Contributions to quasi-governmental public-private partnerships

By Alexis J. Kim, J.D.



  • Quasi-governmental entities may qualify under Sec. 115 to exclude certain income from gross income for federal tax purposes if the income is derived from an activity that is an "essential governmental function," the income accrues to a state or any political subdivision, and no part of the income of the entity inures to the benefit of a private party.
  • A quasi-governmental entity seeking assurance that it qualifies for the Sec. 115 exclusion for the income from its activities may seek a private letter ruling from the IRS. However, the IRS will not issue a ruling letter if the entity is not engaged solely in essential governmental functions.
  • Donors may deduct contributions to a quasi-governmental entity if the entity is an instrumentality of one or more states or political subdivisions for purposes of Sec. 170. Whether an entity meets this requirement is determined under a six-part test that is set out in Rev. Rul. 57-128.
  • Recent revenue rulings provide insight on important issues to consider when setting up a quasi-governmental entity intended to qualify as a Sec. 115 entity, and applying for a private letter ruling to verify the entity's status.

If a taxpayer donates property to his or her local church, there is little doubt the donation is deductible and the church’s income is exempt from tax. However, the IRS generally will not list a church as a qualified charity because a church is not required to file an application to be recognized as a tax-exempt organization. Similarly, a donation to a local municipality or county government is clearly deductible to the donor, and the government entity will not pay federal income tax even though the IRS does not include the entity in its exempt organization database. However, unlike a church, a government entity’s income is not exempt from tax under Sec. 501(a). Instead, its taxation is governed by Sec. 115, which operates entirely differently from Sec. 501(a). This distinction is important for many reasons, not the least of which is the effect it has on the donor of property to the entity.

Now consider a taxpayer who wishes to donate property not to a government agency or entity but to a quasi-governmental organization set up under state or local law and intending to be governed by Sec. 115. Will the entity be a qualified charitable donee under Sec. 170? How can the donor get reassurance that the donation will be deductible? How can the entity be sure its income will be entirely free from income tax?

These questions can be answered by delving into one of the lesser-known sections of the Code, Sec. 115, which excludes from gross income any income derived from essential governmental functions and accruing to a state or political subdivision. This is a very short Code provision that taxpayers and practitioners often overlook. Treasury has not even issued regulations under Sec. 115. While it is clear that a state government, county, or municipality is presumed to derive all income from exercise of governmental powers and thus is immune from federal taxation, it is less than clear how semi-independent nonstock, not-for-profit corporations, created by the exercise of governmental power under state law, are treated.

A group of recently issued private letter rulings addresses the application of both Sec. 115 and Sec. 170 for county land bank organizations that were created under a special state statute to abate community deterioration in the wake of the 2008 economic recession and subsequent national foreclosure crisis.1 These rulings provide a road map that other similar quasi-governmental organizations should follow if they would like to organize themselves as Sec. 115 government instrumentalities and wish to obtain a private letter ruling. These rulings also demonstrate the differences between being organized as a Sec. 501(c)(3) charity and a pure government instrumentality under Sec. 115.2

This article describes the requirements for an organization to meet Sec.115(1), highlighting the differences from Sec. 501(a), provides an explanation of Sec. 115 and Sec. 170 for donors, and, finally, provides guidance and recommendations for structuring a quasi-governmental organization to meet Sec. 115(1), whether or not the entity seeks a private letter ruling. Through this article, donors will gain a better understanding of how a Sec. 115(1) organization can receive tax-deductible donations without having an IRS determination letter, and quasi-governmental agencies will secure a framework to use, in conjunction with tax counsel, during formation and ongoing operations, to comply with Secs. 115 and 170.

Comparing government instrumentalities and those applying for tax exemption under Sec. 501

The options available to a quasi-governmental entity to avoid tax are to (1) exclude all income under Sec. 115; (2) apply for tax-exempt status under Sec. 501(a); or (3) exclude some income under Sec. 115 and simultaneously apply for tax-exempt status under Sec. 501(a) as a hybrid organization. However, the IRS will not issue rulings on the Sec. 115 issue unless all of the entity's activities qualify as essential governmental functions.3

To receive a ruling that it is a government instrumentality under Sec. 115, (1) the entity must derive all its income from activities in furtherance of governmental purposes; (2) all the entity's income, if not used directly for those purposes, must accrue to another government instrumentality; and (3) any private benefit the entity provides must be no more than incidental to the public benefit it provides.4 These requirements are somewhat in contrast to the more familiar requirements for a quasi-governmental entity to gain tax exemption via Sec. 501(a), usually as a Sec. 501(c)(3) charitable organization or possibly as a Sec. 501(c)(4) social welfare organization. The strongest commonality between the requirements under Sec. 115 and Sec. 501(a) is the private benefit prohibition. An organization exempt under Sec. 501(a), however, may engage in activities that are outside the scope of its charitable or other exempt purpose so long as these activities do not comprise a substantial part of the organization's activities or revenue, while a pure Sec. 115 entity may only engage in essential governmental functions.

To discourage exempt organizations from engaging in excessive nonexempt and commercial activities, Congress enacted Sec. 512, imposing a tax on unrelated business taxable income (UBTI) on most exempt organizations. Sec. 501(a) organizations must maintain detailed records of their activities and revenue sources and report them annually on a Form 990, Return of Organization Exempt From Income Tax.5 If the organization engages in unrelated business activity that earns revenue, it will be subject to the unrelated business income tax (UBIT) and required to prepare and file a Form 990-T, Exempt Organization Business Income Tax Return, that separately tracks all UBTI. Exempt organizations are permitted to take various deductions against their UBTI; however, many organizations do pay UBIT annually. Engaging in excessive commercial activity can also risk organizations' exempt status under Sec. 501(a).

If an organization is a Sec. 115 government instrumentality with all of its income excludable under Sec. 115, it cannot engage in any activity beyond its governmental purposes and it is not subject to UBIT. The IRS thus has a vested interest in ensuring that an organization requesting a ruling on the status of its income as excludable under Sec. 115 is actually engaged solely in essential governmental functions; the IRS will not rule if there is even a small amount of income from activity other than essential governmental functions.6 Once an organization receives the IRS ruling, it has no required annual federal tax filings such as the Form 990 or Form 990-T, and the IRS has no mechanism to monitor the ongoing activities of Sec. 115 entities.7 It is in the best interest of a quasi-governmental entity to carefully implement a structure that complies with Sec. 115 so that it can avoid unnecessary returns or the imposition of tax through UBIT or as a fully taxable entity.

Given the option of relying on Sec. 115 or obtaining exempt status under Sec. 501(c)(3), it would, on its face, appear better to be a Sec. 115 organization. However, practical considerations might cause an entity to do otherwise. One benefit of being a Sec. 501(c)(3) exempt organization is that it will be automatically treated as an entity that can accept tax-deductible charitable contributions and included in IRS Publication 78, Cumulative List of Exempt Organizations, which is available on the IRS website and can be searched using the Select Check tool.8 Inclusion on this list gives donors comfort that donations will be tax-deductible under Sec. 170. Although churches and political subdivisions are not listed and do not ordinarily apply for tax exemption, it is not a foregone conclusion that a quasi-governmental agency would qualify under Sec. 115 and Sec. 170. A government instrumentality under Sec. 115 must also meet a political subdivision test under Sec. 170 if it wishes to accept tax-deductible contributions. The political subdivision test under Sec. 170 is similar to the analysis under Sec. 115, with some additional factors given weight.

Government instrumentality status under Sec. 115 is highly preferable to being a Sec. 501(c)(3) exempt organization in many ways. An organization may operate as a Sec. 115 entity without obtaining a private letter ruling; however, many organizations wish to have confirmation from the IRS. This can be a particular concern if the organization wishes to accept donations from donors who want to take a tax deduction for the donation. When a potential donor approaches an organization, if he or she cannot find the organization listed on IRS Select Check, he or she will often request a copy of the determination letter or other documentation that the donation will be tax-deductible. Some quasi-governmental entities may opt to apply for exempt status under Sec. 501(a), but this adds the annual administrative burdens described above. If an organization that engages solely in governmental activities has any doubt as to whether it meets the definition under Sec. 115, it should request a private letter ruling rather than applying to be exempt under Sec. 501(c)(3) or (4). A disadvantage of requesting a private letter ruling is the large user fee, currently $28,300.9 Arguably, the entity may recoup the high upfront cost of obtaining a ruling within the first few years by saving on fees and administrative expenses for Sec. 501(c) application and compliance. If, however, the organization has any income streams from or engages in any activities that may not be essential governmental functions, it would be better to apply for exemption as a Sec. 501(c)(3) or (4) organization and obtain a tax opinion from tax counsel with expertise in this area over which portion of income is excludable under Sec. 115. These two provisions are not mutually exclusive.

According to the recent group of private letter rulings on Sec. 115, the key issues in determining if an organization meets Sec. 115 as a government instrumentality are as follows:

  • Sources of revenue;
  • Government control and oversight;
  • Whether all the organization's activities are in furtherance of a governmental purpose; and
  • Whether unused income accrues to another government instrumentality.

These same concerns come up in the context of Sec. 170, although the test used to determine whether an organization can accept deductible contributions is slightly different.

Summary of existing law on Sec. 115 government instrumentalities

Until the recent private letter rulings, insight into how the IRS views the requirements of Sec. 115, particularly for economic development and land reuse organizations, was sparse. These rulings shed much-needed light on Sec. 115's application.

Sec. 115(1) states that "income derived from . . . the exercise of any essential governmental function and accruing to a State or any political subdivision thereof" is excluded from gross income for federal income tax purposes. For an entity's income to be excluded from gross income under Sec. 115(1), the following requirements must be satisfied:

  1. The activity generating the income must qualify as an "essential governmental function";
  2. The income must "accrue" to a "State or any political subdivision thereof" (i.e., during the entity's existence, any income not used must flow to a political subdivision and upon dissolution of the entity, and, after all creditors have been paid, any remaining assets must flow to the political subdivision supervising the entity);10 and
  3. No part of the income of the entity may inure to the benefit of any private persons.11

Each of the above elements or requirements is discussed in turn below. Most of the recent guidance in this area comes from revenue rulings and private letter rulings, and the recent set of private letter rulings provides helpful analysis of each element. A handful of cases in the 1970s through the mid-1990s went to the appellate courts and the Supreme Court, but there has been no recent case law on Sec. 115, particularly as it applies to these types of quasi-governmental organizations.

Activities of the organization must constitute essential governmental functions

The first requirement for income to be excluded from gross income for federal income tax purposes under Sec. 115(1) is that the income must be derived from an essential governmental function. Several published revenue rulings describe what activities constitute an essential governmental function. In Rev. Rul. 77-261, the IRS ruled that income from an investment fund, established under a written declaration of trust by a state, for the temporary investment of cash balances of the state and its participating political subdivisions, was excludable from gross income for federal income tax purposes under Sec. 115(1). The ruling points out that Congress did not desire in any way to restrict a governmental entity's participation in enterprises that "might be useful in carrying out projects that are desirable" from the standpoint of a state or municipality "which, on a broad consideration of the question, may be the function of the sovereign to conduct."12

The IRS followed Rev. Rul. 77-261 in Rev. Rul. 90-74, taking a similarly broad view of the meaning of "essential governmental function" in ruling that the income of a risk-pooling organization formed, funded, and operated by political subdivisions is excludable from gross income under Sec. 115(1). In this ruling, the IRS also emphasized that the private benefit received from the risk-pooling organization was to be incidental to the public benefit, effectively adding the third element now required to be considered a government instrumentality.

Moreover, the IRS has issued numerous private letter rulings concluding that the activities of quasi-governmental economic development entities constitute "essential governmental functions." Although private letter rulings are only binding for the recipient taxpayer, they can illustrate how the IRS would analyze similar facts.

In Letter Ruling 200738008,13 the IRS ruled that the activity of an economic development corporation created to receive condemned property and redevelop it constituted an essential governmental function for purposes of Sec. 115(1). In Letter Ruling 200736022, the IRS ruled that a not-for-profit corporation established by a city to encourage economic development through the acquisition and disposal of land was exercising an essential governmental function. The IRS ruled "[s]timulating economic development is an essential governmental function for purposes of [Sec.] 115."14

In Letter Ruling 200630001, the IRS ruled that an entity created by a city to develop and sell land to private industry to stimulate economic development by "increas[ing] the inventory" of commercial land available for productive use in an area was exercising an essential governmental function. The IRS ruled that the entity's income came from an "essential governmental function" because "stimulating economic growth and reducing unemployment are essential governmental functions for purposes of [Sec.] 115."

Most recently, in Letter Ruling 201712001the IRS ruled that "[t]ransforming blighted, abandoned or foreclosed property into safe and economically productive property is an essential governmental function."

The organization's income must 'accrue' to a state or a political subdivision

The second requirement for income of an entity to be excluded from gross income for federal income tax purposes under Sec. 115(1) is that the income "accrue" to a state or a political subdivision of the state. The IRS concluded in Rev. Rul. 90-74 that this requirement is satisfied if a state or a political subdivision (or some combination of the two) is entitled to the entity's net assets upon its dissolution. In that revenue ruling, the IRS ruled that a fund created by a state to help member political subdivisions pool casualty risks met the accrual requirement because the fund's governing documents required the fund to distribute the fund's net assets to the member political subdivisions upon the fund's dissolution.

Similarly, in Letter Ruling 200909019, the IRS ruled that an association formed to facilitate the exchange of views on good state governance among the governors of the association's member states was eligible for the Sec. 115(1) exclusion in part because the association's articles of incorporation provided that any remaining assets after satisfaction of liabilities were to be distributed only to the association's member states.

Finally, in Letter Ruling 201712001, the IRS ruled that a land reutilization organization qualified as a Sec. 115 government instrumentality in part because its articles of incorporation ensured that "upon dissolution its assets will be distributed to State, County, another political subdivision of State, or to an entity whose income is excludable from gross income under [Sec.] 115."

The IRS will be particular about the dissolution language in the entity's articles of incorporation and will not allow an organization to rely on state law to comply with the income-accrual requirement. In some instances, the IRS has required changes to the dissolution clause in an organization's articles of incorporation to ensure all income would accrue to a state or political subdivision upon dissolution. It is also notable that the dissolution language in these recent private rulings permitted income to accrue not only directly to the state and its political subdivisions, but also to any other Sec. 115 government instrumentality.

Income of the organization must not inure to the benefit of any private party

In addition to the two statutory requirements addressed above, the IRS has imposed an additional requirement for income to be excluded from gross income for federal income tax purposes under Sec. 115(1). In Rev. Rul. 90-74, the IRS ruled that an entity does not qualify for the Sec. 115(1) exclusion if its operations benefit private persons more than incidentally.15 The IRS ruled that the income of a fund created to enable political subdivisions of a state to efficiently pool various risks was entitled to the Sec. 115(1) exclusion because pooling those risks was an essential governmental function as it fulfilled the obligations of the constituent political subdivisions to protect their financial integrity and because the income of the fund accrued to the constituent political subdivisions.16

The essential governmental function and accrual requirements are clearly found in the text of Sec. 115(1). Nevertheless, the IRS expanded upon the statutory language and ruled that this fund was eligible for the Sec. 115(1) exclusion because any private benefit to employees of participating political subdivisions from the fund's insurance of those political subdivisions was "incidental to the public benefit."17 It is clear from the ruling that, had the IRS found that the fund's operations benefited specific private parties more than incidentally, the IRS would have ruled that the Sec. 115(1) exclusion did not apply.

Subsequent private rulings, including the recently issued private letter rulings, have been consistent with Rev. Rul. 90-74; the IRS has imposed this additional "no more than incidental private benefit" requirement. In those private rulings, if an entity's operations benefited private parties more than incidentally, the IRS refused to rule that the Sec. 115(1) exclusion applied to the income from those operations. For example, the IRS ruled in Letter Ruling 9733003 that income accruing to a settlement fund created to disburse funds to victims of state business code violations was not entitled to the Sec. 115(1) exclusion because private individuals benefited from the fund more than incidentally.18Furthermore, in Letter Ruling 200909019 (discussed above), the IRS ruled that an association met the "no private benefit" requirement when the association's articles of incorporation provided that no part of the association's income and earnings could inure to the benefit or profit of any private interest.

In Letter Ruling 200738008, an economic development corporation was granted a Sec. 115(1) exclusion in part because any private benefit was incidental to the greater benefit to the community, and any income distributed to private parties was in payment of goods or reasonable compensation for services rendered. The IRS emphasized that stimulating economic growth and reducing unemployment are essential governmental functions for purposes of Sec. 115.

In Letter Ruling 201712001, the IRS noted that in addition to being subject to the state's open meetings and public records rules, an economic development organization had taken additional steps to ensure that private interests will not benefit more than incidentally from its activities of reclaiming and revitalizing abandoned or foreclosed real estate. This ruling is helpful to economic development and land reuse organizations because their activities inherently will provide benefit to developers, contractors, owner-occupant buyers, and other members of the community. The key to comply with Sec. 115 is that the organization balance these incidental private benefits by providing a greater community or public benefit through its economic development or rehabilitative projects.

The IRS Tax Exempt & Government Entities division continues to focus on private inurement as a strategic issue area, and the possibility of private inurement in a quasi-governmental entity will immediately raise red flags and potentially disqualify an organization that otherwise meets the statutory requirements of Sec. 115.19 An organization wishing to qualify as a Sec. 115 government instrumentality should take care to implement policies to prohibit private inurement.

Summary of existing law on Sec. 170 charitable contribution deductions

Surprisingly, while donations to a Sec. 501(c)(3) organization are generally deductible by donors, a donation to a Sec. 115 organization may or may not be. This is because the definition of charitable contribution in Sec. 170 directly mirrors the language of Sec. 501(c)(3).20 If a Sec. 115 organization is a political subdivision of a state or local government, a donation will always be tax-deductible. When the Sec. 115 organization is a quasi-governmental organization, it is not always clear whether it will also be considered an instrumentality of a political subdivision under Sec. 170 and therefore able to accept tax-deductible contributions.

A quasi-governmental entity may wish to solicit contributions from the general public. Donors may ask for a copy of the determination letter or other proof that contributions will be tax-deductible. To accept deductible contributions, the entity will have to meet the slightly different political subdivision test of Sec. 170.

Rev. Rul. 57-128 sets forth a six-factor test that is used to determine whether an organization is a political subdivision for Sec. 170 and may accept deductible contributions from potential donors. While the majority of revenue generated by a Sec. 115 entity is likely coming directly from government funds and grants, a significant portion of potential revenue from contributions may still be from the general public. Depending on the type of organization and its purpose, it may be the recipient of in-kind donations or even cash contributions from members of the community who wish to support its purposes.

The Code allows a deduction for "a contribution or gift to or for the use of a State, a possession of the United States, or any political subdivision of any of the foregoing . . . but only if the contribution or gift is made for exclusively public purposes."21 A "political subdivision" is defined for these purposes as "any division of any state or local governmental unit which is a municipal corporation or which has been delegated the right to exercise part of the sovereign power of the unit."22 "Sovereign power" here refers to taxing, eminent domain, sovereign immunity, or police powers.

Quasi-governmental entities that seek rulings under Secs. 115 and 170 generally are not direct political subdivisions of a state or local government because they have not been delegated substantial amounts of taxing, eminent domain, or police powers. This uncertainty is the reason that quasi-governmental agencies may choose to obtain an opinion letter or private letter ruling. Nevertheless, contributions or gifts to these entities may still entitle the donor to a charitable contribution deduction subject to certain limitations if the entity is an "instrumentality" of a state or local government (which is a political subdivision of a state).

The term "instrumentality" for Sec. 170 purposes is defined by reference to a different, independent line of authorities than those that define the term for Sec. 115(1) purposes.23 Nevertheless, the analysis for Sec. 170 purposes is very similar to the Sec. 115(1) analysis, and, in many instances the quasi-governmental entity will be an instrumentality for purposes of allowing the charitable deduction to donors under Sec. 170(c)(1).

Governing law for tax deductibility of contributions

The criteria for identifying instrumentalities of states or of political subdivisions for purposes of Sec. 170 are set forth in Rev. Rul. 57-128. 24 Rev. Rul. 57-128 uses the following six factors to determine whether an entity is an instrumentality of a governmental entity, and no one factor is dispositive.25

1. Whether the entity is used for a governmental purpose and performs a governmental function: As was the case with the Sec. 115(1) exclusion, economic development is a governmental function for Sec. 170 purposes.26 The IRS has likewise ruled that activities designed to ''promote the local economy" (such as conducting programs that are designed to attract conventions and tourists to the area) are governmental purposes under the first factor.27 Moreover, the IRS has ruled that such limited functions as educating citizens about historical events,28 providing a forum for governors to exchange their views on good governance,29 and offering "a variety of programs and services that enhance opportunities for . . . citizens and visitors to participate in the arts, [c]ounty heritage, historic preservation, and public art"30 were governmental functions that satisfied the first factor. Recently, the IRS ruled that an organization "established by County as its agent to facilitate the governmental purposes of reclamation, revitalization, and return to economic productivity of abandoned or foreclosed real estate"31 is performing a governmental function.

2. Whether the entity performs its functions on behalf of one or more states or political subdivisions: To satisfy the second factor, an entity must generally be a "wholly governmentally controlled entity."32 The IRS will also look to whether a governmental entity has the power to control the membership of the board of directors of the second entity and the control that the governmental entity has over the finances of the second entity. In Letter Ruling 201712001 the organization satisfied this factor because it was established by the county as the county's agent and because it was required to submit annual reports from officers and directors affirming the organization's governmental functions. These criteria will also prove important in the fourth factor, below.

3. Whether there are any private interests involved, or whether the state or political subdivision involved has the powers and interests of an owner: To determine whether the third factor is satisfied, the IRS examines the disposition of the assets of the entity upon its dissolution after the entity pays its liabilities—and asks, do the assets flow to a governmental entity, or does the entity instead distribute them according to general corporate law? If the latter is true, the third factor may not be satisfied.

Note that if the entity meets the Sec. 115 income-accrual test, it will likely also meet this factor. This was the case with the recent rulings although the IRS also emphasized that the organization was required to follow the state's open meetings and public records requirements and provide financial reports to the state and the public. The IRS also examined the organization's policies regarding bids for goods or services and its conflict-of-interest policy for officers and directors to ensure that no more than incidental private interests were involved and that the county, as a political subdivision, had the "powers and interests of an owner with respect to [the organization]."33

4. Whether control and supervision of the entity is vested in a public authority: Under this factor, the IRS looks to whether the entity's board is controlled by governmental actors acting as such (rather than as private citizens).34 The fourth factor is not satisfied merely because an entity is subjected to governmental regulation or licensing requirements—the entity must be specifically controlled and supervised by a governmental entity.35 Recently, the IRS ruled that because a majority of the board of directors must always be representatives from county and local government, the organization met the control test.36

5. Whether governmental authorization is necessary for the creation or use of the entity: The IRS has ruled that an organization created under state legislation approving land reclamation and economic development activities meets this factor.37

6. The degree of financial autonomy and the source of the entity's operating revenues: In this regard, the entity need not be entirely dependent on the parent governmental entity for financial support—the IRS has ruled that this factor was satisfied when an entity received only a "significant portion" of its funding from the parent governmental entity.38 The IRS recently ruled that an organization receiving the majority of its funding from a delinquent tax and assessment collection fund and state grants met this factor.39

The IRS has applied these six factors in several subsequent published rulings and in many private letter rulings in addition to the recent rulings discussed here.

In Rev. Rul. 69-453, the IRS applied the six factors to rule that a soil and water conservation district formed as a private nonstock corporation by private individuals was not an instrumentality of the state of Connecticut. The conservation district argued that it was an instrumentality of the state of Connecticut because it was regulated by state law and because state law authorized state officials to assist the conservation district in carrying out its purposes and because Connecticut's commissioner of Agriculture and Natural Resources had made himself an ex officio (nonvoting) member of the district's board. Nevertheless, the state of Connecticut had no control over the district's expenditures and had no authority to remove any member of the district's board, and the district funded its operations through fees that it charged landowners for soil conservation work. The state of Connecticut had no authority or control over the district and only had a memorandum of understanding with the district agreeing to cooperate with it. Moreover, the state of Connecticut had no claim to the district's assets after the district's dissolution.

The IRS noted that the district was a private corporation formed by and acting on behalf of private individuals, the state law that applied to the district was merely regulatory, and any public benefit was merely incidental. Accordingly, the IRS ruled that the district was not an instrumentality of the state of Connecticut.40

Similarly, the IRS ruled in Rev. Rul. 65-26 that a not-for-profit corporation formed to improve municipal government and promote the general welfare of cities in a state was not an instrumentality of that state. The corporation argued that it was an instrumentality of the state because its board of directors was comprised of governmental officials of various cities and villages within the state. Funding for the corporation's operations came from membership dues, publications, advertising, and conference receipts. The corporation was not formed by the state or any political subdivision of the state. Even though the corporation's board was comprised of governmental officials, they acted in their individual capacities, not as agents of their representative governmental entities. These first two rulings are examples of entities created to serve a public purpose, but without the clear government control and oversight that is necessary to be considered a government instrumentality.

In contrast, in Rev. Rul. 65-196, the IRS ruled that a sports area commission formed under an agreement (which was authorized by the enactment of a state law legalizing those agreements) between a city and two villages to erect and operate an athletic stadium was an instrumentality of a governmental entity. The commission was comprised of members appointed by councils of the city and villages as their representatives, each of which was a resident of the state and none of which were members of the governing bodies of the cities and villages. The sole source of financing for the commission came from bonds issued by the city; the city was authorized to issue bonds upon the request of the commission to fund the athletic stadium. The IRS ruled that the commission was an instrumentality of the city and the two villages by whose agreement it was formed because it met substantially all of the Rev. Rul. 57-128 factors: The commission was created by governmental entities under state and local law, the entity was controlled by the governmental entity that created it, no private interests controlled the commission, and the commission was entirely dependent upon the governmental entities that created it for financial support.

Similarly, in the most recent published revenue ruling construing the Rev. Rul. 57-128 factors, Rev. Rul. 75-359, the IRS ruled that a voluntary association of counties organized exclusively for public purposes to "provide more adequate and efficient local government in keeping with a democratic society," by providing research and training to local governmental officials and by lobbying the state legislature was a wholly owned instrumentality of the counties formed and operated exclusively for the public purposes of the counties for Sec. 170 purposes. The association's voting members were all governmental officials from the member counties. Those member counties provided the bulk of the funding for the association. Accordingly, the IRS ruled that the entity met all six Rev. Rul. 57-128 factors.

The IRS has also applied the Rev. Rul. 57-128 factors in a number of more recent private letter rulings. In Letter Ruling 201411018, the IRS concluded that a state board organized to approve the budgets of each state college and university is an organization eligible to receive contributions deductible under Sec. 170(c)(1). The statutory foundation and control of the state legislature and governor over the board significantly affected the IRS rationale indicating that the board met all six factors enumerated in Rev. Rul. 57-128.

In Letter Ruling 200909019, the IRS concluded that an association organized to allow the governors of several states to share views and experiences in governance was an instrumentality eligible to receive deductible charitable contributions. The association met the first factor and the second factor because the association's board consisted of the governors of the states, each of whom served on an ex officio basis for so long as he or she remained governor, and because the association performed its functions of improving governance on behalf of the states that provided the members of its board. The association met the third factor because no private interests were involved; the governors of the states that organized the association were the only parties involved, all of the assets of the association were to be distributed to the member states upon the association's dissolution, and no part of the association's earnings inured to the benefit of any of the member states.

The association satisfied the fourth factor because the control and supervision of the association was vested in the association's board, which consisted of the governors of the member states, serving in their capacity as governors. The association satisfied the fifth factor because express or implied statutory authority was necessary for the association's creation and because membership of the association consisted of governors with the authority to form organizations such as the association. The association satisfied the sixth factor because a "significant portion" of its funding came from membership dues from the member states.

In Letter Ruling 200738008 (also discussed above in the Sec. 115(1) analysis), the IRS concluded that an economic development corporation created to receive condemned property and redevelop it constituted an instrumentality for Sec. 170 purposes because no private interests were involved, the corporation was supervised by the governmental unit that created it, statutory authority for the creation of the corporation was found in the law of the state, and the governmental unit that created the corporation exercised extensive financial control over all of the funds of the corporation.

Similarly, in Letter Ruling 200820012, the IRS ruled that an entity created to foster and facilitate economic development by constructing and operating scientific research facilities was an instrumentality for Sec. 170 purposes because all the board members of the entity were appointed by the governor and the entity was under extensive financial supervision by the state.

Finally, in the recent private letter rulings (also discussed above), the IRS ruled that a land reutilization organization formed by a county under special state legislation met all six Rev. Rul. 57-128 factors and was a wholly owned instrumentality of a political subdivision of the state. Key points that the IRS highlighted included the facts that the organization functions "on behalf of County"; no more than incidental private interests are involved; express statutory authority is required and exists to create the organization; and the organization relies heavily on state funding to operate.41

Issues noted by the IRS in the recent private letter rulings

The recently issued rulings show that the IRS examines each organization closely and holds it to high standards before granting a Sec. 115 ruling. In most instances, the private letter ruling process will be the only opportunity for IRS personnel to examine the financial records and the organization and operation of the entity and ensure that it is operating for the overall public good and without substantial private benefit. Once the IRS issues a favorable ruling under Sec. 115, the entity will have no requirement to file any ongoing reports with the IRS. Following is a discussion of some of the specific issues the IRS raised in the recent private letter rulings.

Multiple income streams

The entity must exclusively serve a governmental function to fall under Sec. 115. This ruling is issued for the entity as a whole, therefore, all of its income must qualify for the governmental activity exclusion.42 The IRS will review financial reports to be sure no nongovernmental activity is producing income, since a Sec. 115 ruling will exempt the organization from information-return filing and UBIT. If the IRS cannot conclude that 100% of the entity's income comes from activities that constitute an essential governmental function, it will refrain from ruling at all on the Sec. 115 question.43

Even activity related to the governmental purpose of economic development may raise some serious private inurement concerns. An organization should be prepared to open its books to the IRS and to provide a strong argument that the public benefit is much greater than any incidental private benefits provided by its activities. Contracts with private parties and joint ventures involving potential risk and/or profits may prevent an entity from being able to obtain a favorable Sec. 115 ruling due to the high risk of private inurement.

Dissolution language

The IRS also focuses on the language of the dissolution provisions in the organizations' articles of incorporation. Merely referring to the state code provisions first and then stating that remaining assets will go to the county or the state, or that the county government will determine where to send the assets, will not suffice. The organization's articles must specify that all remaining assets will go to another entity whose income is excluded under Sec. 115, even if, under state law, the local government would have full authority over the funds. The IRS emphasized the need to comply with the "accruing to a State or any political subdivision thereof" provision in Sec. 115(1).

Although Rev. Proc. 2003-12 applies to entities that are also tax-exempt under Sec. 501(a), the language suggested for a dissolution clause is an excellent example of how to satisfy the accrual requirement of Sec. 115. A straightforward description of the possible distribution of funds upon dissolution ensures that even if the local government were restructured, the assets would end up being used by a political subdivision of the state and meet the Sec. 115(1) accrual requirement.

Description of Sec. 115

The IRS may also raise concerns in its information request letters regarding the way that Sec. 115 is described in the quasi-governmental entity's organizational documents. Many entities fall into the trap of approaching Sec. 115 as an exemption provision while it is truly an income-exclusion provision. An entity is not exempt from taxation under Sec. 115 the way that it would be under Sec. 501(a). To describe it as an exempt organization is inconsistent with the language of Sec. 115. Proper training and experienced tax and legal advice during the formation of the quasi-governmental organization could avoid these concerns. If an entity's organizational documents already contain the incorrect language, modifications should be made to comply with Sec. 115 before requesting a private letter ruling.

Government instrumentality definition for Sec. 170

The IRS will closely examine the state and local government treatment of the organization to see if it holds the powers of a political subdivision, and therefore a ruling under Sec. 170 would be redundant. If state law grants sufficient government powers or authority to the organization, then it will be deemed a political subdivision in its own right, and the ruling would be unnecessary. An organization should seek advice from experienced tax counsel before requesting a ruling on the Sec. 170 issue.

Recommended structure for getting it right the first time

-governmental entities are advised to learn from the experience gained and issues raised in the recent private letter rulings. Based on the ruling letters, the following practices should assist these organizations in becoming qualified as Sec. 115 entities, give comfort to donors, shield income from tax, and reduce the total amount of time spent in correspondence with the IRS if requesting a ruling.

  1. Use the correct terminology when describing the income exclusion of Sec. 115 and how it applies to the organization for everyday operations as well as upon amendment or dissolution;
  2. Set up policies to prevent private inurement and provide continued training to the directors and officers regarding private inurement as well as an understanding of Sec. 115 and how to ensure all the organization's activities serve essential governmental functions under Sec. 115;
  3. Be sure that the organization has strictly complied with its conflict-of-interest policy in all prior and current transactions and that joint ventures with private parties are carefully reviewed and restricted to activities that fit within the essential governmental functions of Sec. 115; and
  4. If the organization has any income streams that are not derived from essential governmental functions or if there are joint ventures with high risk for private inurement, apply for exemption under Sec. 501(a) instead, as an entity whose income is only partially excluded under Sec. 115.

Not all organizations will be able to justify the full cost of obtaining a private letter ruling and may wish to operate under a legal opinion from tax counsel. However, legal fees for the research necessary to prepare a full tax opinion and analyze the law on the framework of the organization's specific facts could be very similar to the legal fees required to write a private letter ruling request. The only additional cost would be the user fee as well as the additional time required for the IRS to review the request and issue the ruling. As a benefit, the organization receives binding documentation it can rely on in its daily operations and use to reassure donors that contributions are deductible, as opposed to an opinion letter from counsel that is nonbinding on the IRS. This is well worthwhile to the organization.

The other option that some organizations may explore is to simply apply for exemption as a charity under Sec. 501(c)(3) and operate under those provisions. This does save upfront costs, as legal fees will likely be much lower than for a private letter ruling, and the user fee for a Form 1023, Application for Recognition of Exemption Under Section 501(c)(3) of the Internal Revenue Code, is a fraction of the cost of the private letter ruling user fee (depending on the organization's gross receipts, the fee for an exemption application is either $400 or $850). The organization must weigh this initial savings with the ongoing administrative and legal costs of complying with the regulations imposed on Sec. 501(c)(3) organizations. Furthermore, if the organization is a quasi-governmental agency, it may be unnecessarily subjecting itself to continuous IRS oversight.

Whether a quasi-governmental organization ultimately chooses to obtain a private letter ruling, apply for exemption under Sec. 501(c)(3), or operate as a Sec. 115 entity without a ruling, it should follow the guidance and recommendations in this article to clear some of the murkiness from the waters that have previously surrounded Sec. 115.  


1IRS Letter Rulings 201712001; 201712002; and 201718001.

2The term "pure Sec. 115 entity" is used in this article to indicate an organization, all of the income of which is excludable under Sec. 115, as opposed to an organization that is eligible for only a partial exclusion of income under Sec. 115.

3Rev. Proc. 2017-3, §3.01(21).

4Sec. 115(1) and Rev. Rul. 90-74.

5Sec. 6033(a)(1).

6See Rev. Proc. 2017-3, §3.01(21).

7Rev. Proc. 95-48, §4.02(a). Note also that Sec. 6033 imposes information-return requirements on exempt organizations under Sec. 501(a), and Sec. 6012(a)(2) imposes filing requirements on corporations subject to tax, but no filing requirements are imposed on a corporation all of whose income is excluded under Sec. 115(1).

8Available at

9Rev. Proc. 2017-1, Appendix A.

10Sec. 115(1).

11See Rev. Rul. 90-74.

12Rev. Rul. 77-261 (citing General Counsel Memorandum (GCM) 14407, which cites pertinent legislative history of Sec. 115(1)'s statutory predecessor).

13Although, pursuant to Sec. 6110(k)(3), private letter rulings may not be cited as precedent, they represent the IRS's administrative practice and likely position.

14Id. See also IRS Letter Ruling 9552045 (holding that the income of a foundation created to receive and disburse funds for economic development was exempt from federal income tax under Sec. 115(1), stating: "The Department established the Foundation to assist the Department's efforts in promoting the economic development of State").

15The continuing vitality of the principles set forth in Rev. Rul. 90-74 was confirmed in 2003 when the IRS issued Rev. Proc. 2003-12, which was also published guidance. Rev. Proc. 2003-12 was not a "ruling" and served only to provide very narrow guidance to an entity seeking exemption under Sec. 501(a) as an organization described in Sec. 501(c)(3). Nevertheless, Rev. Proc. 2003-12 is important because §3.02 of the procedure cites Rev. Rul. 90-74 with approval.

16Rev. Rul. 90-74 (citing Rev. Rul. 77-261).


18IRS Letter Ruling 9733003 (following Rev. Rul. 90-74); but see IRS Letter Ruling 8825087 (predating Rev. Rul. 90-74, granting a tax exemption under Sec. 115(1) to a government pension plan that benefited pensioners); GCM 34704 (12/2/71).

19Tax Exempt and Government Entities FY 2017 Work Plan (Sept. 28, 2016).

20Compare Sec. 170(c)(2)(B) ("organized and operated exclusively for religious, charitable, scientific, literary, or educational purposes . . .") with Sec. 501(c)(3) ("organized and operated exclusively for religious, charitable, scientific, testing for public safety, literary, or educational purposes . . .").

21Sec. 170(c)(1).

22Rev. Rul. 75-359 (citing Regs. Sec. 1.103-1(b)).

23See id.; IRS Letter Ruling 200909019 (ruling that an entity constitutes an instrumentality of a government to which a taxpayer may make deductible charitable contributions in a separate section applying a different line of authority than it applied in its Sec. 115 analysis); IRS Letter Ruling 200301025 (ruling similarly).

24See also Rev. Rul. 75-359 ("The criteria for identifying wholly-owned instrumentalities of states or of political subdivisions are set forth in Rev. Rul. 57-128 . . .").

25Michigan, 40 F.3d 817 (6th Cir. 1994); Rev. Rul. 65-196 (ruling that an entity was an instrumentality of a governmental entity because it met "substantially all" of the Rev. Rul. 57-128 factors).

26IRS Letter Rulings 200820012 and 200738008.

27IRS Letter Ruling 9638019.

28IRS Letter Ruling 200307065.

29IRS Letter Ruling 200909019.

30IRS Letter Ruling 200551034.

31IRS Letter Rulings 201712001 and 201712002.

32IRS Letter Ruling 200222029 (citing Philadelphia Nat'l Bank, 666 F.2d 834 (3d Cir. 1981)).

33IRS Letter Ruling 201712001.

34Rev. Rul. 65-26 (discussed in detail below).

35Rev. Rul. 69-453 (discussed in detail below).

36IRS Letter Ruling 201712001.


38IRS Letter Ruling 200909019; see also IRS Letter Ruling 200222029 (ruling that factor (6) was satisfied when 94% of an entity's funding came from the parent governmental entity, but ultimately ruling that the entity was not an "instrumentality" under Rev. Rul. 57-128 because factors (2)-(5) were not satisfied).

39IRS Letter Ruling 201712001.

40Compare IRS Letter Ruling 201712001 with Rev. Rul. 59-373 (ruling that a soil conservation district created by the state of Colorado and given limited regulatory and taxing power and created to serve a recognized public purpose and whose assets reverted to the state of Colorado upon the district's dissolution was an instrumentality of the state of Colorado); Rev. Rul. 57-120 (ruling similarly with respect to a soil conservation district similar to the soil conservation district in Rev. Rul. 59-373).

41IRS Letter Ruling 201712001.

42See Rev. Proc. 2017-3, §3.01(21).




Alexis J. Kim is an attorney with Walter Haverfield LLP in Cleveland in its Tax and Wealth Management Group. She focuses her practice on federal, state, and local tax planning, not-for-profit law, and estate and succession planning. For more information about this column, contact


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