United States v. Centennial Savings Bank Fsb

Decision Date17 April 1991
Docket NumberNo. 89-1926,89-1926
Citation111 S.Ct. 1512,499 U.S. 573,113 L.Ed.2d 608
PartiesUNITED STATES, Petitioner v. CENTENNIAL SAVINGS BANK FSB (Resolution Trust Corporation, Receiver)
CourtU.S. Supreme Court
Syllabus

During the 1981 tax year, respondent Centennial Savings Bank FSB exchanged participation interests in a set of mortgage loans for interests in a different set of mortgage loans held by another lender. All of the loans were secured by residential properties and had a face value substantially higher than their fair market value. In a separate set of transactions, Centennial collected early withdrawal penalties from customers who prematurely terminated their certificates of deposit (CD's). In its 1981 federal income tax return, Centennial claimed a deduction for the difference between the face value of the mortgage interests it surrendered and the fair market value of the mortgage interests it received. It also treated the early withdrawal penalties it received as "income by reason of the discharge . . . of indebtedness" excludable from gross income under 26 U.S.C. § 108(a)(1)(C) (1982 ed.). After the Internal Revenue Service disallowed the deduction of the losses associated with the mortgages and determined that Centennial was required to declare the early withdrawal penalties as income, Centennial paid the deficiencies and filed a refund action in the District Court. The court entered a judgment for petitioner United States on the mortgage-exchange issue and for Centennial on the early withdrawal penalty issue. The Court of Appeals reversed the mortgage-exchange ruling, but affirmed the early withdrawal penalty holding.

Held:

1. Centennial realized tax-deductible losses when it exchanged mortgage interests with the other lender. Cottage Savings Assn. v. Commissioner, 499 U.S. 554, 111 S.Ct. 1503, 113 L.Ed.2d 589. Pp. 578-579.

2. The early withdrawal penalties collected by Centennial were not excludable from income under § 108(a)(1). A debtor realizes income from the "discharge of indebtedness" only when the income results from the forgiveness of, or release from, an obligation to repay assumed by the debtor at the outset of the debtor-creditor relationship. Here, the depositors who prematurely closed their accounts and incurred penalties did not forgive or release any repayment obligation on the part of Centennial, which paid exactly what it was obligated to pay according to the terms of the agreements entered into at the time the CD's were established. This reading best comports with § 108's purpose, which is to mitigate the effect of treating a discharge of indebtedness as income so that the prospect of immediate tax liability will not discourage businesses from taking advantage of opportunities to repurchase or liquidate their debts at less than face value. A debtor who negotiates in advance the circumstances in which he will liquidate the debt is in a position to anticipate his need for cash with which to pay the resulting income tax and can negotiate the terms of the anticipated liquidation accordingly. Moreover, in this case, Centennial was committed to releasing the deposits at the sole election of the depositors. Thus, unlike a debtor considering the negotiation of an adjustment of the terms of a duty to repay, Centennial had no discretion to take the tax effects of a transaction into account before liquidating its obligation at less than face value. Pp. 579-584.

887 F.2d 595 (CA5 1989), affirmed in part, reversed in part, and remanded.

MARSHALL, J., delivered the opinion of the Court, in which REHNQUIST, C.J., and STEVENS, O'CONNOR, SCALIA, KENNEDY, and SOUTER, JJ., joined, in Parts I and III of which WHITE, J., joined, and in Part III of which BLACKMUN, J., joined. BLACKMUN, J., filed an opinion concurring in part and dissenting in part, in which WHITE, J., joined, post, p. ----.

John G. Roberts, Jr., for petitioner.

Michael F. Duhl, for respondent.

Justice MARSHALL delivered the opinion of the Court.*

In this case, we consider two questions relating to the federal income tax liability of respondent Centennial Savings Bank FSB (Centennial). The first is whether Centennial realized deductible losses when it exchanged its interests in one group of residential mortgage loans for another lender's interests in a different group of residential mortgage loans. The second is whether penalties collected by Centennial for the premature withdrawal of federally insured certificates of deposit (CD's) constituted "income by reason of the discharge . . . of indebtedness" excludable from gross income under 26 U.S.C. § 108(a)(1)(C) (1982 ed.). The Court of Appeals answered both questions affirmatively. We agree with the Court of Appeals that Centennial's mortgage exchange gave rise to an immediately deductible loss, but we reverse the Court of Appeals' determination that Centennial was entitled to exclude from its taxable income the early withdrawal penalties collected from its depositors.

I

Centennial is a mutual savings and loan institution (S & L) formerly regulated by the Federal Home Loan Bank Board (FHLBB).1 At issue in this case are two sets of transactions involving Centennial in the 1981 tax year.

The first was Centennial's exchange of "90% participation interests" in a set of mortgage loans held by Centennial for "90% participation interests" in a different set of mortgage loans held by the Federal National Mortgage Association (FNMA).2 Secured by residential properties located pri- marily in northern Texas, Centennial's 420 loans had a face value of approximately $8.5 million and a fair market value of approximately $5.7 million; FNMA's 377 loans, secured by properties located throughout Texas, likewise had a face value of approximately $8.5 million and a fair market value of $5.7 million. Centennial and FNMA structured the exchange so that the respective mortgage packages would be deemed "substantially identical" under the FHLBB's Memorandum R-49, dated June 27, 1982, a regulatory directive aimed at identifying mortgage exchanges that would not generate accounting losses for FHLBB regulatory purposes but that would generate deductible losses for federal tax purposes. See generally Cottage Savings Assn. v. Commissioner, 499 U.S. 554, 556-557, 111 S.Ct. 1503, 1506, 113 L.Ed.2d 589. On its 1981 return, Centennial claimed a deduction for the loss of $2,819,218, the difference between the face value (and cost basis) of the mortgage interests surrendered to FNMA and the market value of the mortgage interests received from FNMA in return.

The second set of transactions was Centennial's collection of early withdrawal penalties from customers who prematurely terminated their CD accounts. Each CD agreement established a fixed-term, fixed-interest account. See App. 27-29. Consistent with federal regulations, each agreement also provided that the depositor would be required to pay a penalty to Centennial should the depositor withdraw the principal before maturity. See 12 CFR § 526.7(a) (1979); 12 CFR § 526.7(a) (1980); 12 CFR § 1204.103 (1981). Thus, in the event of premature withdrawal, the depositor was entitled under the CD agreement to the principal and accrued interest, minus the applicable penalty. See App. 27-29.

Centennial collected $258,019 in early withdrawal penalties in 1981. In its tax return for that year, Centennial treated the penalties as income from the discharge of indebtedness. Pursuant to 26 U.S.C. §§ 108 and 1017 (1982 ed.), Centennial excluded the $258,019 from its income and reduced the basis of its depreciable property by that amount.

On audit, the Internal Revenue Service disallowed the deduction of the losses associated with Centennial's mortgages, and determined that Centennial should have declared as income the early withdrawal penalties collected that year. After paying the resulting deficiencies, Centennial instituted this refund action in the District Court for the Northern District of Texas, which entered judgment for the United States on the mortgage-exchange issue, and for Centennial on the early withdrawal penalty issue. 682 F.Supp. 1389 (1988).

The Court of Appeals for the Fifth Circuit reversed in part and affirmed in part. 887 F.2d 595 (1989). It reversed the District Court's ruling that Centennial did not realize a deductible loss in the mortgage-exchange transaction. Relying on its reasoning in another decision handed down the same day, see San Antonio Savings Assn. v. Commissioner, 887 F.2d 577 (1989), the Court of Appeals concluded that although the respective mortgage packages exchanged by Centennial and FNMA were "substantially identical" under Memorandum R-49, the two sets of mortgages were nonetheless "materially different" for tax purposes because they were secured by different residential properties. See 887 F.2d, at 600. Consequently, the court held, the exchange of the two sets of mortgages did give rise to a realization event for tax purposes, allowing Centennial immediately to recognize its losses. See ibid.

The Court of Appeals affirmed the District Court's conclusion that Centennial was entitled to treat the early withdrawal penalties as income from the discharge of indebtedness under § 108. The court reasoned that "the characterization of income as income from the discharge of indebtedness depends purely on the spread between the amount received by the debtor and the amount paid by him to satisfy his obligation." Id., at 601. Under this test, the early withdrawal penalties constituted income from the discharge of indebtedness, the court concluded, because the penalties reduced the size of Centennial's obligation to its depositors. See id., at 601-602. The court rejected the United States' characterization of the penalties as merely a "medium of payment" for Centennial's performance of its "separate obligation" to release the deposits prior to maturity. Id., at 604-605.

The United States thereafter petitioned this Court for a writ...

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