Credit Life Ins. Co. v. U.S.

• Decision Date: 31 October 1991
• Docket Number: No. 91-5028,91-5028
• Parties: -5781, 91-2 USTC P 50,526 The CREDIT LIFE INSURANCE COMPANY, Plaintiff-Appellee, v. The UNITED STATES, Defendant-Appellant.
• Court: U.S. Court of Appeals — Federal Circuit

Page 723

948 F.2d 723

68 A.F.T.R.2d 91-5781, 91-2 USTC P 50,526

The CREDIT LIFE INSURANCE COMPANY, Plaintiff-Appellee, v. The UNITED STATES, Defendant-Appellant.

No. 91-5028.

United States Court of Appeals, Federal Circuit.

Oct. 31, 1991.

Suggestion for Rehearing In Banc

Declined Jan. 22, 1992.

Peter H. Winslow, Scribner, Hall & Thompson, Washington, D.C., argued for plaintiff-appellee. With him on the brief was E.P. Baker, of counsel.

Robert W. Metzler, Attorney, Dept. of Justice, Washington, D.C., argued for defendant-appellant. With him on the brief were Shirley D. Peterson, Asst. Atty. Gen., Gary R. Allen and David I. Pincus.

Before NEWMAN, MICHEL, and PLAGER, Circuit Judges.

MICHEL, Circuit Judge.

The government appeals the United States Claims Court's grant of summary judgment in favor of The Credit Life Insurance Company ("Credit Life" or "taxpayer") in its suit for a partial refund of income taxes paid. Credit Life Ins. Co. v. United States, No. 585-84T (Cl.Ct. Oct. 17, 1990). The Claims Court erred in concluding that in claiming a bad debt deduction, taxpayer was entitled to rely on the conclusive presumption of worthlessness in the pertinent Treasury Regulation, 26 C.F.R. § 1.166-2(d)(1) (1973), despite not meeting the conditions set forth in the regulation. We therefore reverse and remand.

BACKGROUND

In 1978 Credit Life entered into a reinsurance agreement with Uniworld Insurance Company, Ltd. and its affiliates (collectively "Uniworld") in which Credit Life agreed to underwrite credit life and credit accident and health insurance business generated by agents secured by Uniworld. Uniworld was to collect premiums and remit them less their authorized commissions to Credit Life, and then through a series of reinsurance agreements, to assume the entire risk for that insurance. From the beginning In a letter dated March 9, 1981, the Ohio Department of Insurance advised Credit Life that it should charge off the Uniworld receivable from its 1980 Annual Statement, either as a reduction of premium income or as a bad debt expense. ² Credit Life accordingly eliminated $5.8 million from its income on its annual statement. Similarly, on its 1980 federal income tax return, Credit Life did not include the receivable in income and claim a bad debt deduction, but rather, simply excluded it altogether from the gross income reported.

                of the arrangement, Uniworld was frequently late in reporting sales and remitting premiums.   In December 1980, Uniworld informed Credit Life that it would default on 35 percent of its obligations under the reinsurance agreement, and Credit Life believed Uniworld to be insolvent.   Credit Life then terminated 35 percent of the reinsurance 1 and demanded payment of an approximately $5.8 million receivable due on the terminated reinsurance
                

In an audit of the 1980 return completed in 1988, the Internal Revenue Service ("IRS" or "Service") determined that Credit Life should have accrued the Uniworld receivable into income. The government then claimed an offset in the Claims Court litigation involving Credit Life's tax liability for 1973-77, arguing that the income accrual in 1980 eliminated an operations loss that otherwise could be carried back to 1977 and 1978.

Both parties moved for summary judgment. Credit Life contended that the Service's adjustment on audit was improper because it was entitled to rely on a conclusive presumption of worthlessness for bad debts in 26 C.F.R. § 1.166-2(d)(1). The Service argued that the regulation did not apply to this situation because, inter alia, it only applies to debts claimed as a deduction on the return when filed, and Credit Life did not include the receivable in income and then claim a bad debt deduction, but simply excluded it from income altogether.

In an oral bench ruling, the Claims Court held that Credit Life was entitled to rely on the regulation despite the requirement of claiming the deduction at the time of filing the return: "[F]or reasons stated by the Plaintiff in those papers I think it is in spite of the surface language about when the return is first filed, that the state of the law is such that they are nonetheless entitled to take that deduction with respect to tax year 1980." Transcript of July 19, 1990 Proceedings (Joint Appendix at 83). The court held that under the regulation's conclusive presumption of worthlessness, the taxpayer was entitled to the deduction and accordingly granted summary judgment in favor of Credit Life. The parties stipulated to partial dismissal of the complaint as to issues not already decided and as to the amount of tax and interest taxpayer would be entitled to recover under the Claims Court's order. The court then entered a final judgment on October 17, 1990.

The United States appeals the grant of summary judgment. We have jurisdiction pursuant to 28 U.S.C. § 1295(a)(3) (1988).

DISCUSSION

I

Treasury Regulation § 1.166-2(d) provides a conclusive presumption of worthlessness for certain bad debts which regulatory agencies require be charged off:

If a bank or other corporation which is subject to supervision by Federal authorities, or by State authorities maintaining substantially equivalent standards, charges off a debt in whole or in part, either--

(i) In obedience to the specific orders of such authorities, or

(ii) In accordance with established policies of such authorities then the debt shall, to the extent charged off during the taxable year, be conclusively presumed to have become worthless, or worthless only in part, as the case may be, during such taxable year.

26 C.F.R. § 1.166-2(d)(1) (1973). But the regulation expressly precludes application of the presumption in cases in which the taxpayer did not claim a bad debt deduction on the return itself:

But no such debt shall be so conclusively presumed to be worthless, or worthless only in part, as the case may be, if the amount so charged off is not claimed as a deduction by the taxpayer at the time of filing the return for the taxable year in which the charge-off takes place.

Id. (emphasis added).

By its terms, then, the regulation cannot apply to a debt, like the Uniworld receivable, which was not "claimed as a deduction by the taxpayer," but simply was excluded from income. Additionally, the second part of the requirement--to claim the deduction "at the time of filing the return"--precludes doing so later. Credit Life, however, argued that it had no choice but to exclude the receivable from income since it believed Uniworld was insolvent and hence the receivable was uncollectible and not properly accruable in 1980 under the all-events test of 26 C.F.R. § 1.451-1(a) (1978). Since the cited regulation is inapplicable, taxpayer's argument is unavailing. Whether the receivable was collectible is a wholly separate question from the events which gave rise to the accrual of this income. Taxpayer's further reliance on Revenue Rule 81-18, 1981-1 Cum.Bull. 295, even assuming it is applicable, at most might justify its accounting treatment of the bad debt against a charge of fraud or negligent failure to report income, issues we need not address. But it cannot negate the regulation and allow taxpayer to exclude income rather than report it and take a deduction. Therefore, Credit Life must deduct the bad debt in the year it filed its return to benefit from the regulation providing a conclusive presumption of worthlessness. Thus Credit Life has failed to satisfy both parts of the conclusive presumption of worthlessness regulation and has proffered no supportable or sufficient explanation for not doing so. The Claims Court, however, in an oral bench opinion, ruled that Credit Life was nevertheless entitled to rely on the regulation for the reason asserted by taxpayer: Substantial compliance with procedural requirements in regulations is sufficient to invoke a tax election. Plaintiff's List of Additional Authorities, Filed July 18, 1990 (Joint Appendix at 820-21). ³

II

The Claims Court's reliance on the doctrine of "substantial compliance" is erroneous. Before the Claims Court, as here, Credit Life relied primarily upon decisions of the Tax Court for the proposition that "substantial compliance with regulatory requirements may suffice when such requirements are procedural and when the essential statutory purposes have been fulfilled." American Air Filter Co. v. Commissioner, 81 T.C. 709, 719 (1983) (citations omitted). See also Fischer Indus., Inc. v. Commissioner, 843 F.2d 224, 226 (6th Cir.1988) (no substantial compliance with procedural requirements for an election of accounting method where there was "nothing in the returns themselves that would have given the Commissioner adequate notice that" an election had taken place); Tipps v. Commissioner, 74 T.C. 458, 468 (1980) (substantial compliance with procedural requirements for an election of accelerated depreciation of assets where there was no prejudice to the service because the same information had been provided on other IRS forms). We are not, of course, bound by the Tax Court decisions in American Air Filter or Tipps--this court has not extended their reasoning in the past, and we decline to do so now. Moreover, as to the Sixth Circuit's decision in Fischer, its requirements were not met here since the Commissioner did not get adequate notice. The regulation in Fischer is not comparable to the regulation in this appeal because the Fischer regulation contemplates that a statement of election "be made on form 970 pursuant to the instructions printed with respect thereto and to the requirements of this section, or in such other manner as may be acceptable to the Commissioner," 26 C.F.R. § 1.472-3(a) (1973) (emphasis added). By contrast, here Congress has expressly restricted the applicability of section 1.166-2(d)(1) so that a taxpayer can rely on the conclusive presumption of worthlessness for bad debts only if they are "claimed as a deduction by the taxpayer at the time...