Taxable Nonprofit Organization Ruled to Be Nontaxable on Loan Proceeds Obtained as Funding Vehicle for Development of Sports Stadium

• Date: 01 August 2017
• Published date: 01 August 2017
• DOI: http://doi.org/10.1002/npc.30353

Bruce R. Hopkins’ NONPROFIT COUNSEL

5

August 2017

THE LAW OF TAX-EXEMPT ORGANIZATIONS MONTHLY

Bruce R. Hopkins’ Nonprofit Counsel DOI:10.1002/npc

TAXABLE NONPROFIT

ORGANIZATION RULED

TO BE NONTAXABLE

ON LOAN PROCEEDS

OBTAINED AS FUNDING

VEHICLE FOR DEVELOPMENT

OF SPORTS STADIUM

The IRS ruled that funds received by a taxable non-

profit corporation from its members are not includible in

its gross income for federal tax purposes because they

are proceeds of loans (Priv. Ltr. Rul. 201722004).

Facts

A sports league approved relocation of a team (Team)

to a city (City). The Team will be a tenant in a stadium to be

built in the City. This corporation and its proceeds program

(described below) are a significant component of the pro-

posed financing of the construction of this new stadium.

This nonprofit corporation is a membership organi-

zation for fans of the Team (Fan Club or club). The initial

member of the Fan Club will be a limited liability com-

pany (LLC1), owned by an individual. The LLC1 will be

the sole voting member of the Fan Club and will appoint

the club’s board of directors.

Another limited liability company (LLC2) owns the

Team. LLC2 is owned by two LLCs (LLC3 and LLC4). LLC4

is wholly owned by an individual. LLC3 is owned by a cor-

poration, which is wholly owned by this individual, and by

this individual personally. The stadium will be constructed

and owned by another limited liability company (LLC5).

The stadium will be privately financed, owned, and

maintained. A portion of the cost of the stadium construc-

tion will be funded by money received by the Fan Club and

loaned to LLC5 (see below). The stadium is contemplated

to be the anchor of a private, multibillion-dollar residential

and commercial complex located a few miles from the City.

The Fan Club and its membership program will be a

significant part of the building of a Team fan base in the

City area. The Fan Club will enter into a contract with

LLC2 pursuant to which the club will receive certain

benefits for its members, including the right of members

to enter into a limited number of “personal seat license”

(PSL) agreements with the club. These PSL agreements

will be assigned by the Fan Club to LLC2, which will

assume all obligations under the agreements.

This contract is being entered into by LLC2 as an

inducement to LLC5 to build the stadium. The contract

will provide that the proceeds transferred by members

with PSL agreements will be segregated from other

assets through use of a trust established for the benefit

of the Fan Club (Trust). The Trust will loan the proceeds

to LLC5 to be dedicated and used exclusively for stadium

construction. The Trust will be treated for federal tax

purposes as a grantor trust of the club.

An individual or organization may become a member

of the Fan Club. Each member of the Fan Club will execute

a membership agreement with the club and pay a one-

time, nonrefundable initiation fee. This fee will be taxable

income to the Fan Club. In accordance with the agree-

ment, each member will receive benefits for each inherit-

able and transferable membership interest in the Fan Club.

Members must also pay refundable proceeds. The

documentation will provide for repayment of the pro-

ceeds at the close of a fixed term. An interest in the Fan

Club will be inheritable and otherwise transferable, sub-

ject to legal requirements. The cost of the development

and maintenance of the stadium will be privately financed

by the owner of LLC4. The proceeds will be received by

the Trust, dedicated to the construction costs of the sta-

dium. The Trust will loan the total amount of the proceeds

to LLC5. This loan will be made at an interest rate that

will be sufficient to allow for operation of the Fan Club.

The Trust’s loan to LLC5 is expected to remain out-

standing for its term, although LLC5 may repay the

loan at any time. An amount will be contributed by the

owner of LLC4 to a defeasance fund; that amount will

be sufficient to equal or exceed on an after-tax basis

the amount required to provide for full repayment of

the Trust loan and repayment by the Fan Club of the

proceeds to the members at the end of the loan’s term.

Analysis

In this case, the IRS accepted the representation that

the proceeds received by the Fan Club from its members

are subject to a legally enforceable obligation of the club

to repay its members. The proceeds are being treated for

all purposes as a liability of the Fan Club. The IRS added

that implementation of the defeasance fund mechanism

will ensure that this liability of the Fan Club to repay the

proceeds to its members will be satisfied.

Therefore, because the Fan Club lacks the requisite

complete control over the proceeds, the IRS ruled that the

proceeds are not gross income to the club for federal income

tax purposes in light of the legally binding obligation of the

club to repay the proceeds to its members. [1.1(a)]

Comment: If nothing else, this ruling illustrates use of a

rare type of entity, the taxable nonprofit organization. ◆

WATCH OUT FOR WEBSITE

CONTENT

An IRS private letter ruling illustrates the agency’s post-

determination process in connection with the streamlined

application for recognition of exemption (Form 1023-EZ)

and the use the IRS makes, in addition to the attestations

on the application, of information on the applicant’s