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Co-ops seek 277 relief.

A continuing interpretation by the Internal Revenue Service (IRS) has cooperative housing groups wielding legal memos.

The IRS is still trying to collect certain taxes on income from housing cooperatives by claiming they fall under Section 277, rather than Subchapter T.

The cooperative housing groups say the courts have consistently agreed - and the legislative history shows - that Section 277 is applicable to social clubs, and not housing communities.

But the IRS is after dollars, and as it interprets each higher court case, it has carved out most cooperatives as exceptions to what the courts have already ruled. The IRS is also latching on to an exception in a recent court case and is trying to tax the income generated by building reserve funds, a situation that is vexing and costly to these buildings.

It is that problem, and a few others, that the cooperative associations believe should now be corrected. So the Washington-based National Association of Housing Cooperatives (NAHC), along with the local Council of New York Cooperatives (CNYC) and the Federation of New York Housing Cooperatives (FNYHC), are organizing to find the "right" case to use to challenge the IRS.

To that end, those accountants that represent cooperatives are searching their files and also contributing to a fund to help finance the challenge.

The groups say the co-ops are already controlled by Section 216. This contains the so-called 80/20 test, whereby cooperatives must obtain 80 percent of their income from their members. The cooperative associations believe Congress intended this to be the only limitation on co-ops, tax attorney Joel Miller explains.

Miller, who wrote the amicus curiae brief on behalf of the cooperative organizations, will be in charge of the litigation, the groups have agreed.

Through the years, the courts have defined how housing cooperatives are different from farmers cooperatives and social clubs, and have interpreted how the income from their members would be taxed differently from non-member income.

The U.S. Tax Court ruled in the 1995 case, Trump Village Section 3 v. Commissioner, that Mitchell-Lama housing projects were not subject to IRS taxes under Section 277. The judges agreed that Section 277 did not apply to those low equity co-ops, which instead, they stated, came under Section T.

In writing the decision, three guiding characteristics of cooperatives were cited as they were described in an earlier Puget Sound v. Commissioner case. These principles basically are the subordination of capital, democratic control, and the allocation of all "fruits and increases" arising from the endeavor.

"They are taking these things out of context in Puget Sound, where workers make plywood," Miller explained.

The cooperative association leaders worried, with good reason, that the IRS would therefore continue to argue against and tax any cooperative that differed in organization from Trump. Village.

Those associations that were organized as corporations, and not under not-for-profit or cooperative corporations acts; those that were not permitted or obligated to make "patronage" distributions; those that had no re-sale restrictions; and those that had proportionate voting based on the number of shares of stock, rather than "one member, one vote," were thought to be particularly vulnerable.

"The IRS said, 'We agree with all of that [which the justices said in Trump Village], but we think conventional co-ops are not under Sub T, and are subject to Section 277,' said Miller. "We found the Thwaites case, and the court allowed us to have amicus curiae."

The associations brought Thwaites as a test case and the 1996 ruling by the U.S. Tax Court in Thwaites Terrace Owners Corp. V. Commissioner agreed that housing co-ops are subject to Subchapter T, rather than Section 277.

So while it eliminated some concerns, it left another unsettled. The court in Thwaites still allowed the IRS to tax the income generated by the reserve fund, but only because the cooperative had not 'stipulated in Thwaites to any facts showing the interest income was patronage, i.e., member income.

The Thwaites ruling is also not a U.S. Supreme Court case, and therefore has become a compliance issue when buildings have tried to obtain refunds of IRS overpayments based on Thwaites.

Miller says at one time the only way to challenge a Federal IRS tax was to pay it, and then apply for refund by going to either District Court or the Court of Federal Claims.

"The Tax Court was invented to provide a forum where taxpayers could make their case without paying the tax," Miller explained.

Now, if a taxpayer gets a bill, he can choose not to pay and make a case in Tax Court, or pay and apply for a refund in the other two courts.

"Where the taxpayers are not paying [this levy] they can go to Tax Court, and we think Tax Court will not change its mind and continue to rule as they did in Thwaites," Miller asserted. "We're concerned about people who asked for refunds under Thwaites and the IRS said no. It's conceivable that a refund court may say they disagree with Thwaites."

What the cooperative groups have decided to do is to reach out to the board accountants, locate a 'good' refund case and try to get the IRS to agree to treat it as a test case.

"When we realized the IRS would not acquiesce on Thwaites, a group met to ponder whether there was some way to fight," said Mary Ann Rothman, executive director of the Council of New York Cooperatives. "If a building has asked for a refund in light of Thwaites and is not getting satisfaction from the IRS, they should be aware we are joining forces in hopes the IRS would allow it to be a test case."

One problem is that IRS refunds are handled by the Dept. of Justice, and they are not the same people as those who adjudicate the U.S. Tax Court cases, which are handled by lawyers in the IRS.

The IRS attorney who handled Thwaites and the U.S. Tax Court litigation is the most knowledgeable on the matters, says Miller, but it is still unknown if the Dept. of Justice will "borrow" him for the expected litigation. That attorney did not return a call seeking comment.

The NAHC has also reached out to Rep. Charles E. Schumer, who is willing to ask the IRS to stop following Thwaites. He has drafted a letter to the IRS, but has been asked by the NAHC to not send it until they have rounded up a Republican co-sponsor.

A draft letter, made available from Rep. Schumer's office, portrays his concern that housing cooperatives have persistently won in court "despite strenuous IRS opposition," yet the IRS has only made "the smallest accommodation possible for certain types of co-ops and continues to fight a losing battle against other types of co-ops. In the meantime, the cost in legal fees to the taxpayer and co-op owners continues to grow."

Rep. Schumer also asks the IRS to reconsider and acquiesce rather than challenging Thwaites.

The local and national cooperative groups and accountants continue to seek a test case, and are gathering political forces to pressure the IRS to abandon its pursuit of unjust cooperative taxes, at a time when the IRS has been revealed through Senate hearings to pursue many taxpayers relentlessly, and without cause.
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Title Annotation:New York housing cooperatives; income tax
Author:Weiss, Lois
Publication:Real Estate Weekly
Date:Dec 10, 1997
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