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Thwaites Terrace Case Overcomes I.R.C. 277
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 meetings), and;

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 members informed.


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