Filed: Sep. 03, 1998
Latest Update: Mar. 03, 2020
Summary: 111 T.C. No. 8 UNITED STATES TAX COURT SECURITY STATE BANK, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent Docket No. 15478-96. Filed September 3, 1998. P is a bank that uses the cash method of accounting. During 1989, P made short-term loans to customers. The principal and interest on the loans were payable at maturity. R determined that P must accrue interest and/or original issue discount on the loans pursuant to sec. 1281(a)(1) and (2), I.R.C. Held: Sec. 1281(a)(2), I.R.C., does
Summary: 111 T.C. No. 8 UNITED STATES TAX COURT SECURITY STATE BANK, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent Docket No. 15478-96. Filed September 3, 1998. P is a bank that uses the cash method of accounting. During 1989, P made short-term loans to customers. The principal and interest on the loans were payable at maturity. R determined that P must accrue interest and/or original issue discount on the loans pursuant to sec. 1281(a)(1) and (2), I.R.C. Held: Sec. 1281(a)(2), I.R.C., does n..
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111 T.C. No. 8
UNITED STATES TAX COURT
SECURITY STATE BANK, Petitioner v. COMMISSIONER OF INTERNAL
REVENUE, Respondent
Docket No. 15478-96. Filed September 3, 1998.
P is a bank that uses the cash method of
accounting. During 1989, P made short-term loans to
customers. The principal and interest on the loans
were payable at maturity. R determined that P must
accrue interest and/or original issue discount on the
loans pursuant to sec. 1281(a)(1) and (2), I.R.C.
Held: Sec. 1281(a)(2), I.R.C., does not require a
bank to accrue interest on short-term loans made in the
ordinary course of its business. Security Bank Minn.
v. Commissioner, 98 T.C. 33 (1992), affd.
994 F.2d 432
(8th Cir. 1993).
Held, further: Sec. 1281(a)(1), I.R.C., does not
require a bank to accrue original issue discount on
short-term loans made in the ordinary course of
business.
Martin J. Peck, for petitioner.
Charles M. Berlau, for respondent.
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OPINION
RUWE, Judge: Respondent determined a deficiency of
$29,972.41 in petitioner's 1989 Federal corporate income tax.
The issue for decision is whether section 1281(a)1 requires
petitioner, a cash basis taxpayer, to accrue interest and/or
original issue discount earned on short-term loans.
Background
The parties submitted this case fully stipulated. The
stipulation of facts and supplemental stipulation of facts are
incorporated herein by this reference. Petitioner is a
corporation whose principal place of business was in Wellington,
Kansas, at the time it filed the petition.
Petitioner is a commercial bank that makes a variety of
loans in the ordinary course of its business. These loans are of
varying duration, including loans of less than 1 year, loans of 1
year, and loans of more than 1 year. Petitioner had, and still
has, business reasons for using notes with a term of 1 year or
less.
During 1989, petitioner made some loans that were
documented by promissory notes with a stated maturity date that
was 1 year from the date the notes were issued. Such loans will
1
Unless otherwise indicated, all section references are to
the Internal Revenue Code in effect for the year in issue.
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be referred to as category X loans. Petitioner held the category
X loans on December 31, 1989. During 1989, petitioner also made
some loans that were documented by promissory notes with a stated
maturity date that was less than 1 year from the date the notes
were issued. Such loans will be referred to as category Y loans.
Petitioner held the category Y loans on December 31, 1989. The
interest and principal payable on all categories X and Y loans
were due at maturity.
Petitioner reported its taxable income using the cash method
of accounting. Petitioner reported interest income from its
categories X and Y loans as it was received pursuant to the cash
method of accounting.
Petitioner had interest income of $60,086.89 during 1989
that had accrued, but was not yet paid, on its category X loans.
Petitioner had interest income of $65,687.11 during 1989 that had
accrued, but was not yet paid, on its category Y loans.
Discussion
Petitioner uses the cash method of accounting to report its
taxable income. Consistent with that method, it did not report
as income on its 1989 return any accrued interest or original
issue discount that was earned but unpaid at the end of 1989.
Respondent does not contest petitioner's general use of the cash
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method.2 Rather, respondent relies on the specific provisions of
section 1281 requiring the accrual of income earned on short-term
obligations.
The pertinent provisions of section 1281(a) are as follows:
SEC. 1281. CURRENT INCLUSION IN INCOME OF DISCOUNT ON
CERTAIN SHORT-TERM OBLIGATIONS.
(a) General Rule.--In the case of any short-term
obligation to which this section applies, for purposes of
this title--
(1) there shall be included in the gross income of
the holder an amount equal to the sum of the daily
portions of the acquisition discount for each day
during the taxable year on which such holder held such
obligation, and
(2) any interest payable on the obligation (other
than interest taken into account in determining the
amount of the acquisition discount) shall be included
in gross income as it accrues.
(b) Short-Term Obligations to Which Section Applies.--
(1) In general.--This section shall apply to any
short-term obligation which--
* * * * * * *
(C) is held by a bank (as defined in section 581),
* * * * * * *
(c) Cross Reference.--For special rules limiting the
application of this section to original issue discount in
the case of nongovernmental obligations, see section
1283(c).
2
Although it is not explicitly indicated in the record, it
appears that petitioner was allowed to use the cash method of
accounting in 1989 because it had gross income of less than $5
million. See secs. 446(a), (c)(1), 448(b)(3).
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Certain pertinent provisions of section 1283 are as follows:
SEC. 1283. DEFINITIONS AND SPECIAL RULES.
(a) Definitions.--For purposes of this subpart--
(1) Short-term obligation.--
(A) In general.--Except as provided in
subparagraph (B), the term "short-term obligation"
means any bond, debenture, note, certificate, or
other evidence of indebtedness which has a fixed
maturity date not more than 1 year from the date
of issue.
(B) Exceptions for tax-exempt obligations.--
The term "short-term obligation" shall not include
any tax-exempt obligation (as defined in section
1275(a)(3)).
* * * * * * *
(c) Special Rules for Nongovernmental Obligations.--
(1) In general.--In the case of any short-term
obligation which is not a short-term Government
obligation (as defined in section 1271(a)(3)(B))--
(A) sections 1281 and 1282 shall be applied
by taking into account original issue discount in
lieu of acquisition discount, and
(B) appropriate adjustments shall be made in
the application of subsection (b) of this section.
Respondent's first argument is that petitioner is required
to accrue interest income from its categories X and Y loans
pursuant to section 1281(a)(2). This is not an issue of first
impression. Indeed, respondent recognizes that in Security Bank
Minn. v. Commissioner, 98 T.C. 33, 42 (1992), affd.
994 F.2d 432
(8th Cir. 1993), we held that section 1281(a)(2) does not apply
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to short-term loans made by banks in the ordinary course of
business. Respondent recognizes that our prior opinion precludes
application of section 1281(a)(2) to the facts in the instant
case, unless we choose to overrule it. Respondent urges us to do
just that.
Security Bank Minn. v. Commissioner, supra, was a Court-
reviewed opinion. The majority opinion contains an extensive
analysis of the statute, its evolution, the context in which it
appears, and its legislative history. There was a dissenting
opinion which was joined by five Judges. In affirming our
opinion, the Court of Appeals for the Eighth Circuit also made an
extensive analysis of the same factors. One of the judges on the
Court of Appeals panel dissented.
No purpose would be served by repeating the statutory
analysis that led this Court and the Court of Appeals to decide
that section 1281(a)(2) does not apply to loans made by banks in
the ordinary course of business. Suffice it to say that this
matter has been thoroughly considered and decided. The doctrine
of stare decisis generally requires that we follow the holding of
a previously decided case, absent special justification. This
doctrine is of particular importance when the antecedent case
involves statutory construction. Hesselink v. Commissioner, 97
T.C. 94, 99-100 (1991). While respondent has skillfully
rearticulated his arguments in support of a different
interpretation of the statute, we find nothing therein that would
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cause us to refrain from applying the doctrine of stare decisis
with respect to the section 1281(a)(2) issue.3
Respondent alternatively argues that the loans in question
were made in return for notes that contained "original issue
discount" within the purview of sections 1281(a)(1) and 1283.
According to respondent, section 1281(a)(1) requires petitioner
to accrue the daily portion of that discount during the year in
which the note was held, regardless of whether petitioner
actually received anything in that year.
In Security Bank Minn. v. Commissioner, supra at 37, the
Commissioner refrained from arguing that section 1281(a)(1)
applied, although he stated on brief that it "arguably does." It
was therefore not necessary for us to make a specific holding
regarding the application of section 1281(a)(1). In a technical
sense, respondent's proposed application of section 1281(a)(1)
presents an issue of first impression. However, we believe that
the analysis upon which the holding in Security Bank Minn. was
based compels us to hold against respondent's argument that
section 1281(a)(1) applies in the instant case.
Our holding in Security Bank Minn. that section 1281(a)(2)
did not apply to loans made by banks in the ordinary course of
3
Respondent has made no argument that the issues presented
are of great overall significance. Sec. 448 generally precludes
corporations with more than $5 million in gross receipts from
using the cash method of accounting. Thus, our holdings appear
to have application only to small banks.
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business was based on our interpretation of section 1281 as
originally enacted in 1984. As originally enacted, section
1281(a) applied only to acquisition discount or original issue
discount. Deficit Reduction Act of 1984, Pub. L. 98-369, sec.
41, 98 Stat. 548. Section 1281 was amended in 1986 to add the
provisions of section 1281(a)(2). Tax Reform Act of 1986, Pub.
L. 99-514, sec. 1803, 100 Stat. 2791. In Security Bank Minn., we
first analyzed section 1281 in its original form. On the basis
of that analysis, we stated:
We conclude that the legislative history supports
petitioner's interpretation of section 1281, i.e., that
it was enacted in 1984 to deal with problems associated
with purchased debt instruments involving a discount
and not with loans made by a bank in the ordinary
course of its business. Accordingly, we hold that the
loans here in dispute are not the sort of obligations
or instruments to which section 1281 applied as enacted
in 1984. [Security Bank Minn. v. Commissioner, supra
at 42.]
We then concluded that the addition of section 1281(a)(2) in 1986
was not intended to cover loans made by banks.
We do not believe that the 1986 amendment, which
originated as a technical correction, was intended to
increase the coverage of section 1281(a) to loans made
if, as we have concluded, such loans were not covered
by the 1984 Act. The amendment, in our view, was
intended to express the amounts to be taken into
current income and not to expand the category of
instruments covered by section 1281(a). [Id. at 43.]
Our analysis in Security Bank Minn. v. Commissioner, supra,
makes clear that we have interpreted section 1281 as having no
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application to loans made by banks in the ordinary course of
business, regardless of whether the loans are characterized as
generating interest or original issue discount.4 We, therefore,
hold that section 1281(a)(1) does not apply to the loans in
issue.
Decision will be entered
for petitioner.
4
Because of our legal conclusion, there is no need to decide
whether respondent is correct in characterizing the loans in
issue as generating original issue discount.
