First Sav. & Loan Ass'n v. Comm'r of Internal Revenue
| Decision Date | 04 June 1963 |
| Docket Number | 92918.,Docket Nos. 86307 |
| Citation | 40 T.C. 474 |
| Court | U.S. Tax Court |
| Parties | FIRST SAVINGS AND LOAN ASSOCIATION, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT |
OPINION TEXT STARTS HERE
Joe W. Magee, for the petitioner.
Glen W. Gilson II, for the respondent.
1. Held, that the amount of accounts carried on the petitioner's books as ‘optional shares' did not constitute ‘deposits or withdrawable accounts of its depositors' for the purpose of the computation, under section 593 of the Internal Revenue Code of 1954, of the amount of the deduction to which the petitioner is entitled under section 166(c) of the Code as a reasonable addition to its reserve for bad debts.
2. Held, further, that amounts representing profit upon sales of homes were properly included by the petitioner in its returns for each of the years in question.
The respondent determined deficiencies in income tax for the taxable years 1956, 1957, and 1958 in the respective amounts of $6,054.45, $3,591.86, and $2,715.07. By amended answers respondent asserts a claim for increased deficiencies for 1957 and 1958 in the respective amounts of $7,628.41 and $13,211.32.
The issues for decision are (1) whether, in the years in question, certain ‘optional share’ accounts should be treated as ‘deposits or withdrawable accounts' in computing deductible additions to petitioner's reserve for bad debts under section 593 of the Internal Revenue Code of 1954; (2) whether any deficiency which may be determined to be due for any year may be accrued by petitioner to diminish undivided profits existing at the beginning of the succeeding year for the purpose of computing the addition to the reserve for bad debts for such succeeding year under section 593; and (3) whether certain profits from real estate transactions are taxable to the petitioner.
Some of the facts have been stipulated and are incorporated herein by this reference.
The petitioner is a Mississippi corporation which as been engaged since April 1, 1952, in a savings and loan business with related activities in Meridian, Miss. Its president from the time of its organization has been C. D. Shields. It maintains its books and records and files its income tax returns on an accrual method of accounting. During the years in question it filed its income tax returns with the district director of internal revenue at Jackson, Miss.
The petitioner accepts deposits, pays interest thereon, and lends these funds out on the security of mortgages and deeds of trust. In order to expand its business it adopted the practice of making loans to homeowners who already had first mortgages outstanding on their homes, but nevertheless had substantial equities therein. However, in such instances, for the purpose of complying with an implication under the laws of Mississippi that a savings and loan association is prohibited from lending money with second mortgages as security, it developed a method of making such loans by the use of ‘optional shares' in lieu of taking second mortgages. Under this method the petitioner would make a cash loan to the homeowner in an amount not exceeding the excess of the fair market value of the home over the existing mortgage. Petitioner would take a promissory note and a new mortgage from the homeowner in the total amount of the existing mortgage, plus the amount of the current loan. The amount of the original mortgage would be entered on the books of the petitioner as the amount of the ‘optional shares.’ The homeowner would then make monthly payments to the petitioner sufficient to cover both the payments required by the original mortgage, plus payments to discharge the loan he had obtained from the petitioner. The petitioner in turn would remit to the original mortgagee the monthly payment on the original mortgage, and would correspondingly reduce the amount of the optional share account.1
On its books the petitioner treated the transaction as if it had loaned the homeowner the amount due under the original mortgage and as if he in turn had deposited such amount with the petitioner. A deposit slip was filled out in the amount due under the original mortgage. (In the example presented in evidence the deposit slip shows the ‘deposit’ to have been received from the original mortgagee rather than from the mortgagor.) Interest was charged to the homeowner (at 6 percent in the example) on both the amount actually loaned by the petitioner and the amount of the original mortgage, and interest was credited on petitioner's books to the homeowner on the amount of the original mortgage (the rate being 4 1/2 percent in the example presented in evidence). In addition to earning interest on the actual loan of cash, the petitioner generally would earn approximately 1 percent on the original mortgage, due to the difference between interest charged by petitioner on the new mortgage (which as shown above includes the amount of the original mortgage) and the interest remitted on the original mortgage.
In the agreement between the petitioner and the homeowner, it was provided that the mortgagee, the petitioner, might pay any part or all of the indebtedness to the original mortgagee. It was further provided that the mortgagor might pay any amount he desired on the mortgage or deed of trust given to the petitioner and that at such time as the amount should be reduced to an amount equal to that due the mortgagee under the original mortgage, then the mortgagor might request cancellation of the mortgage or deed of trust given to the petitioner upon reassuming the payments due under the original mortgage.
In no case did the petitioner assume the original mortgage, and apparently in no case did it elect to pay off the amount of the original mortgage.
The balance sheets attached to the petitioner's income tax returns for the taxable years 1956, 1957, and 1958 showed total deposits or withdrawable accounts of its depositors at the close of each of such years in the respective amounts of $1,258,492.10 (which included $225,704.36 of optional share accounts), $1,530,603.55 (which included $294,107.08 of optional share accounts), and $1,852,282.88 (which included $333,505.74 of optional share accounts). It has been stipulated that such balance sheets erroneously include in optional share accounts for those years the respective amounts of $16,035.58, $19,657.37, and $7,978.61.2
Petitioner's general ledger reflects entries for a ‘legal reserve,‘ which was its reserve for bad debts, as follows:
+-----------------------------------+
¦Year¦Debit ¦Credit ¦Balance ¦
+----+---------+---------+----------¦
¦ ¦ ¦ ¦ ¦
+----+---------+---------+----------¦
¦1952¦0 ¦$3,496.42¦$3,496.42 ¦
+----+---------+---------+----------¦
¦1953¦0 ¦19,221.43¦22,717.85 ¦
+----+---------+---------+----------¦
¦1954¦0 ¦32,853.57¦55,571.42 ¦
+----+---------+---------+----------¦
¦1955¦0 ¦46,856.23¦102,427.65¦
+----+---------+---------+----------¦
¦1956¦0 ¦40,488.37¦142,916.02¦
+----+---------+---------+----------¦
¦1957¦0 ¦37,617.92¦180,533.94¦
+----+---------+---------+----------¦
¦1958¦$2,745.69¦43,881.35¦221,669.60¦
+----+---------+---------+----------¦
¦1959¦3,623.83 ¦36,334.04¦254,379.81¦
+----+---------+---------+----------¦
¦1960¦100.00 ¦24,630.67¦278,910.48¦
+----+---------+---------+----------¦
¦ ¦ ¦ ¦ ¦
+-----------------------------------+
The petitioner showed no surplus or undivided profits in its balance sheets at any time during the years in question.
In its income tax returns for the taxable years 1956, 1957, and 1958 the petitioner reported no taxable income and no tax due.
In its return for 1956 the petitioner showed taxable income, without regard to any deduction of an addition to its reserve for bad debts, of $40,488.37. Such net income was offset by the addition of an equal amount to its reserve for bad debts, pursuant to section 593 of the Internal Revenue Code of 1954, on the ground that such amount was less than the amount by which 12 percent of its total deposits or withdrawable accounts of its depositors at the end of the year exceeded the sum of its surplus, undivided profits, and reserves at the beginning of the taxable year. In the notice of deficiency the respondent determined the petitioner's taxable income for the taxable year 1956 to be $20,181.49, by disallowing that amount of the claimed addition to its reserve for bad debts.
In its return for 1957 the petitioner showed taxable income, without regard to any deduction of an addition to its reserve for bad debts, of $37,617.92. Such net income was offset by the addition of an equal amount to its reserve for bad debts. The respondent determined the petitioner's taxable income for that year to be $11,972.87, by disallowing that amount of the claimed addition to its reserve for bad debts, on the same grounds as for the taxable year 1956.
In its return for the taxable year 1958 the petitioner showed taxable income, without regard to any deduction of an addition to its reserve for bad debts, of $43,881.35. Such net income was offset by the addition of an equal amount to its reserve for bad debts. The respondent determined the petitioner's taxable income for that year to be $9,050.24, by disallowing that amount of the claimed addition to its reserve for bad debts, on the same grounds as for the prior taxable years.
In each of the above instances the respondent, in applying section 593 of the Internal Revenue Code of 1954 in determining the proper amount of petitioner's addition to its reserve for bad debts, excluded from total deposits or withdrawable accounts of petitioner's depositors at the close of each year the amount which the petitioner had included therein on account of ‘optional shares.’
By amended answers the respondent made claim for increased deficienci es of $7,628.41 and $13,211.32, respectively, for the taxable...
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