Commissioner of Internal Revenue v. Lincoln Savings and Loan Association

• Decision Date: 14 June 1971
• Docket Number: No. 544,544
• Parties: COMMISSIONER OF INTERNAL REVENUE, Petitioner, v. LINCOLN SAVINGS AND LOAN ASSOCIATION
• Court: U.S. Supreme Court

29 L.Ed.2d 519

91 S.Ct. 1893

403 U.S. 345

COMMISSIONER OF INTERNAL REVENUE, Petitioner,

v LINCOLN SAVINGS AND LOAN ASSOCIATION.

No. 544.

Argued Feb. 23, 1971.

Decided June 14, 1971.

Syllabus

Payment by a state-chartered savings and loan association of the 'additional premium' required by § 404(d) of the National Housing Act to be paid to the Federal Savings and Loan Insurance Corp. is not deductible for income tax purposes as an ordinary and necessary business expense under § 162(a) of the Internal Revenue Code.

9 Cir., 422 F.2d 90, reversed.

Matthew J. Zinn, Washington, D.C., for petitioner.

Adam Y. Bennion, Los Angeles, Cal., for respondent.

Mr. Justice BLACKMUN delivered the opinion of the Court.

This case presents the question whether the 'additional premium' paid in 1963 by a state-chartered savings and loan association to the Federal Savings and Loan Insurance Corporation under the compulsion of § 404(d) of the National Housing Act, as amended, 12 U.S.C. s 1727(d),¹ is deductible by the association, for income tax purposes, as an ordinary and necessary business expense under § 162(a) of the Internal Revenue Code of 1954, 26 U.S.C. § 162(a).

The Commissioner of Internal Revenue determined a deficiency of $461,454.38 in the 1963 cash basis federal income tax of Lincoln Savings and Loan Association. Nearly all the deficiency was attributable to the disallowance of a deduction claimed for Lincoln's payment of $882,636.86 made pursuant to § 404(d). Lincoln sought redetermination in the Tax Court. Judge Raum, in a decision reviewed by the court without dissent, upheld the deficiency. 51 T.C. 82 (1968). On appeal the Ninth Circuit reversed, one judge dissenting. 422 F.2d 90 (1970).² Because of the importance of the issue for the savings and loan industry and for the Government, we granted certiorari. 400 U.S. 901, 91 S.Ct. 139, 27 L.Ed. 137 (1970).

I

The pertinent facts are not in dispute. Lincoln is a California savings and loan association organized in 1925 and is licensed under state law. It is subject to Division 2 of the California Financial Code, § 5000 et seq., and is also subject to the regulations of the State's Savings and Loan Commissioner. California Administrative Code, Tit. 10, c. 2.

In 1936 Lincoln applied for membership in the Federal Home Loan Bank of San Francisco (then of Los Angeles). That application was granted and Lincoln has remained a member of the Bank since that time. The San Francisco Bank is one of 12 regional ones established and supervised by the Federal Home Loan Bank Board under the Federal Home Loan Bank Act of 1932, 47 Stat. 725, as amended, 12 U.S.C. §§ 1421—1449. These banks provide liquidity and funds for mortgage lending by making advances to member institutions as needed to meet unusual or heavy withdrawal and credit demands. Each member must purchase capital stock in its bank in an amount equal to 1% of its outstanding 'aggregate unpaid loan principal' and maintain that percentage. 12 U.S.C. § 1426(c).

In June 1938 Lincoln became, and still is, an institution insured by the Federal Savings and Loan Insurance Corporation (FSLIC), a corporation created by § 402 of the National Housing Act, 48 Stat. 1256, 12 U.S.C. § 1725, and under the direction of the Federal Home Loan Bank Board. By statute FSLIC has the duty to insure the accounts of all federal savings and loan associations; it also may insure the accounts of qualified state-chartered associations such as Lincoln. Section 403(a), 12 U.S.C. § 1726(a).

Each institution so insured was originally required, by § 404(a) of the Act, 48 Stat. 1258, to pay FSLIC an annual insurance premium measured by the total amount of its accounts plus creditor obligations.³ The statute provided that these premiums were to continue annually until FSLIC's reserve for losses amounted to 5% of the insured accounts plus creditor obligations of all its insured institutions, and at such intervals thereafter as were necessary to maintain the reserve at that level.

This pattern was changed, however, effective January 1, 1962, by the Act of September 8, 1961, 75 Stat. 482. That Act, by its § 3, amended § 404(a), 12 U.S.C. § 1727(a), to its present form.⁴

Section 404(a) now requires FSLIC to establish two reserves, namely, a Primary Reserve 'which shall be the general reserve,' and a Secondary Reserve. The requirement for the annual premium of 1/12 of 1% is continued, but the level of the general reserve was lowered from 5% to 2% of the total of accounts plus creditor obligations. Sections 404(b)(1) and 404(b)(2), 12 U.S.C. §§ 1727(b) (1) and 1727(b)(2). The 1961 Act, moreover, added subsection (d) to § 404. 12 U.S.C. § 1727(d). This required that the insured institution pay FSLIC, with respect to any calendar year, an 'additional premium in the nature of a prepayment with respect to future premiums of such institution under subsection (b) * * *.' This 'additional premium' was, and still is, 2% of the net increase in the total of the institution's insured accounts, less any amount the institution is required, by 12 U.S.C. § 1426(c), as of the end of that year, to expend in purchasing stock in the Federal Home Loan Bank.⁵ The additional premium is to be credited to the Secondary Reserve. Section 404(a), 12 U.S.C. § 1727(a).

As noted, FSLIC's statutorily prescribed Primary Reserve is its general reserve. It is credited annually with the Corporation's net income; this net thus represents retained earnings. The § 404(b)(1) premium payments, that is, the 1/12 of 1% required of each insured institution, constitute a major item in FSLIC's gross income. To the extent these premium payments exceed the corporation's expenses and insurance losses for the year, they flow as part of FSLIC's net to the Primary Reserve. The insured institutions have no property interest in the funds constituting the Primary Reserve.

The Secondary Reserve subsists separately and possesses different characteristics. It, of course, receives the 2% 'additional premium,' to the extent such is payable, required by § 404(d) from each insured institution. FSLIC must also credit the Secondary Reserve annually with a 'return' on the Secondary Reserve's 'outstanding balances * * * at a rate equal to the average annual rate of return to the Corporation during the year * * * on the investments held by the Corporation in obligations of or guaranteed as to principal and interest by, the United States.' Sections 404(a) and 404(e), 12 U.S.C. §§ 1727(a) and 1727(e). In contrast with the Primary Reserve, the Secondary Reserve is 'available * * * only for losses of the Corporation' and then 'only to such extent as other accounts of the Corporation which are available therefor are insufficient for such losses.' Section 404(e), 12 U.S.C. § 1727(e).

Each insured institution has a pro rata share in the Secondary Reserve. Section 404(e) states that this is not assignable or transferable except as FSLIC, by regulation or otherwise, provides 'in cases of merger or consolidation, transfer of bulk assets * * * and similar transactions. * * *' An insured institution may obtain a cash refund of its pro rata share if its status as an insured is terminated, § 407, 12 U.S.C. § 1730, or if a receiver or other legal custodian is appointed for purposes of liquidation, or if the Corporation determines that the institution has gone into liquidation. Section 404(f), 12 U.S.C. § 1727(f).

Following any December 31 on which the aggregate of the Primary Reserve and the Secondary Reserve equals or exceeds 2% of the total of all insured accounts plus creditor obligations of all the insured institutions (and the Primary Reserve alone does not equal or exceed such 2%), the additional premiums required by § 404(d) are suspended. Section 404(g); 12 U.S.C. § 1727(g).⁶ When this takes place, the pro rata share of each insured institution in the Secondary Reserve is used, to the extent available, to discharge the institution's obligation to pay its regular, or basic, premium required for that year under § 404(b)(1). Thereafter, if the aggregate of the two reserves decreases to less than 1 3/4%, the obligation to pay the additional premium under § 404(d) resumes and the pro rata share in the Secondary Reserve is no longer used to pay the § 404(b)(1) regular premium. Whenever, following any December 31, the Primary Reserve alone equals or exceeds such 2%, the Corporation shall pay in cash to each insured institution its pro rata share of the Secondary Reserve and shall not thereafter accept further § 404(d) prepayments.⁷

FSLIC maintains a separate account for each insured institution's share of the Secondary Reserve. It submits to the institution annually a statement disclosing that share and the interest credited to it.⁸ Under regulations issued by the California Savings and Loan Commissioner and by the Federal Home Loan Bank Board, Lincoln reports its interest in FSLIC's Secondary Reserve as an asset on its balance sheet and treats the interest earned on its pro rata share of the Secondary Reserve as income.⁹

LIC annually sends Lincoln an 'Insurance Premium Notice' for the basic premium due under § 404(b)(1). It also sends Lincoln annually a 'Notice of Insurance Premium Prepayments' for the amount, if any, due under § 404(d). For 1963 the former was $135,760.52 and the latter was $882,636.86. Each was paid by Lincoln.

On its 1963 federal income tax return Lincoln deducted both its § 404(b)(1) payment and its § 404(d) payment as ordinary and necessary business expenses under § 162(a) of the Code. The Commissioner allowed the former, but disallowed the latter.

The Tax Court held that the § 404(d) payment was a nondeductible capital expenditure and was not an ordinary and necessary business expense, and that the payment was deductible only when used from the Secondary Reserve to pay § 404(b)(1) premiums or to meet actual losses of FSLIC. As noted above, the Ninth Circuit reversed by a divided panel.

II.

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