Bell Federal Savings and Loan Association v. Commissioner
| Decision Date | 07 August 1991 |
| Docket Number | Docket No. 11822-89. |
| Citation | 62 T.C.M. 376 |
| Parties | Bell Federal Savings and Loan Association and Subsidiary v. Commissioner. |
| Court | U.S. Tax Court |
Joseph D. Ament and Anthony C. Valiulis, 200 N. LaSalle St., Chicago, Ill., for the petitioner. Erin Collins, for the respondent.
Respondent determined deficiencies in petitioner Bell Federal Savings and Loan Association and Subsidiary's (hereinafter petitioner) 1978, 1985, 1986, and 1987 Federal income taxes in the amounts of $433,512, $177,424, $87,542, and $987,092, respectively. Respondent also determined additions to tax for petitioner's taxable year 1987 under section 6653(a)(1)(A) and (B)1 and section 6661.2
The issues to be decided are: (1) Whether petitioner may defer the recognition of loan fees (hereinafter points) charged to a borrower in connection with the borrower's financing of residential real estate when the points are paid by the borrower with funds separate from the financing transaction; and (2) whether taxable income, for purposes of computing the addition to bad debt reserve under the taxable income method of section 593(b)(2), must reflect net operating loss (NOL) carrybacks from subsequent years.
This case was submitted with all facts fully stipulated. The facts as stipulated are found accordingly. The stipulation of facts and attached exhibits are incorporated herein by this reference. Numerous concessions have been made by both parties.
Petitioner is a domestic, Federally chartered savings and loan association having its principal place of business at 79 West Monroe Street in Chicago, Illinois, when the petition was filed in this case. For all relevant times herein, petitioner employed the accrual method of accounting and filed consolidated Federal income tax returns with the Internal Revenue Service Center in Kansas City, Missouri.
One of petitioner's primary functions is the origination of mortgage loans. These mortgage loans include both newly originated loans and refinanced first and second mortgage home loans. In connection with its mortgage loans, petitioner typically charged borrowers loan fees or points paid at the time of the loan closing. Points are an established business practice in the savings and loan industry in petitioner's community. Points are charges for the use of money and are considered prepaid interest in the lending industry. Petitioner does not, in whole or in part, rebate or refund the amount of points to a borrower if a loan is repaid prior to maturity.
In an October 11, 1968, letter to Mr. Lloyd A. Byerhof, an accountant for petitioner, respondent approved petitioner's deferral method for recognizing points over an 8-year life with a half-year convention. As reflected in that letter, petitioner had requested permission from respondent to recognize points as income for Federal income tax purposes as earned by use of a composite basis. Respondent granted such permission based on the fact that petitioner "does not receive cash or a check for the points, and that the loan proceeds are disbursed net to the borrower."
Under these circumstances, respondent granted petitioner permission "to change its accounting treatment of points on discounted loans, for Federal income tax purposes, from the practice of including such points in income in the year the loan is made to the practice of including such points computed on a composite basis as referred to in Revenue Ruling 54-367, C.B. 1954-2, 109, in income in the year in which earned."
During the taxable years at issue, petitioner deferred the recognition of points on both refinanced and newly originated real estate mortgage loans. Petitioner adopted a half-year convention and determined an 8-year life for the refinanced and newly originated real estate mortgage loans. Petitioner then recognized the points as income for Federal income tax purposes ratably over the 8-year life of the loans.
Insofar as the points issue is concerned, respondent determined deficiencies in petitioner's returns for the taxable years 1985, 1986, and 1987. In computing the determined deficiencies, respondent included only the points paid by the borrowers where the borrower paid the points with separate funds at closing and where the loan was a newly originated real estate mortgage for, and secured by, the borrower's principal residence. Respondent did not include in his deficiency determination points associated with second mortgages and refinanced loans originating during the taxable years at issue.
During the years at issue, a typical mortgage loan transaction involved the completion of various documents and numerous steps. Initially, a borrower would enter into a contract to purchase real estate from a third party seller. At the time of the execution of the real estate contract, the borrower would pay the seller earnest money, leaving a balance to be supplied from the borrower's own and borrowed funds. With the intent of obtaining financing for a portion of the purchase price, the borrower would then complete petitioner's loan application and request a mortgage loan. Next, the borrower would sign the loan application, submit it to petitioner for its consideration, and pay petitioner $250 as a nonrefundable application fee.
Shortly after the approval of the loan application, petitioner sends the borrower a commitment to make a mortgage loan at a stated interest rate. The loan commitment is signed by petitioner and then sent to the borrower. If the borrower accepts petitioner's offer, the borrower signs the commitment and returns it to petitioner. The loan commitment is not binding until signed by the borrower. Petitioners 1987 loan commitment letters stated, "The loan is subject to the following * * * Payment of [points] either as a discount out of the proceeds of the loan or as a fee paid at the time of settlement/closing of the loan."
In April 1987, petitioner modified its requirements with respect to loan applications. Although petitioner still required the borrower to pay an application fee of $250 at the time of submitting the application, it also required the borrower to pay an amount equal to 1 percent to 1½ percent of the face amount of the loan within 7 days of receiving the loan commitment from petitioner as an additional fee. The 1 percent to 1½ percent was nonrefundable and enabled the borrower to lock in a specific interest rate for a specific period of time.
After the executed commitment is received by petitioner, but prior to the loan closing, petitioner debits its real estate loan account in the full face amount of the loan and credits that amount to the borrower on a loan-in-process account (the LIP Account) established for that borrower's transactions. The LIP Account is part of petitioner's in-house books and records (i.e. the general ledger). The LIP Account ledgers and the computer printout are never supplied to the borrower. During this debit and credit process, petitioner also credits to the LIP Account the amount of the application fee and the 1 percent or 1½ percent payment received from the borrower. Petitioner then immediately debits the LIP Account in the amounts of these two payments. These in/out entries reflect that the borrower has paid these two amounts with his/her own separate funds and not with proceeds from the loan.
As stated above, after the executed commitment is received by petitioner, but prior to the loan closing date, petitioner credits the borrower's LIP Account in the face amount of the loan. Petitioner also immediately deducts from that account the amount of the closing points charged to the borrower.
At the time of the loan closing the borrower is required to pay, and did pay, separate fresh funds to petitioner in an amount equal to his downpayment, points, and other miscellaneous fees. In addition to providing these fresh funds, the borrower executes a mortgage note in the full amount of the approved loan. The borrower's fresh funds are credited to the LIP Account. The borrower's fresh funds include the amount of the points charged. Also in this account are the net loan proceeds. At closing petitioner issues from the account checks to the seller, to certain creditors of the seller (e.g., to seller's broker), to the borrower's reserve account, and to other entities for closing costs owed by the borrower or seller. At closing, the borrower is also furnished a "Statement of Account," a "Settlement Statement," and a "Disclosure Statement." Petitioner has a fixed right to receive the points charged as of the loan closing date.
For all relevant years, petitioner was a mutual savings and loan association entitled to utilize the provisions of section 593 to calculate the addition to its bad debt reserve. For the years 1978, 1985, 1986, and 1987, petitioner calculated its annual addition to reserve for bad debts under the percentage of taxable income method provided for in section 593(b)(2) and deducted such addition in each taxable year on its Federal income tax return.
Petitioner and respondent agree that the allowable percentage of taxable income for purposes of the deductions for the taxable years 1985, 1986, and 1987 is a function of taxable income as finally determined for those years. Petitioner and respondent also agree that the bad debt deductions, as calculated on petitioner's originally filed tax returns for the taxable years 1978, 1985, 1986, and 1987, are prior to any of respondent's adjustments and prior to any adjustment for carrybacks of NOLs. The parties further agree that petitioner properly calculated additions to reserves for bad debts for each of the years at issue, subject to respondent's deficiency determinations herein.
Petitioner's 1983 consolidated income tax return, Form 1120, reflected a NOL in the amount of $8,865,941. This 1983 consolidated loss was comprised of a loss by Bell...
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