Intellectual Property Law

Tax Treatment of Landline and Wireless Internet Services Provided by Cooperatives under the U.S. Tax Code §501(c)(12)

By Martha L. Arias

There are several types of organizations exempted from tax under the Internal Revenue Code ("IRC") §501(c).  For instance, cooperatives (organizations working for the mutual benefit of its members) are tax exempted under IRC §501(c)(12).  Currently, Internet services in rural areas of the United States, it may be the case in other countries as well, are sometimes offered and financed by cooperatives.  Thus, how the Internal Revenue Service ("IRS") treats those Internet services offered by cooperatives, especially when the bylaws of said organizations were written so long ago that they do not expressly state that they will provide Internet services in their area?  The IRS issued a private letter ruling in October 2005 which answered this question.  Yet, as any private letter ruling, it does not constitute legal precedent but it certainly enlightens attorneys and those interested in taxation of utility cooperatives in rural areas.

IRC §501(c)(12) defined cooperatives as "an organization established by individuals to provide themselves with goods and services or to produce and dispose of the products of their labor. The means of production and distribution are those owned in common and the earnings revert to the members, not on the basis of their investment in the enterprise, but in proportion to their patronage or personal participation in it."  According to Puget Sound Playwood v. Commissioner, 44 T.C. 305 (1965), in addition to meeting the elements on this definition, a cooperative under §501(c)(12) must meet other common law requirements to be classified as a cooperative. The organization must (i) have democratic control by members; (ii) operate at cost for the benefit of members; and (iii) contributors of capital to the organization do not control or receive pecuniary benefits from the organizations' operations.    

According to IRC §501(c)(12), ditch and irrigation companies, telephone companies, electronic companies, and "like organizations," seeking tax exemption under this section must be organized and operated as mutual or cooperative organizations.  

The core issue is to determine whether landline and wireless Internet services are considered 'like organizations" under the above definition of the IRC. 

Private Revenue Ruling 200601031 (Oct. 2005) held that cooperatives offering landline and wireless Internet services are ?like organizations' activities under §501(c)(12) and therefore exempted from Federal income tax.  The IRS concluded this after it analogized other previous rulings that constitute examples of ?like organizations' under this IRC section.  For instance, Revenue Ruling ("Rev. Rul.") 57-420, 1957-2 C.B. 308 held that a cooperative providing two-way radio system for the mutual benefit of its members is a ?like organization' and thus exempted under §501(c)(12).  Similarly, Rev. Rul. 83-170, 1983-2 C.B. 97 concluded that a cooperative organization providing cable television services is a ?like organization under §501(c)(12).  Lastly, the IRS noted that Rev. Rul. 67-265, 1967-2 C.B. 205 held that a light and water cooperative is a ?like organization' under §501(c)(12). 

The company requesting this private ruling was a cooperative offering electricity services to its members in a U.S. rural area. Additionally, they intended to start providing landline Internet services to its members; wireless Internet services via satellite to its members; and cable television services to its members, without losing their §501(c)(12) exempt status. 

After a careful analysis and the application of the above Rev. Ruls., the IRS held these three newly intended services from the cooperative were considered ?like organizations' activities under IRC §501(c)(12) and thus entitled this electricity cooperative to maintain its tax exempted status. 

Full post as published by IBLS Internet Law Blog on March 12, 2008 (boomark / email).