CASH-METHOD BANK NEED NOT ACCRUE INTEREST OR OID ON SHORT-TERM LOANS.
Security State Bank v. Comm.
- Case NameSECURITY STATE BANK, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent
- CourtUnited States Tax Court
- DocketTax Ct. Dkt. No. 15478-96
- JudgeRuwe, Robert P.
- Parallel Citation111 T.C. 210111 T.C. No. 8
- Code Sections
- Subject Areas/Tax Topics
- Index TermsOID, short-term, income inclusionOID, short-term, rules
- Jurisdictions
- LanguageEnglish
- Tax Analysts Document NumberDoc 1998-27347 (9 original pages)
- Tax Analysts Electronic Citation1998 TNT 172-10
Security State Bank v. Comm.
UNITED STATES TAX COURT
Filed September 3, 1998
P is a bank that uses the cash method of accounting. During
1989, P made short-term loans to customers. The principal and
interest on the loans were payable at maturity. R determined
that P must accrue interest and/or original issue discount on
the loans pursuant to sec. 1281(a)(1) and (2), I.R.C.
HELD: Sec. 1281(a)(2), I.R.C., does not require a bank to
accrue interest on short-term loans made in the ordinary course
of its business. Security Bank Minn. v. Commissioner, 98 T.C. 33
(1992), affd. 994 F.2d 432 (8th Cir. 1993).
HELD, FURTHER: Sec. 1281(a)(1), I.R.C., does not require a
bank to accrue original issue discount on short-term loans made
in the ordinary course of business.
Martin J. Peck, for petitioner.
Charles M. Berlau, for respondent.
OPINION
[1] RUWE, JUDGE: Respondent determined a deficiency of $29,972.41 in petitioner's 1989 Federal corporate income tax. The issue for decision is whether section 1281(a) 1 requires petitioner, a cash basis taxpayer, to accrue interest and/or original issue discount earned on short-term loans.
BACKGROUND
[2] The parties submitted this case fully stipulated. The stipulation of facts and supplemental stipulation of facts are incorporated herein by this reference. Petitioner is a corporation whose principal place of business was in Wellington, Kansas, at the time it filed the petition.
[3] Petitioner is a commercial bank that makes a variety of loans in the ordinary course of its business. These loans are of varying duration, including loans of less than 1 year, loans of 1 year, and loans of more than 1 year. Petitioner had, and still has, business reasons for using notes with a term of 1 year or less.
[4] During 1989, petitioner made some loans that were documented by promissory notes with a stated maturity date that was 1 year from the date the notes were issued. Such loans will be referred to as category X loans. Petitioner held the category X loans on December 31, 1989. During 1989, petitioner also made some loans that were documented by promissory notes with a stated maturity date that was less than 1 year from the date the notes were issued. Such loans will be referred to as category Y loans. Petitioner held the category Y loans on December 31, 1989. The interest and principal payable on all categories X and Y loans were due at maturity.
[5] Petitioner reported its taxable income using the cash method of accounting. Petitioner reported interest income from its categories X and Y loans as it was received pursuant to the cash method of accounting.
[6] Petitioner had interest income of $60,086.89 during 1989 that had accrued, but was not yet paid, on its category X loans. Petitioner had interest income of $65,687.11 during 1989 that had accrued, but was not yet paid, on its category Y loans.
DISCUSSION
[7] Petitioner uses the cash method of accounting to report its taxable income. Consistent with that method, it did not report as income on its 1989 return any accrued interest or original issue discount that was earned but unpaid at the end of 1989. Respondent does not contest petitioner's general use of the cash method. 2 Rather, respondent relies on the specific provisions of section 1281 requiring the accrual of income earned on short-term obligations.
[8] The pertinent provisions of section 1281(a) are as follows:
SEC. 1281. CURRENT INCLUSION IN INCOME OF DISCOUNT ON CERTAIN
SHORT-TERM OBLIGATIONS.
(a) General Rule. -- In the case of any short-term
obligation to which this section applies, for purposes of this
title --
(1) there shall be included in the gross income of the
holder an amount equal to the sum of the daily portions of
the acquisition discount for each day during the taxable
year on which such holder held such obligation, and
(2) any interest payable on the obligation (other than
interest taken into account in determining the amount of
the acquisition discount) shall be included in gross income
as it accrues.
(b) Short-Term Obligations to Which Section Applies. --
(1) In general. -- This section shall apply to any
short-term obligation which --
* * * * * * *
(C) is held by a bank (as defined in section 581),
* * *
(c) Cross Reference. -- For special rules limiting the
application of this section to original issue discount in the
case of nongovernmental obligations, see section 1283(c).
Certain pertinent provisions of section 1283 are as follows:
SEC. 1283. DEFINITIONS AND SPECIAL RULES.
(a) Definitions. -- For purposes of this subpart --
(1) Short-term obligation. --
(A) In general. -- Except as provided in
subparagraph (B), the term "short-term obligation"
means any bond, debenture, note, certificate, or other
evidence of indebtedness which has a fixed maturity
date not more than 1 year from the date of issue.
(B) Exceptions for tax-exempt obligations. -- The
term "short-term obligation" shall not include any
tax-exempt obligation (as defined in section
1275(a)(3)).
* * *
(c) Special Rules for Nongovernmental Obligations. --
(1) In general. -- In the case of any short-term
obligation which is not a short-term Government obligation
(as defined in section 1271(a)(3)(B)) --
(A) sections 1281 and 1282 shall be applied by
taking into account original issue discount in lieu of
acquisition discount, and
(B) appropriate adjustments shall be made in the
application of subsection (b) of this section.
[9] Respondent's first argument is that petitioner is required to accrue interest income from its categories X and Y loans pursuant to section 1281(a)(2). This is not an issue of first impression. Indeed, respondent recognizes that in Security Bank Minn. v. Commissioner, 98 T.C. 33, 42 (1992), affd. 994 F.2d 432 (8th Cir. 1993), we held that section 1281(a)(2) does not apply to short-term loans made by banks in the ordinary course of business. Respondent recognizes that our prior opinion precludes application of section 1281(a)(2) to the facts in the instant case, unless we choose to overrule it. Respondent urges us to do just that.
[10] Security Bank Minn. v. Commissioner, supra, was a Court- reviewed opinion. The majority opinion contains an extensive analysis of the statute, its evolution, the context in which it appears, and its legislative history. There was a dissenting opinion which was joined by five Judges. In affirming our opinion, the Court of Appeals for the Eighth Circuit also made an extensive analysis of the same factors. One of the judges on the Court of Appeals panel dissented.
[11] No purpose would be served by repeating the statutory analysis that led this Court and the Court of Appeals to decide that section 1281(a)(2) does not apply to loans made by banks in the ordinary course of business. Suffice it to say that this matter has been thoroughly considered and decided. The doctrine of stare decisis generally requires that we follow the holding of a previously decided case, absent special justification. This doctrine is of particular importance when the antecedent case involves statutory construction. Hesselink v. Commissioner, 97 T.C. 94, 99-100 (1991). While respondent has skillfully rearticulated his arguments in support of a different interpretation of the statute, we find nothing therein that would cause us to refrain from applying the doctrine of stare decisis with respect to the section 1281(a)(2) issue. 3
[12] Respondent alternatively argues that the loans in question were made in return for notes that contained "original issue discount" within the purview of sections 1281(a)(1) and 1283. According to respondent, section 1281(a)(1) requires petitioner to accrue the daily portion of that discount during the year in which the note was held, regardless of whether petitioner actually received anything in that year.
[13] In Security Bank Minn. v. Commissioner, supra at 37, the Commissioner refrained from arguing that section 1281(a)(1) applied, although he stated on brief that it "arguably does." it was therefore not necessary for us to make a specific holding regarding the application of section 1281(a)(1). In a technical sense, respondent's proposed application of section 1281(a)(1) presents an issue of first impression. However, we believe that the analysis upon which the holding in Security Bank Minn. was based compels us to hold against respondent's argument that section 1281(a)(1) applies in the instant case.
[14] Our holding in Security Bank Minn. that section 1281(a)(2) did not apply to loans made by banks in the ordinary course of business was based on our interpretation of section 1281 as originally enacted in 1984. As originally enacted, section 1281(a) applied only to acquisition discount or original issue discount. Deficit Reduction Act of 1984, Pub. L. 98-369, sec. 41, 98 Stat. 548. Section 1281 was amended in 1986 to add the provisions of section 1281(a)(2). Tax Reform Act of 1986, Pub. L. 99-514, sec. 1803, 100 Stat. 2791. In Security Bank Minn., we first analyzed section 1281 in its original form. On the basis of that analysis, we stated:
We conclude that the legislative history supports petitioner's
interpretation of section 1281, i.e., that it was enacted in
1984 to deal with problems associated with purchased debt
instruments involving a discount and not with loans made by a
bank in the ordinary course of its business. Accordingly, we
hold that the loans here in dispute are not the sort of
obligations or instruments to which section 1281 applied as
enacted in 1984. [Security Bank Minn. v. Commissioner, supra at
42.]
We then concluded that the addition of section 1281(a)(2) in 1986 was not intended to cover loans made by banks.
We do not believe that the 1986 amendment, which originated as a
technical correction, was intended to increase the coverage of
section 1281(a) to loans made if, as we have concluded, such
loans were not covered by the 1984 Act. The amendment, in our
view, was intended to express the amounts to be taken into
current income and not to expand the category of instruments
covered by section 1281(a). [Id. at 43.]
[15] Our analysis in Security Bank Minn. v. Commissioner, supra, makes clear that we have interpreted section 1281 as having no application to loans made by banks in the ordinary course of business, regardless of whether the loans are characterized as generating interest or original issue discount. 4 We, therefore, hold that section 1281(a)(1) does not apply to the loans in issue.
[16] Decision will be entered for petitioner.
FOOTNOTES
1 Unless otherwise indicated, all section references are to the Internal Revenue Code in effect for the year in issue.
2 Although it is not explicitly indicated in the record, it appears that petitioner was allowed to use the cash method of accounting in 1989 because it had gross income of less than $5 million. See secs. 446(a), (c)(1), 448(b)(3).
3 Respondent has made no argument that the issues presented are of great overall significance. Sec. 448 generally precludes corporations with more than $5 million in gross receipts from using the cash method of accounting. Thus, our holdings appear to have application only to small banks.
4 Because of our legal conclusion, there is no need to decide whether respondent is correct in characterizing the loans in issue as generating original issue discount.
END OF FOOTNOTES
- Case NameSECURITY STATE BANK, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent
- CourtUnited States Tax Court
- DocketTax Ct. Dkt. No. 15478-96
- JudgeRuwe, Robert P.
- Parallel Citation111 T.C. 210111 T.C. No. 8
- Code Sections
- Subject Areas/Tax Topics
- Index TermsOID, short-term, income inclusionOID, short-term, rules
- Jurisdictions
- LanguageEnglish
- Tax Analysts Document NumberDoc 1998-27347 (9 original pages)
- Tax Analysts Electronic Citation1998 TNT 172-10