AFTER FIVE-YEAR FEDERAL BATTLE, CO-OPS WIN TAX RULING

The Internal Revenue Service last week overturned a 1997 decision that would have forced many telephone cooperatives out of tax-exempt status.

The overturned ruling, which came in the form of a technical advice memorandum, required that the income of wholly owned subsidiaries of telephone co-ops be counted as non-member income.

The FCC in many cases requires co-ops that wish to offer new services to do so through subsidiaries. At the same time, the tax code stipulates that these co-ops can derive no more than 15% of their income from non-member sources if they wish to remain tax-exempt. If the TAM had gone into affect, many co-ops would have surpassed the 15% threshold and become taxable entities.

In the ruling that effectively overturned the 1997 TAM, the IRS concluded that if a wholly owned subsidiary receives its income from co-op members and makes payments to its parent co-op for the purpose of providing service to members, then these payments are considered member income.

The TAM was the work of one IRS employee who misapplied the tax code while performing an audit, according to Tammie Logan, a government affairs representative with the National Telecommunications Cooperative Association, one of the groups that worked to have the ruling overturned.

“One of the things we presented to the IRS is the fact that when the TAM was assessed it was based on a tax code that was not relative to our members,” said Logan. “It was based on a section that dealt with farm co-ops.”

Still, the danger that the TAM would be applied to all telephone co-ops was real, and it took five years for it to be overturned. Much of the effort came from senators of rural states. One, Byron Dorgan (D-N.D.), wrote a letter to the IRS expressing his concerns about the ruling. That letter prompted the IRS to undertake a review of the TAM in late 1998 and refrain from applying it to co-ops while the review was underway.

Still, for some co-ops, the TAM resulted in being pushed into taxable status for a short period of time. For Lafayette, Tenn.-based North Central Telephone Cooperative, which serves about 24,000 access lines, the temporary status cost the company millions and subsequently hurt expansion plans, according to Thomas Rowland, president and CEO of NCTC. Not having to pay these taxes, he said, “would have given us more capital to expand with things like broadband services, which we're trying to deploy in rural areas.”

Indeed, pushing tax-exempt cooperatives into taxable status appears to go against the very purpose of allowing these businesses to avoid taxes in the first place. This benefit was first offered in the 1910s as a means of drumming up interest in what would otherwise be an unattractive market, thereby helping make telephone service universal. With the desire to push broadband Internet services into the same category, co-ops argue that the benefit should continue as a means of closing the digital divide.

“What we're doing is rolling out a lot of digital concentrators to make DSL available,” said Dwight Welch, CEO of Hardy Telecom, which serves 3500 access lines in Lost River, W. Va.

“That would have been curtailed [under this TAM]. If we didn't have these types of incentives, DSL would never be out here.”