81 FR 8870 - Definition of Political Subdivision

DEPARTMENT OF THE TREASURY
Internal Revenue Service

Federal Register Volume 81, Issue 35 (February 23, 2016)

Page Range		8870-8874
FR Document		2016-03790
This document contains proposed regulations that provide guidance regarding the definition of political subdivision for purposes of tax-exempt bonds. The proposed regulations are necessary to specify the elements of a political subdivision. The proposed regulations will affect State and local governments that issue tax-exempt bonds and users of property financed with tax-exempt bonds. Under certain transition rules, however, the proposed definition of political subdivision will not apply for determining whether outstanding bonds are obligations of a political subdivision and will not apply to existing entities for a transition period. This document also provides a notice of a public hearing for these proposed regulations.
Federal Register, Volume 81 Issue 35 (Tuesday, February 23, 2016)
[Federal Register Volume 81, Number 35 (Tuesday, February 23, 2016)]
[Proposed Rules]
[Pages 8870-8874]
From the Federal Register Online  [www.thefederalregister.org]
[FR Doc No: 2016-03790]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[REG-129067-15]
RIN 1545-BM99


Definition of Political Subdivision

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking and notice of public hearing.

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SUMMARY: This document contains proposed regulations that provide 
guidance regarding the definition of political subdivision for purposes 
of tax-exempt bonds. The proposed regulations are necessary to specify 
the elements of a political subdivision. The proposed regulations will 
affect State and local governments that issue tax-exempt bonds and 
users of property financed with tax-exempt bonds. Under certain 
transition rules, however, the proposed definition of political 
subdivision will not apply for determining whether outstanding bonds 
are obligations of a political subdivision and will not apply to 
existing entities for a transition period. This document also provides 
a notice of a public hearing for these proposed regulations.

DATES: Written or electronic comments must be received by May 23, 2016. 
Request to speak and outlines of topics to be discussed at the public 
hearing scheduled for June 6, 2016, at 10:00 a.m., must be received by 
May 23, 2016.

ADDRESSES: Send submissions to: CC:PA:LPD:PR (REG-129067-15), Internal 
Revenue Service, P.O. Box 7604, Ben Franklin Station, Washington, DC 
20044. Submissions may be hand delivered to: CC:PA:LPD:PR Monday 
through Friday between the hours of 8 a.m. and 4 p.m. to CC:PA:LPD:PR 
(REG-129067-15), Courier's Desk, Internal Revenue Service, 1111 
Constitution Avenue NW., Washington, DC, or sent electronically via the 
Federal eRulemaking Portal at www.regulations.gov (REG-129067-15). The 
public hearing will be held at the Internal Revenue Building, 1111 
Constitution Avenue NW., Washington, DC.

FOR FURTHER INFORMATION CONTACT: Concerning the proposed regulations, 
Spence Hanemann at (202) 317-6980; concerning submissions of comments 
and the hearing, Oluwafunmilayo (Funmi) Taylor at (202) 317-6901 (not 
toll-free numbers).

SUPPLEMENTARY INFORMATION:

Background

    This document contains proposed amendments to 26 CFR part 1 under 
section 103 of the Internal Revenue Code (Code). Section 103 generally 
provides that, with certain exceptions, gross income does not include 
interest on any obligation of a State or political subdivision thereof. 
Section 1.103-1 of the Income Tax Regulations (the Existing 
Regulations) defines political subdivision as ``any division of any 
State or local governmental unit which is a municipal corporation or 
which has been delegated the right to exercise part of the sovereign 
power of the unit.''
    On a few occasions, Federal courts have ruled on whether an entity 
qualifies as a political subdivision. E.g., Philadelphia Nat'l Bank v. 
United States, 666 F.2d 834 (3d Cir. 1981); Comm'r of Internal Revenue 
v. White's Estate, 144 F.2d 1019 (2d Cir. 1944). The IRS has also 
addressed this issue in revenue rulings, most recently in 1983. E.g., 
Rev. Rul. 83-131 (1983-2 CB 184); Rev. Rul. 78-138 (1978-1 CB 314). 
Because the results in these revenue rulings generally turn on the 
unique facts and circumstances of the individual cases, numerous 
entities have sought and received letter rulings on whether they are 
political subdivisions. Letter rulings, however, are limited to their 
particular facts, may not be relied upon by taxpayers other than the 
taxpayer that received the ruling, and are not a substitute for 
published guidance. See 26 U.S.C. 6110(k)(3) (2015) (providing 
generally that a ruling, determination letter, or technical advice 
memorandum may not be used or cited as precedent).
    Commenters have requested additional published guidance, to be 
applied prospectively, on which facts and circumstances are germane to 
an entity's status as a political subdivision. The Treasury Department 
and IRS recognize the need to clarify the definition of political 
subdivision to provide greater certainty to prospective issuers and to 
promote greater consistency in how the definition is applied across a 
wide range of factual situations. These proposed regulations (the 
Proposed Regulations) would provide a new definition of political 
subdivision for purposes of tax-exempt bonds and would update and 
streamline other portions of the Existing Regulations. The definition 
of political subdivision in the Proposed Regulations does not apply in 
determining whether an entity is treated as a political subdivision of 
a State for purposes of section 414(d) of the Code.

Explanation of Provisions

1. Definition of Political Subdivision

    The Proposed Regulations clarify and further develop the 
eligibility requirements for a political subdivision. To qualify as a 
political subdivision under the Proposed Regulations, an entity must 
meet three requirements, taking into account all of the facts and 
circumstances: sovereign powers, governmental purpose, and governmental 
control. The Proposed Regulations also authorize the Commissioner to 
set forth in future guidance to be published in the Internal Revenue 
Bulletin additional circumstances in which an entity qualifies as a 
political subdivision.
A. Sovereign Powers
    The Proposed Regulations continue, without substantive change, the 
longstanding requirement that a political subdivision be empowered to 
exercise at least one of the generally recognized sovereign powers. The 
three sovereign powers recognized for this purpose are eminent domain, 
police power, and taxing power. See Comm'r of Internal Revenue v. 
Shamberg's Estate, 144 F.2d 998 (2d Cir. 1944). The entity must be able 
to exercise a substantial amount of at least one of these powers. See, 
e.g., Rev. Rul. 77-164 (1977-1 CB 20); Rev. Rul. 77-165 (1977-1 CB 21).
B. Governmental Purpose
    In determining whether an entity is a political subdivision, the 
case law and administrative guidance interpreting the definition of 
political subdivision in the Existing Regulations commonly consider 
whether the entity serves a public purpose. Historically, the 
determination of whether an entity serves a public purpose has focused 
on the purpose for which the entity was

[[Page 8871]]

created, usually as set forth in the legislation authorizing creation 
of the entity, rather than on the entity's conduct after its creation. 
See, e.g., Shamberg's Estate, 144 F.2d at 1004. The Proposed 
Regulations require that a political subdivision serve a governmental 
purpose. A governmental purpose requires, among other things, that the 
purpose for which the entity was created, as set out in its enabling 
legislation, be a public purpose and that the entity actually serve 
that purpose. It also requires that the entity operate in a manner that 
provides a significant public benefit with no more than incidental 
benefit to private persons. Cf., Rev. Rul. 90-74 (1990-2 CB 34) 
(applying an ``incidental private benefit'' standard for purposes of 
determining whether income is included in gross income under section 
115(1)).
C. Governmental Control
    The Proposed Regulations provide that a political subdivision must 
be governmentally controlled. The Proposed Regulations provide rules 
for determining both what constitutes control and which parties must 
possess that control.
i. Definition of Control
    The Proposed Regulations define control to mean ongoing rights or 
powers to direct significant actions of the entity. Rights or powers to 
direct the entity's actions only at a particular point in time are not 
ongoing and, therefore, do not constitute control. For example, the 
right to approve an entity's plan of operation as a condition of the 
entity's formation is not an ongoing right. To constitute control, a 
collection of rights and powers must enable its holder to direct the 
significant actions of the entity.
    The Proposed Regulations provide three non-exclusive benchmarks of 
rights or powers that constitute control: (1) The right or power both 
to approve and to remove a majority of an entity's governing body; (2) 
the right or power to elect a majority of the governing body of the 
entity in periodic elections of reasonable frequency; or (3) the right 
or power to approve or direct the significant uses of funds or assets 
of the entity in advance of that use. Aside from these three 
arrangements, the determination of whether a collection of rights and 
powers constitutes control will depend on the facts and circumstances. 
Neither the right to dissolve an entity nor procedures designed to 
ensure the integrity of the entity but not to direct significant 
actions of the entity are control. Cf., Rev. Rul. 69-453 (1969-2 CB 
182) (addressing procedures that do not constitute control in the 
context of instrumentalities).
ii. Control Vested in a State or Local Governmental Unit or an 
Electorate
    Control by a small faction of private individuals, business 
corporations, trusts, partnerships, or other persons is fundamentally 
not governmental control. Therefore, the Proposed Regulations generally 
require that control be vested in either a general purpose State or 
local governmental unit or in an electorate established under an 
applicable State or local law of general application. If, however, a 
small faction of private persons controls an electorate, that 
electorate's control of the entity does not constitute governmental 
control of the entity. Accordingly, the Proposed Regulations provide 
that an entity controlled by an electorate is not governmentally 
controlled when the outcome of the exercise of control is determined 
solely by the votes of an unreasonably small number of private persons.
    The determination of whether the number of private persons 
controlling an electorate is unreasonably small generally depends on 
all of the facts and circumstances. To provide certainty, the Proposed 
Regulations limit application of this facts and circumstances test to 
situations that fall between two quantitative measures of concentration 
in voting power. The number of private persons controlling an 
electorate is always unreasonably small if the combined votes of the 
three voters with the largest shares of votes in the electorate will 
determine the outcome of the relevant election, regardless of how the 
other voters vote. The number of private persons controlling an 
electorate is never unreasonably small if determining the outcome of 
the relevant election requires the combined votes of more voters than 
the 10 voters with the largest shares of votes in the electorate. For 
example, control can always be vested in any electorate comprised of 20 
or more voters that each have the right to cast one vote in the 
relevant election without giving rise to a private faction. For 
purposes of applying these measures of concentration in voting power, 
related parties are treated as a single voter and the votes of the 
related parties are aggregated.
iii. Possible Relief for Development Districts
    Some observers have suggested that, despite private control, 
development districts should be political subdivisions during an 
initial development period in which one or two private developers elect 
the district's governing body and no other governmental control exists. 
The Treasury Department and IRS recognize that the governmental control 
requirement may present challenges for such development districts. In 
these circumstances, the Treasury Department and IRS are concerned 
about the potential for excessive private control by individual 
developers, the attendant impact of excessive issuance of tax-exempt 
bonds, and inappropriate private benefits from this Federal subsidy. 
The Treasury Department and IRS seek public comment on whether it is 
necessary or appropriate to permit such districts to be political 
subdivisions during an initial development period; how such relief 
might be structured; what specific safeguards might be included in the 
recommended relief to protect against potential abuse; and whether the 
proposed prospective effective dates and transition periods in Sec.  
1.103-1(d) of the Proposed Regulations provide sufficient relief.

2. Streamlining Amendments

    In addition to amending the definition of political subdivision, 
paragraphs (a) and (b) of the Proposed Regulations update the 
references in the general provisions of the Existing Regulations to 
reflect changes to the Code made in the Tax Reform Act of 1986, Public 
Law 99-514, 100 Stat. 2085, and other laws and regulations since the 
promulgation of the longstanding Existing Regulations. The Proposed 
Regulations also streamline these provisions. In general, the Treasury 
Department and the IRS intend that these proposed amendments not change 
the meaning of the Existing Regulations. The last sentence of Sec.  
1.103-1(a) of the Proposed Regulations, however, clarifies that the 
continued tax-exemption of an issue of bonds depends on its issuer's 
continued status as a qualifying issuer of tax-exempt bonds. The 
Treasury Department and IRS seek comments on the need for remedial 
action provisions in the event the entity ceases to qualify as a 
political subdivision and on the substance of any such provisions.

3. Applicability Dates and Reliance on Proposed Regulations

    Subject to certain transition rules, the Proposed Regulations 
generally would apply to all entities for all purposes of the tax-
exempt bond provisions of sections 103 and 141 to 150 beginning 90 days 
after the Proposed Regulations are finalized. In order to ease hardship 
that may arise from the new definition

[[Page 8872]]

of political subdivision, under proposed transition rules, that 
definition would not apply for purposes of determining whether 
outstanding bonds and refunding bonds in which the weighted average 
maturity is not extended continue to be obligations of a political 
subdivision. While these transition rules for outstanding bonds and 
refunding bonds would apply for the purpose of determining whether 
these bonds continue to be obligations of a political subdivision, the 
new proposed definition of political subdivision would apply for other 
purposes under sections 103 and 141 to 150, such as whether a new 
entity that subsequently became a user of a project financed with such 
bonds qualified as a State or local governmental unit for purposes of 
section 141. Furthermore, under another proposed transition rule that 
would apply to entities in existence prior to 30 days after the 
Proposed Regulations are published, the proposed definition of 
political subdivision would not apply for any purpose until three years 
and ninety days after the Proposed Regulations are finalized. This 
three-year transition period provides existing entities an opportunity 
to restructure as necessary to satisfy the new definition of political 
subdivision and allows existing entities to continue to issue new bonds 
during the transition period. To enhance certainty, an issuer also may 
choose to apply the definition of political subdivision in Sec.  1.103-
1(c) in the final regulations in circumstances in which that definition 
otherwise would not apply under the transition rules.
    In addition, prior to the applicability date of the final 
regulations, issuers may elect to apply the definition of political 
subdivision in Sec.  1.103-1(c) of the Proposed Regulations in whole, 
but not in part, for any purpose of sections 103 and 141 through 150, 
provided such use is applied consistently for all purposes of sections 
103 and 141 through 150 to any given entity.

Special Analyses

    Certain IRS regulations, including this one, are exempt from the 
requirements of Executive Order 12866, as supplemented and reaffirmed 
by Executive Order 13563. Therefore, a regulatory impact assessment is 
not required. It also has been determined that section 553(b) of the 
Administrative Procedure Act (5 U.S.C. chapter 5) does not apply to 
these regulations, and because these regulations do not impose a 
collection of information on small entities, the Regulatory Flexibility 
Act (5 U.S.C. chapter 6) does not apply. Pursuant to section 7805(f) of 
the Code, this notice of proposed rulemaking has been submitted to the 
Chief Counsel for Advocacy of the Small Business Administration for 
comment on its impact on small entities.

Comments and Public Hearing

    Before these Proposed Regulations are adopted as final regulations, 
consideration will be given to any comments that are submitted timely 
to the IRS as prescribed in this preamble under the ``Addresses'' 
heading. The Treasury Department and the IRS request comments on all 
aspects of the proposed rules. All comments will be available at 
www.regulations.gov or upon request.
    A public hearing has been scheduled for June 6, 2016, at 10:00 
a.m., in the Auditorium of the Internal Revenue Building, 1111 
Constitution Avenue NW., Washington, DC. Due to building security 
procedures, visitors must enter at the Constitution Avenue entrance. In 
addition, all visitors must present photo identification to enter the 
building. Because of access restrictions, visitors will not be admitted 
beyond the immediate entrance area more than 30 minutes before the 
hearing starts. For more information about having your name placed on 
the building access list to attend the hearing, see the FOR FURTHER 
INFORMATION CONTACT section of this preamble.
    The rules of 26 CFR 601.601(a)(3) apply to the hearing. Persons who 
wish to present oral comments at the hearing must submit an outline of 
the topics to be discussed and the time to be devoted to each topic by 
May 23, 2016. Submit a signed paper or electronic copy of the outline 
as prescribed in this preamble under the ``Addresses'' heading. A 
period of 10 minutes will be allotted to each person for making 
comments. An agenda showing the scheduling of the speakers will be 
prepared after the deadline for receiving outlines has passed. Copies 
of the agenda will be available free of charge at the hearing.

Drafting Information

    The principal authors of these regulations are Spence Hanemann and 
Timothy Jones, Office of Associate Chief Counsel (Financial 
Institutions and Products), IRS. However, other personnel from the IRS 
and the Treasury Department participated in their development.

Availability of IRS Documents

    IRS revenue rulings cited in this notice of proposed rulemaking are 
made available by the Superintendent of Documents, U.S. Government 
Printing Office, Washington, DC 20402.

List of Subjects in 26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

Proposed Amendments to the Regulations

    Accordingly, 26 CFR part 1 is proposed to be amended as follows:

PART 1--INCOME TAXES

0
Paragraph 1. The authority citation for part 1 continues to read in 
part as follows:

    Authority: 26 U.S.C. 7805 * * *

0
Par. 2. Section 1.103-1 is revised to read as follows:


Sec.  1.103-1  Interest on State or local bonds.

    (a) Interest on State or local bonds. Under section 103(a), except 
as otherwise provided in section 103(b), gross income does not include 
interest on any State or local bond. Under section 103(c), the term 
State or local bond means any obligation (as defined in Sec.  1.150-
1(b)) of a State (including for this purpose the District of Columbia 
or any possession of the United States) or a political subdivision 
thereof (a State or local governmental unit). Obligations issued by or 
on behalf of any State or local governmental unit by a constituted 
authority empowered to issue such obligations are the obligations of 
such a unit. An obligation qualifies as a State or local bond so long 
as the issuer of that obligation remains a State or local governmental 
unit or a constituted authority.
    (b) Certain limitations on interest exclusion. Under section 
103(b), the interest exclusion in section 103(a) is inapplicable to a 
private activity bond under section 141(a) (unless the bond is a 
qualified bond under section 141(e)), an arbitrage bond under section 
148, or a bond which does not meet the applicable requirements of 
section 149.
    (c) Definition of political subdivision--(1) In general. The term 
political subdivision means an entity that meets each of the 
requirements of paragraphs (c)(2) (sovereign powers), (c)(3) 
(governmental purpose), and (c)(4) (governmental control) of this 
section, taking into account all of the facts and circumstances, or 
that is described in published guidance issued pursuant to paragraph 
(c)(5) of this section. Entities that may qualify as political 
subdivisions include, among others, general purpose governmental 
entities, such as cities and counties (whether or not incorporated as 
municipal corporations), and special purpose governmental entities, 
such as special assessment districts that provide for

[[Page 8873]]

roads, water, sewer, gas, light, reclamation, drainage, irrigation, 
levee, school, harbor, port improvements, and other governmental 
purposes for a State or local governmental unit.
    (2) Sovereign powers. Pursuant to a State or local law of general 
application, the entity has a delegated right to exercise a substantial 
amount of at least one of the following recognized sovereign powers of 
a State or local governmental unit: The power of taxation, the power of 
eminent domain, and police power.
    (3) Governmental purpose. The entity serves a governmental purpose. 
The determination of whether an entity serves a governmental purpose is 
based on, among other things, whether the entity carries out the public 
purposes that are set forth in the entity's enabling legislation and 
whether the entity operates in a manner that provides a significant 
public benefit with no more than incidental private benefit.
    (4) Governmental control. A State or local governmental unit 
exercises control over the entity. For this purpose, control is defined 
in paragraph (c)(4)(i) of this section and a State or local 
governmental unit exercises such control only if the control is vested 
in persons described in paragraph (c)(4)(ii) of this section.
    (i) Definition of control. Control means an ongoing right or power 
to direct significant actions of the entity. Rights or powers may 
establish control either individually or in the aggregate. Among rights 
or powers that may establish control, an ongoing ability to exercise 
one or more of the following significant rights or powers, on a 
discretionary and non-ministerial basis, constitutes control: the right 
or power both to approve and to remove a majority of the governing body 
of the entity; the right or power to elect a majority of the governing 
body of the entity in periodic elections of reasonable frequency; or 
the right or power to approve or direct the significant uses of funds 
or assets of the entity in advance of that use. Procedures designed to 
ensure the integrity of the entity but not to direct significant 
actions of the entity are insufficient to constitute control of an 
entity. Examples of such procedures include requirements for submission 
of audited financial statements of the entity to a higher level State 
or local governmental unit, open meeting requirements, and conflicts of 
interest limitations.
    (ii) Control vested in a State or local governmental unit or an 
electorate. Control is vested in persons described in paragraphs 
(c)(4)(ii)(A) or (c)(4)(ii)(B) of this section or a combination 
thereof:
    (A) A State or local governmental unit possessing a substantial 
amount of each of the sovereign powers and acting through its governing 
body or through its duly authorized elected or appointed officials in 
their official capacities; or
    (B) An electorate established under applicable State or local law 
of general application, provided the electorate is not a private 
faction (as defined in paragraph (c)(4)(iii) of this section).
    (iii) Definition of private faction--(A) In general. A private 
faction is any electorate if the outcome of the exercise of control 
described in paragraph (c)(4)(i) of this section is determined solely 
by the votes of an unreasonably small number of private persons. The 
determination of whether a number of such private persons is 
unreasonably small depends on all of the facts and circumstances, 
including, without limitation, the entity's governmental purpose, the 
number of members in the electorate, the relationships of the members 
of the electorate to one another, the manner of apportionment of votes 
within the electorate, and the extent to which the members of the 
electorate adequately represent the interests of persons reasonably 
affected by the entity's actions. For purposes of this definition, the 
special rules in paragraphs (c)(4)(iii)(B) through (D) of this section 
apply.
    (B) Treatment of certain limited electorates as private factions. 
An electorate is a private faction if any three private persons that 
are members of the electorate possess, in the aggregate, a majority of 
the votes necessary to determine the outcome of the relevant exercise 
of control.
    (C) Safe harbor--voting power dispersed among more than 10 persons. 
An electorate is not a private faction if the smallest number of 
private persons who can combine votes to establish a majority of the 
votes necessary to determine the outcome of the relevant exercise of 
control is greater than 10 persons. For example, if an electorate 
consists of 20 private persons with equal, five-percent shares of the 
total votes, that electorate is not a private faction because a minimum 
of 11 members of that electorate is necessary to have a majority of the 
votes. By contrast, for example, if an electorate consists of 20 
private persons with unequal voting shares in which some combination of 
10 or fewer members has a majority of the votes, then that electorate 
does not qualify for the safe harbor from treatment as a private 
faction under this paragraph (c)(4)(iii)(C).
    (D) Operating rules. The following rules apply for purposes of 
determining numbers of voters and voting control in paragraphs 
(c)(4)(iii)(B) and (C) of this section:
    (1) Related parties (as defined in Sec.  1.150-1(b)) are treated as 
a single person; and
    (2) In computing the number of votes necessary to determine the 
outcome of the relevant exercise of control, all voters entitled to 
vote in an election are assumed to cast all votes to which they are 
entitled.
    (5) Authority of the Commissioner. In guidance published in the 
Internal Revenue Bulletin, the Commissioner may set forth additional 
circumstances in which an entity qualifies as a political subdivision 
of a State or local governmental unit. See Sec.  601.601(d)(2)(ii) of 
this chapter.
    (d) Applicability dates--(1) In general. Except as otherwise 
provided in paragraphs (d)(2) through (4) of this section, this section 
applies to all entities for all purposes of sections 103 and 141 
through 150 beginning on the date 90 days after the publication of the 
Treasury decision adopting these rules as final regulations in the 
Federal Register.
    (2) Applicability date of the definition of political subdivision 
for outstanding bonds. For purposes of determining whether outstanding 
bonds of an entity are obligations of a political subdivision under 
section 103, the definition of political subdivision in paragraph (c) 
of this section does not apply to that entity with respect to its 
outstanding bonds that are issued before the general applicability date 
under paragraph (d)(1) of this section.
    (3) Applicability date of the definition of political subdivision 
for refunding bonds. For purposes of determining whether refunding 
bonds of an entity are obligations of a political subdivision under 
section 103, the definition of political subdivision in paragraph (c) 
of this section does not apply to that entity with respect to its 
refunding bonds that are issued on or after the general applicability 
date under paragraph (d)(1) of this section to refund bonds with 
respect to which paragraph (c) of this section otherwise does not 
apply, provided that the weighted average maturity of the refunding 
bonds is no longer than the remaining weighted average maturity of the 
refunded bonds.
    (4) Applicability date of the definition of political subdivision 
for existing entities. For existing entities that are created or 
organized before March 24, 2016, the definition of political 
subdivision in paragraph (c) of this section does not apply for any 
purpose of sections 103 and 141 to 150 during the three-year period 
beginning on the

[[Page 8874]]

general applicability date under paragraph (d)(1) of this section.
    (5) Elective application of definition of political subdivision. An 
issuer may choose to apply the definition of political subdivision in 
paragraph (c) of this section to an issue of bonds in circumstances in 
which that section otherwise would not apply to that issue under 
paragraph (d)(2) or (3) of this section, provided that choice is 
applied consistently to the issue. An entity may choose to apply the 
definition of political subdivision in paragraph (c) of this section to 
an entity in circumstances in which that section otherwise would not 
apply to that entity under paragraph (d)(4) of this section, provided 
that choice is applied consistently to the entity.

John Dalrymple,
Deputy Commissioner for Services and Enforcement.
[FR Doc. 2016-03790 Filed 2-22-16; 8:45 am]
 BILLING CODE 4830-01-P
8870 Federal Register / Vol. 81, No. 35 / Tuesday, February 23, 2016 / Proposed Rules

proposed rule until April 25, 2016. We a.m. and 4 p.m. to CC:PA:LPD:PR (REG– The Treasury Department and IRS
believe that an additional 60-day period 129067–15), Courier’s Desk, Internal recognize the need to clarify the
allows adequate time for interested Revenue Service, 1111 Constitution definition of political subdivision to
persons to submit comments without Avenue NW., Washington, DC, or sent provide greater certainty to prospective
significantly delaying rulemaking on electronically via the Federal issuers and to promote greater
these important issues. The period for eRulemaking Portal at consistency in how the definition is
comments regarding information www.regulations.gov (REG–129067–15). applied across a wide range of factual
collection issues under the Paperwork The public hearing will be held at the situations. These proposed regulations
Reduction Act of 1995 remains Internal Revenue Building, 1111 (the Proposed Regulations) would
unchanged, where comments were to be Constitution Avenue NW., Washington, provide a new definition of political
submitted until February 22, 2016 (see DC. subdivision for purposes of tax-exempt
81 FR 3751, January 22, 2016). FOR FURTHER INFORMATION CONTACT: bonds and would update and streamline
Dated: February 18, 2016. Concerning the proposed regulations, other portions of the Existing
Leslie Kux, Spence Hanemann at (202) 317–6980; Regulations. The definition of political
concerning submissions of comments subdivision in the Proposed Regulations
Associate Commissioner for Policy.
and the hearing, Oluwafunmilayo does not apply in determining whether
[FR Doc. 2016–03716 Filed 2–22–16; 8:45 am]
(Funmi) Taylor at (202) 317–6901 (not an entity is treated as a political
BILLING CODE 4164–01–P subdivision of a State for purposes of
toll-free numbers).
SUPPLEMENTARY INFORMATION: section 414(d) of the Code.
DEPARTMENT OF THE TREASURY Background Explanation of Provisions
This document contains proposed 1. Definition of Political Subdivision
Internal Revenue Service
amendments to 26 CFR part 1 under The Proposed Regulations clarify and
26 CFR Part 1 section 103 of the Internal Revenue further develop the eligibility
Code (Code). Section 103 generally requirements for a political subdivision.
[REG–129067–15] provides that, with certain exceptions, To qualify as a political subdivision
RIN 1545–BM99 gross income does not include interest under the Proposed Regulations, an
on any obligation of a State or political entity must meet three requirements,
Definition of Political Subdivision subdivision thereof. Section 1.103–1 of taking into account all of the facts and
the Income Tax Regulations (the circumstances: sovereign powers,
AGENCY: Internal Revenue Service (IRS), Existing Regulations) defines political governmental purpose, and
Treasury. subdivision as ‘‘any division of any governmental control. The Proposed
ACTION: Notice of proposed rulemaking State or local governmental unit which Regulations also authorize the
and notice of public hearing. is a municipal corporation or which has Commissioner to set forth in future
been delegated the right to exercise part guidance to be published in the Internal
SUMMARY: This document contains of the sovereign power of the unit.’’
proposed regulations that provide Revenue Bulletin additional
On a few occasions, Federal courts circumstances in which an entity
guidance regarding the definition of have ruled on whether an entity
political subdivision for purposes of tax- qualifies as a political subdivision.
qualifies as a political subdivision. E.g.,
exempt bonds. The proposed Philadelphia Nat’l Bank v. United A. Sovereign Powers
regulations are necessary to specify the States, 666 F.2d 834 (3d Cir. 1981); The Proposed Regulations continue,
elements of a political subdivision. The Comm’r of Internal Revenue v. White’s without substantive change, the
proposed regulations will affect State Estate, 144 F.2d 1019 (2d Cir. 1944). longstanding requirement that a
and local governments that issue tax- The IRS has also addressed this issue in political subdivision be empowered to
exempt bonds and users of property revenue rulings, most recently in 1983. exercise at least one of the generally
financed with tax-exempt bonds. Under E.g., Rev. Rul. 83–131 (1983–2 CB 184); recognized sovereign powers. The three
certain transition rules, however, the Rev. Rul. 78–138 (1978–1 CB 314). sovereign powers recognized for this
proposed definition of political Because the results in these revenue purpose are eminent domain, police
subdivision will not apply for rulings generally turn on the unique power, and taxing power. See Comm’r
determining whether outstanding bonds facts and circumstances of the of Internal Revenue v. Shamberg’s
are obligations of a political subdivision individual cases, numerous entities Estate, 144 F.2d 998 (2d Cir. 1944). The
and will not apply to existing entities have sought and received letter rulings entity must be able to exercise a
for a transition period. This document on whether they are political substantial amount of at least one of
also provides a notice of a public subdivisions. Letter rulings, however, these powers. See, e.g., Rev. Rul. 77–164
hearing for these proposed regulations. are limited to their particular facts, may (1977–1 CB 20); Rev. Rul. 77–165
DATES: Written or electronic comments not be relied upon by taxpayers other (1977–1 CB 21).
must be received by May 23, 2016. than the taxpayer that received the
Request to speak and outlines of topics ruling, and are not a substitute for B. Governmental Purpose
to be discussed at the public hearing published guidance. See 26 U.S.C. In determining whether an entity is a
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scheduled for June 6, 2016, at 10:00 6110(k)(3) (2015) (providing generally political subdivision, the case law and
a.m., must be received by May 23, 2016. that a ruling, determination letter, or administrative guidance interpreting the
ADDRESSES: Send submissions to: technical advice memorandum may not definition of political subdivision in the
CC:PA:LPD:PR (REG–129067–15), be used or cited as precedent). Existing Regulations commonly
Internal Revenue Service, P.O. Box Commenters have requested consider whether the entity serves a
7604, Ben Franklin Station, Washington, additional published guidance, to be public purpose. Historically, the
DC 20044. Submissions may be hand applied prospectively, on which facts determination of whether an entity
delivered to: CC:PA:LPD:PR Monday and circumstances are germane to an serves a public purpose has focused on
through Friday between the hours of 8 entity’s status as a political subdivision. the purpose for which the entity was

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Federal Register / Vol. 81, No. 35 / Tuesday, February 23, 2016 / Proposed Rules 8871

created, usually as set forth in the Rev. Rul. 69–453 (1969–2 CB 182) development period in which one or
legislation authorizing creation of the (addressing procedures that do not two private developers elect the
entity, rather than on the entity’s constitute control in the context of district’s governing body and no other
conduct after its creation. See, e.g., instrumentalities). governmental control exists. The
Shamberg’s Estate, 144 F.2d at 1004. Treasury Department and IRS recognize
ii. Control Vested in a State or Local
The Proposed Regulations require that a that the governmental control
Governmental Unit or an Electorate
political subdivision serve a requirement may present challenges for
governmental purpose. A governmental Control by a small faction of private such development districts. In these
purpose requires, among other things, individuals, business corporations, circumstances, the Treasury Department
that the purpose for which the entity trusts, partnerships, or other persons is and IRS are concerned about the
was created, as set out in its enabling fundamentally not governmental potential for excessive private control
legislation, be a public purpose and that control. Therefore, the Proposed by individual developers, the attendant
the entity actually serve that purpose. It Regulations generally require that impact of excessive issuance of tax-
also requires that the entity operate in control be vested in either a general exempt bonds, and inappropriate
a manner that provides a significant purpose State or local governmental private benefits from this Federal
public benefit with no more than unit or in an electorate established subsidy. The Treasury Department and
incidental benefit to private persons. under an applicable State or local law IRS seek public comment on whether it
Cf., Rev. Rul. 90–74 (1990–2 CB 34) of general application. If, however, a is necessary or appropriate to permit
(applying an ‘‘incidental private small faction of private persons controls such districts to be political
benefit’’ standard for purposes of an electorate, that electorate’s control of subdivisions during an initial
determining whether income is the entity does not constitute development period; how such relief
included in gross income under section governmental control of the entity. might be structured; what specific
115(1)). Accordingly, the Proposed Regulations safeguards might be included in the
provide that an entity controlled by an recommended relief to protect against
C. Governmental Control electorate is not governmentally potential abuse; and whether the
The Proposed Regulations provide controlled when the outcome of the proposed prospective effective dates
that a political subdivision must be exercise of control is determined solely and transition periods in § 1.103–1(d) of
governmentally controlled. The by the votes of an unreasonably small the Proposed Regulations provide
Proposed Regulations provide rules for number of private persons. sufficient relief.
determining both what constitutes The determination of whether the
control and which parties must possess number of private persons controlling 2. Streamlining Amendments
that control. an electorate is unreasonably small In addition to amending the definition
generally depends on all of the facts and of political subdivision, paragraphs (a)
i. Definition of Control circumstances. To provide certainty, the and (b) of the Proposed Regulations
The Proposed Regulations define Proposed Regulations limit application update the references in the general
control to mean ongoing rights or of this facts and circumstances test to provisions of the Existing Regulations to
powers to direct significant actions of situations that fall between two reflect changes to the Code made in the
the entity. Rights or powers to direct the quantitative measures of concentration Tax Reform Act of 1986, Public Law 99–
entity’s actions only at a particular point in voting power. The number of private 514, 100 Stat. 2085, and other laws and
in time are not ongoing and, therefore, persons controlling an electorate is regulations since the promulgation of
do not constitute control. For example, always unreasonably small if the the longstanding Existing Regulations.
the right to approve an entity’s plan of combined votes of the three voters with The Proposed Regulations also
operation as a condition of the entity’s the largest shares of votes in the streamline these provisions. In general,
formation is not an ongoing right. To electorate will determine the outcome of the Treasury Department and the IRS
constitute control, a collection of rights the relevant election, regardless of how intend that these proposed amendments
and powers must enable its holder to the other voters vote. The number of not change the meaning of the Existing
direct the significant actions of the private persons controlling an electorate Regulations. The last sentence of
entity. is never unreasonably small if § 1.103–1(a) of the Proposed
The Proposed Regulations provide determining the outcome of the relevant Regulations, however, clarifies that the
three non-exclusive benchmarks of election requires the combined votes of continued tax-exemption of an issue of
rights or powers that constitute control: more voters than the 10 voters with the bonds depends on its issuer’s continued
(1) The right or power both to approve largest shares of votes in the electorate. status as a qualifying issuer of tax-
and to remove a majority of an entity’s For example, control can always be exempt bonds. The Treasury
governing body; (2) the right or power vested in any electorate comprised of 20 Department and IRS seek comments on
to elect a majority of the governing body or more voters that each have the right the need for remedial action provisions
of the entity in periodic elections of to cast one vote in the relevant election in the event the entity ceases to qualify
reasonable frequency; or (3) the right or without giving rise to a private faction. as a political subdivision and on the
power to approve or direct the For purposes of applying these substance of any such provisions.
significant uses of funds or assets of the measures of concentration in voting
entity in advance of that use. Aside from 3. Applicability Dates and Reliance on
power, related parties are treated as a
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these three arrangements, the Proposed Regulations
single voter and the votes of the related
determination of whether a collection of parties are aggregated. Subject to certain transition rules, the
rights and powers constitutes control Proposed Regulations generally would
will depend on the facts and iii. Possible Relief for Development apply to all entities for all purposes of
circumstances. Neither the right to Districts the tax-exempt bond provisions of
dissolve an entity nor procedures Some observers have suggested that, sections 103 and 141 to 150 beginning
designed to ensure the integrity of the despite private control, development 90 days after the Proposed Regulations
entity but not to direct significant districts should be political are finalized. In order to ease hardship
actions of the entity are control. Cf., subdivisions during an initial that may arise from the new definition

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8872 Federal Register / Vol. 81, No. 35 / Tuesday, February 23, 2016 / Proposed Rules

of political subdivision, under proposed been submitted to the Chief Counsel for List of Subjects in 26 CFR Part 1
transition rules, that definition would Advocacy of the Small Business Income taxes, Reporting and
not apply for purposes of determining Administration for comment on its recordkeeping requirements.
whether outstanding bonds and impact on small entities.
refunding bonds in which the weighted Proposed Amendments to the
Comments and Public Hearing Regulations
average maturity is not extended
continue to be obligations of a political Before these Proposed Regulations are Accordingly, 26 CFR part 1 is
subdivision. While these transition rules adopted as final regulations, proposed to be amended as follows:
for outstanding bonds and refunding consideration will be given to any
bonds would apply for the purpose of comments that are submitted timely to PART 1—INCOME TAXES
determining whether these bonds the IRS as prescribed in this preamble
continue to be obligations of a political under the ‘‘Addresses’’ heading. The ■ Paragraph 1. The authority citation
subdivision, the new proposed Treasury Department and the IRS for part 1 continues to read in part as
definition of political subdivision request comments on all aspects of the follows:
would apply for other purposes under proposed rules. All comments will be Authority: 26 U.S.C. 7805 * * *
sections 103 and 141 to 150, such as available at www.regulations.gov or
whether a new entity that subsequently ■ Par. 2. Section 1.103–1 is revised to
upon request.
became a user of a project financed with read as follows:
A public hearing has been scheduled
such bonds qualified as a State or local for June 6, 2016, at 10:00 a.m., in the § 1.103–1 Interest on State or local bonds.
governmental unit for purposes of Auditorium of the Internal Revenue (a) Interest on State or local bonds.
section 141. Furthermore, under another Building, 1111 Constitution Avenue Under section 103(a), except as
proposed transition rule that would NW., Washington, DC. Due to building otherwise provided in section 103(b),
apply to entities in existence prior to 30 security procedures, visitors must enter gross income does not include interest
days after the Proposed Regulations are at the Constitution Avenue entrance. In on any State or local bond. Under
published, the proposed definition of addition, all visitors must present photo section 103(c), the term State or local
political subdivision would not apply identification to enter the building. bond means any obligation (as defined
for any purpose until three years and Because of access restrictions, visitors in § 1.150–1(b)) of a State (including for
ninety days after the Proposed will not be admitted beyond the this purpose the District of Columbia or
Regulations are finalized. This three- immediate entrance area more than 30 any possession of the United States) or
year transition period provides existing minutes before the hearing starts. For a political subdivision thereof (a State or
entities an opportunity to restructure as more information about having your
necessary to satisfy the new definition local governmental unit). Obligations
name placed on the building access list issued by or on behalf of any State or
of political subdivision and allows to attend the hearing, see the FOR
existing entities to continue to issue local governmental unit by a constituted
FURTHER INFORMATION CONTACT section of authority empowered to issue such
new bonds during the transition period. this preamble.
To enhance certainty, an issuer also may obligations are the obligations of such a
choose to apply the definition of The rules of 26 CFR 601.601(a)(3) unit. An obligation qualifies as a State
political subdivision in § 1.103–1(c) in apply to the hearing. Persons who wish or local bond so long as the issuer of
the final regulations in circumstances in to present oral comments at the hearing that obligation remains a State or local
which that definition otherwise would must submit an outline of the topics to governmental unit or a constituted
not apply under the transition rules. be discussed and the time to be devoted authority.
In addition, prior to the applicability to each topic by May 23, 2016. Submit (b) Certain limitations on interest
date of the final regulations, issuers may a signed paper or electronic copy of the exclusion. Under section 103(b), the
elect to apply the definition of political outline as prescribed in this preamble interest exclusion in section 103(a) is
subdivision in § 1.103–1(c) of the under the ‘‘Addresses’’ heading. A inapplicable to a private activity bond
Proposed Regulations in whole, but not period of 10 minutes will be allotted to under section 141(a) (unless the bond is
in part, for any purpose of sections 103 each person for making comments. An a qualified bond under section 141(e)),
and 141 through 150, provided such use agenda showing the scheduling of the an arbitrage bond under section 148, or
is applied consistently for all purposes speakers will be prepared after the a bond which does not meet the
of sections 103 and 141 through 150 to deadline for receiving outlines has applicable requirements of section 149.
any given entity. passed. Copies of the agenda will be (c) Definition of political
available free of charge at the hearing. subdivision—(1) In general. The term
Special Analyses political subdivision means an entity
Drafting Information
Certain IRS regulations, including this that meets each of the requirements of
one, are exempt from the requirements The principal authors of these paragraphs (c)(2) (sovereign powers),
of Executive Order 12866, as regulations are Spence Hanemann and (c)(3) (governmental purpose), and (c)(4)
supplemented and reaffirmed by Timothy Jones, Office of Associate Chief (governmental control) of this section,
Executive Order 13563. Therefore, a Counsel (Financial Institutions and taking into account all of the facts and
regulatory impact assessment is not Products), IRS. However, other circumstances, or that is described in
required. It also has been determined personnel from the IRS and the Treasury published guidance issued pursuant to
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that section 553(b) of the Administrative Department participated in their paragraph (c)(5) of this section. Entities
Procedure Act (5 U.S.C. chapter 5) does development. that may qualify as political
not apply to these regulations, and subdivisions include, among others,
Availability of IRS Documents
because these regulations do not impose general purpose governmental entities,
a collection of information on small IRS revenue rulings cited in this such as cities and counties (whether or
entities, the Regulatory Flexibility Act notice of proposed rulemaking are made not incorporated as municipal
(5 U.S.C. chapter 6) does not apply. available by the Superintendent of corporations), and special purpose
Pursuant to section 7805(f) of the Code, Documents, U.S. Government Printing governmental entities, such as special
this notice of proposed rulemaking has Office, Washington, DC 20402. assessment districts that provide for

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Federal Register / Vol. 81, No. 35 / Tuesday, February 23, 2016 / Proposed Rules 8873

roads, water, sewer, gas, light, (A) A State or local governmental unit numbers of voters and voting control in
reclamation, drainage, irrigation, levee, possessing a substantial amount of each paragraphs (c)(4)(iii)(B) and (C) of this
school, harbor, port improvements, and of the sovereign powers and acting section:
other governmental purposes for a State through its governing body or through (1) Related parties (as defined in
or local governmental unit. its duly authorized elected or appointed § 1.150–1(b)) are treated as a single
(2) Sovereign powers. Pursuant to a officials in their official capacities; or person; and
State or local law of general application, (B) An electorate established under (2) In computing the number of votes
the entity has a delegated right to applicable State or local law of general necessary to determine the outcome of
exercise a substantial amount of at least application, provided the electorate is the relevant exercise of control, all
one of the following recognized not a private faction (as defined in voters entitled to vote in an election are
sovereign powers of a State or local paragraph (c)(4)(iii) of this section). assumed to cast all votes to which they
governmental unit: The power of (iii) Definition of private faction—(A) are entitled.
taxation, the power of eminent domain, In general. A private faction is any (5) Authority of the Commissioner. In
and police power. electorate if the outcome of the exercise guidance published in the Internal
(3) Governmental purpose. The entity of control described in paragraph Revenue Bulletin, the Commissioner
serves a governmental purpose. The (c)(4)(i) of this section is determined may set forth additional circumstances
determination of whether an entity solely by the votes of an unreasonably in which an entity qualifies as a
serves a governmental purpose is based small number of private persons. The political subdivision of a State or local
on, among other things, whether the determination of whether a number of governmental unit. See
entity carries out the public purposes such private persons is unreasonably § 601.601(d)(2)(ii) of this chapter.
that are set forth in the entity’s enabling small depends on all of the facts and (d) Applicability dates—(1) In general.
legislation and whether the entity circumstances, including, without Except as otherwise provided in
operates in a manner that provides a limitation, the entity’s governmental paragraphs (d)(2) through (4) of this
significant public benefit with no more purpose, the number of members in the section, this section applies to all
than incidental private benefit. electorate, the relationships of the entities for all purposes of sections 103
(4) Governmental control. A State or members of the electorate to one and 141 through 150 beginning on the
local governmental unit exercises another, the manner of apportionment date 90 days after the publication of the
control over the entity. For this purpose, of votes within the electorate, and the Treasury decision adopting these rules
control is defined in paragraph (c)(4)(i) extent to which the members of the as final regulations in the Federal
of this section and a State or local electorate adequately represent the Register.
governmental unit exercises such interests of persons reasonably affected (2) Applicability date of the definition
control only if the control is vested in by the entity’s actions. For purposes of of political subdivision for outstanding
persons described in paragraph (c)(4)(ii) this definition, the special rules in bonds. For purposes of determining
of this section. paragraphs (c)(4)(iii)(B) through (D) of whether outstanding bonds of an entity
(i) Definition of control. Control this section apply. are obligations of a political subdivision
means an ongoing right or power to (B) Treatment of certain limited under section 103, the definition of
direct significant actions of the entity. electorates as private factions. An political subdivision in paragraph (c) of
Rights or powers may establish control electorate is a private faction if any this section does not apply to that entity
either individually or in the aggregate. three private persons that are members with respect to its outstanding bonds
Among rights or powers that may of the electorate possess, in the that are issued before the general
establish control, an ongoing ability to aggregate, a majority of the votes applicability date under paragraph
exercise one or more of the following necessary to determine the outcome of (d)(1) of this section.
significant rights or powers, on a the relevant exercise of control. (3) Applicability date of the definition
discretionary and non-ministerial basis, (C) Safe harbor—voting power of political subdivision for refunding
constitutes control: the right or power dispersed among more than 10 persons. bonds. For purposes of determining
both to approve and to remove a An electorate is not a private faction if whether refunding bonds of an entity
majority of the governing body of the the smallest number of private persons are obligations of a political subdivision
entity; the right or power to elect a who can combine votes to establish a under section 103, the definition of
majority of the governing body of the majority of the votes necessary to political subdivision in paragraph (c) of
entity in periodic elections of determine the outcome of the relevant this section does not apply to that entity
reasonable frequency; or the right or exercise of control is greater than 10 with respect to its refunding bonds that
power to approve or direct the persons. For example, if an electorate are issued on or after the general
significant uses of funds or assets of the consists of 20 private persons with applicability date under paragraph
entity in advance of that use. Procedures equal, five-percent shares of the total (d)(1) of this section to refund bonds
designed to ensure the integrity of the votes, that electorate is not a private with respect to which paragraph (c) of
entity but not to direct significant faction because a minimum of 11 this section otherwise does not apply,
actions of the entity are insufficient to members of that electorate is necessary provided that the weighted average
constitute control of an entity. Examples to have a majority of the votes. By maturity of the refunding bonds is no
of such procedures include contrast, for example, if an electorate longer than the remaining weighted
requirements for submission of audited consists of 20 private persons with average maturity of the refunded bonds.
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financial statements of the entity to a unequal voting shares in which some (4) Applicability date of the definition
higher level State or local governmental combination of 10 or fewer members has of political subdivision for existing
unit, open meeting requirements, and a majority of the votes, then that entities. For existing entities that are
conflicts of interest limitations. electorate does not qualify for the safe created or organized before March 24,
(ii) Control vested in a State or local harbor from treatment as a private 2016, the definition of political
governmental unit or an electorate. faction under this paragraph subdivision in paragraph (c) of this
Control is vested in persons described (c)(4)(iii)(C). section does not apply for any purpose
in paragraphs (c)(4)(ii)(A) or (c)(4)(ii)(B) (D) Operating rules. The following of sections 103 and 141 to 150 during
of this section or a combination thereof: rules apply for purposes of determining the three-year period beginning on the

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Document Created: 2018-02-02 14:33:24
Document Modified: 2018-02-02 14:33:24
Category		Regulatory Information
Collection		Federal Register
sudoc Class		AE 2.7: GS 4.107: AE 2.106:
Publisher		Office of the Federal Register, National Archives and Records Administration
Section		Proposed Rules
Action		Notice of proposed rulemaking and notice of public hearing.
Dates		Written or electronic comments must be received by May 23, 2016. Request to speak and outlines of topics to be discussed at the public hearing scheduled for June 6, 2016, at 10:00 a.m., must be received by May 23, 2016.
Contact		Concerning the proposed regulations, Spence Hanemann at (202) 317-6980; concerning submissions of comments and the hearing, Oluwafunmilayo (Funmi) Taylor at (202) 317-6901 (not toll-free numbers).
FR Citation		81 FR 8870
RIN Number		1545-BM99
CFR Associated		Income Taxes and Reporting and Recordkeeping Requirements
81 FR 8870 - Definition of Political Subdivision

DEPARTMENT OF THE TREASURYInternal Revenue Service

Federal Register Volume 81, Issue 35 (February 23, 2016)

DEPARTMENT OF THE TREASURY
Internal Revenue Service
