CHICAGO -- The internal Revenue Service has not yet decided whether to appeal a decision last week by a federal appellate court that found Michigan's prepaid tuition program to be tax-exempt.
James McGovern, an assistant IRS commissioner of employee plans and exempt organizations, declined to comment yesterday on the ruling by the U.S. Court of Appeals for the Sixth Circuit. McGovern, who talked with reporters after giving a speech in Washington, D.C., would say only that the IRS has not decided whether to appeal the decision.
The ruling was seen as a blow for the IRS, which had refused to exempt the trust from federal taxation.
In a 2-to-1 decision, the appellate court reversed a July 1992 district court ruling that supported the IRS action. The U.S. District Court for the Western District of Michigan found that the education trust was not an "integral part of the state of Michigan" and is subject to the IRS code. The lower court also ruled that the program's income was not exempt from taxation "because the income does not accrue to the state of Michigan or one of its political subdivisions."
In its reversal, the appellate court agreed with Michigan's characterization of the trust as being an integral part of state government.
The court found that the trust "is a public agency explicitly authorized to exercise contracting posers on behalf of the state for a purpose that the legislature has declared public."
In its ruling, the appellate court also granted the trust a tax refund of about $57.4 million plus interest, according to John Collins, an attorney at Miller Canfield Paddock & Stone, who served as a special attorney general for Michigan in the case.
Collins said the IRS could decide to ask for a rehearing before the appellate court or take the case directly to the U.S. Supreme Court.
Michigan filed the lawsuit in May 1990 after receiving a letter ruling from the IRS denying the trust a tax exemption. State officials have said the lawsuit was probably the first to challenge federal taxation of state-run prepaid tuition programs.
Under Michigan's six-year-old program, people can buy contracts from the trust to cover a child's future college education costs. The trust invests the money in preferred stocks and corporate bonds, and guarantees the tuition cost of the contract's beneficiary at a state-run college or university.
Michigan stopped selling contracts in 1991 because of uncertainty over the tax status of the trust and double-digit increases in tuition costs at state schools, according to Bobbie McKennon, a spokeswoman for the state treasurer's office. The trust currently has 54,200 contracts and assets of $502 million, she said.
McKennon said the trust's board of directors has not yet decided whether to accept new contracts in light of the appellate court ruling.
Peter A. Roberts, chairman of the College Savings Bank, a private entity that competes with state-sponsored college savings plans, said that if the appellate court's ruling holds, more programs like the one in Michigan would be created.
"A lot of states have passed legislation to commence prepaid programs once [Michigan] gets a clear-cut tax decision," he said.
About six states, including Michigan, have operated prepaid tuition programs.
Roberts said that the court ruling could also spur states to create other kinds of state-run investment vehicles, such as mutual funds, for their residents.
Joan Pryde contributed to this article.
