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
Also, it must be “bargained for.” Moreover, the asset transferred must benefit the transferee “in an amount commensurate with its value,” and it must be shown that the asset so transferred will be employed in, or contribute to, the production of additional income. (See United States v. Chicago, Burlington & Quincy Railroad Co., 412 US 401 (1973).)
In the case described in the 2008 IRS letter, the payment by the city to Alpha met this exceedingly rigorous set of requirements in the following way:
• The underground lines will become a permanent part of Alpha’s working capital;
• The payments do not constitute compensation for services. After the payments are made, Alpha will not be required to provide any services it is not currently providing;
• The burying of the overhead lines is not necessary other than as part of the city’s program to improve community aesthetics and public safety;
• The payments are a bargained-for exchange;
• The payments will result in a benefit to Alpha that is commensurate with their value;
• The buried electric lines and related equipment will be used by Alpha in its trade or business to produce income.
Accordingly, the IRS concluded that the payments made by the city to Alpha for the purpose of undergrounding the overhead electrical lines and related equipment constituted a nontaxable contribution to the capital of Alpha Corp.4
Contributing editor Robert Willens, founder and principal of Robert Willens LLC, writes a weekly tax column for CFO.com.
1 Section 61 of the Internal Revenue Code.
2 See Notice 87-82, 1987-2 C.B. 389.
3 Compare Detroit Edison Co. v. Commissioner, 319 US 98 (1943).
4 However, if, as here, money is received by a corporation as a contribution to capital, and it is not contributed by a shareholder as such, then the basis of any property acquired with such money during the 12-month period beginning on the day of the contribution to capital shall be reduced by the amount of such contribution. (If property other than money is acquired by a corporation as a contribution to capital, and the property is not contributed by a shareholder as such, then the basis of such property shall be zero.) See Section 362(c) of the IRS code.