Published: Summer 1995
Finally, A 277 Decision for a Housing
The long-awaited decision
in Trump Village Section 3, Inc. v. Commissioner
The Tax Court has finally issued its long-awaited decision in Trump
Village Section 3, Inc. v. Commissioner (TC memo 1995-281, 6/22/95) (Tax
Ct. Dkt No. 13569-88). At issue was whether a limited profit (Mitchell-Lama)
housing cooperative was subject to Section 277 of the Internal Revenue
Code, and, specifically, whether interest income received by the cooperative
on various operations and reserve funds during the years 1982, 1983, 1984,
and 1985, was taxable. Almost six years after hearing the case, Judge
Whalen decided in favor of the cooperative.
Section 277 requires a social club or other membership organization to
separate income and deductions into two categories: one for membership
income and one for non-membership income, in order to prevent such an
organization from operating membership activities at a loss and using
the loss to offset nonmembership income.
The cooperative made three principal arguments in support of its position
that Section 277 did not apply. First, the cooperative contended that
it was not a membership organization within the meaning of Section 277,
because it is a housing cooperative which qualifies as a cooperative housing
corporation under Section 216 of the Code, that it has "stockholders"
not "members", that it charges "rent" not "membership
fees", and that it provided "housing", not "goods
or services". Second, the cooperative argued that since it operates
on a cooperative basis within the meaning of Section 1381 of the Code,
it is governed by the provisions of Subchapter T and that, therefore,
it is not subject to Section 277, because the rules of Subchapter T preempt
Section 277. Third, the cooperative argued that even if the Section 277
applied, the interest income which was the subject of the case should
be classified as membership income.
Judge Whalen decided the case based on the second argument of the cooperative.
The Tax Court had recently held in Buckeye Countrymark, Inc. v Commissioner,
103/TC/547 (1994), that Section 277 and Subchapter T are in conflict,
and that accordingly a cooperative that qualifies under Subchapter T cannot
be subject to Section 277.
The court determined that in fact the cooperative did qualify under Subchapter
T. Since it operates on a cooperative basis, which caused the provisions
of Subchapter T to attach a matter of law. To make this determination,
the court relied on a 1965 case involving a company that manufactured
and sold wood products, Puget Sound Plywood, Inc. v Commissioner, 44/TC/305
(1965). In determining this case, the court had identified three necessary
characteristics of a cooperative association, namely: (i) Subordination
of capital both as regards control over the cooperative endeavor, as well
as the right to pecuniary benefits arising from it; (ii) Democratic control
by the members; and (iii) allocation among the members of all of the fruits
of their cooperative endeavor in proportion to their active participation
in the cooperative.
The court found that the test of subordination required limitations upon
the amounts that can be distributed with respect to the stock, and that
control over the management must be vested in the members. In order for
an association to meet the test of democratic control, the court found
that members must periodically assemble at democratically conducted meetings
to resolve problems affecting the cooperative. The third test, allocation
of benefits, requires the cooperative, through its organic documents,
to make allocations of its proceeds among the members in proportion to
their active participation.
After an extensive analysis of the legal documentation creating the cooperative,
and the details of its financial operation, the court found that the Mitchell-Lama
Cooperative complied with the test during the years in question. Control
over the operations was in the hands of petitioner's tenant-shareholders
by reason of their position as proprietary lessees. The board of directors
was elected by the shareholders, and the resident directors were to be
nominated by a minimum number of shareholders residing in the premises
owned by the corporation. The court found that the pecuniary benefits
from owning stock were limited and subordinate, and that the cooperative
was democratically controlled. The tenants were required to own shares
and the by-laws required an annual meeting of the shareholders to elect
directors and transact other business. The fact that the Mitchell-Lama
law required the New York Division of Housing to exercise supervisory
functions to make sure that the project protected the public interest
did not in the court's opinion take away the control the tenants exercised
over the housing project.
Finally, with respect to operation and cost, the court found that all
financial benefits from the operating of the housing corporation were
vested in the tenants in proportion to their proportionate contribution.
Even though the cooperative never made a cash distribution to its cooperators,
the court held that it was sufficient that excess proceeds in one year
were taken into account in determining the budget for the next year so
that excess funds would be disbursed to members in the form of reduced
After nearly seven years of litigation in the Tax Court on this issue,
it is unfortunate that the decision did not resolve more completely the
issues that were raised affecting the taxation of income of cooperatives.
While the case definitively found that a cooperative qualifying under
Subchapter T could not be taxed under Section 277, and that a Mitchell-Lama
housing cooperative does so qualify, the case left many questions unanswered.
The most important unanswered question was the first argument raised
by the petitioner, namely whether qualifying as a cooperative housing
corporation under Section 216 of the Internal Revenue Code is sufficient
to eliminate the application of Section 277. It is thus unclear whether
this decision will apply to privately financed cooperatives. While most
of the Puget Sound analysis of how to determine what is a cooperative
applies to privately financed cooperatives, it is not clear if all of
it does. In a typical private cooperative, voting is not by member, but
by shares. While it would not seem that this should be a distinction,
the courts have yet to rule on this issue. Nor is it clear from the court's
decision exactly what the consequences will be of applying Subchapter
T to the income of housing cooperatives which receive income from sources
such as commercial rent, or rent from residential tenants. While the Trump
Village Section 3 decision clarifies some issues, unfortunately it does
not clarify others, so that there is still need either for legislation
or for further litigation before all open issues will be settled.
Aftermath: In the Courts
Although the 90-day period during which the Internal Revenue Service
may decide to appeal the Trump 3 decision does not end until September
20th, indications are strong that there will not be an appeal. Meanwhile,
to address the other pending 277 cases, the IRS has adopted elaborate
questionnaires to help determine whether those cooperatives are also operating
pursuant to cooperative principles of Subchapter T.
The Tax Court has asked for briefs on issues that remain to be settled
in the aftermath of Trump 3. It is likely that the court will soon decide
some of the pending 277 cases involving privately financed housing cooperatives.
Aftermath: In Congress
Aftermath: In Congress Promising court decisions notwithstanding, the
National Association of Housing Cooperatives continues to work for passage
of the Moynihan/ Rangel/Schumer legislation affirming that Section 277
of the Internal Revenue Code does not apply to housing cooperatives. Once
again, this measure is included in the revenue bill currently being considered
by the Ways and Means Committee, along with 339 other member measures.
This revenue package was recently reviewed by the IRS, which listed our
277 bills among the measures that it "does not support". But,
not to worry. Consider instead the likely fate of the 129 measures to
which treasury is actively "opposed".
When the Congress reconvenes after its summer recess, the revenue bill
will probably move quickly. Although most members of the New York delegation
actively support H.R. 1546, a brief letter or call will remind your representatives
that this issue is important to your cooperative. It will also be help
to get support from lawmakers representing other states. For the names,
addresses, or phone numbers of your representatives, contact the League
of Women Voters between the hours of 10 AM and 4 PM at (212) 674-8484
or CNYC at (212) 496-7400.
The Cooperative Action Fund, maintained by NAHC, has helped fund the
many years of work to affirm that Section 277 does not apply to housing
cooperatives. Many CNYC member cooperatives and condominiums have regularly
contributed to this fund when paying their annual dues. Your contributions
continue to be necessary to this fight. They are greatly appreciated.
Additional contributions are always welcome. Checks to the Cooperative
Action Fund can be sent to the NAHC at 1614 King Street, Alexandria, VA