By Samuel Loney*
As solar and renewable power technology has become cheaper and more accessible, there have been a number of electric power cooperatives sprouting up. Originally, electric cooperatives were created to address rural areas neglected by traditional investor-owned utilities, who were deterred by both high infrastructure cost and low return on investment.[i] Today, electric cooperative entities have stepped into the urban realm and have purposes that extend beyond the provision of electric power, including focuses on democratic control and access to renewable energy,[ii] “providing centralized purchasing and financing services relating to energy efficient and sustainable products and services for members,”[iii] and to facilitate lower electric costs and greater energy independence.[iv]
Generally speaking, electric cooperatives are “considered nonprofit corporations and are granted Federal tax-exempt status under IRC section 501(c)(12).”[v] IRC 501(c)(12) exempts a number of organizations, including mutual or cooperative electric companies and “like organizations,” from federal income tax, provided that the organizations receives 85 percent or more of their income from members for the sole purpose of meeting losses and expenses each year.[vi] However, companies that are created to finance the purchase of appliances and equipment are not deemed a “like organization.”[vii] Neither are companies made with the purpose of “selling electric materials, equipment, and supplies, and furnishing equipment for manufacturing, repair, testing, and other services.”[viii]
Unlike traditional means of electric power generation and transmission, which use power plants and power lines to bring offsite generated energy to members’ homes, solar powered energy provides the potential for onsite electric generation and use. Instead of (or in addition to) selling members electricity, these cooperatives can furnish the means of generating electricity by selling and/or financing the purchase of solar panels to be installed directly on the home.[ix] The question then presented is whether or not this new model qualifies the cooperative as an electric company or “like organization” to be granted 501(c)(12) tax-exempt status.
The issue of what constitutes a “like organization” was addressed head on in Consumers Credit Rural Electric Cooperative Corp. v. Commissioner. In this case, the 6th Circuit affirmed the holding that a cooperative that financed the sale of electric appliances and installed electric systems had operations more akin to that of a bank or finance company, and did not suffice as a “like organization.”[x] This was held despite the fact that the cooperative’s members were themselves “tax exempt rural electric cooperative associations engaged in the distribution of electrical energy.”[xi]
In Rev. Rule 65-201, 1965-2 C.B. 170, the IRS held that an organization formed “to promote and encourage the use of electric energy in rural areas by manufacturing and making available to its member cooperatives and their members, electric devices, equipment, wiring, appliances, fixtures, material, supplies of all kinds, and machinery; [and] to purchase,… sell, and dispose of real and personal property to accomplish its purposes…” did not qualify it as a “like organization” for purposes of 501(c)(12).[xii] However, in making this ruling, the IRS also mentioned that the activities “may be performed individually by the member cooperatives as an incident to their customary and primary function.”[xiii]
This holding by the IRS seems to indicate that an electric cooperative or like organization could engage in these otherwise non-exempt activities so long as these activities were subordinate to its primary purpose. Indeed, this position was affirmed in a 1980 General Counsel Memorandum, in which the IRS concluded that an electric generation and transmission cooperative which sells and services electric appliances is a “like organization” under 501(c)(12).[xiv] The Memorandum also notes that the sale and service activity was “subordinate to its primary purpose” in that it was “limited in scope and incidental to and in furtherance of the purpose of furnishing electric service to members.”[xv] Further, the income received from these activities was only tax-exempt to the extent it was received from members of the cooperative. Income from nonmembers was to be treated as unrelated trade or business income.[xvi] Unrelated trade or business income will be treated as taxable income by the organization, notwithstanding the cooperative’s tax-exempt status.[xvii]
However, even when products are sold to members of a 501(c)(12) tax-exempt cooperative, it is not certain that the associated income will be treated as tax-exempt. In Rev. Rul. 2002-54, 2002-2 C.B. 527 (2002), the IRS held that the distribution of propane to members was not only not exempt, but could also affect the cooperative’s tax-exempt status.[xviii] The reasoning stated by the IRS was that the sale of tanked propane is “not a public utility type service because the rates charged for tanked propane are not and traditionally have not been regulated (aside from safety regulations) by states or the federal government,” and does not require the extensive infrastructure typically involved in the distribution of energy.[xix] Income from the sale of propane is therefore treated as unrelated business income and subject to tax unless and until it causes the organization to fail the 85 percent member income test.[xx]
The 1980 IRS General Counsel Memorandum referred to above did not reference whether the appliances in question were subject to state or federal government regulation outside of safety regulations, nor did it refer to extensive infrastructure that the sale and service of these appliances need be reliant on. In the case of solar panels, while the price of panels themselves might not be regulated, their use creates a public utility parallel via the regulation of electricity rates. Regarding infrastructure, a key benefit of solar panels is that they can be installed onsite at an individual household and do not require the same extensive infrastructure network to bring electricity from the source of generation to the user’s home. However, a solar power energy cooperative which decides to utilize similar offsite power generation (e.g. using a solar farm), or which connects the solar panel into the existing electric grid, such as to feed it back into the grid for a rebate, would be making use of and relying on an extensive infrastructure network.
In this way, a cooperative enterprise may be able to retain tax-exempt status for the sale and servicing of solar panel equipment to individual households. However, the principle underlying whether the cooperative can even receive 501(c)(12) tax-exempt status to begin with centers on whether it is an electric company or “like organization,” and as such its principal purpose needs to be the provision of electricity and not the sale and financing of solar power generating equipment. While the determination will depend on the specific facts and circumstances of each case, a solar power energy cooperative stands the best chance of receiving 501(c)(12) tax-exempt status when its purpose is to provide electricity and any sale of equipment is only done in furtherance of and incidental to that purpose. Further, the panels should be reliant on an infrastructure network to satisfy the framework of the 2002 Revenue Ruling. In practice, this will likely mean setting up a system in which the cooperative entity, and not individual members, own the solar panels being used and setting up a grid-tie system to utilize an infrastructure network.
*Samuel Loney is an Associate Editor on MJEAL. They can be reached via email at email@example.com.
[i] Yassi Eskandari and Jill Jacobs, Energy Cooperatives, Co-OpLaw.Org, https://www.co-oplaw.org/co-op-basics/types/energy-cooperatives/ (last visited Oct. 27, 2019).
[ii] Bylaws of People Power Solar Cooperative, Inc., People Power Solar Coop., 4-5 (Mar. 31, 2019) https://www.peoplepowersolar.org/documents (follow “People Power Bylaws” hyperlink).
[iii] Bylaws of Cooperative Energy Futures, Cooperative Energy Futures, 1 (April 24, 2016).
[iv] About,Hawaii Island Energy Cooperative, http://www.hiec.coop/about.html (last visited Oct. 27, 2019).
[v] Eskandari & Jacobs, supra note 1.
[vi] Organizations Exempt Under IRC 501(c)(12), Internal Revenue Service, (Sep. 10, 2017), https://www.irs.gov/irm/part7/irm_07-025-012.
[vii] Consumers Credit Rural Electric Cooperative Corp. v. Commissioner, 37 T.C. 136 (1961), aff’d on exemption issue, 319 F.2d 475, 478 (6th Cir. 1963).
[viii] Rev. Rul. 65-201, 1965-2 C.B. 170.
[ix] See Solar Homes, Cooperative Energy Futures, https://cooperativeenergyfutures.com/solar-leasing/ (last visited Oct. 27, 2019).
[x] Consumers Credit, 319 F.2d at 478.
[xi] Id.at 477.
[xii] Rev. Rul. 65-201, 1965-2 C.B. 170.
[xiv] I.R.S. Gen. Couns. Mem. 38,511 (I.R.S. Sept. 26, 1980).
[xvii] 26 U.S.C. § 511 (1988).
[xviii] Rev. Rul. 2002-54, 2002-2 C.B. 527 (2002).
[xx] See id.