Federal Communication Commission. FCC's two main divisions affecting cooperatives are listed below. The examiner can find audit information at www.fcc.gov and follow the menu to the pertinent divisions.

Rural Utilities Service. The Technical Accounting and Auditing Staff oversees the accounting regulations by which the RUS loan recipient cooperatives must abide. The regulations and examples in bulletin form are available on the internet at www.usda.gov/rus/pasd .

Traditional FCC ratemaking allows telephone companies to recover their allowable costs to provide regulated telecommunications service plus a reasonable rate of return on investment. M. Kellogg et al., Federal Telecommunications Law §§ 9.2, 9.8 (1992).

When cooperatives' members converse with others on interstate or intrastate long-distance telephone calls, they use the facilities of their telephone cooperative (a local exchange carrier, "LEC" ) plus one or more interexchange carriers ("ICs" ) (such as AT&T) and another LEC. Each of these earns a return on investment and recovers the cost of providing long-distance service. The FCC, through its ratemaking authority, apportions the long-distance charges the end-user pays among them.

Prior to its January 1, 1984, divestiture of local exchange subsidiaries, AT&T, Bell Operating Companies, and independent telephone companies (including cooperatives) participated in joint interstate rates. The local exchange carriers reported all long-distance charges for their members' calls to the pertinent Bell company. AT&T handled the long-distance settlements through the Bell company, which in turn remitted a share of the charges back to the local carrier. See generally, Rev. Rul. 74-362, 1974-2 C.B. 170.

The FCC replaced this system with a system of tariffed access charges, setting forth rules for the charges that interexchange carriers (such as AT&T and end users, e.g., telephone cooperatives' members) paid for access to local carriers for interstate telephone service.

Telephone companies incur two types of costs to provide long distance service. One varies with the number of access lines needed (non-traffic-sensitive), and the other varies with the traffic level (traffic-sensitive).

Billing and collection (data processing, creating, mailing, and collecting invoices) were not considered communication services under IRC 501(c)(12)(B)(i). See Notice 92-33, 1992-2 C.B. 364. This is no longer the position of the Service. Income received by telephone cooperatives for performing billing and collection services for other telephone companies is excluded income for purposes of the 85-percent member-income test. Golden Belt Tel. Ass'n., Inc. v. Commissioner, 108 T.C. 498 (1997), acq. in result only, 1998-2 C.B.. AOD No. 1998-003, CCH para. 51, 217.

Many state public utility commissions (PUCs) regulate local telephone rates. Documents filed with state PUCs may reveal information useful in the audit of telephone cooperatives.

Many telephone cooperatives request RUS financing for new telecommunications plant construction and replacement or refinancing of new or existing plants. RUS only lends for construction of capital assets, not for maintenance or repairs. As a result, cooperatives have an economic incentive to classify disbursements as capital expenditures (as opposed to current expenses). After loan approval and promissory note execution, RUS becomes the first mortgage holder on all the cooperative's property. The cooperative deposits the RUS loan proceeds into a special trustee account and spends its own funds to construct the new plant. When construction is complete, RUS reviews and approves/disapproves the cooperative's documentation of construction expenditures. The cooperative can withdraw the approved amount from the trustee account and deposit the funds in its own cash accounts. The cooperative must reimburse the trustee account for any construction expenditure disallowed later.

To ensure loan repayments, RUS requires telephone cooperatives to follow FCC's Uniform System of Accounting. Its audit procedures are published at 7 C.F.R. § 1770.10 et seq. and on its internet site. An RUS mortgage requires that the cooperative submit detailed annual financial reports to RUS, including certified audits and other reports, all of which are public information. If the cooperative does not comply with these (and other) requirements, RUS may declare the loan in default, suspend future lending, and exercise other remedies under the mortgage. RUS headquarters staff and field accountants review a cooperative's records, reports, and certified financial statements at least once every three years. Field accountants look at direct cost accumulation for plant construction as well as overhead allocations for construction, retirement, and maintenance and perform non-opinion audits of the cooperative's loan fund transactions. These RUS Field Reports also are public documents.

Overview. The FCC regulates certain activities of telecommunications companies (including telephone cooperatives) engaged in interstate commerce. In order to identify regulated and nonregulated income, expenses, and capital expenditures affecting the rate base, the FCC requires the companies/cooperatives to keep financial records according to its Uniform System of Accounting ("USoA" ) and to file annual financial reports. The USoA follows Generally Accepted Accounting Principles ("GAAP" ) in many instances.

USoA Objectives. In general, regulated telecommunications companies recover their allowable costs to provide regulated goods and services and earn a return on investment. (Operating income and expense affecting the rate base are sometimes referred to as "above the line" and nonoperating income and expense as "below the line" ). The USoA separates regulated (operating income and expense) from nonregulated activities (non-operating income and expense). The purpose of this accounting separation is to prevent telecommunications companies from imposing costs and risks of nonregulated activities on the ratepayers (cooperative's members). Expense accounts are grouped by type (e.g., wages) and function (e.g., engineering expense). Examiners must be aware of differences among regulatory accounting, income tax accounting, and GAAP.

Reporting to RUS. RUS also requires telephone cooperatives to keep detailed books as well as detailed financial information and reporting on cooperatives' activities such as corporate structure, reorganizations and acquisitions, investments in affiliated companies, extraordinary gains and losses. RUS requires cooperatives to follow the FCC's USoA with some modifications. Examiners will need to refer to publication of the USoA at 47 C.F.R. Part 32 and 7 C.F.R. § 1770.

Classification of Telephone Companies. Reporting obligations vary with the revenues of the telephone company. Companies with regulated telecommunications revenues exceeding $100 million are Class A companies. All other companies are Class B companies. Almost all cooperatives are Class B companies. Accordingly, these guidelines cite the rules for Class B companies.

Recordkeeping and Accounting Requirements. In accordance with FCC regulations, cooperatives must keep books of account, records, minute books, memoranda, etc., to support all entries and keep financial records "with sufficient particularity to show fully the facts pertaining to all entries" in the USoA and subsidiary records, as necessary. They must use the accrual method of accounting (as defined in GAAP), and regulated (defined in 47 C.F.R. § 32.9000) activities must be accounted for separately.

Non-Regulated Activities. Non-regulated activities also must be accounted for separately. This separate accounting may provide useful information for the 85-percent test and/or UBIT. For rules on revenues from non-regulated activities, see § 32.4999(l). For example, cable TV and direct broadcast TV are not nonregulated activities.

Assets and Expenses. There are two methods to account for assets and expenses:

USoA Accounts for Telephone Cooperatives. FCC/RUS USoA accounts have four digits. The first digit in an account indicates the account classification (for example, an account beginning with " 5" is a revenue account). For RUS reporting, the RUS subaccounts are preceded by "REA." For example, the account for Cash - General Fund is REA 1120.11. All Accounts are set out in 47 C.F.R. Part 32.

The telephone cooperative balance sheet accounts are:

The telephone cooperative income and expense accounts are:

Entities Covered by Financial Statements. A cooperative's financial statements must comply with SFAS No. 94, "Consolidation of All Majority-Owned Subsidiaries." If the cooperative owns a majority interest in one or more subsidiaries, it must prepare consolidated financial statements to include each subsidiary and supplementary schedules presenting a balance sheet and income statement. RUS Form 479 must be prepared on an unconsolidated basis. The RUS regulations contain sample financial statements (with accountants' notes) for a telephone cooperative.

RUS Regulations on CPAs' Audits of RUS Borrowers. The CPAs must prepare and submit the following annual reports to RUS:

There is insufficient space in these guidelines to explore all aspects of the USoA, GAAP, and GAGAS relevant to examination of cooperatives. Examiners should review the particular provisions relevant to their examination and contact the pertinent agency for questions:

The examiner should consult the following for assistance in planning and conducting the examination:

Assistance from Other Functions. If the examiner believes it is also necessary to examine an entity not under the jurisdiction of TE/GE Examination (e.g., a joint venture with another telephone company), he/she should request assistance from the function responsible for examining that entity as soon as he/she identifies the need.

The following Specialists are available for assistance:

Utilities Industry Specialist/Media/Communications Industry Specialist. The Industry Specialists (including cable television and direct TV) can assist the examiner with the following:

VEBA (Voluntary Employees' Beneficiary Association) Industry Specialist. The Industry Specialist can assist with examination of VEBAs.

Computer Audit Specialist. If the services of a computer audit specialist are necessary, obtain a description of the cooperative's hardware, software (including accounting software), and formats of files and records.

Engineer. All cooperative returns with assets of $10 million or more must be referred for engineering action. In examination of exempt and nonexempt cooperatives, the engineer is a valuable resource (e.g., tax exempt bonds, construction techniques, machinery and building design, repairs, depreciation, depletion and valuation of assets). The engineer should be involved in the early planning stages of the examination.

Excise Tax Specialist. Examinations of cooperatives often raise excise tax issues which may require the use of an Excise Tax Specialist.

Employee Plans The industry Specialist can assist with the examination of the pension and profit sharing plans of the cooperative.

Obtain and review the documents listed below to gain a basic understanding of the cooperative's activities, income, expenses, capital structure, and related organizations:

Methods of Accounting. Although basic principles are the same, the accrual method of accounting RUS requires, income tax accounting, and GAAP diverge. When this occurs, income tax accounting rules control. Thor Power Tool Co. v. Commissioner, 439 U.S. 522 (1979); Treas. Reg. section 1.446(e)-1; Rev. Rul. 90-38, 1990-1 C.B. 57; Rev. Proc. 92-20, 1992-1 C.B. 685. Many differences exist that affect timing of income and expense, gain and loss, and raising issues under IRC 61, 118, 451, 1001, 1231, and IRC 446 and 481 for changes in methods of accounting. They also may affect IRC 461 and 512 issues.

IRC 451(f). Accrual basis telephone utilities must recognize income from furnishing telephone and other communications services to customers not later than the taxable year in which they provide the service. Utilities may not accrue income relying on when they bill customers. Adjustments to the cooperative's income may be necessary. For IRC 481(a) adjustments resulting from IRC 451(f), see P.L. 99-514 §§ 821(b)(2), (3) and 100-647 § 1008(h). S. Rep. No. 313, 99th Cong., 2d Sess., 1986-3 C.B. (Vol. 3) 120-121; H. Conf. Rep. No. 841, 99th Cong., 2d Sess., 1986-3 C.B. (Vol. 4) II-322-324. For prior law (cycle billing vs. budget billing), see Rev. Rul. 72-114, 1972-1 C.B. 124.

Rate Increases. For financial accounting purposes, utilities report a permitted rate increase as revenue in the year in which the new rate order is issued. For income tax accounting, increased income is recognized when properly earned or accrued. Notify Headquarters of any instances in which the USoA differs from income tax accounting for:

Statement of Cash Flows. Cooperatives' financial statements must include a statement of cash flows. FAS No. 95. The statement provides information on the cooperative's ability to generate positive cash flows, to pay patronage dividends and need to borrow funds. This statement may assist the examiner in assessing whether the cooperative operates according to cooperative principles (including the reasonableness of cash reserves).

Cash Flows from Investing. Activities reflects the operations of subsidiaries. Analyze the statement of cash flow (or, if a condensed statement of cash flow is used, a more detailed cash flow statement). If appropriate, request the underlying workpapers.

Effect of Accounting Methods. The differences in accounting methods among USoA, GAAP, and income tax that affect timing of income and expense, gain and loss, and raising issues may also affect the 85-percent test in IRC 501(c)(12).

Exhibit 4.76.20-1. This exhibit illustrates the income tax treatment of certain USoA Accounts for purposes of applying the 85-Percent Test.

Members. In general, subscribers served by the cooperative are members of the cooperative. These guidelines assume that all subscribers are members. Cooperatives must keep records of membership subscriptions. See the accounts for "Subscriptions to Memberships" and "Subscriptions to Members' Equity Certificates." The cooperative's subscription ledger should show the amounts due, paid, and owed for each subscriber. New members usually pay a membership fee, which is to a final bill or refunded in cash.

Revenue Accounts. These Accounts are divided into five groups: 1) Local Network Service, 2) Network Access Services Revenues, 3) Long-Distance Network Services Revenues, 4) Miscellaneous Revenues, and 5) Uncollectible Revenues. Network Access Services Revenues and Long-Distance Network Services Revenues, combined, are the largest revenue sources for most cooperatives.

Telecommunications Services. FCC determines the amount, type and source of cooperatives' revenue from regulated telecommunications services. Cooperatives must comply with the USoA, classifying and reporting revenues from regulated and unregulated services. See Exhibit 4.76.20-1 for accounts used to record income from these categories for telecommunications services.

Telecommunications Accounts Receivable. Account 1180 includes all amounts billed to subscribers (local and long-distance service, member income, nonmember income, and excluded income). Also see accounts 1181, 5301, and 5302. Taxpayers must use the specific charge-off method in accounting for losses on bad debts. Accordingly, it may be necessary to adjust accrued income to compute member, nonmember, and excluded income. Review accounts 1190 and 1191.

Income from Interest and Dividends. Review the following accounts:

Forgiveness of Indebtedness Income from Reacquisition of Long-Term Debt. When cooperatives reacquire their debt prior to maturity, the face amount appears in "Reacquired Debt." For income tax purposes, discharge of indebtedness income is (nonmember) gross income in the taxable year realized unless TAMRA § 6203 applies. IRC 61(a)(12), 451, 501(c)(12)(B)(iv).

Other Investment Income, Gain or Loss. Review accounts for gains and losses from foreign exchanges, nonregulated use of regulated facilities, disposition of land and certain property, and nonregulated net income.

Premium Income. If a cooperative has bond financing (uncommon), it may have premium income. Cooperatives must maintain separate accounts for premium, discount, and expense for each class and series of long-term debt. See the account for "Premium on Long-Term Debt." Also see Treas. Reg. section 1.61-12.

Rural Telephone Bank (RTB). RTB, an agency of the United States, provides cooperatives with financing to supplement REA loans. Cooperatives borrowing from RTB must purchase Class B stock. Class B stockholders may receive patronage dividends in the form of additional stock, par value of purchased stock, or stock received as a patronage refund. See accounts for "Investments in Nonaffiliated Companies," "Investments in Nonaffiliated Companies-Class B RTB Stock," "Investments in Nonaffiliated Companies-Class C RTB Stock," and "Other Margins."

Gains and Losses on Disposition of Plant. Gains and losses from disposition or retirement of telecommunications plant and other assets are included in gross income in the taxable year realized and recognized. FCC/RUS USoA rules on plant accounting differ radically from income tax accounting in many ways such as acquisitions, retirements, depreciation reserves, adjusted basis and realization.

Investments in Nonaffiliated Companies. Debt and equity investments are booked at acquisition cost. Separate records must be kept for each investment. A temporary decline in value is charged to "Other Capital." Permanent decline in value becomes a current period loss.

Cable Television. Cable television activities conducted in a division of the cooperative are recorded in" Nonregulated Investments" and "Nonregulated Net Income. "

Miscellaneous. Entries in the following accounts may reveal member, nonmember, or unrelated trade or business income:

Some directory advertising revenues may raise unrelated business taxable income issues during the examination of telephone cooperatives. IRC 513(c); Treas. Reg. sections 1.513-1(d)(2), 1.513-1(d)(4)(iv), 1.513-1(d)(4)(iv), Example (7); Rev. Rul. 74-38, 1974-1 C.B. 144; Rev. Rul. 76-93, 1976-1 C.B. 17.

Cooperatives must keep detailed records on names and addresses of members and a patronage capital ledger. Under cooperative principles, the excess of operating revenues over operating expenses for each year is considered capital furnished by member-patrons). The cooperative assigns such capital to members based on each year's margins:

Cooperatives are responsible for collecting and paying federal excise taxes on certain communications services. These guidelines summarize the communications tax. Consult an Excise Tax Specialist if additional assistance is needed. The following services are taxable:

The tax rate is three percent on the total amount paid for the services. State or local taxes (but not gross receipts or gross earnings taxes) that are separately stated on the bill are not included in the tax base.

A credit or refund may be allowed to the cooperative collecting the tax from members if it establishes that it repaid the amount collected to members or obtains the members' consent to the allowance of a credit or refund. In general, crediting members' patronage capital account has the same effect as refunding the overpaid tax to members. Rev. Rul. 68-206, 1968-1 C.B. 557, amplified Rev. Rul. 70-13, 1970-1 C.B. 273.

The excise taxes on the use of certain large vehicles may also apply. See IRC 4481.

Cooperatives must file Form 720 quarterly (reporting communications tax) and Form 2290 (reporting highway use tax). For exemption certificates, see IRC 4253(k).

Electric Utilities. Electric utilities (including rural electric cooperatives) were once monopolies. Now they confront many challenges, including increased competition from independent power producers and other electric utilities. Industry and government consumers demand electricity at the lowest cost, and, increasingly, if dissatisfied with rates from the local electric utility, they may build their own generating plants (and bypass the electric utility altogether) or purchase electricity from another electric utility. Changes in economics and technology are also challenges to electric utilities. It remains to be seen how much the internet will affect electric utilities as an industry.

Trends. Industry analysts forecast several trends that will likely generate new accounting and tax questions:

Rural Electric Cooperatives. Rural electric cooperatives (cooperatives) provide electric power to members and other consumers. G&Ts construct and operate power plants (alone or in arrangements with other utilities) and sell electricity at wholesale to their member distribution cooperatives, which, in turn, sell electricity retail to consumers. Distribution cooperatives are members of G&T cooperatives. The distribution cooperatives purchase electricity from their G&Ts to furnish electricity to consumers. Each cooperative, in turn, may be a member of other cooperatives, including cooperative subsidiaries. To carry out their activities, G&Ts and distribution cooperatives acquire land and land rights (including easements, water and power rights, diversion rights, submersion rights). They own (or lease) and operate electric generating plant and transmission and distribution plant, office space, furniture, and equipment. (Some distribution cooperatives are not members of a G&T and purchase power from other sources.) Cooperatives also contract for fuel/power supply and operate power plants jointly with other utilities.

Joint Ventures. G&Ts often join with other electric utilities to build and operate power generating stations. The joint venturers may own the station as tenants in common, operating the station and sharing its capacity and energy according to various operating agreements, station agreements, and load management agreements. These joint ventures may raise issues bearing on the 85-percent member-income test.

Diversification. Cooperatives are diversifying, offering water management and sewage treatment, venturing into economic development, offering satellite television service, selling satellite reception equipment, and, less commonly, offering cable television service. Many cooperatives belong to the National Rural Telecommunications Cooperative (NRTC) which offers Rural TV programming via satellite. Many of the satellite and cable television services are for-profit (noncooperative) businesses.

Regulation of electricity rates differs from state to state. To ascertain if rates are regulated by the state governing the electric cooperative being examined, check with the state's public utility commission.

Federal Energy Regulatory Commission (FERC) regulates the rates, terms, and condition of interstate wholesale electric power sales and transmission services. Certain G&Ts file annual reports with FERC (FERC Form 1). These reports are public information.

Like telephone cooperatives, many electric cooperatives finance their utility plant through loans from or guaranteed by the Rural Utilities Service ("RUS," formerly known as "REA" ). G&Ts generally borrow from the Federal Financing Bank (FFB) or from private lenders with a RUS loan guaranty.

Loans from RUS to electric cooperatives work in essentially the same way as those to telephone cooperatives. See IRM 4.76.20.13.5 for discussion.

To ensure repayment of loans, RUS also requires electric cooperatives to follow its Uniform System of Accounts (USoA) and audit procedures. For electric cooperatives, the procedures are published at 7 C.F.R. § 1767.10 et seq. and on the RUS internet site.

RUS holds a first mortgage on all the cooperative's property. The mortgage requires the cooperative to submit detailed annual financial reports to RUS, including certified audits and other reports, all of which are public information. If the cooperative does not comply with these (and other) requirements, RUS may declare the loan in default, suspend future lending, and exercise other remedies under the mortgage. RUS field accountants (sometimes referred to as general field representatives) review the loan fund records, reports, and financial statements of active borrowers at least once every three years. Field accountants look at direct cost accumulation for utility plant construction and overhead allocation among construction, retirement, and maintenance. The field accountants perform non-opinion audits of the cooperative's loan fund transactions. The RUS Field Reports are public documents.

Reporting to RUS. RUS requires electric cooperatives to keep detailed financial information and reporting on activities. See discussion at IRM 4.76.20.13. The USoA is based on FERC's accounting system with some modifications. RUS's Uniform System of Accounts for electric cooperatives is published at 7 C.F.R. § 1767 and its Accounting Methods and Procedures (required of all borrowers) at 7 C.F.R. § 1767.15. RUS also publishes Accounting Interpretations on the USoA. The methods and procedures mandate the entries to book particular transactions and aid in understanding the proper accounting treatment of items. Many accounts and account numbers in the USoA remain unchanged from year to year, so these examination guidelines can generally be used year to year.

Recordkeeping and Accounting Requirements. Cooperatives must keep books of account to support all entries and all supporting books, records, minute books, memoranda, etc. Cooperatives must use the accrual method of accounting (as defined in GAAP). Separate accounting records must be maintained for each power plant and any other utility department (e.g., gas or water). The USoA contains the following Accounts:

Balance Sheet Accounts for Electric Cooperatives

Income and Expense Accounts

Non-Balance Sheet Accounts. Most USoA non-balance sheet accounts are paired revenue and expense accounts. Income accounts (generally, the less significant accounts) combine revenue and expense into a single account. Certain non-balance sheet accounts show revenue and expense for transactions between different departments within the cooperative. Because there are numerous timing and permanent differences between RUS accounting and income tax accounting, it may be necessary to adjust the amounts shown on the financial statements when conducting an examination.

Patronage Capital Accounts. Regarding closing operating and non-operating revenue and expense accounts into patronage capital accounts at the end of the fiscal year, see discussion at IRM 4.76.20.13.

Contact. There is insufficient space in these guidelines to explore all aspects of the USoA, GAAP, and Generally Accepted Government Auditing Standards (GAGAS) relevant to examination of cooperatives. Examiners may contact RUS's Technical Accounting and Auditing Staff with questions at (202) 720-5227.

Subsidiaries. A cooperative's financial statements must comply with FAS No. 94,"Consolidation of All Majority-Owned Subsidiaries." If the cooperative owns a majority interest in a subsidiary, the cooperative must prepare consolidated financial statements including the subsidiary, together with supplementary schedules presenting a balance sheet and income statement for each subsidiary. RUS Forms 7 and 12 must be prepared on an unconsolidated basis. The RUS regulations contain sample financial statements (with accountants' notes) for an electric cooperative.

RUS Regulations on CPAs' Audits of RUS Borrowers. The CPAs must prepare and submit the following annual reports to RUS, which are public documents:

The examiner should consult the following for assistance in planning and conducting the examination:

Request and review the documents listed below to gain a basic understanding of the electric cooperative's activities, capital structure, and related organizations.

Documents to be requested from all electric cooperatives:

Newsletters and other communications to members should be requested from distribution cooperatives.

Methods of Accounting. See discussion at IRM 4.76.20.13.10(1).

IRC 451(f). Electric cooperatives on the accrual basis of accounting must recognize income from the sale of electricity to customers not later than the taxable year in which they provide it. Such electric cooperatives may not rely on the meter-reading or customer billing date when accruing income.

Timing Differences Between RUS Accounting and Income Tax Accounting

In 1988, RUS (then REA) published proposed regulations for borrower rural electric cooperatives to gain approval for a "margin stabilization plan." If REA approved, the electric cooperatives could use accounting methods to defer certain current revenues or expenses to future periods. Under the proposed regulation, the electric cooperative submitted a private letter ruling (PLR) from IRS to REA that essentially deferred the cooperative's tax exempt status and operation as a cooperative under the tax law. REA's proposed regulation also provided that a cooperative could elect to implement a margin stabilization plan before receiving the PLR by submitting to REA a board of directors' resolution stating the cooperative was aware of and accepted responsibility for a potential adverse effect on its tax exempt status. REA required the cooperative to submit the resolution with substantiation of a formal PLR application to the Service.

Subsequently, the REA/RUS modified the proposed regulation to require submission of a board of director's resolution stating that in lieu of a favorable PLR from the Service, margins would be allocated based upon current operating performance, absent any effects of a margin stabilization plan.

RUS has placed a moratorium on approving margin stabilization plans since 1994. Electric cooperatives can elect to discontinue the plan they had implemented, but if they choose to do so, they must notify RUS and recognize income in the year of discontinuance. Otherwise, those electric cooperatives that implemented an REA-approved plan under the proposed procedures may continue to defer certain income and expenses to future periods.

Electric cooperatives must maintain certain financial ratios or their RUS loans are in default. To meet the required ratios, some cooperatives under a margin stabilization plan average their margins. The cooperative selects a target margin by which income is to exceed expenses (usually the ratio required by RUS) and show it as income in financial statements and RUS reports, as opposed to the actual income and expense accrued that year. In a good year, the cooperative books the excess of income over expense as a deferred credit; in a bad year, the operating loss is booked as a deferred charge. GAAP allows this under certain conditions, as does RUS, if the cooperative meets certain requirements and discloses the plan in its financial statements.

These plans raise issues with respect to the 85-percent test and Rev. Rul. 72-36. See EO Technical Instruction Program for FY 1994, " Current Issues Affecting Certain Cooperatives and Like Organizations Described Under IRC § 501(c)(12)."

The Service's position is that the use of margin stabilization plans could result in erroneous calculations of member income for purposes of meeting the 85-percent member-income test. In the case of an electric cooperative company utilizing such plan, determine whether the organization has a Service ruling letter. If so, determine if the cooperative is following all of the letter's provisions. If it does not have a PLR issued by the Service, determine if:

See Exhibit 4.76.20-2, "Applying the 85-Percent Test: Analysis of RUS Uniform System of Accounts (Selected Revenue, Income, Expense and Balance Sheet Accounts)," which illustrates the income tax treatment of certain USoA Accounts.

Operating Revenue from Sale of Electricity. The total amount of the electric operating revenue accounts is entered in "Operating Revenue." A cooperative's electricity customers vary: residential, commercial, industrial, agricultural, governmental consumers, or other public utilities. To verify meeting the annual 85-percent test and to check for possible unrelated trade or business, review accounts that classify sales to members/nonmembers. Compare information on members to those whom the cooperative supplies with electricity. For example, through accounts "Public Street/Highway Lighting" and "Other Sales to Public Authorities," ascertain whether a local, state, or federal government agency is a member of the cooperative. Ascertain if commercial customers are members or nonmembers. Review "Sales for Resale " and "Commercial and Industrial Sales" accounts for member/nonmember income.

Accounts Receivable and Uncollectible. Review customer accounts for member/nonmember income: "Customer Accounts Receivable," "Customer Accounts Receivable-Electric," "Customer Accounts Receivable-Other," "Accumulated Provision for Uncollectible Customer Accounts-Credit," and " Uncollectible Accounts." Taxpayers must use the specific charge-off method in accounting for losses on bad debts. Utilities are not barred from charging off uncollectible accounts merely because they must continue to serve customers in arrears on their accounts. For the change in method of accounting from reserve to specific charge-off and IRC 481(a) adjustment, see P.L. 99-514 § 805(d)(2).

Electricity Purchased for Resale.The account"Purchased Power" shows the cost of electricity purchased for resale and all net settlements for exchange of electricity (including economy power, off-peak power for on-peak power, and spinning reserve capacity). The cooperative must maintain records by months, showing the demands, demand charges, kilowatt-hours, and prices under each purchase contract and the charges and credits under each exchange or power pooling contract.

Income from Interest and Dividends. Review the following accounts:

Forgiveness of Indebtedness Income from Reacquisition of Long-Term Debt. Under the USoA, when cooperatives reacquire or redeem their debt, the difference between the amount paid upon reacquisition and the face value (with certain modifications) is booked to the " Unamortized Loss on Reacquired Debt" or the "Unamortized Gains on Reacquired Debt" account. In general, for income tax purposes, discharge of indebtedness income is nonmember gross income in the taxable year realized.

Rental Income. Analyze "Rents Receivable Non-Operating Rental Income." Review "Electric Plant Leased to Others" and "Revenues from Electric Plant Leased to Others" accounts for source and amount of rental income for the 85-percent test and unrelated trade or business taxable income. Qualified pole rentals are recorded in "Rent from Electric Property."

Gains and Losses. The USoA rules on plant accounting and realization differ from the income tax rules on adjusted basis and realization:

Transfer of Clean Air Act Allowances. The Clean Air Act Amendments of 1990 established a system to issue emission allowances for airborne pollutants, implemented by the Environmental Protection Agency. Electric utilities are issued emission allowances authorizing the emission of a specified amount of airborne pollutants by the utility during a specified calendar year or later period. Starting in 1993, unused allowances may be sold, traded, or held in inventory for use against emissions in future years. G&T cooperatives may have gains and losses from transfers of clean air allowances. Rev. Proc. 92-1, 1992-1 C.B. 503. USoA treatment may vary.

Associated (Affiliated) Companies and Subsidiaries. These accounts may raise issues concerning the 85-percent test, operation as a cooperative, unrelated trade or business, and employment taxes.

Economic Development Loan Fund. Cooperatives are encouraged to participate in the Rural Economic Development Loan and Grant Program administered by the Rural Business-Cooperative Service. RUS provides interest-free loans or grants to cooperatives to promote rural economic development and job-creation projects through revolving loan funds and pass-through grants. Interest earned on rural economic development loans appears in " Interest and Dividends Receivable" and "Interest and Dividend Income" accounts. Analyze activity in these accounts in connection with the 85-percent test.

Miscellaneous. Entries in the following accounts may reveal member, nonmember, or unrelated trade or business income:

Cooperatives must keep detailed records on names and addresses of members and a patronage capital ledger.

The Patronage Capital Cycle. Cooperatives must operate on a cooperative, or nonprofit, basis. Each year, the excess of operating revenues over operating expenses is considered to be capital furnished by member-patrons. Such capital or margins is to be assigned to members on the basis of each year's margins. Cooperatives typically pay patronage dividends on a FIFO basis. Recordkeeping and procedures are basically the same as those of telephone cooperatives. See discussion at IRM 4.76.20.13.