Bell Federal Sav. and Loan Ass'n v. C.I.R.

• Decision Date: 16 November 1994
• Docket Number: No. 93-2679,93-2679
• Parties: -6990, 94-2 USTC P 50,598 BELL FEDERAL SAVINGS AND LOAN ASSOCIATION, Petitioner-Appellee, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellant.
• Court: U.S. Court of Appeals — Seventh Circuit

Page 224

40 F.3d 224

74 A.F.T.R.2d 94-6990, 94-2 USTC P 50,598

BELL FEDERAL SAVINGS AND LOAN ASSOCIATION, Petitioner-Appellee, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellant.

No. 93-2679.

United States Court of Appeals Seventh Circuit.

Argued Sept. 13, 1994.

Decided Nov. 16, 1994.

Sharon Swarsensky Bilow, Anthony C. Valiulis, Jordan Z. Katz, Joseph D. Ament, Much, Shelist, Freed, Denenberg & Ament, Robert E. Ulbricht, Jill A. Dougherty, Kelly, Olson, Rogan & Siepker, Kenneth W. Gideon (argued), Wilmer, Cutler & Pickering, Washington, DC, for petitioner-appellee.

Michael L. Paup, Gary R. Allen, Bruce R. Ellisen, Frank P. Cihlar (argued), Dept. of Justice, Tax Div., Appellate Section, Washington, DC, for respondent-appellant.

Before LAY, ^* BAUER, and WOOD, Jr., Circuit Judges.

HARLINGTON WOOD, Jr., Circuit Judge.

The Commissioner of Internal Revenue ("Commissioner") appeals the decision of the United States Tax Court that the appellee, Bell Federal Savings and Loan Association ("Bell"), was not deficient in its income tax payments for the taxable year 1978. The Tax Court reached this decision after concluding that 26 C.F.R. Sec. 1.593-6A(b)(5)(vi)-(vii) was invalid and contrary to Congress's intent. Issued by the Commissioner in 1978, the ordering rules of Sec. 1.593-6A(b)(5)(vi)-(vii) provide that taxpayers such as Bell who utilize the percentage of taxable income method for computing bad debt reserve deductions must recalculate those bad debt reserve deductions if the taxable income for the tax year in question is later reduced by net operating losses carried back from a subsequent tax year under 26 U.S.C. Sec. 172. For the reasons that follow, we reverse the tax court's finding that 26 C.F.R. Sec. 1.593-6A(b)(5)(vi)-(vii) is invalid and we remand to the tax court for further proceedings.

I.

The facts in this case are fully stipulated and not in dispute. During the relevant period, Bell was a mutual savings and loan association ("mutual institution"), which qualified Bell for the special bad debt reserve deduction established by 26 U.S.C. Sec. 593(a)(1) of the Internal Revenue Code. ¹ Section 166(a) allows a taxpayer to take a deduction for a debt that becomes worthless within the taxable year. Section 166(c), as in effect for the period in issue in this case, provided that in lieu of taking a bad debt deduction under Sec. 166(a), a taxpayer may instead claim "a deduction for a reasonable addition to a reserve for bad debts." Section 593(b) governs the calculation of the amount of the allowable addition to loan loss reserves and provides three different methods of computation which may be chosen by taxpayers such as Bell. Of these, Bell used the "percentage of taxable income" method established in Sec. 593(b)(2) which allows a deduction for addition to loan loss reserves equal to a certain percentage of the taxpayer's "taxable income" for the year. ²

Congress has also enacted another procedure, relevant to this appeal, by which the tax liability of mutual institutions may be lessened. Section 172(b)(1)(F) allows these taxpayers to carry back a net operating loss ("NOL") sustained in one tax year to the ten tax years preceding the loss year. Bell sustained NOLs of $8,865,941 in 1983 and $5,336,627 in 1984. Bell carried its 1983 NOL back to the tax years 1977 and 1978, and it carried its 1984 NOL back to 1978.

A NOL, once carried back in this manner, is treated as a deduction for that previous tax year under Sec. 173(a). Consequently, the taxpayer's income tax liability for that previous year is lessened. The taxpayer will thus usually file an amended return, which recomputes the taxpayer's income tax liability for that year, and seek a partial or total refund of the taxes it previously paid.

The problem that arises in this context, and which forms the crux of this appeal, is determining which taxable income figure the carried-back NOL should be applied to. This confusion derives from the tension inherent in the relationship between the deductions provided in Secs. 172 and 593. The question here is whether the carried-back NOL should be deducted from taxable income before or after the "percentage of taxable income" method for calculating loan loss reserve deductions is employed. The Internal Revenue Code does not directly address this issue.

The Commissioner's regulations solve this problem by expressly requiring that Sec. 172(a) NOL deductions be accounted for prior to the calculation of the loan loss reserve deductions. 26 C.F.R. Sec. 1.593-6A(b)(vi)-(vii). Prior to the issuance of the current regulations, the Commissioner had in force regulations which provided for exactly the opposite approach--NOL deductions were not to be calculated until after the additions to loan loss reserves were calculated. 26 C.F.R. Sec. 1.593-6(b)(2)(iv).

The end result of the new regulations is to increase the amount of taxes paid by taxpayers such as Bell. Since the bad debt reserve deduction is computed as a certain percentage of taxable income, the reduction of taxable income via the NOL deduction serves to concomitantly decrease the amount of the bad debt reserve deduction. At issue in this case is the validity of the new regulations. The tax court, relying upon its earlier holding in Pacific First Fed. Sav. Bank v. Commissioner, 94 T.C. 101, 1990 WL 16898 (1990), held that 26 C.F.R. Sec. 1.593-6A(b)(vi)-(vii) "is invalid and contrary to Congress's intent." The Commissioner contests only Bell's calculation of its 1978 bad debt reserve deduction.

II.

A.

The courts of appeals exercise jurisdiction over decisions of the tax court "in the same manner and to the same extent as decisions of the district courts in civil actions tried without a jury." 26 U.S.C. Sec. 7482(a). The facts in this case are not contested--the only issues for review involve the tax court's conclusions of law. Accordingly, we review the record de novo. Merit Life Ins. Co. v. Commissioner, 853 F.2d 1435, 1438 (7th Cir.1988), vacated on other grounds, 492 U.S. 902, 109 S.Ct. 3208, 106 L.Ed.2d 559 (1989).

B.

The Commissioner argues that the tax court erroneously invalidated 26 C.F.R. Sec. 1.593-6A(b)(5)(vi)-(vii). Two other circuit courts have already addressed this issue and they both rejected the tax court's reasoning behind its Pacific First decision and affirmed the validity of the challenged regulation. See Pacific First Fed. Sav. Bank v. Commissioner, 961 F.2d 800, 805-08 (9th Cir.), cert. denied, --- U.S. ----, 113 S.Ct. 209, 121 L.Ed.2d 150 (1992); Peoples Fed. Sav. & Loan Assoc. of Sidney v. Commissioner, 948 F.2d 289, 304-05 (6th Cir.1991). "Respect for the decisions of other circuits is especially important in tax cases because of the importance of uniformity, and the decision of the Court of Appeals of another circuit should be followed unless it is shown to be incorrect." Federal Life Ins. Co. v. United States, 527 F.2d 1096, 1098-99 (7th Cir.1975) (per curiam) (citing Goodenow v. Commissioner, 238 F.2d 20, 22 (8th Cir.1956)). The reasoning behind the Ninth and Sixth Circuits' opinions is persuasive and, as discussed below, we cannot show it to be incorrect. The thorough consideration to which this matter has already been treated by the Ninth and Sixth Circuits obviates the need for us to delve into this matter in depth; we strive here only to summarize and synthesize the Ninth and Sixth Circuits' analyses upholding the validity of the treasury regulation at issue.

III.

The challenged regulation was issued by the Treasury Department under its authority to "prescribe all needful rules and regulations for the enforcement" of the Internal Revenue Code. 26 U.S.C. Sec. 7805(a). The Ninth and Sixth Circuits adopted slightly different approaches for determining the validity of this interpretive regulation, but both approaches apply essentially the same test and the application of either approach leads to the same result in this case.

The Sixth Circuit applied the rule of deference established by Chevron U.S.A., Inc. v. Natural Resources Defense Council, 467 U.S. 837, 104 S.Ct. 2778, 81 L.Ed.2d 694 (1984), which holds that "if the statute is silent or ambiguous with respect to the specific issue, the question for the court is whether the agency's answer is based upon a permissible construction of the statute." Id. at 843, 104 S.Ct. at 2782 (footnote omitted). The Ninth Circuit, on the other hand, chose to rely more narrowly upon the "traditional rule of deference to Treasury Regulations." Pacific First, 961 F.2d at 803. In particular, the Ninth Circuit cited National Muffler Dealers Assoc., Inc. v. United States, 440 U.S. 472, 99 S.Ct. 1304, 59 L.Ed.2d 519 (1979), which held that where the Internal Revenue Code is silent or unclear on an issue, "this Court customarily defers to the [treasury] regulation, which, if found to implement the congressional mandate in some reasonable manner, must be upheld." Id. at 476, 99 S.Ct. at 1307 (quotations omitted). Although the difference between these two approaches is negligible at best--any regulation which is "based upon a permissible construction" of an ambiguous statute will almost always "implement the congressional mandate in some reasonable manner" and vice versa, the Ninth Circuit is correct to rely upon the more narrowly tailored holding of National Muffler.

The proper test for the validation of a challenged regulation thus requires only that the regulation issued by the Commissioner constitute a reasonable implementation of Congress's mandate. The Commissioner's interpretation need not be the only, or even the most, reasonable interpretation possible as "[t]he choice among reasonable interpretations is for the Commissioner, not the courts." National Muffler, 440 U.S. at 488, 99 S.Ct. at 1312; see also Chevron, 467 U.S. at 843 n. 11, 104 S.Ct. at 2782 n. 11.

A.

The starting point of our analysis is the language of the relevant statutes. "In determining whether a particular...