Government Purchasing Co-Ops Operate Tax Free
Frederick, Donald A., Rural Cooperatives
State and local governments that see opportunities to hold down costs by procuring goods and services through a cooperative should gain assurance from a recent Internal Revenue Service (IRS) administrative determination. While no Subchapter T tax issues are involved, the decision highlights another Internal Revenue Code (Code) section helpful to public institutions which organize a separate entity to engage in joint purchasing activities.
Code Sec. 115 provides that gross income for federal income tax purposes does not include income accruing to a state or territory, or any political subdivision thereof, which is derived from a "... public utility or the exercise of any essential governmental function." This provision gives state and local governments the flexibility to create separate entities to perform essential services without incurring federal income tax liability on earnings that are (1) generated by those entities and (2) retained within the public sector.
In Private Letter Ruling 200610001 (released March 10, 2006), the IRS determined that income earned by a nonprofit corporation, formed by public school districts for the purpose of cooperatively purchasing supplies, is not taxable income under Code section 115.
Two school districts formed a nonprofit corporation for the sole purpose of purchasing goods and services for public school districts and other members. The ruling points out that "Through cooperative purchasing power, Taxpayer enables its members to purchase a range of goods and services at reduced prices."
The ruling doesn't discuss who became members of the association, its governance structure or its previous tax history. But as the basis for submitting its request for a ruling that it is entitled to tax-free status, the purchasing association amended its articles of incorporation to provide that its members must be public school districts or other government entities that meet the requirements of Code Sec. …