935 F. 2d 274 - Lockwood Water Users Association v. United States

MEMORANDUM**

The United States appeals a judgment holding that Lockwood Water Users Association retained its tax exempt status in 1985 under Internal Revenue Code section 501(c)(12)(A). The United States argues that because more than 15 percent of the Association's income in 1985 came from investment interest, the exemption was lost. We reverse.

A mutual company like the Association is tax-exempt under section 501(c)(12)(A) "only if 85 percent or more of the income consists of amounts collected from members for the sole purpose of meeting losses and expenses." In 1985, the Association received $591,135 from its members and $422,860 in interest on bond proceeds held in trust accounts. If the investment interest is part of the Association's 1985 gross income, it constitutes 41.7% of that income.

The district court held that for purposes of section 501(c)(12)(A), the interest was not income and did not come from a nonmember source. We disagree with both conclusions.

Interest received by or credited to the taxpayer constitutes gross income. See 26 U.S.C. Sec. 61(a)(4); 26 C.F.R. Sec. 1.61-7(a); United Grocers, Ltd. v. United States, 308 F.2d 634, 637 (9th Cir.1962) (through broad language of section 61(a), Congress intended to "tax all gains except those specifically exempted"). Although the funds were held for the Association by a trustee, the record reflects that the Association had a voice in the disposition of the money. It used the funds to pay for the construction project and repay the loan from Yellowstone County. The interest was a part of the Association's gross income. See Commissioner v. Wilcox, 327 U.S. 404, 407-08 (1946).

We recognize that the Association applied some of the investment interest toward repaying the loan from the County, but that fact does not support excluding the interest from the Association's gross income. See Helvering v. Horst, 311 U.S. 112, 116-17 (1940) (investment interest included in taxpayer's gross income where taxpayer transferred right to receive interest to another person); Old Colony Trust Co. v. Commissioner, 279 U.S. 716, 729-30 (1929). That the Association was obligated to pay 3 percent more in interest on the loan than it gained from the investment of the loan proceeds is not controlling. Interest payments to the County may properly be deducted from income under 26 U.S.C. Sec. 163.

Although the Association's members ultimately bore the cost of the construction project through higher water rates, the fee paid by the members is the price of providing water, not a contribution to capital. See Detroit Edison Co. v. Commissioner, 319 U.S. 98, 103 (1943) (payments for price of service were not capital contributions); United Grocers, 308 F.2d at 640 (membership payments to grocers' cooperative were payments for price of service and therefore not capital contributions).

Section 501(c)(12)(A) sets forth a requirement, not a guideline. The statute unambiguously provides that if less than 85 percent of the income consists of amounts collected from members, there is no tax exemption. Less than 85% of the Association's income in 1985 came from member sources. The Association therefore does not qualify under section 501(c)(12)(A) as a tax-exempt entity.

Although the record reflects that the Association may have qualified in 1985 for tax exempt status under 26 U.S.C. Sec. 501(c)(4), see United States v. Pickwick Electric Membership Corp., 158 F.2d 272, 276 (6th Cir.1946), no application for exemption under that section was made. We therefore do not reach that issue.

REVERSED.