County Support Organization Wins Income Exclusion

County Support Org Wins Section 115 Exclusion

The IRS has ruled that a nonprofit corporation created to improve the efficiency of a county government can exclude its income from gross income under Section 115(1) of the Internal Revenue Code. The organization, currently a 501(c)(4) organization, qualifies for this exclusion because it performs an essential governmental function and its income accrues to a political subdivision.

Governance by Public Officials

The organization seeking the Section 115(1) exclusion, established as a nonprofit corporation, is the only entity authorized under state law to collect dues and service fees from the state's counties. Its stated purpose, according to its articles of incorporation and bylaws, is to support and strengthen county governments. The organization is governed by a board of directors that wields complete authority over its operations and assets, including the exclusive power to hire and terminate the executive director. Critically, the board is composed entirely of county officials or employees, each representing an affiliated association of county officials, such as county sheriffs, auditors, or treasurers. Furthermore, the organization's articles of incorporation stipulate that no part of its net earnings may benefit any private shareholder or individual. Upon dissolution, its assets, after all debts and liabilities are satisfied, must be distributed to the State, a political subdivision of the State, or organizations whose income is excludable under Section 115(1)—which concerns income accruing to a state or its political subdivisions.

The Essential Governmental Function Test

The IRS's decision hinged on whether the organization's activities constituted an "essential governmental function" and whether its income accrued to a state or political subdivision, as required by Section 115(1). Section 115(1) of the Internal Revenue Code states that gross income does not include income derived from any public utility or the exercise of any essential governmental function, provided that the income accrues to a state or political subdivision.

The IRS cited Revenue Ruling 77-261, which addressed investment funds established by a state for the temporary investment of cash balances. The IRS had previously ruled that income generated by such funds is excludable from gross income under Section 115(1) because such investment constitutes an essential governmental function, and the fund’s income accrues to the state and political subdivisions. The IRS explained that Section 115(1) is intended to apply to the income of an entity engaged in the operation of a public utility or the performance of some governmental function that accrues to a state or political subdivision, rather than the income of a state or municipality resulting from its own participation in activities.

Furthermore, the IRS referenced Revenue Ruling 90-74, which concerned an organization formed by political subdivisions to pool their casualty risks. In that ruling, the IRS concluded that the organization's income was excludable under Section 115(1) because pooling risks of political subdivisions constitutes an essential governmental function; private interests do not significantly benefit; and the organization’s income accrues to political subdivisions.

In the present case, the IRS determined that by improving the efficiency and effectiveness of county governments, the Taxpayer performed an essential governmental function. Referencing both Rev. Rul. 90-74 and Rev. Rul. 77-261, the IRS concluded that the Taxpayer's income was excludable from gross income under Section 115(1) because it derived from the exercise of an essential governmental function and accrued to a state or political subdivision. The IRS emphasized that private interests do not participate in or benefit from the Taxpayer’s operations more than incidentally and that the Taxpayer’s assets, including upon dissolution, would not be distributed or revert to any entity that is not a state, a political subdivision of a state, or an entity whose income is excludable under Section 115(1).

Implications for Quasi-Governmental Entities

The IRS ruled that the Taxpayer's income was excludable from gross income under Section 115(1) because that income was derived from the exercise of an essential governmental function and accrued to a state or political subdivision.

This ruling confirms that a nonprofit organization fully controlled by public officials and funded by public dues can exist outside the standard corporate tax net under Section 115(1), regardless of its status under Section 501(c), which grants tax-exempt status to certain organizations like charities and social welfare groups. Specifically, Section 115(1) excludes from gross income any income derived from a public utility or the exercise of any essential governmental function, accruing to a state or political subdivision. While many entities seek exemption under Section 501(c)(3) or 501(c)(4), this ruling highlights an alternative for organizations deeply intertwined with governmental functions.

It is important to remember that, pursuant to Section 6110(k)(3), this Private Letter Ruling (PLR) cannot be used or cited as precedent.