Virtually all “accessions to wealth” over which the taxpayer has “dominion and control” constitute gross income under the Internal Revenue Code.1 There are, however, certain exceptions that apply, with which companies may want to become familiar. For example, Section 118(a) of the IRS code provides that, in the case of a corporation, gross income does not include a contribution to the capital of the taxpayer.
To offer guidance in such situations, the IRS issued a private letter ruling on February 15, 2008 (LTR 200820033), commenting on a situation involving a corporation (Alpha Corp.) that was in the business of purchasing, transmitting, distributing, and selling electric energy.
In the case, the city in which Alpha conducted its business adopted a program to bury, or “underground,” the overhead utility lines in the historic district of the municipality. The city also said it would pay Alpha to bury the lines. So the question raised is, does Section 118(a) apply to this situation, or is the stipend an element of Alpha’s gross income?
Initially, the ruling pointed out that Section 118(b) says that the term “contribution to the capital of the taxpayer” does not include any contribution “in aid of construction” (CIAC). Property, the ruling said, is a CIAC if it is transferred to provide or encourage the provision of services to — or for the benefit of — the person transferring the property.
A transfer, however, is not a CIAC when it is clearly shown that the benefit of the public as a whole is the primary motivating factor for the transfer. In the case of the utility company, the payments made by the city to Alpha would benefit the “public at large,” primarily by improving community aesthetics and public safety. Therefore, the payments are not a CIAC.2
“To secure contribution to capital treatment, the property must become a permanent part of the transferee’s ‘working capital structure,’ and it must not be compensation such as a direct payment for a specific service provided for the transferor by the transferee.” — Robert Willens
Contribution to Capital
But it was still necessary to determine whether the transfer by Alpha to the city fell within the definition of a contribution to capital. Consider the case of Brown Shoe Co. v. Commissioner, 339 US 583 (1950), in which a group of civic-minded citizens contributed funds to a corporation for the purpose of encouraging it to expand its operations within the city in which they resided. In Brown, the court noted that the only expectation of the contributors was that such contributions might prove advantageous to the community at large.
Since the transfers were not made with the purpose of receiving “direct services or recompense,” the result was a contribution to capital. Further, to secure contribution to capital treatment, the property must become a permanent part of the transferee’s “working capital structure,” and it must not be compensation such as a direct payment for a specific service provided for the transferor by the transferee.3