United States Court of Appeals,

Fifth Circuit.

No. 91–4474.

TEXAS LEARNING TECHNOLOGY GROUP, Petitioner–Appellant,

v.

COMMISSIONER OF INTERNAL REVENUE, Respondent–Appellee.

April 16, 1992.

Appeal from a Decision of the United States Tax Court.

Before THORNBERRY, KING, and DEMOSS, Circuit Judges.

THORNBERRY, Circuit Judge:

Th is is an appeal from the Tax Court's decision in a declaratory judgment action. The

Appellant filed a suit for declaratory judgment in the Tax Court after the Commissioner of the Internal

Revenue Service ruled that the Appellant is not a "political subdivision" under § 170(b)(1)(A)(v) of

the Internal Revenue Code. The Tax Court agreed with the Commissioner that Appellant is not a

"political subdivision." The Appellant now appeals the Tax Court's decision.

I. Background

A. The Proceedings Below

After the Commissioner of the Internal Revenue Service ruled that the Appellant, Texas

Learning Technol o gy Gro up (TLTG), did not qualify as a political subdivision under §

170(b)(1)(A)(v), TLTG filed a suit for declaratory judgment in the Tax Court, requesting a ruling that

it qualifies as a "political subdivision" and is thus excepted from "private foundation" status and its

requirements. The case went before the Tax Court without a trial pursuant to Tax Ct.R. 122, based

upon the pleadings, the administrative record, and a partial stipulation of facts filed by the parties.

The Tax Court found that TLTG failed to qualify for an exemption from "private foundation" status

as a "political subdivision" under § 170(b)(1)(A)(v) because it was not authorized to exercise1 The IRS originally stated that TLTG could avoid "private foundation" status by meeting the

"public support" test under § 170(b)(1)(A)(vi), for charities that receive most of their funding

from governmental units. (TLTG receives almost all of its funding from the school districts which

are governmental units.) TLTG wants to escape "private foundation" status only by means of

subsection (v) and not subsection (vi), because under subsection (vi), TLTG's finances would be

examined periodically to determine whether it continued to satisfy the "public support" test. "sovereign power." 1 TLTG now appeals the Tax Court's ruling.

B. Texas Learning and Technology Group

TLTG is an unincorporated association that was created by an interlocal agreement among

eleven Texas public school districts. The eleven school districts entered into the agreement pursuant

to the Interlocal Cooperati on Act, Tex.Rev.Stat.Ann. art. 4413(32c) (Vernon 1976). The Interlocal

Coop erat io n Act allows any local government to "contract or agree with one or more local

g o vernments to perform governmental functions and services under the terms of [the] Act."

Tex.Rev.Stat.Ann. art. 4413(32c)(4)(a). Hence, the school districts, as local governments, formed

a contract creating TLTG in order to fund, organize, and manage projects designed to improve the

public education curriculum in Texas.

TLTG is governed by a board of d irect o rs that is responsible for TLTG's fiscal and

administrative policies. The board of directors consists of fifteen members: five board members are

appointed by the President of the Texas Association of School Administrators; five board members

are appointed by the President of the Texas Association of School Boards; two mem bers are

appointed by the Texas Board of Education; and the Governor, Lieutenant Governor, and Speaker

of the House of Representatives of Texas each appoint one member.

TLTG entered int o a co ntract with the National Science Center for Communications and

Electronics Found at ion to develop a physical science curriculum. TLTG plans to sell its physical

science curriculum to all public school districts in Texas. The revenues first will be used to pay for

development costs, and any remaining funds will be returned to the member school districts, up to125% of the participating member school district's contributions. Any revenues not returned to

participating member school districts may be used by TLTG for any purpose consistent wit h it s

agreements with its members. In the future, TLTG will fund, organize, and manage new projects that

are consistent with its purposes and objectives. Each member school district will have an opti on to

participate in projects by entering into separate interlocal project agreements. Each member public

school district must pay $500 in annual dues to TLTG and contribute funds for any group project in

which it participates. Also, the school district s are required to fund any deficit that TLTG might

incur.

The parties have stipulated that TLTG does not maintain the power to tax, the power of

eminent domain, or the power to issue government bonds.

C. Relevant Provisions of the Internal Revenue Code

TLTG's tax exempt status is not at issue in this appeal. TLTG challenges only the Tax Court's

conclusion that TLTG is not a political subdivision within the meaning of § 170(b)(1)(A)(v).

TLTG is a § 501(c)(3) organization and any § 501(c)(3) organi zation is presum ed to be a

"private foundation" unless it qualifies under one of the e xcept ions to "private foundation" status

listed in § 509(a). As long as an organization is classified as a "private foundation," it is subject to

certain excise taxes for self-dealing, speculative investing, lobbying, and other restricted activities.

See 26 U.S.C. §§ 4940–4945 (1989). Tax exempt organizations that are classified as "other than

private foundations" are not subject to the requirements of §§ 4940–4945.

Under § 509(a)(1), an organization described in § 170(b)(1)(A)(i) –(vi) is excepted from

private foundation status. Subsection (v), the subsection TLTG seeks to avail itself of, requires by

way of § 170(c)(1) that TLTG be "a state, a possession of the Unite d States, or any political

subdivision of any of the foregoing...." Thus, to escape private foundatio n status by way ofsubsection (v), TLTG must be a "political subdivision" of the state of Texas.

II. Analysis

A. The Standard of Review

"The scope of review by the Courts of Appeal of Tax Court decisions and nonjury District

Court decisions is the same." J OHN C. C HOMMIE

, F EDERAL I NCOME T AXATION , § 301 (1973); 26

U.S.C. § 7482 (1989). The Tax Co urt 's ruling that TLTG is not a "political subdivision" is a

conclusion of law which we review de novo.

B. The Definition of "Political Subdivision"

The term "political subdivision" is not defined in § 170 or in the Tre asury Regulations

accompanying § 170. Treasury Regulation 1.103–1(b), however, provides that any division of the

government that is a municipal corporati on or has been delegated the rig ht to exercise part of the

so vereign power of the government, is a political subdivision. 26 C.F.R. § 1.103–1(b). Case law

both before and after the promulgation of Regulation 1.103–1(b) has required an entity to be

authorized to exercise some sovereign powers in order to be considered a political subdivision. The

power to tax, the power of eminent domain, and the police power are the generally acknowledged

sovereign powers. 1 M E RTENS

, L AW OF F EDERAL I NCOME T AXATION , § 8.09 at 27. As discussed

below, all of the cases addressing the meaning of the term "political subdivision" under the Internal

Revenue Code have required the entity to possess at least one of t h e three generally recognized

sovereign powers in order to be classified as a "political subdivision."

In a 1914 Opinion, t he At t orney General of the United States recognized that in order to

create a political subdivision, a state must delegate some of its sovereign powers to the entity. See

30 Op.Atty.Gen. 252 ("It is not necessary that [the division]

... exercise all the functions of the state

..., it is sufficient if it be authorized to exercise a porti on of them."). The Attorney General found that

the special assessment districts at issue were political subdivisions because they had been created forthe purpose of carrying out state functions and had been given the "power of taxation—perhaps the

most important power possessed by the State." Id.

In Commissioner of Internal Revenue v. Shamberg's Estate, 144 F.2d 998 (2nd Cir.1944),

cert. denied 323 U.S. 792, 65 S.Ct. 433, 89 L.Ed. 631 (1945), the Second Circuit addressed whether

interest on the New York Port Authority's bonds was excludable from gross income under § 22(b)(4)

of the Revenue Acts of 1936 and 1938. The court found that the New York Port Authority was a

political subdivision of New York and New Jersey because it was created by a contract between the

two states and maintained many sovereign powers including the power of eminent domain and police

power (the police power consisted of the power to subpoena, the power to issue orders and enforce

orders against persons within its jurisdiction, and the power to maintain a uniformed police force).

The only one of the three generally recognized sovereign powers that the New York Port Authority

did not main tain was the power to tax. In response to the argum ent that the Authori ty was not a

political subdivision because it was not authorized to tax citizens the court wrote:

[h]ere the activities,

... are exercised for a public purpose by an agency set up by the states

and given many public powers, though not of taxa t ion or control through the suffrages of

citizens. It minimizes its public and political character to treat such an agency as a private

corporati on merely because of the lack of taxing power which is only one of the attributes of

sovereignty.

Shamberg, 144 F.2d at 1005. The Shamberg case does not impose a rigid test for political

subdivision status, but it does require that an entity be authorized to exercise some sovereign power,

recognizing as the most important of these powers, the power to tax, the power of eminent domain,

and the police power.

In Commissioner of Internal Revenue v. White's Estate, 144 F.2d 1019 (2d Cir.1944), cert.

denied, 323 U.S. 792, 65 S.Ct. 433, 89 L.Ed. 632 (1945), the Second Circuit considered whether the

Triborough Bridge Authority (Authority) was a political subdivision in order for the interest on its

bonds to be tax-exempt. The court found that the Authority was a political subdivision of the Stateof New York because the Authority was "plainly a subdivision of state government empowered to

exercise governmental functions on behalf of the City of New Yor k...." W hite, 144 F.2d at 1020.

The Authority maintained the power of eminent domain, and the power "to make use of city agents,

employees, and facilities, and to issue bonds for constructing the bridges." Id.

In The Seagrave Corp. v. Commissioner of Internal Revenue, 38 T.C. 247 (1962), the Tax

Court explicitly recognized that an entity must be authorized to exercise a sovereign power in order

to constitute a political subdivision. In Seagrave, the issue was whether volunteer fire departments

were political subdivisions under § 103 of the Internal Revenue Code. The Tax Court held that

the volunteer fire departments perform a public function in the sense that they perform the

same function that is generally carried on by municipal fire departments. But the volunteer

fire companies he re involved are not created by any special statutes and they received no

delegation of any part of the State's power. It is not enough that t hey perform a public

service. They cannot be called a subdivision of the state unless there has been a delegation

to them of some functions of local government.

Seagrave, 38 T.C. 247 (1962). According to S eagrave and several later opinions, the delegation of

traditional sovereign authority is the crucial factor in determining whether an organization is a

political subdivision. S ee Philadelphia Nt'l. Bank v. United States, 666 F.2d 834, 839 (3rd Cir.1981)

(holding that Temple University was not a political subdivision because sovereign power had not been

delegated), cert. denied, 457 U.S. 1105, 102 S.Ct. 2904, 73 L.Ed.2d 1314 (1982); O ld Colony Trust

Co. v. United States, 438 F.2d 684 (1st Ci r.1971) (holding that a hospital was not a political

subdivision in part because it did not exercise any sovereign powers).

C. Applying the Definition of "Political Subdivision" to TLTG

TLTG argues th at the cases discussed above should not be read to create a strict legal

formula for determining whether an entity is a political subdivision. We agree that the case law may

not have enumerated an exhaustive list of sove reign powers, but we do read the cases to requi re

either the delegation of one or more of the three traditional sovereign powers discussed in Shamberg,

or some other recognized sovereign power. We find that TLTG does not maintain any o f thesovereign powers discussed in Shamberg, nor any other recognized sovereign power.

TLTG concedes that it does not possess the power of eminent domain, the power to levy or

collect taxes, or the power to issue government bonds. (Appellant's Br. at 11). TLTG argues,

however, that its power to establish, regulate, and distribute curricula to t he school districts

constitutes sovereign police power. (Appellant's Br. at 24). The limit ed authority that TLTG is

authorized to exercise regarding the content of public school curriculum, does not constitute police

power. S ee Philadelphia Nt'l Bank v. United States, 666 F.2d 834 (3rd Cir.1981), cert. denied, 457

U.S. 1105, 102 S.Ct. 2904, 73 L.Ed.2d 1314 (1982).

TLTG also contends that, although it does not possess the power to tax, its power to collect

funds from its member scho o l dist rict s for membership dues and operating deficits constitutes a

sovereign assessment power. TLTG intimates that while this power is not equivalent to the power

to tax, it is a recognized sovereign power. As support for this theory, TLTG cites the 1914 Attorney

General Opinion discussed above. TLTG contends that the assessment power of the irrigation

districts at issue in the 1914 Attorney General Opinion was different from a taxing power, but yet was

recognized as a sovereign po wer by t he At torney General. (Appellant's Reply Br. at 10). We

disagree. The Attorney General considered the assessment powers of the irrigation district to be the

equivalent of taxing powers. 30 Op.Atty.Gen. 252 ("As indicated by the term "special assessment

districts,' these divisions are given the power of t axation—perhaps the m ost i m portant power

possessed by the State."). We reject TLTG's argument that the Attorney General did not consider

a delegation of taxi ng power critical to its finding that the irrigation district was a political

subdivision. Furthermore, we do not find merit in TLTG's assertion that its power to collect funding

from its members constitutes a sovereign power.

We agree with the Commissioner and the Tax Court that TLTG has not been delegated any

sovereign powers. Without the authority t o exercise sovereign power, TLTG cannot constitute apolitical subdivision. See 26 C.F.R. § 1.103–1(b).

D. TLTG's "Integral Part" Argument

TLTG argues alternatively that it should be classified as a political subdivision because it is

an "integral part" of its member school distri ct s, which, as the Government concedes, are political

subdivisions. TLTG cites several cases in which courts have held that a division of a larger entity was

entitled to share the tax-exempt status of the larger entity because the division was an "integral part"

of the larger entity. It is true that an "integral part" of a larger entity is entitled to share in the larger

entity's tax-exempt status. S ee, Hospital Bureau of Standards and Supplies v. United States, 158

F.Supp. 560, 141 Ct.Cl. 91 (1958); E state of Philip R. Thayer v. Commissioner, 24 T.C. 384 (1955);

Squire v. Students Book Corp., 191 F.2d 1018 (9th Cir.1951). It is not true, however, that TLTG

is an integral part of a political subdivision. The most that can be said for TLTG in this connection

is that it may be int egrally related to several political subdivisions. Such a relationship does not

automatically entitle the integrally related entity to be classified as a political subdivision.

The courts have consistently recognized that political subdivision status requires a delegation

of sovereign authority. See, Shamberg, 144 F.2d 998; White, 144 F.2d 1019; S eagrave, 38 T.C.

237. To apply the "integral part" cases in this context would completely circumvent the requirement

of sovereign authority for political subdivision status. To bestow political subdivision status on an

entity, merely because it is an integral part of a political subdivision, would bypass the requirement

that a political subdivision must be authorized to exercise some sovereign power. We refuse to throw

out the sovereign power requirement for political subdivision status. Therefore, we find the "integral

part" cases inapplicable to a determination of political subdivision status.

III. Conclusion

We find that a political subdivision, within the meaning of § 170(b)(1)(A)(v), must possess

recognized sovere ign power. TLTG does not maintain any recognized sovereign powers andtherefore is not a political subdivision w it hin the meaning of subsection (v). For this reason, we

AFFIRM the opinion of the Tax Court.