Pac. First Fed. Sav. Bank v. Comm'r of Internal Revenue
| Decision Date | 27 February 1990 |
| Docket Number | Docket No. 27606-87. |
| Citation | 94 T.C. 101,94 T.C. No. 10 |
| Parties | PACIFIC FIRST FEDERAL SAVINGS BANK, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent |
| Court | U.S. Tax Court |
OPINION TEXT STARTS HERE
From 1971 through 1980, P deducted additions to its bad debt reserve. The amounts deducted were calculated with reference to P's taxable income for each year. In 1981 and 1982, P had net operating losses (‘NOLs‘). HELD: Subdivisions (vi) and (vii) of sec. 1.593-6A(b)(5), Income Tax Regs., are invalid to the extent they require that taxable income reflect any NOL carrybacks before the deduction for addition to bad debt reserve is calculated for certain financial institutions. Alan S. Kaden and John F. Coverdale, for the petitioner.
Fera Wagner and Richard Osborne, for the respondent.
Respondent determined the following deficiencies in petitioner's Federal income tax:
+----------------+
¦Year¦Deficiency ¦
+----+-----------¦
¦1978¦$1,743,066 ¦
+----+-----------¦
¦1979¦5,057.885 ¦
+----+-----------¦
¦1980¦2,512,321 ¦
+----------------+
After concessions, the issue presented is whether certain portions of section 1.593-6A(b)(5)(vi) and (vii), Income Tax Regs., are valid. For certain financial institutions, including petitioner, the deduction for addition to bad debt reserve is generally equal to a percentage of the financial institution's taxable income. The challenged portions of the regulation require that taxable income reflect any net operating loss carrybacks before the deduction for addition to bad debt reserve is calculated.
The facts are fully stipulated. We incorporate by reference the stipulation of facts and attached exhibits.
Petitioner is a corporation formed and existing under the laws of the State of Washington and having as its principal place of business when it filed its petition Tacoma, Washington.
From 1971 through 1980, petitioner used the calendar year as its taxable year and deducted amounts added to a reserve for bad debts. Petitioner calculated those amounts by using the ‘percentage of taxable income method‘ set forth in section 593(b)(2)(A). 1 For those years, section 166(c) permitted taxpayers to deduct a ‘reasonable addition‘ to bad debt reserve, in lieu of specific debts as they became worthless. Section 593(b) defined the term ‘reasonable addition‘ for certain financial institutions, including petitioner. Under that subsection, the deduction for addition to reserve with respect to ‘qualifying real property loans‘ (generally those loans secured by improved real property (section 593(d))) was subject to various limits, one of which was set forth in section 593(b)(2)(A). That provision limited the deduction to ‘the applicable percentage of the taxable income‘ for the year. 2
In 1981 and 1982, petitioner had net operating losses (‘NOLs‘) within the meaning of section 172(c) in the amounts of $43,459,246 and $27,748,382, respectively. Under section 172(b)(1)(F), those NOLs may be carried back to each of the ten taxable years preceding the loss years.
Central to resolution of the instant case is the interplay between NOL carrybacks and the deduction for addition to bad debt reserve calculated under the percentage of taxable income method. Respondent contends that petitioner's NOL carrybacks from 1981 and 1982 reduce petitioner's deductions under section 593(b)(2)(A) for 1971 through 1977 by reducing the ‘taxable income‘ base used in calculating the deduction for each of those years. As a consequence, according to respondent, a larger portion of the 1981 and 1982 NOLs are ‘absorbed‘ by the increase in taxable income for 1971 through 1977, and a smaller portion of the NOLs remains available for the years in issue, i.e., 1978, 1979, and 1980. Deficiencies result for these years, according to respondent, because section 172(a) deductions are reduced or eliminated. In other words, respondent advocates an ordering rule which, under the facts of this case, results in faster absorption of NOLs.
Subdivisions (vi) and (vii) of section 1.593-6A(b)(5), Income Tax Regs., support respondent' s position. The provisions generally require that taxable income reflect any NOL carrybacks BEFORE the deduction for addition to bad debt reserve is calculated. Specifically, the pertinent portions of the regulation provide as follows:
(5) Computation of taxable income.
For purposes of * * * (calculating the deduction for addition to bad debt reserve under the percentage of taxable income method ], taxable income is computed --
* * *
(vi) For taxable years beginning before January 1, 1978, without regard to any deduction the amount of which is computed upon, or may be subject to a limitation computed upon, the amount of taxable income, and without regard to any net operating loss carryback to such year from a taxable year beginning before January 1, 1979. (For purposes of this subparagraph, a net operating loss deduction under section 172 is not a deduction the amount of which may be subject to a limitation computed upon the amount of taxable income.)
(vii) For taxable years beginning after December 31, 1977, by taking into account any deduction the amount of which is computed upon, or may be subject to a limitation computed upon, the amount of taxable income, and any other deduction or loss allowed under subtitle A of the Code, such as any deduction allowable under section 172 or any loss allowable under section 1212(a), unless otherwise provided in this subparagraph.
For taxable years beginning after December 31, 1977, subdivision (vii) expressly requires that taxable income reflect the section 172(a) deduction prior to calculating the deduction for addition to bad debt reserve. For taxable years beginning before January 1, 1978, subdivision (vi) requires, by negative implication, that taxable income reflect NOL carrybacks from years beginning after December 31, 1978, prior to calculating the deduction. As originally promulgated on May 17, 1978, the ordering rule was to affect only taxable years beginning after December 31, 1977. T.D. 7549, 1978-1 C.B. 185, 186. Proposed amendments to the regulation would have required retroactive use of the ordering rule for NOLs occurring after 1977 (43 Fed. Reg. 60964 (1978)), but the regulation was amended on May 31, 1979, to have retroactive effect only for NOLs occurring after 1978. T.D. 7626, 1979-2 C.B. 239, 240.
Petitioner argues that the foregoing provisions are invalid and that it should be permitted to use the ordering rule in effect prior to publication of the regulation containing the challenged provisions on May 17, 1978. The ordering rule proposed by petitioner requires calculation of the deduction for addition to bad debt reserve BEFORE any NOL carrybacks are reflected in the calculation of taxable income.
Prior to May 17, 1978, the applicable Treasury regulations were consistent with petitioner's method. They required or were interpreted to require that NOL carrybacks be disregarded when using the percentage of taxable income method to calculate the deduction for addition to bad debt reserve. The first regulations interpreting section 593 provided as follows:
the reasonable addition to a reserve for bad debts shall be an amount determined by the taxpayer which does not exceed the lesser of:
(1) The amount of its taxable income for the taxable year, computed without regard to section 593 and without regard to any section providing for a deduction the amount of which is dependent upon the amount of taxable income (such as section 170, relating to charitable, etc., contributions and gifts),
Sec. 1.593-1(b)(1), Income Tax Regs. (1956). Respondent cited the foregoing regulation in a revenue ruling which required that NOL carrybacks be disregarded when computing the deduction for addition to bad debt reserve. Rev. Rul. 58-10, 1958-1 C.B. 246, 247.
After the Revenue Act of 1962 amended section 593, a new regulation was published that was more explicit than the original regulation. The new regulation provided that taxable income (for the purpose of calculating the deduction for addition to bad debt reserve under the percentage of taxable income method) should be calculated ‘without regard to any net operating loss carryback to such year under section 172.‘ Sec. 1.593-6(b)(2)(iv), Income Tax Regs. (1964).
Thus, the provisions challenged by petitioner reversed an ordering rule that had been in effect for approximately 20 years. The following hypothetical example highlights the difference between the positions of the parties:
+-----------------------------------------------------------------------------+
¦ ¦1971 ¦1972 ¦1981 ¦
+---------------------------+-----------+-------------------------+-----------¦
¦(1) Income before ¦ ¦ ¦ ¦
¦percentage ¦ ¦ ¦ ¦
+---------------------------+-----------+-------------------------+-----------¦
¦method deduction ¦1,000,000 ¦1,000,000 ¦(1,000,000)¦
+---------------------------+-----------+-------------------------+-----------¦
¦(2) Percentage method ¦ ¦ ¦ ¦
+---------------------------+-----------+-------------------------+-----------¦
¦deduction at 54% for ¦ ¦ ¦ ¦
+---------------------------+-----------+-------------------------+-----------¦
¦1971 and 51% for 1972 ¦(540,000) ¦(510,000) ¦--- ¦
+---------------------------+-----------+-------------------------+-----------¦
¦(3) Taxable income before ¦ ¦ ¦ ¦
+---------------------------+-----------+-------------------------+-----------¦
¦carrybacks ¦460,000 ¦490,000 ¦(1,000,000)¦
+---------------------------+-----------+-------------------------+-----------¦
¦(4)...To continue reading
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