Telecom Universal Service Fund payments not excludable from income under Sec. 118.

• Author: Van Leuven, Mary

Federal and state governmental entities sometimes make Universal Service Fund (USF) payments to telecommunications carriers for providing telephone and communication services to low-income users and those users in remote or isolated areas where such services are not as readily available and are more expensive. The courts have recently addressed the tax treatment of those payments.

On January 4, 2011, in AT&T, Inc., 629 F.3d 505 (5th Cir. 2011), the Fifth Circuit affirmed the district court's ruling that USF payments received by AT&T from various federal and state government entities were not excludible from gross income as nonshareholder contributions to capital under Sec. 118. The district court had granted summary judgment to the government, finding there to he no genuine issue of material fact as to whether the payments were intended to subsidize revenue rather than capital (AT&T Inc., No. SA-07-CV-0197 OG (W.D. Tex. 5/4/09)). On appeal to the Fifth Circuit, the taxpayer had argued that the district court erred by failing to apply a five-factor test established by the Supreme Court. The Fifth Circuit agreed with the result reached by the district court but applied both the district court's test and the five-factor test.

Sec. 118

Generally, any contribution of money or property made to the capital of a corporate taxpayer by a shareholder or nonshareholder is excluded from the recipient's income under Sec. 118. Given the absence of guidance in the statute and regulations, the relevant criteria for determining whether a nonshareholder payment is excludible have been developed in the courts, including the Supreme Court on several occasions. In some early decisions, the courts applied a functional use test that focused on the recipient's use of the funds, but subsequent courts have generally applied a more subjective test that focuses on the contributor's motive for the contribution. In Chicago, Burlington & Quincy R.R. Co., 412 U.S. 401 (1973) (CB&Q), the Supreme Court set forth five factors--at least four of which must ordinarily be satisfied before a court could conclude that the contributor's motive was to make a capital contribution:

* The contribution must become a permanent part of the transferee's working capital structure;

* The contribution must not be compensation, such as a direct payment for a specific, quantifiable service provided for the transferor by the transferee;

* The contribution must be bargained for;

* The asset...