Rev. Rul. 82-42

ISSUE

When does a taxpayer include interest earned on a six-month money market certificate in gross income when both the principal and interest are "rolled over" into an "All-Savers Certificate" under the circumstances described below?

FACTS

A, an individual on the cash receipts and disbursements method of accounting, purchased a six-month money market certificate from a qualified institution. The interest income on the certificate was not credited or made available to A for withdrawal without penalty prior to the maturity of the certificate.

Prior to the maturity of the six-month money market certificate, A "rolled over" the principal and accumulated interest on the money market certificate into a qualified "All-Savers Certificate" with a term of one year and an interest rate lower than that of the money market certificate. Normally, 12 C.F.R. sec. 1204.03 (1981) provides for a penalty for premature withdrawals of time deposits. However, under the current rules of depository institution regulatory agencies, a "roll over" from a six-month money market certificate into a deposit contract having a lower or equal interest rate and a longer or equal term does not subject the depositor to a penalty. Thus, when A "rolled over" the six-month money market certificate into the one-year "All-Savers Certificate" with a lower interest rate, no premature withdrawal penalty was imposed and the interest earned on the six-month money market certificate was no longer subject to forfeiture. However, the premature withdrawal penalty provisions of 12 C.F.R. sec. 1204.03 (1981) are applicable to the "All-Savers Certificate."

The principal and interest "rolled over" constituted the principal of the "All-Savers Certificate." The two investments are regarded as separate contracts for income tax purposes. See section 5c.128-1(c)(3), example 9, of the Temporary Income Tax Regulations.

LAW AND ANALYSIS

Section 128(a) of the Internal Revenue Code provides that gross income does not include any amount received by an individual during the taxable year as interest on a depository institution tax-exempt savings certificate.

Section 451(a) of the Code provides that the amount of any item of gross income received by the taxpayer will be included in the gross income of the taxpayer in the taxable year received unless, under the method of accounting used in computing taxable income, such amount is to be properly accounted for as of a different period.

Rev. Rul. 81-218, 1981-2 C.B. 43, provides, in part, that if the two investments are not contractually linked and if the purchase of an "All-Savers Certificate" does not entitle the purchaser to benefits not generally available to other individuals, a taxpayer may "roll over" a six-month money market certificate into an "All-Savers Certificate" that will meet the requirements of section 128 of the Code.

Rev. Rul. 80-157, 1980-1 C.B. 186, provides that interest income on a six-month non-negotiable time deposit certificate that is not credited or made available for the holder to withdraw before maturity of the certificate without penalty is not includible in the holder's gross income prior to the redemption or maturity of the certificate.

Here, the six-month money market certificate and the "All-Savers Certificate" issued to A upon the "roll over" of the money market certificate are regarded as separate contracts. Thus, the acquisitions of the two investments are two separate transactions for federal income tax purposes. When A "rolls over" the principal and accumulated interest on the money market certificate into the "All-Savers Certificate," the "roll-over" is deemed a redemption of the money market certificate for federal income tax purposes. Moreover, as the accumulated interest was used by A to purchase a portion of the "All-Savers Certificate," A actually received interest income at that time. Accordingly, A is required to include the accumulated interest on the money market certificate in gross income in the year of "roll over." However, A is entitled to an interest exclusion for such interest received in 1981 in the manner and to the extent provided under section 116.

HOLDING

A taxpayer on the cash receipts and disbursements method of accounting must include interest earned on a six-month money market certificate in gross income in the taxable year in which the principal and interest are "rolled over" into an "All-Savers Certificate." The result here is applicable even though the money market certificate would have matured in a subsequent taxable year.

EFFECT ON OTHER REVENUE RULINGS

Rev. Ruls. 80-157 and 81-218 are amplified.