                        T.C. Memo. 1996-406



                      UNITED STATES TAX COURT



         THWAITES TERRACE HOUSE OWNERS CORP., Petitioner v.
             COMMISSIONER OF INTERNAL REVENUE, Respondent




     Docket No. 15777-94.                  Filed September 3, 1996.




     Terrence J. Dwyer, for petitioner.1

     Andrew J. Mandell, for respondent.




     1
       Amici curiae briefs were filed by Mark A. Levy and Mayer
Greenberg for Stewart Tenants Corp., and Joel E. Miller for the
National Association of Housing Cooperatives, the Council of New
York Cooperatives, and the Federation of New York Housing
Cooperatives.
                                 2

                        MEMORANDUM OPINION


     COLVIN, Judge:   Respondent determined deficiencies in

petitioner's Federal income tax of $8,117 for 1989 and $6,606 for

1990.

     The issues for decision are:

     1.   Whether petitioner, a housing cooperative under section

216, is subject to subchapter T (sections 1381-1388),

aspetitioner contends, or is a membership organization under

section 277, as respondent contends.   We hold that petitioner is

subject to subchapter T and is not subject to section 277.

     2.   Whether interest income earned by petitioner is

patronage sourced income under section 1388(j)(1).   We hold that

it is not.

     Section references are to the Internal Revenue Code in

effect for the years at issue.   Rule references are to the Tax

Court Rules of Practice and Procedure.

     The facts have been fully stipulated and are so found.    The

relevant facts are summarized below.

Background

A.   Petitioner

     Petitioner's principal place of business was in New York

City when it filed the petition in this case.
                                 3

     Petitioner was formed on September 2, 1983, under New York

business corporation law.   Petitioner uses the accrual method of

accounting.

     Petitioner is a cooperative housing corporation under

section 216(b)(1) and is not tax-exempt under section 501.

     Petitioner's certificate of incorporation was filed on

August 30, 1983, and was amended on May 7, 1984.    Petitioner's

certificate of incorporation states in part that it was formed to

provide homes for its stockholders by leasing apartments to them

under proprietary leases that entitle them to live in the

building.

     Petitioner's certificate of incorporation authorizes

petitioner to issue 70,000 shares of one class of common stock at

a par value of $1 each.   Petitioner may make distributions to its

shareholders only from its earnings and profits unless petitioner

is completely or partially liquidated.

     Petitioner's bylaws did not authorize it to pay patronage

dividends to its members in the years at issue.    Petitioner's

bylaws have no provisions relating to whether petitioner may

distribute net earnings to its tenant-shareholders.    Petitioner

has no rules or regulations requiring it to distribute patronage

dividends to its tenant-shareholders.

     Petitioner could use net earnings to reduce maintenance.

Petitioner has never paid or allocated "net margins" (the excess

of its operating revenues over its cost of operations) to its
                                  4

patrons as patronage dividends.   The record does not show if

petitioner has ever had net margins.

     Petitioner's bylaws require petitioner to hold an annual

meeting of the shareholders to elect directors and to conduct

other business.   The bylaws also provide for special meetings of

the shareholders.   Petitioner must give written notice of all

shareholders' meetings to each shareholder.     Under the bylaws,

each shareholder has one vote at each shareholder's meeting for

each share of stock in his or her name.     The bylaws permit proxy

voting at shareholder's meetings.     Petitioner's bylaws require

petitioner to have at least 3 but not more than 7 directors, the

majority of whom must live in petitioner's building.     The board

of directors manages petitioner, oversees its operations,

oversees the management company, and holds meetings not less than

once every 8 weeks to discuss problems referred to the Board.

Directors serve without pay unless pay is approved by

shareholders owning two-thirds of the outstanding shares.

     Petitioner generally maintains the building and its grounds,

fixtures, elevators, lighting and heating, and other common areas

by hiring a superintendent and janitors.     Petitioner's management

agent collects rents from petitioner's shareholders, keeps

petitioner's books, pays petitioner's expenses, prepares

petitioner's annual operating budget to be approved by

petitioner's directors, and hires and supervises petitioner's
                                  5

employees.    Petitioner provides laundry facilities for its

tenant-shareholders.

     Petitioner is not required to rebate to its members the

excess of its charges collected from them over its operating

costs, and its members have no right to receive those

distributions.

B.   Petitioner's Proprietary Lease

     Petitioner's tenant-shareholders, because of their ownership

of stock in the corporation, may have proprietary leases2 which

entitle them to live in an apartment of petitioner.

     Each shareholder must sign a proprietary lease with

petitioner.    The proprietary lease used by petitioner during the

years in issue referred to tenants as "lessees".    It required

each lessee to pay rent (called "maintenance") in equal monthly

installments.    A lessee could occupy only the apartment he or she

leased.   Monthly rent equaled the lessee's pro rata share of "the

estimated amount in cash which the Directors * * * determine to

be necessary" to operate, maintain and improve the property, and

to create a reserve for contingencies, repairs, and replacements.

The lease provided that petitioner's Board of Directors "from

time to time in its judgment" shall determine the annual

obligation of each lessee.    The lease authorizes the Board of


     2
       A proprietary lease allows a shareholder in a cooperative
to possess an apartment in the cooperative. Black's Law
Dictionary 890 (6th ed. 1990).
                                  6

Directors to "modify its prior determination and increase or

diminish the amount previously determined as cash requirements"

of petitioner.

     Petitioner charges a maintenance fee to its tenant-

shareholders that varies according to the number of shares each

shareholder owns.   Petitioner collects monthly apartment

maintenance payments from each tenant and a monthly parking space

rental fee from some of the tenants.

C.   Petitioner's Income from Savings and Other Accounts

     Petitioner earned interest income of $52,468 in 1989 and

$44,041 in 1990 from various savings and money market accounts,

and certificates of deposit with terms ranging from 2 months to 2

years.   The parties stipulated that petitioner was not required

by law to have savings or money market accounts or certificates

of deposit.D.    Characterization of Petitioner's Income

     Petitioner's books and records did not distinguish between

patronage and nonpatronage sourced income.   Petitioner did not

prepare records for 1989 and 1990 characterizing its current

earnings, liabilities, and net operating losses as patronage or

nonpatronage sourced.

     Petitioner did not pay patronage dividends in the years at

issue.   The parties stipulated that, because petitioner did not

pay patronage dividends, petitioner was not required to and did

not file information returns under section 6044.   Petitioner
                                   7

issued no Forms 1099-PATR (Taxable Distributions Received From

Cooperatives) to its tenant-shareholders for the years at issue.

     Petitioner serves its members at less than cost and realized

a loss from its activities in 1989 and 1990.    It did not pay tax

on its investment income.

     Respondent determined that petitioner's interest income of

$52,468 in 1989 and $44,041 in 1990 was taxable as nonmembership

income by reason of section 277.

Discussion

A.   Background

     The issue for decision is whether petitioner, a section 216

cooperative housing corporation, is a cooperative under

subchapter T (sections 13813-1388), as petitioner contends, or

     3
         Section 1381 provides in part:

     SEC. 1381(a). In General.--This part shall apply to--

          (1) any organization exempt from tax under section 521
     (relating to exemption of farmers' cooperatives from tax),
     and

          (2) any corporation operating on a cooperative basis
     other than an organization--

                  (A) which is exempt from tax under this chapter,

                  (B) which is subject to the provisions of--

                       (i) part II of subchapter H (relating to
                  mutual savings banks, etc.), or

                       (ii) subchapter L (relating to insurance
                  companies), or

                                                      (continued...)
                                  8

whether it is a membership organization under section 2774, as

respondent contends.    If petitioner is subject to subchapter T,

we must also decide whether interest income petitioner received

is patronage or nonpatronage sourced under section 1388(j)(1).

     We consider several sections in our analysis of this case:

(1) section 216, which defines cooperative housing corporations;

(2) section 277, which applies to social clubs and other

membership organizations; and (3) sections 1381-1388 (subchapter

T), which apply to corporations that operate on a cooperative




     3
      (...continued)
               (C) which is engaged in furnishing electric
          energy, or providing telephone service, to persons in
          rural areas.

     4
         Section 277 provides as follows:

     SEC. 277(a). General Rule.--In the case of a social club or
     other membership organization which is operated primarily to
     furnish services or goods to members and which is not exempt
     from taxation, deductions for the taxable year attributable
     to furnishing services, insurance, goods, or other items of
     value to members shall be allowed only to the extent of
     income derived during such year from members or transactions
     with members (including income derived during such year from
     institutes and trade shows which are primarily for the
     education of members). If for any taxable year such
     deductions exceed such income, the excess shall be treated
     as a deduction attributable to furnishing services,
     insurance, goods, or other items of value to members paid or
     incurred in the succeeding taxable year. The deductions
     provided by sections 243, 244, and 245 (relating to
     dividends received by corporations) shall not be allowed to
     any organization to which this section applies for the
     taxable year.
                                    9

basis and to farmers' cooperatives that are exempt under section

521.

       We first decide whether petitioner is subject to subchapter

T.   If petitioner is subject to subchapter T, then we must also

decide whether petitioner's interest income was patronage or

nonpatronage sourced income.

B.     Whether Petitioner Is Subject to Subchapter T

        1.   Background

        Respondent argues that petitioner is not subject to

subchapter T because it does not operate on a cooperative basis.

Respondent argues in the alternative that, if subchapter T

applies, petitioner's interest income is nonpatronage sourced

income that cannot be offset with petitioner's patronage

expenses.

        Petitioner argues that it operates on a cooperative basis

within the meaning of section 1381(a)(2), and that it is governed

by subchapter T.

        Section 1381(a) specifies the organizations that are subject

to subchapter T.      Petitioner is not a farmers' cooperative and is

not exempt under section 521.      Thus, we consider whether

petitioner is a corporation "operating on a cooperative basis".

Sec. 1381(a)(2).      If a corporation operates on a cooperative

basis under section 1381(a)(2), then it is subject to subchapter

T.     Trump Village Section 3, Inc. v. Commissioner, T.C. Memo.

1995-281.
                                  10

     2.   Whether a Section 216 Cooperative Housing Corporation Is
          a Cooperative Under Subchapter T

     In Park Place, Inc. v. Commissioner, 57 T.C. 767 (1972), we

held that the taxpayer was a cooperative under subchapter T

because it was a section 216 cooperative housing corporation.        We

concluded that:

     We disagree with the Commissioner's assertion that
     subchapter T, section 1381, * * * does not apply. Part
     I of that subchapter applies to the taxable year of any
     corporation operating on a cooperative basis after
     December 31, 1962, and that necessarily includes a
     section 216 cooperative housing corporation. [Citation
     omitted.]

Id. at 779.

     The parties have stipulated that petitioner is a section 216

cooperative housing corporation.       Thus, as we discuss further

below in par. B-3-a, we conclude that petitioner is subject to

the provisions of subchapter T.    Id.

     3.   Subordination of Capital, Control by Members, and
          Allocation of Profit to Members

     In Puget Sound Plywood, Inc. v. Commissioner, 44 T.C. 305,

308 (1965), we identified three factors that we said form the

core of economic cooperative theory:

          (1) Subordination of capital, both as regards control
     over the cooperative undertaking, and as regards the
     ownership of the pecuniary benefits arising therefrom; (2)
     democratic control by the worker-members themselves; and (3)
     the vesting in and the allocation among the worker-members
     of all fruits and increases arising from their cooperative
     endeavor (i.e., the excess of the operating revenues over
     the costs incurred in generating those revenues), in
     proportion to the worker-members' active participation in
     the cooperative endeavor.
                                  11

     a.     Respondent’s Contention That Park Place Does Not Control

     Respondent contends that the fact that we applied the Puget

Sound factors in Trump Village Section 3, Inc. v. Commissioner,

supra, shows that Park Place does not establish that section 216

cooperative housing corporations are subject to subchapter T and

that we should apply the Puget Sound factors to decide whether a

section 216 cooperative housing corporation operates on a

cooperative basis for purposes of subchapter T.     We disagree.

     There is no indication that the parties in Trump Village

asked the Court to consider (or that the Court did consider)

whether Park Place establishes that a section 216 cooperative

housing corporation operates on a cooperative basis for purposes

of section 1381.     Thus, Trump Village does not bar our reliance

on Park Place.

     Sections 216 and 1381 both use the term "cooperative".

Congress' use of the same word in both sections supports the

inference that a “cooperative” housing corporation under section

216 is operated on a “cooperative” basis for purposes of section

1381.     The legislative history of the Revenue Act of 1942, ch.

19, tit. I, sec. 128, 56 Stat. 798, 826, which added section

23(z) (the predecessor to section 216) to the Code, states:

     The definitions of the terms "cooperative apartment
     corporation" and "tenant-stockholder" prescribe certain
     standards which are designed to safeguard the revenue by
     assuring that the apartment corporations involved are bona
     fide cooperative apartment corporations and that the
     individuals entitled to deductions under section 23(z) are
     bona fide tenant-stockholders of such corporations.
                                 12

S. Rept. 1361, 77th Cong., 2d Sess. (1942), 1942-2 C.B. 504, 577.

We interpret this to mean that Congress expected that a

cooperative apartment corporation (the predecessor to a

cooperative housing corporation) would be operated as a

cooperative.

     b.   Respondent’s Contention That Petitioner Does Not Operate
          as a Cooperative

     Respondent argues that petitioner does not meet the Puget

Sound factors and thus does not operate on a cooperative basis.

We disagree.    First, petitioner meets the subordination of

capital factor because its tenant-shareholders and patrons are

identical and petitioner operated for the benefit of its patrons.

Second, petitioner is democratically controlled by its tenant-

stockholders.    The fact that petitioner's shareholders may vote

by proxy is akin to voting by absentee ballot.    See Rev. Rul. 75-

97, 1975-1 C.B. 167 (a farmer's cooperative is not denied exempt

status by allowing proxy voting by shareholders).    Also, the fact

that petitioner's shareholders have one vote for each share they

own (instead of one vote per shareholder) and that they own

shares based on the relative sizes of their various dwelling

units is not contrary to democratic principles.    The ownership

percentage of shareholders of a housing cooperative is not only a

measure of their investment; it is also a measure of their

relative “patronage” of the housing cooperative.    Third,

petitioner did not fail to allocate profits to its members; in
                                13

fact, it operated at a loss in the years at issue.   We conclude

that petitioner is a cooperative under the three factors stated

in Puget Sound Plywood, Inc. v. Commissioner, supra, and that

petitioner operates on a cooperative basis under section

1381(a)(2).

     Because petitioner is subject to subchapter T, it is not

subject to section 277.   Buckeye Countrymark, Inc. v.

Commissioner, 103 T.C. 547, 581 (1994); Trump Village Section 3,

Inc. v. Commissioner, T.C. Memo 1995-281; see also Landmark,

Inc., v. United States, 25 Cl. Ct. 100 (1992).   In Buckeye

Countrymark, Inc., v. Commissioner, supra at 581, we said that

“the provisions of section 277 conflict with the provisions of

subchapter T and that the application of section 277 to nonexempt

cooperatives would lead to absurd or futile results.”

C.   Whether Petitioner's Interest Income Is Patronage-Sourced
     Income

     Even if petitioner is a cooperative subject to subchapter T,

petitioner must pay tax on its investment income if the interest

was not patronage sourced.   Petitioner bears the burden of

proving that its interest income is patronage sourced under

subchapter T.   Rule 142(a); Welch v. Helvering, 290 U.S. 111, 115

(1933).

     Petitioner argues that its interest income is patronage

sourced because petitioner earned the interest on funds its
                                 14

shareholders deposited with petitioner to pay its expenses.    We

disagree.

     Subchapter T prohibits cooperatives from using patronage

losses to offset nonpatronage income.    Buckeye Countrymark, Inc.

v. Commissioner, supra at 559; Certified Grocers of Calif., Ltd.

v. Commissioner, 88 T.C. 238, 250 (1987).    A cooperative earns

patronage income from business it does with or for its patrons.

Sec. 1388(a); Illinois Grain Corp. v. Commissioner, 87 T.C. 435,

450 (1986).   Income is patronage sourced if it is derived from an

activity that is so closely intertwined with the main cooperative

effort that it may be characterized as directly related to, and

inseparable from, the cooperative's principal business activity,

and thus facilitates the accomplishment of the cooperative's

business purpose.    Illinois Grain Corp. v. Commissioner, supra at

459-460.    However, if the transaction or account which produces

the income merely enhances the overall profitability of the

cooperative, then the income is from nonpatronage sources.     Id.

at 452-453.   Investment income is not patronage sourced.   Sec.

1.1382-3(c)(2), Income Tax Regs.

     In Illinois Grain Corp. v. Commissioner, supra at 442, 459-

460, the taxpayer-cooperative had a specific business need for

large amounts of cash at short notice.    As a result, it invested

its temporary surplus funds in short-term (e.g., overnight,

weekend, and 10-day or less deposits) debt instruments because it

did not know when it would need the temporary surplus funds in
                                15

its business.   We held that the interest earned by the taxpayer

on its short-term instruments was income from patronage sources

and not investment income.   Id. at 460.   The taxpayer's money

management activities were "inseparably intertwined with the

overall conduct of its cooperative enterprise, and the interest

income which it earned was therefore patronage-sourced".      Id.

     Petitioner earned interest income from money market and

savings accounts and from certificates of deposits with terms

ranging from 2 months to 2 years.    The record contains no

evidence linking the savings and money market accounts to

petitioner's cooperative activities.    The 2-month to 2-year

certificates of deposit were investments that provided income to

petitioner and did not facilitate the accomplishment of

petitioner's cooperative business activities.    See Washington-

Oregon Shippers Coop., Inc. v. Commissioner, T.C. Memo. 1987-32

(taxpayer's money management activities were not integrally

linked to the overall conduct of its cooperative enterprise and

did nothing more than add to its overall profitability).

     Petitioner alleged in the petition5 that its interest income

was patronage-sourced income that can be offset by patronage

deductions.   Respondent denied this allegation in the answer.

Thus, petitioner has been on notice that the character of its

     5
       In the petition, petitioner stated: “This is a co-
operative housing, not a membership, corporation. Further,
income from ancillary sources is used to maintain and/or reduce
maintenance. Deductions are allowed. IRC 1388(j)(1).”
                                  16

interest income as either patronage or nonpatronage-sourced

income has been at issue since the pleadings were filed.     A

taxpayer bears the burden of proving allegations it makes in the

petition when it submits a case fully stipulated.     Rules 122,

217(c)(1)(A); Kitch v. Commissioner, 104 T.C. 1, 5 (1995).       The

stipulation does not include facts that support a finding that

petitioner's interest income was patronage sourced.     The record

includes nothing to suggest that petitioner’s interest income was

earned from required reserves or that petitioner maintained its

savings and money market accounts and certificates of deposit for

business, rather than investment, purposes.     Petitioner failed to

carry its burden of proving that its interest income was

patronage sourced under section 1388.

     We hold that petitioner's interest income is taxable to

petitioner as determined by respondent.

     To reflect the foregoing,

                                       Decision will be entered for

                                 respondent.
