The special tax-exempt bond rule for volunteer fire departments was created in 1981, as a somewhat belated response to the landmark 1962 case of Seagrave Corp. v. Commissioner. The Tax Court concluded that interest on the debts of volunteer fire departments were not tax-exempt because the debts were not issued by a state or local government.
The volunteer fire departments were just a bunch of guys running around in a firetruck, and they were not under control of any government or created by the government. The departments made money from membership fees, by charging non-members for putting out fires, and by selling lottery cards and beer at the clubhouse.
New rules were enacted in 1981, to apply to debts of volunteer fire departments issued after December 31, 1980. The new rules also applied to debts issued between 1970 and 1980 that were held by the First Bank and Trust Company of Indianapolis, Indiana (and no one else!).
Under the new rules, Internal Revenue Code section 150(e) (formerly section 103(i)) provides that debts of volunteer fire departments can be tax-exempt bonds. But in order to prevent volunteer fire departments from being the newest tax shelter, several stringent rules were imposed:
1. 95% or more of the debt proceeds must be used to acquire or improve a firehouse or firetruck used by the department.
2. The volunteer fire department must have a written agreement with the government to actually provide firefighting services.
3. The volunteer fire department must be operating in an area without other firefighting services. But Congress anticipated that this tax rule might create a "Gangs of New York"-style firefighter-fighting bloodbath [clip], and the existence of other volunteer fire departments is okay under this rule as long as the rival fire departments have been continuously providing firefighting services to the area since January 1, 1981.
§ 150 Definitions and special rules.
A bond of a volunteer fire department shall be treated as a bond of a political subdivision of a State if—
(A) such department is a qualified volunteer fire department with respect to an area within the jurisdiction of such political subdivision, and
(B) such bond is issued as part of an issue 95 percent or more of the net proceeds of which are to be used for the acquisition, construction, reconstruction, or improvement of a firehouse (including land which is functionally related and subordinate thereto) or firetruck used or to be used by such department.
For purposes of this subsection, the term “qualified volunteer fire department” means, with respect to a political subdivision of a State, any organization—
(A) which is organized and operated to provide firefighting or emergency medical services for persons in an area (within the jurisdiction of such political subdivision) which is not provided with any other firefighting services, and
(B) which is required (by written agreement) by the political subdivision to furnish firefighting services in such area.
For purposes of subparagraph (A), other firefighting services provided in an area shall be disregarded in determining whether an organization is a qualified volunteer fire department if such other firefighting services are provided by a qualified volunteer fire department (determined with the application of this sentence) and such organization and the provider of such other services have been continuously providing firefighting services to such area since January, 1, 1981.