," Jones said. "We applied for a refund and it was under consideration pending legislation or a court decision, and that came first."

Also upbeat is Mary Ann Ruthman, executive director of the Council of New York Cooperatives. "We're pleased with the decision," she said. "Although the wording in this one is narrow, it holds real promise for all co-ops that have been suffering under the Damocles Sword of 277."

An IRS spokesperson said no decision has been made about an appeal and it would depend on how many buildings the decision affects. "If it's just to the taxpayer there would be no advantage to appealing," the spokesperson noted.

Charles Rappaport, president of the Federation of New York Housing Cooperatives, is optimistic about the ruling's application, but believes there is no reason not to go forward with legislation that has been proposed by Sen. Daniel Patrick Moynihan and Rep. Charles Rangel, but as of yet has not been enacted into law.