Capitol Fed. Sav. & Loan Ass'n & Subsidiary v. Comm'r of Internal Revenue

• Decision Date: 13 February 1991
• Docket Number: Docket No. 20681-88.
• Citation: 96 T.C. No. 11,96 T.C. 204
• Parties: CAPITOL FEDERAL SAVINGS & LOAN ASSOCIATION & SUBSIDIARY, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent
• Court: U.S. Tax Court

96 T.C. 204

96 T.C. No. 11

CAPITOL FEDERAL SAVINGS & LOAN ASSOCIATION & SUBSIDIARY, Petitioner

v.COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 20681-88.

United States Tax Court

Filed February 13, 1991.

While under examination, petitioner applied, pursuant to Rev. Proc. 80-51, for permission to change a method of accounting and asked for permission to spread the adjustment required under section 481(a) over more than one year. Respondent refused to consider the application and made the method change and related section 481(a) adjustment in the earliest open year under examination. HELD, respondent properly exercised his discretion under section 446(b) in changing petitioner's method of accounting. HELD FURTHER, respondent's refusal to consider petitioner's application is reviewable for abuse of discretion. HELD FURTHER, respondent's refusal to permit the adjustment required under section 481(a) to be taken into account over more than one taxable year is reviewable for abuse of discretion. HELD FURTHER, respondent did not abuse his discretion by refusing to consider petitioner's application. Richard L. Bacon, Gary A. Ellal, and David C. Simmons, for the petitioner.

Wilton A. Baker, for the respondent.

WELLS, JUDGE:

Respondent determined deficiencies in petitioner's Federal income tax as follows:

+----------------------------+
                ¦FYE            ¦Deficiency  ¦
                +---------------+------------¦
                ¦Sept. 30, 1978 ¦$712,766    ¦
                +---------------+------------¦
                ¦Sept. 30, 1984 ¦67,508      ¦
                +----------------------------+
                

After concessions, the issue for decision is whether respondent erred in changing petitioner's method of accounting for interest income from mortgage pass-through certificates.

FINDINGS OF FACT

Some of the facts have been stipulated and are so found. The stipulation of facts and the exhibits attached thereto are incorporated herein by reference. Petitioner is a Federal savings and loan association with its principal place of business in Topeka, Kansas. During the years in issue, petitioner used the cash method of accounting and a fiscal year ending September 30 (taxable year) for Federal income tax purposes.

During taxable years 1978 through 1984, petitioner owned mortgage pass-through certificates (the certificates or pass-through certificates), purchased from, and issued by, the Federal National Mortgage Association (FNMA), the Government National Mortgage Association (GNMA), and the Federal Home Loan Mortgage Corporation (FHLMC). Each certificate represented an interest in a pool of residential mortgages originated by savings and loan associations. Each of the certificate issuers acted as a trustee in administering the collection of monthly payments on the underlying mortgages and the transmittal of such payments to the certificate holders.

The date on which the trustee under the certificates received interest payments from homeowners on the residential mortgages underlying the certificates occurred prior to the date on which the trustee actually paid that interest to petitioner. Consequently, interest payments which the trustee received during the month of September were actually paid over to petitioner during the month of October.

During taxable years 1978 through 1984, petitioner reported interest income from the certificates only when it actually received the payments from the trustee, rather than when the trustee received mortgage payments from the homeowners on the underlying mortgages. By reporting such income in October, when it actually was received, petitioner reported such interest in the new taxable year that began in October, rather than in the preceding taxable year, which ended September 30.

Late in 1984, a meeting took place between petitioner's chief financial officer and representatives of petitioner's accounting firm, which had been retained to audit petitioner's books. Petitioner's accounting firm informed petitioner's chief financial officer of a series of Revenue Rulings ¹ in which respondent took the position that holders of mortgage pass-through certificates such as those owned by petitioner should take into account the interest income from such certificates at the time such income was received by the trustee, rather than when it was distributed to the certificate holders.

Petitioner's accounting firm recommended that petitioner change its method of accounting to conform to the practice outlined in the Revenue Rulings and advised petitioner to request respondent's permission to change its method of accounting for such interest income, as provided by section 446(e). ² Based on the recommendation of its accounting firm, petitioner agreed to make the suggested change and authorized its accounting firm to prepare a Form 3115, Application for Change in Accounting Method (the application), for filing with the National Office of the Internal Revenue Service (the National Office). On January 24, 1985, petitioner's chief financial officer signed a letter requesting the change in accounting method and the related adjustment under section 481. On February 15, 1985, petitioner's accounting firm delivered the letter, together with the application, to the National Office. In the application, petitioner requested permission to change its accounting method in its 1985 taxable year and to spread the accounting adjustment required under section 481 over a 7-year period, beginning with the year of the change.

In response to one of the questions on the application, petitioner disclosed that, prior to filing the application, the Internal Revenue Service had contacted it for the purpose of scheduling an examination of its tax returns. The disclosure was made because, on January 11, 1985, one of respondent's revenue agents had informed petitioner's chief financial officer by telephone that a letter requesting information concerning tax refunds claimed by petitioner for taxable years 1982 and 1983 soon would be sent to petitioner. The information was needed for a report concerning the refunds, which exceeded $200,000, to be prepared for submission to the Joint Committee on Taxation. See sec. 6405.

Subsequently, respondent's Wichita, Kansas, District Office sent a letter dated February 7, 1985, to petitioner. The letter stated that petitioner's Federal income tax returns for taxable years 1969 through 1980, 1982, and 1983, had been selected for examination. The letter requested certain information concerning the refunds claimed by petitioner, as well as other data relating to petitioner's financial and business transactions during such years. The letter further stated that petitioner's returns would be accepted as filed if the requested information demonstrated that an examination of petitioner's books was not warranted.

By letter dated October 30, 1985, the National Office informed petitioner that petitioner's application would not be considered under the procedures governing accounting method changes because petitioner was “under examination” and was seeking to change an impermissible method of accounting. The letter stated that petitioner's application was being referred to the District Director, wichita, Kansas, for appropriate action. After petitioner's accounting firm objected to such characterization of petitioner's method of accounting, the National Office subsequently sent a letter dated February 10, 1986, to petitioner. The letter stated that the October 30, 1985, letter was not to be taken as a determination as to the character of the method under review, and informed petitioner that the determination as to whether petitioner's method was impermissible would be made by the District Director examining petitioner's return.

After reviewing the application, agents of the District Director stated that petitioner's request to change its method of accounting for interest on pass-through certificates would not be considered because petitioner was using an impermissible method of accounting and was under examination when the request was made. In his report, the revenue agent who examined petitioner's return stated that such accounting method was not permitted by the Internal Revenue Code and Regulations promulgated thereunder, as explained by respondent's Revenue Rulings. The agent concluded that petitioner was not permitted to request permission to change such method under the procedures governing accounting method change requests because such procedures barred taxpayers under examination from seeking permission to change impermissible accounting methods.

Respondent subsequently issued a statutory notice of deficiency in which he determined that petitioner's method of accounting for interest received on mortgage pass-through certificates did not clearly reflect income. Respondent changed petitioner's method of accounting for such certificates beginning in the taxable year ended September 30, 1982, and took the full amount of the adjustment required under section 481(a) into account in such year.

The accounting method change increased petitioner's income in each of its taxable years 1982, 1983, and 1984. Such change caused a deficiency with respect to 1984; however, because petitioner incurred losses in 1982 and 1983, no deficiencies in income tax for such years were determined. Such increases in petitioner's income, however, reduced the amount of the loss available for application against earlier years' income, and the deficiency in taxable year 1978 is attributable to such reduction.

OPINION

The issue presented in the instant case is whether to uphold respondent's deficiency determinations resulting from his change of petitioner's method of accounting for interest on mortgage pass- through certificates. In his notice of deficiency, respondent determined that petitioner's method of accounting for such interest did not clearly reflect petitioner's income, and respondent accordingly changed such method pursuant to his power under section 446(b).

It is well established...